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.

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.

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.

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.

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.

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.

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

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:

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	Moody’s	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.

●

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

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.

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.

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.


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.

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.

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



	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.

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.

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.

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 customer’s 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

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.

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.

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

			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

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

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.

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;

●

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

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.

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.


	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.

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.

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	)

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

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.

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	%

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.

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)
Moody’s	Aaa	$	505
Moody’s	Aa2		3,208
Moody’s	Aa3		724
Standard & Poor’s	AAA		2,682
Standard & Poor’s	AA		3,690
Standard & Poor’s	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	Moody’s	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

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.

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.

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.

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.

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	%

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	%

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.

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

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

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