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Primis Financial Corp. - Quarter Report: 2009 June (Form 10-Q)

Form 10-Q for the quarterly period ended June 30, 2009
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2009

Commission File No. 001-33037

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

 

Virginia   20-1417448

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

6830 Old Dominion Drive

McLean, Virginia 22101

(Address of principal executive offices) (zip code)

(703) 893-7400

(Registrant’s telephone number, including area code)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES  x    NO  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

YES  ¨    NO  ¨

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

 

Large accelerated filer  ¨    Accelerated filer  ¨    Non-accelerated filer  x    Smaller reporting company  ¨
     

(Do not check if a smaller

reporting company)

  

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

As of July 31, 2009, there were 6,798,547 shares of common stock outstanding.

 

 

 


Table of Contents

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

FORM 10-Q

June 30, 2009

INDEX

 

 

      PAGE
PART 1 - FINANCIAL INFORMATION   
Item 1 - Financial Statements   

Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008

   2

Consolidated Statements of Income and Comprehensive Loss for the three and six months ended June 30, 2009 and 2008

   3

Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2009

   4

Consolidated Statements of Cash Flows for the six months ended June 30, 2009 and 2008

   5

Notes to Consolidated Financial Statements

   6-19
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations    20-32
Item 3 - Quantitative and Qualitative Disclosures about Market Risk    33-35
Item 4 - Controls and Procedures    36
PART II - OTHER INFORMATION   
Item 1 - Legal Proceedings    36
Item 1A - Risk Factors    36
Item 4 - Submission of Matters to a Vote of Security Holders    36-37
Item 6 - Exhibits    37
Signatures    38

 


Table of Contents

ITEM I - FINANCIAL INFORMATION

PART I - FINANCIAL STATEMENTS

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands) (Unaudited)

 

     June 30,
2009
    December 31,
2008
 

ASSETS

    
Cash and cash equivalents:     

Cash and due from financial institutions

   $ 1,768      $ 1,506   

Interest-bearing deposits in other financial institutions

     5,662        13,256   
                

Total cash and cash equivalents

     7,430        14,762   
                
Securities available for sale, at fair value      4,775        15,633   
                
Securities held to maturity, at amortized cost
  (fair value of $47,507 and $48,784, respectively)
     52,990        59,326   
                
Loans, net of unearned income      326,219        302,266   

Less allowance for loan losses

     (4,571     (4,218
                

Net loans

     321,648        298,048   
                
Stock in Federal Reserve Bank and Federal Home Loan Bank      4,464        4,041   
Bank premises and equipment, net      3,379        3,598   
Goodwill      8,713        8,713   
Core deposit intangibles, net      2,778        3,141   
Bank-owned life insurance      13,723        13,435   
Other real estate owned      3,415        3,434   
Deferred tax assets, net      5,811        4,813   
Other assets      3,593        2,980   
                

Total assets

   $ 432,719      $ 431,924   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     
Noninterest-bearing demand deposits    $ 25,249      $ 23,219   
Interest-bearing deposits:     

NOW accounts

     7,226        8,472   

Money market accounts

     50,313        51,040   

Savings accounts

     2,263        1,912   

Time deposits

     229,773        224,817   
                

Total interest-bearing deposits

     289,575        286,241   
                

Total deposits

     314,824        309,460   
                
Securities sold under agreements to repurchase and other short-term borrowings      18,220        20,890   
Federal Home Loan Bank (FHLB) advances      30,000        30,000   
Other liabilities      2,127        2,798   
                

Total liabilities

     365,171        363,148   
                
Commitments and contingencies (See Note 5)      —          —     
Stockholders’ equity:     

Common stock, $.01 par value. Authorized 45,000,000 shares; issued and outstanding, 6,798,547 shares at June 30, 2009 and December 31, 2008

     68        68   

Additional paid in capital

     69,541        69,516   

Retained earnings

     2,246        1,697   

Accumulated other comprehensive loss

     (4,307     (2,505
                

Total stockholders’ equity

     67,548        68,776   
                

Total liabilities and stockholders’ equity

   $ 432,719      $ 431,924   
                

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE LOSS

(dollars in thousands, except per share amounts) (Unaudited)

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2009     2008     2009     2008  
Interest and dividend income :         

Interest and fees on loans

   $ 4,860      $ 4,784      $ 9,464      $ 10,015   

Interest and dividends on taxable securities

     675        1,001        1,456        2,107   

Interest and dividends on other earning assets

     36        78        77        154   
                                

Total interest and dividend income

     5,571        5,863        10,997        12,276   
                                

Interest expense:

        

Interest on deposits

     1,764        2,575        3,831        5,352   

Interest on borrowings

     317        358        630        774   
                                

Total interest expense

     2,081        2,933        4,461        6,126   
                                

Net interest income

     3,490        2,930        6,536        6,150   
                                

Provision for loan losses

     545        255        1,025        706   
                                

Net interest income after provision for loan losses

     2,945        2,675        5,511        5,444   
                                

Noninterest income:

        

Account maintenance and deposit service fees

     138        118        270        234   

Income from bank-owned life insurance

     140        145        288        290   

Net gain (loss) on other real estate owned

     30        —          117        (175

Total other-than-temporary impairment losses

     (5,367     (124     (5,367     (124

Portion of loss recognized in other comprehensive income (before taxes)

     4,504        —          4,504        —     
                                

Net credit impairment losses recognized in earnings

     (863     (124     (863     (124

Gain on sales of securities

     —          —          223        —     

Other

     53        8        57        43   
                                

Total noninterest income (loss)

     (502     147        92        268   
                                

Noninterest expenses:

        

Salaries and benefits

     936        948        1,999        1,918   

Occupancy expenses

     387        379        774        721   

Furniture and equipment expenses

     125        123        246        247   

Amortization of core deposit intangible

     182        182        363        363   

Virginia franchise tax expense

     140        137        282        274   

FDIC special assessment

     190        —          190        —     

FDIC assessment

     123        50        297        99   

Data processing expense

     79        66        159        131   

Telephone and communication expense

     63        63        128        123   

Other operating expenses

     249        273        469        557   
                                

Total noninterest expenses

     2,474        2,221        4,907        4,433   
                                

Income (loss) before income taxes

     (31     601        696        1,279   

Income tax expense (benefit)

     (54     151        147        328   
                                

Net income

   $ 23      $ 450      $ 549      $ 951   
                                

Other comprehensive loss:

        

Unrealized gain (loss) on available for sale securities

   $ 8      $ (2,315   $ 133      $ (2,726

Realized amount on securities sold, net

     —          —          (223     —     

Non-credit component of other-than-temporary impairment on held-to-maturity securities net of amounts previously recorded upon transfer to held-to-maturity from available-for-sale

     (2,671     —          (2,639     —     
                                

Net unrealized loss

     (2,663     (2,315     (2,729     (2,726

Tax effect

     (905     (787     (927     (927
                                

Other comprehensive loss

     (1,758     (1,528     (1,802     (1,799
                                

Comprehensive loss

   $ (1,735   $ (1,078   $ (1,253   $ (848
                                

Earnings per share, basic and diluted

   $ 0.00      $ 0.07      $ 0.08      $ 0.14   
                                

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 SIX MONTHS ENDED JUNE 30, 2009

(dollars in thousands, except per share amounts) (Unaudited)

 

    Common
Stock
  Additional
Paid in
Capital
  Retained
Earnings
  Accumulated
Other
Comprehensive
Loss
    Comprehensive
Loss
    Total  

Balance - January 1, 2009

  $ 68   $ 69,516   $ 1,697   $ (2,505     $ 68,776   
Comprehensive income:            

Net income

        549     $ 549        549   

Stock-based compensation expense

      25           25   

Change in other comprehensive income (loss) (net of tax, $927)

          (1,802     (1,802     (1,802
                 

Total comprehensive loss

          $ (1,253  
                                         

Balance - June 30, 2009

  $ 68   $ 69,541   $ 2,246   $ (4,307     $ 67,548   
                                   

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2009 AND 2008

(dollars in thousands) (Unaudited)

 

     2009     2008  

Operating activities:

    

Net income

   $ 549      $ 951   

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

    

Depreciation

     258        267   

Amortization , net

     347        271   

Provision for loan losses

     1,025        706   

Earnings on bank-owned life insurance

     (288     (290

Stock based compensation expense

     25        13   

Impairment on held-to-maturity securities

     863        124   

Gain on sales of securities

     (223     —     

Net (gain) loss on other real estate owned

     (117     175   

Net increase in other assets

     (738     (181

Net increase (decrease) in other liabilities

     (671     321   
                

Net cash and cash equivalents provided by operating activities

     1,030        2,357   
                

Investing activities:

    

Proceeds from sales of securities available for sale

     9,852        —     

Proceeds from paydowns, maturities and calls of securities available for sale

     1,161        4,814   

Purchases of securities held to maturity

     (4,210     (12,419

Proceeds from paydowns, maturities and calls of securities held to maturity

     7,092        5,486   

Loan originations and payments, net

     (25,123     (29,298

Net increase in stock in Federal Reserve Bank and Federal Home Loan Bank

     (423     (162

Proceeds from sale of other real estate owned

     634        277   

Purchases of bank premises and equipment

     (39     (112
                

Net cash and cash equivalents used in investing activities

     (11,056     (31,414
                

Financing activities:

    

Net increase in deposits

     5,364        34,367   

Proceeds from Federal Home Loan Bank advances

     —          5,000   

Net increase (decrease) in securities sold under agreement to repurchase and other short-term borrowings

     (2,670     2,003   
                

Net cash and cash equivalents provided by financing activities

     2,694        41,370   
                

Increase (decrease) in cash and cash equivalents

     (7,332     12,313   

Cash and cash equivalents at beginning of period

     14,762        1,308   
                

Cash and cash equivalents at end of period

   $ 7,430      $ 13,621   
                

Supplemental Disclosure of Cash Flow Information

    

Cash payments for:

    

Interest

   $ 4,891      $ 5,793   

Income taxes

     380        700   

Supplemental schedule of noncash investing and financing activities

    

Transfer from loans to other real estate owned

     498        84   

Acquisition of fixed assets related to Leesburg Branch

     —          501   

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2009

 

1. ACCOUNTING POLICIES

Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a national bank chartered on April 14, 2005, under the laws of the United States of America. On January 1, 2009, Sonabank changed from a nationally chartered bank to a state chartered bank and moved its headquarters from Charlottesville to McLean, Virginia. Going forward, Sonabank will be regulated by the State Corporation Commission of Virginia and the Federal Reserve Bank of Richmond. Currently, all of the communities served by Sonabank are located in Virginia, and Sonabank does very little lending outside Virginia. The principal activities of Sonabank are to attract deposits and originate loans as permitted under applicable banking regulations. Sonabank conducts full-service banking operations in Fairfax County (Reston, McLean and Fairfax), Charlottesville, Warrenton, Leesburg and Clifton Forge. All of our branches are in Virginia.

The consolidated financial statements include the accounts of Southern National Bancorp of Virginia, Inc. and its subsidiary. Significant inter-company accounts and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with U. S. generally accepted accounting principles (“U. S. GAAP”) for interim financial information and instructions for Form 10-Q and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by U. S. GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in SNBV’s Form 10-K for the year ended December 31, 2008.

Subsequent events have been evaluated through August 14, 2009, the date that the financial statements were issued.

Use of Estimates

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

 

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Reclassifications

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

Recent Accounting Pronouncements

In April 2009, the FASB issued Staff Position No. 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly, (FSP FAS 157-4). This FASB Staff Position (FSP) provides additional guidance for estimating fair value in accordance with FASB Statement No. 157, Fair Value Measurements, when the volume and level of activity for the asset or liability have significantly decreased. It also includes guidance on identifying circumstances that indicate a transaction is not orderly. This FSP is effective for interim and annual reporting periods ending after June 15, 2009. We have adopted this FSP for the interim reporting period ended June 30, 2009, and we followed this guidance to estimate the fair value of trust preferred securities. See Note 3 and Note 7.

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments. This FSP amends the other-than-temporary impairment guidance in U. S. GAAP for debt securities to make the guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities in the financial statements. One change to current practice relates to management’s assertion regarding recovery of fair value declines. Currently, when determining whether impairment is other-than-temporary, an entity must assess whether it has the intent and ability to hold a security until recovery of its cost basis. Under this FSP, an entity must assess whether it intends to sell the security or if it is more likely than not that it will be required to sell the security prior to recovery. If the entity does not intend to sell the security or if it is more likely than not that it will not be required to sell the security before its anticipated recovery, then all available evidence should be considered to estimate the anticipated period over which the cost basis of the security is expected to recover. If the entity does not anticipate recovery of its cost basis, an other-than-temporary impairment should be considered to have occurred and the credit loss component should be recognized in earnings and the other components should be recognized in other comprehensive income. Both the credit and noncredit components will be presented in the income statement. The total other-than-temporary impairment charge will be reduced by the amount recognized in other comprehensive income. This FSP shall be applied to existing and new investments held by an entity as of the beginning of the interim period in which it is adopted. For debt securities held at the beginning of the interim period of adoption for which an other-than-temporary impairment was previously recognized, if an entity does not intend to sell and it is not more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis, the entity shall recognize the cumulative effect of initially applying this FSP as an adjustment to the opening balance of retained earnings with a corresponding adjustment to accumulated other comprehensive income. This FSP is effective for interim and annual reporting periods ending after June 15, 2009. We have adopted this FSP effective April 1, 2009. As a result of implementing the FSP, the amount of OTTI recognized in income for the period was $863 thousand. Had the FSP not been issued, the amount of OTTI that would have been recognized in income for the period would have been $5.4 million. No adjustments were recorded to prior OTTI charges upon adoption as these were for equity securities.

Also in April 2009, FASB issued FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments. This FSP amends FASB Statement No. 107, Disclosures about Fair Value of Financial Instruments, to require disclosures about fair value of financial

 

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instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. This FSP also amends APB Opinion No. 28, Interim Financial Reporting, to require those disclosures in summarized financial information at interim reporting periods. This FSP is effective for interim and annual reporting periods ending after June 15, 2009. We have adopted this FSP for the interim reporting period ended June 30, 2009, and it did not have a material impact on our results of operations or financial position as it only required additional disclosures which are included in Note 7.

In April 2009, the FASB issued FSP FAS 141(R)-1, Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies. This FSP addresses concerns raised by constituents about the application of Statement No. 141(R) to assets and liabilities arising from contingencies in a business combination. The FSP provides a model more consistent with that provided in the original Statement No. 141 to account for pre-acquisition contingencies. The FSP requires an acquirer to recognize at fair value “an asset acquired or liability assumed in a business combination that arises from a contingency if the acquisition-date fair value of that asset or liability can be determined during the measurement period.” The FSP is effective for business combinations whose acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. FSP FAS 141(R)-1 is expected to have an impact on our accounting for any business combinations closing on or after January 1, 2009.

In May 2009, the FASB issued Statement No. 165, “Subsequent Events” which establishes general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. In particular, this Statement sets forth the period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements, the circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements, and the disclosures that an entity should make about events or transactions that occurred after the balance sheet date. In accordance with this Statement, an entity should apply the requirements to interim or annual financial periods ending after June 15, 2009. The impact of adoption did not have a material impact on our results of operations or financial position.

In June 2009, the FASB issued Statement No. 166, “Accounting for Transfers of Financial Assets—an amendment of FASB Statement No. 140.” This statement removes the concept of a qualifying special-purpose entity from Statement 140 and removes the exception from applying FASB Interpretation No. 46 (revised December 2003), Consolidation of Variable Interest Entities, to qualifying special-purpose entities. The objective in issuing this Statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Management is currently evaluating this standard but does not expect the impact of adoption to be material to our results of operations or financial position.

On June 12, 2009, the FASB issued Statement No. 167, Amendments to FASB Interpretation No. 46(R). Statement No. 167 amends FIN 46(R) to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has

 

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the power to direct the activities of a variable interest entity (VIE) that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Unlike FIN 46 (R), this Statement requires ongoing reconsideration of whether (1) an entity is a VIE and (2) an enterprise is the primary beneficiary of a VIE. It is expected that the amendments will result in more entities consolidating VIEs that previously were not consolidated The Statement will also require additional disclosures about an enterprise’s involvement in variable interest entities. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. Management is currently evaluating this standard but does not expect the impact of adoption to be material to our results of operations or financial position.

 

2. 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 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 options price cannot be less than the fair market value of the stock on the grant date. The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule.

SNBV granted 41,500 options during the first six months of 2009. The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model. The following weighted-average assumptions were used to value options granted in the six months ended June 30, 2009:

 

Dividend yield

     0.00

Expected life

     10 years   

Expected volatility

     25.17

Risk-free interest rate

     2.70

Weighted average fair value per option granted

   $ 2.23   

 

   

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.

For the three and six months ended June 30, 2009, stock-based compensation expense was $13 thousand and $25 thousand, respectively, compared to $6 thousand and $13 thousand for the same periods last year. As of June 30, 2009, unrecognized compensation expense associated with the stock options was $193 thousand which is expected to be recognized over a weighted average period of 3.9 years.

 

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A summary of the activity in the stock option plan during the six months ended June 30, 2009 follows (dollars in thousands):

 

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

Options outstanding, beginning of period

   212,925    $ 9.23      

Granted

   41,500      5.50      

Forfeited

   —        —        

Exercised

   —        —        
             

Options outstanding, end of period

   254,425    $ 8.62    7.0    $ 112
                       

Vested or expected to vest

   254,425    $ 8.62    7.0    $ 112

Exercisable at end of period

   177,885    $ 9.15    6.1    $ —  

 

3. SECURITIES

The amortized cost and fair value of securities available-for-sale were as follows (in thousands):

 

     Amortized
Cost
   Gross Unrealized     Fair
Value

June 30, 2009

      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 4,664    $ 76    $ —        $ 4,740

FHLMC preferred stock

     24      11      —          35
                            

Total

   $ 4,688    $ 87    $ —        $ 4,775
                            
     Amortized
Cost
   Gross Unrealized     Fair
Value

December 31, 2008

      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 15,431    $ 243    $ (65   $ 15,609

FHLMC preferred stock

     24      —        —          24
                            

Total

   $ 15,455    $ 243    $ (65   $ 15,633
                            

The carrying amount and fair value of securities held-to-maturity were as follows (in thousands):

 

     Carrying
Amount
   Gross Unrecognized     Fair
Value

June 30, 2009

      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 34,110    $ 1,019    $ (20   $ 35,109

Residential government-sponsored collateralized mortgage obligations

     1,071      13      —          1,084

Other residential collateralized mortgage obligations

     2,247      —        (1,027     1,220

Trust preferred securities

     15,562      —        (5,468     10,094
                            
   $ 52,990    $ 1,032    $ (6,515   $ 47,507
                            
     Carrying
Amount
   Gross Unrecognized     Fair
Value

December 31, 2008

      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 34,924    $ 783    $ (71   $ 35,636

Residential government-sponsored collateralized mortgage obligations

     2,772      15      —          2,787

Other residential collateralized mortgage obligations

     2,510      —        (834     1,676

Trust preferred securities

     19,120      —        (10,435     8,685
                            
   $ 59,326    $ 798    $ (11,340   $ 48,784
                            

The fair value and carrying amount, if different, of debt securities as of June 30, 2009 by contractual maturity were as follows (in thousands). Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage securities, are shown separately.

 

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

Due after ten years

   $ 15,562    $ 10,094    $ —  

Residential mortgage-backed securities

     34,110      35,109      4,740

Residential collateralized mortgage obligations

     3,318      2,304      —  
                    

Total

   $ 52,990    $ 47,507    $ 4,740
                    

During the six months ended June 30, 2009, we sold $9.9 million of available-for-sale mortgage-backed securities resulting in a gross gain of $223 thousand. There were no sales of securities during the first six months of 2008, or for the quarters ended June 30, 2009 and 2008. The tax provision related to the 2009 realized gain was $76 thousand. Also impacting earnings in 2009 was an other-than-temporary impairment (“OTTI”) charge related to credit loss on three trust preferred securities in the amount of $863 thousand which is described below. In the first six months of 2008, we recognized an OTTI charge in the amount of $124 thousand on an investment in FHLMC perpetual preferred stock.

Securities with a carrying amount of approximately $42.2 million and $55.8 million at June 30, 2009 and December 31, 2008, respectively, were pledged to secure public deposits, repurchase agreements and a line of credit for advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

SNBV monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. As outlined in the table below, there are 9 securities with stated maturities totaling approximately $15.3 million in the portfolio that are considered temporarily impaired at June 30, 2009. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, management does not consider these securities to be other-than-temporarily impaired as of June 30, 2009. All of these securities continue to perform according to the contractual terms except for MMCF XVIII, TRAP 2007-XII and TRAP 2007-XIII which have deferred interest payments (see discussion in subsequent paragraphs). The following tables present information regarding securities in a continuous unrealized loss position as of June 30, 2009 and December 31, 2008 (in thousands) by duration of time in a loss position:

 

     Less than 12 months     12 Months or More     Total  

June 30, 2009

   Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
 

Residential mortgage-backed securities

   $ 3,978    $ (20   $ —      $ —        $ 3,978    $ (20

Residential collateralized mortgage obligations

     —        —          1,220      (1,027     1,220      (1,027

Trust preferred securities

     —        —          10,094      (5,468     10,094      (5,468
                                             
   $ 3,978    $ (20   $ 11,314    $ (6,495   $ 15,292    $ (6,515
                                             
               
     Less than 12 months     12 Months or More     Total  

December 31, 2008

   Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
 

Residential mortgage-backed securities

   $ 9,372    $ (136   $ —      $ —        $ 9,372    $ (136

Residential collateralized mortgage obligations

     1,676      (834     —        —          1,676      (834

Trust preferred securities

     4,028      (3,860     4,657      (6,575     8,685      (10,435
                                             
   $ 15,076    $ (4,830   $ 4,657    $ (6,575   $ 19,733    $ (11,405
                                             

 

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As of June 30, 2009, we owned pooled trust preferred securities as follows:

 

     Tranche
Level
  Ratings When
Purchased
  Current
Ratings
  Par
Value
  Book
Value
  Estimated
Fair
Value
  Current
Defaults
and
Deferrals
  % of
Current
Defaults
and

Deferrals
to
Current

Collateral
    Sandler
O’Neill (a)
Sterne Agee
(b)
Estimated
Incremental

Defaults
Required to

Break
Yield (1)
        Previously
Recognized

Cumulative
Other
Comprehensive

Loss (2)
   

Security

    Moody’s   Fitch   Moody’s   Fitch                  
    (in thousands)    

Investment Grade:

                         

ALESCO VII A1B

  Senior   Aaa   AAA   A3   AA   $ 8,832   $ 7,828   $ 6,118   $ 99,300   16   $ 303,717      b   $ 335  

MMCF II B

  Senior
Sub
  A3   AA-   Baa2   BBB     583     533     494     28,000   22     25,300      a     50  

MMCF III B

  Senior
Sub
  A3   A-   Baa3   B     709     691     390     10,000   8     38,100      a     17  
                                           
              10,124     9,052     7,002           $ 402  
                                           

Other:

                           

TPREF FUNDING II

  Mezzanine   A1   A-   Caa3   CC     1,500     1,299     552     87,000   25     30,200      a     201  

TRAP 2007-XII C1

  Mezzanine   A3   A   Ca   CC     2,000     1,409     251     84,750   17     91,559      b     591  

TRAP 2007-XIII D

  Mezzanine   NR   A-   NR   C     2,012     1,382     380     86,000   11     91,439      b     630  

MMC FUNDING XVIII

  Mezzanine   A3   A-   Ca   C     1,020     757     246     62,500   19     28,600      a     264  
                                           
              6,532     4,847     1,429           $ 1,686  
                                           
                                                        Cumulative
Other
Comprehensive
Loss (3)
  Amount
of
OTTI
Related
to
Credit
Loss (3)

Other Than Temporarily Impaired:

                         

ALESCO V C1

  Mezzanine   A2   A   Ca   CC     2,000     704     704     63,500   19     (1,002   b   $ 1,293   $ 3

ALESCO XV C1

  Mezzanine   A3   A-   Ca   CC     3,018     420     420     169,250   25     (31,475   b     1,800     799

ALESCO XVI C

  Mezzanine   A3   A-   Ca   CC     2,012     539     539     110,000   22     (9,851   b     1,411     61
                                               
              7,030     1,663     1,663           $ 4,504   $ 863
                                               

Total

            $ 23,686   $ 15,562   $ 10,094            
                                       

 

(1) A break in yield for a given tranche means that defaults/deferrals have reached such a level that the tranche would not receive all of its contractual cash flows (principal and interest) by maturity (so not just a temporary interest shortfall, but an actual loss in yield on the investment). In other words, the magnitude of the defaults/deferrals has depleted all of the credit enhancement (excess interest and over-collateralization) beneath the given tranche. This represents additional defaults beyond those assumed in our cash flow modeling.

 

(2) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity

 

(3) Pre-tax

Five of the trust preferred securities owned by Sonabank have not continued to pay principal and interest in accordance with the contractual terms of the securities. MMC Funding XVIII continues to defer interest payments since the fourth quarter of 2008. TRAP XII, TRAP XIII, ALESCO XV and ALESCO XVI have had new deferrals which caused failures in senior class principal coverage tests during the second quarter of 2009. When this happens the cash flows to the lower classes are temporarily suspended and used to pay down the principal of the senior classes in order to restore the over-collateralization levels of the senior classes. The bonds will continue to accrue interest, but it will be capitalized rather than paid in cash, also known as payment in kind. Interest will be earned on the capitalized interest at the current coupon rate. Once the senior class coverage test is satisfied, the lower classes will begin to receive current interest as well as capitalized interest.

Management has evaluated each of these securities for potential impairment under EITF 99-20-1 and the most recently issued FSP guidance described in Note 1, and has reviewed each of the issues’ collateral participants using various techniques including the ratings provided in the Bank Financial Quarterly published by IDC Financial Publishing, Inc. Management has also reviewed the interest and principal coverage of each of the tranches it owns. In performing a detailed cash flow analysis of each security, management works with independent third parties to identify its best estimate of the cash flow estimated to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following assumptions:

 

   

Unless the company has received funding under TARP, we assume that all of the issuers rated 1 by IDC Financial Publishing that have not already defaulted will default immediately with 100% loss.

 

   

We assume that annual defaults for the remaining life of each security will be 37.5 basis points. We assume recoveries ranging from 0% to 75% on deferrals after two years depending on the IDC rating of the deferring entity.

 

   

We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security. Our securities have been modeled using the above assumptions by Sandler O’Neill or FTN Financial using the forward LIBOR curve plus original spread to discount projected cash flows to present values.

 

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Management’s analysis in the second quarter deemed three of the ten trust preferred securities we own other than temporarily impaired. The cash flow analysis this quarter indicated that one security, ALESCO XV C1 would probably experience significant credit losses. Two others, ALESCO V C1 and ALESCO XVI C, would probably experience minor credit losses. We have recorded OTTI charges accordingly. The credit portion of the OTTI was recognized in net income and the remainder through other comprehensive income. The following table details the three trust preferred securities with OTTI, their credit rating at June 30, 2009 and the related credit losses recognized in earnings:

 

     ALESCO V C1
Rated Ca
   ALESCO XV C1
Rated Ca
   ALESCO XVI C
Rated Ca
   Total

Amount of other-than-temporary impairment related to credit loss at April 1, 2009

   $ —      $ —      $ —      $ —  

Addition

     3      799      61      863
                           

Amount of other-than-temporary impairment related to credit loss at June 30, 2009

   $ 3    $ 799    $ 61    $ 863
                           

We also own $2.2 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was downgraded from AAA to B by Standard and Poors in June 2009, but has been rated BBB by Fitch since the fourth quarter of 2008. This security was originated in 2005. The average FICO score of the underlying loans at origination was 748. As of June 30, 2009, delinquencies of more than 60 days, foreclosures and REO totaled 27.5% compared to 23.2% at March 31, 2009. Credit support is 13.9 compared to 14 when originally issued, which provides coverage of 1.54 times projected losses in the collateral. The fair market value is $1.2 million. We have evaluated this security for potential impairment and determined that an OTTI does not exist as of June 30, 2009.

We own 80,000 shares of the Freddie Mac perpetual preferred stock Series V. We have recorded total OTTI charges on this security of $1.976 million during 2008 and 2007. The fair value at June 30, 2009 was $35 thousand.

 

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4. LOANS AND ALLOWANCE FOR LOAN LOSSES

The following table summarizes the composition of our loan portfolio as of June 30, 2009 and December 31, 2008:

 

     June 30,
2009
    December 31,
2008
 

Mortgage loans on real estate:

    

Commercial

   $ 126,998      $ 104,866   

Construction loans to residential builders

     4,844        4,752   

Other construction and land loans

     41,054        51,836   

Residential 1-4 family

     62,081        60,376   

Multi- family residential

     7,463        5,581   

Home equity lines of credit

     13,250        11,509   
                

Total real estate loans

     255,690        238,920   

Commercial loans

     67,759        60,820   

Consumer loans

     3,320        3,074   
                

Gross loans

     326,769        302,814   

Less unearned income on loans

     (550     (548
                

Loans, net of unearned income

   $ 326,219      $ 302,266   
                

The following summarizes activity in the allowance for loan losses for the six months ended June 30, 2009 and 2008 (in thousands):

 

     2009     2008  

Balance, beginning of period

   $ 4,218      $ 3,476   

Provision charged to operations

     1,025        706   

Recoveries credited to allowance

     84        8   
                

Total

     5,327        4,190   

Loans charged off

     (756     (180
                

Balance, end of period

   $ 4,571      $ 4,010   
                

Loans identified as impaired in accordance with SFAS 114 totaled $2.4 million as of June 30, 2009. This compares to $974 thousand of impaired loans at December 31, 2008. Included in impaired loans are nonaccrual loans in the amount of $2.2 million and $1.1 million at June 30, 2009 and December 31, 2008, respectively. At June 30, 2009, there were no loans past due 90 days or more and accruing interest, and there was one loan in the amount of $135 thousand past due 90 days or more and accruing interest at December 31, 2008.

 

5. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

SNBV is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and funding risk in excess of the amount recognized in the consolidated balance sheet. Letters of credit are written conditional commitments issued by SNBV to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling $1.4 million and $1.6 million as of June 30, 2009 and December 31, 2008, respectively.

 

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Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis.

At June 30, 2009 and December 31, 2008, we had unfunded lines of credit and undisbursed construction loan funds totaling $38.0 million and $39.0 million, respectively. Our approved loan commitments were $1.3 million and $2.1 million at June 30, 2009 and December 31, 2008, respectively.

 

6. EARNINGS PER SHARE

The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (dollars in thousands, except per share data):

 

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

For the three months ended June 30, 2009

        

Basic EPS

   $ 23    6,799    $ 0.00

Effect of dilutive stock options and warrants

     —      —        —  
                  

Diluted EPS

   $ 23    6,799    $ 0.00
                  

For the three months ended June 30, 2008

        

Basic EPS

   $ 450    6,799    $ 0.07

Effect of dilutive stock options and warrants

     —      —        —  
                  

Diluted EPS

   $ 450    6,799    $ 0.07
                  

For the six months ended June 30, 2009

        

Basic EPS

   $ 549    6,799    $ 0.08

Effect of dilutive stock options and warrants

     —      —        —  
                  

Diluted EPS

   $ 549    6,799    $ 0.08
                  

For the six months ended June 30, 2008

        

Basic EPS

   $ 951    6,799    $ 0.14

Effect of dilutive stock options and warrants

     —      1      —  
                  

Diluted EPS

   $ 951    6,800    $ 0.14
                  

There were 397,925 anti-dilutive options and warrants during the three and six months ended June 30, 2009, and there were 356,425 and 105,900 anti-dilutive options and warrants during the three and six months ended June 30, 2008, respectively.

 

7. FAIR VALUE

FAS 157 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) or identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date

 

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Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability

Assets measured at fair value on a recurring basis are summarized below:

 

     Total at
June 30, 2009
   Fair Value Measurements Using

(dollars in thousands)

      Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
   Significant
Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Financial assets:

           

Available for sale securities

           

Residential mortgage-backed securities

   $ 4,740    $ —      $ 4,740    $ —  

FHLMC preferred stock

     35      —        35      —  
                           

Total available-for-sale securities

   $ 4,775    $ —      $ 4,775    $ —  
                           
     Total at
December 31, 2008
   Fair Value Measurements Using

(dollars in thousands)

      Quoted Prices in
Active Markets
for Identical
Assets

(Level 1)
   Significant
Other
Observable
Inputs

(Level 2)
   Significant
Unobservable
Inputs

(Level 3)

Financial assets:

           

Available for sale securities

           

Residential mortgage-backed securities

   $ 15,609    $ —      $ 15,609    $ —  

FHLMC preferred stock

     24      —        24      —  
                           

Total available-for-sale securities

   $ 15,633    $ —      $ 15,633    $ —  
                           

The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

Securities

Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of SNBV’s available-for-sale securities are considered to be level 2 securities.

 

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Assets and Liabilities Measured on a Non-recurring Basis:

Trust Preferred Securities Classified as Held-to-Maturity

Since late 2007, the markets for trust preferred securities have become increasingly inactive. According to information received from FTN Financial, there have been no issuances of pooled trust preferred securities since 2007. Beginning in the second quarter of 2008, the purchase and sale activity of trust preferred securities decreased significantly as investors elected to hold the securities instead of selling them at depressed prices. Brokers have indicated that little if any activity is occurring in this sector, and the trust preferred securities trades that are taking place are primarily distressed sales. As a result, the bid-ask spreads have widened significantly and the volume of trades decreased compared to historical volumes.

The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, management utilized guidance in FSP FAS 157-4 to value these securities. The base input in calculating fair value is a Bloomberg Fair Value Index yield curve for single issuer trust preferred securities which correspond to the ratings of the securities we own. We also use composite rating indices to fill in the gaps where the bank rating indices did not correspond to the ratings in our portfolio. When a bank index that matches the rating of our security is not available, we used the bank index that most closely matches the rating, adjusted by the spread between the composite index that most closely matches the security’s rating and the composite index with a rating that matches the bank index used. We then use the adjusted index yield, which is further adjusted by a liquidity premium, as the discount rate to be used in the calculation of the present value of the same cash flows used to evaluate the securities for OTTI. The liquidity premiums were derived in consultation with FTN Financial. The liquidity premiums we used ranged from .25% to 4%, and the adjusted discount rates ranged from 7.93% to 16.55% . Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility. We have determined that our trust preferred securities are classified with Level 3 of the fair value hierarchy.

Based on our analysis in the second quarter of 2009, three of the ten trust preferred securities we own were considered to be other than temporarily impaired. The total par value of these three securities was $7.0 million and the fair value was $1.7 million at June 30, 2009. We recognized an OTTI charge of $863 thousand in net income and the remainder through other comprehensive income.

Impaired Loans

SFAS 157 applies to loans measured for impairment using the practical expedients permitted by SFAS 114 at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. Fair value is classified as Level 3 in the fair value hierarchy. Loans identified as impaired in accordance with SFAS 114 totaled $2.4 million as of June 30, 2009 with an allocated allowance for loan losses totaling $194 thousand compared to a carrying amount of $974 thousand with an allocated allowance for loan losses totaling $378 thousand at December 31, 2008. Charge-offs related to impaired loans totaled $140 thousand and $100 thousand during the three and six months ended June 30, 2009 and 2008, respectively.

 

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Other Real Estate Owned (OREO)

OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. OREO is further evaluated quarterly for any additional impairment. Fair value is classified as Level 3 in the fair value hierarchy. The total amount of OREO was $3.4 million at June 30, 2009 and December 31, 2008. There were no write-downs of OREO during the three and six months ended June 30, 2009 and the three months ended June 30, 2008. There were write-downs totaling $200 thousand during the six months ended June 30, 2008.

Fair Value of Financial Instruments

The carrying amount and estimated fair values of financial instruments, not previously presented, were as follows (in thousands):

 

     June 30, 2009    December 31, 2008
     Carrying
Amount
   Fair Value    Carrying
Amount
   Fair Value

Financial assets:

           

Cash and cash equivalents

   $ 7,430    $ 7,430    $ 14,762    $ 14,762

Securities held to maturity

     52,990      47,507      59,326      48,784

Stock in Federal Reserve Bank and Federal

           

Home Loan Bank

     4,464      n/a      4,041      n/a

Net loans

     321,648      323,473      298,048      298,304

Accrued interest receivable

     1,454      1,454      1,395      1,395

Financial liabilities:

           

Deposits:

           

Demand deposits

     32,475      32,475      31,691      31,691

Money market and savings accounts

     52,576      52,576      52,952      52,952

Certificates of deposit

     229,773      231,546      224,817      227,743

Securities sold under agreements to repurchase and other short-term borrowings

     18,220      18,220      20,890      20,890

FHLB advances

     30,000      30,418      30,000      33,436

Accrued interest payable

     992      992      1,422      1,422

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. It was not practicable to determine the fair value of Federal Reserve Bank and Federal Home Loan Bank stock due to restrictions placed on its transferability. Fair value of long-term debt is based on current rates for similar financing. The fair value of off-balance-sheet items is not considered material.

 

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8. WARRANTS

As part of the purchase price of the fixed assets related to the Leesburg branch, SNBV issued 61,000 warrants for the purchase of its common stock at an exercise price of $12.73 per share during the first quarter of 2008. The warrants expire in three years. The fair value of each warrant issued was estimated using the Black-Scholes options-pricing model. The following weighted-average assumptions were used to value the warrants:

 

Dividend yield

     0.00

Expected life

     3 years   

Expected volatility

     19.17

Risk-free interest rate

     2.11

Weighted average fair value per warrant

   $ 0.84   

 

9. BRANCH ACQUISITION

As previously announced Sonabank has entered into a definitive agreement to acquire the Warrenton branch office, approximately $26 million in selected loans and to assume approximately $26 million of the deposits from Millennium Bank, N.A. Under the agreement, approximately half of the loans are scheduled to be transferred to Sonabank at the end of July 2009. The remaining loans and the deposits will be transferred on September 28, 2009, subject to regulatory approval.

 

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of SNBV. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report dated December 31, 2008 on Form 10-K. Results of operations for the three and six month periods ended June 30, 2009 are not necessarily indicative of results that may be attained for any other period.

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.

OVERVIEW

Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a national bank chartered on April 14, 2005, under the laws of the United States of America. On January 1, 2009, Sonabank changed from a nationally chartered bank to a state chartered bank and moved its headquarters from Charlottesville to McLean, Virginia. Going forward, Sonabank will be regulated by the State Corporation Commission of Virginia and the Federal Reserve Bank of Richmond. Currently, all of the communities served by Sonabank are located in Virginia, and Sonabank does very little lending outside Virginia. Moreover, the change should save the company in excess of $35 thousand in regulatory fees per year with increased savings as assets grow in the future. The principal activities of Sonabank are to attract deposits and originate loans as permitted under applicable banking regulations. Sonabank conducts full-service banking operations in Fairfax County (Reston, McLean and Fairfax), Charlottesville, Warrenton, Leesburg and Clifton Forge. All of our branches are in Virginia.

 

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RESULTS OF OPERATIONS

Net Income

Net income for the quarter ended June 30, 2009 was $23 thousand and $549 thousand for the six months ended June 30, 2009 compared to $450 thousand and $951 thousand during the second quarter and the first six months of 2008. Earnings were adversely impacted by OTTI charges of $863 thousand before tax on three of our trust preferred securities which experienced significant incremental deferrals during the quarter. Earnings for the second quarter and the six months were also adversely impacted by the FDIC special assessment of $190 thousand before tax as well as increases in the regular assessment which amounted to $123 thousand during the second quarter of 2009 compared to $50 thousand during the second quarter of 2008.

Net Interest Income

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

Net interest income for the three months ended June 30, 2009 was $3.5 million compared to $2.9 million for the same period last year. Average interest-earning assets for the three months ended June 30, 2009 increased $30.5 million over the same period in 2008. Average loans outstanding increased by $38.1 million in the second quarter of 2009 compared to the second quarter of 2008. Average investment securities decreased by $14.4 million in the quarter ended June 30, 2009, compared to the same period last year. The average balance of other earning assets, primarily interest-earning accounts at the Federal Reserve Bank of Richmond (FRB) and the Federal Home Loan Bank of Atlanta (FHLB), increased from $7.6 million during the second quarter of 2008 to $14.5 million during the second quarter of 2009. The average yield on interest-earning assets decreased from 6.40% in 2008 to 5.60% in 2009 primarily because of the prime rate decreases of 400 basis points during 2008 which accompanied the Federal Reserve Board’s reductions in its federal funds target rate. Average interest-bearing liabilities for the three months ended June 30, 2009 increased $29.7 million compared to the same period in 2008. Average interest-bearing deposits increased by $26.0 million, while average borrowings increased by $3.8 million compared to the second quarter of 2008. The average cost of interest-bearing liabilities decreased from 3.78% in 2008 to 2.44% in 2009. The interest rate spread for the three months ended June 30, 2009 increased from 2.62% to 3.16% compared to the same period last year. The net interest margin for the three months ended June 30, 2009 increased to 3.51% from 3.20% compared to the same period last year.

The net interest margin on a linked quarter basis rose significantly from 3.12% in the first quarter of 2009 to 3.51% in the second quarter of 2009. The rise resulted from a small increase in the yield on loans from 6.04% in the first quarter to 6.08% in the second quarter. This was a result of a stabilized prime rate and Sonabank’s efforts to establish floors on prime rate based loans. This improvement was partially offset by a decline in the yield on investment securities from 4.63% in the first quarter to 4.24% in the second quarter. The yield on earning assets increased from 5.57% during the first quarter to 5.60% during the second quarter.

Net interest income for the six months ended June 30, 2009 was $6.5 million compared to $6.2 million for the same period last year. Average interest-earning assets for the six months ended June 30, 2009 increased $36.4 million over the same period in 2008. Average loans outstanding increased by $38.2 million in the first six months of 2009 compared to the same period in 2008. Average investment securities decreased by $11.5 million in the six months ended June 30, 2009, compared to the same period last year. The average balance of other earning assets, primarily

 

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interest-earning accounts at the Federal Reserve Bank of Richmond (FRB) and the Federal Home Loan Bank of Atlanta (FHLB), increased from $6.8 million during the first six months of 2008 to $16.5 million during the first six months of 2009. The average yield on interest-earning assets decreased from 6.84% in 2008 to 5.58% in 2009 primarily because of the prime rate decreases of 400 basis points during 2008 which accompanied the Federal Reserve Board’s reductions in its federal funds target rate. Average interest-bearing liabilities for the six months ended June 30, 2009 increased $34.7 million compared to the same period in 2008. Average interest-bearing deposits increased by $29.4 million, while average borrowings increased by $5.3 million compared to the first six months of 2008. The average cost of interest-bearing liabilities decreased from 4.03% in 2008 to 2.64% in 2009. The interest rate spread for the six months ended June 30, 2009 increased from 2.82% to 2.94% compared to the same period last year. The net interest margin for the six months ended June 30, 2009 decreased to 3.32% from 3.43% compared to the same period last year.

Our commercial loans (non-real estate), acquisition and development loans, construction loans and SBA loans are predominately priced to a spread over the prime rate, and these loans reprice virtually immediately. Commercial real estate loans are generally priced at a spread over the one, three or five year constant maturity treasury yield (CMT) or our marginal cost of funds and fixed for one, three or five years. On the liability side of the balance sheet we have a large segment of our funding which floats; but certificates of deposit (CDs) reprice only at maturity resulting in a lag which can adversely affect net interest income and the net interest margin when interest rates decline. We have seen substantial improvements during the first six months of 2009. We had CDs mature during the first six months in an amount of $133.0 million with a weighted average rate of 3.31%. During the same period we issued $144.2 million in new CDs at an average rate of 1.40%.

 

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The following table details average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:

 

     Average Balance Sheets and Net Interest
Analysis For the Quarters Ended
 
     6/30/2009     6/30/2008  
     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 (1) (2)

   $ 320,873      $ 4,860    6.08   $ 282,800      $ 4,784    6.80

Investment securities

     63,729        675    4.24     78,087        1,001    5.13

Other earning assets

     14,478        36    1.00     7,647        78    4.10
                                  
Total earning assets      399,080        5,571    5.60     368,534        5,863    6.40
                      

Allowance for loan losses

     (4,492          (3,940     

Total non-earning assets

     41,683             41,154        
                          
Total assets    $ 436,271           $ 405,748        
                          
Liabilities and stockholders’ equity               

Interest-bearing liabilities:

              

NOW accounts

   $ 6,959        2    0.10   $ 6,462        4    0.24

Money market accounts

     48,225        191    1.59     54,375        290    2.15

Savings accounts

     2,248        3    0.55     2,287        1    0.25

Time deposits

     234,991        1,568    2.68     203,327        2,280    4.51
                                  
Total interest-bearing deposits      292,423        1,764    2.42     266,451        2,575    3.89

Borrowings

     49,624        317    2.56     45,848        358    3.14
                                  
Total interest-bearing liabilities      342,047        2,081    2.44     312,299        2,933    3.78
                      

Noninterest-bearing liabilities:

              

Demand deposits

     22,341             20,716        

Other liabilities

     2,221             2,900        
                          
Total liabilities      366,609             335,915        

Stockholders’ equity

     69,662             69,833        
                          
Total liabilities and stockholders’ equity    $ 436,271           $ 405,748        
                          

Net interest income

       3,490          2,930   
                      

Interest rate spread

        3.16        2.62

Net interest margin

        3.51        3.20

 

(1) Includes loan fees in both interest income and the calculation of the yield on loans.

 

(2) Calculations include non-accruing loans in average loan amounts outstanding.

 

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     Average Balance Sheets and Net Interest
Analysis For the Six Months Ended
 
     6/30/2009     6/30/2008  
     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 (1) (2)

   $ 315,063      $ 9,464    6.06   $ 276,897      $ 10,015    7.27

Investment securities

     65,618        1,456    4.44     77,095        2,107    5.47

Other earning assets

     16,500        77    0.94     6,798        154    4.56
                                  
Total earning assets      397,181        10,997    5.58     360,790        12,276    6.84
                      

Allowance for loan losses

     (4,376          (3,781     

Total non-earning assets

     41,898             40,865        
                          
Total assets    $ 434,703           $ 397,874        
                          
Liabilities and stockholders’ equity               

Interest-bearing liabilities:

              

NOW accounts

   $ 7,366        4    0.10   $ 6,269        8    0.24

Money market accounts

     49,438        391    1.59     54,954        749    2.74

Savings accounts

     2,135        4    0.39     2,322        3    0.25

Time deposits

     230,933        3,432    3.00     196,951        4,592    4.69
                                  
Total interest-bearing deposits      289,872        3,831    2.67     260,496        5,352    4.13

Borrowings

     50,809        630    2.50     45,464        774    3.42
                                  
Total interest-bearing liabilities      340,681        4,461    2.64     305,960        6,126    4.03
                      

Noninterest-bearing liabilities:

              

Demand deposits

     22,592             19,682        

Other liabilities

     1,984             2,579        
                          
Total liabilities      365,257             328,221        

Stockholders’ equity

     69,446             69,653        
                          
Total liabilities and stockholders’ equity    $ 434,703           $ 397,874        
                          

Net interest income

     $ 6,536        $ 6,150   
                      

Interest rate spread

        2.94        2.82

Net interest margin

        3.32        3.43

 

(1) Includes loan fees in both interest income and the calculation of the yield on loans.

 

(2) Calculations include non-accruing loans in average loan amounts outstanding.

Provision for Loan Losses

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

The provision for loan losses charged to operations for the three months ended June 30, 2009 and 2008 were $545 thousand and $255 thousand, respectively. We had charge-offs totaling $516 thousand and $100 thousand during the quarters ended June 30, 2009 and 2008, respectively. We had recoveries totaling $81 thousand and $1 thousand during the quarters ended June 30, 2009 and 2008, respectively.

The provision for loan losses charged to operations for the six months ended June 30, 2009 and 2008 were $1.0 million and $706 thousand, respectively. Provision expense for the year ended December 31, 2008 was $1.7 million. We had charge-offs totaling $756 thousand and $180 thousand during the six months ended June 30, 2009 and 2008, respectively. We had recoveries totaling $84 thousand and $8 thousand during the six months ended June 30, 2009 and 2008,

 

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respectively. We had charge-offs, net of recoveries, for the year ended December 31, 2008 in the amount of $915 thousand. The increase in provision expense for the first six months of 2009 relative to 2008 is attributable to the growth and composition of the portfolio, charge-offs, as well as management’s assessment of the current economic and market environment and its impact on loan collectability.

Noninterest Income

The following table presents the major categories on noninterest income (loss) for the three and six months ended June 30, 2009 and 2008:

 

     For the Three Months Ended
June 30,
 
     2009     2008     Change  
     (dollars in thousands)  

Account maintenance and deposit service fees

   $ 138      $ 118      $ 20   

Income from bank-owned life insurance

     140        145        (5

Net gain on other real estate owned

     30        —          30   

Net impairment losses recognized in earnings

     (863     (124     (739

Other

     53        8        45   
                        

Total noninterest income (loss)

   $ (502   $ 147      $ (649
                        
     For the Six Months Ended
June 30,
 
     2009     2008     Change  
     (dollars in thousands)  

Account maintenance and deposit service fees

   $ 270      $ 234      $ 36   

Income from bank-owned life insurance

     288        290        (2

Net gain (loss) on other real estate owned

     117        (175     292   

Net impairment losses recognized in earnings

     (863     (124     (739

Gain on securities

     223        —          223   

Other

     57        43        14   
                        

Total noninterest income

   $ 92      $ 268      $ (176
                        

Noninterest loss was $502 thousand during the second quarter of 2009, compared to income of $147 thousand during the same quarter of the prior year. The OTTI charges recognized offset growth in noninterest income attributable to an increase in account maintenance and deposit service fees and other noninterest income.

Noninterest income decreased from $268 thousand in the first six months of 2008 to $92 thousand in the first six months of 2009. Noninterest income for the first six months of 2009 included a gain on sale of securities of $223 thousand and gain on other real estate owned of $117 thousand, which is offset by the OTTI charge recognized totaling $863 thousand. Noninterest income for the same period last year included a net loss on other real estate owned of $175 thousand. The change in account maintenance and deposit service fees is the result of increased activity.

 

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Noninterest Expense

The following table presents the major categories on noninterest expense for the three and six months ended June 30, 2009 and 2008:

 

     For the Three Months Ended
June 30,
 
     2009    2008    Change  
     (dollars in thousands)  

Salaries and benefits

   $ 936    $ 948    $ (12

Occupancy expenses

     387      379      8   

Furniture and equipment expenses

     125      123      2   

Amortization of core deposit intangible

     182      182      —     

Virginia franchise tax expense

     140      137      3   

FDIC special assessment

     190      —        190   

FDIC assessment

     123      50      73   

Data processing expense

     79      66      13   

Telephone and communication expense

     63      63      —     

Other operating expenses

     249      273      (24
                      

Total noninterest expense

   $ 2,474    $ 2,221    $ 253   
                      
     For the Six Months Ended
June 30,
 
     2009    2008    Change  
     (dollars in thousands)  

Salaries and benefits

   $ 1,999    $ 1,918    $ 81   

Occupancy expenses

     774      721      53   

Furniture and equipment expenses

     246      247      (1

Amortization of core deposit intangible

     363      363      —     

Virginia franchise tax expense

     282      274      8   

FDIC special assessment

     190      —        190   

FDIC assessment

     297      99      198   

Data processing expense

     159      131      28   

Telephone and communication expense

     128      123      5   

Other operating expenses

     469      557      (88
                      

Total noninterest expense

   $ 4,907    $ 4,433    $ 474   
                      

The increase in noninterest expense for the quarter ended June 30, 2009 compared to the same period last year is attributable to the increase in FDIC insurance assessment rates and the FDIC special assessment. One extremely important driver of cost in the second quarter was that Sonabank has long had a semi-annual bonus plan. As a consequence of the difficulties faced in the quarter, we have suspended the bonus payments for the first half of the year, and compensation cost for the quarter is down compared to the same quarter last year.

Despite the costs associated with the new branch and drive-through facility we opened in Leesburg last year and costs to support other organic growth of the Bank, noninterest expenses were well controlled and rose 11% from $4.4 million for the first six months of 2008 to $4.9 million for the first six months of 2009. The increase in occupancy expense was due primarily to inflationary increases in rent expense and one additional month of rent expense for the Leesburg branch compared to the first six months of 2008.

 

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FINANCIAL CONDITION

Balance Sheet Overview

Total assets were $432.7 million at June 30, 2009, as compared to $431.9 million at December 31, 2008. Net loans grew from $298.0 million at the end of 2008 to $321.6 million at June 30, 2009. Investment securities, available for sale and held to maturity, decreased to $57.8 million at June 30, 2009 compared to $75.0 million at December 31, 2008. Cash and cash equivalents decreased from $14.8 million at December 31, 2008 to $7.4 million at June 30, 2009.

As of June 30, 2009, total deposits were $314.8 million compared to $309.5 million as of December 31, 2008. The increase was attributable mostly to an increase in CDs and noninterest-bearing demand deposits. Time deposits increased approximately $5 million during the first six months of 2009. Brokered CDs were $77.9 million at June 30, 2009, compared to $118.3 million at December 31, 2008.

Loan Portfolio

The commercial real estate loan category increased by 21%, rising from $104.9 million at year-end to $127.0 million at June 30, 2009. The commercial and industrial loan category increased by 11% to $67.8 million. Residential 1-4 family mortgage loans increased by 3% to $62.1 million.

The following table summarizes the composition of our loan portfolio as of June 30, 2009 and December 31, 2008:

 

     June 30, 2009     December 31, 2008  

Mortgage loans on real estate:

    

Commercial

   $ 126,998      $ 104,866   

Construction loans to residential builders

     4,844        4,752   

Other construction and land loans

     41,054        51,836   

Residential 1-4 family

     62,081        60,376   

Multi- family residential

     7,463        5,581   

Home equity lines of credit

     13,250        11,509   
                

Total real estate loans

     255,690        238,920   

Commercial loans

     67,759        60,820   

Consumer loans

     3,320        3,074   
                

Gross loans

     326,769        302,814   

Less unearned income on loans

     (550     (548
                

Loans, net of unearned income

   $ 326,219      $ 302,266   
                

 

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Asset Quality

We will generally place a loan on nonaccrual status when it becomes 90 days past due. Loans will also be placed on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Cash payments received while a loan is categorized as nonaccrual will be recorded as a reduction of principal as long as doubt exists as to future collections.

We require appraisals on loans over $250 thousand secured by real estate. 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 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.

Loans identified as impaired in accordance with SFAS 114 totaled $2.4 million as of June 30, 2009. This compares to $974 thousand of impaired loans at December 31, 2008. The increase in impaired loans since December 31, 2008, is attributable to the impairment during the second quarter of 2009 of two residential mortgage loans totaling $218 thousand and one non-residential mortgage loan in the amount of $1.5 million offset by one loan in the amount of $304 thousand which is now current and no longer considered impaired. Nonaccrual loans were $2.2 million and $1.1 million at June 30, 2009 and December 31, 2008, respectively. At June 30, 2009, there were no loans past due 90 days or more and accruing interest, and there was one loan in the amount of $135 thousand past due 90 days or more and accruing interest at December 31, 2008.

Nonperforming assets increased from $4.6 million at December 31, 2008 to $5.7 million at June 30, 2009. This increase is due to an increase in nonaccrual loans.

 

   

There was an addition of one owner occupied commercial real estate loan in the amount of $1.5 million to non-performing status. There is a $1.1 million SBA 504 loan behind us. A current appraisal values the property at $1.7 million, not including several hundred thousand in equipment. This loan was only 45 days past due at June 30, 2009, but the owners have declared Chapter 7 bankruptcy.

 

   

The sale of one residential property in other real estate owned with a carrying value of $280 thousand, as well as a short sale of another residential property to pay off a nonperforming loan with a carrying value of $391 thousand.

We have an internal loan review process and a loan committee which provide on-going monitoring to identify and address issues with problem loans. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at June 30, 2009.

The bulk of our OREO balance continues to be comprised of one property, which contains 33 finished 2 to 4 acre lots in Culpeper. We took a deed in lieu of foreclosure in June 2007. There are no new developments on that property. We continue to monitor the fair value of this property to ensure our carrying value is realizable.

 

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The following table sets forth selected asset quality ratios as of the dates indicated:

 

     As of  
     June 30,
2009
    December 31,
2008
 

Allowance for loan losses to total loans

   1.40   1.40

Nonperforming assets and loans past due 90 days to total assets

   1.31   1.08

Nonperforming assets and loans past due 90 days to total loans

   1.73   1.54

Securities

Investment securities, available for sale and held to maturity, were $57.8 million at June 30, 2009 compared to $75.0 million at December 31, 2008.

At June 30, 2009 the securities portfolio (held to maturity and available for sale) was comprised of the following:

 

   

$38.9 million of FNMA and FHLMC mortgage-backed securities. Since the conservatorship, these securities carry the full faith and credit of the U.S. Government. As of June 30, 2009, the fair market value of these securities was $39.8 million.

 

   

As of June 30, 2009 we owned pooled trust preferred securities broken down as follows:

 

Security

  Tranche
Level
  Ratings
When
Purchased
  Current
Ratings
  Par
Value
  Book
Value
  Estimated
Fair

Value
  Current
Defaults
and

Deferrals
  % of
Current
Defaults
and
Deferrals
to
Current

Collateral
    Sandler
O’Neill (a)
Sterne Agee
(b)
Estimated
Incremental
Defaults
Required to

Break Yield
(1)
        Previously
Recognized
Cumulative
Other
Comprehensive

Loss (2)
   
    Moody’s   Fitch   Moody’s   Fitch                    
   

(in thousands)

   

Investment Grade:

                         

ALESCO VII A1B

  Senior   Aaa   AAA   A3   AA   $ 8,832   $ 7,828   $ 6,118   $ 99,300   16   $ 303,717      b   $ 335  

MMCF II B

  Senior
Sub
  A3   AA-   Baa2   BBB     583     533     494     28,000   22     25,300      a     50  

MMCF III B

  Senior
Sub
  A3   A-   Baa3   B     709     691     390     10,000   8     38,100      a     17  
                                           
              10,124     9,052     7,002           $ 402  
                                           

Other:

                           

TPREF FUNDING II

  Mezzanine   A1   A-   Caa3   CC     1,500     1,299     552     87,000   25     30,200      a     201  

TRAP 2007-XII C1

  Mezzanine   A3   A   Ca   CC     2,000     1,409     251     84,750   17     91,559      b     591  

TRAP 2007-XIII D

  Mezzanine   NR   A-   NR   C     2,012     1,382     380     86,000   11     91,439      b     630  

MMC FUNDING XVIII

  Mezzanine   A3   A-   Ca   C     1,020     757     246     62,500   19     28,600      a     264  
                                           
              6,532     4,847     1,429           $ 1,686  
                                           
                                                        Cumulative
Other
Comprehensive
Loss (3)
  Amount
of
OTTI
Related
to
Credit
Loss (3)

Other Than Temporarily Impaired:

                         

ALESCO V C1

  Mezzanine   A2   A   Ca   CC     2,000     704     704     63,500   19     (1,002   b   $ 1,293   $ 3

ALESCO XV C1

  Mezzanine   A3   A-   Ca   CC     3,018     420     420     169,250   25     (31,475   b     1,800     799

ALESCO XVI C

  Mezzanine   A3   A-   Ca   CC     2,012     539     539     110,000   22     (9,851   b     1,411     61
                                               
              7,030     1,663     1,663           $ 4,504   $ 863
                                               

Total

            $ 23,686   $ 15,562   $ 10,094            
                                       

 

(1) A break in yield for a given tranche means that defaults/deferrals have reached such a level that the tranche would not receive all of its contractual cash flows (principal and interest) by maturity (so not just a temporary interest shortfall, but an actual loss in yield on the investment). In other words, the magnitude of the defaults/deferrals has depleted all of the credit enhancement (excess interest and over-collateralization) beneath the given tranche. This represents additional defaults beyond those assumed in our cash flow modeling.

 

(2) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity

 

(3) Pre-tax

Five of the trust preferred securities owned by Sonabank have not continued to pay principal and interest in accordance with the contractual terms of the securities. MMC Funding XVIII continues to defer interest payments since the fourth quarter of 2008. TRAP XII, TRAP XIII, ALESCO XV and ALESCO XVI have had new deferrals which caused failures in senior class principal coverage tests during the second quarter of 2009. When this happens the cash flows to the lower classes are temporarily suspended and used to pay down the principal of the senior classes in order to restore the over-collateralization levels of the senior classes. The bonds will continue to accrue interest, but it will be capitalized rather than paid in cash, also known as payment in kind. Interest will be earned on the capitalized interest at the current coupon rate. Once the senior class coverage test is satisfied, the lower classes will begin to receive current interest as well as capitalized interest.

 

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Management has evaluated each of these securities for potential impairment under EITF 99-20-1 and the most recently issued FSP guidance described in Note 1 and has reviewed each of the issues’ collateral participants using various techniques including the ratings provided in the Bank Financial Quarterly published by IDC Financial Publishing, Inc. Management has also reviewed the interest and principal coverage of each of the tranches it owns. In performing a detailed cash flow analysis of each security, management works with independent third parties to identify its best estimate of the cash flow estimated to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following assumptions:

 

   

Unless the company has received funding under TARP, we assume that all of the issuers rated 1 by IDC Financial Publishing that have not already defaulted will default immediately with 100% loss.

 

   

We assume that annual defaults for the remaining life of each security will be 37.5 basis points. According to FTN Financial: “The FDIC lists the number of bank failures each year from 1934-2008. Comparing bank failures to the number of FDIC institutions produces an annual average default rate of 36 basis points.”

 

   

We assume recoveries ranging from 0% to 75% on deferrals after two years depending on the IDC rating of the deferring entity.

 

   

We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security. According to FTN Financial: “Prepayments were common in 2006 and 2007 when issuers were able to refinance into lower cost borrowings. That was a much different environment than today and most parties expect prepayments to be very low absent a change in credit conditions.”

 

   

Our securities have been modeled using the above assumptions by Sandler O’Neill or FTN Financial using the forward LIBOR curve plus original spread to discount projected cash flows to present values.

Management’s analysis in the second quarter deemed three of the ten trust preferred securities we own other than temporarily impaired. The cash flow analysis this quarter indicated that one security, ALESCO XV C1 would probably experience significant credit losses. Two others, ALESCO V C1 and ALESCO XVI C, would probably experience minor credit losses. We have recorded OTTI charges accordingly. The credit portion of the OTTI was recognized in net income and the remainder through other comprehensive income.

Trust preferred securities which are issued by financial institutions and insurance companies are classified as held-to-maturity securities. The decline in the level of observable inputs and market activity in this class of investments by the measurement date has been significant and resulted in unreliable external pricing. Broker pricing and bid/ask spreads, when available, vary widely. The once active market has become comparatively inactive. As such, management utilized guidance in FSP FAS 157-4 to value these securities. The pricing for these securities utilized a discount rate from the Bloomberg Fair Value Index yield curve for single issuer trust preferred securities with similar ratings, interest rates and maturity dates (an observable input). In addition a liquidity premium was utilized to take into account liquidity risk (a management estimate and thus an unobservable input). Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.

 

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We also own $2.2 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was downgraded from AAA to B by Standard and Poors in June 2009, but has been rated BBB by Fitch since the fourth quarter of 2008. This security was originated in 2005. The average FICO score of the underlying loans at origination was 748. As of June 30, 2009, delinquencies of more than 60 days, foreclosures and REO totaled 27.5% compared to 23.2% at March 31, 2009. Credit support is 13.9 compared to 14 when originally issued, which provides coverage of 1.54 times projected losses in the collateral. The fair market value is $1.2 million. We have evaluated this security for potential impairment and determined that an OTTI does not exist as of June 30, 2009.

We own 80,000 shares of the Freddie Mac perpetual preferred stock Series V. We have recorded total OTTI charges on this security of $1.976 million during 2008 and 2007. The fair value at June 30, 2009 was $35 thousand.

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 credit from the Federal Home Loan Bank of Atlanta and utilize securities sold under agreements to repurchase from approved securities dealers and retail customers.

Due to the uncertain economic environment, we have maintained much more cash in interest-earning accounts at the FRB and the FHLB during the fourth quarter of 2008 and the first six months of 2009 than we usually do. The average balance held in these interest-earning accounts was $10.1 million, $14.5 million and $14.1 million during the quarters ended June 30 and March 31, 2009 and December 31, 2008, respectively. The balance as of June 30, 2009 was down to $5.7 million.

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. Management anticipates that future funding requirements will be met from the normal sources of funds.

 

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Table of Contents

Capital Resources

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

 

     Actual     Required For
Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
     Amount    Ratio     Amount    Ratio     Amount    Ratio  
June 30, 2009                
SNBV                

Tier 1 risk-based capital ratio

   $ 59,484    15.14   $ 15,718    4.00     N/A    N/A   

Total risk-based capital ratio

     64,055    16.30     31,435    8.00     N/A    N/A   

Leverage ratio

     59,484    14.04     16,953    4.00     N/A    N/A   
Sonabank                

Tier 1 risk-based capital ratio

   $ 57,048    14.52   $ 15,714    4.00   $ 23,571    6.00

Total risk-based capital ratio

     61,619    15.69     31,428    8.00     39,285    10.00

Leverage ratio

     57,048    13.46     16,953    4.00     21,191    5.00
December 31, 2008                
SNBV                

Tier 1 risk-based capital ratio

   $ 58,495    17.46   $ 13,404    4.00     N/A    N/A   

Total risk-based capital ratio

     62,684    18.71     26,808    8.00     N/A    N/A   

Leverage ratio

     58,495    13.71     17,063    4.00     N/A    N/A   
Sonabank                

Tier 1 risk-based capital ratio

   $ 56,055    16.73   $ 13,402    4.00   $ 20,103    6.00

Total risk-based capital ratio

     60,243    17.98     26,804    8.00     33,505    10.00

Leverage ratio

     56,055    13.14     17,063    4.00     21,329    5.00

The most recent regulatory notification categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed the Bank’s category.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are engaged primarily in the business of investing funds obtained from deposits and borrowings into interest-earning loans and investments. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between the interest income on loans and other investments and the interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-earning assets, we are subject to interest rate risk and corresponding fluctuations in net interest income. We have employed asset/liability management policies that seek to manage our interest income, without having to incur unacceptable levels of credit or investment risk.

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

The following tables are based on an analysis prepared by FTN Financial setting forth an analysis of our interest rate risk as measured by the estimated change in MVPE resulting from instantaneous and sustained parallel shifts in the yield curve (plus or minus 300 basis points, measured in 100 basis point increments) as of June 30, 2009 and December 31, 2008:

 

     Sensitivity of Market Value of Portfolio Equity
As of June 30, 2009
 

Change in

Interest Rates

in Basis Points

(Rate Shock)

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

Up 300

   $ 64,702    $ (2,336   -3.48   14.95   95.79

Up 200

     66,097      (941   -1.40   15.27   97.85

Up 100

     67,026      (12   -0.02   15.49   99.23

Base

     67,038      —        0.00   15.49   99.24

Down 100

     64,851      (2,187   -3.26   14.99   96.01

Down 200

     63,086      (3,952   -5.90   14.58   93.39

Down 300

     61,871      (5,167   -7.71   14.30   91.60

 

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Table of Contents
     Sensitivity of Market Value of Portfolio Equity
As of December 31, 2008
 

Change in

Interest Rates

in Basis Points

(Rate Shock)

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

Up 300

   $ 58,494    $ (148   -0.25   13.54   85.05

Up 200

     59,229    $ 587      1.00   13.71   86.12

Up 100

     59,369    $ 727      1.24   13.75   86.32

Base

     58,642    $ —        0.00   13.58   85.27

Down 100

     55,649    $ (2,993   -5.10   12.88   80.91

Down 200

     53,797    $ (4,845   -8.26   12.46   78.22

Down 300

     53,535    $ (5,107   -8.71   12.39   77.84

Our interest rate sensitivity is also monitored by management through the use of a model run by FTN Financial that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. In this regard, the model assumes that the composition of our interest sensitive assets and liabilities existing at June 30, 2009 and December 31, 2008 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 June 30, 2009
 

Change in

Interest Rates

in Basis Points

(Rate Shock)

   Adjusted Net Interest Income    Net Interest Margin  
   Amount    $ Change
From Base
   Percent     % Change
From Base
 
     (Dollar amounts in thousands)  

Up 300

   $ 15,950    $ 1,082    3.97   0.26

Up 200

     15,684      816    3.90   0.19

Up 100

     15,376      508    3.83   0.12

Base

     14,868      —      3.71   0.00

Down 100

     15,609      741    3.89   0.18

Down 200

     15,812      944    3.94   0.23

Down 300

     15,903      1,035    3.96   0.25

 

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Table of Contents

Change in

Interest Rates

in Basis Points

(Rate Shock)

   Sensitivity of Net Interest Income
As of December 31, 2008
 
   Adjusted Net Interest Income    Net Interest Margin  
   Amount    $ Change
From Base
   Percent     % Change
From Base
 
     (Dollar amounts in thousands)  

Up 300

   $ 13,134    $ 1,682    3.31   0.42

Up 200

     12,609      1,157    3.18   0.29

Up 100

     12,058      606    3.05   0.16

Base

     11,452      —      2.89   0.00

Down 100

     12,205      753    3.08   0.19

Down 200

     12,892      1,440    3.25   0.36

Down 300

     12,891      1,439    3.25   0.36

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

 

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Table of Contents

ITEM 4 – CONTROLS AND PROCEDURES

Under the supervision and with the participation of management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are effective. There were no significant changes in our internal controls or in other factors that could significantly affect these controls subsequent to the date of their evaluation.

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.

PART II – OTHER INFORMATION

ITEM 1 – LEGAL PROCEEDINGS

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

ITEM 1A – RISK FACTORS

As of June 30, 2009 there were no material changes to the risk factors previously disclosed on our Annual Report on Form 10-K for the year ended December 31, 2008.

ITEM 4 – SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

SNBV held its Annual Meeting of Stockholders on April 23, 2009, at which time stockholders were asked to consider two proposals, as follows:

 

  1. To elect two directors to serve as Class III directors for a three-year term; and

 

  2. To ratify the appointment of Crowe Horwath LLP as the independent registered public accounting firm of the Company for the year ending December 31, 2009.

The vote tabulation was as follows:

 

  1. Election of two Class III directors to serve for a term of three years:

 

Director

   Votes For    Votes Withheld

Georgia S. Derrico

   5,502,347    123,101

Charles A. Kabbash

   5.502,017    123,431

The following directors’ terms of office continued after the meeting:

Frederick L. Bollerer

Neil J. Call

John J. Forch

R. Roderick Porter

Robin R. Shield

 

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Table of Contents
  2. To ratify the appointment of Crowe Horwath LLP as the independent registered public accounting firm of the Company for 2009:

 

Votes For

 

Votes Against

 

Abstain

5,625,448   0   0

ITEM 6 - EXHIBITS

(a) Exhibits.

The following exhibits are filed as part of this Form 10-Q and this list includes the Exhibit Index:

 

Exhibit No.

  

Description

31.1    Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
31.2    Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
32.1    Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.

 

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Table of Contents

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

    Southern National Bancorp of Virginia, Inc.
   

    (Registrant)

August 14, 2009     /s/ Georgia S. Derrico
            (Date)    

       Georgia S. Derrico,

       Chairman of the Board and Chief Executive Officer

August 14, 2009     /s/ William H. Lagos
            (Date)    

       William H. Lagos,

       Senior Vice President and Chief Financial Officer

 

38