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Primis Financial Corp. - Quarter Report: 2012 September (Form 10-Q)

t74913_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 September 30, 2012
 
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 x                         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 October 31, 2012, there were 11,590,212 shares of common stock outstanding.

 
 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
FORM 10-Q
September 30, 2012
 
INDEX

     
PAGE
         
 
PART 1 - FINANCIAL INFORMATION
     
         
Item 1 -
Financial Statements
     
 
Consolidated Balance Sheets as of September 30, 2012 and December 31, 2011
 
2
 
 
Consolidated Statements of Comprehensive Income
for the three and nine months ended September 30, 2012 and 2011
 
3
 
 
Consolidated Statements of Changes in Stockholders’ Equity
for the nine months ended September 30, 2012
 
4
 
 
Consolidated Statements of Cash Flows for the nine months ended
September 30, 2012 and 2011
 
5
 
 
Notes to Consolidated Financial Statements
 
6- 29
 
         
Item 2 - Management’s Discussion and Analysis of
     
 
Financial Condition and Results of Operations
 
30- 42
 
         
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
 
43-45
 
         
Item 4 – Controls and Procedures
 
46
 
         
 
PART II - OTHER INFORMATION
     
         
Item 1 – Legal Proceedings
 
48
 
         
Item 1A – Risk Factors
 
48
 
         
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
 
48
 
         
Item 3 – Defaults Upon Senior Securities
 
48
 
         
Item 4 – Mine Safety Disclosures
 
48
 
         
Item 5 – Other Information
 
48
 
         
Item 6 - Exhibits
 
48
 
         
Signatures
 
49
 
         
Certifications
 
50-52
 

 
 

 

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)
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
ASSETS
           
Cash and cash equivalents:
           
Cash and due from financial institutions
  $ 4,229     $ 2,432  
Interest-bearing deposits in other financial institutions
    18,059       2,603  
Total cash and cash equivalents
    22,288       5,035  
                 
Securities available for sale, at fair value
    49       9,905  
                 
Securities held to maturity, at amortized cost (fair value of $81,609 and $34,464, respectively)
    80,496       35,075  
                 
Covered loans
    76,600       82,588  
Non-covered loans
    461,169       409,180  
Total loans
    537,769       491,768  
Less allowance for loan losses
    (6,911 )     (6,295 )
Net loans
    530,858       485,473  
                 
Stock in Federal Reserve Bank and Federal Home Loan Bank
    6,190       6,653  
Bank premises and equipment, net
    6,476       6,350  
Goodwill
    9,160       9,160  
Core deposit intangibles, net
    1,480       1,995  
FDIC indemnification asset
    7,006       7,537  
Bank-owned life insurance
    17,633       17,575  
Other real estate owned
    13,452       14,256  
Deferred tax assets, net
    6,153       6,255  
Other assets
    7,021       6,104  
                 
Total assets
  $ 708,262     $ 611,373  
                 
LIABILITIES AND STOCKHOLDERS EQUITY
               
                 
Noninterest-bearing demand deposits
  $ 43,096     $ 32,582  
Interest-bearing deposits:
               
NOW accounts
    20,520       17,497  
Money market accounts
    167,370       148,959  
Savings accounts
    8,997       6,273  
Time deposits
    297,268       255,784  
Total interest-bearing deposits
    494,155       428,513  
Total deposits
    537,251       461,095  
                 
Securities sold under agreements to repurchase and other  short-term borrowings
    32,713       17,736  
Federal Home Loan Bank (FHLB) advances
    30,250       30,000  
Other liabilities
    4,025       3,491  
Total liabilities
    604,239       512,322  
                 
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 September 30, 2012 and December 31, 2011
    116       116  
Additional paid in capital
    96,791       96,645  
Retained earnings
    10,100       5,472  
Accumulated other comprehensive loss
    (2,984 )     (3,182 )
Total stockholders equity
    104,023       99,051  
                 
Total liabilities and stockholders equity
  $ 708,262     $ 611,373  

See accompanying notes to consolidated financial statements.

 
2

 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(dollars in thousands, except per share amounts) (Unaudited)
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
                         
   
2012
   
2011
   
2012
   
2011
 
         
(As Restated)
         
(As Restated)
 
 Interest and dividend income :
                       
 Interest and fees on loans
  $ 9,008     $ 8,165     $ 26,387     $ 23,255  
 Interest and dividends on taxable securities
    490       457       1,401       1,495  
 Interest and dividends on other earning assets
    102       66       247       169  
 Total interest and dividend income
    9,600       8,688       28,035       24,919  
 Interest expense:
                               
 Interest on deposits
    1,304       1,217       3,803       3,744  
 Interest on borrowings
    165       272       628       857  
 Total interest expense
    1,469       1,489       4,431       4,601  
                                 
 Net interest income
    8,131       7,199       23,604       20,318  
                                 
 Provision for loan losses
    1,830       1,550       4,605       5,140  
 Net interest income after provision for loan losses
    6,301       5,649       18,999       15,178  
                                 
 Noninterest income:
                               
 Account maintenance and deposit service fees
    222       218       624       636  
 Income from bank-owned life insurance
    148       129       649       1,196  
 Bargain purchase gain on acquisition
    -       -       3,484       -  
 Gain on sale of loans
    -       -       657       -  
 Net gain (loss) on other real estate owned
    24       -       (2,376 )     (147 )
 Gain on other assets
    -       -       14       -  
 Net gain on sale of available for sale securities
    287       -       274       -  
 Total other-than-temporary impairment losses (OTTI)
    (480 )     (43 )     (721 )     (113 )
 Portion of OTTI recognized in other comprehensive income (before taxes)
    -       -       4       -  
 Net credit related OTTI recognized in earnings
    (480 )     (43 )     (717 )     (113 )
Other
    63       62       198       151  
                                 
 Total noninterest income
    264       366       2,807       1,723  
                                 
 Noninterest expenses:
                               
 Salaries and benefits
    2,073       1,759       5,868       5,066  
 Occupancy expenses
    753       573       2,040       1,667  
 Furniture and equipment expenses
    149       140       448       406  
 Amortization of core deposit intangible
    236       230       694       690  
 Virginia franchise tax expense
    145       171       436       514  
Merger expenses
    11       -       360       -  
FDIC assessment
    146       125       417       397  
 Data processing expense
    175       126       474       400  
 Telephone and communication expense
    183       101       418       289  
 Change in FDIC indemnification asset
    242       (13 )     481       (85 )
 Other operating expenses
    665       702       2,417       1,809  
 Total noninterest expenses
    4,778       3,914       14,053       11,153  
 Income before income taxes
    1,787       2,101       7,753       5,748  
 Income tax expense
    579       692       2,487       1,602  
 Net income
  $ 1,208     $ 1,409     $ 5,266     $ 4,146  
 Other comprehensive income:
                               
   Unrealized gain (loss) on available for sale securities
  $ (107 )   $ (30 )   $ (26 )   $ 167  
   Realized amount on securities sold, net
    (287 )     -       (274 )     -  
   Non-credit component of other-than-temporary impairment on held-to-maturity securities
    475       (70 )     676       26  
 
                               
   Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for-sale
    (17 )     (27 )     (77 )     (44 )
 Net unrealized gain
    64       (127 )     299       149  
 Tax effect
    21       (44 )     101       50  
 Other comprehensive income
    43       (83 )     198       99  
 Comprehensive income
  $ 1,251     $ 1,326     $ 5,464     $ 4,245  
 Earnings per share, basic and diluted
  $ 0.10     $ 0.12     $ 0.45     $ 0.36  
                                 
 See accompanying notes to consolidated financial statements.
                               

 
3

 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
 
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
 
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012
 
(dollars in thousands, except per share amounts) (Unaudited)
 
 
                     
Accumulated
       
         
Additional
         
Other
       
   
Common
   
Paid in
   
Retained
   
Comprehensive
       
   
Stock
   
Capital
   
Earnings
   
Loss
   
Total
 
                               
Balance - January 1, 2012
  $ 116     $ 96,645     $ 5,472     $ (3,182 )   $ 99,051  
Comprehensive income:
                                       
Net income
                    5,266               5,266  
Change in unrealized gain  on available for sale securities (net of tax benefit, $102)
 
 
                      (198 )     (198 )
Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax expense, $203 and accretion, $77 and amounts recorded into other comprehensive income at transfer)
                            396       396  
Dividends on common stock ($.015 per share)
                    (638 )             (638 )
Stock-based compensation expense
            146                       146  
                                         
Balance - September 30, 2012
  $ 116     $ 96,791     $ 10,100     $ (2,984 )   $ 104,023  
                                         
See accompanying notes to consolidated financial statements.
                         

 
4

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2012 AND 2011
(dollars in thousands) (Unaudited)
 
   
2012
   
2011
 
         
(As Restated)
 
Operating activities:
           
Net income
  $ 5,266     $ 4,146  
Adjustments to reconcile net income  to net cash and
cash equivalents provided  by operating activities:
               
Depreciation
    430       393  
Amortization of core deposit intangible
    694       690  
Other amortization, net
    210       (1 )
Accretion of loan discount
    (3,277 )     (2,552 )
(Increase) decrease in FDIC indemnification asset
    481       (85 )
Provision for loan losses
    4,605       5,140  
Earnings on bank-owned life insurance
    (649 )     (396 )
Stock based compensation expense
    146       120  
Bargain purchase gain on acquisition
    (3,484 )     -  
Net gain on sale of available for sale securities
    (274 )     -  
Gain on sale of loans
    (657 )     -  
Impairment on securities
    717       113  
Net loss on other real estate owned
    2,376       147  
Net (increase) decrease in other assets
    (456 )     501  
Net increase in other liabilities
    399       549  
Net cash and cash equivalents provided by operating activities
    6,527       8,765  
Investing activities:
               
Purchases of securities available-for-sale
    (3,128 )     -  
Proceeds from sales of securities available for sale
    22,914       -  
Proceeds from paydowns, maturities and calls of securities available for sale
    1,318       763  
Purchases of securities held to maturity
    (27,410 )     -  
Proceeds from paydowns, maturities and calls of securities held to maturity
    8,973       6,632  
Loan originations and payments, net
    11,238       (29,114 )
Proceeds from sale of HarVest loans
    7,568       -  
Proceeds from sale of SBA loans
    5,713       -  
Net cash received in HarVest acquisition
    47,257       -  
Net (increase) decrease in stock in Federal Reserve Bank and Federal Home Loan Bank
    1,630       (1,006 )
Proceeds from cash surrender value of bank-owned life insurance
    395       -  
Proceeds from sale of other real estate owned
    1,137       854  
Payments received on FDIC indemnification asset
    155       800  
Purchases of bank premises and equipment
    (557 )     (434 )
Net cash and cash equivalents provided by (used in) investing activities
    77,203       (21,505 )
Financing activities:
               
Net decrease in deposits
    (64,328 )     (22,992 )
Cash dividends paid - common stock
    (638 )     -  
Proceeds from Federal Home Loan Bank advances
    -       37,500  
Repayment of Federal Home Loan Bank advances
    (16,488 )     -  
Net increase (decrease)  in securities sold under agreement to repurchase and other short-term borrowings
    14,977       (4,456 )
Net cash and cash equivalents provided by (used in) financing activities
    (66,477 )     10,052  
Increase (decrease) in cash and cash equivalents
    17,253       (2,688 )
Cash and cash equivalents at beginning of period
    5,035       9,745  
Cash and cash equivalents at end of period
  $ 22,288     $ 7,057  
Supplemental Disclosure of Cash Flow Information
               
Cash payments for:
               
Interest
  $ 4,464     $ 4,706  
Income taxes
    1,788       855  
Supplemental schedule of noncash investing and financing activities
               
Transfer from non-covered loans to other real estate owned
    1,959       9,477  
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)
September 30, 2012
 
1.     ACCOUNTING POLICIES
 
Southern National Bancorp of Virginia, Inc. (“Southern National”) 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 15 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, Richmond, Haymarket and Clifton Forge, and five branches in Maryland (four in Montgomery County and one in Frederick County).
 
Sonabank assumed substantially all of the deposits and liabilities and acquired substantially all of the assets of the HarVest Bank of Maryland from the FDIC as receiver. The acquisition included HarVest Bank’s branches in Bethesda, North Rockville, Germantown and Frederick. Adding the new branches to an existing branch in Rockville brings Sonabank’s total number of branches in Maryland to five, four of which are in Montgomery County. This was a strategic acquisition for Sonabank given the expansion into an affluent market. Full details on the transaction are contained in an 8-K/A filed on July 13, 2012.
 
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 Southern National’s Form 10-K for the year ended December 31, 2011.
 
As disclosed in our 2011 Annual Report on Form 10-K filed on April 16, 2012, Southern National restated its financial statements for the year ended December 31, 2009, the interim quarterly periods and year ended December 31, 2010 and the interim quarterly periods through September 30, 2011.  In December 2009, we acquired Greater Atlantic Bank from the FDIC.  We identified errors in the purchase accounting related to that acquisition.  All amounts for the three and nine months ended September 30, 2011 set forth in this Quarterly Report on Form 10-Q, as applicable, reflect the restatement of previously issued financial statements.  See Note 8 for further details.
 
 
6

 
 
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, fair value measurements related to assets acquired and liabilities assumed from business combinations, the FDIC indemnification asset,  mortgage servicing rights, other real estate owned and deferred tax assets.
 
Recent Accounting Pronouncements
 
In May 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-04, Fair Value Measurement (Topic 820), Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS. The guidance clarifies and expands the disclosures pertaining to unobservable inputs used in Level 3 fair value measurements, including the disclosure of quantitative information related to (1) the valuation processes used, (2) the sensitivity of the fair value measurement to changes in unobservable inputs and the interrelationships between those unobservable inputs, and (3) use of a nonfinancial asset in a way that differs from the asset’s highest and best use. The guidance also requires disclosure of the level within the fair value hierarchy for assets and liabilities not measured at fair value in the statement of financial position but for which the fair value is disclosed. The amendments in this Update are to be applied prospectively, effective during interim and annual periods beginning after December 15, 2011. This ASU was adopted in the first quarter of 2012 and its requirements are reflected in our disclosures.
 
In September 2011, the FASB issued ASU 2011-05, Comprehensive Income (Topic 220), Presentation of Comprehensive Income. This ASU amends the disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (OCI) as part of the statement of changes in stockholder’s equity. Under the amended guidance, all changes in OCI are to be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The changes are effective for fiscal years, and interim periods within those years, beginning after December 15, 2011.  In December 2011, the FASB issued ASU 2011-12 to defer changes that relate to the presentation of reclassification adjustments but the other requirements of ASU 2011-05 remain in effect. We present OCI in a single continuous statement of comprehensive income.
 
In October 2012, the FASB issued ASU 2012-06, Business Combinations (Topic 805), Subsequent Accounting for an Indemnification Asset Recognized at the Acquisition Date as a Result of a Government-Assisted Acquisition of a Financial Institution. The amendments of this ASU clarify the applicable guidance for subsequently measuring an indemnification asset recognized as a result of a government-assisted acquisition of a financial institution. The amended guidance requires an indemnification asset recognized in a government-assisted acquisition of a financial institution that includes a loss-sharing agreement to be measured on the same basis as the indemnified asset and changes in the indemnification asset to be amortized over the lesser of the term of the indemnification agreement or the remaining life of the indemnified assets. The changes are effective for fiscal years, and interim periods within those years, beginning after December 15, 2012.  The guidance will be applied prospectively to any new indemnification assets acquired and to changes in expected cash flows of existing indemnification assets occurring on or after the date of adoption.  Any unamortized balance that exists at the date of adoption also will be amortized over the shorter of the remaining term of the loss-sharing agreement or the remaining life of the indemnified assets.  Early adoption is permitted.  We applied the proposed guidance in this ASU in determining the amortization period for the indemnification asset resulting from our re-forecasting of estimated recoveries under the loss-sharing agreement with the FDIC for the 2009 Greater Atlantic Bank acquisition in the second quarter of 2012.
 
 
7

 
 
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 September 30, 2012, options to purchase an aggregate of 302,500 shares of common stock were outstanding and no shares remained available for issuance under this plan. 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 Southern National and to assist in the attracting and retaining of non-employee directors by affording them an opportunity to share in Southern National’s future success.  Under the plan, the option’s exercise price cannot be less than the fair market value of the stock on the grant date.  The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule.
 
SNBV granted 19,000 options during the first nine months of 2012. 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 nine months ended September 30, 2012:
 
Expected life
 
10 years
 
Expected volatility
    35.64 %
Risk-free interest rate
    2.04 %
Weighted average fair value per option granted
  $ 3.03  
 
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. The dividend yield has a de minimis impact on the fair value of the awards given the recent iniation of the dividend and the amount.
 
For the three and nine months ended September 30, 2012, stock-based compensation expense was $49 thousand and $146 thousand, respectively, compared to $47 thousand and $120 thousand for the same periods last year.  As of September 30, 2012, unrecognized compensation expense associated with the stock options was $518 thousand, which is expected to be recognized over a weighted average period of 3.2 years.
 
 
8

 
 
A summary of the activity in the stock option plan during the nine months ended September 30, 2012 follows (dollars in thousands):
 
               
Weighted
       
         
Weighted
   
Average
       
         
Average
   
Remaining
   
Aggregate
 
         
Exercise
   
Contractual
   
Intrinsic
 
   
Shares
   
Price
   
Term
   
Value
 
Options outstanding, beginning of period
    415,325     $ 8.06              
Granted
    19,000       6.48              
Forfeited
    (11,250 )     8.08              
Exercised
    -       -              
Options outstanding, end of period
    423,075     $ 7.99       5.7        
                               
Vested or expected to vest
    423,075     $ 7.99       5.7     $ 245  
                                 
Exercisable at end of period
    251,825     $ 8.59       4.1     $ 91  
 
3.     SECURITIES
 
The amortized cost and fair value of securities available-for-sale were as follows (in thousands):
 
   
Amortized
Cost
   
Gross Unrealized
 
Fair
Value
 
September 30, 2012
     
Gains
   
Losses
     
 FHLMC preferred stock
  $ 16     $ 33     $ -     $ 49  
                                 
   
Amortized
Cost
   
Gross Unrealized
 
Fair
Value
 
December 31, 2011
     
Gains
   
Losses
     
 SBA guaranteed loan pools
  $ 9,557     $ 280     $ -       9,837  
 FHLMC preferred stock
    16       52       -       68  
      Total
  $ 9,573     $ 332     $ -     $ 9,905  
 
The carrying amount and fair value of securities held-to-maturity were as follows (in thousands):
 
    Amortized
Cost
   
Gross Unrecognized
  Fair
Value
 
September 30, 2012
     
Gains
   
Losses
     
 Residential government-sponsored mortgage-backed securities
  $ 38,765     $ 1,930     $ -     $ 40,695  
 Residential government-sponsored collateralized mortgage obligations
    5,713       79       -       5,792  
 Government-sponsored agency securities
    24,982       131       -       25,113  
 Obligations of states and political subdivisions
    2,427       1       -       2,428  
 Other residential collateralized mortgage obligations
    842       8       -       850  
 Trust preferred securities
    7,767       1,188       (2,224 )     6,731  
    $ 80,496     $ 3,337     $ (2,224 )   $ 81,609  
                                 
   
Amortized
Cost
   
Gross Unrecognized
 
Fair
Value
 
December 31, 2011
     
Gains
   
Losses
     
 Residential government-sponsored mortgage-backed securities
  $ 26,105     $ 1,710             $ 27,815  
 Residential government-sponsored collateralized mortgage obligations
    85       2               87  
 Other residential collateralized mortgage obligations
    957       -       (157 )     800  
 Trust preferred securities
    7,928       674       (2,840 )     5,762  
    $ 35,075     $ 2,386     $ (2,997 )   $ 34,464  
 
 
9

 
 
The fair value and carrying amount, if different, of debt securities as of September 30, 2012, 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
 
   
Amortized
       
   
Cost
   
Fair Value
 
 Due after ten years
  $ 35,176     $ 34,272  
 Residential government-sponsored mortgage-backed securities
    38,765       40,695  
 Residential government-sponsored collateralized mortgage obligations
    5,713       5,792  
 Other residential  collateralized mortgage obligations
    842       850  
      Total
  $ 80,496     $ 81,609  
 
During the three and nine months ended September 30, 2012, we sold $8.0 million of available-for-sale SBA pooled securities acquired in the Greater Atlantic Bank transaction resulting in a gross gain of $287 thousand. 
 
Securities with a carrying amount of approximately $28.2 million and $36.0 million at September 30, 2012 and December 31, 2011, 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 September 30, 2012, certain securities’ fair values were below cost. As outlined in the table below, there were securities (ALESCO VII A1B, MMCF III B, and ALESCO V C1) with fair values totaling approximately $4.9 million in the portfolio with the carrying value exceeding the estimated fair value for a period of time greater than twelve months that are considered temporarily impaired at September 30, 2012.  Because the decline in fair value is attributable to changes in interest rates and market illiquidity, and not credit quality, and because we do not have the intent to sell these 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 September 30, 2012.  The following tables present information regarding securities in a continuous unrealized loss position as of September 30, 2012 and December 31, 2011 (in thousands) by duration of time in a loss position:
 
September 30, 2012
                                   
   
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
  $ -     $ -     $ 4,891     $ (2,224 )   $ 4,891       (2,224 )
                                                 
December 31, 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
 
Other residential collateralized mortgage obligations
  $ 800     $ (157 )   $ -     $ -     $ 800     $ (157 )
Trust preferred securities
    -       -       4,783       (2,840 )     4,783       (2,840 )
    $ 800     $ (157 )   $ 4,783     $ (2,840 )   $ 5,583     $ (2,997 )
 
 
10

 
 
As of September 30, 2012, 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
  $ 6,904   $ 6,216   $ 4,211     $ 117,400   $ 296      
MMCF III B
Senior Sub
  A3   A-  
Ba1
 
CC
    435     426     254       37,000     9      
                        7,339     6,642     4,465           $ 305      
                                                         
                                               
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     423     423       134,100     722   $ 355  
TRAP 2007-XII C1
Mezzanine
  A3   A   C   C     2,107     55     55       202,705     759     1,293  
TRAP 2007-XIII D
Mezzanine
 
NR
  A-  
NR
  C     2,039     -     83       214,000     7     2,032  
MMC FUNDING XVIII
Mezzanine
  A3   A-  
Ca
  C     1,070     27     166       96,682     352     691  
ALESCO V C1
Mezzanine
  A2   A   C   C     2,138     473     426       84,000     1,004     661  
ALESCO XV C1
Mezzanine
  A3   A-   C   C     3,175     30     641       249,100     586     2,559  
ALESCO XVI  C
Mezzanine
  A3   A-   C   C     2,113     117     472       86,150     816     1,180  
                        14,142     1,125     2,266           $ 4,246   $ 8,771  
                                                           
Total
                    $ 21,481   $ 7,767   $ 6,731                      
 
(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:
 
●     
.5% of the remaining performing collateral will default or defer per annum.
●     
Recoveries ranging from 25% to 47% with a two year lag on all defaults and deferrals.
●     
No prepayments for 10 years and then 1% per annum for the remaining life of the 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.
 
TRAP 2007-XII C1 and TPREF Funding II were determined to be other than temporarily impaired during the three months ended September 30, 2012. Our analyses resulted in OTTI charges related to credit on TRAP 2007-XII C1 and TPREF Funding II in the amount of $479 thousand and $1 thousand, respectively, during the three months ended September 30, 2012, compared to OTTI charges related to credit on TPREF Funding II in the amount of $43 thousand during the third quarter of 2011. The OTTI charge on TRAP 2007-XII C1 was caused by the deferral of interest payments by a large issuer in the deal which has eroded the credit support below the tranche we own.  This adverse credit development impacts the amount and timing of expected cash flows to the tranche, resulting in the recognition of OTTI. In the first quarter of 2012 we recognized OTTI charges related to credit on MMCF Funding XVIII in the amount of $2 thousand, and in the second quarter of 2012 we recognized OTTI charges related to credit on TRAP 2007-XII C1 in the amount of $235 thousand.
 
 
11

 
 
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 nine months ended September 30, 2012 and 2011 (in thousands):
 
   
2012
   
2011
 
             
Amount of cumulative other-than-temporary impairment related to credit loss prior to January 1
  $ 8,277     $ 8,002  
Amounts related to credit loss for which an other-than-temporary impairment was not previously recognized
    -       -  
Amounts related to credit loss for which an other-than-temporary impairment was previously recognized
    717       113  
Reductions due to realized losses
    (25 )     (28 )
Amount of cumulative other-than-temporary impairment related to credit loss as of September 30
  $ 8,969     $ 8,087  
 
4.     LOANS AND ALLOWANCE FOR LOAN LOSSES
 
The following table summarizes the composition of our loan portfolio as of September 30, 2012 and December 31, 2011:
 
   
 
   
Non-covered Loans
                         
   
Covered
   
HarVest
   
Other
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans (1)
   
Loans (2)
   
Loans
   
Loans
   
Loans (1)
   
Loans
   
Loans
 
   
September 30, 2012
   
December 31, 2011
 
Mortgage loans on real estate:
                                         
Commercial real estate - owner-occupied
  $ 4,276     $ 17,067     $ 77,731     $ 99,074     $ 4,854     $ 82,450     $ 87,304  
Commercial real estate - non-owner-occupied
    11,965       11,233       107,307       130,505       11,243       117,059       128,302  
Secured by farmland
    -       -       1,486       1,486       -       1,506       1,506  
Construction and land loans
    1,244       5,500       54,647       61,391       2,883       39,565       42,448  
Residential 1-4 family
    22,038       13,709       47,330       83,077       25,307       49,288       74,595  
Multi- family residential
    621       736       18,358       19,715       629       19,553       20,182  
Home equity lines of credit
    33,288       1,991       6,925       42,204       35,442       9,040       44,482  
Total real estate loans
    73,432       50,236       313,784       437,452       80,358       318,461       398,819  
                                                         
Commercial loans
    3,058       7,098       89,413       99,569       2,122       89,939       92,061  
Consumer loans
    104       18       1,626       1,748       108       1,868       1,976  
Gross loans
    76,594       57,352       404,823       538,769       82,588       410,268       492,856  
                                                         
Less deferred fees on loans
    6       (5 )     (1,001 )     (1,000 )     -       (1,088 )     (1,088 )
Loans, net of deferred fees
  $ 76,600     $ 57,347     $ 403,822     $ 537,769     $ 82,588     $ 409,180     $ 491,768  
 
(1) Covered Loans are loans acquired in the Greater Atlantic transaction and are covered under an FDIC loss-share agreement.
(2) HarVest Loans are loans acquired in the HarVest transaction and are not covered under an FDIC loss-share agreement.
 
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.” Non-covered loans included $57.3 million of loans acquired in the HarVest acquisition.
 
The covered loans acquired in the Greater Atlantic transaction are and will continue to be 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.
 
Credit-impaired covered loans are those loans showing evidence of credit deterioration since origination and it is probable, at the date of acquisition, that Southern National will not collect all contractually required principal and interest payments. Generally, acquired loans that meet Southern National’s definition for nonaccrual status fall within the definition of credit-impaired covered loans.
 
 
12

 
 
Impaired loans were as follows (in thousands):
 
September 30, 2012
 
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 (3)
   
Investment
   
Losses Allocated
 
With no related allowance recorded
                                   
Commercial real estate - owner occupied
  $ 132     $ -     $ 2,032     $ -     $ 2,164     $ -  
Commercial real estate - non-owner occupied (2)
    2,321       -       1,714       -       4,035       -  
Construction and land development
    1,091       -       4,518       -       5,609       -  
Commercial loans
    208       -       5,550       -       5,758       -  
Residential 1-4 family
    1,162       -       9,946       -       11,108       -  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 4,914     $ -     $ 23,760     $ -     $ 28,674     $ -  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ 277     $ 75     $ 277     $ 75  
Commercial real estate - non-owner occupied (2)
    -       -       1,181       200       1,181       200  
Construction and land development
    -       -       1,975       300       1,975       300  
Commercial loans
    -       -       -       -       -       -  
Residential 1-4 family
    -       -       -       -       -       -  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 3,433     $ 575     $ 3,433     $ 575  
Grand total
  $ 4,914     $ -     $ 27,193     $ 575     $ 32,107     $ 575  
 
(1) Recorded investment is after cumulative prior charge offs of $5.9 million. These loans also have aggregate SBA guarantees of $2.6 million.
(2) Includes loans secured by farmland and multi-family residential loans.
(3) The Bank recognizes loan impairment through earnings and may concurrently record a charge off to the allowance for loan losses.
 
December 31, 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 (3)
   
Investment
   
Losses Allocated
 
With no related allowance recorded
                                   
Commercial real estate - owner occupied
  $ 235     $ -     $ 4,739     $ -     $ 4,974     $ -  
Commercial real estate - non-owner occupied (2)
    1,831       -       3,294       -       5,125       -  
Construction and land development
    1,062       -       4,825       -       5,887       -  
Commercial loans
    213       -       10,704       -       10,917       -  
Residential 1-4 family
    1,355       -       375       -       1,730       -  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 4,696     $ -     $ 23,937     $ -     $ 28,633     $ -  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ -     $ -     $ -     $ -  
Commercial real estate - non-owner occupied (2)
    -       -       -       -       -       -  
Construction and land development
    -       -       1,765       989       1,765       989  
Commercial loans
    -       -       452       50       452       50  
Residential 1-4 family
    -       -       -       -       -       -  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 2,217     $ 1,039     $ 2,217     $ 1,039  
Grand total
  $ 4,696     $ -     $ 26,154     $ 1,039     $ 30,850     $ 1,039  
 
(1) Recorded investment is after cumulative prior charge offs of $5.6 million. These loans also have aggregate SBA guarantees of $2.5 million.
(2) Includes loans secured by farmland and multi-family residential loans.
(3) The Bank recognizes loan impairment through earnings and may concurrently record a charge off to the allowance for loan losses.

 
13

 
 
The following tables present the average recorded investment and interest income for impaired loans recognized by class of loans for the nine months ended September 30, 2012 and 2011 (in thousands):
 
Nine months ended September 30, 2012
                                   
   
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
  $ 135     $ 14     $ 203     $ -     $ 338     $ 14  
Commercial real estate - non-owner occupied (1)
    2,194       55       2,113       17       4,307       72  
Construction and land development
    1,085       76       3,410       50       4,495       126  
Commercial loans
    210       17       3,657       111       3,867       128  
Residential 1-4 family
    1,164       19       2,001       31       3,165       50  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 4,788     $ 181     $ 11,384     $ 209     $ 16,172     $ 390  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ 286     $ 16     $ 286     $ 16  
Commercial real estate - non-owner occupied (1)
    -       -       1,435       78       1,435       78  
Construction and land development
    -       -       2,179       87       2,179       87  
Commercial loans
    -       -       -       -       -       -  
Residential 1-4 family
    -       -       -       -       -       -  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 3,900     $ 181     $ 3,900     $ 181  
Grand total
  $ 4,788     $ 181     $ 15,284     $ 390     $ 20,072     $ 571  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
Nine months ended September 30, 2011
                                   
   
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
  $ 172     $ 14     $ 2,403     $ 102     $ 2,575     $ 116  
Commercial real estate - non-owner occupied (1)
    1,774       64       3,457       134       5,231       198  
Construction and land development
    737       77       3,140       141       3,877       218  
Commercial loans
    217       17       4,314       179       4,531       196  
Residential 1-4 family
    517       4       431       11       948       15  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,417     $ 176     $ 13,745     $ 567     $ 17,162     $ 743  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ -     $ -     $ -     $ -  
Commercial real estate - non-owner occupied (1)
    -       -       -       -       -       -  
Construction and land development
    -       -       1,796       60       1,796       60  
Commercial loans
    -       -       994       54       994       54  
Residential 1-4 family
    -       -       -       -       -       -  
  Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 2,790     $ 114     $ 2,790     $ 114  
Grand total
  $ 3,417     $ 176     $ 16,535     $ 681     $ 19,952     $ 857  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
 
14

 
 
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 September 30, 2012 and December 31, 2011 (in thousands):
 
September 30, 2012
 
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
  $ -     $ -     $ -     $ -     $ -     $ -  
Commercial real estate - non-owner occupied (1)
    2,168       -       625       -       2,793       -  
Construction and land development
    57       -       1,544       -       1,601       -  
Commercial loans
    -       -       4,610       -       4,610       -  
Residential 1-4 family
    1,162       -       320       -       1,482       -  
Other consumer loans
    -       2       -       -       -       2  
                                                 
Total
  $ 3,387     $ 2     $ 7,099     $ -     $ 10,486     $ 2  
                                                 
                                                 
December 31, 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
  $ -     $ -     $ -     $ -     $ -     $ -  
Commercial real estate - non-owner occupied (1)
    1,985       136       625       -       2,610       136  
Construction and land development
    -       -       1,087       -       1,087       -  
Commercial loans
    -       -       2,772       -       2,772       -  
Residential 1-4 family
    1,355       -       57       32       1,412       32  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,340     $ 136     $ 4,541     $ 32     $ 7,881     $ 168  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
Non-covered nonaccrual loans include SBA guaranteed loans with a carrying amount totaling $2.6 million and $2.5 million at September 30, 2012 and December 31, 2011, respectively.
 
 
15

 
 
The following tables present the aging of the recorded investment in past due loans by class of loans as of September 30, 2012 and December 31, 2011 (in thousands):
 
September 30, 2012
  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
  $ 845     $ -     $ -     $ 845     $ -     $ 3,431     $ 4,276  
    Commercial real estate - non-owner occupied (1)
    4,287       -       -       4,287       2,168       6,131       12,586  
    Construction and land development
    81       -       -       81       57       1,106       1,244  
    Commercial loans
    -       -       -       -       -       3,058       3,058  
    Residential 1-4 family
    635       187       -       822       1,162       53,342       55,326  
    Other consumer loans
    -       1       2       3       -       101       104  
                                                         
Total
  $ 5,848     $ 188     $ 2     $ 6,038     $ 3,387     $ 67,169     $ 76,594  
                                                         
Non-covered loans:
                                                       
    Commercial real estate - owner occupied
  $ 8,353     $ 403     $ -     $ 8,756     $ -     $ 86,042     $ 94,798  
    Commercial real estate - non-owner occupied (1)
    204       524       -       728       625       137,767       139,120  
    Construction and land development
    27       1,425       -       1,452       1,544       57,151       60,147  
    Commercial loans
    974       438       -       1,412       4,610       90,489       96,511  
    Residential 1-4 family
    4,241       4,465       -       8,706       320       60,929       69,955  
    Other consumer loans
    1       2       -       3       -       1,641       1,644  
                                                         
Total
  $ 13,800     $ 7,257     $ -     $ 21,057     $ 7,099     $ 434,019     $ 462,175  
                                                         
Total loans:
                                                       
    Commercial real estate - owner occupied
  $ 9,198     $ 403     $ -     $ 9,601     $ -     $ 89,473     $ 99,074  
    Commercial real estate - non-owner occupied (1)
    4,491       524       -       5,015       2,793       143,898       151,706  
    Construction and land development
    108       1,425       -       1,533       1,601       58,257       61,391  
    Commercial loans
    974       438       -       1,412       4,610       93,547       99,569  
    Residential 1-4 family
    4,876       4,652       -       9,528       1,482       114,271       125,281  
    Other consumer loans
    1       3       2       6       -       1,742       1,748  
                                                         
Total
  $ 19,648     $ 7,445     $ 2     $ 27,095     $ 10,486     $ 501,188     $ 538,769  
                                                         
December 31, 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
  $ -     $ 303     $ -     $ 303     $ -     $ 4,551     $ 4,854  
    Commercial real estate - non-owner occupied (1)
    -       -       136       136       1,985       9,751       11,872  
    Construction and land development
    -       -       -       -       -       2,883       2,883  
    Commercial loans
    -       -       -       -       -       2,122       2,122  
    Residential 1-4 family
    269       16       -       285       1,355       59,109       60,749  
    Other consumer loans
    5       -       -       5       -       103       108  
                                                         
Total
  $ 274     $ 319     $ 136     $ 729     $ 3,340     $ 78,519     $ 82,588  
                                                         
Non-covered loans:
                                                       
    Commercial real estate - owner occupied
  $ 847     $ -     $ -     $ 847     $ -     $ 81,603     $ 82,450  
    Commercial real estate - non-owner occupied (1)
    140       -       -       140       625       137,353       138,118  
    Construction and land development
    290       39       -       329       1,087       38,149       39,565  
    Commercial loans
    1,022       585       -       1,607       2,772       85,560       89,939  
    Residential 1-4 family
    953       840       32       1,825       57       56,446       58,328  
    Other consumer loans
    2       -       -       2       -       1,866       1,868  
                                                         
Total
  $ 3,254     $ 1,464     $ 32     $ 4,750     $ 4,541     $ 400,977     $ 410,268  
                                                         
Total loans:
                                                       
    Commercial real estate - owner occupied
  $ 847     $ 303     $ -     $ 1,150     $ -     $ 86,154     $ 87,304  
    Commercial real estate - non-owner occupied (1)
    140       -       136       276       2,610       147,104       149,990  
    Construction and land development
    290       39       -       329       1,087       41,032       42,448  
    Commercial loans
    1,022       585       -       1,607       2,772       87,682       92,061  
    Residential 1-4 family
    1,222       856       32       2,110       1,412       115,555       119,077  
    Other consumer loans
    7       -       -       7       -       1,969       1,976  
                                                         
Total
  $ 3,528     $ 1,783     $ 168     $ 5,479     $ 7,881     $ 479,496     $ 492,856  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
16

 
 
Activity in the allowance for loan and lease losses for the nine months ended September 30, 2012 and 2011 is summarized below (in thousands):
 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
   
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
Nine months ended September 30, 2012
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                               
Beginning balance
  $ 627     $ 1,011     $ 1,367     $ 2,227     $ 1,021     $ 42     $ -     $ 6,295  
  Charge offs
    -       (1,081 )     (1,618 )     (1,378 )     (522 )     (6 )     -       (4,605 )
  Recoveries
    -       262       10       322       16       6       -       616  
  Provision
    186       1,111       1,639       1,225       215       (7 )     236       4,605  
Ending balance
  $ 813     $ 1,303     $ 1,398     $ 2,396     $ 730     $ 35     $ 236     $ 6,911  
                                                                 
Nine months ended September 30, 2011
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ 562     $ 1,265     $ 326     $ 2,425     $ 999     $ 9     $ 13     $ 5,599  
  Charge offs
    (63 )     (950 )     (7 )     (1,867 )     (1,927 )     (6 )     -       (4,820 )
  Recoveries
    3       6       6       127       23       3       -       168  
  Provision
    197       566       928       1,573       1,802       21       53       5,140  
Ending balance
  $ 699     $ 887     $ 1,253     $ 2,258     $ 897     $ 27     $ 66     $ 6,087  
 
(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 September 30, 2012 and December 31, 2011 (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
 
September 30, 2012
                                               
Ending allowance balance attributable to loans:
                                               
  Individually evaluated for impairment
  $ 75     $ 200     $ 300     $ -     $ -     $ -     $ -     $ 575  
  Collectively evaluated for impairment
    738       1,103       1,098       2,396       730       35       236       6,336  
Total ending allowance
  $ 813     $ 1,303     $ 1,398     $ 2,396     $ 730     $ 35     $ 236     $ 6,911  
                                                                 
Loans:
                                                               
  Individually evaluated for impairment
  $ 2,309     $ 2,895     $ 6,493     $ 5,550     $ 9,946     $ -     $ -     $ 27,193  
  Collectively evaluated for impairment
    92,489       136,225       53,654       90,961       60,009       1,644       -       434,982  
Total ending loan balances
  $ 94,798     $ 139,120     $ 60,147     $ 96,511     $ 69,955     $ 1,644     $ -     $ 462,175  
                                                                 
December 31, 2011
                                                               
Ending allowance balance attributable to loans:
                                                               
  Individually evaluated for impairment
  $ -     $ -     $ 989     $ 50     $ -     $ -     $ -     $ 1,039  
  Collectively evaluated for impairment
    627       1,011       378       2,177       1,021       42       -       5,256  
Total ending allowance
  $ 627     $ 1,011     $ 1,367     $ 2,227     $ 1,021     $ 42     $ -     $ 6,295  
                                                                 
Loans:
                                                               
  Individually evaluated for impairment
  $ 4,739     $ 3,294     $ 6,590     $ 11,156     $ 375     $ -     $ -     $ 26,154  
  Collectively evaluated for impairment
    77,711       134,824       32,975       78,783       57,953       1,868       -       384,114  
Total ending loan balances
  $ 82,450     $ 138,118     $ 39,565     $ 89,939     $ 58,328     $ 1,868     $ -     $ 410,268  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
Troubled Debt Restructurings
 
A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower.  The Bank determines that a borrower may be experiencing financial difficulty if the borrower is currently delinquent on any of its debt, or if the Bank is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future.  Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk and borrower/guarantor structures.  Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness.  When evaluating whether a concession has been granted, the Bank also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Bank for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers.  The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.
 
 
17

 
 
Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.
 
During the nine months ended September 30, 2012, we modified four loans in troubled debt restructurings with unpaid principal balances totaling $4.3 million as follows:
 
          Residential 1-4 Family Mortgage 3 loans $2.8 million
          Construction and Land Loans 1 loan $1.5 million
 
All of these loans were restructured by reducing the interest rates and modifying other terms.
 
Two of the residential loans with unpaid principal balances of $195 thousand were thirty days past due as of September 30, 2012.   The other two loans are paying in accordance with their modified terms.  There is no additional commitment to lend to these four borrowers.
 
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 currently has no loan balances 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.
 
Substandard loans may be inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged if any.  Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt.  They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.
 
Doubtful loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable.
 
 
18

 
 
As of September 30, 2012 and December 31, 2011, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
 
September 30, 2012
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
   
Classified/
               
Special
                     
Classified/
             
   
Criticized (1)
   
Pass
   
Total
   
Mention
   
Substandard (3)
   
Pass
   
Total
   
Criticized
   
Pass
   
Total
 
Commercial real estate - owner occupied
  $ 132     $ 4,144     $ 4,276     $ 1,388     $ 2,309     $ 91,101     $ 94,798     $ 3,829     $ 95,245     $ 99,074  
Commercial real estate - non-owner occupied (2)
    2,321       10,265       12,586       -       2,895       136,225       139,120       5,216       146,490       151,706  
Construction and land development
    1,091       153       1,244       -       6,493       53,654       60,147       7,584       53,807       61,391  
Commercial loans
    208       2,850       3,058       33       5,550       90,928       96,511       5,791       93,778       99,569  
Residential 1-4 family
    1,162       54,164       55,326       -       9,946       60,009       69,955       11,108       114,173       125,281  
Other consumer loans
    -       104       104       -       -       1,644       1,644       -       1,748       1,748  
                                                                                 
Total
  $ 4,914     $ 71,680     $ 76,594     $ 1,421     $ 27,193     $ 433,561     $ 462,175     $ 33,528     $ 505,241     $ 538,769  
                                                                                 
December 31, 2011
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
   
Classified/
                   
Special
                           
Classified/
                 
   
Criticized (1)
   
Pass
   
Total
   
Mention
   
Substandard (3)
   
Pass
   
Total
   
Criticized
   
Pass
   
Total
 
Commercial real estate - owner occupied
  $ 235     $ 4,619     $ 4,854     $ 1,404     $ 4,739     $ 76,307     $ 82,450     $ 6,378     $ 80,926     $ 87,304  
Commercial real estate - non-owner occupied (2)
    1,831       10,041       11,872       -       3,294       134,824       138,118       5,125       144,865       149,990  
Construction and land development
    1,062       1,821       2,883       -       6,590       32,975       39,565       7,652       34,796       42,448  
Commercial loans
    213       1,909       2,122       33       11,156       78,750       89,939       11,402       80,659       92,061  
Residential 1-4 family
    1,355       59,394       60,749       40       375       57,913       58,328       1,770       117,307       119,077  
Other consumer loans
            108       108       -       -       1,868       1,868       -       1,976       1,976  
                                                                                 
Total
  $ 4,696     $ 77,892     $ 82,588     $ 1,477     $ 26,154     $ 382,637     $ 410,268     $ 32,327     $ 460,529     $ 492,856  
 
(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.
(3)
Includes SBA guarantees of $2.6 million and $2.5 million as of September 30, 2012 and December 31, 2011, respectively.
 
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 $10.2 million and $6.5 million as of September 30, 2012 and December 31, 2011, 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 customers creditworthiness on a case-by-case basis.
 
At September 30, 2012 and December 31, 2011, we had unfunded lines of credit and undisbursed construction loan funds totaling $91.7 million and $106.6 million, respectively.  Our approved loan commitments were $1.2 million at September 30, 2012 and $690 thousand at December 31, 2011, respectively.
 
 
19

 
 
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 September 30, 2012
                 
Basic EPS
  $ 1,208       11,590     $ 0.10  
Effect of dilutive stock options and warrants
    -       7       -  
Diluted EPS
  $ 1,208       11,597     $ 0.10  
                         
For the three months ended September 30, 2011
                       
Basic EPS (as restated)
  $ 1,409       11,590     $ 0.12  
Effect of dilutive stock options and warrants
    -       1       -  
Diluted EPS (as restated)
  $ 1,409       11,591     $ 0.12  
                         
For the nine months ended September 30, 2012
                       
Basic EPS
  $ 5,266       11,590     $ 0.45  
Effect of dilutive stock options and warrants
    -       4       -  
Diluted EPS
  $ 5,266       11,594     $ 0.45  
                         
For the nine months ended September 30, 2011
                       
Basic EPS (as restated)
  $ 4,146       11,590     $ 0.36  
Effect of dilutive stock options and warrants
    -       2       -  
Diluted EPS (as restated)
  $ 4,146       11,592     $ 0.36  
 
There were 498,247 and 501,438 anti-dilutive options and warrants for the three and nine months ended September 30, 2012, respectively because these options and warrants have exercise prices that are greater than the average market price of our common stock for the periods presented. Anti-dilutive options and warrants totaled 559,209 and 558,120 for the three and nine months ended September 30, 2011, 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
 
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, mortgage products and exchange traded equities.  If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow.  Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities.  In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy.  Currently, Southern National has no available-for-sale debt securities.
 
 
20

 
 
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)
 
September 30, 2012
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                       
  Available for sale securities
                       
    FHLMC preferred stock
  $ 49     $ 49     $ -     $ -  
Total available-for-sale securities
  $ 49     $ 49     $ -     $ -  
                                 
                                 
           
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, 2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                               
  Available for sale securities
                               
    SBA guaranteed loan pools
  $ 9,837     $ -     $ 9,837     $ -  
    FHLMC preferred stock
    68       68       -       -  
Total available-for-sale securities
  $ 9,905     $ 68     $ 9,837     $ -  
 
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 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 9.86% to 13.84%.   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.
 
 
21

 
 
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 September 30, 2012.  The assumptions used in the analysis included a 5.8% prepayment speed, 7.6% default rate, a 55% loss severity and an accounting yield of 2.68%.
 
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 $27.2 million (including SBA guarantees of $2.6 million and HarVest loans of $1.9 million) as of September 30, 2012 with an allocated allowance for loan losses totaling $575 thousand compared to a carrying amount of $26.2 million (including SBA guarantees of $2.5 million) with an allocated allowance for loan losses totaling $1.0 million at December 31, 2011.  Charge-offs related to the impaired loans at September 30, 2012 totaled $963 thousand and $2.6 million for the three and nine months ended September 30, 2012, respectively, compared to $1.5 million and $4.2 million for the three and nine months ended September 30, 2011, 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 September 30, 2012, the total amount of OREO was $13.5 million, of which $12.8 million was non-covered (including $744 thousand acquired from HarVest) and $636 thousand was covered.
 
At December 31, 2011, the total amount of OREO was $14.3 million, of which $13.6 million was non-covered and $636 thousand was covered.
 
 
22

 
 
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)
 
September 30, 2012
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Trust preferred securities, held to maturity
  $ 478                 $ 478  
Impaired non-covered loans:
                               
    Commercial real estate - owner occupied
    2,234                       2,234  
    Commercial real estate - non-owner occupied (1)
    2,695                       2,695  
    Construction and land development
    6,193                       6,193  
    Commercial loans
    5,550                       5,550  
    Residential 1-4 family
    9,946                       9,946  
Impaired covered loans:
                               
    Commercial real estate - owner occupied
    132                       132  
    Commercial real estate - non-owner occupied (1)
    2,321                       2,321  
    Construction and land development
    1,091                       1,091  
    Commercial loans
    208                       208  
    Residential 1-4 family
    1,162                       1,162  
Non-covered other real estate owned:
                               
    Commercial real estate - owner occupied
    746                       746  
    Commercial real estate - non-owner occupied (1)
    1,342                       1,342  
    Construction and land development
    5,515                       5,515  
    Residential 1-4 family
    5,213                       5,213  
Covered other real estate owned:
                               
    Commercial real estate - owner occupied
    557                       557  
    Commercial
    79                       79  
                                 
           
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, 2011
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Trust preferred securities, held to maturity
  $ 32                     $ 32  
Impaired non-covered loans:
                               
    Commercial real estate - owner occupied
    4,739                       4,739  
    Commercial real estate - non-owner occupied (1)
    3,294                       3,294  
    Construction and land development
    5,601                       5,601  
    Commercial loans
    11,106                       11,106  
    Residential 1-4 family
    375                       375  
Impaired covered loans:
                               
    Commercial real estate - owner occupied
    235                       235  
    Commercial real estate - non-owner occupied (1)
    1,831                       1,831  
    Construction and land development
    1,062                       1,062  
    Commercial loans
    213                       213  
    Residential 1-4 family
    1,355                       1,355  
Non-covered other real estate owned:
                               
    Commercial real estate - owner occupied
    1,414                       1,414  
    Commercial real estate - non-owner occupied (1)
    1,519                       1,519  
    Construction and land development
    4,614                       4,614  
    Residential 1-4 family
    6,073                       6,073  
Covered other real estate owned:
                               
    Commercial real estate - owner occupied
    557                       557  
    Commercial
    79                       79  
                                 
(1) Includes loans secured by farmland and multi-family residential loans.
                         

 
23

 
 
Fair Value of Financial Instruments
 
The carrying amount, estimated fair values and fair value hierarchy levels (previously defined) of financial instruments were as follows (in thousands):

         
September 30, 2012
   
December 31, 2011
 
   
Fair Value
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Hierarchy Level
   
Amount
   
Value
   
Amount
   
Value
 
                               
Financial assets:
                             
Cash and cash equivalents
 
Level 1
    $ 22,288     $ 22,288     $ 5,035     $ 5,035  
Securities available for sale
 
See previous table
      49       49       9,905       9,905  
Securities held to maturity
 
Level 2 & Level 3
      80,496       81,609       35,075       34,464  
Stock in Federal Reserve Bank and Federal
                                     
    Home Loan Bank
  n/a       6,190       n/a       6,653       n/a  
Net non-covered loans
 
Level 3
      454,258       453,600       402,885       400,777  
Net covered loans
 
Level 3
      76,600       76,474       82,588       82,079  
Accrued interest receivable
 
Level 3
      2,623       2,623       2,118       2,118  
FDIC indemnification asset
 
Level 3
      7,006       7,006       7,537       7,537  
Financial liabilities:
                                       
Deposits:
                                       
Demand deposits
 
Level 3
      63,616       63,616       50,079       50,079  
Money market and savings accounts
 
Level 3
      176,367       176,367       155,232       155,232  
Certificates of deposit
 
Level 3
      297,268       300,044       255,784       258,928  
Securities sold under agreements to
                                       
  repurchase and other short-term borrowings
 
Level 3
      32,713       32,713       17,736       17,736  
FHLB advances
 
Level 3
      30,250       31,531       30,000       31,293  
Accrued interest payable
 
Level 3
      330       330       363       363  
 
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 fair value of the FDIC indemnification asset was determined by discounting estimated future cash flows using the long-term risk free rate plus a premium and represents the present value of our current expectation for recoveries from the FDIC on covered loans.  The fair value of off-balance-sheet items is not considered material.  The fair value of loans is not presented on an exit price basis.
 
8.     CORRECTION OF ERRORS RELATED TO PURCHASE ACCOUNTING
 
In December 2009, we acquired Greater Atlantic Bank from the FDIC.  We subsequently identified errors in the purchase accounting related to that acquisition.  We had utilized the services of a valuation consultant to assist with the identification and estimation of the fair value of the assets acquired and liabilities assumed.   As disclosed in our 2011 Annual Report on Form 10-K, we have restated our financial statements for year ended December 31, 2009, the interim quarterly periods and year ended December 31, 2010 and the interim quarterly periods through September 30, 2011.
 
 
24

 
 
The most significant error was that a redundant credit loss assumption was applied to the acquired residential and home equity loan portfolios for purposes of calculating the expected credit losses for these portfolios recoverable from the FDIC.  This error resulted in an overstatement of the FDIC indemnification asset.   The correction of the error resulted in the removal of the gain of $11.2 million reported in our 2009 consolidated statement of operations, as well as adjustments to other amounts originally reported in 2009.  We engaged an advisor to assist with calculating the correct initial fair value of the indemnification asset; accretion of the acquired loan discount; calculation of estimated amounts due back to the FDIC in the event that losses do not achieve a specified level (the clawback liability); and other purchase accounting adjustments. Correcting the 2009 purchase accounting entries required adjustments to certain as reported amounts as of and for the three and nine months ended September 30, 2011.
 
Notes (a) through (f) below describe the restatement adjustments to the consolidated balance sheets as of September 30, 2011, and the consolidated statements of income and comprehensive income (loss), changes in stockholders’ equity, and cash flows for the three and nine months ended September 30, 2011  presented in the following tables.
 
(a)
Correct the carrying value of the FDIC indemnification asset as of September 30, 2011.
 
(b)
Correct the accretion amounts for the accretable discount on the acquired loans. On the statement of cash flows as reported, the accretion of the loan discount was previously presented as loan originations and payments, net within investing activities. Reclassifications between covered loans, other assets and goodwill of approximately $500 thousand are reflected as adjustments to the balance sheet presentation in this footnote as of September 30, 2011 as compared to the summarized presentation included in the unaudited quarterly financial information footnote in our 2011 Form 10-K.
 
(c)
Record a liability for amounts expected to be paid to the FDIC at the maturity of the indemnification agreement as credit losses are not expected to reach levels established in the Purchase and Assumption Agreement for the acquisition of Greater Atlantic Bank.  The initial fair value of this liability was reflected at the net present value of expected cash outflows of $586 thousand, and is accreted through other operating expenses to the expected cash disbursement.
 
(d)
Record the tax effects for the impact of the adjustments.
 
(e)
Recognize goodwill of $10 thousand.
 
 
25

 
 
   
Impact on Consolidated Balance Sheets
 
   
September 30, 2011
 
   
As Previously
             
   
Reported
   
As Restated
   
Adjustment
 
   
(dollars in thousands)
 
    (Unaudited)  
ASSETS
                 
Cash and cash equivalents:
                 
Cash and due from financial institutions
  $ 2,432     $ 2,432     $ -  
Interest-bearing deposits in other financial institutions
    4,625       4,625       -  
Total cash and cash equivalents
    7,057       7,057       -  
                         
Securities available for sale, at fair value
    10,438       10,438       -  
                         
Securities held to maturity, at amortized cost
                       
(fair value of $38,097)
    38,354       38,354       -  
                         
Covered loans
    80,398       84,567       4,169  b
Non-covered loans
    396,494       396,494       -  
Total loans
    476,892       481,061       4,169  
Less allowance for loan losses
    (6,087 )     (6,087 )     -  
Net loans
    470,805       474,974       4,169  
                         
Stock in Federal Reserve Bank and Federal Home Loan Bank
    7,356       7,356       -  
Bank premises and equipment, net
    4,700       4,700       -  
Goodwill
    8,713       8,723       10  e
Core deposit intangibles, net
    2,225       2,225       -  
FDIC indemnification asset
    18,226       7,580       (10,646 ) a
Bank-owned life insurance
    14,435       14,435       -  
Other real estate owned
    13,097       13,097       -  
Deferred tax assets, net
    4,440       6,963       2,523  d
Other assets
    5,532       5,522       (10 ) b/d
                      -  
Total assets
  $ 605,378     $ 601,424       (3,954 )
                         
LIABILITIES AND STOCKHOLDERS’ EQUITY
                       
                         
Noninterest-bearing demand deposits
  $ 31,791     $ 31,791     $ -  
Interest-bearing deposits:
                       
NOW accounts
    16,310       16,310       -  
Money market accounts
    140,781       140,781       -  
Savings accounts
    6,335       6,335       -  
Time deposits
    212,765       212,765       -  
Total interest-bearing deposits
    376,191       376,191       -  
Total deposits
    407,982       407,982       -  
                         
Securities sold under agreements to repurchase and other
                       
short-term borrowings
    19,452       19,452       -  
Federal Home Loan Bank (FHLB) advances
    72,500       72,500       -  
Other liabilities
    2,377       2,794       417  c
Total liabilities
    502,311       502,728       417  
                         
Commitments and contingencies (see note 15)
    -       -          
                         
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 September 30, 2011
    116       116       -  
Additional paid in capital
    96,598       96,598       -  
Retained earnings
    9,588       5,217       (4,371 )
Accumulated other comprehensive loss
    (3,235 )     (3,235 )     -  
Total stockholders’ equity
    103,067       98,696       (4,371 )
                         
Total liabilities and stockholders’ equity
  $ 605,378     $ 601,424     $ (3,954 )

 
26

 
 
   
Impact on Consolidated Statements of Income and Comprehensive Income
   
Impact on Consolidated Statements of Income and Comprehensive Income
 
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30, 2011
   
September 30, 2011
 
   
As Previously
               
As Previously
             
   
Reported
   
As Restated
   
Adjustment
   
Reported
   
As Restated
   
Adjustment
 
   
(dollars in thousands)
   
(dollars in thousands)
 
   
(Unaudited)
   
(Unaudited)
 
 Interest and dividend income :
                                   
Interest and fees on loans
  $ 7,871     $ 8,165     $ 294  b    $ 22,202     $ 23,255     $ 1,053  b 
Interest and dividends on taxable securities
    457       457       -       1,495       1,495       -  
Interest and dividends on other earning assets
    66       66       -       169       169       -  
Total interest and dividend income
    8,394       8,688       294       23,866       24,919       1,053  
Interest expense:
                                               
Interest on deposits
    1,217       1,217       -       3,744       3,744       -  
Interest on borrowings
    272       272       -       857       857       -  
Total interest expense
    1,489       1,489       -       4,601       4,601       -  
                                                 
Net interest income
    6,905       7,199       294       19,265       20,318       1,053  
                                                 
Provision for loan losses
    1,550       1,550       -       5,140       5,140       -  
Net interest income after provision
                                               
for loan losses
    5,355       5,649       294       14,125       15,178       1,053  
                                                 
Noninterest income:
                                               
Account maintenance and deposit service fees
    218       218       -       636       636       -  
Income from bank-owned life insurance
    129       129       -       1,196       1,196       -  
Net loss on other assets
    -       -       -       (147 )     (147 )     -  
Total other-than-temporary impairment losses (OTTI)
    (43 )     (43 )     -       (113 )     (113 )     -  
Portion of OTTI recognized in other comprehensive income (before taxes)
    -       -       -       -       -       -  
 Net credit related OTTI recognized in earnings
    (43 )     (43 )     -       (113 )     (113 )     -  
Other
    62       62       -       151       151       -  
                                                 
Total noninterest income
    366       366       -       1,723       1,723       -  
                                                 
Noninterest expenses:
                                               
Salaries and benefits
    1,759       1,759       -       5,066       5,066       -  
Occupancy expenses
    573       573       -       1,667       1,667       -  
Furniture and equipment expenses
    140       140       -       406       406       -  
Amortization of core deposit intangible
    230       230       -       690       690       -  
Virginia franchise tax expense
    171       171       -       514       514       -  
FDIC assessment
    125       125       -       397       397       -  
Data processing expense
    126       126       -       400       400       -  
Telephone and communication expense
    101       101       -       289       289       -  
Change in FDIC indemnification asset
    (140 )     (13 )     127  a      (490 )     (85 )     405  a 
Other operating expenses
    695       702       7  c      1,788       1,809       21  c 
Total noninterest expenses
    3,780       3,914       134       10,727       11,153       426  
Income before income taxes
    1,941       2,101       160       5,121       5,748       627  
Income tax expense
    638       692       54  d      1,387       1,602       215  d 
Net income
  $ 1,303     $ 1,409     $ 106     $ 3,734     $ 4,146     $ 412  
Other comprehensive income (loss):
                                               
Unrealized gain on available for sale securities
  $ (30 )   $ (30 )   $ -     $ 167     $ 167     $ -  
Realized amount on securities sold, net
    -       -       -       -       -       -  
Non-credit component of other-than-temporary impairment on held-to-maturity securities
    (70 )     (70 )     -       26       26       -  
Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for sale
    (27 )     (27 )     -       (44 )     (44 )     -  
Net unrealized gain (loss)
    (127 )     (127 )     -       149       149       -  
Tax effect
    (44 )     (44 )     -       50       50       -  
Other comprehensive income (loss):
    (83 )     (83 )     -       99       99       -  
Comprehensive income
  $ 1,220     $ 1,326     $ 106     $ 3,833     $ 4,245     $ 412  
Earnings per share, basic and diluted
  $ 0.11     $ 0.12     $ 0.01     $ 0.32     $ 0.36     $ 0.04  
 
   
Impact on Consolidated Statements
 
   
of Changes in Stockholders’ Equity
 
   
As Previously
             
   
Reported
   
As Restated
   
Adjustment
 
   
(dollars in thousands)
 
   
(Unaudited)
 
Balance - December 31, 2010
  $ 99,114     $ 94,331     $ (4,783 )
Comprehensive income:
                       
    Net income
    3,734       4,146       412  
    Change in unrealized loss on securities available for sale (net of tax, $57)
    110       110       -  
Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $7 and accretion, $44 and amounts recorded into other ”comprehensive income at transfer)
    (11 )     (11 )     -  
Total comprehensive income
    3,833       4,245       412  
Stock-based compensation expense
    120       120       -  
                         
Balance - September 30, 2011
  $ 103,067     $ 98,696     $ (4,371 )

 
27

 
 
   
Impact on Consolidated Statements Cash Flows
 
   
For the Nine Months Ended
 
   
September 30, 2011
 
   
As Previously
             
   
Reported
   
As Restated
   
Adjustment
 
   
(dollars in thousands)
 
   
(Unaudited)
 
Operating activities:
                 
Net income
  $ 3,734     $ 4,146     $ 412  
Adjustments to reconcile net income (loss) to net cash and
                       
cash equivalents provided  by operating activities:
                       
Depreciation
    393       393       -  
Amortization of core deposit intangible
    690       690       -  
Other amortization, net
    (1 )     (1 )     -  
Accretion of loan discount
    -       (2,552 )     (2,552 ) b
Decrease (increase) in FDIC indemnification asset
    (490 )     (85 )     405  a 
Provision for loan losses
    5,140       5,140       -  
Earnings on bank-owned life insurance
    (396 )     (396 )     -  
Stock based compensation expense
    120       120       -  
Impairment on securities
    113       113       -  
Net loss on other real estate owned
    147       147       -  
Net (increase) decrease in other assets
    1,318       501       (817 ) d
Net increase (decrease) in other liabilities
    549       549       -  
Net cash and cash equivalents provided by operating activities
    11,317       8,765       (2,552 )
Investing activities:
                       
Proceeds from paydowns, maturities and calls of securities available for sale
    763       763       -  
Proceeds from paydowns, maturities and calls of securities held to maturity
    6,632       6,632       -  
Loan originations and payments, net
    (31,666 )     (29,114 )     2,552  b 
Net (increase) decrease in stock in Federal Reserve Bank and Federal Home Loan Bank
    (1,006 )     (1,006 )     -  
Proceeds from sale of other real estate owned
    854       854       -  
Payments received on FDIC indemnification asset
    800       800       -  
Purchases of bank premises and equipment
    (434 )     (434 )     -  
Net cash and cash equivalents used in investing activities
    (24,057 )     (21,505 )     2,552  
Financing activities:
                       
Net increase in deposits
    (22,992 )     (22,992 )     -  
Proceeds from Federal Home Loan Bank advances
    37,500       37,500       -  
Net increase (decrease) in securities sold under agreement to repurchase and
                    -  
other short-term borrowings
    (4,456 )     (4,456 )     -  
Net cash and cash equivalents provided by financing activities
    10,052       10,052       -  
Decrease in cash and cash equivalents
    (2,688 )     (2,688 )     -  
Cash and cash equivalents at beginning of period
    9,745       9,745       -  
Cash and cash equivalents at end of period
  $ 7,057     $ 7,057     $ -  
Supplemental disclosure of cash flow information
                       
Cash payments for:
                       
Interest
  $ 4,706     $ 4,706       -  
Income taxes
    855       855       -  
Supplemental schedule of noncash investing and financing activities
                       
Transfer from non-covered loans to other real estate owned
    9,477       9,477       -  
Transfer from covered loans to other real estate owned
    82       82       -  
 
9.     FDIC-ASSISTED ACQUISITION
 
On April 27, 2012, Sonabank entered into an agreement with the Federal Deposit Insurance Corporation (“FDIC”) to assume all of the deposits and certain assets of HarVest Bank of Maryland (“HarVest”) a state chartered non-Federal Reserve member commercial bank. HarVest operated four branches – North Rockville, Frederick, Germantown and Bethesda (all located in Maryland).
 
 
28

 
 
The assets and liabilities were recorded at their estimated fair values as of the April 27, 2012 acquisition date.  A summary of the net assets acquired from the FDIC is as follows (in thousands):
 
Assets
     
Cash and cash equivalents
  $ 21,704  
Consideration from the FDIC
    25,553  
Investment securities
    38,379  
Loans
    64,966  
Loans held for sale
    7,568  
Federal Home Loan Bank stock
    1,167  
Other real estate owned
    750  
Core deposit intangible
    179  
Other assets
    576  
Total assets acquired
  $ 160,842  
         
Liabilities
       
Deposits
  $ 140,484  
FHLB advances
    16,738  
Other liabilities
    136  
Total liabilities
  $ 157,358  
         
Net assets acquired (bargain purchase gain)
  $ 3,484  
 
A valuation of the acquired loans and core deposit intangible was performed with the assistance of a third-party valuation consultant.  The unpaid principal balance and fair value of performing loans was $67.4 million and $63.0 million, respectively.  The discount of $4.4 million will be accreted through interest income over the life of the loans in accordance with Accounting Standards Codification (ASC) topic 310-20.  The unpaid principal balance and estimated fair value of acquired and retained non-performing loans was $5.3 million and $1.9 million, respectively.  In accordance with ASC 310-30, the discount of $3.4 million for these credit impaired loans will not be accreted.
 
Because HarVest was a distressed financial institution that was seized by the FDIC, certain historical operating information is not available to us and the preparation of pro forma operating disclosures is not practicable.
 
The application of the acquisition method of accounting resulted in the recognition of a bargain purchase gain of $3.5 million, and the bargain purchase gain is equal to the amount by which the fair value of the net assets acquired exceeded the consideration transferred and is influenced significantly by the FDIC-assisted transaction process.  However, the acquired loans in the HarVest transaction are not covered by an indemnification agreement with the FDIC.
 
 
29

 
 
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, 2011.  Results of operations for the three and nine month periods ended September 30, 2012 are not necessarily indicative of results that may be attained for any other period.
 
FORWARD-LOOKING STATEMENTS
 
Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. 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, 2011, factors that could contribute to those differences include, but are not limited to:
 
 
our limited operating history;
 
the effects of future economic, business and market conditions and changes, domestic and foreign;
 
changes in 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;
 
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 and estimates underlying the establishment of and provisions made to the allowance for loan losses;
 
our ability to expand and grow our business and operations, including the establishment of additional branches and acquisition of additional branches and banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities;
 
 
30

 
 
 
changes in governmental monetary and fiscal policies, including interest rate policies of the Board of Governors of the Federal Reserve System, or 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;
 
the continued service of key management personnel;
 
the potential payment of interest on demand deposit accounts to effectively compete for customers;
 
potential environmental liability risk associated with lending activities;
 
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
 
legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, including those associated with the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and changes in the scope and cost of Federal Deposit Insurance Corporation (“FDIC”) insurance and other coverage;
 
increases in regulatory capital requirements for banking organizations generally, which may adversely affect our ability to expand our business or could cause us to shrink our business;
 
the effects of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic conditions;
 
changes in accounting policies, rules and practices and applications or determinations made thereunder;
 
the risk that our deferred tax assets could be reduced if future taxable income  is less than currently estimated, if corporate tax rates in the future are less than current rates,  or if sales of our capital stock trigger limitations on the amount of net operating loss carryforwards that we may utilize for income tax purposes; and
 
other factors and risks described under “Risk Factors” herein and in any of our subsequent reports that we make with the Securities and Exchange Commission (the “Commission” or “SEC”) under the Exchange Act.
 
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. (“Southern National”) 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 has 15 branches in Virginia, located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Middleburg, Leesburg (2), South Riding, Front Royal, New Market, Richmond, Haymarket and Clifton Forge, and five branches in Maryland (four in Montgomery County and one in Frederick County).  We have administrative offices in Warrenton and an executive office in Georgetown, Washington, D.C where senior management is located.
 
 
31

 
 
As disclosed in our 2011 Annual Report on Form 10-K, Southern National restated its financial statements for the year ended December 31, 2009, the interim quarterly periods and year ended December 31, 2010 and the interim quarterly periods through September 30, 2011.  In December 2009, we acquired Greater Atlantic Bank from the FDIC.  We identified errors in the purchase accounting related to that acquisition.  All amounts for the three and nine months ended September 30, 2011 set forth in this Quarterly Report on Form 10-Q, as applicable, reflect the restatement of previously issued financial statements.
 
As previously announced Sonabank assumed substantially all of the deposits and liabilities and acquired substantially all of the assets of the HarVest Bank of Maryland from the FDIC as receiver. The acquisition included HarVest Bank’s branches in Bethesda, North Rockville, Germantown and Frederick. Adding the new branches to an existing branch in Rockville brings Sonabank’s total number of branches in Maryland to five, four of which are in Montgomery County. This was a strategic acquisition for Sonabank given the expansion into an affluent market. This was not simply a financial transaction but an opportunity to broaden and deepen our deposit base. HarVest’s branches have been integrated into the Sonabank branch system, and the core processing systems were succesfully merged in the third quarter of 2012.  Full details on the transaction are contained in an 8-K/A filed on July 13, 2012.
 
RESULTS OF OPERATIONS
 
Net Income
 
Net income for the quarter and nine months ended September 30, 2012 was $1.2 million and $5.3 million compared to $1.4 million and $4.1 million during the third quarter and the first nine months of 2011.
 
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 $8.1 million in the quarter ended September 30, 2012 up from $7.2 million during the same period last year. The accretion of the discount on Greater Atlantic Bank’s loans contributed $674 thousand to third quarter 2012 net interest income compared to $786 thousand during the third quarter of 2011. The accretion of the discount on HarVest’s loans contributed $241 thousand in the third quarter of 2012. Average loans increased $55.6 million for the third quarter of 2012 compared to the quarter ended September 30, 2011, and the cost of funds decreased from 1.25% to 1.08%. Sonabank’s net interest margin was 5.14% in the third quarter of 2012 compared to 5.22% during the comparable quarter last year and 5.07% during the second quarter of 2012.
 
Net interest income was $23.6 million during the nine months ended September 30, 2012, compared to $20.3 million during the comparable period in the prior year. Average loans during the first nine months of 2012 were $523.2 million compared to $472.2 million during the same period last year. The Greater Atlantic Bank loan discount accretion contributed $2.9 million to net interest income during the first nine months of 2012, compared to $2.6 million during the nine months ended September 30, 2011. The loan discount accretion on the HarVest Bank portfolio contributed $412 thousand through the third quarter of 2012.  The net interest margin in the nine months ended September 30, 2012 was 5.26% compared to 5.08% for the same period last year.
 
 
32

 
 
The following tables detail average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:
 
   
Average Balance Sheets and Net Interest
 
   
Analysis For the Quarters Ended
 
   
9/30/2012
   
9/30/2011
 
         
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)
  $ 541,405     $ 9,008       6.62 %   $ 485,773     $ 8,165       6.67 %
Investment securities
    69,802       490       2.81 %     50,018       457       3.65 %
Other earning assets
    17,520       102       2.32 %     11,370       66       2.30 %
                                                 
Total earning assets
    628,727       9,600       6.07 %     547,161       8,688       6.30 %
Allowance for loan losses
    (7,246 )                     (6,544 )                
Total non-earning assets
    71,482                       64,666                  
Total assets
  $ 692,963                     $ 605,283                  
                                                 
Liabilities and stockholders’ equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 19,460       13       0.27 %   $ 15,578       11       0.27 %
Money market accounts
    167,313       333       0.79 %     141,580       305       0.85 %
Savings accounts
    8,926       13       0.58 %     6,092       9       0.58 %
Time deposits
    290,432       945       1.29 %     228,414       892       1.55 %
Total interest-bearing deposits
    486,131       1,304       1.07 %     391,664       1,217       1.23 %
Borrowings
    54,879       165       1.20 %     81,616       272       1.32 %
Total interest-bearing liabilities
    541,010       1,469       1.08 %     473,280       1,489       1.25 %
Noninterest-bearing liabilities:
                                               
Demand deposits
    44,117                       30,766                  
Other liabilities
    3,909                       2,987                  
Total liabilities
    589,036                       507,033                  
Stockholders’ equity
    103,927                       98,250                  
Total liabilities and stockholders’
                                               
equity
  $ 692,963                     $ 605,283                  
Net interest income
            8,131                     $ 7,199          
Interest rate spread
                    4.99 %                     5.05 %
Net interest margin
                    5.14 %                     5.22 %
                                                 
(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.
                         

 
33

 

   
Average Balance Sheets and Net Interest
 
   
Analysis For the Nine Months Ended
 
   
9/30/2012
   
9/30/2011
 
         
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)
  $ 523,182     $ 26,387       6.74 %   $ 472,222     $ 23,255       6.58 %
Investment securities
    59,976       1,401       3.11 %     51,998       1,495       3.83 %
Other earning assets
    16,689       247       1.98 %     10,676       169       2.12 %
                                                 
Total earning assets
    599,847       28,035       6.24 %     534,896       24,919       6.23 %
Allowance for loan losses
    (7,075 )                     (6,154 )                
Total non-earning assets
    71,758                       62,465                  
Total assets
  $ 664,530                     $ 591,207                  
                                                 
Liabilities and stockholders’ equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 18,431       46       0.33 %   $ 15,560       31       0.27 %
Money market accounts
    159,859       959       0.80 %     148,272       989       0.89 %
Savings accounts
    7,873       35       0.60 %     5,874       26       0.60 %
Time deposits
    277,455       2,763       1.33 %     225,999       2,698       1.60 %
Total interest-bearing deposits
    463,618       3,803       1.10 %     395,705       3,744       1.26 %
Borrowings
    51,270       628       1.64 %     64,563       857       1.77 %
Total interest-bearing liabilities
    514,888       4,431       1.15 %     460,268       4,601       1.34 %
Noninterest-bearing liabilities:
                                               
  Demand deposits
    40,986                       31,347                  
  Other liabilities
    6,694                       2,872                  
Total liabilities
    562,568                       494,487                  
Stockholders’ equity
    101,962                       96,720                  
Total liabilities and stockholders’
                                               
  equity
  $ 664,530                     $ 591,207                  
Net interest income
          $ 23,604                     $ 20,318          
Interest rate spread
                    5.09 %                     4.89 %
Net interest margin
                    5.26 %                     5.08 %
                                                 
(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 historical loss factors to each segment.  The historical loss factors may be qualitatively adjusted by considering regulatory and peer data, and the application of management’s judgment.
 
The provision for loan losses in the third quarter of 2012 was $1.8 million compared to $1.6 million in the third quarter of 2011. For the nine months ended September 30, 2012, the provision for loan losses was $4.6 million compared to $5.1 million for the same period last year.
 
Net charge-offs during the third quarter of 2012 were $1.6 million, compared to net charge-offs during the third quarter of 2011 of $1.5 million.
 
Net charge-offs during the nine months ended September 30, 2012 were $4.0 million compared to $4.7 million during the first nine months of 2011.
 
 
34

 
 
Noninterest Income
 
The following table presents the major categories of noninterest income for the three and nine months ended September 30, 2012 and 2011:
 
   
For the Three Months Ended
 
   
September 30,
 
   
2012
   
2011
   
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 222     $ 218     $ 4  
Income from bank-owned life insurance
    148       129       19  
Net gain on other real estate owned
    24       -       24  
Net gain on sale of available for sale securities
    287       -       287  
OTTI losses recognized in earnings
    (480 )     (43 )     (437 )
Other
    63       62       1  
    Total noninterest income
  $ 264     $ 366     $ (102 )
                         
   
For the Nine Months Ended
 
   
September 30,
 
     2012      2011     Change  
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 624     $ 636     $ (12 )
Income from bank-owned life insurance
    649       1,196       (547 )
Bargain purchase gain on acquisition
    3,484       -       3,484  
Gain on sale of loans
    657       -       657  
Net loss on other real estate owned
    (2,376 )     (147 )     (2,229 )
Gain on other assets
    14       -       14  
Net gain on sale of available for sale securities
    274       -       274  
OTTI losses recognized in earnings
    (717 )     (113 )     (604 )
Other
    198       151       47  
    Total noninterest income
  $ 2,807     $ 1,723     $ 1,084  
 
During the third quarter of 2012 Sonabank had noninterest income of $264 thousand compared to noninterest income of $366 thousand during the third quarter of 2011. The decline was primarily related to an OTTI charge on trust preferred securities in the amount of $480 thousand which was partially offset by a gain on the sale of SBA pooled securities in the amount of $287 thousand.
 
Noninterest income increased to $2.8 million in the first nine months of 2012 from $1.7 million in the first nine months of 2011. The increase resulted from the bargain purchase gain of $3.5 million from the HarVest transaction which was partially offset by the recognition of impairment in the values of five OREO properties in the Charlottesville market and one in the Culpeper market during the second quarter of 2012. In addition to the OTTI charge recognized in the third quarter of 2012, there was an OTTI of $235 thousand in one trust preferred security during the second quarter of 2012 compared to $38 thousand in OTTI charges during the second quarter of 2011. Also, during the first quarter of 2012 the bank sold the guaranteed portions of SBA loans and realized a $657 thousand gain. Income from bank owned life insurance (“BOLI”) contributed $649 thousand during the nine months ended September 30, 2012, compared to $1.2 million during  the nine months ended September 30, 2011. Both periods were affected by death benefits; however, the death benefit received in the 2011 period was $800 thousand as compared to $195 in the 2012 period.
 
 
35

 
 
Noninterest Expense
 
The following table presents the major categories of noninterest expense for the three and nine months ended September 30, 2012 and 2011:
 
   
For the Three Months Ended
 
   
September 30,
 
   
2012
   
2011
   
Change
 
         
(As Restated)
       
   
(dollars in thousands)
 
 Salaries and benefits
  $ 2,073     $ 1,759     $ 314  
 Occupancy expenses
    753       573       180  
 Furniture and equipment expenses
    149       140       9  
 Amortization of core deposit intangible
    236       230       6  
 Virginia franchise tax expense
    145       171       (26 )
 Merger expenses
    11       -       11  
 FDIC assessment
    146       125       21  
 Data processing expense
    175       126       49  
 Telephone and communication expense
    183       101       82  
 Change in FDIC indemnification asset
    242       (13 )     255  
 Other operating expenses
    665       702       (37 )
    Total noninterest expense
  $ 4,778     $ 3,914     $ 864  
                         
   
For the Nine Months Ended
 
   
September 30,
 
      2012       2011    
Change
 
           
(As Restated)
         
   
(dollars in thousands)
 
 Salaries and benefits
  $ 5,868     $ 5,066     $ 802  
 Occupancy expenses
    2,040       1,667       373  
 Furniture and equipment expenses
    448       406       42  
 Amortization of core deposit intangible
    694       690       4  
 Virginia franchise tax expense
    436       514       (78 )
 Merger expenses
    360       -       360  
 FDIC assessment
    417       397       20  
 Data processing expense
    474       400       74  
 Telephone and communication expense
    418       289       129  
 Change in FDIC indemnification asset
    481       (85 )     566  
 Other operating expenses
    2,417       1,809       608  
    Total noninterest expense
  $ 14,053     $ 11,153     $ 2,900  
 
 
36

 
 
Noninterest expenses were $4.8 million and $14.1 million during the third quarter and the first nine months of 2012, respectively, compared to $3.9 million and $11.2 million during the same periods in 2011.  Occupancy and furniture and equipment expenses were $902 thousand during the quarter compared to $713 thousand during the third quarter of 2011. $134 thousand of the increase resulted from operating five more branches this quarter, and $43 thousand was a result of expenses related to the HarVest administrative office on a lease which has now been terminated. As a result of recasting estimated recoveries under the FDIC indemnification agreement for the Greater Atlantic Bank acquisition in the second quarter of 2012, amortization expense was $242 thousand for the quarter ended September 30, 2012, compared to accretion of $13 thousand for the same period last year. Audit and consulting fees were $137 thousand during the third quarter of 2012 compared to $93 thousand during the same period in 2011.
 
Audit and consulting fees were $977 thousand during the nine months ended September 30, 2012, compared to $306 thousand during the same period in 2011. Occupancy and furniture and equipment expenses were $2.5 million during the nine months ended September 30, 2012, compared to $2.1 million during the same period in 2011. Of this increase, $213 thousand resulted from operating five additional branches this quarter, and $67 thousand was a result of expenses related to the HarVest administrative office on a lease which has now been terminated.  In addition, salaries and benefits expense has increased $802 thousand during the nine months ended September 30, 2012, compared to the same period in 2011 as a result of the additional branches.   Full-time equivalent employees have increased from 107 at September 30, 2011, to 138 at September 30, 2012. As a result of recasting estimated recoveries under the FDIC indemnification agreement in the second quarter of 2012, amortization expense was $481 thousand for the nine months ended September 30, 2012, compared to accretion of $85 thousand for the same period last year. The efficiency ratio was 55.03% during the nine months ended September 30, 2012, compared to 51.87% during the same period the prior year.
 
FINANCIAL CONDITION
 
Balance Sheet Overview
 
Total assets were $708.3 million as of September 30, 2012 compared to $611.4 million as of December 31, 2011.  Net loans receivable increased from $491.8 million at the end of 2011 to $537.8 million at September 30, 2012. Within that total, covered loans declined by $6.0 million while the non-covered loan portfolio increased by $52.0 million. Non-covered loans included $57.3 million of loans acquired in the HarVest acquisition. We sold $5.7 million of SBA loans during the first quarter of 2012.
 
Total deposits were $537.3 million at September 30, 2012 compared to $461.1 million at December 31, 2011. We acquired deposits in the amount of $140.5 million in the HarVest transaction. Total time deposits were $297.3 million at September 30, 2012, compared to $255.8 million at December 31, 2011. We acquired time deposits totaling $ $107.6 million in the HarVest acquisition. Noninterest-bearing deposits were $43.1 million at September 30, 2012 and $32.6 million at December 31, 2011.
 
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.”
 
 
37

 
 
The following table summarizes the composition of our loan portfolio as of September 30, 2012 and December 31, 2011:
 
   
 
   
Non-covered Loans
                         
   
Covered
   
HarVest
   
Other
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans (1)
   
Loans (2)
   
Loans
   
Loans
   
Loans (1)
   
Loans
   
Loans
 
   
September 30, 2012
   
December 31, 2011
 
 Mortgage loans on real estate:
                                         
Commercial real estate - owner-occupied
  $ 4,276     $ 17,067     $ 77,731     $ 99,074     $ 4,854     $ 82,450     $ 87,304  
Commercial real estate - non-owner-occupied
    11,965       11,233       107,307       130,505       11,243       117,059       128,302  
Secured by farmland
    -       -       1,486       1,486       -       1,506       1,506  
Construction and land loans
    1,244       5,500       54,647       61,391       2,883       39,565       42,448  
Residential 1-4 family
    22,038       13,709       47,330       83,077       25,307       49,288       74,595  
Multi- family residential
    621       736       18,358       19,715       629       19,553       20,182  
Home equity lines of credit
    33,288       1,991       6,925       42,204       35,442       9,040       44,482  
Total real estate loans
    73,432       50,236       313,784       437,452       80,358       318,461       398,819  
                                                         
Commercial loans
    3,058       7,098       89,413       99,569       2,122       89,939       92,061  
Consumer loans
    104       18       1,626       1,748       108       1,868       1,976  
Gross loans
    76,594       57,352       404,823       538,769       82,588       410,268       492,856  
                                                         
 Less deferred fees on loans
    6       (5 )     (1,001 )     (1,000 )     -       (1,088 )     (1,088 )
 Loans, net of deferred fees
  $ 76,600     $ 57,347     $ 403,822     $ 537,769     $ 82,588     $ 409,180     $ 491,768  
 
(1)  Covered Loans are loans acquired in the Greater Atlantic transaction and are covered under an FDIC loss-share agreement.
(2)  HarVest Loans are loans acquired in the HarVest transaction and are not covered under an FDIC loss-share agreement.
 
As of September 30, 2012 and December 31, 2011, 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.
 
Loan growth has been basically flat since the end of the year with the exception of the HarVest acquisition. In the Northern Virginia market, which is heavily dependent on defense spending and related government contracting, there is growing concern about the potential for sequestration. As a consequence, loan demand has been soft in Northern Virginia.
 
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 and the relatively short period of time since the loans were originated.  Whether our loss and delinquency experience in the area of our portfolio will increase significantly depends upon the value of the real estate securing loans and economic factors such as the overall economy of the region.
 
 
38

 
 
Non-covered Loans and Assets
 
Non-covered loans evaluated for impairment totaled $27.2 million with allocated allowance for loan losses in the amount of $575 thousand as of September 30, 2012, including $7.1 million of nonaccrual loans and $4.3 million of restructured loans. This compares to $26.2 million of impaired loans with allocated allowance for loan losses in the amount of $1.0 million at December 31, 2011, including $4.5 million of nonaccrual loans and $1.1 million of restructured loans. The nonaccrual loans included SBA guaranteed amounts of $2.6 million and $2.5 million at September 30, 2012 and December 31, 2011, respectively.  At September 30, 2012 there were no loans past due 90 days or more and accruing interest, compared to $32 thousand as of December 31, 2011.
 
Non-covered nonperforming assets increased from $18.2 million at December 31, 2011 to $19.9 million at September 30, 2012.
 
Non-covered OREO as of September 30, 2012 was $12.8 million compared to $13.6 million as of the end of the previous year. During the first nine months of 2012 we had two foreclosures in the amount of $2.0 million and OREO sales of $1.1 million. Non-covered OREO was comprised of residential lots in Culpeper,  Virginia, a horse facility, an estate in Charlottesville, three construction/land projects, a commercial property in southwest Virginia and three residential properties.
 
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 September 30, 2012.
 
The following table presents a comparison of non-covered nonperforming assets as of September 30, 2012 and December 31, 2011 (in thousands):
 
   
September 30,
   
December 31,
 
   
2012
   
2011
 
             
Nonaccrual loans
  $ 7,099     $ 4,541  
Loans past due 90 days and accruing interest
    -       32  
    Total nonperforming loans
    7,099       4,573  
Other real estate owned
    12,815       13,620  
    Total nonperforming assets
  $ 19,914     $ 18,193  
                 
SBA guaranteed amounts included in nonaccrual loans
  $ 2,590     $ 2,462  
                 
Allowance for loan losses to nonperforming loans
    97.35 %     137.66 %
Allowance for loan losses to total non-covered loans
    1.50 %     1.54 %
Nonperforming assets to total non-covered assets
    3.16 %     3.44 %
Nonperforming assets excluding SBA guaranteed loans to total non-covered assets
    2.75 %     2.98 %
Nonperforming assets to total non-covered loans and OREO
    4.20 %     4.30 %
Nonperforming assets excluding SBA guaranteed loans to total non-covered loans and OREO
    3.65 %     3.72 %
 
 
39

 
 
A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower.  The Bank determines that a borrower may be experiencing financial difficulty if the borrower is currently in default on any of its debt, or if the Bank is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future.  Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk and borrower/guarantor structures.  Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness.  When evaluating whether a concession has been granted, the Bank also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Bank for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers.  The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.
 
Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.
 
During the nine months ended September 30, 2012, we modified four loans in troubled debt restructurings with unpaid principal balances totaling $4.3 million as follows:
 
Residential 1-4 Family Mortgage                             3 loans         $2.8 million
Construction and Land Loans                                  1 loan           $1.5 million
 
All of these loans were restructured by reducing the interest rates and modifying other terms.
 
Two of the residential loans with unpaid principal balances of $195 thousand were thirty days past due as of September 30, 2012.   The other two loans are paying in accordance with their modified terms.  There is no additional commitment to lend to these four borrowers.
 
Covered Loans and Assets
 
Covered loans identified as impaired totaled $4.9 million as of September 30, 2012 and $4.7 million at December 31, 2011. Nonaccrual loans were $3.4 million and $3.3 million at September 30, 2012 and December 31, 2011, respectively. At September 30, 2012 and at December 31, 2011, there were loans past due 90 days or more and accruing interest in the amount of $2 thousand and $136 thousand, respectively.
 
Securities
 
Investment securities, available for sale and held to maturity, were $80.5 million at September 30, 2012 and $45.0 million at December 31, 2011.  In the second quarter of 2012, we acquired securities with a fair value of $38.4 million in the HarVest transaction, and we sold $11.3 million of those securities.  We retained mortgage-backed securities and collateralized mortgage obligations with a fair value of $27.1 million. We purchased $20.0 million of callable agency securities and $2.0 million of tax-exempt municipal securities during the third quarter of 2012.  We also sold $8.0 million of SBA pooled securities which resulted in a gain of $287 thousand during the quarter.
 
 
40

 
 
As of September 30, 2012 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
 
Moodys
 
Fitch
 
Par Value
 
Book Value
 
Value
 
Deferrals
 
Loss (1)
     
                   
(in thousands)
             
ALESCO VII  A1B
Senior
    Aaa
 
AAA
 
Baa3
 
BB
  $ 6,904   $ 6,216   $ 4,211   $ 117,400   $ 296      
MMCF III B
Senior Sub
  A3   A-  
Ba1
 
CC
    435     426     254     37,000     9      
                        7,339     6,642     4,465         $ 305      
                                                       
                                             
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     423     423     134,100     722   $ 355  
TRAP 2007-XII C1
Mezzanine
  A3   A   C   C     2,107     55     55     202,705     759     1,293  
TRAP 2007-XIII D
Mezzanine
   NR
  A-  
NR
  C     2,039     -     83     214,000     7     2,032  
MMC FUNDING XVIII
Mezzanine
  A3   A-  
Ca
  C     1,070     27     166     96,682     352     691  
ALESCO V C1
Mezzanine
  A2   A   C   C     2,138     473     426     84,000     1,004     661  
ALESCO XV C1
Mezzanine
  A3   A-   C   C     3,175     30     641     249,100     586     2,559  
ALESCO XVI  C
Mezzanine
  A3   A-   C   C     2,113     117     472     86,150     816     1,180  
                        14,142     1,125     2,266         $ 4,246   $ 8,771  
                                                         
Total
                    $ 21,481   $ 7,767   $ 6,731                    
 
(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 potential impairment.  In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to identify the most reflective estimate of the cash flow estimated to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary.
 
The analyses resulted in OTTI charges related to credit on two trust preferred securities (TRAP 2007-XII C1 and TPREF Funding II) in the amount of $480 thousand during the third quarter of 2012, compared to OTTI charges related to credit on the trust preferred securities totaling $43 thousand for three months ended September 30, 2011.  The OTTI charge on TRAP 2007-XII C1 was $479 thousand and was caused by the deferral of interest payments by a large issuer in the deal which has eroded the credit support below the tranche we own.  This adverse credit development impacts the amount and timing of expected cash flows to the tranche, resulting in the recognition of OTTI.
 
We also own a residential collateralized mortgage obligation which has been evaluated for potential impairment. We recorded no OTTI charges for credit on this security during the three and nine months ended September 30, 2012 and 2011.
 
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.
 
 
41

 
 
We prepare a one-year cash flow report which forecasts weekly cash needs and availability for the first three months and monthly thereafter, based on forecasts of loan closings from our pipeline report and other factors.
 
During the three and nine months ended September 30, 2012, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At September 30, 2012, we had $91.7 million of unfunded lines of credit and undisbursed construction loan funds. We had approved loan commitments of $1.2 million at September 30, 2012. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.
 
Capital Resources
 
The following table provides a comparison of 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
 
September 30, 2012
                                   
Southern National
                                   
Tier 1 risk-based capital ratio
  $ 96,038       18.25 %   $ 21,050       4.00 %   $ 31,574       6.00 %
Total risk-based capital ratio
    102,605       19.50 %     42,099       8.00 %     52,624       10.00 %
Leverage ratio
    96,038       14.08 %     27,275       4.00 %     34,093       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 93,070       17.70 %   $ 21,038       4.00 %   $ 31,557       6.00 %
Total risk-based capital ratio
    99,633       18.94 %     42,076       8.00 %     52,595       10.00 %
Leverage ratio
    93,070       13.65 %     27,263       4.00 %     34,079       5.00 %
                                                 
December 31, 2011
                                               
Southern National
                                               
Tier 1 risk-based capital ratio
  $ 90,718       19.37 %   $ 18,738       4.00 %   $ 28,107       6.00 %
Total risk-based capital ratio
    96,560       20.61 %     37,476       8.00 %     46,845       10.00 %
Leverage ratio
    90,718       14.89 %     24,367       4.00 %     30,459       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 87,176       18.62 %   $ 18,729       4.00 %   $ 28,094       6.00 %
Total risk-based capital ratio
    93,015       19.87 %     37,459       8.00 %     46,823       10.00 %
Leverage ratio
    87,176       14.31 %     24,367       4.00 %     30,459       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.

 
42

 
 
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 September 30, 2012 and December 31, 2011, and all changes are within our ALM Policy guidelines:
 
   
Sensitivity of Market Value of Portfolio Equity
 
   
As of September 30, 2012
 
                               
                     
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
  $ 84,846     $ (16,560 )     -16.33 %     11.98 %     81.56 %
Up 300
    88,700       (12,706 )     -12.53 %     12.52 %     85.27 %
Up 200
    93,775       (7,631 )     -7.53 %     13.24 %     90.15 %
Up 100
    97,824       (3,582 )     -3.53 %     13.81 %     94.04 %
Base
    101,406       -       0.00 %     14.32 %     97.48 %
Down 100
    98,074       (3,332 )     -3.29 %     13.85 %     94.28 %
Down 200
    97,327       (4,079 )     -4.02 %     13.74 %     93.56 %
 
 
43

 
 
   
Sensitivity of Market Value of Portfolio Equity
 
   
As of December 31, 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
  $ 94,069     $ (6,103 )     -6.09 %     15.39 %     94.97 %
Up 300
    95,562       (4,610 )     -4.60 %     15.63 %     96.48 %
Up 200
    97,934       (2,238 )     -2.23 %     16.02 %     98.87 %
Up 100
    98,965       (1,207 )     -1.20 %     16.19 %     99.91 %
Base
    100,172       -       0.00 %     16.38 %     101.13 %
Down 100
    96,052       (4,120 )     -4.11 %     15.71 %     96.97 %
Down 200
    94,524       (5,648 )     -5.64 %     15.46 %     95.43 %
 
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 September 30, 2012 and December 31, 2011 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 September 30, 2012
 
                         
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
  $ 31,440     $ 2,288       4.85 %     0.35 %
Up 300
    30,899       1,747       4.77 %     0.27 %
Up 200
    30,387       1,235       4.69 %     0.19 %
Up 100
    29,780       628       4.60 %     0.10 %
Base
    29,152       -       4.50 %     0.00 %
Down 100
    29,501       349       4.56 %     0.06 %
Down 200
    29,476       324       4.55 %     0.05 %
 
 
44

 
 
   
Sensitivity of Net Interest Income
 
   
As of December 31, 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
  $ 28,323     $ 2,593       5.16 %     0.46 %
Up 300
    27,654       1,924       5.04 %     0.34 %
Up 200
    27,021       1,291       4.93 %     0.23 %
Up 100
    26,286       556       4.80 %     0.10 %
Base
    25,730       -       4.70 %     0.00 %
Down 100
    26,408       678       4.82 %     0.12 %
Down 200
    26,405       675       4.82 %     0.12 %
 
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.

 
45

 
 
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 upon that evaluation, our chief executive officer and chief financial officer have concluded that these controls and procedures are effective as of the end of the period covered by this Quarterly Report on Form 10-Q.
 
Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure.
 
 (b) Changes in Internal Control over Financial Reporting. As was noted in our Annual Report on Form 10-K for the year ended December 31, 2011, management identified a material weakness in our internal control over financial reporting relating to the design and operation of controls over the accounting for non-routine transactions. In our Quarterly Report on Form 10-Q for the quarter ended March 31, 2012, management disclosed our process of remediating this internal control material weakness through the implementation and improvement of control activities for the accounting for non-routine transactions.
 
We utilize a third-party consultant to assist management with purchase accounting valuation matters and the related accounting.  We also utilize this consultant to assist management with the accounting for the FDIC indemnification asset and related accounting matters.  Internal controls over non-routine transactions include, but may not be limited to:
 
  Reconciliation and review of data used by the third-party consultant to our internal systems and accounting records to ensure completeness and accuracy of the data.
  The review and approval by management of the methods, assumptions and calculations performed by the valuation consultant related to the accounting for non-routine transactions.
  The review and approval by the chief financial officer of all journal entries related to the accounting for non-routine transactions.
  Oversight by management and the Audit Committee of the methods and assumptions used for the valuation of acquired assets and liabilities and the accounting conclusions reached related to non-routine transactions.
  In-depth evaluation and approval of the credentials and expertise of third-party consultants prior to engagement. 
   
During the second quarter of 2012, management engaged in two non-routine transactions against which we were able to apply and assess the implemented control activities, evaluate the design of the activities, and assess operating effectiveness.  The procedures and controls were subject to testing by internal audit and a report was provided to the Audit Committee.
 
During the third quarter of 2012 there was no material change in the accounting for prior non-routine transactions.  We continuously evaluate the design and operating effectiveness of our internal controls over the accounting for non-routine transactions.
 
 
46

 
 
For the quarter ending December 31, 2012 management will re-evaluate the accounting for the FDIC indemnification asset, the results of which will be subject to an internal audit with a report being made to the audit committee.
 
SNBV believes the processes and procedures that have been put in the place are properly designed and operating effectively to ensure the accuracy of the accounting for non-routine transactions based on the testing that has occurred and the review and observations by management through the quarter ended September 30, 2012.

 
47

 
 
PART II - OTHER INFORMATION
 
ITEM 1 –  LEGAL PROCEEDINGS
 
Southern National and Sonabank may, from time to time, be a party to various legal proceedings arising in the ordinary course of business.  There are no other proceedings pending, or to management’s knowledge, threatened, against Southern National or Sonabank as of September 30, 2012.
 
ITEM 1A – RISK FACTORS
 
As of September 30, 2012 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, 2011.
 
ITEM 2. – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
 
Not applicable
 
ITEM 3. – DEFAULTS UPON SENIOR SECURITIES
 
Not applicable
 
ITEM 4. – MINE SAFETY DISCLOSURES
 
Not applicable
 
ITEM 5. – OTHER INFORMATION
 
Not applicable
 
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.
 
     
 *     Filed with this Quarterly Report on Form 10-Q
 **    Furnished with this Quarterly Report on Form 10-Q
 
 
48

 
 
Signatures
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
   
Southern National Bancorp of Virginia, Inc.
   
    (Registrant)    
       
November 8, 2012
  /s/ Georgia S. Derrico  
(Date)   Georgia S. Derrico,  
    Chairman of the Board and Chief Executive Officer  
       
November 8, 2012
  /s/ William H. Lagos  
(Date)   William H. Lagos,  
   
Senior Vice President and Chief Financial Officer
 
 
 
49