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Primis Financial Corp. - Quarter Report: 2014 September (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 September 30, 2014

Commission File No. 001-33037

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)
 
Virginia 20-1417448
(State or other jurisdiction
of incorporation or organization)
(I.R.S. Employer Identification No.)
 
6830 Old Dominion Drive
McLean, Virginia 22101
(Address of principal executive offices) (zip code)

(703) 893-7400
(Registrant’s telephone number, including area code)

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

YES x       NO o

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

YES x       NO o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b–2 of the Exchange Act:

Large accelerated filer    o                                      Accelerated filer   x                                              Smaller reporting company o

Non-accelerated filer      o (Do not check if a smaller reporting company)

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

As of October 31, 2014, there were 12,196,070 shares of common stock outstanding.
 
 
 

 

 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
FORM 10-Q
September 30, 2014

INDEX
 
   
PAGE
     
PART 1 - FINANCIAL INFORMATION
     
Item 1 -
Financial Statements
 
 
Consolidated Balance Sheets as of September 30, 2014 and December 31, 2013
2
 
Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2014 and 2013
3
 
Consolidated Statement of Changes in Stockholders’ Equity for the nine months ended September 30, 2014
4
 
Consolidated Statements of Cash Flows for the nine months ended September 30, 2014 and 2013
5
 
Notes to Consolidated Financial Statements
6- 28
     
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations
29- 41
     
Item 3 – Quantitative and Qualitative Disclosures about Market Risk
42-46
     
Item 4 – Controls and Procedures
47
     
PART II - OTHER INFORMATION
     
Item 1 – Legal Proceedings
47
     
Item 1A – Risk Factors
47
     
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds
47
     
Item 3 – Defaults Upon Senior Securities
47
     
Item 4 – Mine Safety Disclosures
47
     
Item 5 – Other Information
47
     
Item 6 - Exhibits
48
     
Signatures
49
     
Certifications
 
 
 
 
 

 

 
ITEM I - FINANCIAL INFORMATION
PART I - FINANCIAL STATEMENTS
 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share amounts) (Unaudited)
 
   
September 30,
   
December 31,
 
   
2014
   
2013
 
ASSETS
           
Cash and cash equivalents:
           
Cash and due from financial institutions
  $ 5,541     $ 2,679  
Interest-bearing deposits in other financial institutions
    40,262       18,177  
Total cash and cash equivalents
    45,803       20,856  
                 
Securities available for sale, at fair value
    2,271       1,993  
                 
Securities held to maturity, at amortized cost
               
(fair value of $88,970 and $76,193, respectively)
    89,993       82,443  
                 
Covered loans
    47,989       51,701  
Non-covered loans
    617,845       494,357  
Total loans
    665,834       546,058  
Less allowance for loan losses
    (7,124 )     (7,090 )
Net loans
    658,710       538,968  
                 
Stock in Federal Reserve Bank and Federal Home Loan Bank
    6,131       5,915  
Equity investment in mortgage affiliate
    3,745       -  
Preferred investment in mortgage affiliate
    1,805       -  
Bank premises and equipment, net
    9,443       6,324  
Goodwill
    12,073       9,160  
Core deposit intangibles, net
    1,424       813  
FDIC indemnification asset
    3,970       5,804  
Bank-owned life insurance
    20,829       18,374  
Other real estate owned
    12,955       11,792  
Deferred tax assets, net
    8,205       8,281  
Other assets
    5,662       5,462  
                 
Total assets
  $ 883,019     $ 716,185  
                 
LIABILITIES AND STOCKHOLDERS EQUITY
               
                 
Noninterest-bearing demand deposits
  $ 70,679     $ 44,643  
Interest-bearing deposits:
               
NOW accounts
    23,658       24,297  
Money market accounts
    138,390       130,855  
Savings accounts
    41,047       16,999  
Time deposits
    424,311       323,565  
Total interest-bearing deposits
    627,406       495,716  
Total deposits
    698,085       540,359  
                 
Securities sold under agreements to repurchase and other
               
short-term borrowings
    37,779       39,795  
Federal Home Loan Bank (FHLB) advances
    25,000       25,000  
Other liabilities
    5,775       4,417  
Total liabilities
    766,639       609,571  
                 
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, 12,194,570 shares at September 30, 2014 and 11,590,612 at December 31, 2013
    122       116  
Additional paid in capital
    103,791       97,127  
Retained earnings
    15,486       12,561  
Accumulated other comprehensive loss
    (3,019 )     (3,190 )
Total stockholders’ equity
    116,380       106,614  
                 
Total liabilities and stockholders’ equity
  $ 883,019     $ 716,185  
                 
See accompanying notes to consolidated financial statements.
 
2
 

 

 
 SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME
 (dollars in thousands, except per share amounts) (Unaudited)
 
                         
   
For the Three Months Ended
   
For the Nine Months Ended
 
   
September 30,
   
September 30,
 
                         
   
2014
   
2013
   
2014
   
2013
 
                         
Interest and dividend income:
                       
Interest and fees on loans
  $ 9,181     $ 8,168     $ 25,037     $ 24,277  
Interest and dividends on taxable securities
    551       504       1,634       1,540  
Interest and dividends on tax exepmt securities
    101       71       289       159  
Interest and dividends on other earning assets
    151       104       591       443  
Total interest and dividend income
    9,984       8,847       27,551       26,419  
Interest expense:
                               
Interest on deposits
    986       966       2,779       3,086  
Interest on borrowings
    186       157       514       465  
Total interest expense
    1,172       1,123       3,293       3,551  
                                 
Net interest income
    8,812       7,724       24,258       22,868  
                                 
Provision for loan losses
    975       1,197       2,344       3,015  
Net interest income after provision for loan losses
    7,837       6,527       21,914       19,853  
                                 
Noninterest income:
                               
Account maintenance and deposit service fees
    220       198       594       593  
Income from bank-owned life insurance
    159       147       455       445  
Equity income from mortgage affiliate
    176       -       507       -  
Gain on other assets
    -       -       202       13  
Net gain on sale of available for sale securities
    -       -       -       142  
Total other-than-temporary impairment losses (OTTI)
    -       -       (41 )     (3 )
Portion of OTTI recognized in other comprehensive income (before taxes)
    -       -       -       -  
Net credit related OTTI recognized in earnings
    -       -       (41 )     (3 )
Other
    54       30       145       169  
                                 
Total noninterest income
    609       375       1,862       1,359  
                                 
Noninterest expenses:
                               
Salaries and benefits
    2,671       2,338       7,487       6,760  
Occupancy expenses
    804       768       2,335       2,280  
Furniture and equipment expenses
    195       197       571       524  
Amortization of core deposit intangible
    61       123       151       368  
Virginia franchise tax expense
    113       115       342       357  
Merger expenses
    65       -       487       -  
FDIC assessment
    149       218       401       676  
Data processing expense
    146       131       406       433  
Telephone and communication expense
    198       166       556       507  
Change in FDIC indemnification asset
    403       113       837       350  
Net (gain) loss on other real estate owned
    (194 )     (698 )     (433 )     (580 )
Other operating expenses
    678       790       2,313       2,334  
Total noninterest expenses
    5,289       4,261       15,453       14,009  
Income before income taxes
    3,157       2,641       8,323       7,203  
Income tax expense
    1,049       861       2,801       2,341  
Net income
  $ 2,108     $ 1,780     $ 5,522     $ 4,862  
Other comprehensive income (loss):
                               
Unrealized gain (loss) on available for sale securities
  $ 66     $ (12 )   $ 283     $ (207 )
Realized amount on securities sold, net
    -       -       -       (142 )
Non-credit component of other-than-temporary impairment on held-to-maturity securities
    -       -       35       97  
Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for-sale
    (17 )     (12 )     (59 )     (32 )
Net unrealized gain (loss)
    49       (24 )     259       (284 )
Tax effect
    (17 )     8       (88 )     96  
Other comprehensive income (loss)
    32       (16 )     171       (188 )
Comprehensive income
  $ 2,140     $ 1,764     $ 5,693     $ 4,674  
Earnings per share, basic
  $ 0.18     $ 0.15     $ 0.47     $ 0.42  
Earnings per share, diluted
  $ 0.17     $ 0.15     $ 0.47     $ 0.42  
                                 
See accompanying notes to consolidated financial statements.
 
3
 

 

 
 SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
 
 CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
 
 FOR THE NINE MONTHS ENDED SPETEMBER 30, 2014
 
 (dollars in thousands, except per share amounts) (Unaudited)
 
 
                     
Accumulated
       
         
Additional
         
Other
       
   
Common
   
Paid in
   
Retained
   
Comprehensive
       
   
Stock
   
Capital
   
Earnings
   
Loss
   
Total
 
                               
Balance - December 31, 2013
  $ 116     $ 97,127     $ 12,561     $ (3,190 )   $ 106,614  
Comprehensive income:
                                       
Net income
                    5,522               5,522  
Change in unrealized loss  on securities available for sale (net of tax benefit, $96)
                            187       187  
Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $8 and accretion, $59 and amounts recorded into other comprehensive income at transfer)
                            (16 )     (16 )
Dividends on common stock ($.22 per share)
                    (2,597 )             (2,597 )
Issuance of common stock under Stock Incentive Plan (78,100 shares)
    1       688                       689  
Issuance of common stock in exchange for net assets in acquisition (525,858 shares)
    5       5,743                       5,748  
Stock-based compensation expense
            233                       233  
                                         
Balance - September 30, 2014
  $ 122     $ 103,791     $ 15,486     $ (3,019 )   $ 116,380  
                                         
See accompanying notes to consolidated financial statements.
 
4
 

 

 
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
 
CONSOLIDATED STATEMENTS OF CASH FLOWS
 
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 2014 AND 2013
 
(dollars in thousands) (Unaudited)
 
   
2014
   
2013
 
             
Operating activities:
           
Net income
  $ 5,522     $ 4,862  
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
               
Depreciation
    549       495  
Amortization of core deposit intangible
    151       368  
Other amortization, net
    143       275  
Accretion of loan discount
    (2,305 )     (2,725 )
Amortization of FDIC indemnification asset
    837       350  
Provision for loan losses
    2,344       3,015  
Earnings on bank-owned life insurance
    (455 )     (445 )
Equity income on mortgage affiliate
    (507 )     -  
Stock based compensation expense
    233       205  
Net gain on sale of available for sale securities
    -       (142 )
Impairment loss on securities (OTTI)
    41       3  
Net gain on other real estate owned
    (433 )     (580 )
Net decrease in other assets
    1,232       2,261  
Net increase (decrease) in other liabilities
    860       (757 )
Net cash and cash equivalents provided by operating activities
    8,212       7,185  
Investing activities:
               
Proceeds from sales of available for sale securities
    -       159  
Purchases of held to maturity securities
    (12,243 )     (11,345 )
Proceeds from paydowns, maturities and calls of held to maturity securities
    4,616       14,497  
Loan originations and payments, net
    (62,358 )     (2,996 )
Proceeds from sale of PGFSB loans
    3,499       -  
Net cash received in PGFSB acquisition
    22,430       -  
Purchase of bank-owned life insurance
    (2,000 )     -  
Investment in mortgage affiliate
    (5,043 )     -  
Net (increase) decrease in stock in Federal Reserve Bank and Federal Home Loan Bank
    (123 )     972  
Payments received on FDIC indemnification asset
    1,018       1,016  
Proceeds from sale of other real estate owned
    3,029       3,902  
Purchases of bank premises and equipment
    (664 )     (204 )
Net cash and cash equivalents provided by (used in) investing activities
    (47,839 )     6,001  
Financing activities:
               
Net increase (decrease) in deposits
    68,498       (5,023 )
Cash dividends paid - common stock
    (2,597 )     (2,086 )
Issuance of common stock under Stock Incentive Plan
    689       3  
Net decrease in securities sold under agreement to repurchase and other short-term borrowings
    (2,016 )     (12,930 )
Net cash and cash equivalents provided by (used in) financing activities
    64,574       (20,036 )
Increase (decrease) in cash and cash equivalents
    24,947       (6,850 )
Cash and cash equivalents at beginning of period
    20,856       39,200  
Cash and cash equivalents at end of period
  $ 45,803     $ 32,350  
Supplemental disclosure of cash flow information
               
Cash payments for:
               
Interest
  $ 3,144     $ 3,419  
Income taxes
    2,238       3,113  
Supplemental schedule of noncash investing and financing activities
               
Transfer from non-covered loans to other real estate owned
    4,409       3,044  
Transfer from covered loans to other real estate owned
    -       4,158  
Issuance of common stock in exchange for net assets in acquisition
    5,748       -  
                 
See accompanying notes to consolidated financial statements.
 
5
 

 

 
 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
Notes to Consolidated Financial Statements (Unaudited)
September 30, 2014
 
1.
ORGANIZATION AND ACCOUNTING POLICIES
 
Southern National Bancorp of Virginia, Inc. (“Southern National” or “SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a Virginia state chartered bank which commenced operations on April 14, 2005. The principal activities of Sonabank are to attract deposits and originate loans as permitted under applicable banking regulations. Sonabank operates 15 branches in Virginia located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Loudoun County (Middleburg, Leesburg (2), and South Riding), Front Royal, New Market, Richmond, Haymarket and Clifton Forge, and nine branches in Maryland in Rockville, Shady Grove, Germantown, Frederick, Bethesda, Upper Marlboro, Brandywine, Owings and Huntingtown.

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, 2013.

The merger with Prince George’s Federal Savings Bank (PGFSB) was completed on August 1, 2014. Southern National acquired PGFSB in a cash and stock transaction. PGFSB was founded in 1931 and is headquartered in Upper Marlboro, which is the County Seat of Prince George’s County, Maryland. Prince George’s FSB has four offices, all of which are in Maryland, including a main office in Upper Marlboro and three branch offices in Dunkirk, Brandywine and Huntingtown. Prince George’s FSB has an excellent core deposit base reflecting its tenure in the communities it serves. Its lending activities have historically been focused on residential mortgages. See Footnote 8 for details regarding the merger.

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.
 
6
 

 

 
Recent Accounting Pronouncements

In January 2014, the FASB issued ASU No. 2014-04, “Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure.” The objective of this guidance is to clarify when an in substance repossession or foreclosure occurs, that is, when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan receivable should be derecognized and the real estate property recognized. ASU No. 2014-04 states that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, ASU No. 2014-04 requires interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. ASU No. 2014-04 is effective for interim and annual reporting periods beginning after December 15, 2014. The adoption of ASU No. 2014-04 is not expected to have a material impact on the Southern National’s Consolidated Financial Statements.

In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606). These amendments affect any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g. insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance, and creates a Topic 606, Revenue from Contracts with Customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. This ASU will be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The ASU allows for either full retrospective or modified retrospective adoption. SNBV is assessing the effects of this ASU, which exclude financial instruments from its scope, but does not anticipate that it will have a material impact on its financial position or results of operations.
 
In June 2014, the FASB issued ASU No. 2014-12, Compensation—Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved After the Requisite Service Period. The amendments clarify the proper method of accounting for share-based payments when the terms of an award provide that a performance target could be achieved after the requisite service period. This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The performance target should not be reflected in estimating the grant-date fair value of the award. Compensation cost should be recognized in the period in which it becomes probable that the performance target will be achieved and should represent the compensation cost attributable to the period(s) for which the requisite service has already been rendered. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Earlier adoption is permitted. Management does not anticipate that this ASU will significantly impact SNBV.
 
7
 

 

 
2.
STOCK- BASED COMPENSATION

In 2004, the Board of Directors adopted a stock option plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and employees. 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 an additional 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 104,750 options during the first nine months of 2014. The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model. The following weighted-average assumptions were used to value options granted in the nine months ended September 30, 2014:
 
Expected life
 
10 years
 
Expected volatility
    29.30 %
Risk-free interest rate
    2.48 %
Weighted average fair value per option granted
  $ 2.88  
Dividend yield
    2.55 %

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 nine months ended September 30, 2014 and 2013, stock-based compensation expense was $82 thousand and $233 thousand, respectively, compared to $79 thousand and $205 thousand for the same periods last year. As of September 30, 2014, unrecognized compensation expense associated with the stock options was $984 thousand, which is expected to be recognized over a weighted average period of 3.5 years.
 
8
 

 

 
A summary of the activity in the stock option plan during the nine months ended September 30, 2014 follows (dollars in thousands):
 
               
Weighted
       
         
Weighted
   
Average
   
Aggregate
 
         
Average
   
Remaining
   
Intrinsic
 
         
Exercise
   
Contractual
   
Value
 
   
Shares
   
Price
   
Term
   
(in thousands)
 
Options outstanding, beginning of period
    631,075     $ 8.21              
Granted
    104,750       10.47              
Forfeited
    (12,575 )     8.18              
Exercised
    (78,100 )     8.82              
Options outstanding, end of period
    645,150     $ 8.51       6.4     $ 1,999  
                                 
Vested or expected to vest
    645,150     $ 8.51       6.4     $ 1,999  
                                 
Exercisable at end of period
    326,865     $ 8.06       4.3     $ 1,158  
 
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
 
September 30, 2014
 
Cost
   
Gains
   
Losses
   
Value
 
Obligations of states and political subdivisions
  $ 2,296     $ 1     $ (26 )   $ 2,271  
                                 
   
Amortized
   
Gross Unrealized
 
Fair
 
December 31, 2013
 
Cost
   
Gains
   
Losses
   
Value
 
Obligations of states and political subdivisions
  $ 2,302     $ -     $ (309 )   $ 1,993  
 
The amortized cost, unrecognized gains and losses, and fair value of securities held to maturity were as follows (in thousands):
                         
   
Amortized
   
Gross Unrecognized
   
Fair
 
September 30, 2014
 
Cost
   
Gains
   
Losses
   
Value
 
Residential government-sponsored mortgage-backed securities
  $ 22,350     $ 599     $ (58 )   $ 22,891  
Residential government-sponsored collateralized mortgage obligations
    3,724       -       (88 )     3,636  
Government-sponsored agency securities
    40,954       162       (1,697 )     39,419  
Obligations of states and political subdivisions
    15,560       80       (166 )     15,474  
Other residential collateralized mortgage obligations
    612       -       (2 )     610  
Trust preferred securities
    6,793       1,690       (1,543 )     6,940  
    $ 89,993     $ 2,531     $ (3,554 )   $ 88,970  
 
   
Amortized
   
Gross Unrecognized
   
Fair
 
December 31, 2013
 
Cost
   
Gains
   
Losses
   
Value
 
Residential government-sponsored mortgage-backed securities
  $ 25,609     $ 673     $ (294 )   $ 25,988  
Residential government-sponsored collateralized mortgage obligations
    4,295       2       (349 )     3,948  
Government-sponsored agency securities
    29,971       -       (3,994 )     25,977  
Obligations of states and political subdivisions
    14,388       -       (987 )     13,401  
Other residential collateralized mortgage obligations
    659       -       (12 )     647  
Trust preferred securities
    7,521       939       (2,228 )     6,232  
    $ 82,443     $ 1,614     $ (7,864 )   $ 76,193  
 
The amortized cost amounts are net of recognized other than temporary impairment.

The fair value and carrying amount, if different, of debt securities as of September 30, 2014, 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.
 
9
 

 

 
   
Held to Maturity
 
Available for Sale
 
   
Amortized
         
Amortized
       
   
Cost
   
Fair Value
   
Cost
   
Fair Value
 
 Due in five to ten years
  $ 12,685     $ 12,436     $ -     $ -  
 Due after ten years
    50,622       49,397       2,296       2,271  
 Residential government-sponsored mortgage-backed securities
    22,350       22,891       -       -  
 Residential government-sponsored collateralized mortgage obligations
    3,724       3,636       -       -  
 Other residential  collateralized mortgage obligations
    612       610       -       -  
      Total
  $ 89,993     $ 88,970     $ 2,296     $ 2,271  
 
Securities with a carrying amount of approximately $71.4 million and $65.3 million at September 30, 2014 and December 31, 2013, 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 September 30, 2014 and December 31, 2013, certain securities’ fair values were below cost. As outlined in the table below, there were securities with fair values totaling approximately $60.3 million in the portfolio with the carrying value exceeding the estimated fair value that are considered temporarily impaired at September 30, 2014. Because the decline in fair value is attributable to changes in interest rates and market illiquidity, and not credit quality, and because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, management does not consider these securities to be other-than-temporarily impaired as of September 30, 2014. The following tables present information regarding securities in a continuous unrealized loss position as of September 30, 2014 and December 31, 2013 (in thousands) by duration of time in a loss position:
 
September 30, 2014
                                   
   
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
  $ -     $ -     $ 1,785     $ (26 )   $ 1,785     $ (26 )
 
   
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
  $ 11,256     $ (58 )   $ -     $ -     $ 11,256     $ (58 )
 Residential government-sponsored collateralized mortgage obligations
    734       (13 )     2,902       (75 )     3,636       (88 )
 Government-sponsored agency securities
    943       (18 )     28,296       (1,679 )     29,239       (1,697 )
 Obligations of states and political subdivisions
    479       (25 )     9,254       (141 )     9,733       (166 )
 Other residential collateralized mortgage obligations
    610       (2 )     -       -       610       (2 )
 Trust preferred securities
    -       -       4,031       (1,543 )     4,031       (1,543 )
    $ 14,022     $ (116 )   $ 44,483     $ (3,438 )   $ 58,505     $ (3,554 )
 
December 31, 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
  $ 409     $ (78 )   $ 1,584     $ (231 )   $ 1,993     $ (309 )
 
   
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
  $ 12,644     $ (294 )   $ -     $ -     $ 12,644     $ (294 )
 Residential government-sponsored collateralized mortgage obligations
    2,984       (349 )     -       -       2,984       (349 )
 Government-sponsored agency securities
    8,733       (1,250 )     17,244       (2,744 )     25,977       (3,994 )
 Obligations of states and political subdivisions
    10,327       (588 )     3,064       (399 )     13,391       (987 )
 Other residential collateralized mortgage obligations
    647       (12 )     -       -       647       (12 )
 Trust preferred securities
    -       -       4,070       (2,228 )     4,070       (2,228 )
    $ 35,335     $ (2,493 )   $ 24,378     $ (5,371 )   $ 59,713     $ (7,864 )
 
10
 

 

 
As of September 30, 2014, we owned pooled trust preferred securities as follows:

                                                     
Previously
       
                                               
% of Current
   
Recognized
       
                                               
Defaults and
   
Cumulative
       
     
Ratings
                           
Estimated
   
Deferrals to
   
Other
       
 
Tranche
 
When Purchased
   
Current Ratings
               
Fair
   
Total
   
Comprehensive
       
Security
Level
 
Moodys
   
Fitch
   
Moodys
   
Fitch
   
Par Value
   
Book Value
   
Value
   
Collateral
   
Loss (1)
       
                             
(in thousands)
                         
ALESCO VII  A1B
Senior
 
Aaa
   
AAA
      A3    
BBB
    $ 5,773     $ 5,249     $ 3,829       15 %   $ 268        
MMCF III B
Senior Sub
    A3       A-    
Ba1
   
CC
      331       325       202       34 %     6        
                                      6,104       5,574       4,031             $ 274        
                                                                               
                                                                   
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       509       530       41 %     591     $ 400  
TRAP 2007-XII C1
Mezzanine
    A3       A       C       C       2,170       57       428       28 %     820        1,293  
TRAP 2007-XIII D
Mezzanine
 
NR
      A-    
NR
      C       2,039       -       347       19 %     7        2,032  
MMC FUNDING XVIII
Mezzanine
    A3       A-    
Ca
      C       1,095       27       328       21 %     377       691  
ALESCO V C1
Mezzanine
    A2       A       C       C       2,150       475       609       15 %      1,014       661  
ALESCO XV C1
Mezzanine
    A3       A-       C       C       3,268       30       85       33 %     679        2,559  
ALESCO XVI  C
Mezzanine
    A3       A-       C       C       2,172       121       582       14 %     871        1,180  
                                        14,394       1,219       2,909             $ 4,359     $ 8,816  
                                                                                   
Total
                                    $ 20,498     $ 6,793     $ 6,940                          
 
(1) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion
(2)  Pre-tax
 
Each of these securities has been evaluated for other than temporary impairment. In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to estimate expected cash flows and assist with the evaluation of other than temporary impairment. The cash flow analyses performed included the following assumptions:

 
.5% of the remaining performing collateral will default or defer per annum.
 
Recoveries of 11% 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 10% of the collateral issued by banks with assets over $15 billion will prepay in the first year of the forecast, and 15% in the second year.
 
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 three months ended September 30, 2014, and we recognized OTTI charges of $41 thousand for the nine months ended September 30, 2014 related to the TPREF Funding II security. We recognized no OTTI charges during the third quarter of 2013 and recognized OTTI charges of $3 thousand during the first nine months of 2013.
 
11
 

 

 
The following table presents a roll forward of the credit losses on our securities held to maturity recognized in earnings for the nine months ended September 30, 2014 and 2013 (in thousands):

   
2014
   
2013
 
             
Amount of cumulative other-than-temporary impairment
           
  related to credit loss prior to January 1
  $ 8,911     $ 8,964  
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
    41       3  
Reductions due to realized losses
    (3 )     (51 )
Amount of cumulative other-than-temporary impairment related to credit loss as of September 30
  $ 8,949     $ 8,916  
 
Changes in accumulated other comprehensive income by component for the three and nine months ended September 30, 2014 and 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 September 30, 2014
 
Available for Sale
   
Held to Maturity
       
   
Securities
   
Securities
   
Total
 
Beginning balance
  $ (60 )   $ (2,991 )   $ (3,051 )
Other comprehensive income/(loss) before reclassifications
    44       (12 )     32  
Amounts reclassified from accumulated other comprehensive income/(loss)
    -       -       -  
Net current-period other comprehensive income/(loss)
    44       (12 )     32  
Ending balance
  $ (16 )   $ (3,003 )   $ (3,019 )

   
Unrealized Holding
             
   
Gains (Losses) on
             
For the nine months ended September 30, 2014
 
Available for Sale
   
Held to Maturity
       
   
Securities
   
Securities
   
Total
 
Beginning balance
  $ (203 )   $ (2,987 )   $ (3,190 )
Other comprehensive income/(loss) before reclassifications
    187       (16 )     171  
Amounts reclassified from accumulated other comprehensive income/(loss)
    -       -       -  
Net current-period other comprehensive income/(loss)
    187       (16 )     171  
Ending balance
  $ (16 )   $ (3,003 )   $ (3,019 )
 
   
Unrealized Holding
             
   
Gains (Losses) on
             
For the three months ended September 30, 2013
 
Available for Sale
   
Held to Maturity
       
   
Securities
   
Securities
   
Total
 
Beginning balance
  $ (178 )   $ (2,975 )   $ (3,153 )
Other comprehensive income/(loss) before reclassifications
    (8 )     (8 )     (16 )
Amounts reclassified from accumulated other comprehensive income/(loss)
    -       -       -  
Net current-period other comprehensive income/(loss)
    (8 )     (8 )     (16 )
Ending balance
  $ (186 )   $ (2,983 )   $ (3,169 )
 
   
Unrealized Holding
             
   
Gains (Losses) on
             
For the nine months ended September 30, 2013
 
Available for Sale
   
Held to Maturity
       
   
Securities
   
Securities
   
Total
 
Beginning balance
  $ 44     $ (3,025 )   $ (2,981 )
Other comprehensive income/(loss) before reclassifications
    (137 )     43       (94 )
Amounts reclassified from accumulated other comprehensive income/(loss)
    (93 )     (1 )     (94 )
Net current-period other comprehensive income/(loss)
    (230 )     42       (188 )
Ending balance
  $ (186 )   $ (2,983 )   $ (3,169 )
 
12
 

 

 
4.
LOANS AND ALLOWANCE FOR LOAN LOSSES
 
The following table summarizes the composition of our loan portfolio as of September 30, 2014 and December 31, 2013:

   
Covered
   
Non-covered
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans (1)
   
Loans
   
Loans
   
Loans (1)
   
Loans
   
Loans
 
   
September 30, 2014
   
December 31, 2013
 
 Loans secured by real estate:
                                   
Commercial real estate - owner-occupied
  $ 1,363     $ 115,971     $ 117,334     $ 1,603     $ 106,225     $ 107,828  
Commercial real estate - non-owner-occupied
    5,791       182,138       187,929       5,829       150,008       155,837  
    Secured by farmland
    -       580       580       100       508       608  
    Construction and land loans
    -       53,302       53,302       1       39,068       39,069  
    Residential 1-4 family
    15,358       118,423       133,781       16,631       66,482       83,113  
    Multi- family residential
    295       22,481       22,776       585       21,496       22,081  
    Home equity lines of credit
    24,341       10,353       34,694       25,769       6,431       32,200  
     Total real estate loans
    47,148       503,248       550,396       50,518       390,218       440,736  
                                                 
 Commercial loans
    755       114,329       115,084       1,097       104,284       105,381  
 Consumer loans
    78       2,015       2,093       81       1,308       1,389  
      Gross loans
    47,981       619,592       667,573       51,696       495,810       547,506  
                                                 
 Less deferred fees on loans
    8       (1,747 )     (1,739 )     5       (1,453 )     (1,448 )
 Loans, net of deferred fees
  $ 47,989     $ 617,845     $ 665,834     $ 51,701     $ 494,357     $ 546,058  

(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 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 loss sharing agreements on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets. There are two agreements with the FDIC, one for single family loans which is a 10-year agreement expiring in December 2019, and one for non-single family (commercial) assets which is a 5-year agreement expiring in December 2014. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreements; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans”. As of September 30, 2014, non-covered loans included $36.4 million of loans acquired in the HarVest acquisition and $60.9 million acquired in the PGFSB acquisition.

Accretable discount on the acquired covered loans, the PGFSB loans and the HarVest loans was $10.1 million and $8.9 million at September 30, 2014 and December 31, 2013 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.

13
 

 

Impaired loans for the covered and non-covered portfolios were as follows (in thousands):
                   
September 30, 2014
 
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
  $ 753     $ 817     $ -     $ 10,875     $ 10,980     $ -     $ 11,628     $ 11,797     $ -  
Commercial real estate - non-owner occupied (2)
    1,879       2,141       -       -       -       -       1,879       2,141       -  
Construction and land development
    -       -       -       -       -       -       -       -       -  
Commercial loans
    -       -       -       9,269       10,078       -       9,269       10,078       -  
Residential 1-4 family (4)
    1,206       1,420       -       45       47       -       1,251       1,467       -  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ 3,838     $ 4,378     $ -     $ 20,189     $ 21,105     $ -     $ 24,027     $ 25,483     $ -  
                                                                         
With an allowance recorded
                                                                       
Commercial real estate - owner occupied
  $ -     $ -     $ -     $ 91     $ 191     $ 91     $ 91     $ 191     $ 91  
Commercial real estate - non-owner occupied (2)
    -       -       -       -       -       -       -       -       -  
Construction and land development
    -       -       -       -       -       -       -       -       -  
Commercial loans
    -       -       -       -       -       -       -       -       -  
Residential 1-4 family (4)
    -       -       -       6,019       6,168       300       6,019       6,168       300  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ -     $ -     $ -     $ 6,110     $ 6,359     $ 391     $ 6,110     $ 6,359     $ 391  
Grand total
  $ 3,838     $ 4,378     $ -     $ 26,299     $ 27,464     $ 391     $ 30,137     $ 31,842     $ 391  
 
(1) Recorded investment is after cumulative prior charge offs of $931 thousand These loans also have aggregate SBA guarantees of $3.3 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.
(4)  Includes home equity lines of credit.
                                                                         
December 31, 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
  $ 745     $ 844     $ -     $ 7,476     $ 7,476     $ -     $ 8,221     $ 8,320     $ -  
Commercial real estate - non-owner occupied (2)
    2,145       2,486       -       359       449       -       2,504       2,935       -  
Construction and land development
    -       -       -       2,107       2,307       -       2,107       2,307       -  
Commercial loans
    -       -       -       3,155       3,631       -       3,155       3,631       -  
Residential 1-4 family (4)
    1,220       1,439       -       5,358       5,358       -       6,578       6,797       -  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ 4,110     $ 4,769     $ -     $ 18,455     $ 19,221     $ -     $ 22,565     $ 23,990     $ -  
                                                                         
With an allowance recorded
                                                                       
Commercial real estate - owner occupied
  $ -     $ -     $ -     $ 400     $ 500     $ 192     $ 400     $ 500     $ 192  
Commercial real estate - non-owner occupied (2)
    -       -       -       -       -       -       -       -       -  
Construction and land development
    -       -       -       -       -       -       -       -       -  
Commercial loans
    -       -       -       1,718       2,518       325       1,718       2,518       325  
Residential 1-4 family (4)
    -       -       -       2,637       2,637       200       2,637       2,637       200  
Other consumer loans
    -       -       -       -       -       -       -       -       -  
                                                                         
Total
  $ -     $ -     $ -     $ 4,755     $ 5,655     $ 717     $ 4,755     $ 5,655     $ 717  
Grand total
  $ 4,110     $ 4,769     $ -     $ 23,210     $ 24,876     $ 717     $ 27,320     $ 29,645     $ 717  
 
(1) Recorded investment is after cumulative prior charge offs of $1.4 million. These loans also have aggregate SBA guarantees of $2.4 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.
 
14
 

 

 
The following tables present the average recorded investment and interest income for impaired loans recognized by class of loans for the three and nine months ended September 30, 2014 and 2013 (in thousands):
                   
Three months ended September 30, 2014
 
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
  $ 756     $ 13     $ 10,903     $ 175     $ 11,659     $ 188  
Commercial real estate - non-owner occupied (1)
    1,884       67       -       -       1,884       67  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       8,563       95       8,563       95  
Residential 1-4 family (2)
    1,208       10       15       -       1,223       10  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,848     $ 90     $ 19,481     $ 270     $ 23,329     $ 360  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ 95     $ 3     $ 95     $ 3  
Commercial real estate - non-owner occupied (1)
    -       -       -       -       -       -  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       -       -       -       -  
Residential 1-4 family (2)
    -       -       5,811       79       5,811       79  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 5,906     $ 82     $ 5,906     $ 82  
Grand total
  $ 3,848     $ 90     $ 25,387     $ 352     $ 29,235     $ 442  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
                                                 
Three months ended September 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
  $ 135     $ 5     $ 7,564     $ 132     $ 7,699     $ 137  
Commercial real estate - non-owner occupied (1)
    1,448       30       365       9       1,813       39  
Construction and land development
    -       -       2,241       -       2,241       -  
Commercial loans
    44       1       2,408       26       2,452       27  
Residential 1-4 family (2)
    1,504       19       2,917       35       4,421       54  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,131     $ 55     $ 15,495     $ 202     $ 18,626     $ 257  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ 119     $ 4     $ 119     $ 4  
Commercial real estate - non-owner occupied (1)
    -       -       967       17       967       17  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       1,831       -       1,831       -  
Residential 1-4 family (2)
    -       -       5,325       85       5,325       85  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 8,242     $ 106     $ 8,242     $ 106  
Grand total
  $ 3,131     $ 55     $ 23,737     $ 308     $ 26,868     $ 363  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
 
15
 

 

 
                                     
Nine months ended September 30, 2014
                                   
   
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
  $ 746     $ 40     $ 7,942     $ 372     $ 8,688     $ 412  
Commercial real estate - non-owner occupied (1)
    1,889       91       -       -       1,889       91  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       5,195       137       5,195       137  
Residential 1-4 family (2)
    1,212       31       5       -       1,217       31  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,847     $ 162     $ 13,142     $ 509     $ 16,989     $ 671  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ 106     $ 11     $ 106     $ 11  
Commercial real estate - non-owner occupied (1)
    -       -       -       -       -       -  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       -       -       -       -  
Residential 1-4 family (2)
    -       -       5,598       236       5,598       236  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 5,704     $ 247     $ 5,704     $ 247  
Grand total
  $ 3,847     $ 162     $ 18,846     $ 756     $ 22,693     $ 918  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
                                                 
Nine months ended September 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
  $ 136     $ 14     $ 6,144     $ 308     $ 6,280     $ 322  
Commercial real estate - non-owner occupied (1)
    1,464       92       373       28       1,837       120  
Construction and land development
    -       -       903       -       903       -  
Commercial loans
    44       4       1,718       47       1,762       51  
Residential 1-4 family (2)
    1,464       53       2,892       101       4,356       154  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ 3,108     $ 163     $ 12,030     $ 484     $ 15,138     $ 647  
                                                 
With an allowance recorded
                                               
Commercial real estate - owner occupied
  $ -     $ -     $ 125     $ 13     $ 125     $ 13  
Commercial real estate - non-owner occupied (1)
    -       -       972       50       972       50  
Construction and land development
    -       -       -       -       -       -  
Commercial loans
    -       -       1,951       -       1,951       -  
Residential 1-4 family (2)
    -       -       5,434       253       5,434       253  
Other consumer loans
    -       -       -       -       -       -  
                                                 
Total
  $ -     $ -     $ 8,482     $ 316     $ 8,482     $ 316  
Grand total
  $ 3,108     $ 163     $ 20,512     $ 800     $ 23,620     $ 963  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
 
16
 

 

 
The following tables present the aging of the recorded investment in past due loans by class of loans as of September 30, 2014 and December 31, 2013 (in thousands):
                                           
September 30, 2014
  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
  $ -     $ -     $ -     $ -     $ -     $ 1,363     $ 1,363  
Commercial real estate - non-owner occupied (1)
    342       -       -       342       -       5,744       6,086  
Construction and land development
    -       -       -       -       -       -       -  
Commercial loans
    -       -       -       -       -       755       755  
Residential 1-4 family (2)
    83       42       -       125       819       38,755       39,699  
Other consumer loans
    -       -       -       -       -       78       78  
                                                         
Total
  $ 425     $ 42     $ -     $ 467     $ 819     $ 46,695     $ 47,981  
                                                         
Non-covered loans:
                                                       
Commercial real estate - owner occupied
  $ 978     $ 2,106     $ -     $ 3,084     $ 67     $ 112,820     $ 115,971  
Commercial real estate - non-owner occupied (1)
    -       -       -       -       -       205,199       205,199  
Construction and land development
    -       717       -       717       -       52,585       53,302  
Commercial loans
    463       36       -       499       3,195       110,635       114,329  
Residential 1-4 family (2)
    668       -       -       668       886       127,222       128,776  
Other consumer loans
    20       -       -       20       -       1,995       2,015  
                                                         
Total
  $ 2,129     $ 2,859     $ -     $ 4,988     $ 4,148     $ 610,456     $ 619,592  
                                                         
Total loans:
                                                       
Commercial real estate - owner occupied
  $ 978     $ 2,106     $ -     $ 3,084     $ 67     $ 114,183     $ 117,334  
Commercial real estate - non-owner occupied (1)
    342       -       -       342       -       210,943       211,285  
Construction and land development
    -       717       -       717       -       52,585       53,302  
Commercial loans
    463       36       -       499       3,195       111,390       115,084  
Residential 1-4 family (2)
    751       42       -       793       1,705       165,977       168,475  
Other consumer loans
    20       -       -       20       -       2,073       2,093  
                                                         
Total
  $ 2,554     $ 2,901     $ -     $ 5,455     $ 4,967     $ 657,151     $ 667,573  
                                                         
December 31, 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
  $ -     $ -     $ -     $ -     $ -     $ 1,603     $ 1,603  
Commercial real estate - non-owner occupied (1)
    503       -       -       503       245       5,766       6,514  
Construction and land development
    -       -       -       -       -       1       1  
Commercial loans
    -       -       -       -       -       1,097       1,097  
Residential 1-4 family (2)
    41       -       -       41       1,377       40,982       42,400  
Other consumer loans
    -       -       -       -       -       81       81  
                                                         
Total
  $ 544     $ -     $ -     $ 544     $ 1,622     $ 49,530     $ 51,696  
                                                         
Non-covered loans:
                                                       
Commercial real estate - owner occupied
  $ 708     $ 283     $ -     $ 991     $ -     $ 105,234     $ 106,225  
Commercial real estate - non-owner occupied (1)
    359       -       -       359       -       171,653       172,012  
Construction and land development
    8       3       -       11       2,107       36,950       39,068  
Commercial loans
    522       968       -       1,490       3,070       99,724       104,284  
Residential 1-4 family (2)
    957       98       -       1,055       2,637       69,221       72,913  
Other consumer loans
    14       -       -       14       -       1,294       1,308  
                                                         
Total
  $ 2,568     $ 1,352     $ -     $ 3,920     $ 7,814     $ 484,076     $ 495,810  
                                                         
Total loans:
                                                       
Commercial real estate - owner occupied
  $ 708     $ 283     $ -     $ 991     $ -     $ 106,837     $ 107,828  
Commercial real estate - non-owner occupied (1)
    862       -       -       862       245       177,419       178,526  
Construction and land development
    8       3       -       11       2,107       36,951       39,069  
Commercial loans
    522       968       -       1,490       3,070       100,821       105,381  
Residential 1-4 family (2)
    998       98       -       1,096       4,014       110,203       115,313  
Other consumer loans
    14       -       -       14       -       1,375       1,389  
                                                         
Total
  $ 3,112     $ 1,352     $ -     $ 4,464     $ 9,436     $ 533,606     $ 547,506  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
 
Non-covered nonaccrual loans include SBA guaranteed amounts totaling $3.3 million and $1.9 million at September 30, 2014 and December 31, 2013, respectively.
 
17
 

 

 
Activity in the allowance for non-covered loan and lease losses for the three and nine months ended September 30, 2014 and 2013 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 September 30, 2014
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential (2)
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                               
Beginning balance
  $ 596     $ 933     $ 1,400     $ 2,926     $ 785     $ 59     $ 616     $ 7,315  
Charge offs
    (2 )     -       -       (1,057 )     (149 )     -       -       (1,209 )
Recoveries
    2       5       4       9       2       -       -       22  
Provision
    21       16       78       592       441       (6 )     (168 )     975  
Ending balance
  $ 617     $ 954     $ 1,482     $ 2,470     $ 1,079     $ 53     $ 448     $ 7,103  
                                                                 
Three months ended September 30, 2013
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ 732     $ 1,090     $ 1,026     $ 2,742     $ 1,407     $ 55     $ 178     $ 7,230  
Charge offs
    -       -       (350 )     (806 )     -       (2 )     -       (1,158 )
Recoveries
    4       87       1       23       4       1       -       120  
Provision
    (33 )     (198 )     484       552       49       -       346       1,200  
Ending balance
  $ 703     $ 979     $ 1,161     $ 2,511     $ 1,460     $ 54     $ 524     $ 7,392  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
                                                                 
   
Commercial
   
Commercial
                                                 
   
Real Estate
   
Real Estate
   
Construction
                   
Other
                 
Non-covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
                 
Nine months ended September 30, 2014
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                                               
Beginning balance
  $ 814     $ 985     $ 1,068     $ 2,797     $ 1,302     $ 54     $ 19     $ 7,039  
Charge offs
    (73 )     -       -       (1,905 )     (449 )     -       -       (2,427 )
Recoveries
    10       17       4       101       4       5       -       141  
Provision
    (134 )     (48 )     410       1,477       222       (6 )     429       2,350  
Ending balance
  $ 617     $ 954     $ 1,482     $ 2,470     $ 1,079     $ 53     $ 448     $ 7,103  
                                                                 
Nine months ended September 30, 2013
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ 932     $ 1,474     $ 970     $ 2,110     $ 1,163     $ 33     $ 285     $ 6,967  
Charge offs
    -       (199 )     (650 )     (1,471 )     (518 )     (143 )     -       (2,981 )
Recoveries
    12       138       7       97       126       2       -       382  
Provision
    (241 )     (434 )     834       1,775       689       162       239       3,024  
Ending balance
  $ 703     $ 979     $ 1,161     $ 2,511     $ 1,460     $ 54     $ 524     $ 7,392  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
 
18
 

 

 
Activity in the allowance for covered loan and lease losses by class of loan for the three and nine months ended September 30, 2014 and 2013 is summarized below (in thousands).
                                                 
   
Commercial
   
Commercial
                                     
   
Real Estate
   
Real Estate
   
Construction
               
Other
             
Covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
             
Three months ended September 30, 2014
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential (3)
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                               
Beginning balance
  $ -     $ -     $ -     $ -     $ 17     $ 4     $ -     $ 21  
Charge offs
    -       -       -       -       -       -       -       -  
Recoveries
    -       -       -       -       -       -       -       -  
Adjustments (2)
    -       -       -       -       -       -       -       -  
Provision
    -       -       -       -       -       -       -       -  
Ending balance
  $ -     $ -     $ -     $ -     $ 17     $ 4     $ -     $ 21  
                                                                 
Three months ended September 30, 2013
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ -     $ 45     $ -     $ -     $ -     $ 21     $ -     $ 66  
Charge offs
    -       -       -       -       -       -       -       -  
Recoveries
    -       -       -       -       -       -       -       -  
Adjustments (2)
    -       -       -       -       -       (12 )     -       (12 )
Provision
    -       -       -       -       -       (3 )     -       (3 )
Ending balance
  $ -     $ 45     $ -     $ -     $ -     $ 6     $ -     $ 51  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Represents the portion of increased expected losses which is covered by the loss sharing agreement with the FDIC.
(3) Includes home equity lines of credit.
                                                                 
   
Commercial
   
Commercial
                                                 
   
Real Estate
   
Real Estate
   
Construction
                   
Other
                 
Covered loans:
 
Owner
   
Non-owner
   
and Land
   
Commercial
   
1-4 Family
   
Consumer
                 
Nine months ended September 30, 2014
 
Occupied
   
Occupied (1)
   
Development
   
Loans
   
Residential (3)
   
Loans
   
Unallocated
   
Total
 
Allowance for loan losses:
                                                               
Beginning balance
  $ -     $ 45     $ -     $ -     $ -     $ 6     $ -     $ 51  
Charge offs
    -       -       -       -       -       -       -       -  
Recoveries
    -       -       -       -       -       -       -       -  
Adjustments (2)
    -       (36 )     -       -       14       (2 )     -       (24 )
Provision
    -       (9 )     -       -       3       -       -       (6 )
Ending balance
  $ -     $ -     $ -     $ -     $ 17     $ 4     $ -     $ 21  
                                                                 
Nine months ended September 30, 2013
                                                               
Allowance for loan losses:
                                                               
Beginning balance
  $ -     $ 45     $ -     $ 43     $ -     $ 11     $ -     $ 99  
Charge offs
    -       -       -       -       -       -       -       -  
Recoveries
    -       -       -       -       -       -       -       -  
Adjustments (2)
    -       -       -       (35 )     -       (4 )     -       (39 )
Provision
    -       -       -       (8 )     -       (1 )     -       (9 )
Ending balance
  $ -     $ 45     $ -     $ -     $ -     $ 6     $ -     $ 51  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Represents the portion of increased expected losses which is covered by the loss sharing agreement with the FDIC.
(3) Includes home equity lines of credit.
 
19
 

 

 
The following tables present the balance in the allowance for loan losses and the recorded investment in non-covered loans by portfolio segment and based on impairment method as of September 30, 2014 and December 31, 2013 (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
   
Loans
   
Residential (2)
   
Loans
   
Unallocated
   
Total
 
September 30, 2014
                                               
Ending allowance balance attributable to loans:
                                               
Individually evaluated for impairment
  $ 91     $ -     $ -     $ -     $ 300     $ -     $ -     $ 391  
Collectively evaluated for impairment
    526       954       1,482       2,470       779       53       448       6,712  
Total ending allowance
  $ 617     $ 954     $ 1,482     $ 2,470     $ 1,079     $ 53     $ 448     $ 7,103  
                                                                 
Loans:
                                                               
Individually evaluated for impairment
  $ 10,966     $ -     $ -     $ 9,269     $ 6,064     $ -     $ -     $ 26,299  
Collectively evaluated for impairment
    105,005       205,199       53,302       105,060       122,712       2,015       -       593,293  
Total ending loan balances
  $ 115,971     $ 205,199     $ 53,302     $ 114,329     $ 128,776     $ 2,015     $ -     $ 619,592  
                                                                 
December 31, 2013
                                                               
Ending allowance balance attributable to loans:
                                                               
Individually evaluated for impairment
  $ 192     $ -     $ -     $ 325     $ 200     $ -     $ -     $ 717  
Collectively evaluated for impairment
    622       985       1,068       2,472       1,102       54       19       6,322  
Total ending allowance
  $ 814     $ 985     $ 1,068     $ 2,797     $ 1,302     $ 54     $ 19     $ 7,039  
                                                                 
Loans:
                                                               
Individually evaluated for impairment
  $ 7,876     $ 359     $ 2,107     $ 4,873     $ 7,995     $ -     $ -     $ 23,210  
Collectively evaluated for impairment
    98,349       171,653       36,961       99,411       64,918       1,308       -       472,600  
Total ending loan balances
  $ 106,225     $ 172,012     $ 39,068     $ 104,284     $ 72,913     $ 1,308     $ -     $ 495,810  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
 
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 September 30, 2014 and December 31, 2013 (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 (2)
   
Loans
   
Unallocated
   
Total
 
September 30, 2014
                                               
Ending allowance balance attributable to loans:
                                               
Individually evaluated for impairment
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
Collectively evaluated for impairment
    -       -       -       -       17       4       -       21  
Total ending allowance
  $ -     $ -     $ -     $ -     $ 17     $ 4     $ -     $ 21  
                                                                 
Loans:
                                                               
Individually evaluated for impairment
  $ 753     $ 1,879     $ -     $ -     $ 1,206     $ -     $ -     $ 3,838  
Collectively evaluated for impairment
    610       4,207       -       755       38,493       78       -       44,143  
Total ending loan balances
  $ 1,363     $ 6,086     $ -     $ 755     $ 39,699     $ 78     $ -     $ 47,981  
                                                                 
December 31, 2013
                                                               
Ending allowance balance attributable to loans:
                                                               
Individually evaluated for impairment
  $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -  
Collectively evaluated for impairment
    -       45       -       -       -       6       -       51  
Total ending allowance
  $ -     $ 45     $ -     $ -     $ -     $ 6     $ -     $ 51  
                                                                 
Loans:
                                                               
Individually evaluated for impairment
  $ 745     $ 2,145     $ -     $ -     $ 1,220     $ -     $ -     $ 4,110  
Collectively evaluated for impairment
    858       4,369       1       1,097       41,180       81       -       47,586  
Total ending loan balances
  $ 1,603     $ 6,514     $ 1     $ 1,097     $ 42,400     $ 81     $ -     $ 51,696  
 
(1) Includes loans secured by farmland and multi-family residential loans.
(2) Includes home equity lines of credit.
 
20
 

 

 
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 that it would not otherwise consider. 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.

During the three and nine months ending September 30, 2014, there were no loans modified in troubled debt restructurings. No TDRs defaulted during the three and nine months ending September 30, 2014, which had been modified in the previous 12 months.

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 September 30, 2014 or December 31, 2013.

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.
 
21
 

 

 
As of September 30, 2014 and December 31, 2013, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):
                                                             
September 30, 2014
 
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
  $ 753     $ 610     $ 1,363     $ 784     $ 10,966     $ 104,221     $ 115,971     $ 12,503     $ 104,831     $ 117,334  
    Commercial real estate - non-owner occupied (2)
    1,879       4,207       6,086       -       -       205,199       205,199       1,879       209,406       211,285  
    Construction and land development
    -       -       -       614       -       52,688       53,302       614       52,688       53,302  
    Commercial loans
    -       755       755       30       9,269       105,030       114,329       9,299       105,785       115,084  
    Residential 1-4 family (4)
    1,206       38,493       39,699       165       6,064       122,547       128,776       7,435       161,040       168,475  
   Other consumer loans
    -       78       78       -       -       2,015       2,015       -       2,093       2,093  
                                                                                 
   Total
  $ 3,838     $ 44,143     $ 47,981     $ 1,593     $ 26,299     $ 591,700     $ 619,592     $ 31,730     $ 635,843     $ 667,573  

                                                             
December 31, 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
  $ 745     $ 858     $ 1,603     $ 802     $ 7,876     $ 97,547     $ 106,225     $ 9,423     $ 98,405     $ 107,828  
    Commercial real estate - non-owner occupied (2)
    2,145       4,369       6,514       -       359       171,653       172,012       2,504       176,022       178,526  
    Construction and land development
    -       1       1       618       2,107       36,343       39,068       2,725       36,344       39,069  
    Commercial loans
    -       1,097       1,097       31       4,873       99,380       104,284       4,904       100,477       105,381  
    Residential 1-4 family (4)
    1,220       41,180       42,400       176       7,995       64,742       72,913       9,391       105,922       115,313  
   Other consumer loans
    -       81       81       -       -       1,308       1,308       -       1,389       1,389  
                                                                                 
   Total
  $ 4,110     $ 47,586     $ 51,696     $ 1,627     $ 23,210     $ 470,973     $ 495,810     $ 28,947     $ 518,559     $ 547,506  

(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 $3.3 million and $2.4 million as of September 30, 2014 and December 31, 2013, respectively.
(4) Includes home equity lines of credit.
  
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 $8.7 million and $6.9 million as of September 30, 2014 and December 31, 2013, 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 September 30, 2014 and December 31, 2013, we had unfunded lines of credit and undisbursed construction loan funds totaling $109.9 million and $105.8 million, respectively. We had approved loan commitments of $6.3 million at September 30, 2014, and we had no approved loan commitments as of December 31, 2013.  Virtually all of our unfunded lines of credit, undisbursed construction loan funds and approved loan commitments are variable rate.
 
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6.     EARNINGS PER SHARE

The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (dollars in thousands, except per share data):
                   
         
Weighted
       
         
Average
       
   
Income
   
Shares
   
Per Share
 
   
(Numerator)
   
(Denominator)
   
Amount
 
For the three months ended September 30, 2014
                 
Basic EPS
  $ 2,108       11,971     $ 0.18  
Effect of dilutive stock options and warrants
    -       92       -  
Diluted EPS
  $ 2,108       12,063     $ 0.17  
                         
For the three months ended September 30, 2013
                       
Basic EPS
  $ 1,780       11,590     $ 0.15  
Effect of dilutive stock options and warrants
    -       47       -  
Diluted EPS
  $ 1,780       11,637     $ 0.15  
                         
For the nine months ended September 30, 2014
                       
Basic EPS
  $ 5,522       11,724     $ 0.47  
Effect of dilutive stock options and warrants
    -       48       -  
Diluted EPS
  $ 5,522       11,772     $ 0.47  
                         
For the nine months ended September 30, 2013
                       
Basic EPS
  $ 4,862       11,590     $ 0.42  
Effect of dilutive stock options and warrants
    -       35       -  
Diluted EPS
  $ 4,862       11,625     $ 0.42  
 
There were 637,502 and 681,590 anti-dilutive options and warrants for the three and nine months ended September 30, 2014, respectively. Anti-dilutive options and warrants totaled 668,468 and 680,206 for the three and nine months ended September 30, 2013, 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
 
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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
 
     
September 30, 2014
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
(dollars in thousands)
                         
Financial assets:
                         
 Available for sale securities
                         
 Obligations of states and political subdivisions
 
$
2,271
 
$
-
 
$
2,271
 
$
-
 
 
                           
         
Fair Value Measurements Using
 
                 
Significant
       
           
Quoted Prices in
   
Other
   
Significant
 
           
Active Markets for
   
Observable
   
Unobservable
 
     
Total at
   
Identical Assets
   
Inputs
   
Inputs
 
     
December 31, 2013
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
(dollars in thousands)
                         
Financial assets:
                         
 Available for sale securities
                         
 Obligations of states and political subdivisions
 
$
1,993
 
$
-
 
$
1,993
 
$
-
 
 
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 8.91% to 13.95% at September 30, 2014.  The liquidity premiums we used ranged from 2% to 5%, and the adjusted discount rates ranged from 10.97% to 14.97% at December 31, 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.
 
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Other Residential Collateralized Mortgage Obligation Classified as Held-to Maturity

The fair value was estimated within Level 2 fair value hierarchy, as the fair value is based on either pricing models, quoted market prices of securities with similar characteristics, or discounted cash flows.  We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support, it has been determined that no OTTI charge for credit exists for the three months ended September 30, 2014.  The assumptions used in the analysis included a 6.3% prepayment speed, 1.4% default rate, a 72% loss severity and an accounting yield of 2.39% at September 30, 2014.  The assumptions used in the analysis at December 31, 2013, included a 4.3% prepayment speed, 8.9% default rate, a 51% loss severity and an accounting yield of 1.38%.

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 an independent appraisal or evaluation less estimated costs related to selling the collateral.  In some cases appraised value is net of costs to sell.  Estimated selling costs range from 6% to 10% of collateral valuation at September 30, 2014 and December 31, 2013. Fair value is classified as Level 3 in the fair value hierarchy. Non-covered loans identified as impaired totaled $26.3 million (including SBA guarantees of $3.3 million and HarVest loans of $1.2 million) as of September 30, 2014 with an allocated allowance for loan losses totaling $391 thousand compared to a carrying amount of $23.2 million (including SBA guarantees of $2.4 million) with an allocated allowance for loan losses totaling $717 thousand at December 31, 2013.

Other Real Estate Owned (OREO)

OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or evaluation less cost to sell.  In some cases appraised value is net of costs to sell.  Selling costs have been in the range from 6% to 7.6% of collateral valuation at September 30, 2014 and December 31, 2013. Fair value is classified as Level 3 in the fair value hierarchy. OREO is further evaluated quarterly for any additional impairment.  At September 30, 2014, the total amount of OREO was $13.0 million, of which $11.5 million was non-covered and $1.5 million was covered.
 
 
At December 31, 2013, the total amount of OREO was $11.8 million, of which $9.6 million was non-covered (including $509 thousand acquired from HarVest) and $2.2 million was covered.
 
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Assets measured at fair value on a non-recurring basis are summarized below:
                 
       
Fair Value Measurements Using
 
         
Significant
     
       
Quoted Prices in
Other
 
Significant
 
       
Active Markets for
Observable
 
Unobservable
 
   
Total at
 
Identical Assets
Inputs
 
Inputs
 
(dollars in thousands)
 
September 30, 2014
 
(Level 1)
(Level 2)
 
(Level 3)
 
Impaired non-covered loans:
               
    Commercial real estate - owner occupied
  $ 10,875         $ 10,875  
    Commercial loans
    9,269           9,269  
    Residential 1-4 family
    5,764           5,764  
Impaired covered loans:
                   
    Commercial real estate - owner occupied
    753           753  
    Commercial real estate - non-owner occupied (1)
    1,879           1,879  
    Residential 1-4 family
    1,206           1,206  
Non-covered other real estate owned:
                   
    Commercial real estate - owner occupied
    461           461  
    Construction and land development
    6,970           6,970  
    Residential 1-4 family
    4,074           4,074  
Covered other real estate owned:
                   
    Commercial real estate - non-owner occupied (1)
    1,450           1,450  
 
                 
       
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, 2013
 
(Level 1)
(Level 2)
 
(Level 3)
 
Impaired non-covered loans:
               
    Commercial real estate - owner occupied
  $ 7,684         $ 7,684  
    Commercial real estate - non-owner occupied (1)
    359           359  
    Construction and land development
    2,107           2,107  
    Commercial loans
    4,548           4,548  
    Residential 1-4 family
    7,795           7,795  
Impaired covered loans:
                   
    Commercial real estate - owner occupied
    745           745  
    Commercial real estate - non-owner occupied (1)
    2,145           2,145  
    Residential 1-4 family
    1,220           1,220  
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
    6,066           6,066  
    Residential 1-4 family
    1,710           1,710  
Covered other real estate owned:
                   
    Commercial real estate - owner occupied
    557           557  
    Commercial real estate - non-owner occupied (1)
    1,450           1,450  
    Commercial
    79           79  
    Residential 1-4 family
    127           127  
 
(1) Includes loans secured by farmland and multi-family residential loans.
 
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Fair Value of Financial Instruments

The carrying amount, estimated fair values and fair value hierarchy levels (previously defined) of financial instruments were as follows (in thousands):
                               
         
September 30, 2014
   
December 31, 2013
 
   
Fair Value
   
Carrying
   
Fair
   
Carrying
   
Fair
 
   
Hierarchy Level
   
Amount
   
Value
   
Amount
   
Value
 
                               
Financial assets:
                             
Cash and cash equivalents
 
Level 1
    $ 45,803     $ 45,803     $ 20,856     $ 20,856  
Securities available for sale
 
See previous table
      2,271       2,271       1,993       1,993  
Securities held to maturity
 
Level 2 & Level 3
      89,993       88,970       82,443       76,193  
Stock in Federal Reserve Bank and Federal
                                     
    Home Loan Bank
   n/a       6,131       n/a       5,915       n/a  
Net non-covered loans
 
Level 3
      610,742       617,574       487,318       493,472  
Net covered loans
 
Level 3
      47,968       53,957       51,650       57,564  
Accrued interest receivable
 
Level 2 & Level 3
      2,439       2,439       2,186       2,186  
FDIC indemnification asset
 
Level 3
      3,970       2,268       5,804       4,220  
Financial liabilities:
                                     
Demand deposits
 
Level 1
      94,337       94,337       68,940       68,940  
Money market and savings accounts
 
Level 1
      179,437       179,437       147,854       147,854  
Certificates of deposit
 
Level 3
      424,311       424,345       323,565       324,733  
Securities sold under agreements to
                                     
  repurchase and other short-term borrowings
 
Level 1
      37,779       37,779       34,545       34,545  
FHLB advances
 
Level 3
      25,000       25,547       30,250       31,168  
Accrued interest payable
 
Level 1 & Level 3
      490       490       341       341  

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.    ACQUISTIONS

The merger with Prince George’s Federal Savings Bank (PGFSB) was completed on August 1, 2014. Southern National acquired PGFSB in a cash and stock transaction. PGFSB was founded in 1931 and is headquartered in Upper Marlboro, which is the County Seat of Prince George’s County, Maryland. Prince George’s FSB has four offices, all of which are in Maryland, including a main office in Upper Marlboro and three branch offices in Dunkirk, Brandywine and Huntingtown. Prince George’s FSB has an excellent core deposit base reflecting its tenure in the communities it serves, and its lending activities have historically been focused on residential mortgages.
 
27
 

 


The acquisition was accounted for under the acquisition method of accounting.  The assets and liabilities were recorded at their estimated fair values as of the August 1, 2014 acquisition date.  A summary of the net assets acquired is as follows (in thousands):
       
Total purchase price
  $ 11,497  
Fair value of assets acquired:
       
    Cash on hand and in banks
  $ 28,179  
    Loans
    61,832  
    Loans held for sale
    3,499  
    Land and buildings
    3,023  
    Other assets
    1,022  
    Core deposit intangible
    761  
Total assets acquired
  $ 98,316  
         
Fair value of liabilities assumed:
       
    Noninterest-bearing deposits
  $ 19,233  
    Interest-bearing deposits
    69,995  
    Other liabilities
    504  
Total liabilities assumed
  $ 89,732  
         
Net assets acquired
  $ 8,584  
Goodwill
    2,913  
    $ 11,497  
 
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 $64.2 million and $61.2 million, respectively.  The discount of $3.0 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 $1.5 million and $682 thousand, respectively.  The discount of $790 thousand for these credit impaired loans will not be accreted in accordance with ASC 310-30.  We also acquired nonperforming loans with a fair value of $3.5 million which were sold immediately after acquisition.

Merger costs related to the PGFSB acquisition were $445 thousand, consisting primarily of legal, investment banking and data processing expenses.  We recorded goodwill in the amount of $2.9 million which is the difference between the total purchase price and the net assets acquired.

The PGFSB branches have been integrated into the Sonabank branch system.

On May 15, 2014, Southern National Bancorp of Virginia Inc., Jerry Flowers of Southern Trust Mortgage (STM), and Eastern Virginia Bankshares (EVB), the holding company for EVB, completed the purchase of the 62 percent of STM previously owned by Middleburg Bank.  Jerry Flowers and other STM executives now own 51.1 percent of STM, Sonabank owns 44 percent and EVB owns 4.9 percent.

Sonabanks’s investment in STM totaled $5.0 million, including preferred shares in the amount of $1.8 million.  The investment is being accounted for under the equity method.
 
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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of SNBV. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report on Form 10-K for the year ended December 31, 2013. Results of operations for the nine month period ended September 30, 2014 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, 2013, 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;
 
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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

Southern National Bancorp of Virginia, Inc. (“Southern National”, “we” or “our”) is the bank holding company for Sonabank (“Sonabank” or the “Bank”), a Virginia state chartered bank which commenced operations on April 14, 2005. Sonabank conducts full-service community banking operations from locations in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Loudoun County (Middleburg, Leesburg (2), and South Riding), Front Royal, New Market, Richmond, Haymarket and Clifton Forge, and nine branches in Maryland (four in Montgomery County, four in Prince George’s County and one in Frederick County) and maintains loan production offices in Richmond, Charlottesville, Warrenton and Fredericksburg. We have administrative offices in Warrenton and an executive office in Georgetown, Washington, D.C where senior management is located.
 
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RESULTS OF OPERATIONS

Net Income

Net income for the quarter ended September 30, 2014 was $2.1 million and $5.5 million for the first nine months of 2014. That compares to $1.8 million and $4.9 million for the three and nine months ended September 30, 2013.

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

Net interest income was $8.8 million in the quarter ended September 30, 2014 up from $7.7 million during the same period last year. Sonabank’s net interest margin was 4.59% in the third quarter of 2014, compared to 4.85% in the third quarter of 2013. Although we are seeing some egregious examples from new participants in the Richmond market in regards to low loan rates, the irrational exuberance of a year to a year and a half ago has largely subsided. Average loans were $642.6 million in the third quarter of 2014 compared to $562.5 million in the second quarter of 2014. Approximately $62.6 million of the increase was attributable to the Prince George’s FSB acquisition.

We have been loath to invest in securities for some time, believing that yields adjusted for interest rate risk would not adequately compensate us for the inherent risk. Average securities outstanding in the third quarter of 2014 were $91.4 million, compared to $88.2 million last quarter and to $84.2 million in the third quarter of last year. We are well positioned to withstand a rise in interest rates based on the interest sensitivity on our balance sheet. However, during the fourth quarter we will need to expand our securities portfolio modestly for liquidity and collateral purposes.
 
 
Net interest income was $24.3 million during the nine months ended September 30, 2014, compared to $22.9 million during the same period in the prior year. Average loans during the first nine months of 2014 were $583.4 million compared to $513.6 million during the same period last year. The Greater Atlantic Bank loan discount accretion contributed $1.5 million to net interest income during the first nine months of 2014, compared to $1.2 million during the nine months ended September 30, 2013. The loan discount accretion on the HarVest Bank portfolio contributed $734 thousand during the nine months ended September 30, 2014, compared to $1.5 million in same period last year. The accretion of the Prince George’s FSB discount contributed $95 thousand during the two months since the closing.

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The following tables detail average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:
       
   
Average Balance Sheets and Net Interest
 
   
Analysis For the Quarters Ended
 
   
9/30/2014
 
9/30/2013
 
         
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)
  $ 642,622     $ 9,181       5.67 %   $ 521,569     $ 8,169       6.21 %
Investment securities
    91,446       652       2.85 %     84,200       574       2.73 %
Other earning assets
    26,935       151       2.22 %     26,617       104       1.55 %
                                                 
Total earning assets
    761,003       9,984       5.21 %     632,386       8,847       5.55 %
Allowance for loan losses
    (7,392 )                     (7,896 )                
Total non-earning assets
    81,521                       71,941                  
Total assets
  $ 835,132                     $ 696,431                  
                                                 
Liabilities and stockholders equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 23,836       6       0.11 %   $ 22,720       15       0.26 %
Money market accounts
    132,382       89       0.27 %     141,317       97       0.27 %
Savings accounts
    35,379       54       0.61 %     12,823       19       0.59 %
Time deposits
    387,024       836       0.86 %     319,201       835       1.04 %
Total interest-bearing deposits
    578,621       985       0.68 %     496,061       966       0.77 %
Borrowings
    74,397       187       1.00 %     45,513       157       1.37 %
Total interest-bearing liabilities
    653,018       1,172       0.71 %     541,574       1,123       0.82 %
Noninterest-bearing liabilities:
                                               
Demand deposits
    64,995                       43,449                  
Other liabilities
    5,307                       5,598                  
Total liabilities
    723,320                       590,621                  
Stockholders equity
    111,812                       105,810                  
Total liabilities and stockholders equity
  $ 835,132                     $ 696,431                  
Net interest income
            8,812                       7,724          
Interest rate spread
                    4.50 %                     4.73 %
Net interest margin
                    4.59 %                     4.85 %
 
(1)  Includes loan fees in both interest income and the calculation of the yield on loans.
     
(2)  Calculations include non-accruing loans in average loan amounts outstanding.
       
 
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Average Balance Sheets and Net Interest
   
Analysis For the Nine Months Ended
   
9/30/2014
   
9/30/2013
 
         
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)
  $ 583,432     $ 25,037       5.74 %   $ 513,577     $ 24,277       6.32 %
Investment securities
    88,115       1,923       2.91 %     84,095       1,699       2.69 %
Other earning assets
    23,044       591       3.43 %     41,230       443       1.44 %
                                                 
Total earning assets
    694,591       27,551       5.30 %     638,902       26,419       5.53 %
Allowance for loan losses
    (7,434 )                     (7,619 )                
Total non-earning assets
    74,971                       71,558                  
Total assets
  $ 762,128                     $ 702,841                  
                                                 
Liabilities and stockholders equity
                                               
Interest-bearing liabilities:
                                               
NOW accounts
  $ 23,552       19       0.11 %   $ 23,520       46       0.26 %
Money market accounts
    128,133       264       0.28 %     151,889       411       0.36 %
Savings accounts
    24,220       113       0.62 %     11,232       48       0.57 %
Time deposits
    356,167       2,383       0.89 %     315,522       2,581       1.09 %
Total interest-bearing deposits
    532,072       2,779       0.70 %     502,163       3,086       0.82 %
Borrowings
    62,305       514       1.10 %     46,182       465       1.35 %
Total interest-bearing liabilities
    594,377       3,293       0.74 %     548,345       3,551       0.87 %
Noninterest-bearing liabilities:
                                               
Demand deposits
    53,743                       44,313                  
Other liabilities
    4,899                       5,380                  
Total liabilities
    653,019                       598,038                  
Stockholders equity
    109,109                       104,803                  
Total liabilities and stockholders equity
  $ 762,128                     $ 702,841                  
Net interest income
          $ 24,258                     $ 22,868          
Interest rate spread
                    4.56 %                     4.66 %
Net interest margin
                    4.67 %                     4.79 %
 
(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 loan loss provision for the third quarter and the nine months ended September 30, 2014 was $975 thousand and $2.3 million, respectively, compared to $1.2 million and $3.0 million for the same periods last year. Charge offs for the three and nine months ended September 30, 2014 were $1.2 million and $2.4 million, respectively, compared to $1.2 million and $3.0 million for the same periods in 2013.
 
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Noninterest Income

The following tables present the major categories of noninterest income for the three and nine months ended September 30, 2014 and 2013:
       
   
For the Three Months Ended
 
   
September 30,
 
   
2014
   
2013
   
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 220     $ 198     $ 22  
Income from bank-owned life insurance
    159       147       12  
Equity income from mortgage affiliate
    176       -       176  
Other
    54       30       24  
Total noninterest income
  $ 609     $ 375     $ 234  
                         
   
For the Nine Months Ended
 
   
September 30,
 
      2014       2013    
Change
 
   
(dollars in thousands)
 
Account maintenance and deposit service fees
  $ 594     $ 593     $ 1  
Income from bank-owned life insurance
    455       445       10  
Equity income from mortgage affiliate
    507       -       507  
Gain on other assets
    202       13       189  
Net gain on sale of available for sale securities
    -       142       (142 )
Net impairment losses recognized in earnings
    (41 )     (3 )     (38 )
Other
    145       169       (24 )
Total noninterest income
  $ 1,862     $ 1,359     $ 503  

During the third quarter of 2014 Sonabank had noninterest income of $609 thousand compared to noninterest income of $375 thousand during the third quarter of 2013. We recognized income from our investment in STM in the amount of $176 thousand.
 
Noninterest income increased to $1.9 million in the first nine months of 2014 from $1.4 million during the first nine months of 2013. In addition to income from the STM investment in the amount of $507 thousand, we sold part of our investment in CapitalSouth Partners Fund III, a Small Business Investment Company, for a gain of $202 thousand.
 
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Noninterest Expense

The following tables present the major categories of noninterest expense for the three and nine months ended September 30, 2014 and 2013:
       
   
For the Three Months Ended
 
   
September 30,
 
   
2014
   
2013
   
Change
 
   
(dollars in thousands)
 
Salaries and benefits
  $ 2,671     $ 2,338     $ 333  
Occupancy expenses
    804       768       36  
Furniture and equipment expenses
    195       197       (2 )
Amortization of core deposit intangible
    61       123       (62 )
Virginia franchise tax expense
    113       115       (2 )
Merger expenses
    65       -       65  
FDIC assessment
    149       218       (69 )
Data processing expense
    146       131       15  
Telephone and communication expense
    198       166       32  
Change in FDIC indemnification asset
    403       113       290  
Net (gain) loss on other real estate owned
    (194 )     (698 )     504  
Other operating expenses
    678       790       (112 )
Total noninterest expense
  $ 5,289     $ 4,261     $ 1,028  
                         
   
For the Nine Months Ended
 
   
September 30,
 
      2014       2013    
Change
 
   
(dollars in thousands)
 
Salaries and benefits
  $ 7,487     $ 6,760     $ 727  
Occupancy expenses
    2,335       2,280       55  
Furniture and equipment expenses
    571       524       47  
Amortization of core deposit intangible
    151       368       (217 )
Virginia franchise tax expense
    342       357       (15 )
Merger expenses
    487       -       487  
FDIC assessment
    401       676       (275 )
Data processing expense
    406       433       (27 )
Telephone and communication expense
    556       507       49  
Change in FDIC indemnification asset
    837       350       487  
Net (gain) loss on other real estate owned
    (433 )     (580 )     147  
Other operating expenses
    2,313       2,334       (21 )
Total noninterest expense
  $ 15,453     $ 14,009     $ 1,444  

Noninterest expenses were $5.3 million and $15.5 million during the third quarter and the first nine months of 2014, respectively, compared to $4.3 million and $14.0 million during the same periods in 2013. Merger expenses were $64 thousand in the third quarter of 2014 and $487 thousand during the first nine months of 2014. There were no such expenses in 2013.

The net gain on Other Real Estate Owned (OREO) for the three months ended September 30, 2014 was $194 thousand compared to a net gain on OREO of $698 thousand for the same period in 2013. During the three months ended September 30, 2014, we sold three OREO properties resulting in gains of $354 thousand and recognized impairment in the amount of $160 thousand on two OREO properties. The gain of $698 thousand in the third quarter of 2013 consisted of a gain of $1.1 million on two OREO properties and loss and impairment charges totaling $410 thousand on four OREO properties.
 
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The net gain on OREO for the nine months ended September 30, 2014 was $433 thousand compared to a gain on OREO of $580 thousand for the first nine months of 2013. The gain in 2014 resulted from the sale of eight OREO properties at a gain of $1.1 million, the sale of three properties at a loss of $466 thousand, and impairment of $160 thousand on two properties. The gain of $580 thousand in 2013 consisted of a gain of $1.3 million on four OREO properties and losses and impairment totaling $733 thousand on six OREO properties.

As a result of the analysis of the FDIC indemnification asset in the second quarter of 2014, the amortization expense of the indemnification asset increased from $350 thousand for the nine months ended September 30, 2013, to $837 thousand for the nine months ended September 30, 2014. For the quarter ended September 30, 2014, the amortization expense was $403 thousand compared to $113 thousand for the third quarter of 2013.

FINANCIAL CONDITION
 
Balance Sheet Overview

Total assets were $883.0 million as of September 30, 2014 compared to $716.2 million as of December 31, 2013. Net loans receivable increased from $539.0 million at the end of 2013 to $658.7 million at September 30, 2014.

Total deposits increased to $698.1 million at September 30, 2014 from $540.4 million as of December 31, 2013 largely as a result of the Prince George’s FSB acquisition. Notably, non-interest bearing demand deposits increased from a year-end 2013 level of $44.6 million to $70.7 million as of September 30, 2014. Similarly, savings account balances increased from $17.0 million to $41.0 million, and money market account balances increased from $130.9 million to $138.4 million over the same period. Prince George’s FSB was an 83 year old institution with deep relationships in its communities.

Loan Portfolio

As part of the Greater Atlantic acquisition, the Bank and the FDIC entered into a loss sharing agreement on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans.”
 
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The following table summarizes the composition of our loan portfolio as of September 30, 2014 and December 31, 2013:

   
Covered
   
Non-covered
   
Total
   
Covered
   
Non-covered
   
Total
 
   
Loans (1)
   
Loans
   
Loans
   
Loans (1)
   
Loans
   
Loans
 
   
September 30, 2014
 
December 31, 2013
Loans secured by real estate:
                                   
Commercial real estate - owner-occupied
  $ 1,363     $ 115,971     $ 117,334     $ 1,603     $ 106,225     $ 107,828  
Commercial real estate - non-owner-occupied
    5,791       182,138       187,929       5,829       150,008       155,837  
Secured by farmland
    -       580       580       100       508       608  
Construction and land loans
    -       53,302       53,302       1       39,068       39,069  
Residential 1-4 family
    15,358       118,423       133,781       16,631       66,482       83,113  
Multi- family residential
    295       22,481       22,776       585       21,496       22,081  
Home equity lines of credit
    24,341       10,353       34,694       25,769       6,431       32,200  
Total real estate loans
    47,148       503,248       550,396       50,518       390,218       440,736  
                                                 
Commercial loans
    755       114,329       115,084       1,097       104,284       105,381  
Consumer loans
    78       2,015       2,093       81       1,308       1,389  
Gross loans
    47,981       619,592       667,573       51,696       495,810       547,506  
                                                 
Less deferred fees on loans
    8       (1,747 )     (1,739 )     5       (1,453 )     (1,448 )
Loans, net of deferred fees
  $ 47,989     $ 617,845     $ 665,834     $ 51,701     $ 494,357     $ 546,058  
                                                 
(1) Covered Loans were acquired in the Greater Atlantic transaction and are covered under an FDIC loss-share agreement.
 
 
As of September 30, 2014 and December 31, 2013, substantially all of our loans were to customers located in Virginia and Maryland. We are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on operations.

Loan growth has been strong in 2014. The loan portfolio, excluding the Prince George’s FSB acquisition, grew by 10.8% ($58.9 million) from December 31, 2013, mostly in commercial real estate and commercial loans. The Prince George’s FSB acquisition added another $60.9 million, or 11.1%.

The large increase in the residential 1-4 family portfolio from year-end 2013 to September 30, 2014 was attributable to the Prince George’s FSB merger ($50.6 million), and to loans purchased from STM ($7.3 million). As of September 30, 2014, there was $11.3 million in the pipeline with STM.

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.

Non-covered Loans and Assets

Non-covered loans evaluated for impairment totaled $26.3 million with allocated allowance for loan losses in the amount of $391 thousand as of September 30, 2014, including $4.1 million of nonaccrual loans. This compares to $23.2 million of impaired loans with allocated allowance for loan losses in the amount of $717 thousand at December 31, 2013, including $7.8 million of nonaccrual loans. The nonaccrual loans included SBA guaranteed amounts of $3.3 million and $1.9 million at September 30, 2014 and December 31, 2013, respectively. At September 30, 2014 and December 31, 2013 there were no loans past due 90 days or more and accruing interest.
 
37
 

 


Non-covered nonperforming assets decreased from $17.4 million at December 31, 2013 to $15.7 million at September 30, 2014.

Non-covered OREO as of September 30, 2014 was $11.5 million compared to $9.6 million as of the end of 2013. During the first nine months of 2014 we disposed of five non-covered properties in the aggregate amount of $2.3 million. In addition, OREO increased by an aggregate of $4.7 million as a result of foreclosures. We also recognized impairment losses on four properties totaling $400 thousand.
 
Sonabank has an internal loan review and a loan committee, both of which provide on-going monitoring to identify and address issues with problem loans. The loan loss provision is determined after consideration of all known relevant internal and external factors affecting loan collectability to maintain the allowance for loan and lease losses at a level necessary to absorb estimated credit losses. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at September 30, 2014.

The following table presents a comparison of non-covered nonperforming assets as of September 30, 2014 and December 31, 2013 (in thousands):

   
September 30,
   
December 31,
   
2014
   
2013
             
Nonaccrual loans
  $ 4,148     $ 7,814  
Loans past due 90 days and accruing interest
    -       -  
    Total nonperforming loans
    4,148       7,814  
Other real estate owned
    11,505       9,579  
    Total nonperforming assets
  $ 15,653     $ 17,393  
                 
SBA guaranteed amounts included in nonaccrual loans
  $ 3,261     $ 1,852  
                 
Allowance for loan losses to nonperforming loans
    171.24 %     90.08 %
Allowance for loan losses to total non-covered loans
    1.15 %     1.42 %
Nonperforming assets excluding SBA guaranteed loans to
               
    total non-covered assets
    1.71 %     2.35 %
 
The allowance for loan losses as a percentage of non-covered loans at September 30, 2014 was 1.15%, compared to 1.42% at the end of 2013. The ratio has declined largely because the loans acquired from Prince George’s FSB were booked at fair value and are not subject to a loan loss reserve. At September 30, 2014, the allowance for loan losses as a percentage of non-covered loans less the acquired Prince George’s FSB loans was 1.28%. Management believes the allowance is adequate at this time but monitors trends in past due and non-performing loans to determine whether the allowance should be increased.

 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 that it would not otherwise consider. 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.
 
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Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.

During the three and nine months ending September 30, 2014, there were no loans modified in troubled debt restructurings. No TDRs defaulted during the three and nine months ending September 30, 2014, which had been modified in the previous 12 months.

Covered Loans and Assets

Covered loans identified as impaired totaled $3.8 million as of September 30, 2014 and $4.1million as of December 31, 2013. Nonaccrual loans were $819 thousand and $1.6 million at September 30, 2014 and December 31, 2013, respectively. At September 30, 2014 and December 31, 2013, there were no loans past due 90 days or more and accruing interest.

Securities

Investment securities, available for sale and held to maturity, were $92.3 million at September 30, 2014 and $84.4 million at December 31, 2013. The increase was primarily due to the purchases of $11.0 million in callable agency securities and $1.3 million in municipal bonds net of repayments in the first nine months of 2014.

At September 30, 2014, we owned pooled trust preferred securities as follows (in thousands):

                                     
Previously
     
                                 
% of Current
 
Recognized
     
                                 
Defaults and
 
Cumulative
     
   
Ratings
                 
Estimated
   
Deferrals to
 
Other
     
 
Tranche
When Purchased
 
Current Ratings
         
Fair
   
Total
 
Comprehensive
     
Security
Level
Moodys
 
Fitch
 
Moodys
 
Fitch
 
Par Value
 
Book Value
 
Value
   
Collateral
 
Loss (1)
     
                   
(in thousands)
                   
ALESCO VII  A1B
Senior
Aaa
 
AAA
  A3  
BBB
  $ 5,773   $ 5,249   $ 3,829     15 %   $ 268      
MMCF III B
Senior Sub
A3   A-  
Ba1
 
CC
    331     325     202     34 %     6      
                      6,104     5,574     4,031           $ 274      
                                                       
                                             
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     509     530     41 %     591   $ 400  
TRAP 2007-XII C1
Mezzanine
A3   A   C   C     2,170     57     428     28 %     820     1,293  
TRAP 2007-XIII D
Mezzanine
NR
  A-  
NR
  C     2,039     -     347     19 %     7     2,032  
MMC FUNDING XVIII
Mezzanine
A3   A-  
Ca
  C     1,095     27     328     21 %     377     691  
ALESCO V C1
Mezzanine
A2   A   C   C     2,150     475     609     15 %     1,014     661  
ALESCO XV C1
Mezzanine
A3   A-   C   C     3,268     30     85     33 %     679     2,559  
ALESCO XVI  C
Mezzanine
A3   A-   C   C     2,172     121     582     14 %     871     1,180  
                      14,394     1,219     2,909           $ 4,359   $ 8,816  
                                                         
Total
                  $ 20,498   $ 6,793   $ 6,940                      
                                                         
(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
 
 
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Our largest pooled trust preferred security is ALESCO VII A 1B , which was rated triple A at acquisition which is now rated A3 (Moody’s,) BBB (Fitch) and B+ (S&P).

Each of these securities has been evaluated for potential impairment under accounting guidelines. In performing a detailed cash flow analysis of each security, Sonabank works with independent third parties to identify the most reflective estimate of the cash flow estimated to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary.

We recognized no OTTI charges during the three months ended September 30, 2014, and we recognized OTTI charges of $41 thousand and nine months ended September 30, 2014 related to the TPREF Funding II security. We recognized no OTTI charges during the third quarter of 2013 and recognized OTTI charges of $3 thousand during the first nine months of 2013.

Other securities in our investment portfolio are as follows:

 
·
residential government-sponsored mortgage-backed securities in the amount of $22.4 million and residential government-sponsored collateralized mortgage obligations totaling $3.7 million

 
·
callable agency securities in the amount of $41.0 million

 
·
municipal bonds in the amount of $17.8 million with a taxable equivalent yield of 3.17% and ratings as follows:

Rating
     
Amount
 
Service
 
Rating
 
(in thousands)
 
Moodys
 
Aaa
  $ 505  
Moody’s
 
Aa2
    3,631  
Moody’s
 
Aa3
    718  
Moody’s
  A1     1,180  
Standard & Poor’s
 
AAA
    3,136  
Standard & Poor’s
 
AA+
    580  
Standard & Poor’s
 
AA
    7,478  
Standard & Poor’s
 
AA-
    603  
        $ 17,831  

In accordance with regulatory guidance we have performed an independent analysis on each security and monitor the portfolio on an ongoing basis.

 
·
SARM 2005-22 1A2 in the amount of $612 thousand, a residential collateralized mortgage obligation that is not government-sponsored

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.
 
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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 nine months ended September 30, 2014, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At September 30, 2014, we had $109.9 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $6.3 million at September 30, 2014. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.

Capital Resources

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

               
Required
             
               
For Capital
   
To Be Categorized as
 
   
Actual
   
Adequacy Purposes
   
Well Capitalized
 
   
Amount
   
Ratio
   
Amount
   
Ratio
   
Amount
   
Ratio
 
September 30, 2014
                                   
Southern National
                                   
Tier 1 risk-based capital ratio
  $ 105,877       16.36 %   $ 25,887       4.00 %   $ 38,831       6.00 %
Total risk-based capital ratio
    113,002       17.46 %     51,774       8.00 %     64,718       10.00 %
Leverage ratio
    105,877       12.88 %     32,881       4.00 %     41,102       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 104,211       16.11 %   $ 25,874       4.00 %   $ 38,811       6.00 %
Total risk-based capital ratio
    111,336       17.21 %     51,748       8.00 %     64,685       10.00 %
Leverage ratio
    104,211       12.68 %     32,868       4.00 %     41,085       5.00 %
                                                 
December 31, 2013
                                               
Southern National
                                               
Tier 1 risk-based capital ratio
  $ 99,700       18.56 %   $ 21,489       4.00 %   $ 32,234       6.00 %
Total risk-based capital ratio
    106,406       19.81 %     42,978       8.00 %     53,723       10.00 %
Leverage ratio
    99,700       14.22 %     28,038       4.00 %     35,048       5.00 %
Sonabank
                                               
Tier 1 risk-based capital ratio
  $ 98,958       18.43 %   $ 21,478       4.00 %   $ 32,217       6.00 %
Total risk-based capital ratio
    105,660       19.68 %     42,956       8.00 %     53,695       10.00 %
Leverage ratio
    98,958       14.12 %     28,027       4.00 %     35,034       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.
 
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

We use 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.
 
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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 September 30, 2014 and as of December 31, 2013, and all changes are within our ALM Policy guidelines. The effect of the PGFSB merger was less negative than anticipated. The impact from the fixed rate mortgage loans acquired was offset by the lengthening of certificate of deposit maturities. Overall the duration of deposits increased and the duration of loans decreased.

   
Sensitivity of Economic Value of Equity
   
As of September 30, 2014
                               
                     
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
  $ 118,323     $ (19,108 )     -13.90 %     13.40 %     101.67 %
Up 300
    121,894       (15,537 )     -11.31 %     13.80 %     104.74 %
Up 200
    126,228       (11,203 )     -8.15 %     14.30 %     108.46 %
Up 100
    131,831       (5,600 )     -4.07 %     14.93 %     113.28 %
Base
    137,431       -       0.00 %     15.56 %     118.09 %
Down 100
    132,749       (4,682 )     -3.41 %     15.03 %     114.07 %
Down 200
    127,891       (9,540 )     -6.94 %     14.48 %     109.89 %
                                         
   
Sensitivity of Economic Value of Equity
   
As of December 31, 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
  $ 104,514     $ (15,340 )     -12.80 %     14.59 %     98.03 %
Up 300
    106,947       (12,907 )     -10.77 %     14.93 %     100.31 %
Up 200
    110,177       (9,677 )     -8.07 %     15.38 %     103.34 %
Up 100
    114,794       (5,060 )     -4.22 %     16.03 %     107.67 %
Base
    119,854       -       0.00 %     16.74 %     112.42 %
Down 100
    117,479       (2,375 )     -1.98 %     16.40 %     110.19 %
Down 200
    114,952       (4,902 )     -4.09 %     16.05 %     107.82 %
 
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Our interest rate sensitivity is also monitored by management through the use of a model run by FTN Financial that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. In this regard, the model assumes that the composition of our interest sensitive assets and liabilities existing at September 30, 2014 and December 31, 2013 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. The effect of the PGFSB merger was less negative than anticipated as previously mentioned in the discussion of EVE.
 
44
 

 


   
Sensitivity of Net Interest Income
 
   
As of September 30, 2014
 
                   
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
  $ 38,911     $ 7,678       4.67 %     0.91 %
Up 300
    36,678       5,445       4.40 %     0.64 %
Up 200
    34,517       3,284       4.15 %     0.39 %
Up 100
    32,679       1,446       3.93 %     0.17 %
Base
    31,233       -       3.76 %     0.00 %
Down 100
    31,056       (177 )     3.74 %     -0.02 %
Down 200
    30,565       (668 )     3.68 %     -0.08 %
                                 
   
Sensitivity of Net Interest Income
 
   
As of December 31, 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
  $ 32,376     $ 5,627       4.87 %     0.83 %
Up 300
    30,565     $ 3,816       4.60 %     0.56 %
Up 200
    28,856     $ 2,107       4.35 %     0.31 %
Up 100
    27,547     $ 798       4.16 %     0.12 %
Base
    26,749     $ -       4.04 %     0.00 %
Down 100
    27,206     $ 457       4.11 %     0.07 %
Down 200
    26,319     $ (430 )     3.97 %     -0.07 %
 
45
 

 

 
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.
 
46
 

 

 
 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 September 30, 2014.

ITEM 1A – RISK FACTORS

As of September 30, 2014 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, 2013.

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
 
47
 

 

 
ITEM 6 - EXHIBITS

  (a) Exhibits.
 
  Exhibit No.    Description  
 
31.1*
 
Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
         
 
31.2*
 
Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
 
         
 
32.1**
 
Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
 
         
        *       Filed with this Quarterly Report on Form 10-Q
        **     Furnished with this Quarterly Report on Form 10-Q
 
48
 

 

 
Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
Southern National Bancorp of Virginia, Inc.
 
   (Registrant)  
 
November 10, 2014   /s/ Georgia S. Derrico  
(Date)   Georgia S. Derrico,  
    Chairman of the Board and Chief Executive Officer  
       
November 10, 2014   /s/ William H. Lagos  
(Date)   William H. Lagos,  
    Senior Vice President and Chief Financial Officer  
 
49