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Primis Financial Corp. - Quarter Report: 2013 June (Form 10-Q)



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
 
For the Quarterly Period Ended June 30, 2013
 
Commission File No. 001-33037
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)
   
 Virginia        20-1417448
 (State or other jurisdiction     (I.R.S. Employer Identification No.)
   of incorporation or organization)             
 
6830 Old Dominion Drive
McLean, Virginia 22101
(Address of principal executive offices) (zip code)
 
(703) 893-7400
(Registrant’s telephone number, including area code)
 
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 August 2, 2013, there were 11,590,212 shares of common stock outstanding.
 
 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
FORM 10-Q
June 30, 2013
 
INDEX
 
     
PAGE
   
PART 1 - FINANCIAL INFORMATION
   
         
Item 1 -
 
Financial Statements
   
   
Consolidated Balance Sheets as of June 30, 2013 and December 31,
2012
2
 
   
Consolidated Statements of Comprehensive Income
for the three and six months ended June 30, 2013 and 2012
3
 
   
Consolidated Statements of Changes in Stockholders’ Equity
for the six months ended June 30, 2013
4
 
   
Consolidated Statements of Cash Flows for the six months ended
June 30, 2013 and 2012
5
 
   
Notes to Consolidated Financial Statements
6- 27
 
         
Item 2 -  
Management’s Discussion and Analysis of
Financial Condition and Results of Operations
28- 41
 
         
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
42-45
 
         
Item 4 – Controls and Procedures
46
 
         
   
PART II - OTHER INFORMATION
   
         
Item 1 – Legal Proceedings
46
 
         
Item 1A – Risk Factors
46
 
         
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
46
 
         
Item 3 – Defaults Upon Senior Securities
46
 
         
Item 4 – Mine Safety Disclosures
46
 
         
Item 5 – Other Information
46
 
         
Item 6 - Exhibits
47
 
         
Signatures
48
 
         
Certifications
49-51
 
 
 
 
ITEM I - FINANCIAL INFORMATION
           
PART I - FINANCIAL STATEMENTS
           
             
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
           
CONSOLIDATED BALANCE SHEETS
           
(dollars in thousands, except per share amounts) (Unaudited)
           
   
June 30,
   
December 31,
 
   
2013
   
2012
 
ASSETS
           
Cash and cash equivalents:
           
Cash and due from financial institutions
  $ 3,349     $ 4,553  
Interest-bearing deposits in other financial institutions
    25,196       34,647  
Total cash and cash equivalents
    28,545       39,200  
                 
Securities available for sale, at fair value
    2,034       2,391  
                 
Securities held to maturity, at amortized cost (fair value of $79,635 and $84,827, respectively)
    83,354       84,051  
                 
Covered loans
    59,819       71,328  
Non-covered loans
    464,465       458,823  
Total loans
    524,284       530,151  
Less allowance for loan losses
    (7,296 )     (7,066 )
                Net loans     516,988       523,085  
                 
                 
Stock in Federal Reserve Bank and Federal Home Loan Bank
    5,240       6,212  
Bank premises and equipment, net
    6,286       6,552  
Goodwill
    9,160       9,160  
Core deposit intangibles, net
    1,035       1,280  
FDIC indemnification asset
    6,308       6,735  
Bank-owned life insurance
    18,079       17,782  
Other real estate owned
    14,955       13,836  
Deferred tax assets, net
    8,262       8,174  
Other assets
    6,478       5,354  
                 
                Total assets   $ 706,724     $ 723,812  
                 
LIABILITIES AND STOCKHOLDERS EQUITY
               
                 
Noninterest-bearing demand deposits
  $ 45,339     $ 49,644  
Interest-bearing deposits:
               
NOW accounts
    22,008       22,774  
Money market accounts
    146,461       163,233  
Savings accounts
    12,148       9,618  
Time deposits
    319,682       305,708  
Total interest-bearing deposits
    500,299       501,333  
Total deposits
    545,638       550,977  
                 
 
               
Securities sold under agreements to repurchase and other short-term borrowings
    20,530       33,411  
Federal Home Loan Bank (FHLB) advances
    30,250       30,250  
Other liabilities
    5,370       5,998  
Total liabilities
    601,788       620,636  
                 
Commitments and contingencies (See Note 5)
    -       -  
                 
Stockholders equity:
               
Preferred stock, $.01 par value. Authorized 5,000,000 shares; no shares issued and outstanding
    -       -  
Common stock, $.01 par value. Authorized 45,000,000 shares; issued and outstanding, 11,590,212 shares at June 30, 2013 and December 31, 2012
    116       116  
Additional paid in capital
    96,966       96,840  
Retained earnings
    11,007       9,201  
Accumulated other comprehensive loss
    (3,153 )     (2,981 )
                Total stockholders equity     104,936       103,176  
                 
Total liabilities and stockholders equity
  $ 706,724     $ 723,812  
                 
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 Six Months Ended
 
   
June 30,
   
June 30,
 
                         
   
2013
   
2012
   
2013
   
2012
 
                         
Interest and dividend income:
                       
 Interest and fees on loans
  $ 7,765     $ 8,768     $ 16,109     $ 17,379  
 Interest and dividends on taxable securities
    507       509       1,036       911  
 Interest and dividends on tax exepmt securities
    50       -       88       -  
 Interest and dividends on other earning assets
    227       84       339       145  
 Total interest and dividend income
    8,549       9,361       17,572       18,435  
Interest expense:
                               
 Interest on deposits
    1,020       1,301       2,120       2,499  
 Interest on borrowings
    155       227       308       463  
 Total interest expense
    1,175       1,528       2,428       2,962  
                                 
 Net interest income
    7,374       7,833       15,144       15,473  
                                 
Provision for loan losses
    725       1,325       1,818       2,775  
 Net interest income after provision for loan losses
    6,649       6,508       13,326       12,698  
                                 
Noninterest income:
                               
 Account maintenance and deposit service fees
    203       206       396       402  
 Income from bank-owned life insurance
    148       347       297       500  
 Bargain purchase gain on acquisition
    -       3,484       -       3,484  
 Gain on sale of loans
    -       -       -       657  
 Gain on other assets
    13       -       13       14  
 Net gain (loss) on sale of available for sale securities
    -       (13 )     142       (13 )
 Total other-than-temporary impairment losses (OTTI)
    -       (235 )     (3 )     (241 )
 Portion of OTTI recognized in other comprehensive income (before taxes)
    -       -       -       4  
 Net credit related OTTI recognized in earnings
    -       (235 )     (3 )     (237 )
Other
    84       81       139       135  
                                 
 Total noninterest income
    448       3,870       984       4,942  
                                 
Noninterest expenses:
                               
 Salaries and benefits
    2,176       1,970       4,422       3,795  
 Occupancy expenses
    753       705       1,513       1,287  
 Furniture and equipment expenses
    171       143       327       299  
 Amortization of core deposit intangible
    123       228       246       458  
 Virginia franchise tax expense
    115       145       242       291  
Merger expenses
    -       349       -       349  
FDIC assessment
    224       142       458       271  
 Data processing expense
    154       162       302       299  
 Telephone and communication expense
    163       133       341       235  
 Change in FDIC indemnification asset
    107       253       237       239  
 Net loss on other real estate owned
    62       2,201       118       2,400  
 Other operating expenses
    750       732       1,543       1,752  
 Total noninterest expenses
    4,798       7,163       9,749       11,675  
Income before income taxes
    2,299       3,215       4,561       5,965  
Income tax expense
    744       1,000       1,480       1,907  
 Net income
  $ 1,555     $ 2,215     $ 3,081     $ 4,058  
Other comprehensive income (loss):
                               
   Unrealized gain (loss) on available for sale securities
  $ (194 )   $ 65     $ (195 )   $ 94  
   Realized amount on securities sold, net
    -       -       (142 )     -  
Non-credit component of other-than-temporary impairment on held-to-maturity securities
    -       205       97       201  
Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for-sale
    (12 )     (28 )     (20 )     (60 )
Net unrealized gain (loss)
    (206 )     242       (260 )     235  
Tax effect
    70       (82 )     88       (80 )
Other comprehensive income (loss)
    (136 )     160       (172 )     155  
Comprehensive income
  $ 1,419     $ 2,375     $ 2,909     $ 4,213  
Earnings per share, basic and diluted
  $ 0.13     $ 0.19     $ 0.27     $ 0.35  
                                 
See accompanying notes to consolidated financial statements.
                               
 
3
 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
                         
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS EQUITY
             
FOR THE SIX MONTHS ENDED JUNE 30, 2013
                             
(dollars in thousands, except per share amounts) (Unaudited)
                         
                               
                     
Accumulated
       
         
Additional
         
Other
       
   
Common
   
Paid in
   
Retained
   
Comprehensive
       
   
Stock
   
Capital
   
Earnings
   
Loss
   
Total
 
                               
Balance - January 1, 2013
  $ 116     $ 96,840     $ 9,201     $ (2,981 )   $ 103,176  
Comprehensive income:
                                       
    Net income
                    3,081               3,081  
    Change in unrealized loss  on securities available for sale (net of tax benefit, $115)
                            (222 )     (222 )
    Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $27 and accretion, $20 and amounts recorded into other comprehensive income at transfer)
                            50       50  
Dividends on common stock ($.11 per share)
                    (1,275 )             (1,275 )
Stock-based compensation expense
            126                       126  
                                         
Balance - June 30, 2013
  $ 116     $ 96,966     $ 11,007     $ (3,153 )   $ 104,936  
                                         
See accompanying notes to consolidated financial statements.
                         
 
4
 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
           
CONSOLIDATED STATEMENTS OF CASH FLOWS
           
FOR THE SIX MONTHS ENDED JUNE 30, 2013 AND 2012
           
(dollars in thousands) (Unaudited)
           
   
2013
   
2012
 
             
Operating activities:
           
Net income
  $ 3,081     $ 4,058  
Adjustments to reconcile net income to net cash and
               
cash equivalents provided by operating activities:
               
Depreciation
    329       289  
Amortization of core deposit intangible
    246       458  
Other amortization, net
    200       114  
Accretion of loan discount
    (1,577 )     (2,360 )
Amortization of FDIC indemnification asset
    237       239  
Provision for loan losses
    1,818       2,775  
Earnings on bank-owned life insurance
    (297 )     (500 )
Stock based compensation expense
    126       97  
Bargain purchase gain on acquisition
    -       (3,484 )
Net (gain) loss on sale of available for sale securities
    (142 )     13  
Gain on sale of loans
    -       (657 )
Impairment on securities
    3       237  
Net loss on other real estate owned
    118       2,400  
Net decrease in other assets
    621       204  
Net increase (decrease) in other liabilities
    (628 )     72  
Net cash and cash equivalents provided by operating activities
    4,135       3,955  
Investing activities:
               
Purchases of available for sale securities
    -       (3,128 )
Proceeds from sales of available for sale securities
    159       14,414  
Proceeds from paydowns, maturities and calls of available for sale securities
    -       946  
Purchases of held to maturity securities
    (11,345 )     (5,000 )
Proceeds from paydowns, maturities and calls of held to maturity securities
    12,014       5,375  
Loan originations and payments, net
    220       3,020  
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 decrease in stock in Federal Reserve Bank and Federal Home Loan Bank
    972       1,790  
Proceeds from cash surrender value of bank-owned life insurance
    -       395  
Payments received on FDIC indemnification asset
    171       89  
Proceeds from sale of other real estate owned
    2,578       1,107  
Purchases of bank premises and equipment
    (64 )     (72 )
Net cash and cash equivalents provided by investing activities
    4,705       79,474  
Financing activities:
               
Net decrease in deposits
    (5,339 )     (57,577 )
Cash dividends paid - common stock
    (1,275 )     (349 )
Repayment of Federal Home Loan Bank advances
    -       (16,488 )
    Net increase (decrease) in securities sold under agreement to repurchase and other short-term borrowings
    (12,881 )     13,293  
Net cash and cash equivalents used in financing activities
    (19,495 )     (61,121 )
Increase (decrease) in cash and cash equivalents
    (10,655 )     22,308  
Cash and cash equivalents at beginning of period
    39,200       5,035  
Cash and cash equivalents at end of period
  $ 28,545     $ 27,343  
Supplemental disclosure of cash flow information
               
Cash payments for:
               
Interest
  $ 2,326     $ 2,985  
Income taxes
    2,238       1,200  
Supplemental schedule of noncash investing and financing activities
               
Transfer from non-covered loans to other real estate owned
    1,605       1,959  
Transfer from covered loans to other real estate owned
    4,031       -  
                 
See accompanying notes to consolidated financial statements.
               

5
 
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
Notes to Consolidated Financial Statements (Unaudited)
June 30, 2013
 
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 has fifteen branches in Virginia, located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Middleburg, Leesburg (2), South Riding, Front Royal, New Market, Haymarket,  Richmond and Clifton Forge, and five branches in Maryland, in Rockville, Shady Grove, Germantown, Frederick and Bethesda.
 
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, 2012.
 
Use of Estimates
 
The preparation of the consolidated financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates.  Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the carrying value of investment securities, other than temporary impairment of investment securities, the valuation of goodwill and intangible assets, the FDIC indemnification asset,  mortgage servicing rights, other real estate owned and deferred tax assets.
 
Recent Accounting Pronouncements
 
In February 2013, the FASB issued ASU 2013-02, Comprehensive Income (Topic 220), Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income. This standard update requires companies to report the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the consolidated statements of comprehensive income if the amount being reclassified is required under U.S. GAAP to be reclassified in its entirety to net income. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other disclosures required under U.S. GAAP that provide additional detail about those amounts. We adopted this standard in the first quarter of 2013 and have included the additional disclosures.
 
6
 
 
2.    STOCK- BASED COMPENSATION
 
In 2004, the Board of Directors adopted a stock option plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and employees.  As of June 30, 2013, options to purchase an aggregate of 302,500 shares of common stock were outstanding and no shares remained available for issuance. The 2010 Stock Awards and Incentive Plan was approved by the Board of Directors in January 2010 and approved by the stockholders at the Annual Meeting in April 2010. The 2010 plan authorized the reservation of 700,000 shares of common stock for the granting of stock awards. The options granted to officers and employees are incentive stock options and the options granted to non-employee directors are non-qualified stock options.  The purpose of the plan is to afford key employees an incentive to remain in the employ of 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 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.
 
Southern National granted 120,250 options during the first six months of 2013. The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model.  The following weighted-average assumptions were used to value options granted in the six months ended June 30, 2013:
 
Expected life
 
10 years
 
Expected volatility
    34.21 %
Risk-free interest rate
    2.42 %
Weighted average fair value per option granted
  $ 3.58  
Dividend yield
    1.29 %
 
The risk-free interest rate was developed using the U. S. Treasury yield curve for periods equal to the expected life of the options on the grant date.  An increase in the risk-free interest rate will increase stock compensation expense on future option grants.
 
For the three and six months ended June 30, 2013 and 2012, stock-based compensation expense was $63 thousand and $126 thousand, respectively, compared to $47 thousand and $96 thousand for the same periods last year.  As of June 30, 2013, unrecognized compensation expense associated with the stock options was $1.1 million, which is expected to be recognized over a weighted average period of 4.0 years.
 
7
 
 
A summary of the activity in the stock option plan during the six months ended June 30, 2013 follows (dollars in thousands):
 
               
Weighted
       
         
Weighted
   
Average
       
         
Average
   
Remaining
   
Aggregate
 
         
Exercise
   
Contractual
   
Intrinsic
 
   
Shares
   
Price
   
Term
   
Value
 
Options outstanding, beginning of period
    512,825     $ 7.98              
Granted
    120,250       9.18              
Forfeited
    -       -              
Exercised
    -       -              
Options outstanding, end of period
    633,075     $ 8.21       6.5     $ 1,011  
                                 
Vested or expected to vest
    633,075     $ 8.21       6.5     $ 1,011  
                                 
Exercisable at end of period
    304,775     $ 8.35       4.0     $ 451  
 
3.    SECURITIES
 
The amortized cost and fair value of available for sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):
 
   
Amortized
   
Gross Unrealized
 
Fair
 
June 30, 2013
 
Cost
   
Gains
   
Losses
   
Value
 
Obligations of states and political subdivisions
  $ 2,305     $ -     $ (271 )   $ 2,034  
                                 
   
Amortized
   
Gross Unrealized
 
Fair
 
December 31, 2012
 
Cost
   
Gains
   
Losses
   
Value
 
Obligations of states and political subdivisions
  $ 2,309     $ 2     $ (22 )   $ 2,289  
FHLMC preferred stock
    16       86       -       102  
    Total
  $ 2,325     $ 88     $ (22 )   $ 2,391  
 
The amortized cost, unrecognized gains and losses, and fair value of securities held to maturity were as follows (in thousands):
 
   
Amortized
   
Gross Unrecognized
   
Fair
 
June 30, 2013
 
Cost
   
Gains
   
Losses
   
Value
 
Residential government-sponsored mortgage-backed securities
  $ 29,029     $ 769     $ (206 )   $ 29,592  
Residential government-sponsored collateralized mortgage obligations
    4,844       5       (233 )     4,616  
Government-sponsored agency securities
    29,969       -       (2,084 )     27,885  
Obligations of states and political subdivisions
    11,012       -       (883 )     10,129  
Other residential collateralized mortgage obligations
    741       27               768  
Trust preferred securities
    7,759       1,071       (2,185 )     6,645  
    $ 83,354     $ 1,872     $ (5,591 )   $ 79,635  
 
   
Amortized
   
Gross Unrecognized
   
Fair
 
December 31, 2012
 
Cost
   
Gains
   
Losses
   
Value
 
Residential government-sponsored mortgage-backed securities
  $ 35,375     $ 1,559     $ -     $ 36,934  
Residential government-sponsored collateralized mortgage obligations
    5,444       81       -       5,525  
Government-sponsored agency securities
    29,983       52       (4 )     30,031  
Obligations of states and political subdivisions
    4,689       1       (69 )     4,621  
Other residential collateralized mortgage obligations
    817       -       (24 )     793  
Trust preferred securities
    7,743       1,422       (2,242 )     6,923  
    $ 84,051     $ 3,115     $ (2,339 )   $ 84,827  
 
8
 
 
The amortized cost amounts are net of recognized other than temporary impairment.
 
During the six months ended June 30, 2013, we sold 55 thousand shares of available for sale FHLMC preferred stock resulting in a gain of $142 thousand.
 
The fair value and carrying amount, if different, of debt securities as of June 30, 2013, by contractual maturity were as follows (in thousands).  Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.
 
   
Held to Maturity
   
Available for Sale
 
   
Amortized
         
Amortized
       
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
Due in five to ten years
  $ 4,257     $ 4,015     $ -     $ -  
Due after ten years
    44,483       40,644       2,305       2,034  
Residential government-sponsored mortgage-backed securities
    29,029       29,592       -       -  
Residential government-sponsored collateralized mortgage obligations
    4,844       4,616       -       -  
Other residential  collateralized mortgage obligations
    741       768       -       -  
Total
  $ 83,354     $ 79,635     $ 2,305     $ 2,034  
 
Securities with a carrying amount of approximately $66.7 million and $62.3 million at June 30, 2013 and December 31, 2012, 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”).
 
Southern National monitors the portfolio for indicators of other than temporary impairment.  At June 30, 2013 and December 31, 2012, certain securities’ fair values were below cost. As outlined in the table below, there were securities with fair values totaling approximately $63.2 million in the portfolio with the carrying value exceeding the estimated fair value that are considered temporarily impaired at June 30, 2013.  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 June 30, 2013. The following tables present information regarding securities in a continuous unrealized loss position as of June 30, 2013 and December 31, 2012 (in thousands) by duration of time in a loss position:
 
9
 
 
June 30, 2013
                                   
   
Less than 12 months
   
12 Months or More
   
Total
 
Available for Sale
 
Fair value
   
Unrealized
Losses
   
Fair value
   
Unrealized
Losses
   
Fair value
   
Unrealized
Losses
 
Obligations of states and political subdivisions
  $ 2,034     $ (271 )   $ -     $ -     $ 2,034     $ (271 )
                                                 
   
Less than 12 months
   
12 Months or More
   
Total
 
Held to Maturity
 
Fair value
   
Unrecognized
Losses
   
Fair value
   
Unrecognized
Losses
   
Fair value
   
Unrecognized
Losses
 
Residential government-sponsored mortgage-backed securities
  $ 15,439     $ (206 )   $ -     $ -     $ 15,439     $ (206 )
Residential government-sponsored collateralized mortgage obligations
    3,337       (233 )     -       -       3,337       (233 )
Government-sponsored agency securities
    27,885       (2,084 )     -       -       27,885       (2,084 )
Obligations of states and political subdivisions
    10,129       (883 )                   $ 10,129     $ (883 )
Trust preferred securities
    -       -       4,352       (2,185 )     4,352       (2,185 )
    $ 56,790     $ (3,406 )   $ 4,352     $ (2,185 )   $ 61,142     $ (5,591 )
                                                 
December 31, 2012
                                               
   
Less than 12 months
   
12 Months or More
   
Total
 
Available for Sale
 
Fair value
   
Unrealized
Losses
   
Fair value
   
Unrealized
Losses
   
Fair value
   
Unrealized
Losses
 
Obligations of states and political subdivisions
  $ 1,552     $ (22 )   $ -     $ -     $ 1,552     $ (22 )
 
   
Less than 12 months
   
12 Months or More
   
Total
 
Held to Maturity
 
Fair value
   
Unrecognized
Losses
   
Fair value
   
Unrecognized
Losses
   
Fair value
   
Unrecognized
Losses
 
Obligations of states and political subdivisions
  $ 4,189     $ (69 )   $ -     $ -     $ 4,189     $ (69 )
Government-sponsored agency securities
    4,996       (4 )     -       -       4,996       (4 )
Other residential collateralized mortgage obligations
    793       (24 )     -       -       793       (24 )
Trust preferred securities
    -       -       4,849       (2,242 )     4,849       (2,242 )
    $ 9,978     $ (97 )   $ 4,849     $ (2,242 )   $ 14,827     $ (2,339 )
 
As of June 30, 2013, we owned pooled trust preferred securities as follows:
 
                                                     
Previously
       
                                               
% of Current
   
Recognized
       
                                               
Defaults and
   
Cumulative
       
     
Ratings
                           
Estimated
   
Deferrals to
   
Other
       
 
Tranche
 
When Purchased
   
Current Ratings
               
Fair
   
Total
   
Comprehensive
       
Security
Level
 
Moodys
   
Fitch
   
Moody’s
   
Fitch
   
Par Value
   
Book Value
   
Value
   
Collateral
   
Loss (1)
       
                             
(in thousands)
                   
ALESCO VII  A1B
Senior
 
Aaa
   
AAA
   
Baa3
   
BB
    $ 6,777     $ 6,124     $ 4,097     24 %   $ 281        
MMCF III B
Senior Sub
  A3     A-    
Ba1
   
CC
      421       413       255     30 %     8        
                                7,198       6,537       4,352           $ 289        
                                                                       
                                                           
Cumulative Other
   
Cumulative
 
                                                           
Comprehensive
   
OTTI Related to
 
Other Than Temporarily Impaired:
                                                         
Loss (2)
   
Credit Loss (2)
 
TPREF FUNDING II
Mezzanine
  A1     A-    
Caa3
    C       1,500       515       520     44 %     626     $ 359  
TRAP 2007-XII C1
Mezzanine
  A3     A     C     C       2,132       56       140     39 %     783       1,293  
TRAP 2007-XIII D
Mezzanine
 
NR
    A-    
NR
    C       2,039       -       103     29 %     7       2,032  
MMC FUNDING XVIII
Mezzanine
  A3     A-    
Ca
    C       1,081       27       254     30 %     363       691  
ALESCO V C1
Mezzanine
  A2     A     C     C       2,150       475       548     23 %     1,014       661  
ALESCO XV C1
Mezzanine
  A3     A-     C     C       3,210       30       152     35 %     621       2,559  
ALESCO XVI  C
Mezzanine
  A3     A-     C     C       2,136       119       576     16 %     837       1,180  
                                14,248       1,222       2,293           $ 4,251     $ 8,775  
                                                                         
Total
                            $ 21,446     $ 7,759     $ 6,645                        
 
(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 (“OTTI”).  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.

10
 
 
 
Recoveries ranging from 25% to 46% 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.
 
We recognized no OTTI charges during the second quarter of 2013 and recognized OTTI charges of $3 thousand during the first six months of 2013 compared to OTTI charges related to credit on the trust preferred securities totaling $235 thousand and $237 thousand during the same periods of 2012.
 
The following table presents a roll forward of the credit losses on our securities held to maturity recognized in earnings for the six months ended June 30, 2013 and 2012 (in thousands):
 
   
2013
   
2012
 
 
           
Amount of cumulative other-than-temporary impairment related to credit loss prior to January 1
  $ 8,964     $ 8,277  
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
    3       237  
Reductions due to realized losses
    (32 )     (89 )
Amount of cumulative other-than-temporary impairment related to credit loss as of June 30
  $ 8,935     $ 8,425  
 
11
 
 
Changes in accumulated other comprehensive income by component for the three and six months ended June 30, 2013 are shown in the table below.  All amounts are net of tax (in thousands).
                         
   
Unrealized Holding
             
   
Gains (Losses) on
             
For the three months ended June 30, 2013
 
Available for Sale
   
Held to Maturity
       
   
Securities
   
Securities
   
Total
 
Beginning balance
  $ (50 )   $ (2,967 )   $ (3,017 )
Other comprehensive income/(loss) before reclassifications
    (128 )     (8 )     (136 )
Amounts reclassified from accumulated other comprehensive income/(loss)
    -       -       -  
Net current-period other comprehensive income/(loss)
    (128 )     (8 )     (136 )
Ending balance
  $ (178 )   $ (2,975 )   $ (3,153 )
                         
   
Unrealized Holding
                 
   
Gains (Losses) on
                 
For the six months ended June 30, 2013
 
Available for Sale
   
Held to Maturity
         
   
Securities
   
Securities
   
Total
 
Beginning balance
  $ 44     $ (3,025 )   $ (2,981 )
Other comprehensive income/(loss) before reclassifications
    (129 )     52       (77 )
Amounts reclassified from accumulated other comprehensive income/(loss)
    (93 )     (2 )     (95 )
Net current-period other comprehensive income/(loss)
    (222 )     50       (172 )
Ending balance
  $ (178 )   $ (2,975 )   $ (3,153 )

4.    LOANS AND ALLOWANCE FOR LOAN LOSSES

The following table summarizes the composition of our loan portfolio as of June 30, 2013 and December 31, 2012:
                                     
   
Covered
   
Non-covered
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans (1)
   
Loans
   
Loans
   
Loans (1)
   
Loans
   
Loans
 
   
June 30, 2013
   
December 31, 2012
 
 Loans secured by real estate:
                                   
    Commercial real estate - owner-occupied
  $ 3,662     $ 93,837     $ 97,499     $ 4,143     $ 93,288     $ 97,431  
    Commercial real estate - non-owner-occupied
    6,028       140,929       146,957       10,246       130,152       140,398  
    Secured by farmland
    103       517       620       -       1,479       1,479  
    Construction and land loans
    52       31,076       31,128       1,261       44,946       46,207  
    Residential 1-4 family
    19,067       62,544       81,611       21,005       61,319       82,324  
    Multi- family residential
    598       21,924       22,522       614       18,774       19,388  
    Home equity lines of credit
    28,954       7,776       36,730       31,292       9,178       40,470  
    Total real estate loans
    58,464       358,603       417,067       68,561       359,136       427,697  
                                                 
Commercial loans
    1,261       105,752       107,013       2,672       99,081       101,753  
Consumer loans
    87       1,338       1,425       88       1,623       1,711  
Gross loans
    59,812       465,693       525,505       71,321       459,840       531,161  
                                                 
Less deferred fees on loans
    7       (1,228 )     (1,221 )     7       (1,017 )     (1,010 )
Loans, net of deferred fees
  $ 59,819     $ 464,465     $ 524,284     $ 71,328     $ 458,823     $ 530,151  
                                                 
(1) Covered Loans were acquired in the Greater Atlantic transaction and are covered under an FDIC loss-share agreement.
         
 
Accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment, and uncertainty in evaluation of the levels of the allowance required to account for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment, and uncertainty can have on the consolidated financial results.

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 $47.8 million of loans acquired in the HarVest acquisition. Accretable discount on the acquired covered loans and the HarVest loans was $10.1 million and $11.7 million at June 30, 2013 and December 31, 2012, respectively.
 
12
 
 
Credit-impaired covered loans are those loans which presented evidence of credit deterioration at the date of acquisition and it is probable that Southern National would not collect all contractually required principal and interest payments. Generally, acquired loans that meet Southern National’s definition for nonaccrual status fell within the definition of credit-impaired covered loans.

Impaired loans for the covered and non-covered portfolios were as follows (in thousands):
                                                       
June 30, 2013
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
         
Unpaid
               
Unpaid
               
Unpaid
       
   
Recorded
   
Principal
   
Related
   
Recorded
   
Principal
   
Related
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
   
Investment (1)
   
Balance
   
Allowance
   
Investment
   
Balance
   
Allowance
 
With no related allowance recorded
                                                     
    Commercial real estate - owner occupied
  $ 136     $ 231     $ -     $ 7,605     $ 7,605     $ -     $ 7,741     $ 7,836     $ -  
    Commercial real estate - non-owner occupied (2)  
    1,461       2,315       -       1,061       1,154       -       2,522       3,469       -  
    Construction and land development
    -       -       -       3,582       3,582       -       3,582       3,582       -  
    Commercial loans
    45       75       -       2,723       2,860       -       2,768       2,935       -  
    Residential 1-4 family
    1,790       2,176       -       3,638       3,638       -       5,428       5,814       -  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ 3,432     $ 4,797     $ -     $ 18,609     $ 18,839     $ -     $ 22,041     $ 23,636     $ -  
                                                                         
With an allowance recorded
                                                                       
    Commercial real estate - owner occupied
  $ -     $ -     $ -     $ 120     $ 120     $ 120     $ 120     $ 120     $ 120  
    Commercial real estate - non-owner occupied (2)
    -       -       -       970       970       61       970       970       61  
    Construction and land development
    -       -       -       -       -       -       -       -       -  
    Commercial loans
    -       -       -       2,491       2,491       450       2,491       2,491       450  
    Residential 1-4 family
    -       -       -       5,335       5,335       440       5,335       5,335       440  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ -     $ -     $ -     $ 8,916     $ 8,916     $ 1,071     $ 8,916     $ 8,916     $ 1,071  
Grand total
  $ 3,432     $ 4,797     $ -     $ 27,525     $ 27,755     $ 1,071     $ 30,957     $ 32,552     $ 1,071  

 
(1) Recorded investment is after cumulative prior charge offs of $3.2 million.  These loans also have aggregate SBA guarantees of $1.6 million.
(2) Includes loans secured by farmland and multi-family residential loans.
(3) The Bank recognizes loan impairment and may concurrently record a charge off to the allowance for loan losses.
 
                                                       
December 31, 2012
 
Covered Loans
   
Non-covered Loans
   
Total Loans
 
         
Unpaid
               
Unpaid
               
Unpaid
       
   
Recorded
   
Principal
   
Related
   
Recorded
   
Principal
   
Related
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
   
Investment (1)
   
Balance
   
Allowance
   
Investment
   
Balance
   
Allowance
 
With no related allowance recorded
                                                     
    Commercial real estate - owner occupied
  $ 138     $ 234     $ -     $ 3,318     $ 3,357     $ -     $ 3,456     $ 3,591     $ -  
    Commercial real estate - non-owner occupied (2) 
    2,114       3,543       -       1,705       1,802       -       3,819       5,345       -  
    Construction and land development
    1,108       1,852       -       2,981       2,981       -       4,089       4,833       -  
    Commercial loans
    212       359       -       5,212       5,349       -       5,424       5,708       -  
    Residential 1-4 family
    1,555       1,805       -       3,368       3,471       -       4,923       5,276       -  
Other consumer loans
    -               -       -       -       -       -       -       -  
                                                                         
Total
  $ 5,127     $ 7,793     $ -     $ 16,584     $ 16,960     $ -     $ 21,711     $ 24,753     $ -  
                                                                         
With an allowance recorded
                                                                       
    Commercial real estate - owner occupied
  $ -     $ -     $ -     $ 137     $ 137     $ 137     $ 137     $ 137     $ 137  
    Commercial real estate - non-owner occupied (2)
    -       -       -       1,177       1,177       260       1,177       1,177       260  
    Construction and land development
    -       -       -       -       -               -       -       -  
    Commercial loans
    -       -       -       -       -               -       -       -  
    Residential 1-4 family
    -       -       -       5,791       5,791       440       5,791       5,791       440  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ -     $ -     $ -     $ 7,105     $ 7,105     $ 837     $ 7,105     $ 7,105     $ 837  
Grand total
  $ 5,127     $ 7,793     $ -     $ 23,689     $ 24,065     $ 837     $ 28,816     $ 31,858     $ 837  
 
 
(1) Recorded investment is after cumulative prior charge offs of $4.7 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 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 three and six months ended June 30, 2013 and 2012 (in thousands):
                                     
Three months ended June 30, 2013
                                   
   
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
  $ 137     $ 4     $ 7,625     $ 131     $ 7,762     $ 135  
    Commercial real estate - non-owner occupied (2)
    1,463       30       963       21       2,426       51  
    Construction and land development
    -       -       2,044       -       2,044       -  
    Commercial loans
    45       1       2,165       8       2,210       9  
    Residential 1-4 family
    1,789       15       3,462       33       5,251       48  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,434     $ 50     $ 16,259     $ 193     $ 19,693     $ 243  
                                                 
With an allowance recorded
                                               
    Commercial real estate - owner occupied
  $ -     $ -     $ 122     $ 5     $ 122     $ 5  
    Commercial real estate - non-owner occupied (2)
    -       -       971       17       971       17  
    Construction and land development
    -       -       -       -       -       -  
    Commercial loans
    -       -       2,625       -       2,625       -  
    Residential 1-4 family
    -       -       5,401       80       5,401       80  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 9,119     $ 102     $ 9,119     $ 102  
Grand total
  $ 3,434     $ 50     $ 25,378     $ 295     $ 28,812     $ 345  
                                                 
(2) Includes loans secured by farmland and multi-family residential loans.
   
                                                 
Three months ended June 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
  $ 134     $ 4     $ 288     $ -     $ 422     $ 4  
    Commercial real estate - non-owner occupied (2)
    2,280       3       2,050       -       4,330       3  
    Construction and land development
    1,111       26       2,347       43       3,458       69  
    Commercial loans
    210       5       3,488       41       3,698       46  
    Residential 1-4 family
    1,170       9       367       9       1,537       18  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 4,905     $ 47     $ 8,540     $ 93     $ 13,445     $ 140  
                                                 
With an allowance recorded
                                               
    Commercial real estate - owner occupied
  $ -     $ -     $ -     $ -     $ -     $ -  
    Commercial real estate - non-owner occupied (2)
    -       -       1,523       51       1,523       51  
    Construction and land development
    -       -       3,063       44       3,063       44  
    Commercial loans
    -       -       -       -       -       -  
    Residential 1-4 family
    -       -       -       -       -       -  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 4,586     $ 95     $ 4,586     $ 95  
Grand total
  $ 4,905     $ 47     $ 13,126     $ 188     $ 18,031     $ 235  
                                                 
(2) Includes loans secured by farmland and multi-family residential loans.
 
 
14
 
 
                                                 
Six months ended June 30, 2013
                                               
   
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
  $ 137     $ 9     $ 5,536     $ 176     $ 5,673     $ 185  
    Commercial real estate - non-owner occupied (2)
    1,471       62       1,028       42       2,499       104  
    Construction and land development
    -       -       1,699       23       1,699       23  
    Commercial loans
    45       2       2,178       20       2,223       22  
    Residential 1-4 family
    1,757       37       3,185       67       4,942       104  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,410     $ 110     $ 13,626     $ 328     $ 17,036     $ 438  
                                                 
With an allowance recorded
                                               
    Commercial real estate - owner occupied
  $ -     $ -     $ 127     $ 9     $ 127     $ 9  
    Commercial real estate - non-owner occupied (2)
    -       -       974       33       974       33  
    Construction and land development
    -       -       -       -       -       -  
    Commercial loans
    -       -       2,663       -       2,663       -  
    Residential 1-4 family
    -       -       5,480       168       5,480       168  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 9,244     $ 210     $ 9,244     $ 210  
Grand total
  $ 3,410     $ 110     $ 22,870     $ 538     $ 26,280     $ 648  
                                                 
(2) Includes loans secured by farmland and multi-family residential loans.
                   
                                                 
Six months ended June 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     $ 9     $ 287     $ 11     $ 422     $ 20  
    Commercial real estate - non-owner occupied (2)
    2,131       42       2,319       37       4,450       79  
    Construction and land development
    1,081       51       3,005       74       4,086       125  
    Commercial loans
    211       11       3,682       83       3,893       94  
    Residential 1-4 family
    1,165       15       1,267       12       2,432       27  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 4,723     $ 128     $ 10,560     $ 217     $ 15,283     $ 345  
                                                 
With an allowance recorded
                                               
    Commercial real estate - owner occupied
  $ -     $ -     $ -     $ -     $ -     $ -  
    Commercial real estate - non-owner occupied (2)
    -       -       1,492       51       1,492       51  
    Construction and land development
    -       -       2,546       58       2,546       58  
    Commercial loans
    -       -       -       -       -       -  
    Residential 1-4 family
    -       -       -       -       -       -  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 4,038     $ 109     $ 4,038     $ 109  
Grand total
  $ 4,723     $ 128     $ 14,598     $ 326     $ 19,321     $ 454  
                                                 
(2) Includes loans secured by farmland and multi-family residential loans.
 
 
15
 
 
The following tables present the aging of the recorded investment in past due loans by class of loans as of June 30, 2013 and December 31, 2012 (in thousands):
                                           
June 30, 2013
   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
  $ 337     $ -     $ -     $ 337     $ -     $ 3,325     $ 3,662  
    Commercial real estate - non-owner occupied (1)  
    389       -       -       389       268       6,072       6,729  
    Construction and land development
    -       41       -       41       -       11       52  
    Commercial loans
    -       -       -       -       -       1,261       1,261  
    Residential 1-4 family
    317       -       -       317       1,624       46,080       48,021  
    Other consumer loans
            2       -       2       -       85       87  
                                                         
Total
  $ 1,043     $ 43     $ -     $ 1,086     $ 1,892     $ 56,834     $ 59,812  
                                                         
Non-covered loans:
                                                       
    Commercial real estate - owner occupied
  $ 2,293     $ -     $ -     $ 2,293     $ -     $ 91,544     $ 93,837  
    Commercial real estate - non-owner occupied (1)
    1,285       -       -       1,285       -       162,085       163,370  
    Construction and land development
    -       2,332       -       2,332       1,275       27,469       31,076  
    Commercial loans
    1,396       866       -       2,262       4,132       99,358       105,752  
    Residential 1-4 family
    6,240       2,523       -       8,763       868       60,689       70,320  
    Other consumer loans
    5       -       -       5       -       1,333       1,338  
                                                         
Total
  $ 11,219     $ 5,721     $ -     $ 16,940     $ 6,275     $ 442,478     $ 465,693  
                                                         
Total loans:
                                                       
    Commercial real estate - owner occupied
  $ 2,630     $ -     $ -     $ 2,630     $ -     $ 94,869     $ 97,499  
    Commercial real estate - non-owner occupied (1)
    1,674       -       -       1,674       268       168,157       170,099  
    Construction and land development
    -       2,373       -       2,373       1,275       27,480       31,128  
    Commercial loans
    1,396       866       -       2,262       4,132       100,619       107,013  
    Residential 1-4 family
    6,557       2,523       -       9,080       2,492       106,769       118,341  
    Other consumer loans
    5       2       -       7       -       1,418       1,425  
                                                         
Total
  $ 12,262     $ 5,764     $ -     $ 18,026     $ 8,167     $ 499,312     $ 525,505  
                                                         
December 31, 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
  $ 373     $ -     $ -     $ 373     $ -     $ 3,770     $ 4,143  
    Commercial real estate - non-owner occupied (1)
    151       2,321       -       2,472       -       8,388       10,860  
    Construction and land development
    72       -       -       72       51       1,138       1,261  
    Commercial loans
    143       -       -       143       1,963       566       2,672  
    Residential 1-4 family
    257       -       -       257       1,555       50,485       52,297  
    Other consumer loans
    -       -       -       -       -       88       88  
                                                         
Total
  $ 996     $ 2,321     $ -     $ 3,317     $ 3,569     $ 64,435     $ 71,321  
                                                         
Non-covered loans:
                                                       
    Commercial real estate - owner occupied
  $ 2,025     $ -     $ -     $ 2,025     $ 580     $ 90,683     $ 93,288  
    Commercial real estate - non-owner occupied (1)
    861       -       -       861       626       148,918       150,405  
    Construction and land development
    35       -       -       35       1,484       43,427       44,946  
    Commercial loans
    1,164       191       -       1,355       4,469       93,257       99,081  
    Residential 1-4 family
    3,586       2,888       -       6,474       469       63,554       70,497  
    Other consumer loans
    150       -       -       150       -       1,473       1,623  
                                                         
Total
  $ 7,821     $ 3,079     $ -     $ 10,900     $ 7,628     $ 441,312     $ 459,840  
                                                         
Total loans:
                                                       
    Commercial real estate - owner occupied
  $ 2,398     $ -     $ -     $ 2,398     $ 580     $ 94,453     $ 97,431  
    Commercial real estate - non-owner occupied (1)
    1,012       2,321       -       3,333       626       157,306       161,265  
    Construction and land development
    107       -       -       107       1,535       44,565       46,207  
    Commercial loans
    1,307       191       -       1,498       6,432       93,823       101,753  
    Residential 1-4 family
    3,843       2,888       -       6,731       2,024       114,039       122,794  
    Other consumer loans
    150       -       -       150       -       1,561       1,711  
                                                         
Total
  $ 8,817     $ 5,400     $ -     $ 14,217     $ 11,197     $ 505,747     $ 531,161  
                                                         
(1) Includes loans secured by farmland and multi-family residential loans.
                   
 
16
 
 
Non-covered nonaccrual loans include SBA guaranteed amounts totaling $1.6 million and $2.6 million at June 30, 2013 and December 31, 2012, respectively.
 
Activity in the allowance for non-covered loan and lease losses for the three and six months ended June 30, 2013 and 2012 is summarized below (in thousands):
                                                 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
Non-covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
Three months ended June 30, 2013
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                               
Beginning balance
  $ 898     $ 1,191     $ 1,048     $ 2,095     $ 1,296     $ 64     $ 560     $ 7,152  
Charge offs
    -       -       -       (266 )     (480 )     (1 )     -       (747 )
Recoveries
    8       51       3       35       2       1       -       100  
Provision
    (174 )     (152 )     (25 )     878       589       (9 )     (382 )     725  
Ending balance
  $ 732     $ 1,090     $ 1,026     $ 2,742     $ 1,407     $ 55     $ 178     $ 7,230  
                                                                 
Three months ended June 30, 2012
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ 649     $ 1,666     $ 500     $ 2,552     $ 948     $ 38     $ 549     $ 6,902  
Charge offs
    -       (32 )     (1,280 )     (344 )     (190 )     (3 )     -       (1,849 )
Recoveries
    -       -       -       261       12       4       -       277  
Provision
    (24 )     (619 )     2,254       75       115       (4 )     (472 )     1,325  
Ending balance
  $ 625     $ 1,015     $ 1,474     $ 2,544     $ 885     $ 35     $ 77     $ 6,655  
 
   
Commercial
   
Commercial
                                                 
   
Real Estate
   
Real Estate
   
Construction
                   
Other
                 
Non-covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
                 
Six months ended June 30, 2013
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                                               
Beginning balance
  $ 932     $ 1,474     $ 970     $ 2,110     $ 1,163     $ 33     $ 285     $ 6,967  
Charge offs
    -       (199 )     (300 )     (665 )     (518 )     (141 )     -       (1,823 )
Recoveries
    8       51       5       74       123       1       -       262  
Provision
    (208 )     (236 )     351       1,223       639       162       (107 )     1,824  
Ending balance
  $ 732     $ 1,090     $ 1,026     $ 2,742     $ 1,407     $ 55     $ 178     $ 7,230  
                                                                 
Six months ended June 30, 2012
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ 627     $ 1,011     $ 1,367     $ 2,227     $ 1,021     $ 42     $ -     $ 6,295  
Charge offs
    -       (32 )     (1,280 )     (1,167 )     (222 )     (6 )     -       (2,707 )
Recoveries
    -       -       -       273       13       6       -       292  
Provision
    (2 )     36       1,387       1,211       73       (7 )     77       2,775  
Ending balance
  $ 625     $ 1,015     $ 1,474     $ 2,544     $ 885     $ 35     $ 77     $ 6,655  
                                                                 
(1) Includes loans secured by farmland and multi-family residential loans.
 
Activity in the allowance for covered loan and lease losses by class of loan for the three and six months ended June 30, 2013 is summarized below (in thousands).  There was no allowance for loan and lease losses for covered loans recorded in the six months ended June 30, 2012.
 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
Covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
Three months ended June 30, 2013
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                               
Beginning balance
  $ -     $ 45     $ -     $ -     $ -     $ 21     $ -     $ 66  
Charge offs
    -       -       -       -       -       -       -       -  
Recoveries
    -       -       -       -       -       -       -       -  
Adjustments (2)
    -       -       -       -       -       -       -       -  
Provision
    -       -       -       -       -       -       -       -  
Ending balance
  $ -     $ 45     $ -     $ -     $ -     $ 21     $ -     $ 66  
 
17
 
 
                                                                 
                                                                 
   
Commercial
   
Commercial
                                                 
   
Real Estate
   
Real Estate
   
Construction
                   
Other
                 
Covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
                 
Six months ended June 30, 2013
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                                               
Beginning balance
  $ -     $ 45     $ -     $ 43     $ -     $ 11     $ -     $ 99  
Charge offs
    -       -       -       -       -       -       -       -  
Recoveries
    -       -       -       -       -       -       -       -  
Adjustments (2)
    -       -       -       (35 )     -       8       -       (27 )
Provision
    -       -       -       (8 )     -       2       -       (6 )
Ending balance
  $ -     $ 45     $ -     $ -     $ -     $ 21     $ -     $ 66  
                                                                 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Represents the portion of decreased expected losses which is covered by the loss sharing agreement with the FDIC.
 
The following tables present the balance in the allowance for loan losses and the recorded investment in non-covered loans by portfolio segment and based on impairment method as of June 30, 2013 and December 31, 2012 (in thousands):
                                                 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
   
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
Non-covered loans:
 
Occupied
   
Occupied (1)
   
Development (2)
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
June 30, 2013
                                               
Ending allowance balance attributable to loans:
                                               
  Individually evaluated for impairment
  $ 120     $ 61     $ 300     $ 450     $ 440     $ -     $ -     $ 1,371  
  Collectively evaluated for impairment
    612       1,029       726       2,292       967       55       178       5,859  
Total ending allowance
  $ 732     $ 1,090     $ 1,026     $ 2,742     $ 1,407     $ 55     $ 178     $ 7,230  
                                                                 
Loans:
                                                               
  Individually evaluated for impairment
  $ 7,725     $ 2,031     $ 3,582     $ 5,214     $ 8,973     $ -     $ -     $ 27,525  
  Collectively evaluated for impairment
    86,112       161,339       27,494       100,538       61,347       1,338       -       438,168  
Total ending loan balances
  $ 93,837     $ 163,370     $ 31,076     $ 105,752     $ 70,320     $ 1,338     $ -     $ 465,693  
                                                                 
December 31, 2012
                                                               
Ending allowance balance attributable to loans:
                                                               
  Individually evaluated for impairment
  $ 137     $ 260     $ -     $ -     $ 440     $ -     $ -     $ 837  
  Collectively evaluated for impairment
    795       1,214       970       2,110       723       33       285       6,130  
Total ending allowance
  $ 932     $ 1,474     $ 970     $ 2,110     $ 1,163     $ 33     $ 285     $ 6,967  
                                                                 
Loans:
                                                               
  Individually evaluated for impairment
  $ 3,455     $ 2,882     $ 2,981     $ 5,212     $ 9,159     $ -     $ -     $ 23,689  
  Collectively evaluated for impairment
    89,833       147,523       41,965       93,869       61,338       1,623       -       436,151  
Total ending loan balances
  $ 93,288     $ 150,405     $ 44,946     $ 99,081     $ 70,497     $ 1,623     $ -     $ 459,840  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes an allowance for a loan that was evaluated but not considered impaired at June 30, 2013.
 
18
 
 
The following tables present the balance in the allowance for covered loan losses and the recorded investment in covered loans by portfolio segment and based on impairment method as of June 30, 2013 and December 31, 2012 (in thousands):
                                                 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
   
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
Covered loans:
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
June 30, 2013
                                               
Ending allowance balance attributable to loans:
                                               
  Individually evaluated for impairment
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
  Collectively evaluated for impairment
    -       45       -       -       -       21       -       66  
Total ending allowance
  $ -     $ 45     $ -     $ -     $ -     $ 21     $ -     $ 66  
                                                                 
Loans:
                                                               
  Individually evaluated for impairment
  $ 136     $ 1,461     $ -     $ 45     $ 1,790     $ -     $ -     $ 3,432  
  Collectively evaluated for impairment
    3,526       5,268       52       1,216       46,231       87       -       56,380  
Total ending loan balances
  $ 3,662     $ 6,729     $ 52     $ 1,261     $ 48,021     $ 87     $ -     $ 59,812  
                                                                 
December 31, 2012
                                                               
Ending allowance balance attributable to loans:
                                                               
  Individually evaluated for impairment
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
  Collectively evaluated for impairment
    -       45       -       43       -       11       -       99  
Total ending allowance
  $ -     $ 45     $ -     $ 43     $ -     $ 11     $ -     $ 99  
                                                                 
Loans:
                                                               
  Individually evaluated for impairment
  $ 138     $ 2,114     $ 1,108     $ 212     $ 1,555     $ -     $ -     $ 5,127  
  Collectively evaluated for impairment
    4,005       8,746       153       2,460       50,742       88       -       66,194  
Total ending loan balances
  $ 4,143     $ 10,860     $ 1,261     $ 2,672     $ 52,297     $ 88     $ -     $ 71,321  
                                                                 
(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.
 
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.
 
As of June 30, 2013, we had one construction and land loan modified in a troubled debt restructuring with an unpaid principal balance of $1.3 million which was restructured by reducing the interest rate and modifying other terms. The unpaid principal balance did not change. This loan defaulted subsequent to restructuring, and is now a nonaccrual loan. There is no additional commitment to lend to this borrower.  We also had one commercial real estate owner-occupied loan modified in a troubled debt restructuring with an unpaid principal balance of $712 thousand which was restructured by reducing the principal portion of the contractual principal and interest payment without modifying the interest rate.  There is no additional commitment to lend to this borrower.
 
19
 
 
Credit Quality Indicators
 
Through its system of internal controls Southern National evaluates and segments loan portfolio credit quality on a quarterly basis using regulatory definitions for Special Mention, Substandard and Doubtful.  Special Mention loans are considered to be criticized.  Substandard and Doubtful loans are considered to be classified.  Southern National had no loans classified Doubtful at June 30, 2013 or December 31, 2012.
 
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.
 
As of June 30, 2013 and December 31, 2012, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
                                                             
June 30, 2013
 
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
  $ 136     $ 3,526     $ 3,662     $ 813     $ 7,725     $ 85,299     $ 93,837     $ 8,674     $ 88,825     $ 97,499  
Commercial real estate - non-owner occupied (2)
    1,461       5,268       6,729       102       2,031       161,237       163,370       3,594       166,505       170,099  
Construction and land development
    -       52       52       643       3,582       26,851       31,076       4,225       26,903       31,128  
Commercial loans
    45       1,216       1,261       425       5,214       100,113       105,752       5,684       101,329       107,013  
Residential 1-4 family
    1,790       46,231       48,021       -       8,973       61,347       70,320       10,763       107,578       118,341  
Other consumer loans
    -       87       87       -       -       1,338       1,338       -       1,425       1,425  
                                                                                 
Total
  $ 3,432     $ 56,380     $ 59,812     $ 1,983     $ 27,525     $ 436,185     $ 465,693     $ 32,940     $ 492,565     $ 525,505  
 
                                                                                 
December 31, 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
  $ 138     $ 4,005     $ 4,143     $ 821     $ 3,455     $ 89,012     $ 93,288     $ 4,414     $ 93,017     $ 97,431  
Commercial real estate - non-owner occupied (2)
    2,114       8,746       10,860       -       2,882       147,523       150,405       4,996       156,269       161,265  
Construction and land development
    1,108       153       1,261       -       2,981       41,965       44,946       4,089       42,118       46,207  
Commercial loans
    212       2,460       2,672       32       5,212       93,837       99,081       5,456       96,297       101,753  
Residential 1-4 family
    1,555       50,742       52,297       -       9,159       61,338       70,497       10,714       112,080       122,794  
Other consumer loans
    -       88       88       -       -       1,623       1,623       -       1,711       1,711  
                                                                                 
Total
  $ 5,127     $ 66,194     $ 71,321     $ 853     $ 23,689     $ 435,298     $ 459,840     $ 29,669     $ 501,492     $ 531,161  
                                                                                 
(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 $1.6 million and $2.6 million as of June 30, 2013 and December 31, 2012, respectively.
 
5.    FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
 
Southern National is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers.  These financial instruments include commitments to extend credit 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 Southern National to guarantee the performance of a customer to a third party.  The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.  We had letters of credit outstanding totaling $6.8 million and $10.3 million as of June 30, 2013 and December 31, 2012, respectively.
 
20
 
 
Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments.  We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Unless noted otherwise, we do not require collateral or other security to support financial instruments with credit risk.
 
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract.  Commitments are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee.  Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.  We evaluate each customers creditworthiness on a case-by-case basis.
 
At June 30, 2013 and December 31, 2012, we had unfunded lines of credit and undisbursed construction loan funds totaling $90.7 million and $82.5 million, respectively. We had approved loan commitments of $9.9 million at June 30, 2013, and we had no approved loan commitments as of December 31, 2012.  Virtually all of our unfunded lines of credit, undisbursed construction loan funds and approved loan commitments are variable rate.
 
6.     EARNINGS PER SHARE
 
The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (dollars in thousands, except per share data):
                   
         
Weighted
       
         
Average
       
   
Income
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Amount
 
For the three months ended June 30, 2013
                 
Basic EPS
  $ 1,555       11,590     $ 0.13  
Effect of dilutive stock options and warrants
    -       44       -  
Diluted EPS
  $ 1,555       11,634     $ 0.13  
                         
For the three months ended June 30, 2012
                       
Basic EPS
  $ 2,215       11,590     $ 0.19  
Effect of dilutive stock options and warrants
    -       4       -  
Diluted EPS
  $ 2,215       11,594     $ 0.19  
                         
For the six months ended June 30, 2013
                       
Basic EPS
  $ 3,081       11,590     $ 0.27  
Effect of dilutive stock options and warrants
    -       33       -  
Diluted EPS
  $ 3,081       11,623     $ 0.27  
                         
For the six months ended June 30, 2012
                       
Basic EPS
  $ 4,058       11,590     $ 0.35  
Effect of dilutive stock options and warrants
    -       3       -  
Diluted EPS
  $ 4,058       11,593     $ 0.35  
 
21
 
 
There were 671,262 and 682,365 anti-dilutive options and warrants for the three and six months ended June 30, 2013, respectively. Anti-dilutive options and warrants totaled 514,104 and 515,390 for the three and six months ended June 30, 2012, 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, all of Southern National’s available-for-sale debt securities are considered to be Level 2 securities.
 
22
 
 
Assets measured at fair value on a recurring basis are summarized below:
 
         
Fair Value Measurements Using
 
               
Significant
       
         
Quoted Prices in
   
Other
   
Significant
 
         
Active Markets for
   
Observable
   
Unobservable
 
   
Total at
   
Identical Assets
   
Inputs
   
Inputs
 
(dollars in thousands)
 
June 30, 2013
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                       
Available for sale securities
                       
Obligations of states and political subdivisions
  $ 2,034     $ -     $ 2,034     $ -  
                                 
           
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, 2012
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial assets:
                               
Available for sale securities
                               
Obligations of states and political subdivisions
  $ 2,289     $ -     $ 2,289     $ -  
FHLMC preferred stock
    102       102       -       -  
Total available-for-sale securities
  $ 2,391     $ 102     $ 2,289     $ -  
 
Assets and Liabilities Measured on a Non-recurring Basis:
 
Trust Preferred Securities Classified as Held-to-Maturity
 
The base input in calculating fair value is a Bloomberg Fair Value Index yield curve for single issuer trust preferred securities which correspond to the ratings of the securities we own.  We also use composite rating indices to fill in the gaps where the bank rating indices did not correspond to the ratings in our portfolio.  When a bank index that matches the rating of our security is not available, we used the bank index that most closely matches the rating, adjusted by the spread between the composite index that most closely matches the security’s rating and the composite index with a rating that matches the bank index used.  Then, we use the adjusted index yield, which is further adjusted by a liquidity premium, as the discount rate to be used in the calculation of the present value of the same cash flows used to evaluate the securities for OTTI.  The liquidity premiums were derived in consultation with a securities advisor. The liquidity premiums we used ranged from 2% to 5%, and the adjusted discount rates ranged from 10.42% to 14.33% at June 30, 2013.   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.
 
Other Residential Collateralized Mortgage Obligation Classified as Held-to Maturity
 
The fair value was estimated within Level 2 fair value hierarchy, as the fair value is based on either pricing models, quoted market prices of securities with similar characteristics, or discounted cash flows.  We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support, it has been determined that no OTTI charge for credit exists for the three months ended June 30, 2013.  The assumptions used in the analysis included a 3.7% prepayment speed, 9.2% default rate, a 47% loss severity and an accounting yield of 2.57% during the three months ended June 30, 2013.
 
23
 
 
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.  Discounts have predominantly been in the range of 0% to 8.4%. In some cases liquidation expenses may be netted from the appraised value which may result in a 0% discount. Fair value is classified as Level 3 in the fair value hierarchy. Non-covered loans identified as impaired totaled $27.5 million (including SBA guarantees of $1.6 million and HarVest loans of $370 thousand) as of June 30, 2013 with an allocated allowance for loan losses totaling $1.1 million compared to a carrying amount of $23.7 million (including SBA guarantees of $2.6 million) with an allocated allowance for loan losses totaling $837 thousand at December 31, 2012.  Charge offs related to the impaired loans at June 30, 2013 totaled $746 thousand and $1.2 million for the three and six months ended June 30, 2013, respectively, compared to $1.4 million and $1.6 million for the three and six months ended June 30, 2012.
 
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. Discounts have predominantly been in the range of 0% to 7.9%. In some cases liquidation expenses may be netted from the appraised value which may result in a 0% discount. Fair value is classified as Level 3 in the fair value hierarchy. OREO is further evaluated quarterly for any additional impairment. At June 30, 2013, the total amount of OREO was $14.9 million, of which $12.1 million was non-covered (including $739 thousand acquired from HarVest) and $2.8 million was covered.
 
At December 31, 2012, the total amount of OREO was $13.8 million, of which $13.2 million was non-covered (including $744 thousand acquired from HarVest) and $636 thousand was covered.
 
Assets measured at fair value on a non-recurring basis are summarized below:
 
       
Fair Value Measurements Using
 
         
Significant
     
       
Quoted Prices in
Other
 
Significant
 
       
Active Markets for
Observable
 
Unobservable
 
   
Total at
 
Identical Assets
Inputs
 
Inputs
 
(dollars in thousands)
 
June 30, 2013
 
(Level 1)
(Level 2)
 
(Level 3)
 
Impaired non-covered loans:
               
Commercial real estate - owner occupied
    7,605           7,605  
Commercial real estate - non-owner occupied (1)
    1,970           1,970  
Construction and land development
    3,582           3,582  
Commercial loans
    4,764           4,764  
Residential 1-4 family
    8,533           8,533  
Impaired covered loans:
                   
Commercial real estate - owner occupied
    136           136  
Commercial real estate - non-owner occupied (1)
    1,461           1,461  
Commercial loans
    45           45  
Residential 1-4 family
    1,790           1,790  
Non-covered other real estate owned:
                   
Commercial real estate - owner occupied
    713           713  
Commercial real estate - non-owner occupied (1)
    1,342           1,342  
Construction and land development
    5,746           5,746  
Residential 1-4 family
    4,318           4,318  
Covered other real estate owned:
                   
Commercial real estate - owner occupied
    557           557  
Commercial real estate - non-owner occupied (1)
    2,200           2,200  
Commercial
    79           79  
 
24
 
 
       
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, 2012
 
(Level 1)
(Level 2)
 
(Level 3)
 
Impaired non-covered loans:
               
Commercial real estate - owner occupied
  $ 3,318         $ 3,318  
Commercial real estate - non-owner occupied (1)
    2,622           2,622  
Construction and land development
    2,981           2,981  
Commercial loans
    5,212           5,212  
Residential 1-4 family
    8,719           8,719  
Impaired covered loans:
                   
Commercial real estate - owner occupied
    138           138  
Commercial real estate - non-owner occupied (1)
    2,114           2,114  
Construction and land development
    1,108           1,108  
Commercial loans
    212           212  
Residential 1-4 family
    1,555           1,555  
Non-covered other real estate owned:
                   
Commercial real estate - owner occupied
    461           461  
Commercial real estate - non-owner occupied (1)
    1,342           1,342  
Construction and land development
    6,484           6,484  
Residential 1-4 family
    4,913           4,913  
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.
 
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):
 
         
June 30, 2013
   
December 31, 2012
 
   
Fair Value
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Hierarchy Level
   
Amount
   
Value
   
Amount
   
Value
 
                               
Financial assets:
                             
Cash and cash equivalents
 
Level 1
    $ 28,545     $ 28,545     $ 39,200     $ 39,200  
Securities available for sale
 
See previous table
      2,034       2,034       2,391       2,391  
Securities held to maturity
 
Level 2 & Level 3
      83,354       79,635       84,051       84,827  
Stock in Federal Reserve Bank and Federal
                                     
Home Loan Bank
  n/a       5,240       n/a       6,212       n/a  
Net non-covered loans
 
Level 3
      457,235       461,148       451,757       457,906  
Net covered loans
 
Level 3
      59,753       63,910       71,328       77,976  
Accrued interest receivable
 
Level 2 & Level 3
      2,222       2,222       2,455       2,455  
FDIC indemnification asset
 
Level 3
      6,308       4,671       6,735       6,735  
Financial liabilities:
                                     
Demand deposits
 
Level 1
      67,347       67,347       72,418       72,418  
Money market and savings accounts
 
Level 1
      158,609       158,609       172,851       172,851  
Certificates of deposit
 
Level 3
      319,682       321,203       305,708       308,160  
Securities sold under agreements to
                                     
repurchase and other short-term borrowings
 
Level 1
      20,530       20,530       33,411       33,411  
FHLB advances
 
Level 3
      30,250       31,848       30,250       31,380  
Accrued interest payable
 
Level 1 & Level 3
      360       360       258       258  
 
25
 
 
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. A discount for liquidity risk was not considered necessary in estimating the fair value of loans. 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.    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).
 
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 due 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  
 
26
 
 
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.
 
27
 
 
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, 2012.  Results of operations for the three and six month periods ended June 30, 2013 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, 2012, factors that could contribute to those differences include, but are not limited to:
 
 
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, obligations of states and political subdivisions 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;
 
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;
 
28
 
 
 
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;
 
risks of mergers and acquisitions, including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings;
 
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 fifteen branches in Virginia, located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Middleburg, Leesburg (2), South Riding, Front Royal, New Market, Haymarket,  Richmond and Clifton Forge, and five branches in Maryland, in Rockville, Shady Grove, Germantown, Frederick and Bethesda.  We have administrative offices in Warrenton and an executive office in Georgetown, Washington, D.C where senior management is located.
 
29
 
 
RESULTS OF OPERATIONS
 
Net Income
 
Net income for the quarter ended June 30, 2013 was $1.6 million and $3.1 million for the first half of 2013. That compares to $2.2 million and $4.1 million for the three and six months ended June 30, 2012.
 
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 $7.4 million in the quarter ended June 30, 2013 down from $7.8 million during the same period last year. The accretion of the discount on Greater Atlantic Bank’s loans contributed $361 thousand to second quarter 2013 net interest income compared to $705 thousand during the second quarter of 2012. The accretion of the discount on HarVest’s loans contributed $440 thousand in the second quarter of 2013 compared to $172 thousand during the second quarter of 2012. The cost of funds decreased from 1.16% for the quarter ended June 30, 2012, to 0.84% for the second quarter of 2013. Sonabank’s net interest margin was 4.57% in the second quarter of 2013 compared to 5.07% during the comparable quarter last year and 4.94% during the first quarter of 2013.
 
Net interest income was $15.1 million during the six months ended June 30, 2013, compared to $15.5 million during the comparable period in the prior year. Approximately $805 thousand of the 2012 net interest income resulted from the recovery of discount recognized in purchase accounting during the first quarter of 2012 for two impaired loans acquired in the Greater Atlantic Bank acquisition following the receipt of payment from the borrowers. The total accretion of the discount on the Greater Atlantic Bank loan portfolio, including the aforementioned $805 thousand, amounted to $2.2 million in the first six months of 2012, compared to $808 thousand in the first half of 2013. The cost of funds decreased from 1.19% for the six months ended June 30, 2012, to 0.89% for the six months ended June 30, 2013. Sonabank’s net interest margin was 4.76% in the first six months of 2013 compared to 5.32% during the same period last year.
 
30
 
 
The following table details average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:
                                         
   
Average Balance Sheets and Net Interest
 
   
Analysis For the Quarters Ended
 
   
6/30/2013
   
6/30/2012
 
         
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)
  $ 505,106     $ 7,765       6.17 %   $ 539,322     $ 8,768       6.54 %
Investment securities
    83,521       557       2.67 %     65,483       509       3.11 %
Other earning assets
    58,488       227       1.56 %     15,965       84       2.12 %
                                                 
Total earning assets
    647,115       8,549       5.30 %     620,770       9,361       6.07 %
Allowance for loan losses
    (7,304 )                     (7,032 )                
Total non-earning assets
    72,567                       72,680                  
Total assets
  $ 712,378                     $ 686,418                  
                                                 
Liabilities and stockholders equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 23,101       16       0.28 %   $ 19,160       22       0.46 %
Money market accounts
    155,843       124       0.32 %     163,001       327       0.81 %
Savings accounts
    10,759       16       0.60 %     8,321       13       0.61 %
Time deposits
    322,638       864       1.07 %     287,092       939       1.32 %
Total interest-bearing deposits
    512,341       1,020       0.80 %     477,574       1,301       1.10 %
Borrowings
    45,799       155       1.36 %     51,788       227       1.76 %
Total interest-bearing liabilities
    558,140       1,175       0.84 %     529,362       1,528       1.16 %
Noninterest-bearing liabilities:
                                               
  Demand deposits
    43,920                       43,228                  
  Other liabilities
    5,550                       12,106                  
Total liabilites
    607,610                       584,696                  
Stockholders equity
    104,768                       101,722                  
Total liabilities and stockholders equity
  $ 712,378                     $ 686,418                  
Net interest income
            7,374                       7,833          
Interest rate spread
                    4.45 %                     4.90 %
Net interest margin
                    4.57 %                     5.07 %
                                                 
(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.
   
 
31
 

                                           
   
Average Balance Sheets and Net Interest
 
   
Analysis For the Six Months Ended
 
   
6/30/2013
   
6/30/2012
 
         
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)
  $ 509,514     $ 16,109       6.38 %   $ 513,970     $ 17,379       6.80 %
Investment securities
    84,041       1,124       2.67 %     55,008       911       3.31 %
Other earning assets
    48,659       339       1.40 %     16,269       145       1.79 %
                                                 
Total earning assets
    642,214       17,572       5.52 %     585,247       18,435       6.33 %
Allowance for loan losses
    (7,478 )                     (6,989 )                
Total non-earning assets
    71,364                       71,899                  
Total assets
  $ 706,100                     $ 650,157                  
                                                 
Liabilities and stockholders equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 23,927       31       0.26 %   $ 17,911       33       0.37 %
Money market accounts
    157,263       314       0.40 %     156,091       626       0.81 %
Savings accounts
    10,424       29       0.56 %     7,340       22       0.60 %
Time deposits
    313,652       1,746       1.12 %     270,896       1,818       1.35 %
Total interest-bearing deposits
    505,266       2,120       0.85 %     452,238       2,499       1.11 %
Borrowings
    46,522       308       1.34 %     49,446       463       1.88 %
Total interest-bearing liabilities
    551,788       2,428       0.89 %     501,684       2,962       1.19 %
Noninterest-bearing liabilities:
                                               
  Demand deposits
    44,751                       39,402                  
  Other liabilities
    5,270                       8,102                  
Total liabilites
    601,809                       549,188                  
Stockholders equity
    104,291                       100,969                  
Total liabilities and stockholders equity
  $ 706,100                     $ 650,157                  
Net interest income
          $ 15,144                     $ 15,473          
Interest rate spread
                    4.63 %                     5.14 %
Net interest margin
                    4.76 %                     5.32 %
                                                 
(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 second quarter of 2013 was $725 thousand, down from $1.3 million in the second quarter of 2012. For the six months ended June 30, 2013, the provision for loan losses was $1.8 million compared to $2.8 million for the same period last year.
 
32
 

Net charge offs during the quarter ended June 30, 2013 were $648 thousand compared to $1.6 million during the second quarter of 2012. Net charge offs during the six months ended June 30, 2013 were $1.6 million compared to $2.4 million during the first half of 2012.

Noninterest Income

The following tables present the major categories of noninterest income for the three and six months ended June 30, 2013 and 2012:
                   
   
For the Three Months Ended
 
   
June 30,
 
   
2013
   
2012
   
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 203     $ 206     $ (3 )
Income from bank-owned life insurance
    148       347       (199 )
Bargain purchase gain on acquisition
    -       3,484       (3,484 )
Net loss on sale of available for sale securities
    -       (13 )     13  
Net impairment losses recognized in earnings
    -       (235 )     235  
Gain on other assets
    13       -       13  
Other
    84       81       3  
    Total noninterest income
  $ 448     $ 3,870     $ (3,422 )
                         
   
For the Six Months Ended
 
   
June 30,
 
    2013     2012    
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 396     $ 402     $ (6 )
Income from bank-owned life insurance
    297       500       (203 )
Bargain purchase gain on acquisition
    -       3,484       (3,484 )
Gain on sale of loans
    -       657       (657 )
Gain on other assets
    13       14       (1 )
Net gain (loss) on sale of available for sale securities
    142       (13 )     155  
Net impairment losses recognized in earnings
    (3 )     (237 )     234  
Other
    139       135       4  
    Total noninterest income
  $ 984     $ 4,942     $ (3,958 )
 
During the second quarter of 2013 Sonabank had noninterest income of $448 thousand compared to noninterest income of $3.9 million during the second quarter of 2012. The decrease resulted primarily from the bargain purchase gain of $3.5 million from the HarVest transaction in the second quarter of 2012. In addition, there was an other than temporary impairment (“OTTI”) of $235 thousand in one trust preferred security during the second quarter of 2012 compared to no OTTI charges during the second quarter of 2013. Income from bank owned life insurance (“BOLI”) contributed $148 thousand during the second quarter of 2013 compared to $347 thousand the prior year quarter. The second quarter of 2012 was affected by a death benefit.
 
Noninterest income decreased from $4.9 million in the first six months of 2012 to $984 thousand in the first six months of 2013. The drivers of the decrease from the first half of 2012 were largely the same as the quarter except that during the first quarter of 2012 the bank sold the guaranteed portions of SBA loans and realized a $657 thousand gain.
 
33
 
 
Noninterest Expense

The following table presents the major categories of noninterest expense for the three and six months ended June 30, 2013 and 2012:
                   
   
For the Three Months Ended
 
   
June 30,
 
   
2013
   
2012
   
Change
 
   
(dollars in thousands)
 
 Salaries and benefits
  $ 2,176     $ 1,970     $ 206  
 Occupancy expenses
    753       705       48  
 Furniture and equipment expenses
    171       143       28  
 Amortization of core deposit intangible
    123       228       (105 )
 Virginia franchise tax expense
    115       145       (30 )
 Merger expenses
    -       349       (349 )
 FDIC assessment
    224       142       82  
 Data processing expense
    154       162       (8 )
 Telephone and communication expense
    163       133       30  
 Change in FDIC indemnification asset
    107       253       (146 )
 Net loss on other real estate owned
    62       2,201       (2,139 )
 Other operating expenses
    750       732       18  
    Total noninterest expense
  $ 4,798     $ 7,163     $ (2,365 )
                         
   
For the Six Months Ended
 
   
June 30,
 
    2013     2012    
Change
 
   
(dollars in thousands)
 
 Salaries and benefits
  $ 4,422     $ 3,795     $ 627  
 Occupancy expenses
    1,513       1,287       226  
 Furniture and equipment expenses
    327       299       28  
 Amortization of core deposit intangible
    246       458       (212 )
 Virginia franchise tax expense
    242       291       (49 )
 Merger expenses
    -       349       (349 )
 FDIC assessment
    458       271       187  
 Data processing expense
    302       299       3  
 Telephone and communication expense
    341       235       106  
 Change in FDIC indemnification asset
    237       239       (2 )
 Net loss on other real estate owned
    118       2,400       (2,282 )
 Other operating expenses
    1,543       1,752       (209 )
    Total noninterest expense
  $ 9,749     $ 11,675     $ (1,926 )
 
34
 
 
Noninterest expenses were $4.8 million and $9.7 million during the second quarter and the first half of 2013, respectively, compared to $7.2 million and $11.7 million during the same periods in 2012. Noninterest expenses for the second quarter of 2012 included the recognition of impairment in the values of five OREO properties in the Charlottesville market and one in the Culpeper market in the amount of $2.2 million. Also affecting the second quarter of 2012 were merger expenses relating to the HarVest transaction totaling $349 thousand, and other noninterest expenses related to the HarVest branches were $245 thousand. Occupancy and furniture and equipment expenses were $1.8 million during the first six months of 2013, compared to $1.6 million during 2012. Of this increase, $310 thousand resulted from operating five additional branches, four from the HarVest acquisition and one denovo.  In addition, salaries and benefits expense has increased $627 thousand during the six months ended June 30, 2013, compared to 2012 due to the HarVest acquisition and other additional personnel.   Full-time equivalent employees have increased from 137 at June 30, 2012, to 144 at June 30, 2013. Audit and accounting fees have decreased from $569 thousand during the six months ended June 30, 2012 to $251 thousand during the first six months of 2013.  These fees were abnormally high in 2012 because of the restatement of 2010 and 2009 financial statements.

The efficiency ratio was 60.28% during the six months ended June 30, 2013 compared to 56.90% during the first half of 2012.

FINANCIAL CONDITION
 
Balance Sheet Overview

Total assets were $706.7 million as of June 30, 2013 compared to $723.8 million as of December 31, 2012.  Net loans receivable decreased from $523.1 million at the end of 2012 to $517.0 million at June 30, 2013. Within that total, covered loans declined by $11.5 million while the non-covered loan portfolio increased by $5.6 million.

Total deposits were $545.6 million at June 30, 2013 compared to $551.0 million at December 31, 2012. Certificates of deposit increased $14.0 million during the six months.  This was offset by a decrease in money market accounts of $16.8 million during the six months ended June 30, 2013.  Noninterest-bearing deposits were $45.3 million at June 30, 2013 and $49.6 million at December 31, 2012.  Noninterest-bearing deposits were historically high at December 31, 2012, primarily because of large balances held by title companies.

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.”
 
35
 
 
The following table summarizes the composition of our loan portfolio as of June 30, 2013 and December 31, 2012:
                                     
   
Covered
   
Non-covered
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans (1)
   
Loans
   
Loans
   
Loans (1)
   
Loans
   
Loans
 
   
June 30, 2013
   
December 31, 2012
 
 Loans secured by real estate:
                                   
    Commercial real estate - owner-occupied
  $ 3,662     $ 93,837     $ 97,499     $ 4,143     $ 93,288     $ 97,431  
    Commercial real estate - non-owner-occupied
    6,028       140,929       146,957       10,246       130,152       140,398  
    Secured by farmland
    103       517       620       -       1,479       1,479  
    Construction and land loans
    52       31,076       31,128       1,261       44,946       46,207  
    Residential 1-4 family
    19,067       62,544       81,611       21,005       61,319       82,324  
    Multi- family residential
    598       21,924       22,522       614       18,774       19,388  
    Home equity lines of credit
    28,954       7,776       36,730       31,292       9,178       40,470  
    Total real estate loans
    58,464       358,603       417,067       68,561       359,136       427,697  
                                                 
 Commercial loans
    1,261       105,752       107,013       2,672       99,081       101,753  
 Consumer loans
    87       1,338       1,425       88       1,623       1,711  
      Gross loans
    59,812       465,693       525,505       71,321       459,840       531,161  
                                                 
 Less deferred fees on loans
    7       (1,228 )     (1,221 )     7       (1,017 )     (1,010 )
 Loans, net of deferred fees
  $ 59,819     $ 464,465     $ 524,284     $ 71,328     $ 458,823     $ 530,151  
                                                 
(1) Covered Loans were acquired in the Greater Atlantic transaction and are covered under an FDIC loss-share agreement.
 

As of June 30, 2013 and December 31, 2012, 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.

Loans, net of deferred fees, decreased $5.9 million from $530.2 million at the end of 2012 to $524.3 million at June 30, 2013, but increased $14.3 million from March 31, 2013.  We had payoffs of large loans of approximately $8.3 million and $3.5 million in foreclosures during the quarter. However, that was offset this quarter by very strong loan closings of $36.0 million most of which closed near quarter-end.

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.
 
36
 
 
Non-covered Loans and Assets
 
Non-covered loans evaluated for impairment totaled $27.5 million with allocated allowance for loan losses in the amount of $1.1 million as of June 30, 2013, including $6.3 million of nonaccrual loans. This compares to $23.7 million of impaired loans with allocated allowance for loan losses in the amount of $837 thousand at December 31, 2012, including $7.6 million of nonaccrual loans. The nonaccrual loans included SBA guaranteed amounts of $1.6 million and $2.6 million at June 30, 2013 and December 31, 2012, respectively.  At June 30, 2013 and December 31, 2012 there were no loans past due 90 days or more and accruing interest.
 
Non-covered nonperforming assets decreased from $20.8 million at December 31, 2012 to $18.4 million at June 30, 2013.
 
Non-covered OREO as of June 30, 2013 was $12.1 million compared to $13.2 million as of the end of 2012. During the three months ended June 30, 2013 we had two foreclosures in the non-covered portfolio in the amount of $1.3 million and OREO sales of $617 thousand. For the six months ended June 30, 2013 we had four foreclosures in the non-covered portfolio totaling $1.6 million and OREO sales of $2.6 million.
 
Sonabank has an internal loan review and a loan committee, both of which provide on-going monitoring to identify and address issues with problem loans.  The loan loss provision is determined after consideration of all known relevant internal and external factors affecting loan collectability to maintain the allowance for loan and lease losses at a level necessary to absorb estimated credit losses. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at June 30, 2013.
 
The following table presents a comparison of non-covered nonperforming assets as of June 30, 2013 and December 31, 2012 (in thousands):
 
   
June 30,
   
December 31,
 
   
2013
   
2012
 
             
Nonaccrual loans
  $ 6,275     $ 7,628  
Loans past due 90 days and accruing interest
    -       -  
    Total nonperforming loans
    6,275       7,628  
Other real estate owned
    12,119       13,200  
    Total nonperforming assets
  $ 18,394     $ 20,828  
                 
SBA guaranteed amounts included in nonaccrual loans
  $ 1,641     $ 2,607  
                 
Allowance for loan losses to nonperforming loans
    115.22 %     91.33 %
Allowance for loan losses to total non-covered loans
    1.55 %     1.52 %
Nonperforming assets excluding SBA guaranteed loans to total non-covered assets
    2.60 %     2.80 %
 
37
 
 
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.
 
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.
 
As of June 30, 2013, we had one construction and land loan modified in a troubled debt restructuring with an unpaid principal balance of $1.3 million which was restructured by reducing the interest rate and modifying other terms. The unpaid principal balance did not change. This loan defaulted subsequent to restructuring, and is now a nonaccrual loan. There is no additional commitment to lend to this borrower.  We also had one commercial real estate owner-occupied loan modified in a troubled debt restructuring with an unpaid principal balance of $712 thousand which was restructured by reducing the principal portion of the contractual principal and interest payment without modifying the interest rate.  There is no additional commitment to lend to this borrower.
 
Covered Loans and Assets
 
Covered loans identified as impaired totaled $3.4 million as of June 30, 2013 and $5.1 million at December 31, 2012. Nonaccrual loans were $1.9 million and $3.6 million at June 30, 2013 and December 31, 2012, respectively. At June 30, 2013 and December 31, 2012, there were no loans past due 90 days or more and accruing interest.
 
Covered OREO as of June 30, 2013 was $2.8 million compared to $636 thousand as of the end of 2012. In the covered portfolio we had one foreclosure during the three months ended June 30, 2013 in the amount of $2.2 million and during the six months had two foreclosures totaling $4.0 million.  In the second quarter of 2013, we sold the property foreclosed on in the first quarter of 2013 for $1.9 million which resulted in a small gain.
 
Securities
 
Investment securities, available for sale and held to maturity, were $85.4 million at June 30, 2013 and $86.4 million at December 31, 2012.
 
38
 
 
Investment activity during the first six months of 2013 was concentrated on municipal bonds (as it was in the fourth quarter of 2012) and to a lesser extent on callable agencies. The yields available on FNMA and FHLMC mortgage pass through securities where we have historically invested excess cash have been adversely affected by the Federal Reserve Board’s third round of quantitative easing and its purchases of $40 billion a month in mortgage-backed securities. The yields on higher quality, bank qualified municipal bonds have been significantly higher on a taxable equivalent basis although they do entail some extension risk. We went into the strategy of investing in municipals with an overall asset sensitive balance sheet and are monitoring it to ensure we do not get outside our risk tolerance level. Through the end of the second quarter of 2013, we had assembled a portfolio of $13.0 million with a taxable equivalent yield of 3.02% and ratings as follows:
 
 
Rating
     
Amount
 
 
Service
 
Rating
 
(in thousands)
 
 
Moodys
 
Aaa
  $ 505  
 
Moodys
 
Aa2
    3,208  
 
Moodys
 
Aa3
    724  
 
Standard & Poors
 
AAA
    2,682  
 
Standard & Poors
 
AA
    3,690  
 
Standard & Poors
 
AA-
    2,237  
          $ 13,046  
 
In accordance with regulatory guidance we have performed an independent analysis on each security and monitor the portfolio on an ongoing basis.
 
As of June 30, 2013 we owned pooled trust preferred securities as follows:
 
                                                     
Previously
       
                                               
% of Current
   
Recognized
       
                                               
Defaults and
   
Cumulative
       
     
Ratings
                           
Estimated
   
Deferrals to
   
Other
       
 
Tranche
 
When Purchased
   
Current Ratings
         
Fair
   
Total
   
Comprehensive
       
Security
Level
 
Moodys
   
Fitch
   
Moodys
   
Fitch
   
Par Value
   
Book Value
   
Value
   
Collateral
   
Loss (1)
       
                             
(in thousands)
                   
ALESCO VII  A1B
Senior
 
Aaa
   
AAA
   
Baa3
   
BB
    $ 6,777     $ 6,124     $ 4,097     24 %   $ 281        
MMCF III B
Senior Sub
  A3     A-    
Ba1
   
CC
      421       413       255     30 %     8        
                                7,198       6,537       4,352           $ 289        
                                                                       
Other Than Temporarily Impaired:
                                                         
Cumulative Other
Comprehensive
Loss (2)
   
Cumulative
OTTI Related to
Credit Loss (2)
 
TPREF FUNDING II
Mezzanine
  A1     A-    
Caa3
    C       1,500       515       520     44 %     626      $ 359  
TRAP 2007-XII C1
Mezzanine
  A3     A     C     C       2,132       56       140     39 %     783       1,293  
TRAP 2007-XIII D
Mezzanine
 
NR
    A-    
NR
    C       2,039       -       103     29 %     7       2,032  
MMC FUNDING XVIII
Mezzanine
  A3     A-    
Ca
    C       1,081       27       254     30 %     363       691  
ALESCO V C1
Mezzanine
  A2     A     C     C       2,150       475       548     23 %     1,014       661  
ALESCO XV C1
Mezzanine
  A3     A-     C     C       3,210       30       152     35 %     621       2,559  
ALESCO XVI  C
Mezzanine
  A3     A-     C     C       2,136       119       576     16     837       1,180  
                                14,248       1,222       2,293           $ 4,251     $ 8,775  
                                                                         
Total
                            $ 21,446     $ 7,759     $ 6,645                        

(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 under Accounting Standards Codification Topic 325.  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.
 
We recognized no OTTI charges during the second quarter of 2013 and recognized OTTI charges of $3 thousand during the first six months of 2013 compared to OTTI charges related to credit on the trust preferred securities totaling $235 thousand and $237 thousand during the same periods of 2012.
 
39
 
 
Liquidity and Funds Management
 
The objective of our liquidity management is to assure the ability to meet our financial obligations. These obligations include the payment of deposits on demand or at maturity, the repayment of borrowings at maturity and the ability to fund commitments and other new business opportunities. We obtain funding from a variety of sources, including customer deposit accounts, customer certificates of deposit and payments on our loans and investments. Historically, our level of core deposits has been insufficient to fully fund our lending activities. As a result, we have sought funding from additional sources, including institutional certificates of deposit and the sale of available-for-sale investment securities. In addition, we maintain lines of credit from the Federal Home Loan Bank of Atlanta and utilize securities sold under agreements to repurchase and reverse repurchase agreement borrowings from approved securities dealers.
 
We prepare a cash flow forecast for one year with the first three months prepared on a weekly basis and on a monthly basis thereafter. The projections incorporate all scheduled maturities of loans excluding impaired loans and all scheduled maturities of out of area certificates of deposit. In addition, prepayments on investment securities are estimated by using a projection produced by our bond accounting system. To estimate loan growth over the one year period, the projection incorporates the scheduled loan closings in the Loan Pipeline Report along with other management estimates.
 
 During the six months ended June 30, 2013, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At June 30, 2013, we had $90.7 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $9.9 million at June 30, 2013. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.
 
40
 
 
Capital Resources
 
The following table provides a comparison of our leverage and risk-weighted capital ratios and the leverage and risk-weighted capital ratios of the bank at the dates indicated to the minimum and well-capitalized regulatory standards (dollars in thousands):
                                     
               
Required
             
               
For Capital
   
To Be Categorized as
 
   
Actual
   
Adequacy Purposes
   
Well Capitalized
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
June 30, 2013
                                   
Southern National
                                   
Tier 1 risk-based capital ratio
  $ 97,761       18.84 %   $ 20,754       4.00 %   $ 31,130       6.00 %
Total risk-based capital ratio
    104,243       20.09 %     41,507       8.00 %     51,884       10.00 %
Leverage ratio
    97,761       13.92 %     28,097       4.00 %     35,121       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 97,143       18.73 %   $ 20,742       4.00 %   $ 31,113       6.00 %
Total risk-based capital ratio
    103,620       19.98 %     41,484       8.00 %     51,855       10.00 %
Leverage ratio
    97,143       13.84 %     28,085       4.00 %     35,107       5.00 %
                                                 
December 31, 2012
                                               
Southern National
                                               
Tier 1 risk-based capital ratio
  $ 95,539       18.33 %   $ 20,853       4.00 %   $ 31,280       6.00 %
Total risk-based capital ratio
    102,048       19.57 %     41,707       8.00 %     52,133       10.00 %
Leverage ratio
    95,539       13.69 %     27,908       4.00 %     34,884       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 94,754       18.18 %   $ 20,842       4.00 %   $ 31,264       6.00 %
Total risk-based capital ratio
    101,260       19.43 %     41,685       8.00 %     52,106       10.00 %
Leverage ratio
    94,754       13.59 %     27,896       4.00 %     34,871       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.
 
41
 
 
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 simulation modeling 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 economic value of equity (EVE) over a range of interest rate scenarios.  EVE is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts using assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.
 
During the fourth quarter of 2012, we converted to an enhanced model with FTN Financial that uses detailed data on loans and deposits that is extracted directly from the loan and deposit applications and requires more detailed assumptions about interest rates on new volumes.  The new model also accommodates the analysis of floors, ceilings, etc. on a loan-by-loan basis.  The greater level of input detail provides more meaningful reports compared to the summarized input data previously used.
 
42
 
 
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 EVE resulting from instantaneous and sustained parallel shifts in the yield curve (plus 400 basis points or minus 200 basis points, measured in 100 basis point increments) as of June 30, 2013 and as of December 31, 2012, and all changes are within our ALM Policy guidelines:

   
Sensitivity of Economic Value of Equity
 
   
As of June 30, 2013
 
                               
                     
Economic Value of
 
Change in
 
Economic Value of Equity
   
Equity as a % of
 
Interest Rates
                             
in Basis Points
       
$ Change
   
% Change
   
Total
   
Equity
 
(Rate Shock)
 
Amount
   
From Base
   
From Base
   
Assets
   
Book Value
 
   
(Dollar amounts in thousands)
 
                               
Up 400
  $ 100,937     $ (13,373 )     -11.70 %     14.28 %     96.19 %
Up 300
    103,061       (11,249 )     -9.84 %     14.58 %     98.21 %
Up 200
    106,221       (8,089 )     -7.08 %     15.03 %     101.22 %
Up 100
    111,010       (3,300 )     -2.89 %     15.71 %     105.79 %
Base
    114,310       -       0.00 %     16.17 %     108.93 %
Down 100
    110,949       (3,361 )     -2.94 %     15.70 %     105.73 %
Down 200
    107,258       (7,052 )     -6.17 %     15.18 %     102.21 %
                                         
   
Sensitivity of Economic Value of Equity
 
   
As of December 31, 2012
 
                                         
                           
Economic Value of
 
Change in
 
Economic Value of Equity
   
Equity as a % of
 
Interest Rates
                                       
in Basis Points
         
$ Change
   
% Change
   
Total
   
Equity
 
(Rate Shock)
 
Amount
   
From Base
   
From Base
   
Assets
   
Book Value
 
   
(Dollar amounts in thousands)
 
                                         
Up 400
  $ 105,710     $ (11,198 )     -9.58 %     14.60 %     102.46 %
Up 300
    107,601       (9,307 )     -7.96 %     14.87 %     104.29 %
Up 200
    110,442       (6,466 )     -5.53 %     15.26 %     107.04 %
Up 100
    115,426       (1,482 )     -1.27 %     15.95 %     111.87 %
Base
    116,908       -       0.00 %     16.15 %     113.31 %
Down 100
    111,153       (5,755 )     -4.92 %     15.36 %     107.73 %
Down 200
    111,252       (5,656 )     -4.84 %     15.37 %     107.83 %
 
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 June 30, 2013 and December 31, 2012 remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. All changes are within our ALM Policy guidelines.
 
   
Sensitivity of Net Interest Income
 
   
As of June 30, 2013
 
                         
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
  $ 32,639     $ 6,643       4.90 %     0.98 %
Up 300
    30,496       4,500       4.58 %     0.66 %
Up 200
    28,488       2,492       4.29 %     0.37 %
Up 100
    26,954       958       4.06 %     0.14 %
Base
    25,996       -       3.92 %     0.00 %
Down 100
    25,757       (239 )     3.89 %     -0.03 %
Down 200
    25,281       (715 )     3.82 %     -0.10 %
                                 
   
Sensitivity of Net Interest Income
 
   
As of December 31, 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
  $ 34,211     $ 6,829       4.93 %     0.97 %
Up 300
    32,008       4,626       4.62 %     0.66 %
Up 200
    29,925       2,543       4.33 %     0.37 %
Up 100
    28,423       1,041       4.11 %     0.15 %
Base
    27,382       -       3.96 %     0.00 %
Down 100
    27,663       281       4.00 %     0.04 %
Down 200
    27,755       373       4.02 %     0.06 %
 
44
 
 
Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements.  Modeling changes in EVE requires the making of certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates.  Accordingly, although the EVE tables and 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 EVE 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. There have been no changes in Southern National’s internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
 
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 proceedings pending, or to management’s knowledge, threatened, against Southern National or Sonabank as of June 30, 2013.
 
ITEM 1A – RISK FACTORS
 
As of June 30, 2013 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, 2012.
 
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
 
46
 
 
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
                        
47
 
 
 Signatures
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
   
Southern National Bancorp of Virginia, Inc.
   
      (Registrant)    
       
August 9, 2013      
  /s/ Georgia S. Derrico  
(Date)         Georgia S. Derrico,  
    Chairman of the Board and Chief Executive Officer
       
August 9, 2013       /s/ William H. Lagos  
(Date)       William H. Lagos,  
    Senior Vice President and Chief Financial Officer  
       
48