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Village Bank & Trust Financial Corp. - Quarter Report: 2013 March (Form 10-Q)

f10qvillage03312013.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

__________

FORM 10-Q
x QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2013

¨ TRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT

For the transition period from ______ to ______

__________


Commission file number: 0-50765

VILLAGE BANK AND TRUST FINANCIAL CORP.
(Exact name of registrant as specified in its charter)

Virginia
16-1694602
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
   
15521 Midlothian Turnpike, Midlothian, Virginia
23113
(Address of principal executive offices)
(Zip code)
   
   
804-897-3900
 (Registrant’s telephone number, including area code)

Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 £.

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 S     No £

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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large Accelerated Filer £
Accelerated Filer £
Non-Accelerated Filer £  (Do not check if smaller reporting company)
Smaller Reporting Company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date.
4,251,795 shares of common stock, $4.00 par value, outstanding as of May 8, 2013

 


 
 
1

 
 
Village Bank and Trust Financial Corp.
Form 10-Q

TABLE OF CONTENTS

Part I – Financial Information
     
 
Item 1.    Financial Statements
 
     
 
Consolidated Balance Sheets
 
 
March 31, 2013 (unaudited) and December 31, 2012
3
     
 
Consolidated Statements of Operations
 
 
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
4
     
 
Consolidated Statements of Comprehensive Income (Loss)
 
 
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
5
     
 
Consolidated Statements of Stockholders’ Equity
 
 
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
6
     
 
Consolidated Statements of Cash Flows
 
 
For the Three Months Ended March 31, 2013 and 2012 (unaudited)
7
     
 
Notes to Condensed Consolidated Financial Statements (unaudited)
8
     
 
Item 2.    Management’s Discussion and Analysis of Financial Condition
 
 
                and Results of Operations
35
     
 
Item 3.    Quantitative and Qualitative Disclosures About Market Risk
55
     
 
Item 4.    Controls and Procedures
55
     
     
Part II – Other Information
     
 
Item 1.    Legal Proceedings
56
     
 
Item 1A.  Risk Factors
56
     
 
Item 2.    Unregistered Sales of Equity Securities and Use of Proceeds
56
     
 
Item 3.    Defaults Upon Senior Securities
56
     
 
Item 4.    Mine Safety Disclosures
56
     
 
Item 5.    Other Information
56
     
 
Item 6.    Exhibits
56
     
Signatures
57

 
2

 

PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

Village Bank and Trust Financial Corp. and Subsidiary
 
Consolidated Balance Sheets
 
March 31, 2013 (Unaudited) and December 31, 2012
 
             
             
   
March 31,
   
December 31,
 
   
2013
   
2012
 
Assets
           
Cash and due from banks
  $ 12,340,643     $ 13,945,105  
Federal funds sold
    56,796,937       39,185,837  
Total cash and cash equivalents
    69,137,580       53,130,942  
Investment securities available for sale
    29,635,046       25,154,046  
Loans held for sale
    16,377,826       24,188,384  
Loans
               
Outstandings
    324,004,492       354,910,266  
Allowance for loan losses
    (10,319,965 )     (10,807,827 )
Deferred fees and costs
    783,137       787,823  
      314,467,664       344,890,262  
Premises and equipment, net
    23,992,037       25,815,342  
Accrued interest receivable
    1,580,147       1,676,518  
Bank owned life insurance
    6,625,325       6,575,018  
Other real estate owned
    21,382,831       20,203,691  
Other assets
    7,855,987       8,453,169  
                 
    $ 491,054,443     $ 510,087,372  
                 
Liabilities and Stockholders' Equity
               
Liabilities
               
Deposits
               
Noninterest bearing demand
  $ 62,301,743     $ 57,049,348  
Interest bearing
    359,117,502       379,273,614  
Total deposits
    421,419,245       436,322,962  
Federal Home Loan Bank advances
    27,000,000       28,000,000  
Long-term debt - trust preferred securities
    8,764,000       8,764,000  
Other borrowings
    1,882,346       4,851,811  
Accrued interest payable
    981,527       911,635  
Other liabilities
    6,780,872       6,272,163  
Total liabilities
    466,827,990       485,122,571  
                 
Stockholders' equity
               
Preferred stock, $4 par value, $1,000 liquidation preference,
               
1,000,000 shares authorized, 14,738 shares issued and outstanding
    58,952       58,952  
Common stock, $4 par value - 10,000,000 shares authorized;
               
4,251,795 shares issued and outstanding at March 31, 2013
               
4,251,795 shares issued and outstanding at December 31, 2012
    17,007,180       17,007,180  
Additional paid-in capital
    40,705,498       40,705,257  
Retained earnings (deficit)
    (33,905,887 )     (33,173,525 )
Common stock warrant
    732,479       732,479  
Discount on preferred stock
    (161,887 )     (198,993 )
Accumulated other comprehensive loss
    (209,882 )     (166,549 )
Total stockholders' equity
    24,226,453       24,964,801  
                 
    $ 491,054,443     $ 510,087,372  
                 
See accompanying notes to consolidated financial statements.
               


 
3

 

 
Village Bank and Trust Financial Corp. and Subsidiary
 
Consolidated Statements of Operations
 
Three Months Ended March 31, 2013 and 2012
 
(Unaudited)
 
             
             
   
Three Months Ended March 31,
 
   
2013
   
2012
 
Interest income
           
Loans
  $ 5,142,951     $ 5,899,208  
Investment securities
    188,099       150,349  
Federal funds sold
    25,115       20,932  
Total interest income
    5,356,165       6,070,489  
                 
Interest expense
               
Deposits
    1,042,384       1,358,238  
Borrowed funds
    224,392       290,986  
Total interest expense
    1,266,776       1,649,224  
                 
Net interest income
    4,089,389       4,421,265  
Provision for loan losses
    823,000       1,735,000  
Net interest income after provision
               
for loan losses
    3,266,389       2,686,265  
                 
Noninterest income
               
Service charges and fees
    511,504       507,643  
Gain on sale of loans
    1,955,717       1,750,663  
Gain (loss) on sale of assets
    598,182       -  
Gain (loss) on sale of investment securities
    90,067       164,207  
Rental income
    264,697       176,496  
Other
    186,305       89,644  
Total noninterest income
    3,606,472       2,688,653  
                 
Noninterest expense
               
Salaries and benefits
    3,439,408       3,098,224  
Occupancy
    556,930       546,367  
Equipment
    177,855       205,364  
Supplies
    105,272       91,902  
Professional and outside services
    686,360       635,382  
Advertising and marketing
    63,301       76,063  
OREO expense
    1,574,700       1,118,775  
Other operating expenses
    780,069       1,003,221  
Total noninterest expense
    7,383,895       6,775,298  
                 
Net income (loss) before income taxes
    (511,034 )     (1,400,380 )
Income tax expense (benefit)
    -       -  
                 
Net income (loss)
    (511,034 )     (1,400,380 )
                 
Preferred stock dividends and amortization of discount
    221,328       220,448  
                 
Net income (loss) available to common shareholders
  $ (732,362 )   $ (1,620,828 )
                 
Earnings (loss) per share, basic
  $ (0.17 )   $ (0.38 )
Earnings (loss) per share, diluted
  $ (0.17 )   $ (0.38 )
                 
See accompanying notes to consolidated financial statements.
               


 
4

 



Village Bank and Trust Financial Corp. and Subsidiary
 
Consolidated Statements of Changes in Comprehensive Income (Loss)
 
Three Months Ended March 31, 2013 and 2012
 
(Unaudited)
 
                                     
   
Three Months Ended March 31,
 
   
2013
   
2012
 
         
Tax
               
Tax
       
         
Expense
               
Expense
       
   
Amount
   
(Benefit)
   
Total
   
Amount
   
(Benefit)
   
Total
 
                                     
Net loss
  $ (511,034 )   $ -     $ (511,034 )   $ (1,400,380 )   $ -     $ (1,400,380 )
Other comprehensive income (loss)
                                               
Unrealized holding gains (losses)
                                               
arising during the period
    21,161       7,195       13,966       (377,355 )     (128,301 )     (249,054 )
Reclassification adjustment for
                                               
losses realized in income
    (90,067 )     (30,623 )     (59,444 )     (164,207 )     (55,830 )     (108,377 )
Minimum pension adjustment
    3,250       1,105       2,145       3,250       1,105       2,145  
Total other comprehensive loss
    (65,656 )     (22,323 )     (43,333 )     (538,312 )     (183,026 )     (355,286 )
                                                 
Total comprehensive loss
  $ (576,690 )   $ (22,323 )   $ (554,367 )   $ (1,938,692 )   $ (183,026 )   $ (1,755,666 )
                                                 
                                                 
See accompanying notes to consolidated financial statements.
                                 










 
5

 



Village Bank and Trust Financial Corp. and Subsidiary
 
Consolidated Statements of Stockholders' Equity
 
Three Months Ended March 31, 2013 and 2012
 
(Unaudited)
 
                                                 
                                       
Accumulated
       
               
Additional
   
Retained
         
Discount on
   
Other
       
   
Preferred
   
Common
   
Paid-in
   
Earnings
         
Preferred
   
Comprehensive
       
   
Stock
   
Stock
   
Capital
   
(Deficit)
   
Warrant
   
Stock
   
Income (loss)
   
Total
 
                                                 
                                                 
Balance, December 31, 2012
  $ 58,952     $ 17,007,180     $ 40,705,257     $ (33,173,525 )   $ 732,479     $ (198,993 )   $ (166,549 )   $ 24,964,801  
Amortization of preferred stock
                                                    -       -  
discount
    -                       (37,106 )     -       37,106               -  
Preferred stock dividend
    -       -               (184,222 )     -       -       -       (184,222 )
Issuance of common stock
    -       -       -       -       -       -       -       -  
Stock based compensation
                    241                                       241  
Minimum pension adjustment
                                                               
(net of income taxes of $2,917)
    -       -       -       -       -       -       2,145       2,145  
Net loss
    -       -       -       (511,034 )     -       -       -       (511,034 )
Change in unrealized gain on
                                                               
investment securities available-for-sale,
                                                               
net of reclassification and tax effect
    -       -       -       -       -       -       (45,478 )     (45,478 )
                                                                 
Balance, March 31, 2013
  $ 58,952     $ 17,007,180     $ 40,705,498     $ (33,905,887 )   $ 732,479     $ (161,887 )   $ (209,882 )   $ 24,226,453  
                                                                 
Balance, December 31, 2011
  $ 58,952     $ 16,973,512     $ 40,732,178     $ (21,895,557 )   $ 732,479     $ (346,473 )   $ (7,449 )   $ 36,247,642  
Amortization of preferred stock
                                                    -       -  
discount
    -                       (36,729 )     -       36,729               -  
Preferred stock dividend
    -       -               (183,719 )     -       -       -       (183,719 )
Issuance of common stock
    -       33,668       (33,668 )     -       -       -       -       -  
Stock based compensation
                    1,589                                       1,589  
Minimum pension adjustment
                                                               
(net of income taxes of $2,917)
    -       -       -       -       -       -       2,145       2,145  
Net loss
    -       -       -       (1,400,380 )     -       -       -       (1,400,380 )
Change in unrealized gain on
                                                               
investment securities available-for-sale,
                                                               
net of reclassification and tax effect
    -       -       -       -       -       -       (357,431 )     (357,431 )
                                                                 
Balance, March 31, 2012
  $ 58,952     $ 17,007,180     $ 40,700,099     $ (23,516,385 )   $ 732,479     $ (309,744 )   $ (362,735 )   $ 34,309,846  
                                                                 
See accompanying notes to consolidated financial statements.
                                                 


 
6

 

Village Bank and Trust Financial Corp. and Subsidiary
 
Consolidated Statements of Cash Flows
 
Three Months Ended March 31, 2013 and 2012
 
(Unaudited)
 
             
   
Three Months Ended March 31,
 
   
2013
   
2012
 
             
Cash Flows from Operating Activities
           
Net loss
  $ (511,034 )   $ (1,400,380 )
Adjustments to reconcile net loss to net
               
cash provided by (used in) operating activities:
               
Depreciation and amortization
    258,649       344,244  
Deferred income taxes
    (108,145 )     1,104  
Valuation allowance
    -       476,129  
Provision for loan losses
    823,000       1,735,000  
Write-down of other real estate owned
    397,053       670,023  
Gain on securities sold
    (90,067 )     (164,207 )
Gain on loans sold
    (1,955,717 )     (1,750,663 )
Gain on sale of premises and equipment
    (598,182 )     -  
(Gain) loss on sale of other real estate owned
    129,821       4,355  
Stock compensation expense
    241       1,589  
Proceeds from sale of mortgage loans
    67,727,357       64,848,047  
Origination of mortgage loans for sale
    (57,961,082 )     (64,120,807 )
Amortization of premiums and accretion of discounts on securities, net
    86,934       39,306  
Decrease in interest receivable
    96,371       146,743  
Increase in bank owned life insurance
    (50,307 )     (50,392 )
(Increase) decrease  in other assets
    730,900       2,899,037  
Increase (decrease) in interest payable
    69,892       74,487  
Increase (decrease) in other liabilities
    324,488       (2,959,078 )
Net cash provided by operating activities
    9,370,172       794,537  
                 
Cash Flows from Investing Activities
               
Purchases of available for sale securities
    (12,791,077 )     (20,764,694 )
Proceeds from the sale or calls of available for sale securities
    8,244,304       14,277,005  
Proceeds from maturities and principal payments of  available for sale securities
    -       874,715  
Net decrease (increase) in loans
    26,731,220       5,847,047  
Proceeds from sale of other real estate owned
    1,162,364       526,370  
Purchases of premises and equipment
    481,213       (44,839 )
Proceeds from sale of premises and equipment
    1,681,624       -  
Net cash provided by  investing activities
    25,509,648       715,604  
                 
Cash Flows from Financing Activities
               
Net increase (decrease) in deposits
    (14,903,717 )     (20,127,993 )
Net increase (decrease) in Federal Home Loan Bank Advances
    (1,000,000 )     (1,000,000 )
Net increase (decrease) in other borrowings
    (2,969,465 )     (571,092 )
Net cash used in financing activities
    (18,873,182 )     (21,699,085 )
                 
Net increase (decrease) in cash and cash equivalents
    16,006,638       (20,188,944 )
Cash and cash equivalents, beginning of period
    53,130,942       62,786,016  
                 
Cash and cash equivalents, end of period
  $ 69,137,580     $ 42,597,072  
                 
Supplemental Schedule of Non Cash Activities
               
Real estate owned assets acquired in settlement of loans
  $ 2,868,378     $ 6,614,046  
Dividends on preferred stock accrued
  $ 184,224     $ 183,719  
                 
See accompanying notes to consolidated financial statements.
               


 
7

 


Village Bank and Trust Financial Corp. and Subsidiary
Notes to Condensed Consolidated Financial Statements
Three Months Ended March 31, 2013 and 2012
(Unaudited)


Note 1 - Principles of presentation

Village Bank and Trust Financial Corp. (the “Company”) is the holding company of Village Bank (the “Bank”).  The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s subsidiaries.  All material intercompany balances and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying condensed consolidated financial statements of the Company have been prepared on the accrual basis in accordance with generally accepted accounting principles for interim financial information.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included.  The results of operations for the three month period ended March 31, 2013 are not necessarily indicative of the results to be expected for the full year ending December 31, 2013.  The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission.

Note 2 - Use of estimates

The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the statements of financial condition and revenues and expenses during the reporting period.  Actual results could differ significantly from those estimates.  A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses and the related provision.













 
8

 


Note 3 – Earnings (loss) per common share

The following table presents the basic and diluted earnings per share computations:
 
   
Three Months Ended March 31,
 
   
2013
   
2012
 
Numerator
           
Net income (loss) - basic and diluted
  $ (511,034 )   $ (1,400,380 )
Preferred stock dividend and accretion
    221,328       220,448  
Net income (loss) available to common
               
shareholders
  $ (732,362 )   $ (1,620,828 )
                 
Denominator
               
Weighted average shares outstanding - basic
    4,253,932       4,249,336  
Dilutive effect of common stock options and
               
      restricted stock awards
    -       -  
                 
Weighted average shares outstanding - diluted
    4,253,932       4,249,336  
                 
Earnings (loss) per share - basic and diluted
               
Earnings (loss) per share - basic
  $ (0.17 )   $ (0.38 )
Effect of dilutive common stock options
    -       -  
                 
Earnings (loss) per share - diluted
  $ (0.17 )   $ (0.38 )


Outstanding options and warrants to purchase common stock were considered in the computation of diluted earnings per share for the periods presented.  Stock options for 254,630 and 264,530 shares of common stock were not included in computing diluted earnings per share for the three months ended March 31, 2013 and 2012, respectively, because their effects were anti-dilutive.  Warrants for 499,029 shares of common stock were not included in computing earnings per share in 2013 and 2012 because their effects were also anti-dilutive.

Note 4 – Investment securities

At March 31, 2013 and December 31, 2012, all of our securities were classified as available for sale.  The following table presents the composition of our investment portfolio at the dates indicated (dollars in thousands).

 
9

 

               
Gross
   
Gross
   
Estimated
       
   
Par
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
   
Average
 
   
Value
   
Cost
   
Gains
   
Losses
   
Value
   
Yield
 
                                     
March 31, 2013
                                   
US Government Agencies
                                   
Five to ten years
  $ 3,500     $ 4,375     $ -     $ (33 )   $ 4,342       1.97 %
More than ten years
    12,000       11,715       40       -       11,755       2.91 %
Total
    15,500       16,090       40       (33 )     16,097       2.65 %
Mortgage-backed securities
                                               
More than ten years
    1,445       1,513       2       (2 )     1,513       0.97 %
Total
    1,445       1,513       2       (2 )     1,513       0.97 %
Municipals
                                               
Five to ten years
    3,700       4,226       2       (26 )     4,202       2.16 %
More than ten years
    6,280       7,984       3       (164 )     7,823       2.27 %
Total
    9,980       12,210       5       (190 )     12,025       2.23 %
                                                 
Total investment securities
  $ 26,925     $ 29,813     $ 47     $ (225 )   $ 29,635       2.40 %
                                                 
December 31, 2012
                                               
US Government Agencies
                                               
More than ten years
  $ 10,500     $ 11,394     $ 8     $ (15 )   $ 11,387       2.27 %
Total
    10,500       11,394       8       (15 )     11,387       2.27 %
Mortgage-backed securities
                                               
More than ten years
    1,744       1,830       1       (2 )     1,829       0.97 %
Total
    1,744       1,830       1       (2 )     1,829       0.97 %
Municipals
                                               
One to five years
    1,000       1,100       -       (22 )     1,078       3.25 %
Five to ten years
    3,500       4,031       -       (47 )     3,984       2.29 %
More than ten years
    5,280       6,908       10       (42 )     6,876       2.70 %
Total
    9,780       12,039       10       (111 )     11,938       2.61 %
                                                 
Total investment securities
  $ 22,024     $ 25,263     $ 19     $ (128 )   $ 25,154       2.34 %
                                                 


Investment securities available for sale that have an unrealized loss position at March 31, 2013 and December 31, 2012 are detailed below (in thousands):

 
10

 
   
Securities in a loss
   
Securities in a loss
             
   
Position for less than
   
Position for more than
             
   
12 Months
   
12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair Value
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
(Loss)
   
Losses
   
Value
   
Losses
 
                                     
March 31, 2013
     
Investment Securities
                                   
available for sale
                                   
US Treasuries
  $ 6,241     $ (33 )   $ -     $ -     $ 6,241     $ (33 )
Municipals
    8,797       (190 )     -       -       8,797       (190 )
Mortgage-backed securities
    162       (2 )     -       -       162       (2 )
                                                 
Total
  $ 15,200     $ (225 )   $ -     $ -     $ 15,200     $ (225 )
                                                 
December 31, 2012
     
Investment Securities
                                               
available for sale
                                               
US Treasuries
  $ 4,378     $ (15 )   $ -     $ -     $ 4,378     $ (15 )
Municipals
    8,064       (111 )     -       -       8,064       (111 )
Mortgage-backed securities
    167       (2 )     -       -       167       (2 )
                                                 
Total
  $ 12,609     $ (128 )   $ -     $ -     $ 12,609     $ (128 )


Management does not believe that any individual unrealized loss as of March 31, 2013 and December 31, 2012 is other than a temporary impairment.  These unrealized losses are primarily attributable to changes in interest rates.  As of March 31, 2013, management does not have the intent to sell any of the securities classified as available for sale and management believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.

Note 5 – Loans and allowance for loan losses

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated (dollars in thousands).

 
11

 
   
March 31, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
Construction and land development
                       
Residential
  $ 3,002       0.93 %   $ 2,845       0.80 %
Commercial
    36,209       11.18 %     41,210       11.61 %
    Total construction and land development
    39,211       12.11 %     44,055       12.41 %
Commercial real estate
                               
Farmland
    2,571       0.79 %     2,581       0.73 %
Commercial real estate - owner occupied
    81,459       25.14 %     92,773       26.14 %
Commercial real estate - non-owner occupied
    47,470       14.65 %     54,551       15.37 %
Multifamily
    8,908       2.75 %     7,979       2.25 %
    Total commercial real estate
    140,408       43.33 %     157,884       44.49 %
Consumer real estate
                               
Home equity lines
    24,614       7.60 %     25,521       7.19 %
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    78,796       24.32 %     80,788       22.76 %
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    8,668       2.67 %     9,517       2.68 %
   Total consumer real estate
    112,078       34.59 %     115,827       32.63 %
Commercial and industrial loans
                               
(except those secured by real estate)
    29,647       9.15 %     34,384       9.69 %
Consumer and other
    2,660       0.82 %     2,761       0.78 %
                                 
Total Loans
    324,004       100.0 %     354,910       100.0 %
Deferred loan cost (unearned income), net
    783               788          
Less:  Allowance for loan losses
    (10,320 )             (10,808 )        
                                 
    $ 314,467             $ 344,890          

The Company assigns risk rating classifications to its loans.  These risk ratings are divided into the following groups:

 
·
Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating.  1-4 assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;
 
·
Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;
 
·
Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;
 
·
Risk rated 7 loans have all the weaknesses inherent in substandard loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 
12

 
 
The following tables provide information on the risk rating of loans at the dates indicated:

   
March 31, 2013
 
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Total
 
      1-4       5       6       7    
Loans
 
                                       
Construction and land development
                                     
Residential
  $ 2,794,616     $ 207,597     $ -     $ -     $ 3,002,213  
Commercial
    14,490,031       7,441,270       14,277,551       -       36,208,852  
Total construction and land development
    17,284,647       7,648,867       14,277,551       -       39,211,065  
Commercial real estate
                                       
Farmland
    1,521,465               1,049,489       -       2,570,954  
Commercial real estate - owner occupied
    54,565,411       13,111,802       13,781,322       -       81,458,535  
Commercial real estate - non-owner occupied
    17,545,150       17,237,400       12,431,518       256,067       47,470,135  
Multifamily
    5,426,270       1,072,501       2,409,185       -       8,907,956  
Total commercial real estate
    79,058,296       31,421,703       29,671,514       256,067       140,407,580  
Consumer real estate
                                       
Home equity lines
    19,225,118       1,533,770       3,855,576       -       24,614,464  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    48,349,677       12,472,929       17,973,830       -       78,796,436  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    6,756,458       205,169       1,706,021       -       8,667,648  
Total consumer real estate
    74,331,253       14,211,868       23,535,427       -       112,078,548  
Commercial and industrial loans
                                       
(except those secured by real estate)
    21,795,862       2,987,775       4,863,410       -       29,647,047  
Consumer and other
    2,316,604       172,908       170,740       -       2,660,252  
                                         
Total loans
  $ 194,786,662     $ 56,443,121     $ 72,518,642     $ 256,067     $ 324,004,492  
                                         
                                         
   
December 31, 2012
 
                                         
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Total
 
      1-4       5       6       7    
Loans
 
                                         
Construction and land development:
                                       
Residential
  $ 2,173,885     $ 671,709     $ -     $ -     $ 2,845,594  
Commercial
    17,638,646       7,496,950       16,074,235       -       41,209,831  
    Total construction and land development
    19,812,531       8,168,659       16,074,235       -       44,055,425  
                                         
Commercial real estate:
                                       
Farmland
    1,531,808       -       1,049,489       -       2,581,297  
Commercial real estate - owner occupied
    63,772,277       19,273,229       9,727,026       -       92,772,532  
Commercial real estate - non-owner occupied
    24,199,053       15,671,633       14,170,546       509,585       54,550,817  
Multifamily
    5,438,427       1,739,283       800,679       -       7,978,389  
    Total commercial real estate
    94,941,565       36,684,145       25,747,740       509,585       157,883,035  
Consumer real estate:
                                       
Home equity lines
    20,180,206       2,015,248       3,325,943       -       25,521,397  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    49,659,724       11,235,261       19,893,440       -       80,788,425  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    7,385,394       342,770       1,789,081       -       9,517,245  
   Total consumer real estate
    77,225,324       13,593,279       25,008,464       -       115,827,067  
Commercial and industrial loans
                                       
(except those secured by real estate)
    26,712,028       2,590,735       5,081,354       -       34,384,117  
Consumer and other
    2,446,304       261,140       53,178       -       2,760,622  
                                         
Total Loans
  $ 221,137,752     $ 61,297,958     $ 71,964,971     $ 509,585     $ 354,910,266  
                                         
                                         
 
 
13

 

 
The following table presents the aging of the recorded investment in past due loans and leases as of the dates indicated:

   
March 31, 2013
 
                                       
Recorded
 
               
Greater
                     
Investment >
 
   
30-59 Days
   
60-89 Days
   
Than
   
Total Past
         
Total
   
90 Days and
 
   
Past Due
   
Past Due
   
90 Days
   
Due
   
Current
   
Loans
   
Accruing
 
                                           
Construction and land development
                                         
Residential
  $ -     $ -     $ -     $ -     $ 3,002,213     $ 3,002,213     $ -  
Commercial
    86,941       6,051       120,489       213,481       35,995,371       36,208,852       120,489  
    Total construction and land development
    86,941       6,051       120,489       213,481       38,997,584       39,211,065       120,489  
                                                         
Commercial real estate
                                                       
Farmland
    -       -       -       -       2,570,954       2,570,954       -  
Commercial real estate - owner occupied
    1,576,739       376,707       -       1,953,446       79,505,089       81,458,535       -  
Commercial real estate - non-owner occupied
    1,186,292       -       -       1,186,292       46,283,843       47,470,135       -  
Multifamily
    -       -       -       -       8,907,956       8,907,956       -  
    Total commercial real estate
    2,763,031       376,707       -       3,139,738       137,267,842       140,407,580       -  
                                                         
Consumer real estate
                                                       
Home equity lines
    168,713       -       -       168,713       24,445,751       24,614,464       -  
Secured by 1-4 family residential,
                                                       
secured by first deeds of trust
    1,121,751       60,778       -       1,182,529       77,613,907       78,796,436       -  
Secured by 1-4 family residential,
                                                       
secured by second deeds of trust
    515,043       -       -       515,043       8,152,605       8,667,648       -  
   Total consumer real estate
    1,805,507       60,778       -       1,866,285       110,212,263       112,078,548       -  
Commercial and industrial loans
                                                       
(except those secured by real estate)
    246,611       -       -       246,611       29,400,436       29,647,047       -  
Consumer and other
    11,535       13,962       -       25,497       2,634,755       2,660,252       -  
                                                         
Total loans
  $ 4,913,625     $ 457,498     $ 120,489     $ 5,491,612     $ 318,512,880     $ 324,004,492     $ 120,489  
                                                         
                                                         
 
    December 31, 2012  
                                       
Recorded
 
               
Greater
                     
Investment >
 
   
30-59 Days
   
60-89 Days
   
Than
   
Total Past
         
Total
   
90 Days and
 
   
Past Due
   
Past Due
   
90 Days
   
Due
   
Current
   
Loans
   
Accruing
 
                                           
                                           
Construction and land development:
                                         
Residential
  $ -     $ -     $ -     $ -     $ 2,845,594     $ 2,845,594     $ -  
Commercial
    76,351       10,709       -       87,060       41,122,771       41,209,831       -  
    Total construction and land development
    76,351       10,709       -       87,060       43,968,365       44,055,425       -  
                                                         
Commercial real estate:
                                                       
Farmland
    -       -       -       -       2,581,297       2,581,297       -  
Commercial real estate - owner occupied
    708,278       377,563       -       1,085,841       91,686,691       92,772,532       -  
Commercial real estate - non-owner occupied
    1,094,906       714,655       -       1,809,561       52,741,256       54,550,817       -  
Multifamily
    -       -       -       -       7,978,389       7,978,389       -  
    Total commercial real estate
    1,803,184       1,092,218       -       2,895,402       154,987,633       157,883,035       -  
Consumer real estate:
                                                       
Home equity lines
    110,614       24,746       16,130       151,490       25,369,907       25,521,397       16,130  
Secured by 1-4 family residential,
                                                       
secured by first deeds of trust
    645,807       1,507,073       -       2,152,880       78,635,545       80,788,425       -  
Secured by 1-4 family residential,
                                                       
secured by second deeds of trust
    157,816       50,016       50,000       257,832       9,259,413       9,517,245       50,000  
   Total consumer real estate
    914,237       1,581,835       66,130       2,562,202       113,264,865       115,827,067       66,130  
Commercial and industrial loans
                                                       
(except those secured by real estate)
    40,171       31,057       49,139       120,367       34,263,750       34,384,117       49,139  
Consumer and other
    4,286       36,030       -       40,316       2,720,306       2,760,622       -  
                                                         
Total Loans
  $ 2,838,229     $ 2,751,849     $ 115,269     $ 5,705,347     $ 349,204,919     $ 354,910,266     $ 115,269  
                                                         
 
Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.  Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans.  If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.  Impaired loans are set forth in the following table as of the dates indicated.
 
 
14

 

 
   
March 31, 2013
 
                   
         
Unpaid
       
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
 
                   
With no related allowance recorded
                 
Construction and land development
                 
Residential
  $ 140,000     $ -     $ -  
Commercial
    7,083,847       10,655,937       -  
    Total construction and land development
    7,223,847       10,655,937       -  
Commercial real estate
                       
Farmland
    -       -       -  
Commercial real estate - owner occupied
    7,221,916       7,267,500       -  
Commercial real estate - non-owner occupied
    14,521,050       14,719,050       -  
Multifamily
    3,035,772       3,035,772       -  
    Total commercial real estate
    24,778,738       25,022,322       -  
Consumer real estate
                       
Home equity lines
    1,801,054       1,813,711       -  
Secured by 1-4 family residential, secured by first deeds of trust
    12,471,376       12,791,266       -  
Secured by 1-4 family residential, secured by second deeds of trust
    502,373       623,745       -  
   Total consumer real estate
    14,774,803       15,228,722       -  
Commercial and industrial loans (except those secured by real estate)
    887,084       1,486,503       -  
Consumer and other
    65,200       65,200       -  
    $ 47,729,672     $ 52,458,684     $ -  
                         
With an allowance recorded
                       
Construction and land development
                       
Residential
  $ -     $ -     $ -  
Commercial
    1,511,725       1,511,725       576,673  
    Total construction and land development
    1,511,725       1,511,725       576,673  
Commercial real estate
                       
Farmland
    1,049,489       1,049,489       808,000  
Commercial real estate - owner occupied
    2,232,374       2,232,374       498,556  
Commercial real estate - non-owner occupied
    253,517       509,585       253,517  
Multifamily
    -       -       -  
    Total commercial real estate
    3,535,380       3,791,448       1,560,073  
Consumer real estate
                       
Home equity lines
    269,450       269,450       39,000  
Secured by 1-4 family residential, secured by first deeds of trust
    831,350       831,350       71,301  
Secured by 1-4 family residential, secured by second deeds of trust
    331,943       380,227       37,054  
   Total consumer real estate
    1,432,743       1,481,027       147,355  
Commercial and industrial loans (except those secured by real estate)
    64,672       64,672       37,600  
Consumer and other
    -       -       -  
    $ 6,544,520     $ 6,848,872     $ 2,321,701  
                         
Total
                       
Construction and land development
                       
Residential
  $ 140,000     $ -     $ -  
Commercial
    8,595,572       12,167,662       576,673  
    Total construction and land development
    8,735,572       12,167,662       576,673  
Commercial real estate
                       
Farmland
    1,049,489       1,049,489       808,000  
Commercial real estate - owner occupied
    9,454,290       9,499,874       498,556  
Commercial real estate - non-owner occupied
    14,774,567       15,228,635       253,517  
Multifamily
    3,035,772       3,035,772       -  
    Total commercial real estate
    28,314,118       28,813,770       1,560,073  
Consumer real estate
                       
Home equity lines
    2,070,504       2,083,161       39,000  
Secured by 1-4 family residential, secured by first deeds of trust
    13,302,726       13,622,616       71,301  
Secured by 1-4 family residential, secured by second deeds of trust
    834,316       1,003,972       37,054  
   Total consumer real estate
    16,207,546       16,709,749       147,355  
Commercial and industrial loans (except those secured by real estate)
    951,756       1,551,175       37,600  
Consumer and other
    65,200       65,200       -  
    $ 54,274,192     $ 59,307,556     $ 2,321,701  
                         
 
 
15

 
 
 
   
December 31, 2012
 
                   
         
Unpaid
       
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
 
                   
With no related allowance recorded
                 
Construction and land development
                 
Residential
  $ -     $ -     $ -  
Commercial
    8,254,440       13,625,670       -  
    Total construction and land development
    8,254,440       13,625,670       -  
Commercial real estate
                       
Farmland
    1,049,489       1,049,489       -  
Commercial real estate - owner occupied
    8,250,071       8,715,684       -  
Commercial real estate - non-owner occupied
    13,777,787       14,124,016       -  
Multifamily
    2,825,274       2,825,274       -  
    Total commercial real estate
    25,902,621       26,714,463       -  
Consumer real estate
                       
Home equity lines
    1,939,020       1,938,005       -  
Secured by 1-4 family residential, secured by first deeds of trust
    10,686,435       10,928,024       -  
Secured by 1-4 family residential, secured by second deeds of trust
    601,805       861,158       -  
   Total consumer real estate
    13,227,260       13,727,187       -  
Commercial and industrial loans (except those secured by real estate)
    858,136       1,421,196       -  
Consumer and other
    50,415       50,390       -  
    $ 48,292,872     $ 55,538,906     $ -  
                         
With an allowance recorded
                       
Construction and land development:
                       
Residential
  $ -     $ -     $ -  
Commercial
    430,828       430,828       62,643  
    Total construction and land development
    430,828       430,828       62,643  
Commercial real estate:
                       
Farmland
                       
Commercial real estate - owner occupied
    2,940,647       3,261,584       663,330  
Commercial real estate - non-owner occupied
    1,434,195       1,434,195       508,704  
Multifamily
    -       -       -  
    Total commercial real estate
    4,374,842       4,695,779       1,172,034  
Consumer real estate:
                       
Home equity lines
    -       -       -  
Secured by 1-4 family residential, secured by first deeds of trust
    1,155,027       1,155,027       20,896  
Secured by 1-4 family residential, secured by second deeds of trust
    338,345       386,629       43,456  
   Total consumer real estate
    1,493,372       1,541,656       64,352  
Commercial and industrial loans (except those secured by real estate)
    182,840       182,840       39,243  
Consumer and other
    -       -       -  
    $ 6,481,882     $ 6,851,103     $ 1,338,272  
                         
Total
                       
Construction and land development
                       
Residential
  $ -     $ -     $ -  
Commercial
    8,685,268       14,056,498       62,643  
    Total construction and land development
    8,685,268       14,056,498       62,643  
Commercial real estate
                       
Farmland
    1,049,489       1,049,489       -  
Commercial real estate - owner occupied
    11,190,718       11,977,268       663,330  
Commercial real estate - non-owner occupied
    15,211,982       15,558,211       508,704  
Multifamily
    2,825,274       2,825,274       -  
    Total commercial real estate
    30,277,463       31,410,242       1,172,034  
Consumer real estate
                       
Home equity lines
    1,939,020       1,938,005       -  
Secured by 1-4 family residential, secured by first deeds of trust
    11,841,462       12,083,051       20,896  
Secured by 1-4 family residential, secured by second deeds of trust
    940,150       1,247,787       43,456  
   Total consumer real estate
    14,720,632       15,268,843       64,352  
Commercial and industrial loans (except those secured by real estate)
    1,040,976       1,604,036       39,243  
Consumer and other
    50,415       50,390       -  
    $ 54,774,754     $ 62,390,009     $ 1,338,272  
                         
                         
                         

 
16

 
 
The following is a summary of average recorded investment in impaired loans with and without a valuation allowance and interest income recognized on those loans for periods indicated:

   
For the Three Months
   
For the Three Months
 
   
Ended March 31, 2013
   
Ended March 31, 2012
 
                         
   
Average
   
Interest
   
Average
   
Interest
 
   
Recorded
   
Income
   
Recorded
   
Income
 
   
Investment
   
Recognized
   
Investment
   
Recognized
 
                         
With no related allowance recorded
                       
Construction and land development
                       
Residential
  $ -     $ -     $ 1,623,982     $ 7,401  
Commercial
    7,406,223       60,175       13,733,356       122,256  
    Total construction and land development
    7,406,223       60,175       15,357,338       129,657  
Commercial real estate
                               
Farmland
    -       -       -          
Commercial real estate - owner occupied
    7,119,781       136,728       9,534,154       99,464  
Commercial real estate - non-owner occupied
    14,579,438       206,192       8,079,949       173,981  
Multifamily
    3,043,344       51,755       613,649       8,828  
    Total commercial real estate
    24,742,563       394,675       18,227,752       282,273  
Consumer real estate
                               
Home equity lines
    1,801,054       -       1,392,575       5,024  
Secured by 1-4 family residential, secured by first deeds of trust
    12,541,557       128,977       10,085,840       107,583  
Secured by 1-4 family residential, secured by second deeds of trust
    507,002       6,789       488,266       5,550  
   Total consumer real estate
    14,849,613       135,766       11,966,681       118,157  
Commercial and industrial loans (except those secured by real estate)
    897,988       8,944       1,255,796       8,612  
Consumer and other
    68,248       1,092       361,260       648  
    $ 47,964,635     $ 600,652     $ 47,168,827     $ 539,347  
                                 
With an allowance recorded
                               
Construction and land development
                               
Residential
  $ -     $ -     $ 179,863     $ -  
Commercial
    458,065       1,628       10,555,142       37,116  
    Total construction and land development
    458,065       1,628       10,735,005       37,116  
Commercial real estate
                               
Farmland
    1,049,489       1,100       -          
Commercial real estate - owner occupied
    2,400,696       11,935       4,673,921          
Commercial real estate - non-owner occupied
    256,067       -       961,039       -  
Multifamily
    -       -       -       -  
    Total commercial real estate
    3,706,252       13,035       5,634,960       -  
Consumer real estate
                               
Home equity lines
    269,450       6,792       135,404       156  
Secured by 1-4 family residential, secured by first deeds of trust
    835,505       6,076       2,430,635       10,377  
Secured by 1-4 family residential, secured by second deeds of trust
    349,192       6,401       -          
   Total consumer real estate
    1,454,147       19,269       2,566,039       10,533  
Commercial and industrial loans (except those secured by real estate)
    64,672       1,290       493,239       7,516  
Consumer and other
    -       -       -       -  
    $ 5,683,136     $ 35,222     $ 19,429,243     $ 55,165  
                                 
Total
                               
Construction and land development
                               
Residential
  $ -     $ -     $ 1,803,845     $ 7,401  
Commercial
    7,864,288       61,803       24,288,498       159,372  
    Total construction and land development
    7,864,288       61,803       26,092,343       166,773  
Commercial real estate
                               
Farmland
    1,049,489       1,100       -       -  
Commercial real estate - owner occupied
    9,520,477       148,663       14,208,075       99,464  
Commercial real estate - non-owner occupied
    14,835,505       206,192       9,040,988       173,981  
Multifamily
    3,043,344       51,755       613,649       8,828  
    Total commercial real estate
    28,448,815       407,710       23,862,712       282,273  
Consumer real estate
                               
Home equity lines
    2,070,504       6,792       1,527,979       5,180  
Secured by 1-4 family residential, secured by first deeds of trust
    13,377,062       135,053       12,516,475       117,960  
Secured by 1-4 family residential, secured by second deeds of trust
    856,194       13,190       488,266       5,550  
   Total consumer real estate
    16,303,760       155,035       14,532,720       128,690  
Commercial and industrial loans (except those secured by real estate)
    962,660       10,234       1,749,035       16,128  
Consumer and other
    68,248       1,092       361,260       648  
    $ 53,647,771     $ 635,874     $ 66,598,070     $ 594,512  
                                 
 
Included in impaired loans are loans classified as troubled debt restructurings (TDRs). A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrowers financial difficulties that it would not otherwise consider. For loans classified as impaired TDRs, the Company further evaluates the loans as performing or nonperforming. If, at the time of restructure, the loan is not
 
 
17

 
 
considered nonaccrual, it will be classified as performing. TDRs originally classified as nonperforming are able to be reclassified as performing if, subsequent to restructure, they experience six months of payment performance according to the restructured terms. The following is a summary of performing and nonaccrual TDRs and the related specific valuation allowance by portfolio segment as of the dates indicated.

   
March 31, 2013
 
                     
Specific
 
                     
Valuation
 
   
Total
   
Performing
   
Nonaccrual
   
Allowance
 
Construction and land development
                       
Residential
  $ -     $ -     $ -     $ -  
Commercial
    5,273,375       3,462,875       1,810,500       24,335  
Total construction and land development
    5,273,375       3,462,875       1,810,500       24,335  
                                 
Commercial real estate
                               
Farmland
    -       -       -       -  
Commercial real estate - owner occupied
    7,085,576       6,611,634       473,942       16,158  
Commercial real estate - non-owner occupied
    13,904,061       13,196,846       707,215       -  
Multifamily
    3,035,772       3,035,772       -       -  
Total commercial real estate
    24,025,409       22,844,252       1,181,157       16,158  
                                 
Consumer real estate
                               
Home equity lines
    -       -       -       -  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    7,447,130       3,572,375       3,874,755       33,299  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    331,943       -       331,943       37,054  
Total consumer real estate
    7,779,073       3,572,375       4,206,698       70,353  
Commercial and industrial loans
                               
(except those secured by real estate)
    321,477       123,234       198,243       -  
Consumer and other
    -       -       -       -  
                                 
Total loans
  $ 37,399,334     $ 30,002,736     $ 7,396,598     $ 110,846  
                                 
Number of loans
    78       51       27       4  

 
18

 

   
December 31, 2012
 
                     
Specific
 
                     
Valuation
 
   
Total
   
Performing
   
Nonaccrual
   
Allowance
 
                         
Construction and land development
                       
Commercial
  $ 6,116,248     $ 3,728,403     $ 2,387,845     $ -  
Total construction and land development
    6,116,248       3,728,403       2,387,845       -  
Commercial real estate
                               
Commercial real estate - owner occupied
    8,881,257       6,373,122       2,508,135       3,321  
Commercial real estate - non-owner occupied
    13,266,992       12,805,727       461,265       -  
Multifamily
    2,825,274       2,825,274       -       -  
Total commercial real estate
    24,973,523       22,004,123       2,969,400       3,321  
Consumer real estate
                               
Home equity lines
    -       -       -       -  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    7,011,329       3,431,124       3,580,205       15,633  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    338,344       -       338,344       43,456  
Total consumer real estate
    7,349,673       3,431,124       3,918,549       59,089  
Commercial and industrial loans
                               
(except those secured by real estate)
    380,427       5,803       374,624       39,243  
                                 
Total
  $ 38,819,871     $ 29,169,453     $ 9,650,418     $ 101,653  
                                 
Number of loans
    73       46       27       7  

The following table provides information about TDRs identified during the indicated periods:

   
March 31, 2013
   
December 31, 2012
 
         
Pre-
   
Post-
         
Pre-
   
Post-
 
         
Modification
   
Modification
         
Modification
   
Modification
 
   
Number of
   
Recorded
   
Recorded
   
Number of
   
Recorded
   
Recorded
 
   
Loans
   
Balance
   
Balance
   
Loans
   
Balance
   
Balance
 
                                     
Construction and land development:
                                   
Residential
    -     $ -     $ -           $ -     $ -  
Commercial
    1       196,440       196,440       6       653,612       653,612  
    Total construction and land development
    1       196,440       196,440       6       653,612       653,612  
Commercial real estate:
                                            -  
Farmland
            -       -                       -  
Commercial real estate - owner occupied
    1       277,272       277,272       1       522,715       522,715  
Commercial real estate - non-owner occupied
    -       -       -       6       2,102,231       2,102,231  
Multifamily
    -       -       -       -       -       -  
    Total commercial real estate
    1       277,272       277,272       7       2,624,946       2,624,946  
Consumer real estate:
                                               
Home equity lines
    -       -       -       -       -       -  
Secured by 1-4 family residential,
                                               
secured by first deeds of trust
    4       437,089       437,089       25       5,570,245       5,570,245  
Secured by 1-4 family residential,
                                               
secured by second deeds of trust
    -       -       -       1       338,344       338,344  
   Total consumer real estate
    4       437,089       437,089       26       5,908,589       5,908,589  
Commercial and industrial loans
                                               
(except those secured by real estate)
    -       -       -       1       117,813       117,813  
Consumer and other
    -       -       -       -       -       -  
      6     $ 910,801     $ 910,801       40     $ 9,304,960     $ 9,304,960  


 
19

 

The following table provides information about defaults of TDRs for the period indicated:

   
Three Months Ended
 
   
March 31, 2013
 
   
Number of
   
Recorded
 
Defaults on TDRs
 
Loans
   
Balance
 
Construction and land development
           
Residential
           
Commercial
    4     $ 1,403,928  
Total construction and land development
    4       1,403,928  
Commercial real estate
               
Farmland
    -       -  
Commercial real estate - owner occupied
    1       473,942  
Commercial real estate - non-owner occupied
    -       -  
Multifamily
    1       473,942  
Total commercial real estate
               
Consumer real estate
               
Home equity lines
    -       -  
Secured by 1-4 family residential,
               
secured by first deeds of trust
    3       414,216  
Secured by 1-4 family residential,
               
secured by second deeds of trust
    -       -  
Total consumer real estate
    3       414,216  
Commercial and industrial loans
               
(except those secured by real estate)
    3       206,760  
Consumer and other
    -       -  
                 
Total
    11     $ 2,498,846  
                 
 
 
20

 

Activity in the allowance for loan losses is as follows for the periods indicated:

   
Allowance for Loan Losses
 
   
Beginning
   
Provision for
               
Ending
 
   
Balance
   
Loan Losses
   
Charge-offs
   
Recoveries
   
Balance
 
Three Months Ended March 31, 2013
                             
Construction and land development
                             
Residential
  $ 494,742     $ -     $ -     $ 450     $ 495,192  
Commercial
    4,611,410       15,000       (84,284 )     -       4,542,126  
Commercial real estate
                                       
Farmland
    -       808,000       -       -       808,000  
Commercial real estate - owner occupied
    1,358,863       -       (136,378 )     -       1,222,485  
Commercial real estate - non-owner occupied
    816,852       -       (256,068 )     -       560,784  
Multifamily
    23,434       -       -       -       23,434  
Consumer real estate
                                       
Home equity lines
    658,135       -       (54,657 )     200       603,678  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    1,358,102       -       (343,133 )     8,026       1,022,995  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    223,307       -       (214,720 )     3,035       11,622  
Commercial and industrial loans
                                       
(except those secured by real estate)
    1,161,654       -       (288,831 )     56,376       929,199  
Consumer and other
    101,328       -       (3,762 )     2,884       100,450  
                                         
Total
  $ 10,807,827     $ 823,000     $ (1,381,833 )   $ 70,971     $ 10,319,965  
                                         
Year Ended December 31, 2012
                                       
Construction and land development
                                       
Residential
  $ 704,728     $ 542,067     $ (797,286 )   $ 45,233     $ 494,742  
Commercial
    6,798,177       3,444,160       (5,645,064 )     14,137       4,611,410  
Commercial real estate
                                       
Farmland
    -       -       -       -       -  
Commercial real estate - owner occupied
    1,496,466       623,552       (961,155 )     200,000       1,358,863  
Commercial real estate - non-owner occupied
    1,548,899       (300,898 )     (431,354 )     205       816,852  
Multifamily
    406,635       (373,238 )     (9,963 )     -       23,434  
Consumer real estate
                                       
Home equity lines
    860,307       668,614       (883,848 )     13,062       658,135  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    1,881,470       2,610,905       (3,220,072 )     85,799       1,358,102  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    397,504       468,192       (663,135 )     20,746       223,307  
Commercial and industrial loans
                                       
(except those secured by real estate)
    1,655,713       1,230,555       (1,879,517 )     154,903       1,161,654  
Consumer and other
    321,525       181,091       (408,302 )     7,014       101,328  
                                         
Total
  $ 16,071,424     $ 9,095,000     $ (14,899,696 )   $ 541,099     $ 10,807,827  
 
   
Allowance for Loan Losses
 
   
Beginning
   
Provision for
               
Ending
 
   
Balance
   
Loan Losses
   
Charge-offs
   
Recoveries
   
Balance
 
Three Months Ended March 31, 2012
                             
Construction and land development
                             
Residential
  $ 704,728     $ (16,552 )   $ (59,250 )   $ 450     $ 629,376  
Commercial
    6,798,177       1,028,575       (1,547,200 )     -       6,279,552  
Commercial real estate
                                       
Farmland
    -       -       -       -       -  
Commercial real estate - owner occupied
    1,496,466       379,264       (29,000 )     -       1,846,730  
Commercial real estate - non-owner occupied
    1,548,899       (695,971 )     (90,748 )     205       762,385  
Multifamily
    406,635       (314,860 )     -       -       91,775  
Consumer real estate
                                       
Home equity lines
    860,307       32,099       (122,500 )     692       770,598  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    1,881,470       364,980       (965,749 )     60,800       1,341,501  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    397,504       128,294       (190,639 )     193       335,352  
Commercial and industrial loans
                                       
(except those secured by real estate)
    1,655,713       759,125       (260,402 )     27,367       2,181,803  
Consumer and other
    321,525       70,046       (269,794 )     1,104       122,881  
                                         
Total
  $ 16,071,424     $ 1,735,000     $ (3,535,283 )   $ 90,811     $ 14,361,953  


 
21

 

Loans were evaluated for impairment as follows for the periods indicated:

   
Individually
   
Collectively
   
Total
 
Three Months Ended March 31, 2013
                 
Construction and land development
                 
Residential
  $ 576,000     $ 2,426,213     $ 3,002,213  
Commercial
    23,702,091       12,506,761       36,208,852  
Commercial real estate
                       
Farmland
    1,388,359       1,182,595       2,570,954  
Commercial real estate - owner occupied
    58,403,265       23,055,270       81,458,535  
Commercial real estate - non-owner occupied
    35,892,993       11,577,142       47,470,135  
Multifamily
    7,227,452       1,680,504       8,907,956  
Consumer real estate
                       
Home equity lines
    2,172,383       22,442,081       24,614,464  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    13,664,311       65,132,125       78,796,436  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    551,467       8,116,181       8,667,648  
Commercial and industrial loans
                       
(except those secured by real estate)
    12,018,582       17,628,465       29,647,047  
Consumer and other
    -       2,660,252       2,660,252  
              -          
Total
  $ 155,596,903     $ 168,407,589     $ 324,004,492  
                         
Year Ended December 31, 2012
                       
Construction and land development
                       
Residential
  $ 1,247,709     $ 1,597,885     $ 2,845,594  
Commercial
    27,351,857       13,857,974       41,209,831  
Commercial real estate
                       
Farmland
    1,391,501       1,189,796       2,581,297  
Commercial real estate - owner occupied
    67,167,587       25,604,945       92,772,532  
Commercial real estate - non-owner occupied
    41,801,577       12,749,240       54,550,817  
Multifamily
    6,461,639       1,516,750       7,978,389  
Consumer real estate
                       
Home equity lines
    2,185,040       23,336,357       25,521,397  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    15,526,551       65,261,874       80,788,425  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    557,600       8,959,645       9,517,245  
Commercial and industrial loans
                       
(except those secured by real estate)
    15,101,291       19,282,826       34,384,117  
Consumer and other
    -       2,760,622       2,760,622  
                         
Total
  $ 178,792,352     $ 176,117,914     $ 354,910,266  



 
22

 


Note 6 – Deposits

Deposits as of March 31, 2013 and December 31, 2012 were as follows:

   
March 31, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
                         
Demand accounts
  $ 62,301,743       14.8 %   $ 57,049,348       13.1 %
Interest checking accounts
    43,567,794       10.3 %     45,861,199       10.5 %
Money market accounts
    63,546,257       15.1 %     66,007,160       15.1 %
Savings accounts
    20,469,642       4.9 %     20,922,112       4.8 %
Time deposits of $100,000 and over
    107,426,419       25.5 %     113,332,481       26.0 %
Other time deposits
    124,107,390       29.4 %     133,150,662       30.5 %
                                 
Total
  $ 421,419,245       100.0 %   $ 436,322,962       100.0 %


Note 7 – Trust preferred securities

During the first quarter of 2005, Southern Community Financial Capital Trust I, a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable securities.  On February 24, 2005, $5.2 million of Trust Preferred Capital Notes were issued through a pooled underwriting.  The securities have a LIBOR-indexed floating rate of interest (three-month LIBOR plus 2.15%) which adjusts, and is payable, quarterly. The interest rate at March 31, 2013 was 2.43%.  The securities were redeemable at par beginning on March 15, 2010 and each quarter after such date until the securities mature on March 15, 2035.  No amounts have been redeemed at March 31, 2013 and there are no plans to do so.  The principal asset of the Trust is $5.2 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

During the third quarter of 2007, Village Financial Statutory Trust II, a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable securities.  On September 20, 2007, $3.6 million of Trust Preferred Capital Notes were issued through a pooled underwriting.  The securities  have a five year fixed income rate of 6.29% payable quarterly, converting after five years to a LIBOR-indexed floating rate of interest (three-month LIBOR plus 1.40%) which adjusts, and is also payable, quarterly.  The securities may be redeemed at par at any time commencing in December 2012 until the securities mature in 2037.  No amounts have been redeemed at March 31, 2013 and there are no plans to do so.  The principal asset of the Trust is $3.6 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion.  The portion of the Trust Preferred Capital Notes not considered as Tier 1 capital may be included in Tier 2 capital.

The obligations of the Company with respect to the issuance of the Trust Preferred Capital Notes constitute a full and unconditional guarantee by the Company of the Trust’s obligations with respect to the Trust Preferred Capital Notes.  Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related Trust Preferred Capital Notes and require a deferral of common dividends.  In consideration of our
 
 
23

 
 
agreements with our regulators, which require regulatory approval to make interest payments on these securities, the Company has deferred an aggregate of $716,347 in interest payments on the junior subordinated debt securities as March 31, 2013.  The Company has been deferring interest payments since June 2011.  Although we elected to defer payment of interest due, the amount has been accrued and is included in interest expense in the consolidated statement of operations.

Note 8 – Stock incentive plan

The Company has a stock incentive plan which authorizes the issuance of up to 455,000 shares of common stock to assist the Company in recruiting and retaining key personnel.

The following table summarizes stock options outstanding under the stock incentive plan at the indicated dates:

   
Three Months Ended March 31,
   
2013
 
2012
         
Weighted
                 
Weighted
         
         
Average
                 
Average
         
         
Exercise
   
Fair Value
 
Intrinsic
       
Exercise
   
Fair Value
 
Intrinsic
   
Options
   
Price
   
Per Share
 
Value
 
Options
   
Price
   
Per Share
 
Value
                                         
Options outstanding,
                                       
beginning of period
    255,630     $ 9.48     $ 4.70         264,980     $ 9.48     $ 4.73    
Granted
    -       -       -         -       -       -    
Forfeited
    (1,000 )     7.75       5.05         (450 )     8.50       4.88    
Exercised
    -       -       -         -       -       -    
Options outstanding,
                                                   
end of period
    254,630     $ 9.57     $ 4.64  
 $                -
    264,530     $ 9.65     $ 4.73  
 $                -
Options exercisable,
                                                   
end of period
    249,630                         261,530                    

The fair value of the stock is calculated under the same methodology as stock options and the expense is recognized over the vesting period.  Unamortized stock-based compensation related to nonvested share based compensation arrangements granted under the Incentive Plan as of March 31, 2013 and 2012 was $2,249 and $4,755 respectively.  The time based unamortized compensation of $2,249 is expected to be recognized over a weighted average period of 2.33 years.

Stock-based compensation expense was $241 and $1,589 for the three months ended March 31, 2013 and 2012 respectively.

Note 9 — Fair value

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction between market participants.  A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.  The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs.  An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and
 
 
24

 
 
customary for transaction involving such assets and liabilities; it is not a forced transaction.  Market participants are buyers and sellers in the principal market that are independent, knowledgeable, able to transact and willing to transact.

FASB Codification Topic 820: Fair Value Measurements and Disclosures establishes a hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair values hierarch is as follows:

 
·
Level 1 Inputs — 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 Inputs — 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 Inputs- Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods to determine the fair value of each type of financial instrument:

Securities:  Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating.  Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Levels 1 and 2).
 
Impaired loans: The fair values of impaired loans are measured for impairment using the fair value of the collateral for collateral-dependent loans on a nonrecurring basis. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable.  The vast majority of the Company’s collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2).  However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than two years old, then a Level 3 valuation is considered to measure the fair value.  The value of business equipment is based upon an outside appraisal if deemed significant using observable market data.  Likewise, values for inventory and account receivables collateral are based on financial statement balances or aging reports (Level 3).  Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Real Estate Owned: Real estate owned assets are adjusted to fair value upon transfer of the loans to foreclosed assets.  Subsequently, real estate owned assets are carried at net realizable
 
 
25

 
 
value.  Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring level 3.

Assets and liabilities measured at fair value under Topic 820 on a recurring and non-recurring basis are summarized below for the indicated dates:

   
Fair Value Measurement
 
   
at March 31, 2013 Using
 
   
(In thousands)
 
         
Quoted Prices
             
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
   
Carrying
   
Identical Assets
   
Inputs
   
Inputs
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial Assets - Recurring
                       
US Government Agencies
  $ 16,097     $ 1,899     $ 14,198     $ -  
MBS
    1,513       -       1,513       -  
Municipals
    12,025       -       12,025       -  
Residential loans held for sale
    16,378       -       16,378       -  
                      -          
Financial Assets - Non-Recurring
                               
Impaired loans
    54,274       -       45,750       8,524  
Real estate owned
    21,383       -       20,084       1,299  
                                 

   
Fair Value Measurement
 
   
at December 31, 2012 Using
 
   
(In thousands)
 
         
Quoted Prices
             
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
   
Carrying
   
Identical Assets
   
Inputs
   
Inputs
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial Assets - Recurring
                       
US Government Agencies
  $ 11,387     $ 5,000     $ 6,387     $ -  
MBS
    1,829       -       1,829       -  
Municipals
    11,938       2,918       9,020       -  
Residential loans held for sale
    24,188       -       24,188       -  
                      -          
Financial Assets - Non-Recurring
                               
Impaired loans
    54,775       -       47,016       7,759  
Real estate owned
    20,204       -       18,675       1,529  


 
26

 
 
The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value at March 31, 2013:

               
Range
   
Fair Value
 
Valuation
 
Unobservable
 
(Weighted
   
 Estimate
 
Techniques
 
Input
 
Average)
   
(In thousands)
                 
Impaired loans - real estate secured
 
 $    7,064
 
Appraisal (1) or Internal Valuation (2)
 
Appraisal Adjustments Liquidation Expenses (3)
 
10%-30%
Impaired loans - non-real estate secured
 
 $    1,460
 
Appraisal (1) or Discounted Cash Flow
 
Appraisal Adjustments Liquidation Expenses (3)
 
10%-20%
Real estate owned
 
 $    1,299
 
Appraisal (1) or Internal Valuation (2)
 
Appraisal Adjustments Liquidation Expenses (3)
 
7%-30%
                 
(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally
     included various level 3 inputs which are not identifiable
(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances
(3) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated
     liquidation expenses


The following table presents the changes in the Level 3 fair value category for the three months ended March 31, 2013.

   
Impaired
   
Real Estate
       
   
Loans
   
Owned
   
Total Assets
 
   
(In thousands)
 
                   
Balance at December 31, 2012
  $ 7,759     $ 1,529     $ 9,288  
                         
Total realized and unrealized gains (losses)
                       
Included in earnings
    -       (130 )     (130 )
Included in other comprehensive income
    -       -       -  
Net transfers in and/or out of Level 3
    765       (100 )     665  
                         
Balance at March 31, 2013
  $ 8,524     $ 1,299     $ 9,823  

In general, fair value of securities is based upon quoted market prices, where available.  If such quoted market prices are not available, fair value is based upon market prices determined by an outside, independent entity that primarily uses as inputs, observable market-based parameters.  Fair value of loans held for sale is based upon internally developed models that primarily use as inputs, observable market-based parameters.  Valuation adjustments may be made to ensure that financial instruments are recorded at fair value.  These adjustments may include amounts to reflect counterparty credit quality, among other things, as well as unobservable parameters.  Any such valuation adjustments are applied consistently over time.  The Company valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values.  While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and or quarter valuation process.

 
27

 
 
Cash and cash equivalents – The carrying amount of cash and cash equivalents approximates fair value.

Investment securities – The fair value of investment securities available-for-sale is estimated based on bid quotations received from independent pricing services for similar assets.  The carrying amount of other investments approximates fair value.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values.  For all other loans, fair values are calculated by discounting the contractual cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans, or by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits – The fair value of deposits with no stated maturity, such as demand, interest checking and money market, and savings accounts, is equal to the amount payable on demand at year-end.  The fair value of certificates of deposit is based on the discounted value of contractual cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowings – The fair value of borrowings is based on the discounted value of contractual cash flows using the rates currently offered for borrowings of similar remaining maturities.

Accrued interest – The carrying amounts of accrued interest receivable and payable approximate fair value.

     
March 31,
   
December 31,
 
     
2013
   
2012
 
 
Level in Fair
                       
 
Value
 
Carrying
   
Estimated
   
Carrying
   
Estimated
 
 
Hierarchy
 
Value
   
Fair Value
   
Value
   
Fair Value
 
                           
Financial assets
                         
Cash
Level 1
  $ 12,340,643     $ 12,340,643     $ 13,945,105     $ 13,945,105  
Cash equivalents
Level 2
    56,796,937       56,796,937       39,185,837       39,185,837  
Investment securities available for sale
Level 1
    1,898,730       1,898,730       7,918,420       7,918,420  
Investment securities available for sale
Level 2
    27,736,316       27,736,316       17,235,626       17,235,626  
Federal Home Loan Bank stock
Level 2
    1,867,300       1,867,300       2,121,900       2,121,900  
Loans held for sale
Level 2
    16,377,826       16,377,826       24,188,384       24,188,384  
Loans
Level 2
    261,016,472       265,851,990       290,115,508       294,476,846  
Impaired loans
Level 2
    45,750,544       45,750,544       47,016,065       47,016,065  
Impaired loans
Level 3
    8,523,648       8,523,648       7,758,689       7,758,689  
Other real estate owned
Level 2
    20,083,837       20,083,837       18,675,164       18,675,164  
Other real estate owned
Level 3
    1,298,994       1,298,994       1,528,527       1,528,527  
Bank owned life insurance
Level 3
    6,625,325       6,625,325       6,575,018       6,575,018  
Accrued interest receivable
Level 2
    1,580,147       1,580,147       1,676,518       1,676,518  
                                   
Financial liabilities
                                 
Deposits
Level 2
    421,419,245       423,055,395       436,322,962       437,644,329  
FHLB borrowings
Level 2
    27,000,000       27,423,217       28,000,000       28,424,029  
Trust preferred securities
Level 2
    8,764,000       7,537,040       8,764,000       7,537,040  
Other borrowings
Level 2
    1,882,346       1,882,346       4,851,811       4,851,811  
Accrued interest payable
Level 2
    981,527       981,527       911,635       911,635  



 
28

 


Note 10 – Capital Purchase Program

On May 1, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 (“EESA”), the Company entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 14,738 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $4.00 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 499,029 shares of the Company’s common stock at an initial exercise price of $4.43 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $14,738,000 in cash.  The fair value of the preferred stock was estimated using discounted cash flow methodology at an assumed market equivalent rate of 13%, with 20 quarterly payments over a five year period.  The fair value of the warrant was estimated using the Black-Scholes option pricing model, with assumptions of 25% volatility, a risk-free rate of 2.03%, a yield of 6.162% and an estimated life of 5 years.  The value attributed to the warrant is being accreted as a discount on the preferred stock using the effective interest rate method over five years.

The Preferred Stock qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5% until May 1, 2014 and 9% thereafter, unless the shares are redeemed by the Company.  The Preferred Stock is generally non-voting, other than on certain matters that could adversely affect the Preferred Stock.

The Warrant is immediately exercisable.  The Warrant provides for the adjustment of the exercise price and the number of shares of common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of common stock, and upon certain issuances of common stock at or below a specified price relative to the then-current market price of common stock.  The Warrant expires ten years from the issuance date.  Pursuant to the Purchase Agreement, the Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

As required by the Federal Reserve Bank of Richmond, the Company notified the U.S. Treasury in May 2011 that the Company was going to defer the payment of the quarterly cash dividend of $184,225 due on May 16, 2011, and subsequent quarterly payments, on the Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  The total arrearage on such preferred stock as of March 31, 2013 was $1,565,912.  This amount has been accrued for and is included in other liabilities in the consolidated balance sheet.

In June 2012 the Treasury asked to allow an observer at the Company’s meetings of its board of directors.  The observer started attending board meetings in August 2012.  The Treasury has the contractual right to nominate up to two members to the board of directors upon the Company’s sixth missed dividend payment.  The Company has deferred eight dividend payments as of March 31, 2013.  However, Treasury has not indicated that it will nominate two directors to the board of directors.

The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.  Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and
 
 
29

 
 
certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Note 11 – Commitments and contingencies

Off-balance-sheet risk – The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the financial statements.  The contract amounts of these instruments reflect the extent of involvement that the Company has in particular classes of instruments.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, and to potential credit loss associated with letters of credit issued, is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for loans and other such on-balance sheet instruments.

The Company had outstanding the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk at the dates indicated:

             
   
March 31,
   
December 31,
 
   
2013
   
2012
 
             
Undisbursed credit lines
  $ 32,983,000     $ 35,780,000  
Commitments to extend or originate credit
    36,131,000       25,016,000  
Standby letter of credit
    2,906,000       3,314,000  
                 
Total commitments to extend credit
  $ 72,020,000     $ 64,110,000  


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 generally have fixed expiration dates or other termination clauses and may require the payment of a fee.  Historically, many commitments expire without being drawn upon; therefore, the total commitment amounts shown in the above table are not necessarily indicative of future cash requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, as deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the customer.  Collateral held varies but may include personal or income-producing commercial real estate, accounts receivable, inventory and equipment.

Concentrations of credit risk – All of the Company’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area.  Although the Company is building a diversified loan portfolio, a substantial portion of its clients’ ability to honor contracts is reliant upon the economic stability of the Richmond, Virginia area, including the real estate markets in the area.  The concentrations of credit by type of loan are set forth in Note 5.  The distribution of commitments to extend credit approximates the distribution of loans outstanding.

 
30

 
 
Consent Order – In February 2012, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order (“Consent Agreement”) with the Federal Deposit Insurance Corporation and the Virginia Bureau of Financial Institutions (the “Supervisory Authorities”), and the Supervisory Authorities have issued the related Consent Order (the “Order”) effective February 3, 2012.  The description of the Consent Agreement and the Order is set forth below:

Management. The Order requires that the Bank have and retain qualified management, including at a minimum a chief executive officer, senior lending officer and chief operating officer, with qualifications and experience commensurate with their assigned duties and responsibilities within 90 days from the effective date of the order.  Within 30 days of the effective date of the Order, the Bank must retain a bank consultant to develop a written analysis and assessment of the Bank’s management and staffing needs for the purpose of providing qualified management for the Bank.  Within 30 days from receipt of the consultant’s management report, the Bank must formulate a written management plan that incorporates the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a timeframe for completing each action.

Capital Requirements. Within 90 days from the effective date of the Order and during the life of the Order, the Bank must have Tier 1 capital equal to or greater than 8 percent of its total assets, and total risk-based capital equal to or greater than 11 percent of the Bank’s total risk-weighted assets.  Within 90 days from the effective date of the Order, the Bank must submit a written capital plan to the Supervisory Authorities.  The capital plan must include a contingency plan in the event that the Bank fails to maintain the minimum capital ratios required in the Order, submit a capital plan that is acceptable to the Supervisory Authorities, or implement or adhere to the capital plan.

Charge-offs. The Order requires the Bank to eliminate from its books, by charge-off or collection, all assets or portions of assets classified “Loss” and 50 percent of those classified “Doubtful”.  If an asset is classified “Doubtful”, the Bank may, in the alternative, charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment.  The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, on whole or in part, “loss” or “doubtful” and is uncollected.  The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.”  These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify the Supervisory Authorities at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition.  The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from the Supervisory Authorities.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of the Supervisory Authorities.  In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior written approval of the Supervisory Authorities.
 
 
31

 

 
Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits.  These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank is required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:
     
 
·Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management
     
 
·Plan to reduce assets of $250,000 or greater classified “doubtful” and “substandard”
     
 
·Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

     
·Effective internal loan review and grading system
 
     
·Policy for managing the Bank’s other real estate
 
     
·Business/strategic plan covering the overall operation of the Bank
 
     
·Plan and comprehensive budget for all categories of income and expense for the year 2011
 
     
·Policy and procedures for managing interest rate risk
 
     
·Assessment of the Bank’s information technology function
 
Under the Order, the Bank’s board of directors has agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank must also establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the Supervisory Authorities.

While subject to the Consent Order, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with the terms.  In addition, certain provisions of the Consent Order described above could adversely impact the Company’s businesses and results of operations.

Written Agreement – In June 2012, the Company entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (“Reserve Bank”).  Under the terms of the Written Agreement, the Company agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans to maintain sufficient capital and
 
 
32

 
 
correct any violations of section 23A of the Federal Reserve Act and Regulation W.  In addition, the Company will submit a written statement of its planned sources and uses of cash for debt service, operation expenses, and other purposes.

The Company also has agreed that it will not, without prior regulatory approval:
 
·
pay or declare any dividends;
 
·
take any other form of payment representing a reduction in Bank’s capital;
 
·
make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities;
 
·
incur, increase or guarantee any debt;
 
·
purchase or deem any shares of its stock.

Since entering into the Order and the Written Agreement, the Company has taken numerous steps to comply with the terms of the consent order.

Note 12 – Income Taxes

The net deferred tax asset is included in other assets on the balance sheet.  Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results.  In making such judgments, significant weight is given to evidence that can be objectively verified.  The deferred tax assets are analyzed quarterly for changes affecting realization.  Management determined that as of March 31, 2013, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance for all of the net deferred tax asset of approximately $10,368,000.

Note 13 – Recent accounting pronouncements

In February 2013, the Financial Accounting Standards Board (FASB) issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other required disclosures that provide additional detail about those amounts. This ASU is effective prospectively in the first quarter of 2013, and is not expected to have a material effect on the Company’s consolidated financial statements.

In June 2011, the FASB issued ASU No. 2011-05, Presentation of Comprehensive Income ("ASU 2011-05"). ASU 2011-05 requires an entity to present the total of comprehensive income, the components of net income and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. ASU 2011-05 eliminates the option to present the components of other comprehensive income as part of the statement of equity. ASU 2011-05 became effective for the Company on January 1, 2012. In connection with the application of ASU 2011-05, the Company's financial statements now include separate statements of comprehensive income.

 
33

 
 
In May 2011, the FASB issued ASU No. 2011-04, Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs. The Company adopted ASU 2011-04, which generally aligns the principles of fair value measurements with International Financial Reporting Standards (IFRSs), in its consolidated financial statements in the first quarter 2012. The provisions of ASU 2011-04 clarify the application of existing fair value measurement requirements, and expand the disclosure requirements for fair value measurements. The increased provisions of ASU 2011-04 did not have a material effect on the Company’s consolidated financial statements.


 
34

 

ITEM 2 – MANAGEMENT’S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

Caution about forward-looking statements

In addition to historical information, this report may contain forward-looking statements.  For this purpose, any statement, that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy and financial and other goals.  Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning.  You can also identify them by the fact that they do not relate strictly to historical or current facts.  Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to:

 
·
the inability of the Bank to comply with the requirements of agreements with its regulators;
 
·
the inability to reduce nonperforming assets consisting of nonaccrual loans and foreclosed real estate;
 
·
our inability to improve our regulatory capital position;
 
·
the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
 
·
changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;
 
·
changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;
 
·
risks inherent in making loans such as repayment risks and fluctuating collateral values;
 
·
changes in operations of Village Bank Mortgage Corporation as a result of the activity in the residential real estate market;
 
·
legislative and regulatory changes, including the Dodd-Frank Act Wall Street Reform and Consumer Protection Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
 
·
exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
 
·
the effects of future economic, business and market conditions;
 
·
governmental monetary and fiscal policies;
 
·
changes in accounting policies, rules and practices;
 
·
maintaining capital levels adequate to remain well capitalized;
 
·
reliance on our management team, including our ability to attract and retain key personnel;
 
·
competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
 
·
demand, development and acceptance of new products and services;
 
·
problems with technology utilized by us;
 
·
changing trends in customer profiles and behavior; and
 
 
35

 
 
 
·
other factors described from time to time in our reports filed with the SEC.

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements.  Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.  In addition, past results of operations are not necessarily indicative of future results.

General

The Company’s primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk.  The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company’s results of operations and financial condition.

Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions.  If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income.  Over the last three years, the Company has recorded record provisions for loan losses due primarily to loans collateralized by real estate located in its principal market area.

There is intense competition in all areas in which the Company conducts its business. The Company competes with banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions.  Many of these competitors have substantially greater resources and lending limits and provide a wider array of banking services.  To a limited extent, the Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.  Competition is based on a number of factors, including prices, interest rates, services, availability of products and geographic location.

At the beginning of 2012, our business strategy included efforts to reduce our total assets and liabilities due to a continued depressed economy as well as capital limitations at the time.  These efforts resulted in declines of approximately $72 million in total assets and approximately $60 million in total liabilities in 2012.  With the sale of a branch completed in the first quarter of 2013, we further reduced our total assets and liabilities by approximately $18 million.  This strategy helped strengthen our regulatory capital ratios in 2012 and the first quarter of 2013.  While we do not anticipate significant growth in 2013, we do not expect to continue our efforts to reduce total assets and liabilities.

Results of Operations

The following presents management’s discussion and analysis of the financial condition of the Company at March 31, 2013 and December 31, 2012 and the results of operations for the Company for the three months ended March 31, 2013 and 2012.  This discussion should be read in conjunction with the Company’s condensed consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report.

 
36

 
 
Income Statement Analysis

Summary

For the three months ended March 31, 2013, the Company had a net loss of $(511,000) and a net loss available to common shareholders of $(732,000), or $(0.17) per fully diluted share, compared to a net loss of $(1,400,000) and a net loss available to common shareholders of $(1,621,000) or $(0.38) per fully diluted basis, for the same period in 2012.  The key factors in the decrease in the loss were decreases in the provision for loan losses of $912,000 and the gain on the sale of a branch of $598,000, offset by the increase in expenses associated with foreclosed real estate of $456,000 from $1,119,000 for the first quarter of 2012 to $1,575,000 for the first quarter of 2013.  The decrease in the provision for loan losses is attributable to an improving loan portfolio as well as a decline in need due to the decline in total loans.  However, as we resolve nonperforming loans through foreclosure, costs associated with foreclosed real estate will continue to be a significant expense.

Our cost of deposits declined from 1.34% for the first quarter of 2012 to 1.12% for the first quarter of 2013.  This decline in cost of deposits is a result of the repricing of higher cost certificates of deposit during the low interest rate environment that has existed for the last three years as well as an effort to change our deposit mix so that we are not so dependent on higher cost deposits.  Our mortgage company’s profit increased slightly in the first quarter of 2013 compared to 2012 by $8,000 despite the mortgage company closing $57,961,000 in mortgage loans in the first quarter of 2013 compared to $64,121,000 in the first quarter of 2012.

Net interest income

Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company’s primary source of earnings.  Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholders’ equity.  Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.  The net yield on interest-earning assets (“net interest margin”) is calculated by dividing tax equivalent net interest income by average interest-earning assets.  Generally, the net interest margin will exceed the net interest spread because a portion of interest-earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing deposits and shareholders’ equity.

Net interest income for the first quarter of $4,089,000 represents a decrease of $332,000, or 8%, compared to the first quarter of 2012, and a decrease of $625,000, or 13%, compared to the fourth quarter of 2012.

Compared to the first quarter of 2012, average interest-earning assets for the first quarter of 2013 decreased by $65,689,000, or 13%.  The decrease in average interest-earning assets was due
 
 
37

 
 
primarily to decreases in portfolio loans of $74,597,000, offset by increases in loans held for sale of $3,090,000 and federal funds sold of $7,119,000.  The decline in average interest-earning assets was somewhat mitigated by an increase in the average yield on interest-earning assets from 4.85% for the first quarter of 2012 to 4.96% for the first quarter of 2013.  These fluctuations resulted in a decline in interest income from the first quarter of 2012 to the first quarter of 2013 of $714,000, or 12%.

Average interest-bearing liabilities for the first quarter of 2013 decreased by $42,513,000, or 9%, compared to the first quarter of 2012.  The decrease in interest-bearing liabilities was due to declines in average deposits of $32,363,000 and average borrowings of $10,150,000.  The average cost of interest-bearing liabilities decreased to 1.23% for the first quarter of 2013 from 1.45% for the first quarter of 2012.  The principal reason for the decrease in liability costs was the maintenance of short-term interest rates at a low level by the Federal Reserve.  The continuing low interest rates have allowed us to reduce our cost of funds as certificates of deposit and borrowings mature.  See our discussion of interest rate sensitivity below for more information.

The Company’s net interest margin is not a measurement under accounting principles generally accepted in the United States, but it is a common measure used by the financial services industry to determine how profitably earning assets are funded.  Our net interest margin over the last several quarters is provided in the following table:

   
Net
   
Interest
Quarter Ended
 
Margin
       
March 31, 2012
    3.53%
June 30, 2012
    3.65%
September 30, 2012
    3.70%
December 31, 2012
    4.25%
March 31, 2013
    3.79%


The significant increase in the net interest margin in the fourth quarter of 2012 is attributable to the recapture of interest on returning approximately $14.4 million of nonaccrual loans to accrual status during the quarter.  The net interest margin for the first quarter of 2013 is more consistent with the net interest margin for the first three quarters of 2012 and the trend over the last five quarters has been improving.  This improving net interest margin is a result of a declining cost of funds which decreased by 22 basis points from the first quarter of 2012 to the first quarter of 2013.

The following table illustrates average balances of total interest-earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, shareholders' equity and related income, expense and corresponding weighted-average yields and rates.  The average balances used in these tables and other statistical data were calculated using daily average balances.  We had no tax exempt assets for the periods presented.

 
38

 
Average Balance Sheets
 
(in thousands)
 
                                     
                                     
   
Three Months Ended March 31, 2013
   
Three Months Ended March 31, 2012
 
         
Interest
   
Annualized
         
Interest
   
Annualized
 
   
Average
   
Income/
   
Yield
   
Average
   
Income/
   
Yield
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
                                     
Loans
  $ 345,623     $ 4,977       5.84 %   $ 420,220     $ 5,768       5.52 %
Investment securities
    30,007       188       2.54 %     31,307       150       1.93 %
Loans held for sale
    16,201       166       4.16 %     13,111       131       4.01 %
Federal funds and other
    45,776       25       0.22 %     38,657       21       0.22 %
Total interest earning assets
    437,607       5,356       4.96 %     503,296       6,070       4.85 %
                                                 
Allowance for loan losses and deferred fees
    (10,591 )                     (11,845 )                
Cash and due from banks
    13,159                       15,305                  
Premises and equipment, net
    25,530                       26,710                  
Other assets
    37,950                       33,255                  
Total assets
  $ 503,655                     $ 566,720                  
                                                 
Interest bearing deposits
                                               
Interest checking
  $ 43,329     $ 35       0.32 %   $ 42,168     $ 40       0.38 %
Money market
    66,293       61       0.37 %     73,422       76       0.42 %
Savings
    20,908       23       0.45 %     16,186       21       0.52 %
Certificates
    245,906       924       1.52 %     277,023       1,221       1.77 %
Total
    376,436       1,043       1.12 %     408,799       1,358       1.34 %
Borrowings
    39,655       224       2.29 %     49,805       291       2.35 %
Total interest bearing liabilities
    416,091       1,267       1.23 %     458,604       1,649       1.45 %
Noninterest bearing deposits
    55,216                       63,206                  
Other liabilities
    7,170                       3,675                  
Total liabilities
    478,477                       525,486                  
Equity capital
    25,178                       41,234                  
                                                 
Total liabilities and capital
  $ 503,655                     $ 566,720                  
                                                 
Net interest income before provision for loan losses
    $ 4,089                     $ 4,421          
                                                 
Interest spread - average yield on interest
                                               
earning assets, less average rate on
                                               
interest bearing liabilities
                    3.74 %                     3.40 %
                                                 
Annualized net interest margin (net
                                               
interest income expressed as
                                               
percentage of average earning assets)
                    3.79 %                     3.53 %
                                                 

Provision for loan losses

There was a provision for loan losses for the three months ended March 31, 2013 of $823,000 compared to a provision of $1,735,000 for the same period in 2012.  The decline in the provision for loan losses for the first quarter of 2013 was primarily driven by an $88 million decline in loans outstanding from March 31, 2012 to March 31, 2013 as well as a decline in the impairment on specific nonperforming loans.  The provision for loan losses for the first quarter of 2013 was primarily attributable to one nonperforming loan relationship for which the collateral was determined to be deficient.  While we are encouraged by this decline in the provision for loan losses, overall asset quality continues to be a concern as there continues to be uncertainty in the economy and the level of nonperforming assets remains significant.

 
39

 
 
Noninterest income

Noninterest income increased from $2,688,000 for the first quarter of 2012 to $3,606,000 for the same period in 2013, an increase of $918,000, or 34%.  This increase in noninterest income was primarily the result of higher gains on loan sales from increased loan production by our mortgage banking subsidiary of $205,000, and the gain on the sale of the Robious branch of $598,000.

Noninterest expense

Noninterest expense for the three months ended March 31, 2013 was $7,384,000 compared to $6,775,000 for the three months ended March 31, 2012, an increase of $609,000 or 9%.  The most significant increases in noninterest expense occurred in expenses related to foreclosed real estate of $456,000 and salaries and benefits of $341,000.  The increase in expenses related to foreclosed real estate is a result of our efforts to foreclose on troubled loans and the disposition of the collateral, and the increase in salaries and benefits is primarily attributable to increases in commissions paid to mortgage loan officers.

Income taxes

Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit.  Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

The net deferred tax asset is included in other assets on the balance sheet.  Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results.  In making such judgments, significant weight is given to evidence that can be objectively verified.  The deferred tax assets are analyzed quarterly for changes affecting realization.  Management determined that as of December 31, 2012, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance on its net deferred tax asset of approximately $10,158,000.  At March 31, 2013, management continues to believe that the objective negative evidence represented by the Company’s continued losses in the first quarter outweighed the more subjective positive evidence and, as a result, recognized an addition to the valuation allowance on its net deferred tax asset of approximately $210,000.  The net operating losses available to offset future taxable income amounted to $14,684,000 at March 31, 2013 and expire through 2031.

Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes.  Instead, they are subject to a franchise tax based on bank capital.  The Company recorded a franchise tax expense of $42,000 for the three months ended March 31, 2012.  Due to the Company’s adjusted capital level we were not subject to franchise tax expense in the first quarter of 2013.

Balance Sheet Analysis

Our total assets decreased to $491,054,000 at March 31, 2013 from $510,087,000 at December 31, 2012, a decrease of $19,033,000, or 4%.  During the first quarter of 2013 there were decreases in net loans of $30,423,000, loans held for sale of $7,810,000 and premises and equipment of $1,823,000 offset by an increase in liquid assets (cash and due from banks, federal funds sold and investment securities available for sale) of $20,488,000.  The branch sale discussed previously was the primary driver of the decline for the quarter.

 
40

 
 
Loans

A management objective is to maintain the quality of the loan portfolio.  The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower.  The portfolio strategies include seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar.

The Company’s real estate loan portfolios, which represent approximately 90% of all loans, are secured by mortgages on real property located principally in the Commonwealth of Virginia.  Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral.  The Company’s commercial loan portfolio represents approximately 9% of all loans.  Loans in this category are typically made to individuals, small and medium-sized businesses and range between $250,000 and $2.5 million.  Based on underwriting standards, commercial and industrial loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory, and real property.  The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions.  The remainder of our loan portfolio is in consumer loans which represent approximately 1% of the total.

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated (in thousands):

   
March 31, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
Construction and land development
                       
Residential
  $ 3,002       0.93 %   $ 2,845       0.80 %
Commercial
    36,209       11.18 %     41,210       11.61 %
    Total construction and land development
    39,211       12.11 %     44,055       12.41 %
Commercial real estate
                               
Farmland
    2,571       0.79 %     2,581       0.73 %
Commercial real estate - owner occupied
    81,459       25.14 %     92,773       26.14 %
Commercial real estate - non-owner occupied
    47,470       14.65 %     54,551       15.37 %
Multifamily
    8,908       2.75 %     7,979       2.25 %
    Total commercial real estate
    140,408       43.33 %     157,884       44.49 %
Consumer real estate
                               
Home equity lines
    24,614       7.60 %     25,521       7.19 %
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    78,796       24.32 %     80,788       22.76 %
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    8,668       2.67 %     9,517       2.68 %
   Total consumer real estate
    112,078       34.59 %     115,827       32.63 %
Commercial and industrial loans
                               
(except those secured by real estate)
    29,647       9.15 %     34,384       9.69 %
Consumer and other
    2,660       0.82 %     2,761       0.78 %
                                 
Total Loans
    324,004       100.0 %     354,910       100.0 %
Deferred loan cost (unearned income), net
    783               788          
Less:  Allowance for loan losses
    (10,320 )             (10,808 )        
                                 
    $ 314,467             $ 344,890          

 
41

 
 
The decline in our total loan portfolio for the first quarter of 2013 was primarily due to the branch sale which included the sale of approximately $12 million in loans, as well as management’s strategy to decrease our level of assets to improve our regulatory capital ratios and reduce our overhead expenses.

The Company assigns risk rating classifications to its loans.  These risk ratings are divided into the following groups:

 
·
Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating.  1-4 assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;
 
·
Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;
 
·
Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;
 
·
Risk rated 7 loans have all the weaknesses inherent in substandard loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loans are considered impaired when, based on current information and events it is probably the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments.  Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans.  If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Allowance for loan losses

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance:  the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type.  A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical net charge-off rates, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 
42

 
 
The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses.  This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made.  If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates.  We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

The allowance for loan losses at March 31, 2013 was $10,320,000, compared to $10,808,000 at December 31, 2012.  The ratio of the allowance for loan losses to gross portfolio loans (net of unearned income and excluding mortgage loans held for sale) at March 31, 2013 and December 31, 2012 was 3.18% and 3.04%, respectively.  The decrease in the allowance for loan losses for the first quarter of 2013 was primarily a result of charge-offs recognized during the quarter for which specific provisions for loan losses had been previously provided.  The provision for loan losses for the first quarter of 2013 was attributable to one nonperforming loan relationship for which the collateral was determined to be deficient.  We believe the amount of the allowance for loan losses at March 31, 2013 is adequate to absorb the losses that can reasonably be anticipated from the loan portfolio at that date.

 
43

 
 
The following table presents an analysis of the changes in the allowance for loan losses for the periods indicated (in thousands).

   
Three Months Ended
 
   
March 31,
 
   
2013
   
2012
 
             
Beginning balance
  $ 10,808     $ 16,071  
Provision for loan losses
    823       1,735  
Charge-offs
               
Construction and land development
               
Residential
    -       (59 )
Commercial
    (84 )     (1,547 )
Commercial real estate
               
Commercial real estate - owner occupied
    (136 )     (29 )
Commercial real estate - non-owner occupied
    (256 )     (91 )
Consumer real estate
               
Home equity lines
    (55 )     (122 )
Secured by 1-4 family residential,
               
secured by first deeds of trust
    (343 )     (966 )
Secured by 1-4 family residential,
               
secured by second deeds of trust
    (215 )     (191 )
Commercial and industrial loans
               
(except those secured by real estate)
    (289 )     (260 )
Consumer and other
    (4 )     (270 )
Total charge-offs
    (1,382 )     (3,535 )
Recoveries
               
Construction and land development
               
Residential
    1       1  
Consumer real estate
               
Home equity lines
    -       1  
Secured by 1-4 family residential,
               
secured by first deeds of trust
    8       61  
Secured by 1-4 family residential,
               
secured by second deeds of trust
    3       -  
Commercial and industrial loans
               
(except those secured by real estate)
    56       27  
Consumer and other
    3       1  
Total recoveries
    71       91  
Net charge-offs
    (1,311 )     (3,444 )
                 
Ending balance
  $ 10,320     $ 14,362  
                 
Loans outstanding at end of period(1)
  $ 324,787     $ 412,732  
Ratio of allowance for loan losses as
               
a percent of loans outstanding at
               
end of period
    3.18 %     3.48 %
                 
Average loans outstanding for the period(1)
  $ 345,623     $ 420,220  
Ratio of net charge-offs to average loans
               
outstanding for the period
    0.38 %     0.82 %
                 
(1) Loans are net of unearned income.
               

 
44

 

The allowance for loan losses as a percentage of net loans decreased from 3.48% at March 31, 2012 to 3.18% at March 31, 2013 primarily as a result of a significant charge-offs recognized during the prior year for which specific provisions for loan losses had been previously provided.

Asset quality

The following table summarizes asset quality information at the dates indicated (dollars in thousands).

   
March 31,
   
December 31,
   
March 31,
 
   
2013
   
2012
   
2012
 
                   
Nonaccrual loans
  $ 24,271     $ 25,605     $ 54,900  
Foreclosed properties
    21,383       20,204       14,590  
Total nonperforming assets
  $ 45,654     $ 45,809     $ 69,490  
                         
Restructured loans still accruing
  $ 30,003     $ 38,820     $ 15,321  
                         
Loans past due 90 days and still accruing
                       
(not included in nonaccrual loans above)
  $ 120     $ 115     $ -  
                         
Nonperforming assets to loans (1)
    14.1 %     12.9 %     16.8 %
                         
Nonperforming assets to total assets
    9.3 %     9.0 %     12.5 %
                         
Allowance for loan losses to nonaccrual loans
    42.5 %     42.2 %     26.2 %
                         
(1) Loans are net of deferred fees and costs.
 
 
The following table presents an analysis of the changes in nonperforming assets for the three months ended March 31, 2013 (dollars in thousands).

   
Nonaccrual
   
Foreclosed
       
   
Loans
   
Properties
   
Total
 
                   
Balance December 31, 2012
  $ 25,605     $ 20,204     $ 45,809  
Additions, net
    4,860       69       4,929  
Transfers to OREO
    (3,484 )     3,484       -  
Repayments
    (1,398 )     -       (1,398 )
Charge-offs
    (1,313 )     (1,044 )     (2,357 )
Sales
            (1,330 )     (1,330 )
                         
Balance March 31, 2013
  $ 24,271     $ 21,383     $ 45,654  

Until a nonperforming restructured loan has performed in accordance with its restructured terms for a minimum of six months, it will remain on nonaccrual status.

 
45

 
 
Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful.  Commercial and unsecured consumer loans are designated as non-accrual when the Company considers collection of expected principal and interest doubtful.  Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and interest is not significant.  When loans are placed in non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received.  Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

Of the total nonaccrual loans of $24,271,000 at March 31, 2013 that were considered impaired, 18 loans totaling $6,544,000 had specific allowances for loan losses totaling $2,322,000.  This compares to $25,605,000 in nonaccrual loans at December 31, 2012 of which 15 loans totaling $4,648,000 had specific allowances for loan losses of $1,338,000.

Cumulative interest income that would have been recorded had nonaccrual loans been performing would have been approximately $1,143,000 and $1,808,000 at March 31, 2013 and 2012, respectively.

Deposits

Deposits as of March 31, 2013 and December 31, 2012 were as follows:

   
March 31, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
                         
Demand accounts
  $ 62,301,743       14.8 %   $ 57,049,348       13.1 %
Interest checking accounts
    43,567,794       10.3 %     45,861,199       10.5 %
Money market accounts
    63,546,257       15.1 %     66,007,160       15.1 %
Savings accounts
    20,469,642       4.9 %     20,922,112       4.8 %
Time deposits of $100,000 and over
    107,426,419       25.5 %     113,332,481       26.0 %
Other time deposits
    124,107,390       29.4 %     133,150,662       30.5 %
                                 
Total
  $ 421,419,245       100.0 %   $ 436,322,962       100.0 %


Total deposits decreased by $14,904,000, or 3.4%, from $436,323,000 at December 31, 2012 to $421,419,000 at March 31, 2013, as compared to a decrease of $20,128,000, or 4.1%, during the first three months of 2012. Checking and savings accounts increased by $2,507,000, money market accounts decreased by $2,461,000 and time deposits decreased by $14,949,000.  The decline in time deposits was a result of the branch sale as well as repricing maturing time deposits at rates below market for noncore depositors.  The cost of our interest bearing deposits declined to 1.12% for the first quarter of 2013 compared to 1.20% for the fourth quarter of 2012 and 1.34% for the first quarter of 2012.

The variety of deposit accounts that we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility to, although not to eliminate, the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities).  Our ability to attract and retain deposits, and our cost of funds, has been, and is expected to continue to be, significantly affected by money market conditions.

 
46

 
 
Borrowings

We utilize borrowings to supplement deposits when they are available at a lower overall cost to us or they can be invested at a positive rate of return.

As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB and is authorized to apply for borrowings from the FHLB.  Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities.  The FHLB may prescribe the acceptable uses to which the advances may be put, as well as on the size of the advances and repayment provisions.  Borrowings from the FHLB were $27,000,000 and $28,000,000 at March 31, 2013 and December 31, 2012, respectively.  The FHLB advances are secured by the pledge of residential mortgage loans.

Capital resources

Stockholders’ equity at March 31, 2013 was $24,226,000, compared to $24,965,000 at December 31, 2012.  On May 1, 2009, the Company received a $14,738,000 investment by the United States Department of the Treasury under its Capital Purchase Program (the TARP Program).  The TARP Program is a voluntary program designed to provide capital for healthy banks to improve the flow of funds from banks to their customers.  Under the TARP Program, the Company issued to the Treasury $14,738,000 of preferred stock and warrants to purchase 499,030 shares of the Company’s common stock at a purchase price of $4.43 per share. The preferred stock issued by the Company under the TARP Capital Purchase Program carries a 5% dividend until May 1, 2014, and 9% thereafter, unless the shares are redeemed by the Company.  The $739,000 decrease in equity during the first three months of 2013 was primarily due to the net loss available to common shareholders of $(732,000).

During the first quarter of 2005, the Company issued $5.2 million in Trust Preferred Capital Notes to increase its regulatory capital and to help fund its expected growth in 2005.  During the third quarter of 2007, the Company issued $3.6 million in Trust Preferred Capital Notes to partially fund the construction of an 80,000 square foot building completed in 2008.  The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion.

The Company is currently prohibited by its Written Agreement with the Reserve Bank from making dividend or interest payments on the TARP program preferred stock or trust preferred capital notes without prior regulatory approval.  In addition, the Consent Order with the FDIC and BFI provides that the Bank will not pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction in capital, without regulatory approval.  At March 31, 2013, the aggregate amount of all of the Company’s total accrued but deferred dividend payments on TARP was $1,565,912 and interest payments on trust preferred capital notes was $716,347.

In June 2012 as a result of the unpaid dividends, Treasury requested that an observer appointed by Treasury be allowed to attend the Company’s meetings of its board of directors. The observer started attending board meetings in August 2012. Treasury has the contractual right to nominate up to two members to the board of directors upon the Company’s sixth deferred dividend payment. The Company has deferred eight dividend payments as of March 31, 2013. However, Treasury has not indicated at this time it will nominate two directors to our board.

 
47

 
 
The Company is currently evaluating potential sources of additional capital, with the objective is to become compliant with the capital requirements of the Consent Order as soon as practically possible. In addition the Company is considering various alternatives for the repayment of the preferred stock issued under the TARP Program. However, no assurance can be given that sources of new capital will be received.

The following table presents the composition of regulatory capital and the capital ratios for the Company at the dates indicated (dollars in thousands).

   
March 31,
   
December 31,
 
   
2013
   
2012
 
             
Tier 1 capital
           
Preferred stock
  $ 59     $ 59  
Common stock
    17,007       17,007  
Additional paid-in capital
    40,705       40,705  
Retained earnings (deficit)
    (33,906 )     (33,174 )
Warrant surplus
    732       732  
Discount on preferred stock
    (162 )     (199 )
Qualifying trust preferred securities
    3,062       3,306  
Less intangible assets
    (369 )     (393 )
Total Tier 1 capital
    27,128       28,043  
                 
Tier 2 capital
               
Qualifying trust preferred securities
    5,702       5,458  
Allowance for loan losses
    4,406       4,795  
Total Tier 2 capital
    10,108       10,253  
                 
Total risk-based capital
    37,236       38,296  
                 
Risk-weighted assets
  $ 346,599     $ 377,572  
                 
Average assets
  $ 500,511     $ 505,046  
                 
Capital ratios
               
Leverage ratio (Tier 1 capital to
               
average assets)
    5.42 %     5.55 %
Tier 1 capital to risk-weighted assets
    7.83 %     7.43 %
Total capital to risk-weighted assets
    10.74 %     10.14 %
Equity to total assets
    5.09 %     4.89 %


 
48

 
 
The following table presents the composition of regulatory capital and the capital ratios for the Bank at the dates indicated (dollars in thousands).

   
March 31,
   
December 31,
 
   
2013
   
2012
 
             
Tier 1 capital
           
Common stock
  $ 6,849     $ 6,849  
Additional paid-in capital
    55,407       55,406  
Retained earnings (deficit)
    (29,349 )     (28,925 )
Less intangible assets
    (369 )     (393 )
Total Tier 1 capital
    32,538       32,937  
                 
Tier 2 capital
               
Allowance for loan losses
    4,405       4,769  
Total Tier 2 capital
    4,405       4,769  
                 
Total risk-based capital
    36,943       37,706  
                 
Risk-weighted assets
  $ 346,452     $ 375,451  
                 
Average assets
  $ 500,084     $ 505,150  
                 
Capital ratios
               
Leverage ratio (Tier 1 capital to
               
average assets)
    6.51 %     6.52 %
Tier 1 capital to risk-weighted assets
    9.39 %     8.77 %
Total capital to risk-weighted assets
    10.66 %     10.04 %
Equity to total assets
    6.71 %     6.55 %


Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized. The Bank met the ratio requirements to be categorized as a “well capitalized” institution as of December 31, 2012, 2011 and 2010. However, due to the minimum capital ratios required by the Consent Order, the Bank currently is considered adequately capitalized. The Consent Order requires the Bank to maintain a leverage ratio of at least 8% and a total capital to risk-weighted assets ratio of at least 11%.  At March 31, 2013, the Bank’s leverage ratio was 6.51% and the total capital to risk-weighted assets ratio was 10.66%.  As required by the Consent Order the Bank has provided a capital plan to the FDIC and BFI that demonstrates how the Bank will come into compliance with the required minimum capital ratios set forth in the Consent Order. When capital falls below the “well capitalized” requirement, consequences can include: new branch approval could be withheld; more frequent examinations by the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC; and other potential limitations as described in FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section 29.  In addition, the FDIC insurance assessment increases when an institution falls below the “well capitalized” classification.

Liquidity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities.  Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day
 
 
49

 
 
cash flow requirements while maximizing profits.  Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made.  However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

At March 31, 2013, our liquid assets, consisting of cash, cash equivalents and investment securities available for sale totaled $98,773,000, or 20% of total assets.  Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.  However, approximately $5,889,000 of these securities are pledged against borrowings.  Therefore, the related borrowings would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

Our holdings of liquid assets plus the ability to maintain and expand our deposit base and borrowing capabilities serve as our principal sources of liquidity.  We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings.  In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities.  We maintain two federal funds lines of credit with correspondent banks totaling $22 million for which there were no borrowings against the lines at March 31, 2013.

At March 31, 2013, we had commitments to originate $70,020,000 of loans.  Fixed commitments to incur capital expenditures were less than $25,000 at March 31, 2013.  Certificates of deposit scheduled to mature in the 12-month period ending March 31, 2014 totaled $82,588,000.  We believe that a significant portion of such deposits will remain with us. We further believe that deposit growth, loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs.

Interest rate sensitivity

An important element of asset/liability management is the monitoring of our sensitivity to interest rate movements.  In order to measure the effects of interest rates on our net interest income, management takes into consideration the expected cash flows from the securities and loan portfolios and the expected magnitude of the repricing of specific asset and liability categories.  We evaluate interest sensitivity risk and then formulate guidelines to manage this risk based on management’s outlook regarding the economy, forecasted interest rate movements and other business factors.  Our goal is to maximize and stabilize the net interest margin by limiting exposure to interest rate changes.

Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolio.  The average lives of mortgage loans are substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which gives us the right to declare a loan immediately due and payable in the event, among other things, the borrower sells the real property subject to the mortgage and the loan is not repaid.  In addition, certain borrowers increase their equity in the security property by making payments in excess of those required under the terms of the mortgage.

The sale of fixed rate loans is intended to protect us from precipitous changes in the general level of interest rates. The valuation of adjustable rate mortgage loans is not as directly dependent on the level of interest rates as is the value of fixed rate loans.  As with other investments, we regularly monitor the appropriateness of the level of adjustable rate mortgage loans in our portfolio and may decide from time to time to sell such loans and reinvest the proceeds in other adjustable rate investments.
 
 
50

 
 
The data in the following table reflects repricing or expected maturities of various assets and liabilities at March 31, 2013.  The gap analysis represents the difference between interest-sensitive assets and liabilities in a specific time interval.  Interest sensitivity gap analysis presents a position that existed at one particular point in time, and assumes that assets and liabilities with similar repricing characteristics will reprice at the same time and to the same degree.

Village Bank and Trust Financial Corp.
 
Interest Rate Sensitivity GAP Analysis
 
March 31, 2013
 
(In thousands)
 
                                     
                                     
   
Within 3
   
3 to 6
   
6 to 12
   
13 to 36
   
More than
       
   
Months
   
Months
   
Months
   
Months
   
36 Months
   
Total
 
Interest Rate Sensitive Assets
                                   
Loans (1)
                                   
Fixed rate
  $ 6,175     $ 10,981     $ 13,716     $ 21,503     $ 77,040     $ 129,415  
Variable rate
    40,767       10,732       25,653       34,475       82,962       194,589  
Investment securities
    -       -               -       29,635       29,635  
Loans held for sale
    16,378       -       -       -       -       16,378  
Federal funds sold
    56,797       -       -       -       -       56,797  
                                                 
Total rate sensitive assets
    120,117       21,713       39,369       55,978       189,637       426,814  
Cumulative rate sensitive assets
    120,117       141,830       181,199       237,177       426,814          
                                                 
Interest Rate Sensitive Liabilities
                                               
Interest checking
    -       -       -       43,568       -       43,568  
Money market accounts
    63,546       -       -       -       -       63,546  
Savings
    -       -       -       20,470       -       20,470  
Certificates of deposit
    13,461       28,733       40,394       94,233       54,713       231,534  
FHLB advances
    4,000       5,000       1,000       16,000       1,000       27,000  
Trust Preferred Securities
    -       -       -               8,764       8,764  
Other borrowings
    1,882       -       -       -       -       1,882  
                                                 
Total rate sensitive liabilities
    82,889       33,733       41,394       174,271       64,477       396,764  
Cumulative rate sensitive liabilities
    82,889       116,622       158,016       332,287       396,764          
                                                 
Rate sensitivity gap for period
  $ 37,228     $ (12,020 )   $ (2,025 )   $ (118,293 )   $ 125,160     $ 30,050  
Cumulative rate sensitivity gap
  $ 37,228     $ 25,208     $ 23,183     $ (95,110 )   $ 30,050          
                                                 
Ratio of cumulative gap to total assets
    7.6 %     5.1 %     4.7 %     (19.4 )%     6.1 %        
Ratio of cumulative rate sensitive
                                               
assets to cumulative rate sensitive
                                               
liabilities
    144.9 %     121.6 %     114.7 %     71.4 %     107.6 %        
Ratio of cumulative gap to cumulative
                                               
rate sensitive assets
    31.0 %     17.8 %     12.8 %     (40.1 )%     7.0 %        
                                                 
                                                 
                                                 
(1) Includes nonaccrual loans of approximately $24,271,000, which are spread throughout the categories.
                 


At March 31, 2013, our balance sheet is asset sensitive for the next twelve months, meaning that our assets reprice more quickly than our liabilities during that period, and liability sensitive for the next thirteen to thirty-six months, meaning that our liabilities will reprice more quickly than our assets during that period, with a ratio of cumulative gap to total assets ranging from a positive gap of 7.6% for the first three months to a negative gap of (19.4)% for the thirteen to thirty-six month period.  A negative gap can adversely affect earnings in periods of increasing interest rates.  Given the Federal Reserve’s recent announcement that it will maintain short-term interest rates at current levels until the end of 2014, we do not expect interest rates to increase in the foreseeable future.  However, we believe our balance sheet should be asset sensitive and, accordingly, we have adopted pricing policies to lengthen the maturities/repricing of our liabilities relative to the maturities/pricing or our assets.

 
51

 
 
Critical accounting policies

General

The accounting and reporting policies of the Company and its subsidiary are in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and conform to general practices within the banking industry.  The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and amounts reported for revenues, expenses and related disclosures.  Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.

The more critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses, troubled debt restructurings, real estate acquired in settlement of loans and income taxes.  The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations.
 
 
The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions, and judgments.

Allowance for loan losses

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance:  the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type.  A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.
 
 
 
52

 
 
The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses.  This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made.  If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates.  If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses.  We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

Troubled debt restructurings

A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider.  A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions.  Troubled debt restructurings can be in either accrual or nonaccrual status.  Nonaccrual troubled debt restructurings are included in nonperforming loans.  Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.  Troubled debt restructurings generally remain categorized as nonperforming loans and leases until a six-month payment history has been maintained.

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans.  Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described above under Allowance for loan losses.  Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies.  Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

Real estate acquired in settlement of loans

Real estate acquired in settlement of loans represent properties acquired through foreclosure or physical possession.  Write-downs to fair value of foreclosed assets at the time of transfer are charged to allowance for loan losses.  Subsequent to foreclosure, the Company periodically evaluates the value of foreclosed assets held for sale and records an impairment charge for any subsequent declines in fair value less selling costs.  Subsequent declines in value are charged to operations.  Fair value is based on an assessment of information available at the end of a reporting period and depends upon a number of factors, including historical experience, economic conditions, and issues specific to individual properties.  The evaluation of these factors involves subjective estimates and judgments that may change.

 
53

 
 
Income taxes

The Company uses the asset and liability method of accounting for income taxes.  Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established.  Management considers the determination of this valuation allowance to be a critical accounting policy due to the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income.  These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.  A valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, or if management projects lower levels of future taxable income.  Management determined that as of December 31, 2012 and March 31, 2013, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance of $10,158,000 and $10,368,000, respectively, representing 100% of the net deferred tax asset at the indicated date.

New accounting standards

In February 2013, the Financial Accounting Standards Board (FASB) issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other required disclosures that provide additional detail about those amounts. This ASU is effective prospectively in the first quarter of 2013.  The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

Impact of inflation and changing prices

The Company’s consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States, which require the Company to measure financial position and operating results primarily in terms of historical dollars.  Changes in the relative value of money due to inflation or recession are generally not considered.  The primary effect of inflation on the operations of the Company is reflected in increased operating costs.  In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate.  While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate.  Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

 
54

 

ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.


ITEM 4 – CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of March 31, 2013.  Based on that evaluation, management concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2013 in ensuring that all material information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed summarized and reported with the time periods specified in SEC rules and regulations and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.  There were no changes in our internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 
55

 

PART II – OTHER INFORMATION


ITEM 1 – LEGAL PROCEEDINGS


Not applicable.


ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS


Not applicable.


ITEM 3 – DEFAULTS UPON SENIOR SECURITIES


In consideration of our agreements with our regulators, which require regulatory approval to make dividend payment son our preferred stock, the Company notified the U.S. Treasury in May 2011 that the Company was going to defer the payment of the quarterly cash dividend of $184,225 due on May 16, 2011, and subsequent quarterly payments, on the Preferred Stock.  The total arrearage on such preferred stock as of March 31, 2013 was $1,565,912.


ITEM 4 – MINE SAFETY DISCLOSURES


ITEM 5 – OTHER INFORMATION


Not applicable.


ITEM 6 – EXHIBITS

 
31.1
Certification of Chief Executive Officer
     
 
31.2
Certification of Chief Financial Officer
     
 
32.1
Statement of Chief executive Officer and Chief Financial Officer
   
Pursuant to 18 U.S.C. Section 1350
     
 
101
The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended March 31, 2013 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Stockholders' Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.

 
56

 


SIGNATURES

In accordance with 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.


     
VILLAGE BANK AND TRUST FINANCIAL CORP.
     
(Registrant)
           
           
Date:
May 15, 2013
 
By:
/s/ Thomas W. Winfree
 
       
Thomas W. Winfree
       
President and
       
Chief Executive Officer
           
           
Date:
May 15, 2013
 
By:
/s/ C. Harril Whitehurst, Jr.
 
       
C. Harril Whitehurst, Jr.
       
Senior Vice President and
       
Chief Financial Officer



 
57

 

EXHIBIT INDEX


Exhibit
 
Number
Document
   
31.1
Certification of Chief Executive Officer
   
31.2
Certification of Chief Financial Officer
   
32.1
Statement of Chief executive Officer and Chief Financial Officer
 
Pursuant to 18 U.S.C. Section 1350
   
101
The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended March 31, 2013 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Stockholders' Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.