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Primis Financial Corp. - Quarter Report: 2011 June (Form 10-Q)

t71227_10q.htm


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, 2011
 
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 o                      
 
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 o                                            NO o
 
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 o      Accelerated filer x   Smaller reporting company o
 
Non-accelerated filer o (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 o   No x
 
As of July 29, 2011, there were 11,590,212 shares of common stock outstanding.

 
 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
FORM 10-Q
June 30, 2011
 
INDEX
 
     
PAGE
         
     
         
Item 1 - Financial Statements      
   
2
 
   
3
 
   
4
 
   
5
 
   
6- 22
 
       
 
23- 35
 
       
 
36-38
 
       
 
39
 
       
     
       
 
39
 
       
 
39
 
       
 
39
 
       
 
39
 
       
 
39
 
       
 
39
 
       
 
40
 
       
 
41
 
       
Certifications
 
42-44
 
 
 
 

 
 
ITEM I - FINANCIAL INFORMATION
PART I - FINANCIAL STATEMENTS
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts) (Unaudited)
 
   
June 30,
   
December 31,
 
   
2011
   
2010
 
ASSETS
           
Cash and cash equivalents:
           
Cash and due from financial institutions
  $ 2,191     $ 2,180  
Interest-bearing deposits in other financial institutions
    1,495       7,565  
Total cash and cash equivalents
    3,686       9,745  
                 
Securities available for sale, at fair value
    10,751       11,068  
                 
Securities held to maturity, at amortized cost
(fair value of $39,791 and $43,965, respectively)
    40,021       44,895  
                 
Covered loans
    82,935       92,171  
 Non-covered loans
    394,052       367,266  
Total loans
    476,987       459,437  
Less allowance for loan losses
    (6,063 )     (5,599 )
Net loans
    470,924       453,838  
                 
Stock in Federal Reserve Bank and Federal Home Loan Bank
    5,972       6,350  
Bank premises and equipment, net
    4,691       4,659  
Goodwill
    8,713       8,713  
Core deposit intangibles, net
    2,455       2,915  
FDIC indemnification asset
    18,088       18,536  
Bank-owned life insurance
    14,310       14,568  
Other real estate owned
    9,613       4,577  
Deferred tax assets, net
    4,128       3,782  
Other assets
    8,035       7,178  
                 
Total assets
  $ 601,387     $ 590,824  
                 
LIABILITIES AND STOCKHOLDERS’ EQUITY
               
                 
Noninterest-bearing demand deposits
  $ 33,917     $ 34,529  
Interest-bearing deposits:
               
NOW accounts
    15,013       15,961  
Money market accounts
    141,928       169,861  
Savings accounts
    5,814       5,490  
Time deposits
    237,319       205,133  
Total interest-bearing deposits
    400,074       396,445  
Total deposits
    433,991       430,974  
                 
Securities sold under agreements to repurchase and other
short-term borrowings
    19,968       23,908  
Federal Home Loan Bank (FHLB) advances
    43,500       35,000  
Other liabilities
    2,128       1,828  
Total liabilities
    499,587       491,710  
                 
Commitments and contingencies (See Note 5)
    -       -  
                 
Stockholders’ equity:
               
Preferred stock, $.01 par value.  Authorized 5,000,000 shares;
no shares issued and outstanding
    -       -  
Common stock, $.01 par value.  Authorized 45,000,000 shares;
issued and outstanding, 11,590,212 shares at June 30, 2011 and December 31, 2010
    116       116  
Additional paid in capital
    96,551       96,478  
Retained earnings
    8,285       5,854  
Accumulated other comprehensive loss
    (3,152 )     (3,334 )
 Total stockholders’ equity
    101,800       99,114  
                 
Total liabilities and stockholders’ equity
  $ 601,387     $ 590,824  
 
See accompanying notes to consolidated financial statements.
 
 
2

 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
(dollars in thousands, except per share amounts) (Unaudited)
 
   
For the Three Months Ended
   
For the Six Months Ended
 
   
June 30,
   
June 30,
 
                         
   
2011
   
2010
   
2011
   
2010
 
                         
Interest and dividend income:
                       
 Interest and fees on loans
  $ 7,210     $ 7,829     $ 14,331     $ 15,443  
 Interest and dividends on taxable securities
    482       684       1,038       1,418  
 Interest and dividends on other earning assets
    51       48       103       91  
 Total interest and dividend income
    7,743       8,561       15,472       16,952  
Interest expense:
                               
 Interest on deposits
    1,249       1,790       2,526       3,593  
 Interest on borrowings
    267       330       585       657  
 Total interest expense
    1,516       2,120       3,111       4,250  
                                 
 Net interest income
    6,227       6,441       12,361       12,702  
                                 
Provision for loan losses
    2,250       1,450       3,590       2,750  
 
                               
 Net interest income after provision for loan losses
    3,977       4,991       8,771       9,952  
                                 
Noninterest income:
                               
 Account maintenance and deposit service fees
    218       235       418       476  
 Income from bank-owned life insurance
    933       137       1,067       276  
 Net gain (loss) on other real estate owned
    (108 )     19       (147 )     39  
 Total other-than-temporary impairment losses (OTTI)
    (38 )     (4 )     (70 )     (10 )
 Portion of OTTI recognized in other comprehensive income (before taxes)
    -       -       -       -  
 Net credit related OTTI recognized in earnings
    (38 )     (4 )     (70 )     (10 )
 Other
    44       148       89       293  
                                 
 Total noninterest income
    1,049       535       1,357       1,074  
                                 
Noninterest expenses:
                               
 Salaries and benefits
    1,705       1,523       3,308       3,164  
 Occupancy expenses
    554       527       1,093       1,069  
 Furniture and equipment expenses
    131       151       267       305  
 Amortization of core deposit intangible
    230       236       460       472  
 Virginia franchise tax expense
    171       184       343       368  
FDIC assessment
    119       212       272       401  
 Data processing expense
    132       159       274       314  
 Telephone and communication expense
    100       101       188       220  
 Change in FDIC indemnification asset
    (192 )     406       (351 )     650  
 Other operating expenses
    543       528       1,093       1,042  
 Total noninterest expenses
    3,493       4,027       6,947       8,005  
Income before income taxes
    1,533       1,499       3,181       3,021  
Income tax expense
    222       474       750       955  
 Net income
  $ 1,311     $ 1,025     $ 2,431     $ 2,066  
Other comprehensive income:
                               
Unrealized gain on available for sale securities
  $ 101     $ 161     $ 197     $ 222  
Realized amount on securities sold, net
    -       -       -       -  
Non-credit component of other-than-temporary impairment on held-to-maturity securities
    41       33       96       109  
Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for-sale
    (6 )     (31 )     (17 )     (61 )
Net unrealized gain
    136       163       276       270  
Tax effect
    46       55       94       91  
Other comprehensive income
    90       108       182       179  
Comprehensive income
  $ 1,401     $ 1,133     $ 2,613     $ 2,245  
Earnings per share, basic and diluted
  $ 0.11     $ 0.09     $ 0.21     $ 0.18  
 
See accompanying notes to consolidated financial statements.
 
 
3

 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
FOR THE SIX MONTHS ENDED JUNE 30, 2011
(dollars in thousands, except per share amounts) (Unaudited)
 
                     
Accumulated
             
         
Additional
         
Other
             
   
Common
   
Paid in
   
Retained
   
Comprehensive
   
Comprehensive
       
   
Stock
   
Capital
   
Earnings
   
Loss
   
Income
   
Total
 
                                     
Balance - January 1, 2011
  $ 116     $ 96,478     $ 5,854     $ (3,334 )         $ 99,114  
                                               
Comprehensive income:
                                             
                                               
Net income
                    2,431             $ 2,431       2,431  
Change in unrealized gain on available for sale securities (net of tax, $67)
                            130       130       130  
Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $27 and accretion, $17 and amounts recorded into other comprehensive income at transfer)
                            52       52       52  
                                                 
Total comprehensive income
                                  $ 2,613          
                                                 
Stock-based compensation expense
            73                               73  
                                                 
Balance - June 30, 2011
  $ 116     $ 96,551     $ 8,285     $ (3,152 )           $ 101,800  
 
See accompanying notes to consolidated financial statements.
 
 
4

 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE SIX MONTHS ENDED JUNE 30, 2011 AND 2010
(dollars in thousands) (Unaudited)
 
   
2011
 
2010
 
               
Operating activities:
             
Net income
 
$
2,431
 
$
2,066
 
Adjustments to reconcile net income to net cash and cash equivalents provided  by operating activities:
             
Depreciation
   
253
   
276
 
Amortization of core deposit intangible
   
460
   
472
 
Other amortization, net
   
(23
)
 
88
 
(Increase) decrease in FDIC indemnification asset
   
(351
)
 
650
 
Provision for loan losses
   
3,590
   
2,750
 
Earnings on bank-owned life insurance
   
(1,067
)
 
(276
)
Stock based compensation expense
   
73
   
35
 
Impairment on securities
   
70
   
10
 
Net (gain) loss on other real estate owned
   
147
   
(39
)
Net increase in other assets
   
(59
)
 
(1,685
)
Net increase (decrease) in other liabilities
   
300
   
(3,014
)
Net cash and cash equivalents provided by operating activities
   
5,824
   
1,333
 
Investing activities:
             
Proceeds from paydowns, maturities and calls of securities available for sale
   
489
   
1,126
 
Proceeds from paydowns, maturities and calls of securities held to maturity
   
5,056
   
5,308
 
Loan originations and payments, net
   
(26,668
)
 
(5,940
)
Net (increase) decrease in stock in Federal Reserve Bank and Federal Home Loan Bank
   
378
   
(835
)
Payments received on FDIC indemnification asset
   
799
   
-
 
Proceeds from sale of other real estate owned
   
771
   
583
 
Purchases of bank premises and equipment
   
(285
)
 
(1,826
)
Net cash and cash equivalents used in investing activities
   
(19,460
)
 
(1,584
)
Financing activities:
             
Net increase (decrease) in deposits
   
3,017
   
(76
)
Proceeds from Federal Home Loan Bank advances
   
8,500
   
5,000
 
Net decrease  in securities sold under agreement to repurchase and other short-term borrowings
   
(3,940
)
 
(1,646
)
Additional cost of 2009 common stock issuance
   
-
   
(48
)
Net cash and cash equivalents provided by financing activities
   
7,577
   
3,230
 
Increase (decrease) in cash and cash equivalents
   
(6,059
)
 
2,979
 
Cash and cash equivalents at beginning of period
   
9,745
   
8,070
 
Cash and cash equivalents at end of period
 
$
3,686
 
$
11,049
 
Supplemental Disclosure of Cash Flow Information
             
Cash payments for:
             
Interest
 
$
3,250
 
$
4,566
 
Income taxes
   
825
   
880
 
Supplemental schedule of noncash investing and financing activities
             
Transfer from non-covered loans to other real estate owned
   
5,910
   
2,352
 
Transfer from covered loans to other real estate owned
   
82
   
-
 
 
See accompanying notes to consolidated financial statements.
 
 
5

 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2011
 
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 Virginia state chartered bank which commenced operations on April 14, 2005.  The principal activities of Sonabank are to attract deposits and originate loans as permitted under applicable banking regulations.  Sonabank operates 13 branches in Virginia located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Loudoun County (Middleburg, Leesburg (2), and South Riding), Front Royal, New Market and Clifton Forge, and we also have a branch in Rockville, Maryland.
 
The consolidated financial statements include the accounts of Southern National Bancorp of Virginia, Inc. and its subsidiary.  Significant inter-company accounts and transactions have been eliminated in consolidation.
 
The unaudited consolidated financial statements have been prepared in accordance with U. S. generally accepted accounting principles (“U. S. GAAP”) for interim financial information and instructions for Form 10-Q and follow general practice within the banking industry.  Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by U. S. GAAP for complete financial statements.  However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in SNBV’s Form 10-K for the year ended December 31, 2010.
 
Use of Estimates
 
The preparation of the consolidated financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the carrying value of investment securities, other than temporary impairment of investment securities, the valuation of goodwill and intangible assets, the FDIC indemnification asset,  mortgage servicing rights, other real estate owned and deferred tax assets.
 
Reclassifications
 
Some items in the prior year financial statements were reclassified to conform to the current presentation, and the reclassifications had no impact on prior period net income or shareholders’ equity.
 
 
6

 
 
Recent Accounting Pronouncements
 
In April 2011, the FASB issued ASU No. 2011-02, Receivables (Topic 310):  A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring. This amendment clarifies the guidance on the evaluation made by a creditor on whether a restructuring constitutes a troubled debt restructuring.  It clarifies the guidance related to a creditor’s evaluation of whether it has granted a concession to a debtor and also clarifies the guidance on a creditor’s evaluation of whether the debtor is experiencing financial difficulties.  The amendment is effective for public entities for the first interim or annual period beginning on or after June 15, 2011, and should be applied retrospectively to the beginning of the annual period of adoption.  The disclosures required which were deferred by ASU No. 2011-01, Receivables (Topic 310): Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20, is effective for interim and annual periods beginning on or after June 15, 2011, and we will adopt the standard effective for the third quarter.  The adoption of this standard is not expected to have a material impact on our consolidated financial condition or results of operation.
 
2.   STOCK- BASED COMPENSATION
 
In 2004, the Board of Directors adopted a stock option plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and employees.  As of June 30, 2011, options to purchase an aggregate of 302,500 shares of common stock were outstanding and no shares remained available for issuance. The 2010 Stock Awards and Incentive Plan was approved by the Board of Directors in January 2010 and approved by the stockholders at the Annual Meeting in April 2010. The 2010 plan authorized the reservation of 700,000 shares of common stock for the granting of stock awards. The options granted to officers and employees are incentive stock options and the options granted to non-employee directors are non-qualified stock options.  The purpose of the plan is to afford key employees an incentive to remain in the employ of SNBV and to assist in the attracting and retaining of non-employee directors by affording them an opportunity to share in SNBV’s future success.  Under the plan, the option’s price cannot be less than the fair market value of the stock on the grant date.  The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule.
 
SNBV granted 103,750 options during the first six months of 2011. The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model.  The following weighted-average assumptions were used to value options granted in the six months ended June 30, 2011:
 
   
2011
 
Dividend yield
    0.00%  
Expected life
 
10 years
 
Expected volatility
    46.13%  
Risk-free interest rate
    3.34%  
Weighted average fair value per option granted
  $ 4.39  
 
 
We have paid no dividends.
 
 
Due to SNBV’s short existence, the volatility was estimated using historical volatility of comparative publicly traded financial institutions in the Virginia market combined with that of SNBV.
 
 
7

 
 
 
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, 2011, stock-based compensation expense was $47 thousand and $73 thousand, respectively, compared to $18 thousand and $35 thousand for the same periods last year.  As of June 30, 2011, unrecognized compensation expense associated with the stock options was $700 thousand, which is expected to be recognized over a weighted average period of 4.1 years.
 
A summary of the activity in the stock option plan during the three months ended June 30, 2011 follows (dollars in thousands):
 
               
Weighted
       
         
Weighted
   
Average
       
         
Average
   
Remaining
   
Aggregate
 
         
Exercise
   
Contractual
   
Intrinsic
 
   
Shares
   
Price
   
Term
   
Value
 
Options outstanding, beginning of period
    312,675     $ 8.35              
Granted
    103,750       7.20              
Forfeited
    -       -              
Exercised
    -       -              
Options outstanding, end of period
    416,425     $ 8.06       6.8     $ 52  
                                 
Vested or expected to vest
    416,425     $ 8.06       6.8     $ 52  
                                 
Exercisable at end of period
    207,745     $ 8.90       4.6     $ 21  
 
3.   SECURITIES
 
The amortized cost and fair value of securities available-for-sale were as follows (in thousands):
 
     
Amortized
   
Gross Unrealized
   
Fair
 
 
June 30, 2011
 
Cost
   
Gains
   
Losses
   
Value
 
 
SBA guaranteed loan pools
  $ 10,308     $ 278     $ -       10,586  
 
FHLMC preferred stock
    16       149       -       165  
 
Total
  $ 10,324     $ 427     $ -     $ 10,751  
                                   
     
Amortized
   
Gross Unrealized
   
Fair
 
 
December 31, 2010
 
Cost
   
Gains
   
Losses
   
Value
 
 
SBA guaranteed loan pools
  $ 10,822     $ 216     $ -       11,038  
 
FHLMC preferred stock
    16       14       -       30  
 
Total
  $ 10,838     $ 230     $ -     $ 11,068  
 
 
8

 
 
The carrying amount and fair value of securities held-to-maturity were as follows (in thousands):
 
   
Amortized
   
Gross Unrecognized
   
Fair
 
June 30, 2011
 
Cost
   
Gains
   
Losses
   
Value
 
Residential government-sponsored mortgage-backed securities
  $ 29,982     $ 1,409     $ -     $ 31,391  
Residential government-sponsored collateralized mortgage obligations
    127       5       -       132  
Other residential collateralized mortgage obligations
    1,040       -       -       1,040  
Trust preferred securities
    8,872       816       (2,460 )     7,228  
    $ 40,021     $ 2,230     $ (2,460 )   $ 39,791  
                                 
   
Amortized
   
Gross Unrecognized
   
Fair
 
December 31, 2010
 
Cost
   
Gains
   
Losses
   
Value
 
Residential government-sponsored mortgage-backed securities
  $ 34,088     $ 1,247     $ -     $ 35,335  
Residential government-sponsored collateralized mortgage obligations
    188       8       -       196  
Other residential collateralized mortgage obligations
    1,166       5       -       1,171  
Trust preferred securities
    9,453       675       (2,865 )     7,263  
    $ 44,895     $ 1,935     $ (2,865 )   $ 43,965  
 
The fair value and carrying amount, if different, of debt securities as of June 30, 2011, by contractual maturity were as follows (in thousands).  Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.
 
   
Held to Maturity
   
Available for Sale
 
   
Amortized
         
Amortized
       
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
Due in one to five years
  $ -     $ -     $ 304     $ 310  
Due in five to ten years
    -       -       1,130       1,154  
Due after ten years
    8,872       7,228       8,874       9,122  
Residential government-sponsored mortgage-backed securities
    29,982       31,391       -       -  
Residential government-sponsored collateralized mortgage obligations
    127       132       -       -  
Other residential collateralized mortgage obligations
    1,040       1,040       -       -  
Total
  $ 40,021     $ 39,791     $ 10,308     $ 10,586  
 
Securities with a carrying amount of approximately $40.7 million and $45.3 million at June 30, 2011 and December 31, 2010, respectively, were pledged to secure public deposits, repurchase agreements and a line of credit for advances from the Federal Home Loan Bank of Atlanta (“FHLB”).
 
SNBV monitors the portfolio for indicators of other than temporary impairment.  At June 30, 2011 and December 31, 2010, certain securities’ fair values were below cost. As outlined in the table below, there were securities with fair values totaling approximately $4.6 million in the portfolio that are considered temporarily impaired at June 30, 2011.  Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, management does not consider these securities to be other-than-temporarily impaired as of June 30, 2011.  The following tables present information regarding securities in a continuous unrealized loss position as of June 30, 2011 and December 31, 2010 (in thousands) by duration of time in a loss position:
 
June 30, 2011
                                   
   
Less than 12 months
   
12 Months or More
   
Total
 
Held to Maturity
 
Fair value
   
Unrecognized Losses
   
Fair value
   
Unrecognized Losses
   
Fair value
   
Unrecognized Losses
 
Trust preferred securities
  $ -     $ -     $ 4,597     $ (2,460 )   $ 4,597     $ (2,460 )
                                                 
December 31, 2010
                                               
                                                 
   
Less than 12 months
   
12 Months or More
   
Total
 
Held to Maturity
 
Fair value
   
Unrecognized Losses
   
Fair value
   
Unrecognized Losses
   
Fair value
   
Unrecognized Losses
 
Trust preferred securities
  $ -     $ -     $ 4,805     $ (2,865 )   $ 4,805     $ (2,865 )
 
 
9

 
 
As of June 30, 2011, we owned pooled trust preferred securities as follows:

                                                     
Previously
       
                                                     
Recognized
       
                                                     
Cumulative
       
     
Ratings
                           
Estimated
   
Current
   
Other
       
 
Tranche
 
When Purchased
   
Current Ratings
         
Fair
   
Defaults and
   
Comprehensive
       
Security
Level
 
Moodys
   
Fitch
   
Moody’s
   
Fitch
   
Par Value
   
Book Value
   
Value
   
Deferrals
   
Loss (1)
       
                             
(in thousands)
                   
ALESCO VII  A1B
Senior
 
Aaa
   
AAA
   
Baa3
   
BB
    $ 7,174     $ 6,420     $ 4,189     $ 209,056     $ 310        
MMCF II B
Senior Sub
    A3    
AA-
   
Baa2
   
BB
      493       455       477       34,000       38        
MMCF III B
Senior Sub
    A3       A-    
Ba1
   
CC
      652       637       408       37,000       14        
                                    8,319       7,512       5,074             $ 362        
                                                                             
                                                                 
Cumulative
   
Cumulative
 
                                                                 
Other Comprehensive
   
OTTI Related to
 
Other Than Temporarily Impaired:
                                                             
Loss (2)
   
Credit Loss (2)
 
TPREF FUNDING II
Mezzanine
    A1       A-    
Caa3
      C       1,500       496       496       131,100       693     $ 311  
TRAP 2007-XII C1
Mezzanine
    A3       A       C       C       2,066       127       352       155,705       1,360       579  
TRAP 2007-XIII D
Mezzanine
 
NR
      A-    
NR
      C       2,032       -       38       231,250       -       2,032  
MMC FUNDING XVIII
Mezzanine
    A3       A-    
Ca
      C       1,050       132       132       111,682       444       474  
ALESCO V C1
Mezzanine
    A2       A    
Ca
      C       2,083       461       537       117,942       961       661  
ALESCO XV C1
Mezzanine
    A3       A-       C       C       3,112       29       159       266,100       524       2,559  
ALESCO XVI  C
Mezzanine
    A3       A-    
Ca
      C       2,072       115       440       149,900       777       1,180  
                                        13,915       1,360       2,154             $ 4,759     $ 7,796  
                                                                                   
Total
                                    $ 22,234     $ 8,872     $ 7,228                          
 
(1)  Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion
(2)  Pre-tax
 
Each of these securities has been evaluated for other than temporary impairment.  In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to estimate expected cash flows and assist with the evaluation of other than temporary impairment. The cash flow analyses performed included the following assumptions:
 
 
We assume that .5% of the remaining performing collateral will default or defer per annum.
 
We assume recoveries ranging from 25% to 47% with a two year lag on all defaults and deferrals.
 
We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security.
 
Additionally banks with assets over $15 billion will no longer be allowed to count down streamed trust preferred proceeds as Tier 1 capital (although it will still be counted as Tier 2 capital). That will incent the large banks to prepay their trust preferred securities if they can or if it is economically desirable. As a consequence we have projected in all of our pools that 25% of the collateral issued by banks with assets over $15 billion will prepay in 2013.
 
Our securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve to discount projected cash flows to present values.
 
These assumptions resulted in OTTI charges related to credit on two of the trust preferred securities in the amount of $38 thousand during the quarter ended June 30, 2011, compared to no OTTI charges related to credit on the trust preferred securities for the quarter ended June 30, 2010.
 
We also own approximately $1.0 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was originally rated AAA by Standard and Poor’s. After a series of downgrades this security has been evaluated for potential impairment. Based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support it has been determined that no OTTI charge for credit was required for the quarter ended June 30, 2011.  The assumptions used in the analysis included a 4.7% prepayment speed, 14% default rate, a 50% loss severity and an accounting yield of 2.55%.  We recorded OTTI charges for credit on this security of $3 thousand in the second quarter of 2010.
 
 
10

 
 
The following table presents a roll forward of the credit losses for the trust preferred securities and the residential collateralized mortgage obligation recognized in earnings for the six months ended June 30, 2011 and 2010 (in thousands):
 
   
2011
   
2010
 
             
Amount of cumulative other-than-temporary impairment related to credit loss prior to January 1
  $ 8,002     $ 7,714  
Amounts related to credit loss for which an other-than-temporary impairment was previously recognized
    70       10  
                 
Amount of cumulative other-than-temporary impairment related to credit loss as of June 30
  $ 8,072     $ 7,724  
 
4.   LOANS AND ALLOWANCE FOR LOAN LOSSES
 
The following table summarizes the composition of our loan portfolio as of June 30, 2011 and December 31, 2010:
 
   
Covered
   
Non-covered
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans
   
Loans
   
Loans
   
Loans
   
Loans
   
Loans
 
   
June 30, 2011
   
December 31, 2010
 
Mortgage loans on real estate:
                                   
Commercial real estate - owner-occupied
  $ 4,703     $ 94,137     $ 98,840     $ 5,246     $ 81,487     $ 86,733  
Commercial real estate - non-owner-occupied
    10,412       87,323       97,735       13,898       76,068       89,966  
Secured by farmland
    -       3,503       3,503       -       3,522       3,522  
Construction and land loans
    849       33,599       34,448       1,098       39,480       40,578  
Residential 1-4 family
    27,615       54,562       82,177       29,935       58,900       88,835  
Multi- family residential
    553       22,227       22,780       563       19,177       19,740  
Home equity lines of credit
    37,954       9,308       47,262       40,287       10,532       50,819  
Total real estate loans
    82,086       304,659       386,745       91,027       289,166       380,193  
                                                 
Commercial loans
    713       88,251       88,964       998       76,644       77,642  
Consumer loans
    136       1,997       2,133       146       2,010       2,156  
Gross loans
    82,935       394,907       477,842       92,171       367,820       459,991  
                                                 
Less deferred fees on loans
    -       (855 )     (855 )     -       (554 )     (554 )
Loans, net of unearned income
  $ 82,935     $ 394,052     $ 476,987     $ 92,171     $ 367,266     $ 459,437  
 
As part of the Greater Atlantic acquisition, the Bank and the FDIC entered into a loss sharing agreement on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets.  The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.”  Loans not acquired from Greater Atlantic Bank are referred to as “non-covered loans.” The covered loans are subject to our internal and external credit review. As a result, if and when credit deterioration is noted subsequent to the acquisition date, such deterioration will be measured through our allowance for loan loss calculation methodology and a provision for credit losses will be charged to earnings. There has been no incremental provision recorded on covered loans since acquisition.  The FDIC indemnification asset is reduced for cash payments received, and adjusted each quarter for changes in expected recoveries from the FDIC based on the expected cash flows from the covered loans.  The adjustment amount is recorded through earnings.  As information and other developments warrant, we reassess our anticipated recoveries from the FDIC on the covered loans and adjust the carrying value of the FDIC indemnification asset through earnings.
 
 
11

 

Credit-impaired covered loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, that SNBV will not collect all contractually required principal and interest payments. Generally, acquired loans that meet SNBV’s definition for nonaccrual status fall within the definition of credit-impaired covered loans.
 
Impaired loans were as follows (in thousands):
 
June 30, 2011
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
         
Allowance
         
Allowance
         
Allowance
 
   
Recorded
   
for Loan
   
Recorded
   
for Loan
   
Recorded
   
for Loan
 
   
Investment
   
Losses Allocated
   
Investment (1)
   
Losses Allocated
   
Investment
   
Losses Allocated
 
With no related allowance recorded
                                   
Commercial real estate - owner occupied
  $ 245     $ -     $ 5,333     $ -     $ 5,578     $ -  
Commercial real estate - non-owner occupied (2)
    1,854       -       5,769       -       7,623       -  
Construction and land development
    745       -       2,821       -       3,566       -  
Commercial loans
    215       -       11,067       -       11,282       -  
Residential 1-4 family
    762       -       4,339       -       5,101       -  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,821     $ -     $ 29,329     $ -     $ 33,150     $ -  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ -             $ -     $ -  
Commercial real estate - non-owner occupied (2)
    -       -       -               -       -  
Construction and land development
    -       -       1,994       52       1,994       52  
Commercial loans
    -       -       1,617       527       1,617       527  
Residential 1-4 family
    -       -       -       -       -       -  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 3,611     $ 579     $ 3,611     $ 579  
Grand total
  $ 3,821     $ -     $ 32,940     $ 579     $ 36,761     $ 579  
 
(1) Recorded investment is after charge offs of $3.2 million and includes SBA guarantees of $2.0 million.
(2) Includes loans secured by farmland and multi-family residential loans.

December 31, 2010
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
         
Allowance
         
Allowance
         
Allowance
 
   
Recorded
   
for Loan
   
Recorded
   
for Loan
   
Recorded
   
for Loan
 
   
Investment
   
Losses Allocated
   
Investment (1)
   
Losses Allocated
   
Investment
   
Losses Allocated
 
With no related allowance recorded
                                   
Commercial real estate - owner occupied
  $ 141     $ -     $ 358     $ -     $ 499     $ -  
Commercial real estate - non-owner occupied (2)
    1,807       -       5,508       -       7,315       -  
Construction and land development
    1,055       -       4,844       -       5,899       -  
Commercial loans
    285       -       1,558       -       1,843       -  
Residential 1-4 family
    108       -       2,969       -       3,077       -  
Other consumer loans
    77       -       -       -       77       -  
                                                 
Total
  $ 3,473     $ -     $ 15,237     $ -     $ 18,710     $ -  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ -     $ -     $ -     $ -  
Commercial real estate - non-owner occupied (2)
    -       -       1,076       50       1,076       50  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       935       376       935       376  
Residential 1-4 family
    -       -       4,564       20       4,564       20  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 6,575     $ 446     $ 6,575     $ 446  
Grand total
  $ 3,473     $ -     $ 21,812     $ 446     $ 25,285     $ 446  
 
(1) Recorded investment is after charge offs of $7.8 million and includes SBA guarantees of $1.7 million.
(2) Includes loans secured by farmland and multi-family residential loans.
 
 
12

 
 
The following table presents the average recorded investment and interest income for impaired loans recognized by class of loans for the six months ended June 30, 2011 (in thousands):
 
   
Covered Loans
   
Non-covered Loans
   
Total Loans
 
   
Average
   
Interest
   
Average
   
Interest
   
Average
   
Interest
 
   
Recorded
   
Income
   
Recorded
   
Income
   
Recorded
   
Income
 
   
Investment
   
Recognized
   
Investment
   
Recognized
   
Investment
   
Recognized
 
With no related allowance recorded
                                   
Commercial real estate - owner occupied
  $ 155     $ 10     $ 1,159     $ 11     $ 1,314     $ 21  
Commercial real estate - non-owner occupied (2)
    1,750       42       4,915       89       6,665       131  
Construction and land development
    750       51       1,937       52       2,687       103  
Commercial loans
    218       11       2,518       7       2,736       18  
Residential 1-4 family
    377       3       4,671       149       5,048       152  
Other consumer loans
                    -       -       -       -  
                                                 
Total
  $ 3,250     $ 117     $ 15,200     $ 308     $ 18,450     $ 425  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ -     $ -     $ -     $ -  
Commercial real estate - non-owner occupied (2)
    -       -       -       -       -       -  
Construction and land development
    -       -       2,011       63       2,011       63  
Commercial loans
    -       -       1,441       26       1,441       26  
Residential 1-4 family
    -       -       -       -       -       -  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 3,452     $ 89     $ 3,452     $ 89  
Grand total
  $ 3,250     $ 117     $ 18,652     $ 397     $ 21,902     $ 514  
 
(2) Includes loans secured by farmland and multi-family residential loans.
 
The following tables present the recorded investment in nonaccrual and loans past due over 90 days and still accruing by class of loans as of June 30, 2011 and December 31, 2010 (in thousands):

June 30, 2011
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
         
Loans Past Due
         
Loans Past Due
         
Loans Past Due
 
   
Nonaccrual
   
90 Days or More
   
Nonaccrual
   
90 Days or More
   
Nonaccrual
   
90 Days or More
 
   
Loans
   
Still on Accrual
   
Loans
   
Still on Accrual
   
Loans
   
Still on Accrual
 
Commercial real estate - owner occupied
  $ 106     $ -     $ 511     $ -     $ 617     $ -  
Commercial real estate - non-owner occupied (1)
    1,985       -       1,304       -       3,289       -  
Construction and land development
    -       -       204       -       204       -  
Commercial loans
    -       -       2,062       -       2,062       -  
Residential 1-4 family
    762       318       3,537       -       4,299       318  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 2,853     $ 318     $ 7,618     $ -     $ 10,471     $ 318  
                                                 
December 31, 2010
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
           
Loans Past Due
           
Loans Past Due
           
Loans Past Due
 
   
Nonaccrual
   
90 Days or More
   
Nonaccrual
   
90 Days or More
   
Nonaccrual
   
90 Days or More
 
   
Loans
   
Still on Accrual
   
Loans
   
Still on Accrual
   
Loans
   
Still on Accrual
 
Commercial real estate - owner occupied
  $ -     $ -     $ 358     $ -     $ 358     $ -  
Commercial real estate - non-owner occupied (1)
    1,796       -       2,600       -       4,396       -  
Construction and land development
    -       -       2,304       -       2,304       -  
Commercial loans
    67       -       1,516       -       1,583       -  
Residential 1-4 family
    108       -       2,807       -       2,915       -  
Other consumer loans
    77       234       -       -       77       234  
                                                 
Total
  $ 2,048     $ 234     $ 9,585     $ -     $ 11,633     $ 234  
                                                 
(1) Includes loans secured by farmland and multi-family residential loans.
   
 
Non-covered nonaccrual loans include SBA guaranteed amounts totaling $2.0 million and $1.4 million at June 30, 2011 and December 31, 2010, respectively.
 
 
13

 
 
The following tables present the aging of the recorded investment in past due loans by class of loans as of June 30, 2011 and December 31, 2010 (in thousands):

June 30, 2011
  30 - 59     60 - 89                                
   
Days
   
Days
   
90 Days
   
Total
   
Nonaccrual
   
Loans Not
   
Total
 
   
Past Due
   
Past Due
   
or More
   
Past Due
   
Loans
   
Past Due
   
Loans
 
Covered loans:
                                             
Commercial real estate - owner occupied
  $ -     $ 408     $ -     $ 408     $ 106     $ 4,189     $ 4,703  
Commercial real estate - non-owner occupied (1)
    138       -       -       138       1,985       8,842       10,965  
Construction and land development
    -       -       -       -       -       849       849  
Commercial loans
    -       -       -       -       -       713       713  
Residential 1-4 family
    -       192       318       510       762       64,297       65,569  
Other consumer loans
    -       2       -       2       -       134       136  
                                                         
Total
  $ 138     $ 602     $ 318     $ 1,058     $ 2,853     $ 79,024     $ 82,935  
                                                         
Non-covered loans:
                                                       
Commercial real estate - owner occupied
  $ 300     $ -     $ -     $ 300     $ 511     $ 93,326     $ 94,137  
Commercial real estate - non-owner occupied (1)
    -       1,983       -       1,983       1,304       109,766       113,053  
Construction and land development
    1,796       -       -       1,796       204       31,599       33,599  
Commercial loans
    1,603       243       -       1,846       2,062       84,343       88,251  
Residential 1-4 family
    1,109       367       -       1,476       3,537       58,857       63,870  
Other consumer loans
    14       1       -       15       -       1,982       1,997  
                                                         
Total
  $ 4,822     $ 2,594     $ -     $ 7,416     $ 7,618     $ 379,873     $ 394,907  
                                                         
Total loans:
                                                       
Commercial real estate - owner occupied
  $ 300     $ 408     $ -     $ 708     $ 617     $ 97,515     $ 98,840  
Commercial real estate - non-owner occupied (1)
    138       1,983       -       2,121       3,289       118,608       124,018  
Construction and land development
    1,796       -       -       1,796       204       32,448       34,448  
Commercial loans
    1,603       243       -       1,846       2,062       85,056       88,964  
Residential 1-4 family
    1,109       559       318       1,986       4,299       123,154       129,439  
Other consumer loans
    14       3       -       17       -       2,116       2,133  
                                                         
Total
  $ 4,960     $ 3,196     $ 318     $ 8,474     $ 10,471     $ 458,897     $ 477,842  
 
December 31, 2010
  30 - 59     60 - 89                                          
   
Days
   
Days
   
90 Days
   
Total
   
Nonaccrual
   
Loans Not
   
Total
 
   
Past Due
   
Past Due
   
or More
   
Past Due
   
Loans
   
Past Due
   
Loans
 
Covered loans:
                                                       
Commercial real estate - owner occupied
  $ 316     $ 412     $ -     $ 728     $ -     $ 4,518     $ 5,246  
Commercial real estate - non-owner occupied (1)
    436       -       -       436       1,796       12,229       14,461  
Construction and land development
    -       -       -       -       -       1,098       1,098  
Commercial loans
    -       -       -       -       67       931       998  
Residential 1-4 family
    -       134       -       134       108       29,693       29,935  
Other consumer loans
    -       39       234       273       77       40,083       40,433  
                                                         
Total
  $ 752     $ 585     $ 234     $ 1,571     $ 2,048     $ 88,552     $ 92,171  
                                                         
Non-covered loans:
                                                       
Commercial real estate - owner occupied
  $ 551     $ 719     $ -     $ 1,270     $ 358     $ 79,859     $ 81,487  
Commercial real estate - non-owner occupied (1)
    868       -       -       868       2,600       95,299       98,767  
Construction and land development
    30       -       -       30       2,304       37,146       39,480  
Commercial loans
    1,646       30       -       1,676       1,516       73,452       76,644  
Residential 1-4 family
    3,739       32       -       3,771       2,807       52,322       58,900  
Other consumer loans
    10       134       -       144       -       12,398       12,542  
                                                         
Total
  $ 6,844     $ 915     $ -     $ 7,759     $ 9,585     $ 350,476     $ 367,820  
                                                         
Total loans:
                                                       
Commercial real estate - owner occupied
  $ 867     $ 1,131     $ -     $ 1,998     $ 358     $ 84,377     $ 86,733  
Commercial real estate - non-owner occupied (1)
    1,304       -       -       1,304       4,396       107,528       113,228  
Construction and land development
    30       -       -       30       2,304       38,244       40,578  
Commercial loans
    1,646       30       -       1,676       1,583       74,383       77,642  
Residential 1-4 family
    3,739       166       -       3,905       2,915       82,015       88,835  
Other consumer loans
    10       173       234       417       77       52,481       52,975  
                                                         
Total
  $ 7,596     $ 1,500     $ 234     $ 9,330     $ 11,633     $ 439,028     $ 459,991  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
 
 
14

 
 
Activity in the allowance for loan and lease losses for the six months ended June 30, 2011, is summarized below (in thousands):
 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
   
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
   
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                               
Beginning balance
  $ 562     $ 1,265     $ 326     $ 2,425     $ 999     $ 9     $ 13     $ 5,599  
Charge offs
    (63 )     (600 )     (7 )     (846 )     (1,757 )     (5 )     -       (3,278 )
Recoveries
    -       6       5       123       16       2       -       152  
Provision
    137       170       737       182       1,649       21       694       3,590  
Ending balance
  $ 636     $ 841     $ 1,061     $ 1,884     $ 907     $ 27     $ 707     $ 6,063  
                                                                 
(1) Includes loans secured by farmland and multi-family residential loans.
 
 
The following tables present the balance in the allowance for loan losses and the recorded investment in non-covered loans by portfolio segment and based on impairment method as of June 30, 2011 and December 31, 2010 (in thousands):
 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
   
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
   
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
June 30, 2011
                                               
Ending allowance balance attributable to loans:
                                               
Individually evaluated for impairment
  $ -     $ -     $ 52     $ 527     $ -     $ -     $ -     $ 579  
Collectively evaluated for impairment
    636       841       1,009       1,357       907       27       707       5,484  
Total ending allowance
  $ 636     $ 841     $ 1,061     $ 1,884     $ 907     $ 27     $ 707     $ 6,063  
                                                                 
Loans:
                                                               
Individually evaluated for impairment
  $ 5,333     $ 5,769     $ 4,815     $ 12,684     $ 4,339     $ -     $ -     $ 32,940  
Collectively evaluated for impairment
    88,804       107,284       28,784       75,567       59,531       1,997       -       361,967  
Total ending loan balances
  $ 94,137     $ 113,053     $ 33,599     $ 88,251     $ 63,870     $ 1,997     $ -     $ 394,907  
                                                                 
December 31, 2010
                                                               
Ending allowance balance attributable to loans:
                                                               
Individually evaluated for impairment
  $ -     $ 50     $ -     $ 376     $ 20     $ -     $ -     $ 446  
Collectively evaluated for impairment
    562       1,215       326       2,049       979       9       13       5,153  
Total ending allowance
  $ 562     $ 1,265     $ 326     $ 2,425     $ 999     $ 9     $ 13     $ 5,599  
                                                                 
Loans:
                                                               
Individually evaluated for impairment
  $ 358     $ 6,584     $ 4,844     $ 2,493     $ 7,533     $ -     $ -     $ 21,812  
Collectively evaluated for impairment
    81,129       92,183       34,636       74,151       61,899       2,010       -       346,008  
Total ending loan balances
  $ 81,487     $ 98,767     $ 39,480     $ 76,644     $ 69,432     $ 2,010     $ -     $ 367,820  
                                                                 
(1) Includes loans secured by farmland and multi-family residential loans.
   
 
It is Sonabank’s practice to charge off collateral dependent loans to recoverable value rather than establish a specific reserve.  Charge offs on loans individually evaluated for impairment totaled approximately $2.7 million during the first six months of 2011.
 
Troubled Debt Restructurings
 
At June 30, 2011, we had loans modified in troubled debt restructurings totaling $2.0 million.  These modifications did not occur in 2011.  These loans are paying in accordance with their modified terms and do not involve any additional commitments to lend.
 
Credit Quality Indicators
 
Through its system of internal controls SNBV evaluates and segments loan portfolio credit quality on a quarterly basis using regulatory definitions for Special Mention, Substandard and Doubtful.  Special Mention loans are considered to be criticized.  Substandard and Doubtful loans are considered to be classified.  SNBV has no loans classified Doubtful.
 
Special Mention loans are loans that have a potential weakness that deserves management’s close attention.  If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position.
 
 
15

 
 
Substandard loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
Doubtful loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
 
As of June 30, 2011 and December 31, 2010, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

June 30, 2011
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
   
Classified/
               
Special
                     
Classified/
             
   
Criticized (1)
   
Pass
   
Total
   
Mention
   
Substandard
   
Pass
   
Total
   
Criticized
   
Pass
   
Total
 
Commercial real estate - owner occupied
  $ 245     $ 4,458     $ 4,703     $ 1,414     $ 5,333     $ 87,390     $ 94,137     $ 6,992     $ 91,848     $ 98,840  
Commercial real estate - non-owner occupied (2)
    1,854       9,111       10,965       -       5,769       107,284       113,053       7,623       116,395       124,018  
Construction and land development
    745       104       849       -       4,815       28,784       33,599       5,560       28,888       34,448  
Commercial loans
    215       498       713       230       12,684       75,337       88,251       13,129       75,835       88,964  
Residential 1-4 family
    762       64,807       65,569       40       4,339       59,491       63,870       5,141       124,298       129,439  
Other consumer loans
    -       136       136       -       -       1,997       1,997       -       2,133       2,133  
                                                                                 
Total
  $ 3,821     $ 79,114     $ 82,935     $ 1,684     $ 32,940     $ 360,283     $ 394,907     $ 38,445     $ 439,397     $ 477,842  
                                                                                 
December 31, 2010
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
   
Classified/
                   
Special
                           
Classified/
                 
   
Criticized (1)
   
Pass
   
Total
   
Mention
   
Substandard
   
Pass
   
Total
   
Criticized
   
Pass
   
Total
 
Commercial real estate - owner occupied
  $ 141     $ 5,105     $ 5,246     $ 557     $ 358     $ 80,572     $ 80,572     $ 1,056     $ 85,677     $ 86,733  
Commercial real estate - non-owner occupied (2)
    1,807       12,654       14,461       867       6,585       91,315       91,315       9,259       103,969       113,228  
Construction and land development
    1,055       43       1,098       -       4,844       34,636       34,636       5,899       34,679       40,578  
Commercial loans
    285       713       998       233       2,492       73,919       73,919       3,010       74,632       77,642  
Residential 1-4 family
    108       29,827       29,935       40       7,533       61,859       69,432       7,681       91,686       99,367  
Other consumer loans
    77       40,356       40,433       -       -       2,010       2,010       77       42,366       42,443  
                                                                                 
Total
  $ 3,473     $ 88,698     $ 92,171     $ 1,697     $ 21,812     $ 344,311     $ 351,884     $ 26,982     $ 433,009     $ 459,991  
 
(1) Credit quality is enhanced by a loss sharing agreement with the FDIC in the covered portfolio. The same credit quality indicators used in the non-covered portfolio are combined.
(2) Includes loans secured by farmland and multi-family residential loans.

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 $6.6 million and $2.4 million as of June 30, 2011 and December 31, 2010, respectively.
 
Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments.  We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee.  Since many of the commitments may 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, 2011 and December 31, 2010, we had unfunded lines of credit and undisbursed construction loan funds totaling $112.2 million and $104.9 million, respectively.  Our approved loan commitments were $3.8 million and $35.0 million at June 30, 2011 and December 31, 2010, respectively.
 
 
16

 
 
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):

         
Weighted
       
         
Average
       
   
Income
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Amount
 
For the three months ended June 30, 2011
                 
Basic EPS
  $ 1,311       11,590     $ 0.11  
Effect of dilutive stock options and warrants
    -       1       -  
Diluted EPS
  $ 1,311       11,591     $ 0.11  
                         
For the three months ended June 30, 2010
                       
Basic EPS
  $ 1,025       11,590     $ 0.09  
Effect of dilutive stock options and warrants
    -       4       -  
Diluted EPS
  $ 1,025       11,594     $ 0.09  
                         
For the six months ended June 30, 2011
                       
Basic EPS
  $ 2,431       11,590     $ 0.21  
Effect of dilutive stock options and warrants
    -       3       -  
Diluted EPS
  $ 2,431       11,593     $ 0.21  
                         
For the six months ended June 30, 2010
                       
Basic EPS
  $ 2,066       11,590     $ 0.18  
Effect of dilutive stock options and warrants
    -       4       -  
Diluted EPS
  $ 2,066       11,594     $ 0.18  

Anti-dilutive options and warrants totaled 558,921 and 557,612 for the three and six months ended June 30, 2011, respectively, as the exercise price exceeded the average share price during the period.  Anti-dilutive options and warrants totaled 411,719 and 412,432 for the three and six months ended June 30, 2010, respectively.
 
7.    FAIR VALUE
 
ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
 
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date
 
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data
 
Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability
 
 
17

 
 
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 Available for Sale
 
Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy.  Level 1 securities would include highly liquid government bonds and exchange traded equities.  If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.  Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities.  In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy.  Currently, all of SNBV’s available-for-sale debt securities are considered to be level 2 securities.
 
Assets measured at fair value on a recurring basis are summarized below:
 
         
Fair Value Measurements Using
 
               
Significant
       
         
Quoted Prices in
   
Other
   
Significant
 
         
Active Markets for
   
Observable
   
Unobservable
 
   
Total at
   
Identical Assets
   
Inputs
   
Inputs
 
(dollars in thousands)
 
June 30, 2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                       
Available for sale securities
                       
SBA guaranteed loan pools
  $ 10,586     $ -     $ 10,586     $ -  
FHLMC preferred stock
    165       165       -       -  
Total available-for-sale securities
  $ 10,751     $ 165     $ 10,586     $ -  
 
           
Fair Value Measurements Using
 
                   
Significant
         
           
Quoted Prices in
   
Other
   
Significant
 
           
Active Markets for
   
Observable
   
Unobservable
 
   
Total at
   
Identical Assets
   
Inputs
   
Inputs
 
(dollars in thousands)
 
December 31, 2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                               
Available for sale securities
                               
SBA guaranteed loan pools
  $ 11,038     $ -     $ 11,038     $ -  
FHLMC preferred stock
    30       30       -       -  
Total available-for-sale securities
  $ 11,068     $ 30     $ 11,038     $ -  
 
Assets and Liabilities Measured on a Non-recurring Basis:
 
Trust Preferred Securities Classified as Held-to-Maturity
 
The base input in calculating fair value is a Bloomberg Fair Value Index yield curve for single issuer trust preferred securities which correspond to the ratings of the securities we own.  We also use composite rating indices to fill in the gaps where the bank rating indices did not correspond to the ratings in our portfolio.  When a bank index that matches the rating of our security is not available, we used the bank index that most closely matches the rating, adjusted by the spread between the composite index that most closely matches the security’s rating and the composite index with a rating that matches the bank index used.  Then, we use the adjusted index yield, which is further adjusted by a liquidity premium, as the discount rate to be used in the calculation of the present value of the same cash flows used to evaluate the securities for OTTI.  The liquidity premiums were derived in consultation with a securities advisor. The liquidity premiums we used ranged from 2% to 5%, and the adjusted discount rates ranged from 9.40% to 14.78%.   Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility.  We have determined that our trust preferred securities are classified within Level 3 of the fair value hierarchy.
 
 
18

 
 
Based on our analysis in the first six months of 2011, we recorded OTTI charges related to credit on trust preferred securities in the amount of $70 thousand.  There were no OTTI charges on trust preferred securities during the first six months of 2010.
 
Other Residential Collateralized Mortgage Obligation Classified as Held-to Maturity
 
The fair value was estimated within Level 2 fair value hierarchy, as the fair value is based on either pricing models, quoted market prices of securities with similar characteristics, or discounted cash flows.  We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support, it has been determined that no OTTI charge for credit exists for the three months ended June 30, 2011.  The assumptions used in the analysis included a 4.7% prepayment speed, 14% default rate, a 50% loss severity and an accounting yield of 2.55%.  We recorded OTTI charges for credit on this security of $3 thousand in the second quarter of 2010.
 
Other Securities Classified as Held-to-Maturity
 
Our other securities classified as held-to-maturity include residential government sponsored mortgage-backed securities and residential government sponsored collateralized mortgage obligations. There was no OTTI recorded on these securities. Currently, all of SNBV’s other securities classified as held-to-maturity are considered to be level 2 securities.
 
Impaired Loans
 
Generally, we measure the impairment for impaired loans considering the fair value of the loan’s collateral (if the loan is collateral dependent).  Fair value of the loan’s collateral is determined by appraisals or other valuation which is then adjusted for the cost related to liquidation of the collateral.  Fair value is classified as Level 3 in the fair value hierarchy. Non-covered loans identified as impaired totaled $32.9 million as of June 30, 2011 with an allocated allowance for loan losses totaling $579 thousand compared to a carrying amount of $21.8 million with an allocated allowance for loan losses totaling $446 thousand at December 31, 2010.  Charge offs related to the impaired loans at June 30, 2011 totaled $1.6 million and 2.7 million for the three and six months ended June 30, 2011, respectively, compared to $30 thousand and $430 thousand for the three and six months ended June 30, 2010, respectively.
 
Other Real Estate Owned (OREO)
 
OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell.  OREO is further evaluated quarterly for any additional impairment.  Fair value is classified as Level 3 in the fair value hierarchy.  At June 30, 2011, the total amount of OREO was $9.6 million, of which $8.9 million was non-covered and $718 thousand was covered.
 
At December 31, 2010, the total amount of OREO was $4.6 million, of which $3.9 million was non-covered and $676 thousand was covered.
 
 
19

 
 
Assets measured at fair value on a non-recurring basis are summarized below:
 
         
Fair Value Measurements Using
 
               
Significant
       
         
Quoted Prices in
   
Other
   
Significant
 
         
Active Markets for
   
Observable
   
Unobservable
 
   
Total at
   
Identical Assets
   
Inputs
   
Inputs
 
(dollars in thousands)
 
June 30, 2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Trust preferred securities, held to maturity
  $ 628     $ -     $ -     $ 628  
Impaired non-covered loans:
                               
Commercial real estate - owner occupied
    5,333       -       -       5,333  
Commercial real estate - non-owner occupied (1)
    5,769       -       -       5,769  
Construction and land development
    4,815       -       -       4,815  
Commercial loans
    12,684       -       -       12,684  
Residential 1-4 family
    4,339       -       -       4,339  
Impaired covered loans:
                               
Commercial real estate - owner occupied
    245       -       -       245  
Commercial real estate - non-owner occupied (1)
    1,854       -       -       1,854  
Construction and land development
    745       -       -       745  
Commercial loans
    215       -       -       215  
Residential 1-4 family
    762       -       -       762  
Non-covered other real estate owned:
                               
Commercial real estate - owner occupied
    953       -       -       953  
Construction and land development
    5,435       -       -       5,435  
Residential 1-4 family
    2,507       -       -       2,507  
Covered other real estate owned:
                               
Commercial real estate - owner occupied
    557       -       -       557  
Commercial
    79       -       -       79  
Residential 1-4 family
    82       -       -       82  
 
           
Fair Value Measurements Using
 
                   
Significant
         
           
Quoted Prices in
   
Other
   
Significant
 
           
Active Markets for
   
Observable
   
Unobservable
 
   
Total at
   
Identical Assets
   
Inputs
   
Inputs
 
(dollars in thousands)
 
December 31, 2010
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Trust preferred securities, held to maturity
  $ 973     $ -     $ -     $ 973  
Other residential collateralized mortgage obligations
    1,171       -       1,171     $ -  
Impaired non-covered loans:
                               
Commercial real estate - owner occupied
    358       -       -       358  
Commercial real estate - non-owner occupied (1)
    6,534       -       -       6,534  
Construction and land development
    4,844       -       -       4,844  
Commercial loans
    2,117       -       -       2,117  
Residential 1-4 family
    7,513       -       -       7,513  
Impaired covered loans:
                               
Commercial real estate - owner occupied
    141       -       -       141  
Commercial real estate - non-owner occupied (1)
    1,807       -       -       1,807  
Construction and land development
    1,055       -       -       1,055  
Commercial loans
    285       -       -       285  
Residential 1-4 family
    108       -       -       108  
Other consumer loans
    77       -       -       77  
Non-covered other real estate owned:
                               
Commercial real estate - owner occupied
    578       -       -       578  
Construction and land development
    2,797       -       -       2,797  
Residential 1-4 family
    526       -       -       526  
Covered other real estate owned:
                               
Commercial real estate - owner occupied
    597       -       -       597  
Commercial
    79       -       -       79  
                                 
(1) Includes loans secured by farmland and multi-family residential loans.
                               
 
 
20

 
 
Fair Value of Financial Instruments
 
The carrying amount and estimated fair values of financial instruments were as follows (in thousands):
 
   
June 30, 2011
   
December 31, 2010
 
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Amount
   
Value
   
Amount
   
Value
 
Financial assets:
                       
Cash and cash equivalents
  $ 3,686     $ 3,686     $ 9,745     $ 9,745  
Securities available for sale
    10,751       10,751       11,068       11,068  
Securities held to maturity
    40,021       39,791       44,895       43,965  
Stock in Federal Reserve Bank and Federal Home Loan Bank
    5,972       n/a       6,350       n/a  
Net non-covered loans
    387,989       386,048       361,667       360,016  
Net covered loans
    82,935       82,422       92,171       91,661  
Accrued interest receivable
    2,016       2,016       2,141       2,141  
FDIC indemnification asset
    18,088       18,088       18,536       18,536  
Financial liabilities:
                               
Deposits:
                               
Demand deposits
    48,930       48,930       50,490       50,490  
Money market and savings accounts
    147,742       147,742       175,351       175,351  
Certificates of deposit
    237,319       239,800       205,133       207,221  
Securities sold under agreements to repurchase and other short-term borrowings
    19,968       19,968       23,908       23,908  
FHLB advances
    43,500       44,771       35,000       36,458  
Accrued interest payable
    276       276       415       415  
 
Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, savings accounts, money market accounts, short-term debt, and variable rate loans that reprice frequently and fully.  For fixed rate loans or deposits and for variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. It was not practicable to determine the fair value of Federal Reserve Bank and Federal Home Loan Bank stock due to restrictions placed on its transferability.  Fair value of long-term debt is based on current rates for similar financing.  The FDIC indemnification asset was measured at estimated fair value on the date of acquisition.  The fair value was determined by discounting estimated future cash flows using the long-term risk free rate plus a premium.  Subsequent additions to the asset are valued at par as it is anticipated that these amounts will be shortly received. The fair value of off-balance-sheet items is not considered material.
 
8.   BRANCH ACQUISITION
 
As previously announced, Sonabank has entered into a definitive agreement to purchase all deposits of approximately $46 million, and certain assets of the Midlothian branch office of The Bank of Hampton Roads. The transaction, subject to regulatory approval, is expected to be completed by fourth quarter 2011.
 
 
21

 
 
9.  BANK-OWNED LIFE INSURANCE TRANSACTION
 
Sonabank recorded income of $800 thousand and a reduction in the cash surrender value of bank-owned life insurance in the amount of $526 thousand due to the death of an officer covered by the life insurance.  These amounts were received in July 2011.
 
 
22

 
 
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of SNBV.  This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report on Form 10-K for the year ended December 31, 2010.  Results of operations for the three and six month periods ended June 30, 2011 are not necessarily indicative of results that may be attained for any other period.
 
SPECIAL CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
 
Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” and similar words, or the negatives of these words, are intended to identify forward-looking statements.
 
Many possible events or factors could affect our future financial results and performance and could cause our actual results to differ materially from the expectations of future results we express or imply in any forward-looking statements. In addition to the Risk Factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2010, factors that could contribute to those differences include, but are not limited to:
 
 
our limited operating history;
 
changes in the strength of the United States economy in general and the local economies in our market areas adversely affect our customers and their ability to transact profitable business with us, including the ability of our borrowers to repay their loans according to their terms or a change in the value of the related collateral;
 
changes in the availability of funds resulting in increased costs or reduced liquidity;
 
our reliance on brokered deposits;
 
a deterioration or downgrade in the credit quality and credit agency ratings of the securities in our securities portfolio;
 
impairment concerns and risks related to our investment portfolio of collateralized mortgage obligations, agency mortgage-backed securities and pooled trust preferred securities;
 
the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations;
 
increased credit risk in our assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of our total loan portfolio;
 
the concentration of our loan portfolio in loans collateralized by real estate;
 
our level of construction and land development and commercial real estate loans;
 
changes in the levels of loan prepayments and the resulting effects on the value of our loan portfolio;
 
the failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses;
 
 
23

 
 
 
our ability to expand and grow our business and operations, including the establishment of additional branches and acquisition of additional branches and banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities;
 
changes in interest rates and market prices, which could reduce our net interest margins, asset valuations and expense expectations;
 
increased competition for deposits and loans adversely affecting rates and terms;
 
increases in FDIC deposit insurance premiums and assessments;
 
the continued service of key management personnel;
 
increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;
 
our ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; and
 
fiscal and governmental policies of the United States federal government.
 
Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We believe we have chosen these assumptions or bases in good faith and that they are reasonable. We caution you, however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this Quarterly Report on Form 10-Q. These statements speak only as of the date of this Quarterly Report on Form 10-Q.  Except as required by applicable law, we undertake no obligation to update publicly these statements in light of new information or future events.
 
OVERVIEW
 
Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a Virginia state bank.  Sonabank was originally chartered as a national bank under the laws of the United States of America on April 14, 2005. On January 1, 2009, Sonabank converted from a nationally chartered bank to a state chartered bank and moved its headquarters from Charlottesville to McLean, Virginia.  Sonabank is now regulated by the State Corporation Commission of Virginia and the Federal Reserve Bank of Richmond. Sonabank conducts full-service banking operations in Charlottesville, Clifton Forge, Leesburg, Warrenton, Middleburg, New Market, Front Royal, South Riding and Fairfax County in Virginia and in Rockville, Maryland.  We also have loan production offices in Charlottesville, Fredericksburg, Warrenton and Richmond in Virginia.  We have administrative offices in Warrenton and an executive office in Georgetown, Washington, D.C where senior management is located.
 
RESULTS OF OPERATIONS
 
Net Income
 
Net income for the quarter ended June 30, 2011 was $1.3 million and $2.4 million for the six months ended June 30, 2011, compared to $1.0 million and $2.1 million during the first quarter of 2010 and the six months ended June 30, 2010, respectively.
 
 
24

 
 
Net Interest Income
 
Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings.
 
Net interest income was $6.2 million for the second quarter of 2011, compared to $6.4 million for the second quarter of 2010. The decline resulted primarily from a decline in average earning assets quarter to quarter as average loan balances increased $5.8 million, but the average balance of investment securities and other earning assets declined by $27.0 million. The accretion of the discount on the Greater Atlantic Bank loan portfolio amounted to $437 thousand in the second quarter of 2011, compared to $635 thousand in the second quarter of 2010. The decrease in the discount accretion was partially the result of an adjustment made in the second quarter of 2011 of approximately $90 thousand to the carrying value of the Greater Atlantic Bank loan portfolio due to changes in prepayment speed assumptions used in the original valuation.  The net interest margin was 4.73% in the quarter ended June 30, 2011, up from 4.70% in the second quarter of 2010.  The decline in the yield on earning assets was ameliorated somewhat by the reduction in securities and other earning asset as a percentage of earning assets. Also, the weighted average rate paid on deposits declined largely as a result of the repricing of certain money market accounts at the beginning of 2011, and the average cost of borrowing was reduced because of the restructuring of $25 million of convertible advances in the first quarter of 2011.
 
Net interest income was $12.4 million for the six months ended June 30, 2011, compared to $12.7 million for the first six months of 2010. The decline resulted primarily from a decline in average earning assets as average loan balances increased $1.1 million, but the average balance of investment securities and other earning assets declined by $25.4 million. The accretion of the discount on the Greater Atlantic Bank loan portfolio amounted to $1.0 million in six months ended June 30, 2011, compared to $1.3 million in the first half of 2010. Part of the decrease in the accretion was due to the $90 thousand adjustment discussed above. The net interest margin was 4.75% in the six months ended June 30, 2011, up from 4.66% in the same period last year.  The improvement in the net interest margin was due to the factors mentioned above in the discussion of the second quarters of 2011 and 2010.
 
 
25

 
 
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
 
   
6/30/2011
   
6/30/2010
 
         
Interest
               
Interest
       
   
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
   
(Dollar amounts in thousands)
 
Assets
                                   
Interest-earning assets:
                                   
Loans, net of unearned income (1) (2)
  $ 467,512     $ 7,210       6.19 %   $ 461,725     $ 7,829       6.80 %
Investment securities
    51,679       482       3.73 %     71,890       684       3.81 %
Other earning assets
    9,092       51       2.25 %     15,892       48       1.21 %
                                                 
Total earning assets
    528,283       7,743       5.88 %     549,507       8,561       6.25 %
Allowance for loan losses
    (5,934 )                     (5,812 )                
Total non-earning assets
    70,187                       68,490                  
Total assets
  $ 592,536                     $ 612,185                  
                                                 
Liabilities and stockholders’ equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 15,235       10       0.27 %   $ 15,513       11       0.29 %
Money market accounts
    144,615       319       0.88 %     171,355       707       1.65 %
Savings accounts
    5,909       9       0.60 %     5,033       9       0.68 %
Time deposits
    235,806       911       1.55 %     227,439       1,063       1.87 %
Total interest-bearing deposits
    401,565       1,249       1.25 %     419,340       1,790       1.71 %
Borrowings
    56,285       267       1.90 %     55,118       330       2.40 %
Total interest-bearing liabilities
    457,850       1,516       1.33 %     474,458       2,120       1.79 %
Noninterest-bearing liabilities:
                                               
Demand deposits
    31,177                       33,150                  
Other liabilities
    2,254                       6,568                  
Total liabilites
    491,281                       514,176                  
Stockholders equity
    101,255                       98,009                  
Total liabilities and stockholders equity
  $ 592,536                     $ 612,185                  
Net interest income
            6,227                       6,441          
Interest rate spread
                    4.55 %                     4.46 %
Net interest margin
                    4.73 %                     4.70 %
 
(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.
                         
 
 
26

 
 
   
Average Balance Sheets and Net Interest
 
   
Analysis For the Six Months Ended
 
   
6/30/2011
   
6/30/2010
 
         
Interest
               
Interest
       
   
Average
   
Income/
   
Yield/
   
Average
   
Income/
   
Yield/
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
   
(Dollar amounts in thousands)
 
Assets
                                   
Interest-earning assets:
                                   
Loans, net  of unearned income (1) (2)
  $ 461,568     $ 14,331       6.26 %   $ 460,503     $ 15,443       6.76 %
Investment securities
    53,003       1,038       3.92 %     73,372       1,418       3.87 %
Other earning assets
    10,323       103       2.01 %     15,341       91       1.20 %
                                                 
Total earning assets
    524,894       15,472       5.94 %     549,216       16,952       6.22 %
Allowance for loan losses
    (5,956 )                     (5,554 )                
Total non-earning assets
    69,255                       70,263                  
Total assets
  $ 588,193                     $ 613,925                  
                                                 
Liabilities and stockholders’ equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 15,550       21       0.27 %   $ 15,371       23       0.30 %
Money market accounts
    151,673       684       0.91 %     158,959       1,340       1.70 %
Savings accounts
    5,763       18       0.61 %     4,852       16       0.66 %
Time deposits
    224,771       1,804       1.62 %     241,900       2,214       1.85 %
Total interest-bearing deposits
    397,757       2,526       1.28 %     421,082       3,593       1.72 %
Borrowings
    55,894       585       2.11 %     55,289       657       2.40 %
Total interest-bearing liabilities
    453,651       3,111       1.38 %     476,371       4,250       1.80 %
Noninterest-bearing liabilities:
                                               
Demand deposits
    31,643                       33,344                  
Other liabilities
    2,196                       6,653                  
Total liabilites
    487,490                       516,368                  
Stockholders’ equity
    100,703                       97,557                  
Total liabilities and stockholders’ equity
  $ 588,193                     $ 613,925                  
Net interest income
          $ 12,361                     $ 12,702          
Interest rate spread
                    4.56 %                     4.42 %
Net interest margin
                    4.75 %                     4.66 %
 
(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, as well as applying management’s judgment.
 
The provision for loan losses in the second quarter of 2011 was $2.3 million compared to $1.5 million in the second quarter of 2010. For the six months ended June 30, 2011, the provision for loan losses was $3.6 million compared to $2.8 million for the same period last year.
 
Net charge-offs during the second quarter of 2011 were $1.9 million as credit quality continued to be a challenge for our loan portfolio. The largest component of the charge-off was related to a loan on an estate in Charlottesville on which the guarantor experienced financial difficulties in his business. We’ve placed this loan on non-accrual and also recognized a charge-off to its current assessed value. The remaining charge-offs were divided among 11 other loans, reflecting deep seated and ongoing problems in our economy.  Net charge-offs during the second quarter of 2010 were $1.4 million.
 
 
27

 
 
Net charge offs during the six months ended June 30, 2011 were $3.1 million compared to $2.5 million during the first half of 2010.
 
Noninterest Income
 
The following table presents the major categories of noninterest income for the three and six months ended June 30, 2011 and 2010:
 
   
For the Three Months Ended
 
   
June 30,
 
   
2011
   
2010
   
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 218     $ 235     $ (17 )
Income from bank-owned life insurance
    933       137       796  
Net gain  (loss) on other real estate owned
    (108 )     19       (127 )
Net impairment losses recognized in earnings
    (38 )     (4 )     (34 )
Other
    44       148       (104 )
Total noninterest income (loss)
  $ 1,049     $ 535     $ 514  
 
   
For the Six Months Ended
 
   
June 30,
 
    2011     2010    
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 418     $ 476     $ (58 )
Income from bank-owned life insurance
    1,067       276       791  
Net gain  (loss) on other real estate owned
    (147 )     39       (186 )
Net impairment losses recognized in earnings
    (70 )     (10 )     (60 )
Other
    89       293       (204 )
Total noninterest income
  $ 1,357     $ 1,074     $ 283  
 
During the second quarter of 2011 Sonabank had noninterest income of $1.0 million compared to noninterest income of $535 thousand during the second quarter of 2010. The increase was largely attributable to an $800 thousand insurance benefit resulting from the death of an officer covered by bank-owned life insurance.  The insurance benefit was received in July 2011.
 
Noninterest income increased to $1.4 million in the first six months of 2011 from $1.1 million in the first six months of 2010. Again, the most important factor in the increase was the death benefit described above. This was partially offset by a decrease of $191 thousand in fees on letters of credit related to a short-term letter of credit which expired in June 2010.  Also, during the first six months of 2011, there were net losses on other real estate owned (“OREO”) of $147 thousand compared to gains of $39 thousand during the six months ended June 30, 2010.  There were other than temporary impairment (“OTTI”) charges of $70 thousand during the first six months of 2011, compared to $10 thousand for the same period last year.
 
 
28

 
 
Noninterest Expense
 
The following table presents the major categories of noninterest expense for the three and six months ended June 30, 2011 and 2010:
 
   
For the Three Months Ended
 
   
June 30,
 
   
2011
   
2010
   
Change
 
   
(dollars in thousands)
 
Salaries and benefits
  $ 1,705     $ 1,523     $ 182  
Occupancy expenses
    554       527       27  
Furniture and equipment expenses
    131       151       (20 )
Amortization of core deposit intangible
    230       236       (6 )
Virginia franchise tax expense
    171       184       (13 )
FDIC assessment
    119       212       (93 )
Data processing expense
    132       159       (27 )
Telephone and communication expense
    100       101       (1 )
Change in FDIC indemnification asset
    (192 )     406       (598 )
Other operating expenses
    543       528       15  
Total noninterest expense
  $ 3,493     $ 4,027     $ (534 )
 
   
For the Six Months Ended
 
   
June 30,
 
    2011     2010    
Change
 
   
(dollars in thousands)
 
Salaries and benefits
  $ 3,308     $ 3,164     $ 144  
Occupancy expenses
    1,093       1,069       24  
Furniture and equipment expenses
    267       305       (38 )
Amortization of core deposit intangible
    460       472       (12 )
Virginia franchise tax expense
    343       368       (25 )
FDIC assessment
    272       401       (129 )
Data processing expense
    274       314       (40 )
Telephone and communication expense
    188       220       (32 )
Change in FDIC indemnification asset
    (351 )     650       (1,001 )
Other operating expenses
    1,093       1,042       51  
Total noninterest expense
  $ 6,947     $ 8,005     $ (1,058 )
 
Noninterest expenses were $3.5 million and $6.9 million during the second quarter and the first half of 2011, respectively, compared to $4.0 million and $8.0 million during the same periods in 2010. During the three and six months ended June 30, 2011, there was accretion of the FDIC indemnification asset of $192 thousand and $351 thousand, respectively.  During the second quarter and first six months of 2010 the accretion was more than offset by charges to the FDIC indemnification asset due to impaired covered loans that paid off.
 
The efficiency ratio improved from 58.23% during the six months ended June 30, 2010, to 52.89% during the first half of 2011.
 
 
29

 
 
FINANCIAL CONDITION
 
Balance Sheet Overview
 
Total assets of Southern National Bancorp of Virginia were $601.4 million as of June 30, 2011 compared to $590.8 million as of December 31, 2010.  Net loans receivable increased from $453.8 million at the end of 2010 to $470.9 million at June 30, 2011. Within that total, covered loans declined by $9.2 million while the non-covered loan portfolio increased by $26.8 million. Our loan pipeline has slowed somewhat, but we will continue to pursue quality credits.
 
Total deposits were $434.0 million at June 30, 2011 compared to $431.0 million at December 31, 2010. Certificates of deposit increased $32.2 million during the six months ended June 30, 2011.  This was partially offset by a decrease in money market accounts of $27.9 million during same period.  We had paid rates in excess of market on large money market accounts for former Greater Atlantic Bank customers to retain them during 2010, and as of the beginning of 2011, we reduced those rates.  Brokered certificates of deposit have decreased from $27.0 million at December 31, 2010, to $22.0 million as of June 30, 2011.  Noninterest-bearing deposits were $33.9 million at June 30, 2011 and $34.5 million at December 31, 2010.
 
Loan Portfolio
 
As part of the Greater Atlantic acquisition, the Bank and the FDIC entered into a loss sharing agreement on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets.  The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.”  Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans.” As information and other developments warrant, we reassess our anticipated recoveries from the FDIC on the covered loans and adjust the carrying value of the FDIC indemnification asset through earnings.
 
The following table summarizes the composition of our loan portfolio as of June 30, 2011 and December 31, 2010:
 
   
Covered
   
Non-covered
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans
   
Loans
   
Loans
   
Loans
   
Loans
   
Loans
 
   
June 30, 2011
   
December 31, 2010
 
Mortgage loans on real estate:
                                   
Commercial real estate - owner-occupied
  $ 4,703     $ 94,137     $ 98,840     $ 5,246     $ 81,487     $ 86,733  
Commercial real estate - non-owner-occupied
    10,412       87,323       97,735       13,898       76,068       89,966  
Secured by farmland
    -       3,503       3,503       -       3,522       3,522  
Construction and land loans
    849       33,599       34,448       1,098       39,480       40,578  
Residential 1-4 family
    27,615       54,562       82,177       29,935       58,900       88,835  
Multi- family residential
    553       22,227       22,780       563       19,177       19,740  
Home equity lines of credit
    37,954       9,308       47,262       40,287       10,532       50,819  
Total real estate loans
    82,086       304,659       386,745       91,027       289,166       380,193  
                                                 
Commercial loans
    713       88,251       88,964       998       76,644       77,642  
Consumer loans
    136       1,997       2,133       146       2,010       2,156  
Gross loans
    82,935       394,907       477,842       92,171       367,820       459,991  
                                                 
Less deferred fees on loans
    -       (855 )     (855 )     -       (554 )     (554 )
Loans, net of unearned income
  $ 82,935     $ 394,052     $ 476,987     $ 92,171     $ 367,266     $ 459,437  
 
As of June 30, 2011 and December 31, 2010, substantially all of our loans were to customers located in Virginia and Maryland.  We are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on operations.
 
 
30

 
 
Asset Quality
 
We will generally place a loan on nonaccrual status when it becomes 90 days past due.  Loans will also be placed on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement.  Cash payments received while a loan is categorized as nonaccrual will be recorded as a reduction of principal as long as doubt exists as to future collections.
 
We maintain appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential problem loans.  In instances where appraisals reflect reduced collateral values, we make an evaluation of the borrower’s overall financial condition to determine the need, if any, for impairment or write-down to their fair values.  If foreclosure occurs, we record other real estate owned at the lower of our recorded investment in the loan or fair value less our estimated costs to sell.
 
Our loss and delinquency experience on our loan portfolio has been limited by a number of factors, including our underwriting standards.  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 the overall economic environment in which we operate.
 
Non-covered Loans and Assets
 
Non-covered loans identified as impaired totaled $32.9 million with allocated allowance for loan losses in the amount of $579 thousand as of June 30, 2011, including $7.6 million of nonaccrual loans and $2.0 million of restructured loans. This compares to $21.8 million of impaired loans with allocated allowance for loan losses in the amount of $446 thousand at December 31, 2010, including $9.6 million of nonaccrual loans and $6.6 million of restructured loans. The nonaccrual loans included SBA guaranteed amounts of $2.0 million and $1.4 million at June 30, 2011 and December 31, 2010, respectively.  At June 30, 2011 and December 31, 2010, there were no loans past due 90 days or more and accruing interest.
 
Non-covered nonperforming assets increased from $13.5 million at December 31, 2010 to $16.5 million at June 30, 2011.
 
Our OREO in the non-covered portfolio is comprised of the Culpeper property, which contains 33 finished 2 to 4 acre lots, the Kluge development property which was a non-performing loan at the end of 2010 which we foreclosed on during the first quarter, two commercial properties and two residential properties.  Non-covered OREO at June 30, 2011 was $8.9 million compared to $3.9 million at December 31, 2010.
 
Sonabank has an internal loan review and a loan committee, both of which provide on-going monitoring to identify and address issues with problem loans.  The loan loss provision is determined after consideration of all known relevant internal and external factors affecting loan collectability to maintain the allowance for loan and lease losses at a level necessary to absorb estimated credit losses. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at June 30, 2011.
 
 
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The following table sets forth selected asset quality ratios as of the dates indicated:
 
   
As of
   
June 30,
 
December 31,
   
2011
 
2010
             
Allowance for loan losses to total non-covered loans
    1.54 %     1.52 %
Non-covered nonperforming assets to total non-covered assets
    3.19 %     2.71 %
Non-covered nonperforming assets excluding SBA guaranteed loans to total non-covered assets
    2.81 %     2.43 %
 
We do not have a formal loan modification program.  Rather, we work with individual customers on a case-by-case basis to facilitate the orderly collection of our principal and interest before a loan becomes a non-performing loan.  If a customer is unable to make contractual payments, we review the circumstances of the customer’s situation and may negotiate a revised payment stream.  In other words, we identify performing customers experiencing financial difficulties and through negotiations, we permit them to pay interest only or lesser principal payments.  We do not forgive principal payments.  Our goal when restructuring a credit is to afford the customer a reasonable period of time to remedy the issue causing cash flow constraints within their business so that they can return to performing status over time.
 
Our loan modifications have taken the form of deferral of interest payments and/or curtailment of scheduled principal payments.  Our restructured loans are all collateral secured loans.  If a customer fails to perform under the modified terms, we place the loan on non-accrual status and begin the process of working with the customer to liquidate the underlying collateral to satisfy the debt.
 
At June 30, 2011, we had outstanding balances on restructured loans totaling $2.0 million with borrowers who experienced deterioration in financial condition.  These loan restructurings were negotiated prior to 2011. These loans were included in impaired loans. These loans were granted interest rate deferrals to provide cash flow relief to customers experiencing cash flow difficulties.  There were no concessions made to forgive principal or interest relative to these loans.  Management believes these loans are well secured and the borrowers have the ability to repay the loans in accordance with the renegotiated terms.  As such, these restructured loans were on accrual status at the balance sheet date as payments were being made according to the restructured loan terms.  These loans have not had a partial charge-off.  We continue to report restructured loans as restructured until such time as the loan has developed a reasonable repayment history, the borrower displays the financial capacity to repay, and the loan terms return to the terms in place prior to the restructure.  If the customer fails to perform, we place the loan on non-accrual status and seek to liquidate the underlying collateral for these loans.  Changes in value for impairment, including the amount attributed to the passage of time, are recorded entirely within the provision for loans losses.
 
We consider any loan that is restructured for a borrower experiencing financial difficulties due to a borrower’s potential inability to pay in accordance with contractual terms of the loan a troubled debt restructure (“TDR”).  Specifically, we consider a concession involving a modification of the loan terms, such as (i) temporary reduction of the stated interest rate, (ii) temporary reduction or deferral of principal, (iii) temporary reduction or deferral of accrued interest at a stated interest rate lower than the current market rate for new debt with similar risk all to be TDRs.  When a modification of terms is made for a competitive reason, we do not consider that to be a TDR.  The primary example of a competitive modification would be an interest rate reduction for a performing credit worthy customer to a market rate as the result of a market decline in rates.
 
 
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Covered Loans and Assets
 
Covered loans identified as impaired totaled $3.8 million as of June 30, 2011 and $3.5 million at December 31, 2010. Nonaccrual loans were $2.9 million and $2.0 million at June 30, 2011 and December 31, 2010, respectively. At June 30, 2011 and at December 31, 2010, there were loans past due 90 days or more and accruing interest in the amount of $318 thousand and $234 thousand, respectively.
 
Securities
 
Investment securities, available for sale and held to maturity, were $50.8 million at June 30, 2011 and $56.0 million at December 31, 2010.
 
As of June 30, 2011 we owned pooled trust preferred securities as follows:
 
                                                     
Previously
       
                                                     
Recognized
       
                                                     
Cumulative
       
     
Ratings
                           
Estimated
   
Current
   
Other
       
 
Tranche
 
When Purchased
   
Current Ratings
         
Fair
   
Defaults and
   
Comprehensive
       
Security
Level
 
Moody’s
   
Fitch
   
Moody’s
   
Fitch
   
Par Value
   
Book Value
   
Value
   
Deferrals
   
Loss (1)
       
                             
(in thousands)
                   
ALESCO VII  A1B
Senior
 
Aaa
   
AAA
   
Baa3
   
BB
    $ 7,174     $ 6,420     $ 4,189     $ 209,056     $ 310        
MMCF II B
Senior Sub
  A3    
AA-
   
Baa2
   
BB
      493       455       477       34,000       38        
MMCF III B
Senior Sub
  A3     A-    
Ba1
   
CC
      652       637       408       37,000       14        
                                    8,319       7,512       5,074             $ 362        
                                                                             
                                                                 
Cumulative
   
Cumulative
 
                                                                 
Other Comprehensive
   
OTTI Related to
 
Other Than Temporarily Impaired:
                                                             
Loss (2)
   
Credit Loss (2)
 
TPREF FUNDING II
Mezzanine
  A1       A-    
Caa3
      C       1,500       496       496       131,100       693     $ 311  
TRAP 2007-XII C1
Mezzanine
   A3       A       C       C       2,066       127       352       155,705       1,360       579  
TRAP 2007-XIII D
Mezzanine
 
NR
      A-    
NR
      C       2,032       -       38       231,250       -       2,032  
MMC FUNDING XVIII
Mezzanine
    A3       A-    
Ca
      C       1,050       132       132       111,682       444       474  
ALESCO V C1
Mezzanine
    A2       A    
Ca
      C       2,083       461       537       117,942       961       661  
ALESCO XV C1
Mezzanine
    A3       A-       C       C       3,112       29       159       266,100       524       2,559  
ALESCO XVI  C
Mezzanine
    A3       A-    
Ca
      C       2,072       115       440       149,900       777       1,180  
                                        13,915       1,360       2,154             $ 4,759     $ 7,796  
                                                                                   
Total
                                    $ 22,234     $ 8,872     $ 7,228                          
                                                                                   
(1) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion
 
(2)  Pre-tax
                                                                                 
 
Each of these securities has been evaluated for other than temporary impairment.  In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to estimate expected cash flows, and assist with the evaluation of other than temporary impairment. The cash flow analyses performed included the following assumptions:
 
 
We assume that .5% of the remaining performing collateral will default or defer per annum.
 
We assume recoveries ranging from 25% to 47% with a two year lag on all defaults and deferrals.
 
We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security.
 
Additionally banks with assets over $15 billion will no longer be allowed to count down streamed trust preferred proceeds as Tier 1 capital (although it will still be counted as Tier 2 capital). That will incent the large banks to prepay their trust preferred securities if they can or if it is economically desirable. As a consequence we have projected in all of our pools that 25% of the collateral issued by banks with assets over $15 billion will prepay in 2013.
 
Our securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve plus original spread to discount projected cash flows to present values.
 
 
33

 
 
These assumptions resulted in OTTI charges related to credit on two of the trust preferred securities in the amount of $38 thousand during the quarter ended June 30, 2011, compared to no OTTI charges related to credit on the trust preferred securities for the quarter ended June 30, 2010. Events within these two structures which contributed to a decline in our expectations of cash flows included an issuer that had previously deferred interest payments, had resumed payments, then deferred again, and there was a large redemption during the second quarter of 2011 which negatively affected our subordinate tranche because the senior tranche received the payment.
 
We also own approximately $1.0 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was originally rated AAA by Standard and Poor’s. After a series of downgrades this security has been other than temporarily impaired in past reporting periods. For the second quarter of 2011 and based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support it has been determined that no OTTI charge for credit was required for the quarter ended June 30, 2011.  The assumptions used in the analysis included a 4.7% prepayment speed, 14% default rate, a 50% loss severity and an accounting yield of 2.55%.  We recorded OTTI charges for credit on this security of $3 thousand in the second quarter of 2010.
 
Liquidity and Funds Management
 
The objective of our liquidity management is to assure the ability to meet our financial obligations. These obligations include the payment of deposits on demand or at maturity, the repayment of borrowings at maturity and the ability to fund commitments and other new business opportunities. We obtain funding from a variety of sources, including customer deposit accounts, customer certificates of deposit and payments on our loans and investments. Historically, our level of core deposits has been insufficient to fully fund our lending activities. As a result, we have sought funding from additional sources, including institutional certificates of deposit and the sale of available-for-sale investment securities. In addition, we maintain lines of credit from the Federal Home Loan Bank of Atlanta and utilize securities sold under agreements to repurchase and reverse repurchase agreement borrowings from approved securities dealers.
 
We prepare a monthly cash flow report which forecasts weekly cash needs and availability for the coming three months, based on forecasts of loan closings from our pipeline report and other factors.
 
During the three months ended June 30, 2011, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At June 30, 2011, we had $112.2 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $3.8 million at June 30, 2011. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.
 
 
34

 
 
Capital Resources
 
The following table provides a comparison of our leverage and risk-weighted capital ratios and the leverage and risk-weighted capital ratios of the bank at the dates indicated to the minimum and well-capitalized regulatory standards (dollars in thousands):
 
               
Required
       
               
For Capital
   
To Be Categorized as
 
   
Actual
   
Adequacy Purposes
   
Well Capitalized
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
June 30, 2011
                                   
SNBV
                                   
Tier 1 risk-based capital ratio
  $ 93,330       20.41 %   $ 18,287       4.00 %   $ 27,431       6.00 %
Total risk-based capital ratio
    99,025       21.66 %     36,575       8.00 %     45,719       10.00 %
Leverage ratio
    93,330       16.08 %     23,224       4.00 %     29,029       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 89,841       19.66 %   $ 18,278       4.00 %   $ 27,417       6.00 %
Total risk-based capital ratio
    95,533       20.91 %     36,557       8.00 %     45,696       10.00 %
Leverage ratio
    89,841       15.47 %     23,224       4.00 %     29,029       5.00 %
                                                 
December 31, 2010
                                               
SNBV
                                               
Tier 1 risk-based capital ratio
  $ 90,214       20.52 %   $ 17,585       4.00 %   $ 26,377       6.00 %
Total risk-based capital ratio
    95,689       21.77 %     35,169       8.00 %     43,961       10.00 %
Leverage ratio
    90,214       15.23 %     23,701       4.00 %     29,626       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 86,757       19.74 %   $ 17,580       4.00 %   $ 26,370       6.00 %
Total risk-based capital ratio
    92,231       20.99 %     35,160       8.00 %     43,950       10.00 %
Leverage ratio
    86,757       14.64 %     23,701       4.00 %     29,626       5.00 %
 
The most recent regulatory notification categorized Sonabank as well capitalized under the regulatory framework for prompt corrective action.  There are no conditions or events since that notification that management believes have changed Sonabank’s category.
 
 
35

 
 
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 400 basis points or minus 200 basis points, measured in 100 basis point increments) as of June 30, 2011 and (plus or minus 300 basis points, measured in 100 basis point increments) as of December 31, 2010, and all changes are within our ALM Policy guidelines:
 
   
Sensitivity of Market Value of Portfolio Equity
 
   
As of June 30, 2011
 
                               
                     
Market Value of
 
Change in
 
Market Value of Portfolio Equity
   
Portfolio Equity as a % of
 
Interest Rates
                         
Portfolio
 
in Basis Points
       
$ Change
   
% Change
   
Total
   
Equity
 
(Rate Shock)
 
Amount
   
From Base
   
From Base
   
Assets
   
Book Value
 
   
(Dollar amounts in thousands)
 
                               
Up 400
  $ 95,817     $ (4,230 )     -4.23 %     15.93 %     94.07 %
Up 300
    96,543       (3,504 )     -3.50 %     16.05 %     94.78 %
Up 200
    98,012       (2,035 )     -2.03 %     16.30 %     96.22 %
Up 100
    98,530       (1,517 )     -1.52 %     16.38 %     96.73 %
Base
    100,047       -       0.00 %     16.63 %     98.22 %
Down 100
    96,769       (3,278 )     -3.28 %     16.09 %     95.00 %
Down 200
    93,401       (6,646 )     -6.64 %     15.53 %     91.70 %
 
 
36

 
 
   
Sensitivity of Market Value of Portfolio Equity
 
   
As of December 31, 2010
 
                                         
                           
Market Value of
 
Change in
 
Market Value of Portfolio Equity
   
Portfolio Equity as a % of
 
Interest Rates
                                 
Portfolio
 
in Basis Points
         
$ Change
   
% Change
   
Total
   
Equity
 
(Rate Shock)
 
Amount
   
From Base
   
From Base
   
Assets
   
Book Value
 
   
(Dollar amounts in thousands)
 
                                         
Up 300
  $ 99,642     $ (1,643 )     -1.62 %     16.86 %     100.20 %
Up 200
    100,576       (709 )     -0.70 %     17.01 %     101.14 %
Up 100
    100,578       (707 )     -0.70 %     17.01 %     101.14 %
Base
    101,285       -       0.00 %     17.13 %     101.85 %
Down 100
    97,672       (3,613 )     -3.57 %     16.52 %     98.22 %
Down 200
    93,048       (8,237 )     -8.13 %     15.74 %     93.57 %
Down 300
    90,390       (10,895 )     -10.76 %     15.29 %     90.90 %
 
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, 2011 and December 31, 2010 remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. All changes are within our ALM Policy guidelines.
 
   
Sensitivity of Net Interest Income
 
   
As of June 30, 2011
 
                         
Change in
 
Adjusted Net Interest Income
   
Net Interest Margin
 
Interest Rates
                       
in Basis Points
       
$ Change
         
% Change
 
(Rate Shock)
 
Amount
   
From Base
   
Percent
   
From Base
 
   
(Dollar amounts in thousands)
 
                         
Up 400
  $ 28,894     $ 3,142       5.29 %     0.56 %
Up 300
    28,006       2,254       5.13 %     0.40 %
Up 200
    27,156       1,404       4.98 %     0.25 %
Up 100
    26,236       484       4.82 %     0.09 %
Base
    25,752       -       4.73 %     0.00 %
Down 100
    26,035       283       4.78 %     0.05 %
Down 200
    26,025       273       4.78 %     0.05 %
 
 
37

 
 
   
Sensitivity of Net Interest Income
 
   
As of December 31, 2010
 
                                 
Change in
 
Adjusted Net Interest Income
   
Net Interest Margin
 
Interest Rates
                               
in Basis Points
         
$ Change
           
% Change
 
(Rate Shock)
 
Amount
   
From Base
   
Percent
   
From Base
 
   
(Dollar amounts in thousands)
 
                                 
Up 300
  $ 27,668     $ 3,361       5.09 %     0.61 %
Up 200
    26,466     $ 2,159       4.87 %     0.39 %
Up 100
    25,193     $ 886       4.64 %     0.16 %
Base
    24,307     $ -       4.48 %     0.00 %
Down 100
    24,670     $ 363       4.55 %     0.07 %
Down 200
    24,676     $ 369       4.55 %     0.07 %
Down 300
    24,747     $ 440       4.56 %     0.08 %
 
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 (NII) tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on our net worth and net interest income.  Sensitivity of MVPE and NII are modeled using different assumptions and approaches.  In the low interest rate environment that currently exists, limitations on downward adjustments for interest rates, particularly as they apply to deposits, can and do result in anomalies in scenarios that are unlikely to occur due to the current low interest rate environment.
 
 
38

 
 
ITEM 4 – CONTROLS AND PROCEDURES
 
(a)  Evaluation of Disclosure Controls and Procedures. As of the end of the period covered by this quarterly report on Form 10-Q under the supervision and with the participation of management, including our chief executive officer and chief financial officer, we have evaluated the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d -15(c) under the Securities Exchange Act of 1934).  Based on that evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q.   
 
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
(b)  Changes in Internal Control over Financial Reporting.  Other than the remediation of the material weakness related to the misidentification of a subsequent event described in our Annual Report on Form 10-K for the year ended December 31, 2010, there have been no other changes in SNBV’s internal control over financial reporting that occurred during the quarter ended June 30, 2011 that have materially affected, or are reasonably likely to materially affect, SNBV’s internal control over financial reporting.
 
PART II - OTHER INFORMATION
 
ITEM 1 – LEGAL PROCEEDINGS
 
SNBV and Sonabank may, from time to time, be a party to various legal proceedings arising in the ordinary course of business.  Sonabank is a party to one small lawsuit considered to be in the ordinary course of business.  There are no other proceedings pending, or to management’s knowledge, threatened, against SNBV or Sonabank as of June 30, 2011.
 
ITEM 1A – RISK FACTORS
 
As of June 30, 2011 there were no material changes to the risk factors previously disclosed on our Annual Report on Form 10-K for the year ended December 31, 2010.
 
ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable
 
ITEM 3. – DEFAULTS UPON SENIOR SECURITIES
 
Not applicable
 
ITEM 4. – (REMOVED AND RESERVED)
 
ITEM 5. – OTHER INFORMATION
 
Not applicable
 
 
39

 
 
ITEM 6 - EXHIBITS                                              
 
  (a) Exhibits.    
       
  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.
       
 
101
 
The following information from the Company’s quarterly report on Form 10-Q for the quarterly period ended June 30, 2011 formatted in Extensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets; (ii) Consolidated Statements of Income and Comprehensive Income; (iii) Consolidated Statements of Changes in Stockholders’ Equity; (iv) Consolidated Statements of Cash Flows; and (v) Notes to Consolidated Financial Statements, tagged as blocks of text.
       
       
       
 *   Filed with this Quarterly Report on Form 10-Q 
 **   Furnished with this Quarterly Report on Form 10-Q
 
 
40

 
 
 
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 9, 2011
 
/s/ Georgia S. Derrico
 
(Date)
 
Georgia S. Derrico,
   
Chairman of the Board and Chief Executive Officer
     
August 9, 2011
 
/s/ William H. Lagos
 
(Date)
 
William H. Lagos,
   
Senior Vice President and Chief Financial Officer
 
 
41