UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

  

 

 

FORM 10-K

 

 

 

xANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2013

 

¨TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

 

Commission file number: 0-20293

 

 

  

UNION FIRST MARKET BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

 

   

VIRGINIA 54-1598552

(State or other jurisdiction of

incorporation or organization)

(I.R.S. Employer

Identification No.)

 

1051 East Cary Street, Suite 1200, Richmond, Virginia 23219

(Address of principal executive offices) (Zip Code)

 

Registrant’s telephone number, including area code is (804) 633-5031

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class  Name of exchange on which registered 
Common Stock, par value $1.33 per share The NASDAQ Global Select Market

 

Securities registered pursuant to Section 12(g) of the Act: None

  

 

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 29.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

 

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. (Check one):

 

Large accelerated filer ¨ Accelerated filer x
       
Non-accelerated filer ¨ Smaller reporting company ¨

 

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

  

The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2013 was approximately $494,929,402 based on the closing share price on that date of $20.59 per share.

 

The number of shares of common stock outstanding as of March 4, 2014 was 46,858,764.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the registrant’s definitive proxy statement to be used in conjunction with the registrant’s 2014 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

 

 

 
 

  

UNION FIRST MARKET BANKSHARES CORPORATION

FORM 10-K

INDEX

 

ITEM   PAGE
  PART I  
Item 1. Business 2
Item 1A. Risk Factors 13
Item 1B. Unresolved Staff Comments 21
Item 2. Properties 21
Item 3. Legal Proceedings 21
Item 4. Mine Safety Disclosures 21
     
  PART II  
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 22
Item 6. Selected Financial Data 24
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 25
Item 7A. Quantitative and Qualitative Disclosures About Market Risk 54
Item 8. Financial Statements and Supplementary Data 55
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure 117
Item 9A. Controls and Procedures 117
Item 9B. Other Information 117
     
  PART III  
     
Item 10. Directors, Executive Officers and Corporate Governance 118
Item 11. Executive Compensation 119
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 119
Item 13. Certain Relationships and Related Transactions, and Director Independence 120
Item 14. Principal Accounting Fees and Services 120
     
  PART IV  
     
Item 15. Exhibits, Financial Statement Schedules 120

 

ii
 

  

Glossary of Acronyms

 

ALCO Asset Liability Committee
ALL Allowance for loan losses
ASC Accounting Standards Codification
ASU Accounting Standards Update
ATM Automated teller machine
the Bank Union First Market Bank
the Subsidiary Banks Union First Market Bank and StellarOne Bank
BHCA Bank Holding Company Act of 1956
CDARS Certificates of Deposit Account Registry Service
CFPB Consumer Financial Protection Bureau
the Company Union First Market Bankshares Corporation
COSO Committee of Sponsoring Organizations
CRA Community Reinvestment Act of 1977
DIF Deposit Insurance Fund
Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
EPS Earnings per share
ESOP Employee Stock Ownership Plan
Exchange Act Securities Exchange Act of 1934
FASB Financial Accounting Standards Board
Federal Reserve Bank Federal Reserve Bank of Richmond
FDIA Federal Deposit Insurance Act
FDIC Federal Deposit Insurance Corporation
FDICIA Federal Deposit Insurance Corporation Improvement Act
FHLB Federal Home Loan Bank of Atlanta
FICO Financing Corporation
FMB First Market Bank
FRB or Federal Reserve Board of Governors of the Federal Reserve System
HELOC Home equity line of credit
LIBOR London Interbank Offered Rate
NPA Nonperforming assets
OREO Other real estate owned
OTTI Other than temporary impairment
PCA Prompt Corrective Action
SCC Virginia State Corporation Commission
SEC Securities and Exchange Commission
StellarOne StellarOne Corporation
TDR Troubled debt restructuring
Treasury U.S. Department of the Treasury
UIG Union Insurance Group, LCC
UISI Union Investment Services, Inc.
UMG Union Mortgage Group, Inc.
GAAP Accounting principles generally accepted in the United States

 

 
 

  

FORWARD-LOOKING STATEMENTS

 

Certain statements in this report may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are statements that include projections, predictions, expectations, or beliefs about future events or results or otherwise and are not statements of historical fact.  Such statements are often characterized by the use of qualified words (and their derivatives) such as “expect,” “believe,” “estimate,” “plan,” “project,” “anticipate,” “intend,” “will,” or words of similar meaning or other statements concerning opinions or judgment of the Company and its management about future events.  Although the Company believes that its expectations with respect to forward-looking statements are based upon reasonable assumptions within the bounds of its existing knowledge of its business and operations, there can be no assurance that actual results, performance, or achievements of the Company will not differ materially from any future results, performance, or achievements expressed or implied by such forward-looking statements.  Actual future results and trends may differ materially from historical results or those anticipated depending on a variety of factors, including, but not limited to, the effects of and changes in: general economic and bank industry conditions, the interest rate environment, legislative and regulatory requirements, competitive pressures, new products and delivery systems, inflation, stock and bond markets, accounting standards or interpretations of existing standards, mergers and acquisitions, technology, and consumer spending and savings habits.  More information is available on the Company’s website, http://investors.bankatunion.com and on the SEC’s website, www.sec.gov. The information on the Company’s website is not a part of this Form 10-K. The Company does not intend or assume any obligation to update or revise any forward-looking statements that may be made from time to time by or on behalf of the Company.

 

PART I

 

ITEM 1. - BUSINESS.

 

GENERAL

 

The Company is a financial holding company and a bank holding company organized under Virginia law and registered under the BHCA. The Company, headquartered in Richmond, Virginia is committed to the delivery of financial services through its community bank subsidiaries Union First Market Bank and StellarOne Bank and three non-bank financial services affiliates. The Company’s bank subsidiaries and non-bank financial services affiliates are:

 

Community Bank
Union First Market Bank Richmond, Virginia
StellarOne Bank Charlottesville, Virginia
 
Financial Services Affiliates
Union Mortgage Group, Inc. Glen Allen, Virginia
Union Investment Services, Inc. Ashland, Virginia
Union Insurance Group, LLC Richmond, Virginia

 

History

 

The Company was formed in connection with the July 1993 merger of Northern Neck Bankshares Corporation and Union Bancorp, Inc. Although the Company was formed in 1993, certain of the community banks that were acquired and ultimately merged to form what is now Union First Market Bank were among the oldest in Virginia.

 

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The table below indicates the year each community bank was formed, acquired by the Company and merged into what is now Union First Market Bank (except StellarOne Bank).

 

    Formed     Acquired     Merged  
Union Bank and Trust Company   1902   n/a   2010
Northern Neck State Bank   1909   1993   2010
King George State Bank   1974   1996   1999
Rappahannock National Bank   1902   1998   2010
Bay Community Bank   1999   de novo bank   2008
Guaranty Bank   1981   2004   2004
Prosperity Bank & Trust Company   1986   2006   2008
First Market Bank, FSB   2000   2010   2010
StellarOne Bank   1900   2014  

 

On January 1, 2014, the Company acquired StellarOne, a bank holding company based in Charlottesville, Virginia, in an all stock transaction pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of June 9, 2013, between the Company and StellarOne, and a related Plan of Merger (together, the “StellarOne Merger Agreement”). As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company. The Company expects to operate StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank is expected to be merged with and into Union First Market Bank.

 

The Company’s operations center is located in Ruther Glen, Virginia.

 

The Company elected to be treated as a financial holding company by the Federal Reserve in September 2013.

 

Product Offerings and Market Distribution

 

The Company is the largest community banking organization headquartered in Virginia in terms of asset size, and provides full service banking and other financial services to the Northern, Central, Rappahannock, Roanoke Valley, Shenandoah, Tidewater, and Northern Neck regions of Virginia. The Subsidiary Banks operate 144 locations in the counties of Albemarle, Augusta, Bedford, Buena Vista, Caroline, Chesterfield, Culpeper, Essex, Fairfax, Fauquier, Floyd, Fluvanna, Franklin, Frederick, Giles, Hanover, Henrico, James City, King George, King William, Lancaster, Loudoun, Madison, Montgomery, Nelson, Northumberland, Orange, Pulaski, Rappahannock, Richmond, Roanoke, Rockbridge, Rockingham, Spotsylvania, Stafford, Warren, Westmoreland, Wythe, and York, and the independent cities of Bedford, Charlottesville, Colonial Heights, Covington, Fredericksburg, Harrisonburg, Lynchburg, Newport News, Radford, Richmond, Roanoke, Salem, Staunton, Virginia Beach, and Waynesboro.

 

The Subsidiary Banks are full service community banks offering consumers and businesses a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, as well as loans for commercial, industrial, residential mortgage and consumer purposes. The Subsidiary Banks issue credit cards and delivers ATM services through the use of reciprocally shared ATMs in the major ATM networks as well as remote ATMs for the convenience of customers and other consumers. The Subsidiary Banks also offer internet banking services and online bill payment for all customers, whether retail or commercial. The Subsidiary Banks also offer private banking and trust services to individuals and corporations through a Wealth Management Group.

 

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UISI has provided securities, brokerage and investment advisory services since its formation in February 1993. UISI has 9 offices within the Bank’s trade area and is a full service investment company handling all aspects of wealth management including stocks, bonds, annuities, mutual funds and financial planning. Securities are offered through a third party contractual arrangement with Raymond James Financial Services, Inc., an independent broker dealer.

 

As of December 31, 2013, UMG has offices in Virginia (13), Maryland (3), North Carolina (6), and South Carolina (1). UMG is also licensed to do business in selected states throughout the Mid-Atlantic and Southeast, as well as Washington, D.C.  It provides a variety of mortgage products to customers in those areas. The mortgage loans originated by UMG generally are sold in the secondary market through purchase agreements with institutional investors.

 

UIG, an insurance agency, is owned by the Bank and UMG. This agency operates in a joint venture with Bankers Insurance, LLC, a large insurance agency owned by community banks across Virginia and managed by the Virginia Bankers Association. UIG generates revenue through sales of various insurance products, including long term care insurance and business owner policies.

 

SEGMENTS

 

The Company has two reportable segments: its traditional full service community banking business and its mortgage loan origination business. For more financial data and other information about each of the Company’s operating segments, refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, “Community Bank Segment” and “Mortgage Segment,” and to Note 17 “Segment Reporting Disclosures” in the “Notes to Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

EXPANSION AND STRATEGIC ACQUISITIONS

 

The Company expands its market area and increases its market share through organic growth (internal growth and de novo expansion) and strategic acquisitions. Strategic acquisitions by the Company to date have included whole bank acquisitions, branch and deposit acquisitions, and purchases of existing branches from other banks. The Company generally considers acquisitions of companies in strong growth markets or with unique products or services that will benefit the entire organization. Targeted acquisitions are priced to be economically feasible with minimal short-term drag to achieve positive long-term benefits. These acquisitions may be paid for in the form of cash, stock, debt, or a combination thereof. The amount and type of consideration and deal charges paid could have a short-term dilutive effect on the Company’s earnings per share or book value. However, cost savings and revenue enhancements in such transactions are anticipated to provide long-term economic benefit to the Company.

 

The Company’s new construction expansion during the last three years consists of opening two new bank branches in Virginia:

 

Three James Center, Union First Market Bank branch located in the city of Richmond, Virginia (November 2011)

 

Berea Marketplace, Union First Market Bank branch located in Stafford County, Virginia (March 2011)

 

On January 1, 2014, the Company acquired StellarOne in an all stock transaction pursuant to the terms and conditions of the StellarOne Merger Agreement. Pursuant to the StellarOne Merger Agreement, StellarOne’s common shareholders received 0.9739 shares of the Company’s common stock in exchange for each share of StellarOne’s common stock, resulting in the Company issuing 22,147,874 common shares. As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company. The Company expects to operate StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank is expected to be merged with and into the Bank. Further information about the StellarOne acquisition can be found in Note 20 “Subsequent Events”. As part of the acquisition plan and cost control efforts, the Company has decided to consolidate 13 overlapping bank branches into nearby locations during 2014.  In all cases, customers will be able to use branches within close proximity or continue to use the Subsidiary Banks’ other delivery channels including internet and mobile banking.

 

In June 2011, the Bank opened seven in-store bank branches in MARTIN’S Food Markets located in Harrisonburg, Waynesboro, Staunton, Winchester (2), Culpeper, and Stephens City, Virginia. The Bank currently operates in-store bank branches in 28 MARTIN’S Food Markets through its acquisition of FMB primarily in the Richmond area market.

 

In May 2011, the Company acquired deposits of approximately $48.9 million and loans of approximately $70.8 million at book value through the acquisition of the Harrisonburg, Virginia branch of NewBridge Bank. The Bank retained the commercial loan operation team from the branch and all employees of the branch. The transaction also included the purchase of a real estate parcel/future branch site in Waynesboro, Virginia.

 

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On February 1, 2010, the Company acquired First Market Bank, FSB, a privately held federally chartered savings bank based in Richmond, Virginia, in an all stock transaction. Upon the acquisition, FMB became a state chartered commercial bank subsidiary of the Company until it merged with Union Bank and Trust Company in March 2010 and the combined bank began to operate under the name Union First Market Bank.

 

During 2011 and 2012, the Bank conducted a performance and opportunity analysis of its branch network.  As a result, the Company decided to consolidate bank branches into nearby locations during 2012.  The Company closed eight branches located in Charlottesville, Mechanicsville, Port Royal, Fredericksburg, Williamsburg, Northumberland County, and two located in Fairfax County. In all cases, customers could use branches within close proximity or continue to use the Bank’s other delivery channels including internet and mobile banking.

 

EMPLOYEES

 

As of December 31, 2013, the Company had approximately 1,025 full-time equivalent employees, including executive officers, loan and other banking officers, branch personnel, operations, and other support personnel. Of this total, 175 were mortgage segment personnel. None of the Company’s employees are represented by a union or covered under a collective bargaining agreement. The Company provides employees with a comprehensive employee benefit program which includes the following: group life, health and dental insurance, paid time off, educational opportunities, a cash incentive plan, a stock purchase plan, stock incentive plans, deferred compensation plans for officers and key employees, an ESOP and a 401(k) plan with employer match.

 

COMPETITION

 

The financial services industry remains highly competitive and is constantly evolving. The Company experiences strong competition in all aspects of its business. In its market areas, the Company competes with large national and regional financial institutions, credit unions, other independent community banks, as well as consumer finance companies, mortgage companies, loan production offices, mutual funds and life insurance companies. Competition for deposits and loans is affected by various factors including interest rates offered, the number and location of branches and types of products offered, and the reputation of the institution. Credit unions increasingly have been allowed to expand their membership definitions and, because they enjoy a favorable tax status, have been able to offer more attractive loan and deposit pricing. The Company’s non-bank affiliates also operate in highly competitive environments. The Company believes its community bank framework and philosophy provide a competitive advantage, particularly with regard to larger national and regional institutions, allowing the Company to compete effectively. The Company’s community bank segment generally has strong market shares within the markets it serves. The Company’s deposit market share in Virginia was 1.96% of total bank deposits as of June 30, 2013.

 

ECONOMY

 

The economy in the Company’s footprint showed some signs of improvement during 2013, though growth remains sluggish and unemployment continues to be elevated by historical standards. Interest rates steepened somewhat, but continue to be low relative to historical rates. Housing starts and sales improved in 2013; however, higher long term interest rates may suppress continued progress in the housing market. The continued weakness in employment, continued low rates, and the burden of regulatory requirements enacted in response to the most recent financial crisis made for a challenging 2013 for the Company and for community banks in general. The effects of federal sequestration and spending cuts on Virginia’s economy remain uncertain and could have significant consequences, as approximately 30% of Virginia’s economy is tied to the federal government and the state is the leader in Department of Defense contracts. Despite this uncertainty, Virginia topped Forbes’ 2013 list of the Best States for Business. In response to the continued slow economic recovery during 2013, the Company’s management focused significant attention on managing nonperforming assets and controlling costs, while working with borrowers to mitigate and protect against risk of loss.

 

SUPERVISION AND REGULATION

 

The Company and its bank subsidiaries are extensively and increasingly regulated under both federal and state laws. The following description briefly addresses certain historic and current provisions of federal and state laws and certain regulations, proposed regulations, and the potential impacts on the Company and the Subsidiary Banks. To the extent statutory or regulatory provisions or proposals are described in this report, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.

 

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Regulatory Reform – The Dodd-Frank Act

 

On July 21, 2010, President Obama signed into law the Dodd-Frank Act. The Dodd-Frank Act significantly restructured the financial regulatory regime in the United States and has a broad impact on the financial services industry. The Dodd-Frank Act provides for new and stronger capital standards that, among other things, eliminate the treatment of trust preferred securities as Tier 1 capital. Existing trust preferred securities are grandfathered for banking entities with less than $15 billion of assets, such as the Company. The Dodd-Frank Act also permanently raises deposit insurance levels to $250,000. Pursuant to modifications under the Dodd-Frank Act, deposit insurance assessments are now calculated based on an insured depository institution’s assets rather than its insured deposits and the minimum reserve ratio of the Deposit Insurance Fund of the FDIC was raised to 1.35%. The Dodd-Frank Act also established the CFPB as an independent bureau of the Board of Governors of the FRB. The CFPB has the exclusive authority to prescribe rules governing the provision of consumer financial products and services, which in the case of the Subsidiary Banks will be enforced by the Federal Reserve.

 

Although a significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized, certain of the act’s requirements have yet to be implemented. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the federal bank regulatory agencies in the future, the full extent of the impact such requirements will have on the operations of the Company and the Subsidiary Banks is unclear. The changes resulting from the Dodd-Frank Act may affect the profitability of business activities, require changes to certain business practices, impose more stringent regulatory requirements or otherwise adversely affect the business and financial condition of the Company and the Subsidiary Banks. These changes may also require the Company to invest significant management attention and resources to evaluate and make necessary changes to comply with new statutory and regulatory requirements.

 

The Company

 

General. As a financial holding company and a bank holding company registered under the BHCA, the Company is subject to supervision, regulation, and examination by the Federal Reserve. The Company elected to be treated as financial holding company by the Federal Reserve in September 2013. The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation, and examination by the SCC.

 

Permitted Activities. A bank holding company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In addition, bank holding companies that qualify and elect to be financial holding companies, such as the Company, may engage in any activity, or acquire and retain the shares of a company engaged in any activity, that is either (i) financial in nature or incidental to such financial activity (as determined by the Federal Reserve in consultation with the Secretary of the Treasury) or (ii) complementary to a financial activity and does not pose a substantial risk to the safety and soundness of depository institutions or the financial system generally (as solely determined by the Federal Reserve), without prior approval of the Federal Reserve. Activities that are financial in nature include securities underwriting and dealing, insurance underwriting and making merchant banking investments.

 

To maintain financial holding company status, a financial holding company and all of its depository institution subsidiaries must be “well capitalized” and “well managed.” A depository institution subsidiary is considered to be “well capitalized” if it satisfies the requirements for this status under applicable Federal Reserve capital requirements. A depository institution subsidiary is considered “well managed” if it received a composite rating and management rating of at least “satisfactory” in its most recent examination. A financial holding company’s status will also depend upon it maintaining its status as “well capitalized” and “well managed” under applicable Federal Reserve regulations. If a financial holding company ceases to meet these capital and management requirements, the Federal Reserve’s regulations provide that the financial holding company must enter into an agreement with the Federal Reserve to comply with all applicable capital and management requirements. Until the financial holding company returns to compliance, the Federal Reserve may impose limitations or conditions on the conduct of its activities, and the company may not commence any of the broader financial activities permissible for financial holding companies or acquire a company engaged in such financial activities without prior approval of the Federal Reserve. If the company does not return to compliance within 180 days, the Federal Reserve may require divestiture of the holding company’s depository institutions.

 

In order for a financial holding company to commence any new activity permitted by the BHCA or to acquire a company engaged in any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. See below under “The Subsidiary Banks – Community Reinvestment Act.”

 

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Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

 

Banking Acquisitions; Changes in Control. The BHCA requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the CRA and its compliance with fair housing and other consumer protection laws.

 

Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company’s acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered its securities with the SEC under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock is registered under Section 12 of the Exchange Act.

 

In addition, Virginia law requires the prior approval of the SCC for (i) the acquisition of more than 5% of the voting shares of a Virginia bank or any holding company that controls a Virginia bank, or (ii) the acquisition by a Virginia bank holding company of a bank or its holding company domiciled outside Virginia.

 

Source of Strength. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Subsidiary Banks, including times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

 

Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the FDICIA, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

 

Under the FDIA, the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

 

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Capital Requirements. The Federal Reserve imposes certain capital requirements on bank holding companies under the BHCA, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “The Subsidiary Banks – Capital Requirements”. Subject to its capital requirements and certain other restrictions, the Company is able to borrow money to make a capital contribution to the Subsidiary Banks, and such loans may be repaid from dividends paid by the Subsidiary Banks to the Company.

 

Limits on Dividends and Other Payments. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the revenues of the Company result from dividends paid to it by the Subsidiary Banks. There are various legal limitations applicable to the payment of dividends by the Subsidiary Banks to the Company and to the payment of dividends by the Company to its shareholders. The Subsidiary Banks are subject to various statutory restrictions on its ability to pay dividends to the Company. Under current regulations, prior approval from the Federal Reserve is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. The payment of dividends by the Subsidiary Banks or the Company may be limited by other factors, such as requirements to maintain capital above regulatory guidelines. Bank regulatory agencies have the authority to prohibit the Subsidiary Banks or the Company from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending on the financial condition of the Subsidiary Banks, or the Company, could be deemed to constitute such an unsafe or unsound practice.

 

Under the FDIA, insured depository institutions such as the Subsidiary Banks, are prohibited from making capital distributions, including the payment of dividends, if, after making such distributions, the institution would become “undercapitalized” (as such term is used in the statute). Based on the Subsidiary Banks’ current financial condition, the Company does not expect this provision will have any impact on its ability to receive dividends from the Subsidiary Banks. The Company’s non-bank subsidiaries pay dividends to the Company periodically on a non-regulated basis.

 

In addition to dividends it receives from the Subsidiary Banks, the Company receives management fees from its affiliated companies for expenses incurred related to external financial reporting and audit fees, investor relations expenses, board of directors fees, and legal fees related to corporate actions. These fees are charged to each subsidiary based upon various specific allocation methods measuring the estimated usage of such services by that subsidiary. The fees are eliminated from the financial statements in the consolidation process.

 

The Subsidiary Banks

 

General. The Subsidiary Banks are supervised and regularly examined by the Federal Reserve and the SCC. The various laws and regulations administered by the bank regulatory agencies affect corporate practices, such as the payment of dividends, incurrence of debt, and acquisition of financial institutions and other companies; they also affect business practices, such as the payment of interest on deposits, the charging of interest on loans, types of business conducted, and location of offices. Certain of these law and regulations are referenced above under “The Company.”

 

Current Capital Requirements. The Federal Reserve and the other federal banking agencies have issued risk-based and leverage capital guidelines applicable to U.S. banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Under the current risk-based capital requirements of the Federal Reserve, the Company and the Subsidiary Banks are required to maintain a minimum ratio of total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) to risk-weighted assets of at least 8.0%. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, are multiplied by a risk-weight factor of 0% to 1,250%, assigned by the capital regulation based on the risks believed inherent in the type of asset. At least half of the total capital is required to be “Tier 1 capital,” which consists principally of common and certain qualifying preferred shareholders’ equity (including grandfathered trust preferred securities), less certain intangibles and other adjustments. The remainder (“Tier 2 capital”) consists of cumulative preferred stock, long-term perpetual preferred stock, a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments), and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company were 13.05% and 14.17%, respectively, as of December 31, 2013, thus exceeding the minimum requirements. The Tier 1 and total capital to risk-weighted asset ratios of the Bank were 12.43% and 13.56%, respectively, as of December 31, 2013, also exceeding the minimum requirements.

 

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Each of the federal bank regulatory agencies also has established a minimum leverage capital ratio of Tier 1 capital to average adjusted assets (“Tier 1 leverage ratio”). The guidelines provide for a minimum Tier 1 leverage ratio of 3.0% for financial holding companies and banking organizations that have the highest supervisory rating. All other banking organizations are required to maintain a minimum Tier 1 leverage ratio of 4.0% unless a different minimum is specified by an appropriate regulatory authority. In addition, for a depository institution to be considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 leverage ratio must be at least 5.0%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve has not advised the Company or the Subsidiary Banks of any specific minimum leverage ratio applicable to either entity. As of December 31, 2013, the Tier 1 leverage ratios of the Company and the Bank were 10.70% and 10.19%, respectively, well above the minimum requirements.

 

New Capital Requirements. On June 7, 2012, the Federal Reserve issued a series of proposed rules that would revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. On July 2, 2013, the Federal Reserve approved certain revisions to the proposals and finalized new capital requirements for banking organizations.

 

Effective January 1, 2015, the final rules require the Company and the Subsidiary Banks to comply with the following new minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6.0% of risk-weighted assets (increased from the current requirement of 4.0%); (iii) a total capital ratio of 8.0% of risk-weighted assets (unchanged from current requirement); and (iv) a leverage ratio of 4.0% of total assets. These are the initial capital requirements, which will be phased in over a four-year period. When fully phased in on January 1, 2019, the rules will require the Company and the Subsidiary Banks to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7.0% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation), and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 capital to average assets.

 

The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

 

With respect to the Subsidiary Banks, the rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the current 6.0%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized.

 

The new capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on nonaccrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

 

If the new minimum capital ratios described above had been effective as of December 31, 2013, based on management’s interpretation and understanding of the new rules, the Company would have remained “well capitalized” as of such date.

 

Deposit Insurance. Substantially all of the deposits of the Subsidiary Banks are insured up to applicable limits by the DIF of the FDIC and are subject to deposit insurance assessments to maintain the DIF. On April 1, 2011, the deposit insurance assessment base changed from total deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act.

 

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The FDIA, as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating. On February 27, 2009, the FDIC introduced three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50% of an institution’s assessment rate before the increase for secured liabilities in excess of 25% of domestic deposits; and (iii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10% of domestic deposits. In 2013 and 2012, the Company paid only the base assessment rate for “well capitalized” institutions, which totaled $2.8 million and $2.1 million, respectively, in regular deposit insurance assessments.

 

In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately one basis point of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the FICO bonds mature in 2017 through 2019.

 

Transactions with Affiliates. Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Subsidiary Banks to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Subsidiary Banks and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Subsidiary Banks generally may not purchase securities issued or underwritten by affiliates.

 

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank (“10% Shareholders”), are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the Subsidiary Banks’ unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Subsidiary Banks are permitted to extend credit to executive officers.

 

Prompt Corrective Action. Federal banking regulators are authorized and, under certain circumstances, required to take certain actions against banks that fail to meet their capital requirements. The federal bank regulatory agencies have additional enforcement authority with respect to undercapitalized depository institutions. “Well capitalized” institutions may generally operate without supervisory restriction. With respect to “adequately capitalized” institutions, such banks cannot normally pay dividends or make any capital contributions that would leave it undercapitalized, they cannot pay a management fee to a controlling person if, after paying the fee, it would be undercapitalized, and they cannot accept, renew or roll over any brokered deposit unless the bank has applied for and been granted a waiver by the FDIC.

 

Immediately upon becoming “undercapitalized,” a depository institution becomes subject to the provisions of Section 38 of the FDIA, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions. The Subsidiary Banks meet the definition of being “well capitalized” as of December 31, 2013.

 

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As described above in “The Subsidiary Banks – New Capital Requirements,” the new capital requirement rules issued by the Federal Reserve incorporate new requirements into the prompt corrective action framework.

 

Community Reinvestment Act. The Subsidiary Banks are subject to the requirements of the CRA. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of the local communities, including low and moderate income neighborhoods. If the Subsidiary Banks receive a rating from the Federal Reserve of less than “satisfactory” under the CRA, restrictions on operating activities would be imposed. In addition, in order for a financial holding company, like the Company, to commence any new activity permitted by the BHCA, or to acquire any company engaged in any new activity permitted by the BHCA, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA. The Subsidiary Banks currently have a “satisfactory” CRA rating.

 

Privacy Legislation. Several recent laws, including amendments to the Dodd-Frank Act, and related regulations issued by the federal bank regulatory agencies, provide new protections against the transfer and use of customer information by financial institutions. A financial institution must provide to its customers information regarding its policies and procedures with respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

 

USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (“Patriot Act”) was enacted in response to the September 11, 2001 terrorist attacks in New York, Pennsylvania, and Northern Virginia. The Patriot Act is intended to strengthen U. S. law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism. The continuing impact on financial institutions of the Patriot Act and related regulations and policies is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities to identify persons who may be involved in terrorism or money laundering.

 

Volcker Rule. The Dodd-Frank Act prohibits insured depository institutions and their holding companies from engaging in proprietary trading except in limited circumstances, and prohibits them from owning equity interests in excess of 3% of Tier 1 capital in private equity and hedge funds (known as the “Volcker Rule”). On December 10, 2013, the federal bank regulatory agencies adopted final rules implementing the Volcker Rule. These final rules prohibit banking entities from (i) engaging in short-term proprietary trading for their own accounts, and (ii) having certain ownership interests in and relationships with hedge funds or private equity funds. The final rules are intended to provide greater clarity with respect to both the extent of those primary prohibitions and of the related exemptions and exclusions. The final rules also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include (for the largest entities) making regular reports about those activities to regulators. Although the final rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company and the Subsidiary Banks. The final rules are effective April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2015. The Company has evaluated the implications of the final rules on its investments and does not expect any material financial implications.

 

Under the final rules implementing the Volcker Rule, banking entities would have been prohibited from owning certain collateralized debt obligations (“CDOs”) backed by trust preferred securities (“TruPS”) as of July 21, 2015, which could have forced banking entities to recognize unrealized market losses based on the inability to hold any such investments to maturity. However, on January 14, 2014, the federal bank regulatory agencies issued an interim rule, effective April 1, 2014, exempting TruPS CDOs from the Volcker Rule if (i) the CDO was established prior to May 19, 2010, (ii) the banking entity reasonably believes that the offering proceeds of the CDO were used to invest primarily in TruPS issued by banks with less than $15 billion in assets, and (iii) the banking entity acquired the CDO on or before December 10, 2013. However, regulators are soliciting comments to the Interim Rule, and this exemption could change prior to its effective date. The Company currently does not have any impermissible holdings of TruPS CDOs under the interim rule, and therefore, will not be required to divest of any such investments or change the accounting treatment.

 

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Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implemented by the Truth in Lending Act, requiring creditors to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Creditors are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the creditor to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the creditor can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance. To meet the mortgage credit needs of a broader customer base, the Company is predominantly an originator of mortgages that are in compliance with the Ability-to-Pay rules.

 

Consumer Laws and Regulations. The Subsidiary Banks are also subject to certain consumer laws and regulations issued thereunder that are designed to protect consumers in transactions with banks. These laws include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, Real Estate Settlement Procedures Act, Home Mortgage Disclosure Act, the Fair Credit Reporting Act, the Fair Debt Collection Practices Act, the Fair Housing Act and the Servicemembers Civil Relief Act, among others. The laws and related regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. The Subsidiary Banks must comply with the applicable provisions of these consumer protection laws and regulations as part of their ongoing customer relations.

 

Incentive Compensation. In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the financial institution’s board of directors.

 

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Company and the Subsidiary Banks, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2013, the Company and the Subsidiary Banks have not been made aware of any instances of non-compliance with the final guidance.

 

Effect of Governmental Monetary Policies

 

The Company’s operations are affected not only by general economic conditions but also by the policies of various regulatory authorities. In particular, the Federal Reserve regulates money and credit conditions and interest rates to influence general economic conditions. These policies have a significant impact on overall growth and distribution of loans, investments and deposits; they affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks, including the Company, in the past and are expected to do so in the future.

 

Filings with the SEC

 

The Company files annual, quarterly, and other reports under the Exchange Act with the SEC. These reports and this Form 10-K are posted and available at no cost on the Company’s investor relations website, http://investors.bankatunion.com, as soon as reasonably practicable after the Company files such documents with the SEC. The information contained on the Company’s website is not a part of this Form 10-K. The Company’s filings are also available through the SEC’s website at www.sec.gov.

 

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ITEM 1A. - RISK FACTORS

 

An investment in the Company’s securities involves risks. In addition to the other information set forth in this report, investors in the Company’s securities should carefully consider the factors discussed below. These factors could materially and adversely affect the Company’s business, financial condition, liquidity, results of operations and capital position, and could cause the Company’s actual results to differ materially from its historical results or the results contemplated by the forward-looking statements contained in this report, in which case the trading price of the Company’s securities could decline.

 

Risks Related To The Company’s Business

 

The Company’s business may be adversely affected by conditions in the financial markets and economic conditions generally.

 

The community banking industry is directly affected by national, regional, and local economic conditions. The economy in the Company’s footprint showed some signs of improvement during 2013, though growth remains sluggish and unemployment continues to be elevated. The effects of federal sequestration and spending cuts on Virginia’s economy remain uncertain and could have significant consequences. Management allocates significant resources to mitigate and respond to risks associated with the current economic conditions, however, such conditions cannot be predicted or controlled. Therefore, such conditions, including a reduction in federal government spending, a flatter yield curve and extended low interest rates, could adversely affect the credit quality of the Company’s loans, and/or the Company’s results of operations and financial condition. The Company’s financial performance is dependent on the business environment in the markets where the Company operates, in particular, the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers. In addition, the Company holds securities which can be significantly affected by various factors including credit ratings assigned by third parties, and an adverse credit rating in securities held by the Company could result in a reduction of the fair value of its securities portfolio and have an adverse impact on its financial condition. While general economic conditions in Virginia and the U.S. continued to improve in 2013, there can be no assurance that this improvement will continue.

 

Combining the Company and StellarOne may be more difficult, costly or time-consuming than expected, and the anticipated benefits and cost savings of the merger may not be realized.

 

The Company and StellarOne operated independently until the completion of the merger in January 2014. The success of the merger will depend, in part, on the Company’s ability to realize the anticipated benefits and cost savings from combining and integrating the businesses of the Company and StellarOne and to do so in a manner that permits growth opportunities and cost savings to be realized without materially disrupting existing customer relationships or decreasing revenues due to loss of customers. The integration process in the merger could result in the loss of key employees, the disruption of ongoing business, inconsistencies in standards, controls, procedures and policies that affect adversely the combined company’s ability to maintain relationships with customers and employees or achieve the anticipated benefits and cost savings of the merger. The loss of key employees or delays or other problems in implementing planned system conversions could adversely affect the Company’s ability to successfully conduct its business, which could have an adverse effect on the Company’s financial results and the value of its common stock. If the Company experiences difficulties with the integration process, the anticipated benefits of the merger may not be realized fully or at all, or may take longer to realize than expected. As with any merger of financial institutions, there also may be business disruptions that cause the Company to lose customers or cause customers to remove their accounts from the Company’s subsidiary banks and move their business to competing financial institutions. These integration matters could have an adverse effect on the Company. If the Company is not able to achieve its business objectives in the merger, the anticipated benefits and cost savings of the merger may not be realized fully or at all or may take longer to realize than expected.

 

The inability of the Company to successfully manage its growth or implement its growth strategy may adversely affect the Company’s results of operations and financial conditions.

 

The Company may not be able to successfully implement its growth strategy if it is unable to identify attractive markets, locations, or opportunities to expand in the future. In addition, the ability to manage growth successfully depends on whether the Company can maintain adequate capital levels, maintain cost controls, effectively manage asset quality, and successfully integrate any businesses acquired into the organization.

 

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As the Company continues to implement its growth strategy by opening new branches or acquiring branches or banks, it expects to incur increased personnel, occupancy, and other operating expenses. In the case of new branches, the Company must absorb those higher expenses while it begins to generate new deposits; there is also further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, the Company’s plans to expand could depress earnings in the short run, even if it efficiently executes a branching strategy leading to long-term financial benefits.

 

Difficulties in combining the operations of acquired entities with the Company’s own operations may prevent the Company from achieving the expected benefits from acquisitions.

 

The Company may not be able to achieve fully the strategic objectives and operating efficiencies expected in an acquisition, including the Company’s recent acquisition of StellarOne. Inherent uncertainties exist in integrating the operations of an acquired entity. In addition, the markets and industries in which the Company and its potential acquisition targets operate are highly competitive. The Company may lose customers or the customers of acquired entities as a result of an acquisition; the Company may lose key personnel, either from the acquired entity or from itself; and the Company may not be able to control the incremental increase in noninterest expense arising from an acquisition in a manner that improves its overall operating efficiencies. These factors could contribute to the Company’s not achieving the expected benefits from its acquisitions within desired time frames, if at all. Future business acquisitions could be material to the Company and it may issue additional shares of common stock to pay for those acquisitions, which would dilute current shareholders’ ownership interests. Acquisitions also could require the Company to use substantial cash or other liquid assets or to incur debt; the Company could therefore become more susceptible to economic downturns and competitive pressures.

 

Changes in interest rates could adversely affect the Company’s income and cash flows.

 

The Company’s income and cash flows depend to a great extent on the difference between the interest rates earned on interest-earning assets, such as loans and investment securities, and the interest rates paid on interest-bearing liabilities, such as deposits and borrowings. These rates are highly sensitive to many factors beyond the Company’s control, including general economic conditions and the policies of the Federal Reserve and other governmental and regulatory agencies. Changes in monetary policy, including changes in interest rates, will influence the origination of loans, the prepayment of loans, the purchase of investments, the generation of deposits, and the rates received on loans and investment securities and paid on deposits or other sources of funding. The impact of these changes may be magnified if the Company does not effectively manage the relative sensitivity of its assets and liabilities to changes in market interest rates. In addition, the Company’s ability to reflect such interest rate changes in pricing its products is influenced by competitive pressures. Fluctuations in these areas may adversely affect the Company and its shareholders. The Subsidiary Banks are often at a competitive disadvantage in managing its costs of funds compared to the large regional, super-regional, or national banks that have access to the national and international capital markets.

 

The Company generally seeks to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that it may reasonably maintain its net interest margin; however, interest rate fluctuations, loan prepayments, loan production, deposit flows, and competitive pressures are constantly changing and influence the ability to maintain a neutral position. Generally, the Company’s earnings will be more sensitive to fluctuations in interest rates depending upon the variance in volume of assets and liabilities that mature and re-price in any period. The extent and duration of the sensitivity will depend on the cumulative variance over time, the velocity and direction of changes in interest rates, shape and slope of the yield curve, and whether the Company is more asset sensitive or liability sensitive. Accordingly, the Company may not be successful in maintaining a neutral position and, as a result, the Company’s net interest margin may be affected.

 

The Company’s allowance for loan losses may prove to be insufficient to absorb losses in its loan portfolio.

 

Like all financial institutions, the Company maintains an allowance for loan losses to provide for loans that its borrowers may not repay in their entirety. The Company believes that it maintains an allowance for loan losses at a level adequate to absorb probable losses inherent in the loan portfolio as of the corresponding balance sheet date and in compliance with applicable accounting and regulatory guidance. However, the allowance for loan losses may not be sufficient to cover actual loan losses and future provisions for loan losses could materially and adversely affect the Company’s operating results. Accounting measurements related to impairment and the loan loss allowance require significant estimates that are subject to uncertainty and changes relating to new information and changing circumstances. The significant uncertainties surrounding the ability of the Company’s borrowers to execute their business models successfully through changing economic environments, competitive challenges, and other factors complicate the Company’s estimates of the risk of loss and amount of loss on any loan. Because of the degree of uncertainty and susceptibility of these factors to change, the actual losses may vary from current estimates. The Company expects fluctuations in the loan loss provisions due to the uncertain economic conditions.

 

The Company’s banking regulators, as an integral part of their examination process, periodically review the allowance for loan losses and may require the Company to increase its allowance for loan losses by recognizing additional provisions for loan losses charged to expense, or to decrease the allowance for loan losses by recognizing loan charge-offs, net of recoveries. Any such required additional provisions for loan losses or charge-offs could have a material adverse effect on the Company’s financial condition and results of operations.

 

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The Company’s concentration in loans secured by real estate may adversely affect earnings due to changes in the real estate markets.

 

The Company offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer, and other loans. Many of the Company’s loans are secured by real estate (both residential and commercial) in the Company’s market areas. A major change in the real estate markets, resulting in deterioration in the value of this collateral, or in the local or national economy, could adversely affect borrowers’ ability to pay these loans, which in turn could affect the Company. Risks of loan defaults and foreclosures are unavoidable in the banking industry; the Company tries to limit its exposure to these risks by monitoring extensions of credit carefully. The Company cannot fully eliminate credit risk; thus, credit losses will occur in the future. Additionally, changes in the real estate market also affect the value of foreclosed assets and, therefore, additional losses may occur when management determines it is appropriate to sell the assets.

 

The Company has a significant concentration of credit exposure in commercial real estate, and loans with this type of collateral are viewed as having more risk of default.

 

The Company’s commercial real estate portfolio consists primarily of owner-operated properties and other commercial properties. These types of loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the owner’s business or the property to service the debt. Cash flows may be affected significantly by general economic conditions, and a downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because the Company’s loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in the percentage of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on the Company’s financial condition.

 

The Company’s banking regulators generally give commercial real estate lending greater scrutiny, and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of commercial real estate lending growth and exposures, which could have a material adverse effect on the Company’s results of operations.

 

The Company’s loan portfolio contains construction and development loans, and a decline in real estate values and economic conditions would adversely affect the value of the collateral securing the loans and have an adverse effect on the Company’s financial condition.

 

Although most of the Company’s construction and development loans are secured by real estate, the Company believes that, in the case of the majority of these loans, the real estate collateral by itself may not be a sufficient source for repayment of the loan if real estate values decline and there is a downturn in the local and national economies. If the Company is required to liquidate the collateral securing a construction and development loan to satisfy the debt, its earnings and capital may be adversely affected. A period of reduced real estate values may continue for some time, resulting in potential adverse effects on the Company’s earnings and capital.

 

The Company’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses.

 

The Company assumes credit risk by virtue of making loans and leases and extending loan commitments and letters of credit. The Company manages credit risk through a program of underwriting standards, the review of certain credit decisions and a continuous quality assessment process of credit already extended. The Company’s exposure to credit risk is managed through the use of consistent underwriting standards that emphasize local lending while avoiding highly leveraged transactions as well as excessive industry and other concentrations. The Company’s credit administration function employs risk management techniques to help ensure that problem loans and leases are promptly identified. While these procedures are designed to provide the Company with the information needed to implement policy adjustments where necessary and to take appropriate corrective actions, there can be no assurance that such measures will be effective in avoiding undue credit risk.

 

- 15 -
 

  

The Company’s focus on lending to small to mid-sized community-based businesses may increase its credit risk.

 

Most of the Company’s commercial business and commercial real estate loans are made to small business or middle market customers. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the market areas in which the Company operates negatively impact this important customer sector, the Company’s results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by the Company in recent years and the borrowers may not have experienced a complete business or economic cycle. Any deterioration of the borrowers’ businesses may hinder their ability to repay their loans with the Company, which could have a material adverse effect on the Company’s financial condition and results of operations.

 

Nonperforming assets take significant time to resolve and adversely affect the Company’s results of operations and financial condition.

 

The Company’s nonperforming assets adversely affect its net income in various ways. The Company does not record interest income on nonaccrual loans, which adversely affects its income and increases loan administration costs. When the Company receives collateral through foreclosures and similar proceedings, it is required to mark the related loan to the then fair market value of the collateral less estimated selling costs, which may result in a loss. An increase in the level of nonperforming assets also increases the Company’s risk profile and may affect the capital levels regulators believe are appropriate in light of such risks. The Company utilizes various techniques such as workouts, restructurings, and loan sales to manage problem assets. Increases in or negative adjustments in the value of these problem assets, the underlying collateral, or in the borrowers’ performance or financial condition, could adversely affect the Company’s business, results of operations, and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and staff, which can be detrimental to the performance of their other responsibilities, including origination of new loans. There can be no assurance that the Company will avoid further increases in nonperforming loans in the future.

 

The Company faces substantial competition that could adversely affect the Company’s growth and/or operating results.

 

The Company operates in a competitive market for financial services and faces intense competition from other financial institutions both in making loans and attracting deposits which can greatly affect pricing for our products and services. The Company’s primary competitors include community, regional, and national banks as well as credit unions and mortgage companies. Many of these financial institutions have been in business for many years, are significantly larger, have established customer bases and have greater financial resources and higher lending limits. In addition, credit unions are exempt from corporate income taxes, providing a significant competitive pricing advantage. Accordingly, some of the Company’s competitors in its market have the ability to offer products and services that it is unable to offer or to offer at more competitive rates.

 

The carrying value of goodwill may be adversely affected.

 

When the Company completes an acquisition, often times, goodwill is recorded on the date of acquisition as an asset. Current accounting guidance requires goodwill to be tested for impairment; the Company performs such impairment analysis at least annually. A significant adverse change in expected future cash flows or sustained adverse change in the Company’s common stock could require the asset to become impaired. If impaired, the Company would incur a charge to earnings that would have a significant impact on the results of operations. The Company’s carrying value of goodwill was approximately $59.4 million at December 31, 2013.

 

The Company’s exposure to operational, technological, and organizational risk may adversely affect the Company.

 

Similar to other financial institutions, the Company is exposed to many types of operational and technological risk, including reputation, legal, and compliance risk. The Company’s ability to grow and compete is dependent on its ability to build or acquire the necessary operational and technological infrastructure and to manage the cost of that infrastructure while it expands and integrates acquired businesses. Operational risk can manifest itself in many ways, such as errors related to failed or inadequate processes, faulty or disabled computer systems, fraud by employees or persons outside of the Company, and exposure to external events. The Company is dependent on its operational infrastructure to help manage these risks. From time to time, it may need to change or upgrade its technology infrastructure. The Company may experience disruption, and it may face additional exposure to these risks during the course of making such changes. As the Company acquires other financial institutions, it faces additional challenges when integrating different operational platforms. Such integration efforts may be more disruptive to the business and/or more costly than anticipated.

 

The Company’s operations may be adversely affected by cyber security risks.

 

In the ordinary course of business, the Company collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees in systems and on networks. The secure processing, maintenance and use of this information is critical to operations and the Company’s business strategy. The Company has invested in accepted technologies, and continually reviews processes and practices that are designed to protect its networks, computers and data from damage or unauthorized access. Despite these security measures, the Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance, or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations, and damage to the Company’s reputation, which could adversely affect our business.

 

- 16 -
 

  

The Company’s dependency on its management team and the unexpected loss of any of those personnel could adversely affect operations.

 

The Company is a customer-focused and relationship-driven organization. Future growth is expected to be driven in large part by the relationships maintained with customers. While the Company has assembled an experienced management team, is building the depth of that team, and has management development plans in place, the unexpected loss of key employees could have a material adverse effect on the Company’s business and may result in lower revenues or greater expenses.

 

Legislative or regulatory changes or actions, or significant litigation, could adversely affect the Company or the businesses in which the Company is engaged.

 

The Company is subject to extensive state and federal regulation, supervision, and legislation that govern almost all aspects of its operations. Laws and regulations change from time to time and are primarily intended for the protection of consumers, depositors, and the FDIC’s DIF. The impact of any changes to laws and regulations or other actions by regulatory agencies may negatively affect the Company or its ability to increase the value of its business. Such changes could include higher capital requirements, increased insurance premiums, increased compliance costs, reductions of non-interest income, and limitations on services that can be provided. Actions by regulatory agencies or significant litigation against the Company could cause it to devote significant time and resources to defend itself and may lead to liability or penalties that materially affect the Company and its shareholders. Future changes in the laws or regulations or their interpretations or enforcement could be materially adverse to the Company and its shareholders.

 

The Dodd-Frank Act substantially changes the regulation of the financial services industry and it could have a material adverse effect upon the Company.

 

The Dodd-Frank Act provides wide-ranging changes in the way banks and financial services firms generally are regulated and affects the way the Company and its customers and counterparties do business with each other. Among other things, it requires increased capital and regulatory oversight for banks and their holding companies, changes the deposit insurance assessment system, changes responsibilities among regulators, establishes the new CFPB, and makes various changes in the securities laws and corporate governance that affect public companies, including the Company. The Dodd-Frank Act also requires numerous studies and regulations related to its implementation. The Company is continually evaluating the effects of the Dodd-Frank Act, together with implementing the regulations that have been proposed and adopted. The ultimate effects of the Dodd-Frank Act and the resulting rulemaking cannot be predicted at this time, but it has increased our operating and compliance costs in the short-term, and it could have a material adverse effect on the Company’s results of operation and financial condition.

 

The Company will be subject to more stringent capital and liquidity requirements as a result of the Basel III regulatory capital reforms and the Dodd-Frank Act, the short-term and long-term impact of which is uncertain.

 

The Company and the Subsidiary Banks are each subject to capital adequacy guidelines and other regulatory requirements specifying minimum amounts and types of capital which each must maintain. From time to time, regulators implement changes to these regulatory capital adequacy guidelines. Under the Dodd-Frank Act, the federal banking agencies have established stricter capital requirements and leverage limits for banks and bank holding companies that are based on the Basel III regulatory capital reforms. If the Company and the Subsidiary Banks fail to meet these minimum capital guidelines and/or other regulatory requirements, the Company’s financial condition would be materially and adversely affected.

 

- 17 -
 

  

New regulations issued by the CFPB could adversely impact the Company’s earnings.

 

The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule effective January 10, 2014, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms, or to originate “qualified mortgages” that meet specific requirements with respect to terms, pricing and fees. The new rule also contains new disclosure requirements at mortgage loan origination and in monthly statements. These requirements could limit the Company’s ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could adversely impact the Company’s profitability.

 

The Subsidiary Banks rely upon independent appraisals to determine the value of the real estate which secures a significant portion of its loans, and the values indicated by such appraisals may not be realizable if the Subsidiary Banks are forced to foreclose upon such loans.

 

A significant portion of the Subsidiary Banks’ loan portfolio consists of loans secured by real estate. The Subsidiary Banks rely upon independent appraisers to estimate the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment that adversely affect the reliability of their appraisals. In addition, events occurring after the initial appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some of the Subsidiary Bank’s loans may be more or less valuable than anticipated at the time the loans were made. If a default occurs on a loan secured by real estate that is less valuable than originally estimated, the Subsidiary Banks may not be able to recover the outstanding balance of the loan.  

 

The Company and the Subsidiary Banks rely on other companies to provide key components of its business infrastructure.

 

Third parties provide key components of the Company’s (and the Subsidiary Banks’) business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections and network access. While the Company has selected these third party vendors carefully, it does not control their actions. Any problem caused by these third parties, including poor performance of services, failure to provide services, disruptions in communication services provided by a vendor and failure to handle current or higher volumes, could adversely affect the Company’s ability to deliver products and services to its customers and otherwise conduct its business, and may harm its reputation. Financial or operational difficulties of a third party vendor could also hurt the Company’s operations if those difficulties affect the vendor’s ability to serve the Company. Replacing these third party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to the Company’s business operations.

 

The Company depends on the accuracy and completeness of information about clients and counterparties, and its financial condition could be adversely affected if it relies on misleading information.

 

In deciding whether to extend credit or to enter into other transactions with clients and counterparties, the Company may rely on information furnished to it by or on behalf of clients and counterparties, including financial statements and other financial information, which the Company does not independently verify. The Company also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, the Company may assume that a customer’s audited financial statements conform to GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. The Company’s financial condition and results of operations could be negatively impacted to the extent it relies on financial statements that do not comply with GAAP or are materially misleading.

 

Changes in accounting standards could impact reported earnings.

 

The authorities that promulgate accounting standards, including the FASB, SEC, and other regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of financial statements for prior periods. Such changes could also require the Company to incur additional personnel or technology costs.

 

- 18 -
 

  

Failure to maintain effective systems of internal and disclosure control could have a material adverse effect on the Company’s results of operation and financial condition.

 

Effective internal and disclosure controls are necessary for the Company to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. If the Company cannot provide reliable financial reports or prevent fraud, its reputation and operating results would be harmed. As part of the Company’s ongoing monitoring of internal control, it may discover material weaknesses or significant deficiencies in its internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.

 

The Company has in the past discovered, and may in the future discover, areas of its internal controls that need improvement. Even so, the Company is continuing to work to improve its internal controls. The Company cannot be certain that these measures will ensure that it implements and maintains adequate controls over its financial processes and reporting in the future. Any failure to maintain effective controls or to timely implement any necessary improvement of the Company’s internal and disclosure controls could, among other things, result in losses from fraud or error, harm the Company’s reputation or cause investors to lose confidence in the Company’s reported financial information, all of which could have a material adverse effect on the Company’s results of operation and financial condition.

 

Limited availability of financing or inability to raise capital could adversely impact the Company.

 

The amount, type, source, and cost of the Company’s funding directly impacts the ability to grow assets. The ability to raise funds through deposits, borrowings, and other sources could become more difficult, more expensive, or altogether unavailable. A number of factors could make such financing more difficult, more expensive or unavailable including: the financial condition of the Company at any given time; rate disruptions in the capital markets; the reputation for soundness and security of the financial services industry as a whole; and, competition for funding from other banks or similar financial service companies, some of which could be substantially larger or be more favorably rated.

 

Consumers may increasingly decide not to use the Subsidiary Banks to complete their financial transactions, which would have a material adverse impact on the Company’s financial condition and operations.

 

Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.

 

The Company is subject to claims and litigation pertaining to fiduciary responsibility.

 

From time to time, customers make claims and take legal action pertaining to the performance of the Company’s fiduciary responsibilities. Whether customer claims and legal action related to the performance of the Company’s fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to the Company, they may result in significant financial liability and/or adversely affect the market perception of the Company and its products and services, as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on the Company’s business, which, in turn, could have a material adverse effect on the Company’s financial condition and results of operations.

 

The Company is a defendant in a variety of litigation and other actions, which may have a material adverse effect on its financial condition and results of operation.

 

The Company may be involved from time to time in a variety of litigation arising out of its business. The Company’s insurance may not cover all claims that may be asserted against it, and any claims asserted against it, regardless of merit or eventual outcome, may harm the Company’s reputation. Should the ultimate judgments or settlements in any litigation exceed the Company’s insurance coverage, they could have a material adverse effect on the Company’s financial condition and results of operation for any period. In addition, the Company may not be able to obtain appropriate types or levels of insurance in the future, nor may the Company be able to obtain adequate replacement policies with acceptable terms, if at all.

 

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On November 20, 2013, the Company entered into a memorandum of understanding (the “Memorandum”) with plaintiffs regarding the settlement of certain litigation in response to the announcement of the StellarOne Merger Agreement. As described in the joint proxy statement/prospectus of Union and StellarOne dated October 22, 2013, on June 14, 2013, Jaclyn Crescente, individually and purportedly on behalf of all other StellarOne shareholders, filed a class action complaint against StellarOne, its current directors, StellarOne Bank (the “StellarOne Defendants”) and the Company, in the U.S. District Court for the Western District of Virginia, Charlottesville Division (the “Court”) (Case No. 3:13-cv-00021-NKM). The complaint alleges that the StellarOne directors breached their fiduciary duties by approving the merger with the Company, and that the Company aided and abetted in such breaches of duty. The complaint seeks, among other things, an order enjoining the defendants from proceeding with or consummating the merger, as well as other equitable relief and/or money damages in the event that the transaction is completed. Under the terms of the Memorandum, the Company, the StellarOne Defendants and the plaintiffs have agreed to settle the lawsuit and release the defendants from all claims made by the plaintiffs relating to the merger, subject to approval by the Court. If the Court approves the settlement contemplated by the Memorandum, the lawsuit will be dismissed with prejudice. The parties to the Memorandum have agreed that final resolution by the Court of any fee petition will not be a precondition to the dismissal of the lawsuit. There can be no assurance that the parties will ultimately enter into a stipulation of settlement or that the Court will approve the settlement, even if the parties were to enter into such stipulation. In such event, the proposed settlement as contemplated by the Memorandum may be terminated.

 

Risks Related To The Company’s Securities

 

The Company’s ability to pay dividends depends upon the results of operations of its subsidiaries.

 

The Company is a financial holding company and a bank holding company that conducts substantially all of its operations through the Subsidiary Banks and other subsidiaries. As a result, the Company’s ability to make dividend payments on its common stock depends primarily on certain federal regulatory considerations and the receipt of dividends and other distributions from its subsidiaries. There are various regulatory restrictions on the ability of the Subsidiary Banks to pay dividends or make other payments to the Company. Although the Company has historically paid a cash dividend to the holders of its common stock, holders of the common stock are not entitled to receive dividends, and regulatory or economic factors may cause the Company’s board of directors to consider, among other things, the reduction of dividends paid on the Company’s common stock.

 

While the Company’s common stock is currently traded on the NASDAQ Global Select Market, it has less liquidity than stocks for larger companies quoted on a national securities exchange.

 

The trading volume in the Company’s common stock on the NASDAQ Global Select Market has been relatively low when compared with larger companies listed on the NASDAQ Global Select Market or other stock exchanges. There is no assurance that a more active and liquid trading market for the common stock will exist in the future. Consequently, shareholders may not be able to sell a substantial number of shares for the same price at which shareholders could sell a smaller number of shares. In addition, we cannot predict the effect, if any, that future sales of the Company’s common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of the common stock. Sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, could cause the price of the Company’s common stock to decline, or reduce the Company’s ability to raise capital through future sales of common stock.

 

Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive.

 

The Company is not restricted from issuing additional shares of common stock, including any securities that are convertible into or exchangeable for, or that represent the right to receive, shares of common stock. Issuances of a substantial number of shares of common stock, or the expectation that such issuances might occur, including in connection with acquisitions by the Company, could materially adversely affect the market price of the shares of the common stock and could be dilutive to shareholders. Because the Company’s decision to issue common stock in the future will depend on market conditions and other factors, it cannot predict or estimate the amount, timing, or nature of possible future issuances of its common stock. Accordingly, the Company’s shareholders bear the risk that future issuances will reduce the market price of the common stock and dilute their stock holdings in the Company.

 

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The Company’s governing documents and Virginia law contain anti-takeover provisions that could negatively affect its shareholders.

 

The Company’s Articles of Incorporation and Bylaws and the Virginia Stock Corporation Act contain certain provisions designed to enhance the ability of the Company’s board of directors to deal with attempts to acquire control of the Company. These provisions and the ability to set the voting rights, preferences, and other terms of any series of preferred stock that may be issued, may be deemed to have an anti-takeover effect and may discourage takeovers (which certain shareholders may deem to be in their best interest). To the extent that such takeover attempts are discouraged, temporary fluctuations in the market price of the Company’s common stock resulting from actual or rumored takeover attempts may be inhibited. These provisions also could discourage or make more difficult a merger, tender offer, or proxy contest, even though such transactions may be favorable to the interests of shareholders, and could potentially adversely affect the market price of the Company’s common stock.

 

The current economic conditions may cause volatility in the Company’s common stock value.

 

In the current economic environment, the value of publicly traded stocks in the financial services sector has been volatile. However, even in a more stable economic environment the value of the Company’s common stock can be affected by a variety of factors such as excepted results of operations, actual results of operations, actions taken by shareholders, news or expectations based on the performance of others in the financial services industry, and expected impacts of a changing regulatory environment. These factors not only impact the value of the Company’s common stock but could also affect the liquidity of the stock given the Company’s size, geographical footprint, and industry.

 

ITEM 1B. - UNRESOLVED STAFF COMMENTS.

 

The Company does not have any unresolved staff comments to report for the year ended December 31, 2013.

 

ITEM 2. - PROPERTIES.

 

The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Effective October 31, 2011, the corporate headquarters was relocated from 111 Virginia Street, Suite 200, Richmond, Virginia to 1051 East Cary Street, Suite 1200, Richmond, Virginia. The Company’s subsidiaries own or lease various other offices in the counties and cities in which they operate. At December 31, 2013, the Bank operated 90 branches throughout Virginia. All of the offices of UMG are leased, either through a third party or within a Bank branch. The vast majority of the offices of UISI are located within the retail branch properties. The Company’s operations center is in Ruther Glen, Virginia. See the Note 1 “Summary of Significant Accounting Policies” and Note 4 “Bank Premises and Equipment” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K for information with respect to the amounts at which Bank premises and equipment are carried and commitments under long-term leases.

 

ITEM 3. - LEGAL PROCEEDINGS.

 

In the ordinary course of its operations, the Company and its subsidiaries are parties to various legal proceedings. Based on the information presently available, and after consultation with legal counsel, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business or the financial condition or results of operations of the Company.

 

ITEM 4. - MINE SAFETY DISCLOSURES.

 

None.

 

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PART II

 

ITEM 5. - MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.

 

The following performance graph does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Exchange Act, except to the extent the Company specifically incorporates the performance graph by reference therein.

 

Five-Year Stock Performance Graph

 

The following chart compares the yearly percentage change in the cumulative shareholder return on the Company’s common stock during the five years ended December 31, 2013, with (1) the Total Return Index for the NASDAQ Stock Market and (2) the Total Return Index for NASDAQ Bank Stocks. This comparison assumes $100 was invested on December 31, 2008 in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends.

 

Union First Market Bankshares Corporation

 

 

       Period Ending 
Index  12/31/08   12/31/09   12/31/10   12/31/11   12/31/12   12/31/13 
Union First Market Bankshares Corporation   100.00    51.04    62.02    57.10    69.52    112.23 
NASDAQ Composite   100.00    145.36    171.74    170.38    200.63    281.22 
NASDAQ Bank   100.00    83.70    95.55    85.52    101.50    143.84 

 

Source: SNL Financial Corporation LC, Charlottesville, VA (2014)

 

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Information on Common Stock, Market Prices and Dividends

 

There were 24,976,434 shares of the Company’s common stock outstanding at the close of business on December 31, 2013, which were held by 2,378 shareholders of record. The closing price of the Company’s common stock on December 31, 2013 was $24.81 per share compared to $15.77 on December 31, 2012.

 

The following table summarizes the high and low sales prices and dividends declared for quarterly periods during the years ended December 31, 2013 and 2012.

 

                   Dividends 
   Sales Prices   Declared 
   2013   2012   2013   2012 
   High   Low   High   Low         
First Quarter  $20.25   $15.87   $14.93   $13.00   $0.13   $0.07 
Second Quarter   21.40    18.01    14.75    13.08   $0.13   $0.08 
Third Quarter   23.54    20.48    15.81    14.31   $0.14   $0.10 
Fourth Quarter   26.29    22.99    16.29    14.23   $0.14   $0.12 
                       $0.54   $0.37 

 

Regulatory restrictions on the ability of the Bank to transfer funds to the Company at December 31, 2013 are set forth in Note 19, “Parent Company Financial Information,” contained in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K. A discussion of certain limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends on its common stock, is set forth in Part I., Item 1 - Business, of this Form 10-K under the headings “Supervision and Regulation – The Company - Limits on Dividends and Other Payments.”

 

It is anticipated that dividends will continue to be paid on a quarterly basis. In making its decision on the payment of dividends on the Company’s common stock, the Board of Directors considers operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and other factors.

 

Stock Repurchase Program

In December 2011, the Company was authorized to repurchase up to 350,000 shares of its common stock in the open market or in private transactions. No shares were repurchased during 2011.

 

In February 2012, the Company was authorized to enter into a stock purchase agreement with James E. Ukrop, then a member of the Company’s Board of Directors, and a trust related to Mr. Ukrop. Pursuant to the agreement, the Company repurchased 335,649 shares of its common stock for an aggregate purchase price of $4,363,437, or $13.00 per share. The repurchase was funded with cash on hand. The Company transferred 115,384 of the repurchased shares to its ESOP for $13.00 per share. The remaining 220,265 shares were retired. On February 6, 2012, the Company filed a Current Report on Form 8-K with respect to the agreement and repurchase.

 

In December 2012, the Company was authorized to repurchase up to 750,000 shares of the Company’s common stock on the open market or in private transactions. Subsequently, in December 2012, the Company entered into an agreement to purchase 750,000 shares of its common stock from Markel Corporation, the Company’s largest shareholder at that time, for an aggregate purchase price of $11,580,000, or $15.44 per share. Steven A. Markel was a director of the Company and Vice Chairman of Markel Corporation at that time. The repurchase was funded with cash on hand and the Company retired the shares. On December 12 and 21, 2012, the Company filed Current Reports on Form 8-K with respect to the authorization and repurchase.

 

In March 2013, the Company entered into an agreement to purchase 500,000 shares of its common stock from Markel Corporation, at that time the Company’s largest shareholder, for an aggregate purchase price of $9,500,000, or $19.00 per share. Steven A. Markel was a director of the Company and Vice Chairman of Markel Corporation at that time. The repurchase was funded with cash on hand and the shares were retired. The Company’s authorization to repurchase an additional 250,000 shares under its current repurchase program authorization expired December 31, 2013.

 

On January 30, 2014, the Company received authorization from its Board of Directors to purchase up to $65.0 million of the Company’s common stock on the open market or in privately negotiated transactions. The repurchase program is authorized through December 31, 2015.

 

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ITEM 6. – SELECTED FINANCIAL DATA.

 

The following table sets forth selected financial data for the Company over each of the past five years ended December 31, (dollars in thousands, except per share amounts):

 

   2013   2012   2011   2010   2009 
Results of Operations (1)                         
Interest and dividend income  $172,127   $181,863   $189,073   $189,821   $128,587 
Interest expense   20,501    27,508    32,713    38,245    48,771 
Net interest income   151,626    154,355    156,360    151,576    79,816 
Provision for loan losses   6,056    12,200    16,800    24,368    18,246 
Net interest income after provision for loan losses   145,570    142,155    139,560    127,208    61,570 
Noninterest income   38,728    41,068    32,964    34,217    23,442 
Noninterest expenses   137,289    133,479    130,815    129,920    75,762 
Income before income taxes   47,009    49,744    41,709    31,505    9,250 
Income tax expense   12,513    14,333    11,264    8,583    890 
Net income  $34,496   $35,411   $30,445   $22,922   $8,360 
                          
Financial Condition                         
Assets  $4,176,571   $4,095,865   $3,907,087   $3,837,247   $2,587,272 
Loans, net of unearned income   3,039,368    2,966,847    2,818,583    2,837,253    1,874,224 
Deposits   3,236,842    3,297,767    3,175,105    3,070,059    1,916,364 
Stockholders' equity   438,239    435,863    421,639    428,085    282,088 
                          
Ratios                         
Return on average assets (1)   0.85%   0.89%   0.79%   0.61%   0.32%
Return on average equity (1)   7.91%   8.13%   6.90%   5.50%   2.90%
Efficiency ratio (FTE) (1)   70.19%   66.86%   67.55%   68.19%   70.81%
Efficiency ratio - community bank segment (FTE) (1)   65.81%   65.88%   66.84%   68.59%   71.72%
Efficiency ratio - mortgage bank segment (FTE)   130.58%   77.66%   79.20%   64.22%   63.41%
Common equity to total assets   10.49%   10.64%   10.79%   10.26%   10.90%
Tangible common equity / tangible assets   8.94%   8.97%   8.91%   8.22%   8.64%
                          
Asset Quality                         
Allowance for loan losses  $30,135   $34,916   $39,470   $38,406   $30,484 
Nonaccrual loans  $15,035   $26,206   $44,834   $61,716   $22,348 
Other real estate owned  $34,116   $32,834   $32,263   $36,122   $22,509 
ALL / total outstanding loans   0.99%   1.18%   1.40%   1.35%   1.63%
ALL / total outstanding loans, adjusted for acquisition accounting (1)   1.10%   1.35%   1.71%   1.82%   N/A 
ALL / nonperforming loans   200.43%   133.24%   88.04%   62.23%   136.41%
NPAs / total outstanding loans   1.62%   1.99%   2.74%   3.45%   2.39%
Net charge-offs / total outstanding loans   0.36%   0.56%   0.56%   0.58%   0.71%
Provision / total outstanding loans   0.20%   0.41%   0.60%   0.86%   0.97%
                          
Per Share Data                         
Earnings per share, basic (1)  $1.38   $1.37   $1.07   $0.83   $0.19 
Earnings per share, diluted (1)   1.38    1.37    1.07    0.83    0.19 
Cash dividends paid   0.54    0.37    0.28    0.25    0.30 
Market value per share   24.81    15.77    13.29    14.78    12.39 
Book value per common share   17.56    17.30    16.17    15.16    15.34 
Price to earnings ratio, diluted   17.98    11.51    12.42    17.81    65.21 
Price to book value ratio   1.41    0.91    0.82    0.98    0.81 
Dividend payout ratio   39.13%   27.01%   26.17%   30.12%   157.89%
Weighted average shares outstanding, basic   24,975,077    25,872,316    25,981,222    25,222,565    15,160,619 
Weighted average shares outstanding, diluted   25,030,711    25,900,863    26,009,839    25,268,216    15,201,993 

 

(1) Refer to "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations", section "Non GAAP Measures" for supplemental performance measures which the Company believes may be useful to investors as they exclude non-operating adjustments resulting from acquisitions and allow investors to see the combined economic results of the organization. These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be viewed as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies. Operating metrics, which exclude acquisition-related costs, including operating earnings, return on average assets, return on average equity, efficiency ratio, and earnings per share are shown for the years ended December 31, 2013, 2012, and 2011 only.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.

 

The following discussion and analysis provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company and its subsidiaries. This discussion and analysis should be read in conjunction with the “Consolidated Financial Statements” and the “Notes to the Consolidated Financial Statements” presented in Item 8 “Financial Statements and Supplementary Data” contained in this Form 10-K.

 

CRITICAL ACCOUNTING POLICIES

 

General

 

The accounting and reporting policies of the Company and its subsidiaries are in accordance with 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, mergers and acquisitions, and goodwill and intangible assets. The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations. Accordingly, the Company’s significant accounting policies are discussed in detail in Note 1 “Summary of Significant Accounting Policies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

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

 

The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans are charged against the allowance when management believes the collectability of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on an evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to make adjustments to the allowance based on their judgments about information available to them at the time of their examination.

 

The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. The credit reviews consist of reviews by its Internal Audit group and reviews performed by an independent third party. Upon origination, each commercial loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk. This risk rating scale is the Company’s primary credit quality indicator. Consumer loans are generally not risk rated; the primary credit quality indicator for this portfolio segment is delinquency status. The Company has various committees that review and ensure that the allowance for loan losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.

 

The Company’s ALL consists of specific, general, and unallocated components.

 

Specific Reserve Component - The specific reserve component relates to impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Upon being identified as impaired, for loans not considered to be collateral dependent, an allowance is established when the discounted cash flows of the impaired loan are lower than the carrying value of that loan. Nonaccrual loans under $100,000 and other impaired loans under $500,000 are aggregated based on similar risk characteristics. The level of credit impairment within the pool(s) is determined based on historical loss factors for loans with similar risk characteristics, taking into consideration environmental factors specifically related to the underlying pool. The impairment of collateral dependent loans is measured based on the fair value of the underlying collateral (based on independent appraisals), less selling costs, compared to the carrying value of the loan. If the Company determines that the value of an impaired collateral dependent loan is less than the recorded investment in the loan, it either recognizes an impairment reserve as a specific component to be provided for in the allowance for loan losses or charge-off the deficiency if it is determined that such amount represents a confirmed loss. Typically, a loss is confirmed when the Company is moving towards foreclosure (or final disposition) of the underlying collateral, the collateral deficiency has not improved for two consecutive quarters, or when there is a payment default of 180 days, whichever occurs first.

 

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The Company obtains independent appraisals from a pre-approved list of independent, third party appraisal firms located in the market in which the collateral is located. The Company’s approved appraiser list is continuously maintained to ensure the list only includes such appraisers that have the experience, reputation, character, and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is currently licensed in the state in which the property is located, experienced in the appraisal of properties similar to the property being appraised, has knowledge of current real estate market conditions and financing trends, and is reputable. The Company’s internal Real Estate Valuation Group, which reports to the Risk and Compliance Group, performs either a technical or administrative review of all appraisals obtained. A technical review will ensure the overall quality of the appraisal, while an administrative review ensures that all of the required components of an appraisal are present. Generally, independent appraisals are updated every 12 to 24 months or as necessary. The Company’s impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Adjustments to appraisals generally include discounts for continued market deterioration subsequent to the appraisal date. Any adjustments from the appraised value to carrying value are documented in the impairment analysis, which is reviewed and approved by senior credit administration officers and the Special Assets Loan Committee. External appraisals are the primary source to value collateral dependent loans; however, the Company may also utilize values obtained through broker price opinions or other valuations sources. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed, and approved on a quarterly basis at or near the end of each reporting period.

 

General Reserve Component - The general reserve component covers non-impaired loans and is derived from an estimate of credit losses adjusted for various environmental factors applicable to both commercial and consumer loan segments. The estimate of credit losses is a function of the product of net charge-off historical loss experience to the loan balance of the loan portfolio averaged during the preceding twelve quarters, as management has determined this to adequately reflect the losses inherent in the loan portfolio. The environmental factors consist of national, local, and portfolio characteristics and are applied to both the commercial and consumer segments. The following table shows the types of environmental factors management considers:

 

ENVIRONMENTAL FACTORS
Portfolio   National   Local
Experience and ability of lending team   Interest rates   Level of economic activity
Depth of lending team   Inflation   Unemployment
Pace of loan growth   Unemployment   Competition
Franchise expansion   Gross domestic product   Military/government impact
Execution of loan risk rating process   General market risk and other concerns    
Degree of oversight / underwriting standards   Legislative and regulatory environment    
Value of real estate serving as collateral        
Delinquency levels in portfolio        
Charge-off levels in portfolio        
Credit concentrations / nature and volume  of the portfolio        

 

Unallocated Component – This component may be used to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Together, the specific, general, and any unallocated allowance for loan loss represents management’s estimate of losses inherent in the current loan portfolio. Though provisions for loan losses may be based on specific loans, the entire allowance for loan losses is available for any loan management deems necessary to charge-off. At December 31, 2013, there were no material amounts considered unallocated as part of the allowance for loan losses.

 

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Impaired Loans

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. A loan that is classified substandard or worse is considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The impaired loan policy is the same for each of the seven classes within the commercial portfolio segment.

 

For the consumer loan portfolio segment, large groups of smaller balance homogeneous loans are collectively evaluated for impairment. This evaluation subjects each of the Company’s homogenous pools to a historical loss factor derived from net charge-offs experienced over the preceding twelve quarters. The Company applies payments received on impaired loans to principal and interest based on the contractual terms until they are placed on nonaccrual status. All payments received are then applied to reduce the principal balance and recognition of interest income is terminated.

 

Mergers and Acquisitions

 

The Company’s merger and acquisition strategy focuses on high-growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance, and good asset quality, among other factors.

 

Business combinations are accounted for under ASC 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, the Company will continue to rely on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions. If they are necessary to implement its plan to exit an activity of an acquiree, costs that the Company expects, but is not obligated, to incur in the future are not liabilities at the acquisition date, nor are costs to terminate the employment of or relocate an acquiree’s employees. The Company does not recognize these costs as part of applying the acquisition method. Instead, the Company recognizes these costs as expenses in its post-combination financial statements in accordance with other applicable GAAP.

 

Acquisition-related costs are costs the Company incurs to effect a business combination. Those costs include advisory, legal, accounting, valuation, and other professional or consulting fees. Some other examples of acquisition-related costs to the Company include systems conversions, integration planning consultants, and advertising costs. The Company will account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP. These acquisition-related costs are included within the Consolidated Statements of Income classified within the noninterest expense caption.

 

Goodwill and Intangible Assets

 

The Company follows ASC 350, Goodwill and Other Intangible Assets, which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of this guidance discontinued the amortization of goodwill and intangible assets with indefinite lives but require an impairment review at least annually and more frequently if certain impairment indicators are evident.

 

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RESULTS OF OPERATIONS

 

Executive Overview

 

·The Company reported net income of $34.5 million and earnings per share of $1.38 for its year ended December 31, 2013. Excluding after-tax acquisition-related costs of $2.0 million, operating earnings(1) for the year were $36.5 million and operating earnings per share(1) were $1.46. The annual results represent an increase of $1.1 million, or 3.2%, in operating earnings and $0.09 per share, or 6.6%, from 2012 levels. The year to date financial results do not include the financial results of StellarOne, which the Company acquired on January 1, 2014, and are prior to the effective date of the merger with StellarOne.
·The Company’s community banking segment reported operating earnings of $39.2 million (or $1.57 per share), an increase of $6.3 million (or $0.30 per share) from the prior year. The Company’s mortgage segment reported a net loss of $2.7 million, a decrease of $5.2 million, from net income of $2.5 million in the prior year.
·The Company experienced continued improvement in asset quality with reduced levels of impaired loans, troubled debt restructurings, past due loans, and nonperforming assets, which were at their lowest levels since the fourth quarter of 2009.
·Net charge-offs and the loan loss provision, as well as their respective ratios of net charge-offs to total loans and provision to total loans decreased from the prior year. The allowance to nonperforming loans coverage ratio was at the highest level since the first quarter of 2008.
·Average loans outstanding increased $109.8 million, or 3.8%, in 2013 over 2012.

 

(1)For a reconciliation of the non-GAAP measures operating earnings, ROA, ROE, EPS, and efficiency ratio, see “NON-GAAP MEASURES” included in this Item 7.

 

Net Income

 

Net income for the year ended December 31, 2013 decreased $915,000, or 2.6%, from $35.4 million to $34.5 million and represented earnings per share of $1.38 compared to $1.37 for the prior year. Excluding after-tax acquisition-related expenses of $2.0 million, operating earnings for 2013 were $36.5 million and operating earnings per share was $1.46. Return on average equity for the year ended December 31, 2013 was 7.91% compared to 8.13% for the prior year while return on average assets was 0.85% compared to 0.89% for the prior year; operating return on average equity for the year ended December 31, 2013 was 8.38% compared to 8.13% for the prior year while operating return on average assets was 0.90% compared to 0.89% for the prior year.

 

The $915,000 decrease in net income was principally a result of a decrease in net interest margin of $2.7 million related to a decline in the yield on interest-earning assets that outpaced the reduction in the cost of funds, a decrease in noninterest income of $2.4 million largely due to lower gains on sales of mortgage loans, net of commission expenses, of $4.8 million, and higher noninterest expenses of $3.8 million primarily driven by salary and benefits expenses and costs related to the StellarOne merger. These items were partially offset by a $6.1 million decrease in provision for loan losses due to continued improvement in asset quality.

 

Net income for the year ended December 31, 2012 increased $5.0 million, or 16.3%, from 2011. Net income available to common shareholders increased $7.6 million, or 27.5%, from 2011, which included preferred dividends and discount accretion on preferred stock of $2.7 million. Return on average equity for the year ended December 31, 2012 was 8.13% compared to 6.90% for 2011 while return on average assets was 0.89% compared to 0.79% for 2011. Earnings per share was $1.37, an increase of $0.30, or 28.0%, from $1.07 for the year ended December 31, 2011. Earnings per share included preferred dividends and discount accretion on preferred stock of $2.7 million, or $0.10 per share, in 2011.

 

The $5.0 million increase in net income was principally a result of higher net gains on sales of mortgage loans driven by higher origination volumes, lower provision for loan losses, reductions in FDIC insurance expense due to changes in the assessment base and rate, lower core deposit intangible amortization expense, and an increase in account service charges and net debit and credit card interchange fees. Partially offsetting these results were higher salaries and benefits related to the addition of mortgage loan originators and support personnel in 2012 and lower net interest income driven by reductions in interest income on interest-earning assets that outpaced the impact of lower costs on interest-bearing liabilities.

 

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Net Interest Income

 

Net interest income, which represents the principal source of revenue for the Company, is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of average earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income, the net interest margin, and net income.

 

The decline in the general level of interest rates over the last five years has placed downward pressure on the Company’s earning asset yields and related interest income. The decline in earning asset yields, however, has been offset principally by the repricing of money market deposit accounts and certificates of deposits and lower borrowing costs. The Company believes that its net interest margin will continue to decline modestly over the next several quarters as decreases in earning asset yields are projected to outpace declines in rates paid on interest-bearing liabilities.

 

The following table shows interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated (dollars in thousands):

 

   For the Year Ended 
   Dollars in thousands 
   12/31/13   12/31/12   Change 
             
Average interest-earning assets  $3,716,849   $3,649,865   $66,984 
Interest income (FTE)  $177,383   $186,085   $(8,702)
Yield on interest-earning assets   4.77%   5.10%   (33)bps
Average interest-bearing liabilities  $2,914,139   $2,922,373   $(8,234)
Interest expense  $20,501   $27,508   $(7,007)
Cost of interest-bearing liabilities   0.70%   0.94%   (24)bps
Cost of funds   0.55%   0.76%   (21)bps
Net Interest Income (FTE)  $156,882   $158,577   $(1,695)
Net Interest Margin (FTE)   4.22%   4.34%   (12)bps
Core Net Interest Margin (FTE) (1)   4.18%   4.24%   (6)bps

 

(1) Core net interest margin (FTE) excludes the impact of acquisition accounting accretion and amortization adjustments in net interest income.

 

For the year ended December 31, 2013, tax-equivalent net interest income was $156.9 million, a decrease of $1.7 million, or 1.1%, when compared to the same period last year. The tax-equivalent net interest margin decreased by 12 basis points to 4.22% from 4.34% in the prior year. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets (-6 bps) and a decline in the yield on interest-earning assets that outpaced the reduction in the cost of funds (-6 bps). Lower interest-earning asset income was principally due to lower yields on loans as new loans and renewed loans were originated and repriced at lower rates and declining investment securities yields driven by cash flows from securities investments reinvested at lower yields.

 

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   For the Year Ended 
   Dollars in thousands 
   12/31/12   12/31/11   Change 
             
Average interest-earning assets  $3,649,865   $3,523,330   $126,535 
Interest income (FTE)  $186,085   $193,399   $(7,314)
Yield on interest-earning assets   5.10%   5.50%   (40)bps
Average interest-bearing liabilities  $2,922,373   $2,875,242   $47,131 
Interest expense  $27,508   $32,713   $(5,205)
Cost of interest-bearing liabilities   0.94%   1.14%   (20)bps
Cost of funds   0.76%   0.93%   (17)bps
Net Interest Income (FTE)  $158,577   $160,686   $(2,109)
Net Interest Margin (FTE)   4.34%   4.57%   (23)bps
Core Net Interest Margin (FTE) (1)   4.24%   4.37%   (13)bps

 

(1) Core net interest margin (FTE) excludes the impact of acquisition accounting accretion and amortization adjustments in net interest income.

 

For the year ended December 31, 2012, tax-equivalent net interest income was $158.6 million, a decrease of $2.1 million, or 1.3%, when compared to the same period in 2011. The tax-equivalent net interest margin decreased by 23 basis points to 4.34% from 4.57% in 2011. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets (-10 bps) and a decline in the yield on interest-earning assets that outpaced the reduction in the cost of interest-bearing liabilities (-13 bps). Lower interest-earning asset income was principally due to lower yields on loans and investment securities as new loans and renewed loans were originated and repriced at lower rates, faster prepayments on mortgage backed securities, and cash flows from securities investments reinvested at lower yields. The reduction in the cost of interest-bearing liabilities was primarily driven by a shift in the mix of the Company’s deposit accounts as customers moved from certificates of deposits to transaction and money market accounts. During the third quarter of 2012, the Company modified its fixed rate convertible FHLB advances to floating rate advances, which resulted in reducing the Company’s FHLB borrowing costs. The modification of the FHLB advances lowered the 2012 cost of interest-bearing liabilities by 3 bps subsequent to executing the modification during the third quarter of 2012.

 

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The following table shows interest income on earning assets and related average yields as well as interest expense on interest-bearing liabilities and related average rates paid for the years indicated (dollars in thousands):

 

AVERAGE BALANCES, INCOME AND EXPENSES, YIELDS AND RATES (TAXABLE EQUIVALENT BASIS)

 

   For the Year Ended December 31, 
   2013   2012   2011 
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
   Average
Balance
   Interest
Income /
Expense
   Yield /
Rate (1)
 
Assets:                                             
Securities:                                             
Taxable  $391,804   $8,202    2.09%  $462,996   $11,912    2.57%  $427,443   $13,387    3.13%
Tax-exempt   223,054    12,862    5.77%   179,977    11,155    6.20%   167,818    10,897    6.49%
Total securities (2)   614,858    21,064    3.43%   642,973    23,067    3.59%   595,261    24,284    4.08%
Loans, net (3) (4)   2,985,733    152,868    5.12%   2,875,916    159,682    5.55%   2,818,022    166,869    5.92%
Loans held for sale   105,450    3,433    3.26%   104,632    3,273    3.13%   53,463    2,122    3.97%
Federal funds sold   421    1    0.22%   365    1    0.24%   351    1    0.24%
Money market investments   1    -    0.00%   -    -    0.00%   96    -    0.00%
Interest-bearing deposits in other banks   10,386    17    0.17%   25,979    62    0.24%   56,137    123    0.24%
Other interest-bearing deposits   -    -    0.00%   -    -    0.00%   -    -    0.00%
Total earning assets   3,716,849    177,383    4.77%   3,649,865    186,085    5.10%   3,523,330    193,399    5.50%
Allowance for loan losses   (34,533)             (40,460)             (40,105)          
Total non-earning assets   369,752              365,820              378,403           
Total assets  $4,052,068             $3,975,225             $3,861,628           
                                              
Liabilities and Stockholders' Equity:                                             
Interest-bearing deposits:                                             
Checking  $461,594    351    0.08%  $419,550    445    0.11%  $385,715    621    0.16%
Money market savings   942,127    2,345    0.25%   909,408    3,324    0.37%   849,676    5,429    0.64%
Regular savings   226,343    680    0.30%   197,228    662    0.34%   172,627    638    0.37%
Time deposits: (5)                                             
$100,000 and over   473,244    5,751    1.22%   540,501    7,957    1.47%   573,276    9,045    1.58%
Under $100,000   488,115    4,970    1.02%   558,751    7,058    1.26%   604,172    8,613    1.43%
Total interest-bearing deposits   2,591,423    14,097    0.54%   2,625,438    19,446    0.74%   2,585,466    24,346    0.94%
Other borrowings (6)   322,716    6,404    1.98%   296,935    8,062    2.72%   289,776    8,367    2.89%
Total interest-bearing liabilities   2,914,139    20,501    0.70%   2,922,373    27,508    0.94%   2,875,242    32,713    1.14%
                                              
Noninterest-bearing liabilities:                                             
Demand deposits   664,203              577,740              513,352           
Other liabilities   37,662              39,338              31,994           
Total liabilities   3,616,004              3,539,451              3,420,588           
Stockholders' equity   436,064              435,774              441,040           
Total liabilities and stockholders' equity  $4,052,068             $3,975,225             $3,861,628           
                                              
Net interest income       $156,882             $158,577             $160,686      
                                              
Interest rate spread (7)             4.07%             4.16%             4.36%
Interest expense as a percent of average earning assets             0.55%             0.76 %             0.93%
Net interest margin (8)             4.22%             4.34%             4.57%

 

(1) Rates and yields are annualized and calculated from actual, not rounded amounts in thousands, which appear above.

(2) Interest income on securities includes $15 thousand, $201 thousand, and $387 thousand for the year ended December 31, 2013, 2012, and 2011 in accretion of the fair market value adjustments.

(3) Nonaccrual loans are included in average loans outstanding.

(4) Interest income on loans includes $2.1 million, $3.7 million, and $6.2 million for the year ended December 31, 2013, 2012, and 2011 in accretion of the fair market value adjustments related to the acquisitions.

(5) Interest expense on certificates of deposits includes $7 thousand, $233 thousand, and $886 thousand for the year ended December 31, 2013, 2012 and 2011 in accretion of the fair market value adjustments related to the acquisitions.

(6) Interest expense on borrowings includes $489 thousand for the year ended December 31, 2013, 2012, and 2011 in amortization of the fair market value adjustments related to acquisitions.

(7) Income and yields are reported on a taxable equivalent basis using the statutory federal corporate tax rate of 35%.

(8) Core net interest margin excludes purchase accounting adjustments and was 4.18%, 4.24%, and 4.37% for the year ended December 31, 2013, 2012 and 2011.

 

- 31 -
 

 

The Volume Rate Analysis table below presents changes in interest income and interest expense and distinguishes between the changes related to increases or decreases in average outstanding balances of earning assets and interest-bearing liabilities (volume), and the changes related to increases or decreases in average interest rates on such assets and liabilities (rate). Changes attributable to both volume and rate have been allocated proportionally. Results, on a taxable equivalent basis, are as follows in this Volume Rate Analysis table for the years ended December 31, (dollars in thousands):

 

   2013 vs. 2012   2012 vs. 2011 
   Increase (Decrease) Due to Change in:   Increase (Decrease) Due to Change in: 
   Volume   Rate   Total   Volume   Rate   Total 
Earning Assets:                              
Securities:                              
Taxable  $(1,675)  $(2,035)  $(3,710)  $1,050   $(2,525)  $(1,475)
Tax-exempt   2,523    (816)   1,707    768    (510)   258 
Total securities   848    (2,851)   (2,003)   1,818    (3,035)   (1,217)
Loans, net   5,908    (12,722)   (6,814)   3,375    (10,562)   (7,187)
Loans held for sale   25    135    160    1,678    (527)   1,151 
Interest-bearing deposits in other banks   (31)   (14)   (45)   (62)   1    (61)
Total earning assets  $6,750   $(15,452)  $(8,702)  $6,809   $(14,123)  $(7,314)
                               
Interest-Bearing Liabilities:                              
Interest-bearing deposits:                              
Checking  $42   $(136)  $(94)  $50   $(226)  $(176)
Money market savings   120    (1,099)   (979)   358    (2,463)   (2,105)
Regular savings   97    (79)   18    88    (64)   24 
Certificates of deposit:                              
$100,000 and over   (932)   (1,274)   (2,206)   (501)   (587)   (1,088)
Under $100,000   (834)   (1,254)   (2,088)   (619)   (936)   (1,555)
Total interest-bearing deposits   (1,507)   (3,842)   (5,349)   (624)   (4,276)   (4,900)
Other borrowings   662    (2,320)   (1,658)   203    (508)   (305)
Total interest-bearing liabilities   (845)   (6,162)   (7,007)   (421)   (4,784)   (5,205)
                               
Change in net interest income  $7,595   $(9,290)  $(1,695)  $7,230   $(9,339)  $(2,109)

 

The Company’s fully taxable equivalent net interest margin includes the impact of acquisition accounting fair value adjustments. The 2013 and remaining estimated discount/premium and net accretion impact are reflected in the following table (dollars in thousands):

 

   Loan
Accretion
   Certificates of
Deposit
   Investment
Securities
   Borrowings   Total 
                     
For the year ended December 31, 2013  $2,065   $7   $15   $(489)  $1,598 
For the years ending:                         
2014   1,459    4    -    (489)   974 
2015   1,002    -    -    (489)   513 
2016   557    -    -    (163)   394 
2017   172    -    -    -    172 
2018   19    -    -    -    19 
Thereafter   132    -    -    -    132 

 

- 32 -
 

  

Noninterest Income

 

   For the Year Ended 
   Dollars in thousands 
   12/31/13   12/31/12   $   % 
Noninterest income:                    
Service charges on deposit accounts  $9,492   $9,033   $459    5.1%
Other service charges, commissions and fees   12,309    10,898    1,411    12.9%
Gains on securities transactions   21    190    (169)   NM 
Gains on sales of mortgage loans, net of commissions   11,900    16,651    (4,751)   -28.5%
(Losses) gains on bank premises   (340)   2    (342)   NM 
Other operating income   5,346    4,294    1,052    24.5%
Total noninterest income  $38,728   $41,068   $(2,340)   -5.7%
                     
Mortgage segment operations  $(11,906)  $(16,660)  $4,754    -28.5%
Intercompany eliminations   670    468    202    43.2%
Community Bank segment  $27,492   $24,876   $2,616    10.5%

 

NM - Not Meaningful

 

For the year ended December 31, 2013, noninterest income decreased $2.4 million, or 5.7%, to $38.7 million, from $41.1 million a year ago. Excluding mortgage segment operations, noninterest income increased $2.6 million, or 10.5%, from last year. Service charges on deposit accounts increased $459,000 primarily related to higher overdraft and returned check fees as well as service charges on savings accounts. Other account service charges and fees increased $1.4 million due to higher net interchange fee income, revenue on retail investment products, and fees on letters of credit. Other operating income increased $1.1 million primarily related to increased income on bank owned life insurance, trust income, and other insurance-related revenues. Conversely, gains on bank premises decreased $342,000 as the Company recorded a loss in the current year on the closure of bank premises coupled with net gains in the prior year related to sale of bank premises. Gains on sales of mortgage loans, net of commissions, decreased $4.8 million driven by lower loan origination volume and lower gain on sale margins in 2013. Mortgage loan originations decreased by $154.8 million, or 14.1%, to $941.4 million in 2013 compared to $1.1 billion in 2012. Of the loan originations in the current year, 38.9% were refinances compared to 54.3% in 2012. Lower gain on sale margins were also partly due to reductions resulting from valuation reserves of $363,000 related to aged mortgage loans held-for-sale as well as a non-recurring charge of $966,000 for contractual indemnifications related to prior period errors in mortgage insurance premium calculations in certain mortgage loans.

 

   For the Year Ended 
   Dollars in thousands 
   12/31/12   12/31/11   $   % 
Noninterest income:                    
Service charges on deposit accounts  $9,033   $8,826   $207    2.3%
Other service charges, commissions and fees   10,898    9,736    1,162    11.9%
Gains on securities transactions   190    913    (723)   NM 
Other-than-temporary impairment losses   -    (400)   400    -100.0%
Gains on sales of mortgage loans, net of commissions   16,651    11,052    5,599    50.7%
(Losses) gains on bank premises   2    (996)   998    NM 
Other operating income   4,294    3,833    461    12.0%
Total noninterest income  $41,068   $32,964   $8,104    24.6%
                     
Mortgage segment operations  $(16,660)  $(11,050)  $(5,610)   50.8%
Intercompany eliminations   468    468    -    0.0%
Community Bank segment  $24,876   $22,382   $2,494    11.1%

 

NM - Not Meaningful

 

- 33 -
 

  

For the year ended December 31, 2012, noninterest income increased $8.1 million, or 24.6%, to $41.1 million, from $33.0 million in 2011. Gains on sales of mortgage loans, net of commissions, increased $5.6 million driven by an increase in loan origination volume, a result of additional loan originators hired in 2012 and historically low interest rates. Service charges on deposit accounts and other account fees increased $1.4 million primarily related to higher net interchange fee income, higher brokerage commissions, and higher ATM fee income. In addition, gains on bank premises increased $998,000 as the Company sold a former branch building and recorded a loss on the sale of $626,000 during 2011. Gains on securities transactions decreased $723,000 as a result of a gain on the sale of municipal securities in the prior year. Also, other-than-temporary losses of $400,000 related to a single issuer trust preferred security was recorded in the prior year. Excluding mortgage segment operations, noninterest income increased $2.5 million, or 11.1%, from the same period a year ago.

 

Noninterest expense

 

   For the Year Ended 
   Dollars in thousands 
   12/31/13   12/31/12   $   % 
Noninterest expense:                    
Salaries and benefits  $70,369   $68,648   $1,721    2.5%
Occupancy expenses   11,543    12,150    (607)   -5.0%
Furniture and equipment expenses   6,884    7,251    (367)   -5.1%
OREO and credit-related expenses (1)   4,880    4,639    241    5.2%
Acquisition-related expenses   2,132    -    2,132    NM 
Other operating expenses   41,481    40,791    690    1.7%
Total noninterest expense  $137,289   $133,479   $3,810    2.9%
                     
Mortgage segment operations  $(17,703)  $(13,971)  $(3,732)   26.7%
Intercompany eliminations   670    468    202    43.2%
Community Bank segment  $120,256   $119,976   $280    0.2%

 

NM - Not Meaningful

 

(1) OREO related costs include foreclosure related expenses, gains/losses on the sale of OREO, valuation reserves, and asset resolution related legal expenses.

 

For the year ended December 31, 2013, noninterest expense increased $3.8 million, or 2.9%, to $137.3 million, from $133.5 million a year ago. Excluding mortgage segment operations and acquisition-related costs of $2.1 million incurred in 2013, noninterest expense declined $1.8 million, or 1.5%, compared to 2012. Salaries and benefits expense increased $1.7 million due to costs associated with strategic investments in mortgage segment personnel in 2012 and 2013 and severance expense recorded in the current year related to the relocation of Union Mortgage Group, Inc.’s headquarters to Glen Allen, Virginia. Occupancy expenses decreased $607,000 and furniture and equipment expenses declined $367,000, primarily due to branch closures in 2012. OREO and credit-related expenses increased $241,000, or 5.2%, mainly related to valuation adjustments on OREO property in the current year. Other operating expenses increased $690,000, or 1.7%, due to increases in legal and litigation-related expenses of $1.2 million and FDIC insurance expenses of $672,000, partially offset by lower amortization expenses of $1.5 million.

 

- 34 -
 

  

   For the Year Ended 
   Dollars in thousands 
   12/31/12   12/31/11   $   % 
Noninterest expense:                    
Salaries and benefits  $68,648   $62,865   $5,783    9.2%
Occupancy expenses   12,150    11,104    1,046    9.4%
Furniture and equipment expenses   7,251    6,920    331    4.8%
OREO and credit-related expenses (1)   4,639    5,668    (1,029)   -18.2%
Acquisition-related expenses   -    426    (426)   -100.0%
Other operating expenses   40,791    43,832    (3,041)   -6.9%
Total noninterest expense  $133,479   $130,815   $2,664    2.0%
                     
Mortgage segment operations  $(13,971)  $(9,793)  $(4,178)   42.7%
Intercompany eliminations   468    468    -    0.0%
Community Bank segment  $119,976   $121,490   $(1,514)   -1.2%

 

NM - Not Meaningful

 

(1) OREO related costs include foreclosure related expenses, gains/losses on the sale of OREO, valuation reserves, and asset resolution related legal expenses.

 

For the year ending December 31, 2012, noninterest expense increased $2.7 million, or 2.0%, to $133.5 million, from $130.8 million during 2011. Salaries and benefits expense increased $5.8 million due to the addition of mortgage loan originators and support personnel hired in 2012, group insurance cost increases, and severance expense recorded in the current year. Occupancy costs increased $1.0 million primarily due to the addition of mortgage offices in the first quarter of 2012 and increases in bank branch lease costs. Furniture and equipment expense increased $331,000, primarily related to equipment maintenance contracts and software amortization. Partially offsetting these increases were other operating expenses which decreased $3.5 million, or 7.8%, primarily due to reductions in FDIC insurance expense of $2.6 million resulting from changes in the assessment base and rate as well as lower core deposit intangible amortization expense of $1.2 million. OREO and related costs decreased $1.0 million, or 18.2%, during 2012 due to lower valuation adjustments and losses on sales of OREO and declines in problem loan legal fees as asset quality improved. Excluding mortgage segment operations, noninterest expense decreased $1.5 million, or 1.2%, compared to the same period in 2011.

 

SEGMENT INFORMATION

 

Community Bank Segment

 

2013 compared to 2012

For the year ended December 31, 2013, the community bank segment’s net income increased $4.3 million, or 13.0%, to $37.2 million when compared to the prior year; excluding after-tax acquisition-related costs of $2.0 million in 2013, net income increased $6.3 million, or 19.3%. Net interest income decreased $3.0 million, or 2.0%, to $150.0 million when compared to the prior year due to declines in the net interest margin partially offset by loan growth. In addition, the Company’s provision for loan losses was $6.1 million lower than the prior year due to continued improvement in asset quality.

 

Noninterest income increased $2.6 million, or 10.5%, to $27.5 million from $24.9 million last year. Service charges on deposit accounts increased $459,000 primarily related to higher overdraft and returned check fees as well as service charges on savings accounts. Other account service charges and fees increased $1.4 million due to higher net interchange fee income, revenue on retail investment products, and fees on letters of credit. Other operating income increased $1.3 million primarily related to increased income on bank owned life insurance, trust income, and other insurance-related revenues. Partially offsetting these increases were decreases in gains on sale of bank premises of $342,000, as a loss was recognized in the current year compared to gains in 2012, and lower net gains on securities of $169,000.

 

- 35 -
 

  

Noninterest expense increased $280,000, or 0.2%, to $120.3 million in 2013 from $120.0 million in 2012. Excluding acquisition-related costs of $2.1 million in 2013, noninterest expense decreased $1.8 million, or 1.5%, from the prior year. Salaries and benefits declined $475,000 related to lower equity based compensation expense. Occupancy expenses and furniture and equipment expenses declined $1.2 million and $367,000, respectively, largely due to branch closures that occurred in 2012.

 

2012 compared to 2011

 

The community bank’s net income for the year ended December 31, 2012 increased $4.1 million, or 14.0%, to $32.9 million compared to $28.8 million for the year ended December 31, 2011 principally a result of lower provision for loan losses, a reduction in FDIC insurance due to change in base assessment and rate, lower amortization on the acquired deposit portfolio, and an increase in account service charges and fees. Partially offsetting these results were higher salaries and benefits costs and lower net interest income primarily due to reductions in interest-earning assets interest income outpacing lower costs on interest-bearing liabilities. Net interest income decreased $2.0 million, or 1.3%, when compared to the same period in 2011. The tax-equivalent net interest margin decreased by 23 basis points to 4.34% from 4.57% in 2011. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets and a decline in income from interest-earning assets outpacing lower costs on interest-bearing liabilities. Lower interest-earning asset income was principally due to lower yields on loans and investment securities as new loans and renewed loans were originated and repriced at lower rates, faster prepayments on mortgage backed securities, and cash flows from securities investments were reinvested at lower yields.

 

Noninterest income increased $2.5 million, or 11.2%, to $24.9 million from $22.4 million during 2011. Service charges on deposit accounts and other account fees increased $1.4 million primarily related to higher net interchange fee income, higher brokerage commissions, and higher ATM fee income. In addition, gains on bank premises increased $992,000 as the Company sold a former branch building and recorded a loss on the sale of $626,000 during 2011. Gains on securities transactions decreased $723,000 as a result of a gain on the sale of municipal securities in 2011. Also, an other-than-temporary loss of $400,000 related to a single issuer trust preferred security was recorded in 2011.

 

Noninterest expense decreased $1.5 million, or 1.2%, to $120.0 million, from $121.5 million during 2011. Salaries and benefits expense increased $2.8 million due to group insurance cost increases and severance payments to affected employees in addition to general salary increases, resulting from merit increases and additional personnel. Occupancy costs increased $747,000 primarily due to bank branch rent increases. Partially offsetting these cost increases were other operating expenses which decreased $5.2 million, or 11.0%. Included in the reduction of other operating expenses was a $2.6 million reduction in FDIC insurance due to change in base assessment and rate, lower core deposit intangible amortization of $1.2 million, and a decrease in conversion costs related to acquisition activity during 2011.

 

Mortgage Segment

 

2013 compared to 2012

 

For the year ended December 31, 2013, the mortgage segment incurred a net loss of $2.7 million compared to net income of $2.5 million during the prior year, representing a decline of $5.2 million. Mortgage loan originations decreased by $154.8 million, or 14.1%, to $941.4 million from $1.1 billion during the prior year. Loan origination volume, particularly refinance volume, is highly sensitive to changes in interest rates, and was negatively affected by the higher interest rate environment in the second half of 2013 compared to the lower interest rate environment for the full year 2012. As a result, of the loan originations in the current year, 38.9% were refinances compared to 54.3% in 2012. 

 

Related to the decline in origination volume, gains on sales of mortgage loans, net of commission expenses, decreased 28.5%, or $4.8 million. The decrease included reductions from valuation reserves of $363,000 related to aged mortgage loans held-for-sale and the non-recurring $966,000 charge for indemnification claims previously discussed. Excluding this accrual, net gains on sales of loans decreased $3.8 million, or 22.7%, driven by the 14.1% drop in mortgage loan originations and lower margins. The year to year comparative decline in net income was affected not only by the impact of the rising interest rate environment, but also the full year impact of the additional mortgage loan officers in 2013, added in the first half of 2012.

 

Expenses increased by $3.7 million, or 26.7%, over last year primarily due to increases in salary and benefit expenses of $2.2 million related to the addition of personnel to support mortgage loan originators in 2012, investments made in the current year to enhance the mortgage segment’s operating capabilities, and severance related to the relocation of the mortgage segment’s headquarters to Richmond. In addition, increases in expenses included higher rent expense of $563,000 related to annual rent increases, lease termination costs, and the headquarters relocation, loan-related expenses of $236,000, primarily related to appraisal and credit reporting expenses, and professional fees of $200,000.

 

- 36 -
 

 

2012 compared to 2011

For the year ended December 31, 2012, the mortgage segment net income increased $933,000, or 57.8%, from $1.6 million in 2011 to $2.5 million.  In early 2012, the Company significantly increased its mortgage loan production capacity by hiring additional loan originators and support personnel who were formerly employed by a national mortgage company that exited the mortgage origination business. Originations increased by $436.8 million, or 66.2%, to $1.1 billion from $659.4 million in 2011 due to the addition of mortgage loan originators and the historically low interest rate environment.  Gains on sales of loans, net of commission expenses, increased $5.6 million, or 50.7%, while salary and benefit expenses increased $3.0 million, or 55.4%, primarily due to the addition of mortgage loan originators and support personnel in early 2012.  Refinanced loans represented 54.3% of originations during the year compared to 37.4% during 2011.

 

BALANCE SHEET

 

At December 31, 2013, total assets were $4.2 billion, an increase of $80.7 million from December 31, 2012. Total cash and cash equivalents were $73.0 million at December 31, 2013, a decrease of $9.9 million from the same period last year. Investment in securities increased $91.9 million, or 15.7%, from $585.4 million at December 31, 2012 to $677.3 million at December 31, 2013. Mortgage loans held for sale were $53.2 million, a decrease of $114.5 million from December 31, 2012.

 

At December 31, 2013, loans (net of unearned income) were $3.0 billion, an increase of $72.5 million, or 2.4%, from December 31, 2012. Average loans outstanding increased $109.8 million, or 3.8%, from December 31, 2012.

 

As of December 31, 2013, total deposits were $3.2 billion, a decrease of $60.9 million, or 1.8%, when compared to December 31, 2012. The decline of year over year deposit totals was driven by decreases in time deposits of $160.9 million, partially offset by an increase of lower cost demand deposit levels of $45.8 million and an increase of NOW accounts of $43.9 million.

 

As of December 31, 2013, net short term borrowings increased $131.7 million, or 99.6% from December 31, 2012, primarily related to securities purchases (primarily mortgage backed and tax-free municipals) in the fourth quarter of 2013 in anticipation of the StellarOne merger. During the third quarter of 2012, the Company modified its fixed rate convertible FHLB advances to floating rate advances, which resulted in reducing the Company’s FHLB borrowing costs. In connection with this modification, the Company incurred a prepayment penalty of $19.6 million which is being amortized, as a component of interest expense on borrowing, over the life of the advances. The prepayment amount is reported as a component of long-term borrowings in the Company’s Consolidated Balance Sheet.

 

During the first quarter of 2013, the Company entered into an agreement to purchase 500,000 shares of its common stock from Markel Corporation, then the Company’s largest shareholder, for an aggregate purchase price of $9,500,000, or $19.00 per share. The repurchase was funded with cash on hand and the shares were retired. During the remainder of 2013, the Company did not repurchase any shares. The Company’s authorization to repurchase an additional 250,000 shares under its 2013 repurchase program authorization expired December 31, 2013.

 

On January 30, 2014, the Company’s Board of Directors authorized a share repurchase program to purchase up to $65.0 million worth of the Company’s common stock on the open market or in privately negotiated transactions. The repurchase program is authorized through December 31, 2015.

 

Securities

At December 31, 2013, the Company had total investments, in the amount of $703.4 million, or 16.8% of total assets, as compared to $606.1 million, or 14.8% of total assets, at December 31, 2012. The Company seeks to diversify its portfolio to minimize risk. It focuses on purchasing mortgage-backed securities for cash flow and reinvestment opportunities and securities issued by states and political subdivisions due to the tax benefits and the higher yield offered from these securities. All of the Company’s mortgage-backed securities are investment grade. The investment portfolio has a high percentage of municipals and mortgage-backed securities; therefore a higher taxable equivalent yield exists on the portfolio compared to its peers. The Company does not engage in structured derivative or hedging activities within the investment portfolio.

 

- 37 -
 

  

The table below sets forth a summary of the securities available for sale and restricted stock, at fair value for the following periods (dollars in thousands):

 

   2013   2012 
U.S. government and agency securities  $2,153   $2,849 
Obligations of states and political subdivisions   254,830    229,778 
Corporate and other bonds   9,434    7,212 
Mortgage-backed securities   407,362    342,174 
Other securities   3,569    3,369 
Total securities available for sale, at fair value   677,348    585,382 
           
Federal Reserve Bank stock   6,734    6,754 
Federal Home Loan Bank stock   19,302    13,933 
Total restricted stock   26,036    20,687 
Total investments  $703,384   $606,069 

 

During each quarter and at year end, the Company conducts an assessment of the securities portfolio for OTTI consideration. The Company determined that a single issuer trust preferred security incurred credit-related OTTI of $400,000 during the year ended December 31, 2011; there is no remaining unrealized loss for this issue as of December 31, 2013. No OTTI was recognized in 2012 or 2013. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes, and credit risk changes, to determine whether adjustments are needed. Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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The following table summarizes the contractual maturity of securities available for sale at fair value and their weighted average yields as of December 31, 2013 (dollars in thousands):

 

   1 Year or Less   1 - 5 Years   5 - 10 Years   Over 10 Years
and Equity
Securities
   Total 
U.S. government and agency securities:                         
Amortized cost  $-   $1,594   $-   $60   $1,654 
Fair value   -    1,628    -    525    2,153 
Weighted average yield (1)   -    2.78    -    -    2.67 
                          
Mortgage backed securities:                         
Amortized cost   209    11,839    67,865    325,476    405,389 
Fair value   211    12,248    68,704    326,199    407,362 
Weighted average yield (1)   4.21    2.96    2.08    2.02    2.06 
                          
Obligations of states and political subdivisions:                         
Amortized cost   2,965    7,463    48,870    196,037    255,335 
Fair value   3,016    7,817    50,565    193,432    254,830 
Weighted average yield (1)   6.96    6.32    6.19    5.29    5.51 
                          
Corporate bonds and other securities:                         
Amortized cost   3,617    770    -    8,709    13,096 
Fair value   3,569    804    -    8,630    13,003 
Weighted average yield (1)   1.99    4.99    -    4.90    4.10 
                          
Total securities available for sale:                         
Amortized cost   6,791    21,666    116,735    530,282    675,474 
Fair value   6,796    22,497    119,269    528,786    677,348 
Weighted average yield (1)   4.23    4.17    3.80    3.28    3.41 

 

(1) Yields on tax-exempt securities have been computed on a tax-equivalent basis.

 

As of December 31, 2013, the Company maintained a diversified municipal bond portfolio with approximately 70% of its holdings in general obligation issues and the remainder backed by revenue bonds. Issuances within the Commonwealth of Virginia represented 11% and issuances within the State of Texas represented 22% of the municipal portfolio; no other state had a concentration above 10%. Approximately 92% of municipal holdings are considered investment grade by Moody’s or Standard & Poor’s. The non-investment grade securities are principally insured Texas municipalities with no underlying rating. When purchasing municipal securities, the Company focuses on strong underlying ratings for general obligation issuers or bonds backed by essential service revenues.

 

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Loan Portfolio

Loans, net of unearned income, were $3.0 billion at both December 31, 2013 and 2012. Loans secured by real estate continue to represent the Company’s largest category, comprising 83.8% of the total loan portfolio at December 31, 2013.

 

The following table presents the Company’s composition of loans, net of unearned income, in dollar amounts and as a percentage of total gross loans as of December 31, (dollars in thousands):

 

   2013   2012   2011   2010   2009 
Loans secured by real estate:                                                  
Residential 1-4 family  475,688    15.7%  472,985   15.9%  447,544    15.9%  431,614    15.2%  349,277    18.6%
Commercial   1,094,451    36.0%   1,044,396    35.2%   985,934    34.9%   924,548    32.6%   596,773    31.9%
Construction, land development and other land loans   470,684    15.5%   470,638    15.9%   444,739    15.8%   489,601    17.3%   307,726    16.4%
Second mortgages   34,891    1.1%   39,925    1.3%   55,630    2.0%   64,534    2.3%   34,942    1.9%
Equity lines of credit   302,965    10.0%   307,668    10.4%   304,320    10.8%   305,741    10.8%   182,449    9.7%
Multifamily   146,433    4.8%   140,038    4.7%   108,260    3.8%   91,397    3.2%   46,581    2.5%
Farm land   20,769    0.7%   22,776    0.8%   26,962    1.0%   26,787    0.9%   26,191    1.4%
Total real estate loans   2,545,881    83.8%   2,498,426    84.2%   2,373,389    84.2%   2,334,222    82.3%   1,543,939    82.4%
                                                   
Commercial Loans   194,809    6.4%   186,528    6.3%   169,695    6.0%   180,840    6.4%   126,157    6.8%
                                                   
Consumer installment loans                                                  
Personal   238,368    7.8%   222,812    7.5%   241,753    8.6%   277,184    9.8%   148,811    7.9%
Credit cards   23,211    0.8%   21,968    0.7%   19,006    0.7%   19,308    0.6%   17,743    0.9%
Total consumer installment loans   261,579    8.6%   244,780    8.2%   260,759    9.3%   296,492    10.4%   166,554    8.8%
                                                   
All other loans   37,099    1.2%   37,113    1.3%   14,740    0.5%   25,699    0.9%   37,574    2.0%
Gross loans  $3,039,368    100.0%  $ 2,966,847    100.0%  $ 2,818,583    100.0%  $ 2,837,253    100.0%  $ 1,874,224    100.0%

 

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The following table presents the remaining maturities, based on contractual maturity, by loan type and by rate type (variable or fixed), as of December 31, 2013 (dollars in thousands):

 

           Variable Rate   Fixed Rate 
   Total Maturities   Less than 1
year
   Total   1-5 years   More than 5
years
   Total   1-5 years   More than
5 years
 
Loans secured by real estate:                                        
Residential 1-4 family  $475,688   $66,151   $73,136   $19,788   $53,348   $336,401   $204,244   $132,157 
Commercial   1,094,451    169,626    95,457    88,130    7,327    829,368    556,863    272,505 
Construction, land development and other land loans   470,684    318,623    8,572    5,292    3,280    143,489    120,737    22,752 
Second mortgages   34,891    3,401    2,678    2,089    589    28,812    14,231    14,581 
Equity lines of credit   302,965    194,977    43    -    43    107,945    17,695    90,250 
Multifamily   146,433    18,490    23,644    23,644    -    104,299    83,746    20,553 
Farm land   20,769    13,903    493    454    39    6,373    5,888    485 
Total real estate loans   2,545,881    785,171    204,023    139,397    64,626    1,556,687    1,003,404    553,283 
                                         
Commercial Loans   194,809    82,806    137    137    -    111,866    89,840    22,026 
                                         
Consumer installment loans                                        
Personal   238,368    7,326    -    -    -    231,042    105,715    125,327 
Credit cards   23,211    23,211    -    -    -    -    -    - 
Total consumer installment loans   261,579    30,537    -    -    -    231,042    105,715    125,327 
                                         
All other loans   37,099    7,171    3,228    3,228    -    26,700    3,720    22,980 
Gross loans  $3,039,368   $905,685   $207,388   $142,762   $64,626   $1,926,295   $1,202,679   $723,616 

 

While the current economic environment is challenging, the Company remains committed to originating soundly underwritten loans to qualifying borrowers within its markets. The Company is focused on providing community-based financial services and discourages the origination of portfolio loans outside of its principal trade areas. As reflected in the loan table, at December 31, 2013, the largest component of the Company’s loan portfolio consisted of real estate loans, concentrated in commercial, construction, and residential 1-4 family. The risks attributable to these concentrations are mitigated by the Company’s credit underwriting and monitoring processes, including oversight by a centralized credit administration function and credit policy and risk management committee, as well as seasoned bankers focusing their lending to borrowers with proven track records in markets with which the Company is familiar. UMG serves as a mortgage brokerage operation, selling the majority of its loan production in the secondary market or selling loans to meet the Bank’s current asset/liability management needs.

 

Asset Quality

 

Overview

During 2013, the Company continued to see improvement in asset quality with reduced levels of impaired loans, troubled debt restructurings, past due loans, and nonperforming assets, which were at their lowest levels since the fourth quarter of 2009. Net charge-offs and the loan loss provision, as well as their respective ratios of net charge-offs to total loans and provision to total loans, also decreased from the prior year. The allowance to nonperforming loans coverage ratio was at the highest level since the first quarter of 2008. The magnitude of any change in the real estate market and its impact on the Company is still largely dependent upon continued recovery of residential housing and commercial real estate and the pace at which the local economies in the Company’s operating markets improve.

 

The Company’s continued proactive efforts to effectively manage its loan portfolio have contributed to the improvement in asset quality. Efforts include identifying existing problem credits as well as generating new business relationships. Through early identification and diligent monitoring of specific problem credits where the uncertainty has been realized, or conversely, has been reduced or eliminated, the Company’s management has been able to quantify the credit risk in its loan portfolio, adjust collateral dependent credits to appropriate reserve levels, and further identify those credits not recoverable. The Company continues to refrain from originating or purchasing loans from foreign entities or loans classified by regulators as highly leveraged transactions. The Company’s loan portfolio generally does not include exposure to option adjustable rate mortgage products, high loan-to-value ratio mortgages, interest only mortgage loans, subprime mortgage loans or mortgage loans with initial teaser rates, which are all considered higher risk instruments.

 

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Troubled Debt Restructurings

A modification of a loan’s terms constitutes a TDR if the creditor grants a concession that it would not otherwise consider to the borrower for economic or legal reasons related to the borrower’s financial difficulties. The Company generally does not provide concession on interest rates, with the primary concession being an extension of the term of the loan from the original maturity date. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. The Company reviews previously restructured loans quarterly in order to determine whether any has performed, subsequent to the restructure, at a level that would allow for it to be removed from TDR status. The Company generally would consider a change in this classification if the loan has performed under the restructured terms for a consecutive twelve month period.

 

The total recorded investment in TDRs as of December 31, 2013 was $41.8 million, a decrease of $21.7 million, or 34.2%, from $63.5 million at December 31, 2012. The decline in the TDR balance from the prior year is attributable to $13.6 million being removed from TDR status, $11.6 million in net payments, $2.4 million in transfers to OREO, and $1.9 million in charge-offs, partially offset by additions of $7.8 million. Loans removed from TDR status represent restructured loans with a market rate of interest at the time of the restructuring, which were performing in accordance with their modified terms for a consecutive twelve month period and that were no longer considered impaired. Loans removed from TDR status are collectively evaluated for impairment and due to the significant improvement in the expected future cash flows, these loans are grouped based on their primary risk characteristics, typically using the Company’s internal risk rating system as its primary credit quality indicator, and impairment is measured based on historical loss experience taking into consideration environmental factors. The significant majority of these loans have been subject to new credit decisions due to the improvement in the expected future cash flows, the financial condition of the borrower, and other factors considered during underwriting. The TDR activity during the quarter did not have a material impact on the Company’s allowance for loan losses, financial condition, or results of operations.

 

Of the $41.8 million of TDRs at December 31, 2013, $34.5 million, or 82.5%, were considered performing while the remaining $7.3 million were considered nonperforming. Of the $63.5 million of TDRs at December 31, 2012, $51.5 million, or 81.1%, were considered performing while the remaining $12.0 million were considered nonperforming.

 

Nonperforming Assets

At December 31, 2013, nonperforming assets totaled $49.2 million, a decrease of $9.8 million, or 16.6%, from December 31, 2012. In addition, NPAs as a percentage of total outstanding loans declined 37 basis points to 1.62% from 1.99% at the end of the prior year.

 

The following table shows a summary of assets quality balances and related ratios as of and for the years ended December 31, (dollars in thousands):

 

   2013   2012   2011   2010   2009 
Nonaccrual loans (excluding purchased impaired)  $15,035   $26,206   $44,834   $61,716   $22,348 
Foreclosed properties   34,116    32,834    31,243    35,102    21,489 
Real estate investment   -    -    1,020    1,020    1,020 
Total nonperforming assets   49,151    59,040    77,097    97,838    44,857 
Loans past due 90 days and accruing interest   6,746    8,843    19,911    15,332    7,296 
Total nonperforming assets and Loans past due 90 days and accruing interest  $55,897   $67,883   $97,008   $113,170   $52,153 
                          
Performing Restructurings  $34,520   $51,468   $98,834   $13,086   $- 
                          
NPAs to total loans   1.62%   1.99%   2.74%   3.45%   2.39%
NPAs & loans 90 days past due to total loans   1.84%   2.29%   3.44%   3.99%   2.78%
NPAs to total loans & OREO   1.60%   1.97%   2.70%   3.40%   2.36%
NPAs & loans 90 days past due to total loans & OREO   1.82%   2.26%   3.40%   3.94%   2.75%
ALLL to nonaccrual loans   200.43%   133.24%   88.04%   62.23%   136.41%
ALLL to nonaccrual loans & loans 90 days past due   138.35%   99.62%   60.96%   49.85%   102.83%

 

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Nonperforming assets at December 31, 2013 included $15.0 million in nonaccrual loans (excluding purchased impaired loans), a net decrease of $11.2 million, or 42.7%, from the prior year. The following table shows the activity in nonaccrual loans for the years ended December 31, (dollars in thousands):

  

                 
   2013   2012   2011   2010 
Beginning Balance  $26,206   $44,834   $61,716   $22,348 
Net customer payments   (12,393)   (13,624)   (18,661)   (8,985)
Additions   16,725    10,265    19,905    75,099 
Charge-offs   (8,743)   (8,510)   (8,716)   (10,005)
Loans returning to accruing status   (2,718)   (3,455)   (3,607)   (1,017)
Transfers to OREO   (4,042)   (3,304)   (5,803)   (15,724)
Ending Balance  $15,035   $26,206   $44,834   $61,716 

 

The additions during the year were primarily related to commercial and industrial loans and mortgages. The reductions in nonaccrual loans during the year were primarily related to the commercial loan portfolio, particularly commercial construction and raw land loans.

 

The following table presents the composition of nonaccrual loans (excluding purchased impaired loans) and the coverage ratio, which is the allowance for loan losses expressed as a percentage of nonaccrual loans, at the years ended December 31, (dollars in thousands):

  

   2013   2012   2011   2010 
Raw Land and Lots  $2,560   $8,760   $13,322   $22,546 
Commercial Construction   1,596    5,781    10,276    11,410 
Commercial Real Estate   2,212    3,018    7,993    10,157 
Single Family Investment Real Estate   1,689    3,420    5,048    10,226 
Commercial and Industrial   3,848    2,036    5,297    4,797 
Other Commercial   126    193    238    458 
Consumer   3,004    2,998    2,660    2,122 
Total  $15,035   $26,206   $44,834   $61,716 
                     
Coverage Ratio   200.43%   133.24%   88.04%   62.23%

 

Nonperforming assets at December 31, 2013 also included $34.1 million in OREO, an increase of $1.3 million, or 4.0%, from the prior year. The following table shows the activity in OREO for the years ended December 31, (dollars in thousands):

  

   2013   2012   2011   2010 
Beginning Balance  $32,834   $32,263   $36,122   $22,509 
Additions   9,542    14,275    11,625    24,792 
Capitalized Improvements   561    380    528    404 
Valuation Adjustments   (791)   (301)   (707)   (43)
Proceeds from sales   (7,569)   (13,152)   (14,240)   (11,747)
Gains (losses) from sales   (461)   (631)   (1,065)   207 
Ending Balance  $34,116   $32,834   $32,263   $36,122 

 

During the year ended December 31, 2013, the additions to OREO were principally related to residential real estate and raw land; sales from OREO were principally related to residential real estate.

 

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The following table presents the composition of the OREO portfolio at the years ended December 31, (dollars in thousands):

 

   2013   2012   2011   2010 
Land  $10,310   $8,657   $6,327   $7,689 
Land Development   10,904    10,886    11,309    11,233 
Residential Real Estate   7,379    7,939    11,024    13,402 
Commercial Real Estate   5,523    5,352    2,583    2,778 
Former Bank Premises (1)   -    -    1,020    1,020 
Total  $34,116   $32,834   $32,263   $36,122 

(1) Includes closed branch property and land previously held for branch sites.

 

Included in land development is $9.3 million related to a residential community in the Northern Neck region of Virginia, which includes developed residential lots, a golf course, and undeveloped land. Foreclosed properties were adjusted to their fair values at the time of each foreclosure and any losses were taken as loan charge-offs against the allowance for loan losses at that time. OREO asset balances are also evaluated at least quarterly by the subsidiary bank’s Special Asset Loan Committee and any necessary write downs to fair values are recorded as impairment.

 

Past Due Loans

At December 31, 2013, total accruing past due loans were $26.5 million, or 0.87% of total loans, a decrease from $32.4 million, or 1.09% of total loans, a year ago. This net decrease of $5.9 million, or 18.2%, is a result of management’s diligence in handling problem loans and an improving economy.

 

Charge-offs and delinquencies

For the year ended December 31, 2013, net charge-offs of loans were $10.8 million, or 0.36%, compared to $16.8 million, or 0.56%, last year. Of the $10.8 million in net charge-offs, approximately $8.8 million, or 81%, related to impaired loans specifically reserved for in the prior periods. Net charge-offs in the current year included commercial loans of $7.0 million and consumer loans of $3.8 million.

 

Provision

The provision for loan losses for the year ended December 31, 2013 was $6.1 million, a decrease of $6.1 million, or 50.0%, from the prior year. The lower provision for loan losses compared to last year is driven by improving asset quality and the impact of overall lower historical charge-off factors. The provision to loans ratio for the year ended December 31, 2013 was 0.20% compared to 0.41% for the prior year.

 

Allowance for Loan Losses

The allowance for loan losses as a percentage of the total loan portfolio, adjusted for acquisition accounting (non-GAAP), was 1.10% at December 31, 2013, a decrease from 1.35% a year ago. In acquisition accounting, there is no carryover of previously established allowance for loan losses. The allowance for loan losses as a percentage of the total loan portfolio was 0.99% at December 31, 2013, a decrease from 1.18% at December 31, 2012. The decrease in the allowance and related ratios was primarily attributable to the charge-off of impaired loans specifically reserved for in prior periods and improving credit quality metrics.

 

Impaired loans have declined from $155.4 million at December 31, 2012 to $112.6 million at December 31, 2013. The nonaccrual loan coverage ratio also improved, as it increased to 200.4% at December 31, 2013 from 133.2% at December 31, 2012. The rise in the coverage ratio, which is at the highest level since the first quarter of 2008, illustrates that management’s proactive diligence in working through problem credits is having a significant impact on asset quality. The current level of the allowance for loan losses reflects specific reserves related to nonperforming loans, current risk ratings on loans, net charge-off activity, loan growth, delinquency trends, and other credit risk factors that the Company considers important in assessing the adequacy of the allowance for loan losses.

 

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The following table summarizes activity in the allowance for loan losses during the years ended December 31, (dollars in thousands):

  

   2013   2012   2011   2010   2009 
Balance, beginning of year  $34,916   $39,470   $38,406   $30,484   $25,496 
Loans charged-off:                         
Commercial   3,080    1,439    2,183    2,205    2,039 
Real estate   8,596    14,127    12,669    12,581    8,702 
Consumer   1,942    2,899    3,014    3,763    3,667 
Total loans charged-off   13,618    18,465    17,866    18,549    14,408 
Recoveries:                         
Commercial   746    207    413    551    71 
Real estate   1,125    465    571    628    807 
Consumer   910    1,039    1,146    924    272 
Total recoveries   2,781    1,711    2,130    2,103    1,150 
Net charge-offs   10,837    16,754    15,736    16,446    13,258 
Provision for loan losses   6,056    12,200    16,800    24,368    18,246 
Balance, end of year  $30,135   $34,916   $39,470   $38,406   $30,484 
                          
ALL to loans   0.99%   1.18%   1.40%   1.35%   1.63%
ALL to loans, adjusted for acquisition accounting (Non-GAAP)   1.10%   1.35%   1.71%   1.82%   N/A 
Net charge-offs to total loans   0.36%   0.56%   0.56%   0.58%   0.71%
Provision to total loans   0.20%   0.41%   0.60%   0.86%   0.97%

 

The following table shows both an allocation of the allowance for loan losses among loan categories based upon the loan portfolio’s composition and the ratio of the related outstanding loan balances to total loans as of December 31, (dollars in thousands):

  

   2013   2012   2011   2010   2009 
   $   % (1)   $   % (1)   $   % (1)   $   % (1)   $   % (1) 
Commercial  $1,932    6.4%  $2,195    6.3%  $2,376    6.0%  $2,448    6.4%  $2,052    6.7%
Real estate   25,242    83.8%   29,403    84.2%   33,236    84.2%   31,597    82.3%   25,112    82.4%
Consumer   2,961    9.8%   3,318    9.5%   3,858    9.8%   4,361    11.3%   3,320    10.9%
Total  $30,135    100.0%  $34,916    100.0%  $39,470    100.0%  $38,406    100.0%  $30,484    100.0%

 

(1) The percent represents the loan balance divided by total loans.

 

Deposits

As of December 31, 2013, total deposits were $3.2 billion, down $60.9 million, or 1.8%, from December 31, 2012. Total interest-bearing deposits consist of NOW, money market, savings, and time deposit account balances. Total time deposit balances of $871.9 million accounted for 34.3% of total interest-bearing deposits at December 31, 2013. The Company continues to experience a shift from time deposits into lower cost transaction (demand deposits, NOW, money market, and savings) accounts. This shift is driven by the Company’s focus on acquiring low cost deposits and customer preference for liquidity in a historically low interest rate environment.

 

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The community bank segment may also borrow additional funds by purchasing certificates of deposit through a nationally recognized network of financial institutions. The Company utilizes this funding source when rates are more favorable than other funding sources. As of December 31, 2013 and 2012, there were $13.7 million and $10.2 million, respectively, purchased and included in certificates of deposit on the Company’s Consolidated Balance Sheet. Maturities of time deposits as of December 31, 2013 are as follows (dollars in thousands):

  

   Within 3
Months
   3 - 12
Months
   Over 12
Months
   Total   Percent Of
Total
Deposits
 
Maturities of time deposits of $100,000 and over  $102,186   $169,565   $155,846   $427,597    13.21%
Maturities of other time deposits   71,496    218,350    154,408    444,254    13.72%
Total time deposits  $173,682   $387,915   $310,254   $871,851    26.93%

 

Capital Resources

 

Capital resources represent funds, earned or obtained, over which financial institutions can exercise greater or longer control in comparison with deposits and borrowed funds. The adequacy of the Company’s capital is reviewed by management on an ongoing basis with reference to size, composition, and quality of the Company’s resources and consistency with regulatory requirements and industry standards. Management seeks to maintain a capital structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses, yet allow management to effectively leverage its capital to maximize return to shareholders.

 

The FRB and the FDIC have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total assets is 8.0%, of which 4.0% must be Tier 1 capital, consisting of principally common equity, retained earnings and a limited amount of perpetual preferred stock, less certain intangible items. The table below shows the Company exceeded the definition of “well capitalized” for regulatory purposes.

 

In connection with two bank acquisitions, prior to 2006, the Company issued trust preferred capital notes to fund the cash portion of those acquisitions, collectively totaling $58.5 million. The trust preferred capital notes currently qualify for Tier 1 capital of the Company for regulatory purposes.

 

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The following table summarizes the Company’s regulatory capital and related ratios over the past three years ended December 31, (dollars in thousands):

 

   2013   2012   2011 
Tier 1 Capital:               
Common Stock - par value  $33,020   $33,510   $34,672 
Surplus   170,770    176,635    187,493 
Retained Earnings   236,639    215,634    189,824 
Total Equity   440,429    425,779    411,989 
Plus: qualifying trust preferred capital notes   58,500    58,500    58,500 
Less: disallowed intangibles   71,380    75,211    80,547 
Plus: goodwill deferred tax liability   940    810    681 
Total Tier 1 Capital  $428,489   $409,878   $390,623 
                
Tier 2 Capital:               
Net unrealized gain/loss on equity securities  $191   $128   $83 
Subordinated debt   6,544    9,522    12,305 
Allowance for loan losses   30,135    34,916    38,007 
Total Tier 2 Capital  $36,870   $44,566   $50,395 
Total risk-based capital  $465,359   $454,444   $441,018 
                
Risk-weighted assets  $3,284,430   $3,119,063   $3,039,099 
                
Capital ratios:               
Tier 1 risk-based capital ratio   13.05%   13.14%   12.85%
Total risk-based capital ratio   14.17%   14.57%   14.51%
Leverage ratio (Tier 1 capital to average adjusted assets)   10.70%   10.52%   10.34%
Common equity to total assets   10.49%   10.64%   10.79%
Tangible common equity to tangible assets   8.94%   8.97%   8.91%

 

In July 2013, the FRB issued revised final rules that make technical changes to its market risk capital rules to align it with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final new capital rules require the Company to comply with the following new minimum capital ratios, effective January 1, 2015: (1) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the current requirement of 4%); (3) a total capital ratio of 8% of risk-weighted assets (unchanged from current requirement); and, (4) a leverage ratio of 4% of total assets.

 

If the new minimum capital ratios described above had been effective as of December 31, 2013, based on management’s interpretation and understanding of the new rules, the Company would have remained “well capitalized” as of such date.

 

Commitments and off-balance sheet obligations

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments. For more information pertaining to these commitments, reference Note 8 “Commitments and Contingencies” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

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The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support off-balance sheet financial instruments with credit risk.

 

At December 31, 2013, UMG had rate lock commitments to originate mortgage loans amounting to $54.8 million and loans held for sale of $53.2 million. UMG has entered into corresponding commitments on a best-efforts basis to sell loans on a servicing-released basis totaling approximately $108.0 million. These commitments to sell loans are designed to reduce the mortgage company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

 

The following table represents the Company’s other commitments with balance sheet or off-balance sheet risk as of December 31, (dollars in thousands):

  

   2013   2012 
Commitments with off-balance sheet risk:          
Commitments to extend credit (1)  $891,680   $844,766 
Standby letters of credit   48,107    45,536 
Mortgage loan rate lock commitments   54,834    133,326 
Total commitments with off-balance sheet risk  $994,621   $1,023,628 
Commitments with balance sheet risk:          
Loans held for sale  $53,185   $167,698 
Total other commitments  $1,047,806   $1,191,326 
           
(1) Includes unfunded overdraft protection.          

 

The following table presents the Company’s contractual obligations and scheduled payment amounts due at the various intervals over the next five years and beyond as of December 31, 2013 (dollars in thousands):

 

   Total   Less than 1
year
   1-3 years   4-5 years   More than 5
years
 
Long-term debt  $139,049   $-   $16,359   $-   $122,690 
Trust preferred capital notes   60,310    -    -    -    60,310 
Operating leases   32,781    5,380    9,217    7,774    10,410 
Other short-term borrowings   211,500    211,500    -    -    - 
Repurchase agreements   52,455    52,455    -    -    - 
Total contractual obligations  $496,095   $269,335   $25,576   $7,774   $193,410 

 

For more information pertaining to the previous table, reference Note 4 “Bank Premise and Equipment” and Note 7 “Borrowings” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of the Form 10-K.

 

Interest Sensitivity

 

Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates, and equity prices. The Company’s market risk is composed primarily of interest rate risk. The ALCO of the Company is responsible for reviewing the interest rate sensitivity position of the Company and establishing policies to monitor and limit exposure to this risk. The Company’s Board of Directors reviews and approves the guidelines established by ALCO.

 

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Interest rate risk is monitored through the use of three complementary modeling tools: static gap analysis, earnings simulation modeling, and economic value simulation (net present value estimation). Each of these models measures changes in a variety of interest rate scenarios. While each of the interest rate risk models has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships. Static gap, which measures aggregate re-pricing values, is less utilized because it does not effectively measure the options risk impact on the Company and is not addressed here. Earnings simulation and economic value models, which more effectively measure the cash flow and optionality impacts, are utilized by management on a regular basis and are explained below.

 

The Company determines the overall magnitude of interest sensitivity risk and then formulates policies and practices governing asset generation and pricing, funding sources and pricing, and off-balance sheet commitments. These decisions are based on management’s expectations regarding future interest rate movements, the states of the national, regional and local economies, and other financial and business risk factors. The Company uses computer simulation modeling to measure and monitor the effect of various interest rate scenarios and business strategies on net interest income. This modeling reflects interest rate changes and the related impact on net interest income and net income over specified time horizons.

 

Earnings Simulation Analysis

 

Management uses simulation analysis to measure the sensitivity of net interest income to changes in interest rates. The model calculates an earnings estimate based on current and projected balances and rates. This method is subject to the accuracy of the assumptions that underlie the process, but it provides a better analysis of the sensitivity of earnings to changes in interest rates than other analyses, such as the static gap analysis discussed above.

 

Assumptions used in the model are derived from historical trends and management’s outlook and include loan and deposit growth rates and projected yields and rates. Such assumptions are monitored by management and periodically adjusted as appropriate. All maturities, calls, and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loans and mortgage-backed securities prepayment assumptions are based on industry estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Different interest rate scenarios and yield curves are used to measure the sensitivity of earnings to changing interest rates. Interest rates on different asset and liability accounts move differently when the prime rate changes and are reflected in the different rate scenarios.

 

The Company uses its simulation model to estimate earnings in rate environments where rates are instantaneously shocked up or down around a “most likely” rate scenario, based on implied forward rates. The analysis assesses the impact on net interest income over a 12 month time horizon after an immediate increase or “shock” in rates, of 100 basis points up to 300 basis points. The shock down 200 or 300 basis points analysis is not as meaningful as interest rates across most of the yield curve are at historic lows and cannot decrease another 200 or 300 basis points. The model, under all scenarios, does not drop the index below zero.

 

 The following table represents the interest rate sensitivity on net interest income for the Company across the rate paths modeled for balances ended December 31, 2013 (dollars in thousands):

 

   Change In Net Interest Income 
   %   $ 
Change in Yield Curve:          
+300 basis points   (2.01)   (3,274)
+200 basis points   (1.16)   (1,896)
+100 basis points   (0.86)   (1,405)
Most likely rate scenario   -    - 
-100 basis points   (1.91)   (3,118)
-200 basis points   (5.85)   (9,546)
-300 basis points   (7.34)   (11,980)

 

Economic Value Simulation

 

Economic value simulation is used to calculate the estimated fair value of assets and liabilities over different interest rate environments. Economic values are calculated based on discounted cash flow analysis. The net economic value of equity is the economic value of all assets minus the economic value of all liabilities. The change in net economic value over different rate environments is an indication of the longer-term earnings capability of the balance sheet. The same assumptions are used in the economic value simulation as in the earnings simulation. The economic value simulation uses instantaneous rate shocks to the balance sheet.

 

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The following chart reflects the estimated change in net economic value over different rate environments using economic value simulation for the balances at the period ended December 31, 2013 (dollars in thousands):

 

   Change In Economic Value of Equity 
   %   $ 
Change in Yield Curve:          
+300 basis points   (11.84)   (75,364)
+200 basis points   (7.28)   (46,371)
+100 basis points   (3.30)   (21,002)
Most likely rate scenario   -    - 
-100 basis points   0.35    2,217 
-200 basis points   (2.48)   (15,794)
-300 basis points   (2.84)   (18,103)

 

The shock down 200 or 300 basis points analysis is not as meaningful since interest rates across most of the yield curve are at historic lows and cannot decrease another 200 or 300 basis points.  While management considers this scenario highly unlikely, the natural floor increases the Company’s sensitivity in rates down scenarios.

 

Liquidity

 

Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, money market investments, federal funds sold, securities available for sale, loans held for sale, and loans maturing or re-pricing within one year. Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary through federal funds lines with several correspondent banks, a line of credit with the FHLB, the purchase of brokered certificates of deposit, and a corporate line of credit with a large correspondent bank. Management considers the Company’s overall liquidity to be sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

 

At December 31, 2013, cash and cash equivalents, restricted stock, and securities classified as available for sale comprised 18.6% of total assets, compared to 16.8% at December 31, 2012. Asset liquidity is also provided by managing loan and securities maturities and cash flows.

 

Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary. The community bank segment maintains federal funds lines with several regional banks totaling $125.0 million as of December 31, 2013. As of December 31, 2013, there were $31.5 million outstanding on these federal funds lines. The Company had outstanding borrowings pursuant to securities sold under agreements to repurchase transactions with a maturity of one day of $52.5 million as of December 31, 2013 compared to $54.3 million as of December 31, 2012. Lastly, the Company had a collateral dependent line of credit with the FHLB for up to $805.2 million. Based on the underlying collateralized loans, the Company has $635.2 million available as of December 31, 2013. There was approximately $320.0 million outstanding under this line at December 31, 2013 compared to $494.0 million as of December 31, 2012.

 

The community bank segment may also borrow additional funds by purchasing certificates of deposit through a nationally recognized network of financial institutions. The Bank utilizes this funding source when rates are more favorable than other funding sources. As of December 31, 2013, there were $13.7 million purchased and included in certificates of deposit on the Consolidated Balance Sheet.

 

As of December 31, 2013, the liquid assets that mature within one year totaled $1.2 billion, or 30.3%, of total earning assets. As of December 31, 2013, approximately $976.0 million, or 32.1%, of total loans are scheduled to mature within one year based on contractual maturity, adjusted for expected prepayments.

 

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NON-GAAP MEASURES

 

In reporting the results of December 31, 2013, the Company has provided supplemental performance measures on an operating or tangible basis. Operating measures exclude acquisition costs unrelated to the Company’s normal operations. The Company believes these measures are useful to investors as they exclude non-operating adjustments resulting from acquisition activity and allow investors to see the combined economic results of the organization. Tangible common equity is used in the calculation of certain capital and per share ratios. The Company believes tangible common equity and the related ratios are meaningful measures of capital adequacy because they provide a meaningful base for period-to-period and company-to-company comparisons, which the Company believes will assist investors in assessing the capital of the Company and its ability to absorb potential losses.

 

These measures are a supplement to GAAP used to prepare the Company’s financial statements and should not be viewed as a substitute for GAAP measures. In addition, the Company’s non-GAAP measures may not be comparable to non-GAAP measures of other companies.

 

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The following table reconciles these non-GAAP measures from their respective GAAP basis measures for the years ended December 31, (dollars in thousands, except per share amounts):

  

   2013   2012   2011 
             
Operating Earnings               
Net Income (GAAP)  $34,496   $35,411   $30,445 
Plus: Merger and conversion related expense, after tax   2,042    -    277 
Net operating earnings (loss) (non-GAAP)  $36,538   $35,411   $30,722 
                
Operating earnings per share - Basic  $1.46   $1.37   $1.18 
Operating earnings per share - Diluted   1.46    1.37    1.18 
                
Operating ROA   0.90%   0.89%   0.80%
Operating ROE   8.38%   8.13%   6.97%
Operating ROTCE   10.07%   9.89%   9.42%
                
Community Bank Segment Operating Earnings               
Net Income (GAAP)  $37,155   $32,866   $28,833 
Plus: Merger and conversion related expense, after tax   2,042    -    277 
Net operating earnings (loss) (non-GAAP)  $39,197   $32,866   $29,110 
                
Operating earnings per share - Basic  $1.57   $1.27   $1.12 
Operating earnings per share - Diluted   1.57    1.27    1.12 
                
Operating ROA   0.97%   0.83%   0.75%
Operating ROE   9.18%   7.67%   6.68%
Operating ROTCE   11.08%   9.37%   9.07%
                
Operating Efficiency Ratio FTE               
Net Interest Income (GAAP)  $151,626   $154,355   $156,360 
FTE adjustment   5,256    4,222    4,326 
Net Interest Income (FTE)   156,882    158,577    160,686 
Noninterest Income (GAAP)   38,728    41,068    32,964 
Noninterest Expense (GAAP)  $137,289   $133,479   $130,815 
Merger and conversion related expense   2,132    -    426 
Noninterest Expense (non-GAAP)  $135,157   $133,479   $130,389 
                
Operating Efficiency Ratio FTE (non-GAAP)   69.10%   66.86%   67.33%
                
Community Bank Segment Operating Efficiency Ratio FTE          
Net Interest Income (GAAP)  $149,975   $153,024   $155,045 
FTE adjustment   5,256    4,223    4,325 
Net Interest Income (FTE)   155,231    157,247    159,370 
Noninterest Income (GAAP)   27,492    24,876    22,382 
Noninterest Expense (GAAP)  $120,256   $119,976   $121,490 
Merger and conversion related expense   2,132    -    426 
Noninterest Expense (non-GAAP)  $118,124   $119,976   $121,064 
                
Operating Efficiency Ratio FTE (non-GAAP)   64.65%   65.88%   66.61%
                
Tangible Common Equity               
Ending equity  $438,239   $435,863   $421,639 
Less: Ending trademark intangible   -    33    433 
Less: Ending goodwill   59,400    59,400    59,400 
Less: Ending core deposit intangibles   11,980    15,778    20,714 
Ending tangible common equity  $366,859   $360,652   $341,092 
                
Average equity  $436,064   $435,774   $441,040 
Less: Average trademark intangible   1    231    631 
Less: Average goodwill   59,400    59,400    58,494 
Less: Average core deposit intangibles   13,804    18,159    23,654 
Less: Average preferred equity   -    -    32,171 
Average tangible common equity  $362,859   $357,984   $326,090 

 

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The allowance for loan losses, adjusted for acquisition accounting (non-GAAP) ratio includes an adjustment for the credit mark on purchased performing loans. The purchased performing loans are reported net of the related credit mark in loans, net of unearned income, on the Company’s Consolidated Balance Sheet; therefore, the credit mark is added back to the balance to represent the total loan portfolio. The adjusted allowance for loan losses, including the credit mark, represents the total reserve on the Company’s loan portfolio. GAAP requires the acquired allowance for loan losses not be carried over in an acquisition or merger. The Company believes the presentation of the allowance for loan losses, adjusted for acquisition accounting ratio is useful to investors because the acquired loans were purchased at a market discount with no allowance for loan losses carried over to the Company and the credit mark on the purchased performing loans represents the allowance associated with those purchased loans. The Company believes that this measure is a better reflection of the reserves on the Company’s loan portfolio. The following table shows the allowance for loan losses as a percentage of the total loan portfolio, adjusted for acquisition accounting, at December 31, (dollars in thousands):

  

   2013   2012   2011   2010 
                 
Allowance for loan losses  $30,135   $34,916   $39,470   $38,406 
Remaining credit mark on purchased loans   3,341    5,350    9,010    13,589 
Adjusted allowance for loan losses  $33,476   $40,266   $48,480   $51,995 
                     
Loans, net of unearned income  $3,039,368   $2,966,847   $2,818,583   $2,837,253 
Remaining credit mark on purchased loans   3,341    5,350    9,010    13,589 
Adjusted loans, net of unearned income  $3,042,709   $2,972,197   $2,827,593   $2,850,842 
                     
ALL / gross loans, adjusted for acquisition accounting   1.10%   1.35%   1.71%   1.82%

 

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QUARTERLY RESULTS

 

The following table presents the Company’s quarterly performance, as previously filed, for the years ended December 31, 2013 and 2012 (dollars in thousands, except per share amounts):

  

   Quarter 
   First   Second   Third   Fourth 
For the Year 2013                    
Interest and dividend income  $43,285   $42,686   $42,841   $43,315 
Interest expense   5,532    5,283    4,983    4,702 
Net interest income   37,753    37,403    37,858    38,613 
Provision for loan losses   2,050    1,000    1,800    1,206 
Net interest income after provision for loan losses   35,703    36,403    36,058    37,407 
Noninterest income   9,835    11,299    9,216    8,379 
Noninterest expenses   33,501    34,283    34,132    35,375 
Income before income taxes   12,037    13,419    11,142    10,411 
Income tax expense   3,054    3,956    3,196    2,306 
Net income  $8,983   $9,463   $7,946   $8,105 
                     
Earnings per share, basic  $0.36   $0.38   $0.32   $0.32 
Earnings per share, diluted  $0.36   $0.38   $0.32   $0.32 
                     
For the Year 2012                    
Interest and dividend income  $45,874   $45,302   $45,503   $45,183 
Interest expense   7,527    7,215    6,741    6,023 
Net interest income   38,347    38,087    38,762    39,160 
Provision for loan losses   3,500    3,000    2,400    3,300 
Net interest income after provision for loan losses   34,847    35,087    36,362    35,860 
Noninterest income   8,477    10,253    10,502    11,835 
Noninterest expenses   32,268    33,607    33,268    34,336 
Income before income taxes   11,056    11,733    13,596    13,359 
Income tax expense (benefit)   3,133    3,313    3,970    3,917 
Net income  $7,923   $8,420   $9,626   $9,442 
                     
Earnings per share, basic  $0.31   $0.32   $0.37   $0.37 
Earnings per share, diluted  $0.31   $0.32   $0.37   $0.37 

 

ITEM 7A. – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

This information is incorporated herein by reference from Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Form 10-K.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Union First Market Bankshares Corporation

Richmond, Virginia

 

We have audited the accompanying consolidated balance sheets of Union First Market Bankshares Corporation and subsidiaries as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, changes in stockholders' equity, and cash flows for each of the three years in the period ended December 31, 2013. These consolidated financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Union First Market Bankshares Corporation and subsidiaries as of December 31, 2013 and 2012, and the results of their operations and their cash flows for each of the three years in the period ended December 31, 2013, in conformity with U.S. generally accepted accounting principles.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Union First Market Bankshares Corporation and subsidiaries’ internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992, and our report dated March 11, 2014 expressed an unqualified opinion on the effectiveness of Union First Market Bankshares Corporation and subsidiaries’ internal control over financial reporting.

 

/s/ Yount, Hyde & Barbour, P.C.

 

Winchester, Virginia

March 11, 2014

 

- 55 -
 

 

 

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

 

To the Board of Directors and Stockholders

Union First Market Bankshares Corporation

Richmond, Virginia

 

We have audited Union First Market Bankshares and subsidiaries' internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992. Union First Market Bankshares Corporation and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the company's internal control over financial reporting based on our audit.

 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

 

A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (b) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company's assets that could have a material effect on the financial statements.

 

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

In our opinion, Union First Market Bankshares Corporation and subsidiaries’ maintained, in all material respects, effective internal control over financial reporting as of December 31, 2013, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission in 1992.

 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets as of December 31, 2013 and 2012, and the related consolidated statements of income, comprehensive income, change in stockholders’ equity and cash flows for each of the three years in the period ended December 31, 2013 of Union First Market Bankshares Corporation and subsidiaries and our report dated March 11, 2014 expressed an unqualified opinion.

 

/s/ Yount, Hyde & Barbour, P.C.

 

Winchester, Virginia

March 11, 2014

 

- 56 -
 

  

UNION FIRST MARKET BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2013 AND 2012

(Dollars in thousands, except share data)

 

   2013   2012 
ASSETS          
Cash and cash equivalents:          
Cash and due from banks  $66,090   $71,426 
Interest-bearing deposits in other banks   6,781    11,320 
Money market investments   1    1 
Federal funds sold   151    155 
Total cash and cash equivalents   73,023    82,902 
           
Securities available for sale, at fair value   677,348    585,382 
Restricted stock, at cost   26,036    20,687 
Loans held for sale   53,185    167,698 
Loans, net of unearned income   3,039,368    2,966,847 
Less allowance for loan losses   30,135    34,916 
Net loans   3,009,233    2,931,931 
           
Bank premises and equipment, net   82,815    85,409 
Other real estate owned, net of valuation allowance   34,116    32,834 
Core deposit intangibles, net   11,980    15,778 
Goodwill   59,400    59,400 
Other assets   149,435    113,844 
Total assets  $4,176,571   $4,095,865 
           
LIABILITIES          
Noninterest-bearing demand deposits   691,674    645,901 
Interest-bearing deposits:          
NOW accounts   498,068    454,150 
Money market accounts   940,215    957,130 
Savings accounts   235,034    207,846 
Time deposits of $100,000 and over   427,597    508,630 
Other time deposits   444,254    524,110 
Total interest-bearing deposits   2,545,168    2,651,866 
Total deposits   3,236,842    3,297,767 
           
Securities sold under agreements to repurchase   52,455    54,270 
Other short-term borrowings   211,500    78,000 
Trust preferred capital notes   60,310    60,310 
Long-term borrowings   139,049    136,815 
Other liabilities   38,176    32,840 
Total liabilities   3,738,332    3,660,002 
           
Commitments and contingencies          
           
STOCKHOLDERS' EQUITY          
Common stock, $1.33 par value, shares authorized 36,000,000; issued and outstanding, 24,976,434 shares and 25,270,970 shares, respectively.   33,020    33,510 
Surplus   170,770    176,635 
Retained earnings   236,639    215,634 
Accumulated other comprehensive (loss) income   (2,190)   10,084 
Total stockholders' equity   438,239    435,863 
           
Total liabilities and stockholders' equity  $4,176,571   $4,095,865 

 

See accompanying notes to consolidated financial statements.

 

- 57 -
 

  

UNION FIRST MARKET BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

YEARS ENDED DECEMBER 31, 2013, 2012, AND 2011

(Dollars in thousands, except per share amounts)

 

   2013   2012   2011 
             
Interest and dividend income:               
Interest and fees on loans  $155,547   $162,637   $168,479 
Interest on Federal funds sold   1    1    1 
Interest on deposits in other banks   17    62    123 
Interest and dividends on securities:               
Taxable   8,202    11,912    13,387 
Nontaxable   8,360    7,251    7,083 
Total interest and dividend income   172,127    181,863    189,073 
                
Interest expense:               
Interest on deposits   14,097    19,446    24,346 
Interest on federal funds purchased   89    50    7 
Interest on short-term borrowings   265    234    352 
Interest on long-term borrowings   6,050    7,778    8,008 
Total interest expense   20,501    27,508    32,713 
                
Net interest income   151,626    154,355    156,360 
Provision for loan losses   6,056    12,200    16,800 
Net interest income after provision for loan losses   145,570    142,155    139,560 
                
Noninterest income:               
Service charges on deposit accounts   9,492    9,033    8,826 
Other service charges, commissions and fees   12,309    10,898    9,736 
Gains on securities transactions, net   21    190    913 
Other-than-temporary impairment losses   -    -    (400)
Gains on sales of mortgage loans, net of commissions   11,900    16,651    11,052 
(Losses) gains on sales of bank premises   (340)   2    (996)
Other operating income   5,346    4,294    3,833 
Total noninterest income   38,728    41,068    32,964 
                
Noninterest expenses:               
Salaries and benefits   70,369    68,648    62,865 
Occupancy expenses   11,543    12,150    11,104 
Furniture and equipment expenses   6,884    7,251    6,920 
Other operating expenses   48,493    45,430    49,926 
Total noninterest expenses   137,289    133,479    130,815 
                
Income before income taxes   47,009    49,744    41,709 
Income tax expense   12,513    14,333    11,264 
Net income  $34,496   $35,411   $30,445 
Dividends paid and accumulated on preferred stock   -    -    1,499 
Accretion of discount on preferred stock   -    -    1,177 
Net income available to common shareholders  $34,496   $35,411   $27,769 
Earnings per common share, basic  $1.38   $1.37   $1.07 
Earnings per common share, diluted  $1.38   $1.37   $1.07 

 

See accompanying notes to consolidated financial statements.

 

- 58 -
 

  

UNION FIRST MARKET BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

YEARS ENDED DECEMBER 31, 2013, 2012, AND 2011

(Dollars in thousands)

 

   2013   2012   2011 
             
Net income  $34,496   $35,411   $30,445 
Other comprehensive income (loss):               
Cash flow hedges:               
Change in fair value of cash flow hedges   583    (922)   (3,233)
Reclassification adjustment for losses included in net income (net of tax, $281, $391, and $223 for the year ended December 31, 2013, 2012, and 2011)   524    726    415 
Unrealized (losses) gains on securities:               
Unrealized holding (losses) gains arising during period (net of tax, $7,198, $405, and $4,346 for the year ended December 31, 2013, 2012, and 2011)   (13,367)   753    9,231 
Reclassification adjustment for losses included in net income (net of tax, $7, $67, and $179 for the year ended December 31, 2013, 2012, and 2011)   (14)   (123)   (334)
Other comprehensive income (loss)   (12,274)   434    6,079 
Comprehensive income  $22,222   $35,845   $36,524 

 

See accompanying notes to consolidated financial statements.

 

- 59 -
 

  

UNION FIRST MARKET BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

YEARS ENDED DECEMBER 31, 2013, 2012, AND 2011

(Dollars in thousands, except share amounts)

 

   Preferred
Stock
   Common
Stock
   Surplus   Retained
Earnings
   Discount
on
Preferred
Stock
   Accumulated
Other
Comprehensive
Income (Loss)
   Total 
                             
Balance - December 31, 2010  $35,595   $34,532   $185,763   $169,801   $(1,177)  $3,571   $428,085 
Net income - 2011                  30,445              30,445 
Other comprehensive income (net of tax, $4,167)                            6,079    6,079 
Cash dividends on common stock ($.28 per share)                  (7,284)             (7,284)
Tax benefit from exercise of stock awards             15                   15 
Repurchase of preferred stock (35,595 shares)   (35,595)                            (35,595)
Dividends on preferred stock                  (1,961)             (1,961)
Accretion of discount on preferred stock                  (1,177)   1,177         - 
Issuance of common stock under Dividend Reinvestment Plan (11,932 shares)        16    361                   377 
Issuance of common stock under Equity Compensation Plan (29,625 shares)        39    158                   197 
Vesting of restricted stock under Equity Compensation Plan (17,312 shares)        23    (23)                  - 
Issuance of common stock for services rendered (46,806 shares)        62    502                   564 
Stock-based compensation expense             717                   717 
Balance - December 31, 2011   -    34,672    187,493    189,824    -    9,650    421,639 
Net income - 2012                  35,411              35,411 
Other comprehensive income (net of tax, $339)                            434    434 
Dividends on Common Stock ($.37 per share)                  (8,969)             (8,969)
Stock purchased under stock repurchase plan (970,265 shares)        (1,291)   (13,154)                  (14,445)
Issuance of common stock under Dividend Reinvestment Plan (45,502 shares)        61    571    (632)             - 
Issuance of common stock under Equity Compensation Plan (2,376 shares)        3    28                   31 
Vesting of restricted stock under Equity Compensation Plan (15,492 shares)        21    (21)                  - 
Issuance of common stock for services rendered (37,134 shares)        49    516                   565 
Net settle for taxes on Restricted Stock Awards (3,670 shares)        (5)   (50)                  (55)
Stock-based compensation expense             1,252                   1,252 
Balance - December 31, 2012   -    33,510    176,635    215,634    -    10,084    435,863 
Net income - 2013                  34,496              34,496 
Other comprehensive loss (net of tax, $7,205)                            (12,274)   (12,274)
Dividends on Common Stock ($.54 per share)                  (12,535)             (12,535)
Stock purchased under stock repurchase plan (500,000 shares)        (664)   (8,835)                  (9,499)
Issuance of common stock under Dividend Reinvestment Plan (47,598 shares)        63    893    (956)             - 
Issuance of common stock under Equity Compensation Plan (50,119 shares)        67    860                   927 
Vesting of restricted stock under Equity Compensation Plan (19,763 shares)        26    (26)                  - 
Issuance of common stock for services rendered (18,815 shares)        25    452                   477 
Net settle for taxes on Restricted Stock Awards (5,059 shares)        (7)   (98)                  (105)
Stock-based compensation expense             889                   889 
Balance - December 31, 2013  $-   $33,020   $170,770   $236,639   $-   $(2,190)  $438,239 

 

See accompanying notes to consolidated financial statements.

 

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UNION FIRST MARKET BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2013, 2012, AND 2011

(Dollars in thousands)

 

   2013   2012   2011 
Operating activities:            
Net income  $34,496   $35,411   $30,445 
Adjustments to reconcile net income to net cash and cash equivalents provided by (used in) operating activities:               
Depreciation of bank premises and equipment   6,024    6,631    6,715 
Writedown of OREO   791    301    707 
Other-than-temporary impairment recognized in earnings   -    -    400 
Amortization, net   13,900    15,466    20,172 
Provision for loan losses   6,056    12,200    16,800 
Gains on the sale of investment securities   (21)   (190)   (913)
Deferred tax expense (benefit)   262    (195)   (615)
Decrease (increase) in loans held for sale, net   114,513    (92,875)   (849)
Losses on sales of other real estate owned, net   461    631    1,065 
Losses (gains) on bank premises, net   340    (2)   996 
Stock-based compensation expenses   889    1,252    717 
Issuance of common stock grants for services   477    565    657 
Net increase in other assets   (27,422)   (2,173)   (3,089)
Net increase (decrease) in other liabilities   6,263    987    (2,160)
Net cash and cash equivalents provided by (used in) operating activities   157,029    (21,991)   71,048 
Investing activities:               
Purchases of securities available for sale   (300,324)   (160,751)   (217,643)
Proceeds from sales of securities available for sale   43,354    18,944    28,800 
Proceeds from maturities, calls and paydowns of securities available for sale   129,942    168,078    126,786 
Net (increase) decrease in loans   (91,911)   (178,639)   62,126 
Net increase in bank premises and equipment   (4,759)   (2,102)   (5,466)
Proceeds from sales of other real estate owned   7,569    13,152    14,240 
Improvements to other real estate owned   (561)   (381)   (528)
Cash paid for equity-method investments   (2,000)   -    - 
Cash paid in bank acquisition   -    -    (26,437)
Cash acquired in bank and branch acquisitions   -    -    230 
Net cash and cash equivalents used in investing activities   (218,690)   (141,699)   (17,892)
Financing activities:               
Net increase in noninterest-bearing deposits   45,773    111,366    45,302 
Net increase in NOW accounts   43,918    41,545    19,374 
Net (decrease) increase in money market accounts   (16,915)   52,237    114,012 
Net increase in savings accounts   27,188    28,689    24,515 
Net decrease in time deposits of $100,000 and over   (81,033)   (42,925)   (74,186)
Net decrease in other time deposits   (79,856)   (68,250)   (72,840)
Net increase (decrease) in short-term borrowings   131,685    69,275    (29,972)
Net increase (decrease) in long-term borrowings (1)   2,234    (18,566)   489 
Cash dividends paid - common stock   (12,535)   (8,969)   (7,284)
Cash dividends paid - preferred stock   -    -    (1,961)
Repurchase of preferred stock   -    -    (35,595)
Repurchase of common stock   (9,499)   (14,445)   - 
Issuance of common stock   927    31    574 
Taxes paid related to net share settlement of equity awards   (105)   (55)   (78)
Net cash and cash equivalents provided by (used in) financing activities   51,782    149,933    (17,650)
(Decrease) Increase in cash and cash equivalents   (9,879)   (13,757)   35,506 
Cash and cash equivalents at beginning of the period   82,902    96,659    61,153 
Cash and cash equivalents at end of the period  $73,023   $82,902   $96,659 
                
Supplemental Disclosure of Cash Flow Information               
Cash payments for:               
Interest  $21,013   $27,960   $33,030 
Income taxes   11,500    14,661    8,837 
                
Supplemental schedule of noncash investing and financing activities               
Unrealized (loss) gain on securities available for sale  $(20,586)  $968   $(13,064)
Changes in fair value of interest rate swap loss   1,107    (196)   (2,818)
Transfers from loans to other real estate owned   8,553    13,621    11,625 
Transfers from bank premises to other real estate owned   989    653    - 
                
Transactions related to bank and branch acquisitions               
Assets acquired   -    -    75,141 
Liabilities assumed   -    -    48,934 

 

(1) See Note 7 "Borrowings" related to 2013 activity.

 

See accompanying notes to consolidated financial statements.

 

- 61 -
 

 

 

UNION FIRST MARKET BANKSHARES CORPORATION AND SUBSIDIARIES

NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS

YEARS ENDED DECEMBER 31, 2013, 2012, AND 2011

 

1.SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

 

The accounting policies and practices of Union First Market Bankshares Corporation and subsidiaries conform to GAAP and follow general practices within the banking industry. Major policies and practices are described below.

 

Nature of Operations - Union First Market Bankshares Corporation is a financial holding company and a bank holding company headquartered in Richmond, Virginia and committed to the delivery of financial services through its community bank subsidiary Union First Market Bank and three non-bank financial services affiliates: Union Mortgage Group, Inc., providing a variety of mortgage products, Union Investment Services, Inc. providing securities, brokerage and investment advisory services, and Union Insurance Group, LLC, an insurance agency, which operates in a joint venture with Bankers Insurance, LLC, a large insurance agency owned by community banks across Virginia and managed by the Virginia Bankers Association.

 

Principles of Consolidation - The consolidated financial statements include the accounts of the Company, which is a financial holding company and a bank holding company that owns all of the outstanding common stock of its banking subsidiary, Union First Market Bank and of Union Investment Services, Inc. The Company also owns a non-controlling interest in The Payments Company which is accounted for under the equity method of accounting. Union Mortgage Group, Inc. is a wholly owned subsidiary of Union First Market Bank. Union First Market Bank also has a non-controlling interest in Johnson Mortgage Company, LLC, which is accounted for under the equity method of accounting. The Company’s Statutory Trust I and II, wholly owned subsidiaries of the Company, were formed for the purpose of issuing redeemable Trust Preferred Capital Notes in connection with the Company’s acquisitions of Guaranty Financial Corporation and its wholly owned subsidiary, Guaranty Bank, in May 2004 and Prosperity Bank & Trust Company in April 2006. ASC 860, Transfers and Servicing, precludes the Company from consolidating Statutory Trusts I and II. The subordinated debts payable to the trusts are reported as liabilities of the Company. All significant inter-company balances and transactions have been eliminated.

 

Variable Interest Entities - Current accounting guidance states that if a business enterprise is the primary beneficiary of a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity should be included in the consolidated financial statements of the business enterprise. This interpretation explains how to identify variable interest entities and how an enterprise assesses its interest in a variable interest entity to decide whether to consolidate the entity. It also requires existing unconsolidated variable interest entities to be consolidated by their primary beneficiaries if the entities do not effectively disperse risks among parties involved. Variable interest entities that effectively disperse risks will not be consolidated unless a single party holds an interest or combination of interests that effectively recombines risks that were previously dispersed. Management has evaluated the Company’s investment in variable interest entities. The Company’s primary exposure to variable interest entities are the trust preferred securities structures.

 

Currently, other than the impact described above from the deconsolidation of the trust preferred capital notes, this accounting guidance has not had a material impact on the financial condition or the operating results of the Company.

 

Use of Estimates - The preparation of the consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the valuation of goodwill and intangible assets, other real estate owned, deferred tax assets and liabilities, other-than-temporary impairment of securities, and the fair value of financial instruments.

 

Business Combinations - Business combinations are accounted for under ASC 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, the Company will continue to rely on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions. Costs that the Company expects, but is not obligated to incur in the future, to effect its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree’s employees are not liabilities at the acquisition date. The Company will not recognize these costs as part of applying the acquisition method. Instead, the Company will recognize these costs in its post-combination financial statements in accordance with other applicable accounting guidance.

 

- 62 -
 

  

Acquisition-related costs are costs the Company incurs to effect a business combination. Those costs include advisory, legal, accounting, valuation, and other professional or consulting fees. Some other examples of costs to the Company include systems conversions, integration planning consultants, and advertising costs. The Company will account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities will be recognized in accordance with other applicable accounting guidance. These acquisition-related costs are included within the Consolidated Statements of Income classified within the noninterest expense caption.

 

On January 1, 2014, the Company completed the acquisition of StellarOne, a bank holding company based in Charlottesville, Virginia, in an all stock transaction. Additional information on this acquisition is disclosed in Note 20, “Subsequent Events.”

 

Cash and Cash Equivalents - For purposes of reporting cash flows, the Company defines cash and cash equivalents as cash, cash due from banks, interest-bearing deposits in other banks, money market investments, other interest-bearing deposits, and federal funds sold.

 

Investment Securities - Securities classified as available for sale are those debt and equity securities that management intends to hold for an indefinite period of time, including securities used as part of the Company’s asset/liability strategy, and that may be sold in response to changes in interest rates, liquidity needs, or other similar factors. Securities available for sale are reported at fair value, with unrealized gains or losses, net of deferred taxes, included in accumulated other comprehensive income in stockholders’ equity.

 

Debt securities that the Company has the positive intent and ability to hold to maturity are classified as held-to-maturity and reported at amortized cost. The Company has no securities in this category.

 

Securities classified as held for trading are those debt and equity securities that are bought and held principally for the purpose of selling them in the near term and are reported at fair value, with unrealized gains and losses included in earnings. The Company has no securities in this category.

 

Purchased premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of held to maturity and available for sale securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other-than-temporary impairment losses, an impairment is other-than-temporary if any of the following conditions exist: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or, the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). If a credit loss exists, but an entity does not intend to sell the impaired debt security and is not more likely than not to be required to sell before recovery, the impairment is other-than-temporary and should be separated into a credit portion to be recognized in earnings and the remaining amount relating to all other factors recognized as other comprehensive loss. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.

 

Due to restrictions placed upon the Company’s common stock investment in the Federal Reserve Bank and FHLB, these securities have been classified as restricted equity securities and carried at cost. These restricted securities are not subject to the investment security classifications. The FHLB requires the Bank to maintain stock in an amount equal to 4.5% of outstanding borrowings and a specific percentage of the member’s total assets. The Federal Reserve Bank of Richmond requires the Company to maintain stock with a par value equal to 6% of its outstanding capital.

 

Loans Held for Sale - Loans originated and intended for sale in the secondary market are sold, servicing released, and carried at the lower of cost or estimated fair value, which is determined in the aggregate based on sales commitments to permanent investors or on current market rates for loans of similar quality and type. In addition, the Company requires a firm purchase commitment from a permanent investor before a loan can be closed, thus limiting interest rate risk. As a result, loans held for sale are stated at fair value. Net unrealized losses, if any, are recognized through a valuation allowance by charges to income.

 

Loans - The Company originates commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by commercial and residential real estate loans (including acquisition and development loans and residential construction loans) throughout its market area. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in those markets.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for any charge-offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.

 

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The Company has two loan portfolio level segments and fourteen loan class levels for reporting purposes. The two loan portfolio level segments are commercial and consumer.

 

Within the commercial loan portfolio segment there are seven loan classes for reporting purposes: commercial construction, commercial real estate – owner occupied, commercial real estate – non owner occupied, raw land and lots, single family investment real estate, commercial and industrial, and other commercial.

 

Commercial construction loans are generally made to commercial and residential builders for specific construction projects. The successful repayment of these types of loans is generally dependent upon (a) a pre-planned commitment for permanent financing from the Company or another lender, or (b) from the sale of the constructed property. These loans carry more risk than both types of commercial real estate term loans due to the dynamics of construction projects, changes in interest rates, the long-term financing market, and state and local government regulations. As in commercial real estate term lending, the Company manages risk by using specific underwriting policies and procedures for these types of loans and by avoiding concentrations to any one business or industry.

 

Commercial real estate – owner occupied loans are term loans made to support owner occupied real estate properties that rely upon the successful operation of the business occupying the property for repayment. General market conditions and economic activity may affect these types of loans. In addition to using specific underwriting policies and procedures for these types of loans, the Company manages risk by avoiding concentrations to any one business or industry.

 

Commercial real estate – non-owner occupied loans are term loans typically made to borrowers to support income producing properties that rely upon the successful operation of the property for repayment. General market conditions and economic activity may impact the performance of these types of loans. In addition to using specific underwriting policies and procedures for these types of loans, the Company manages risk by diversifying the lending to various lines of businesses, such as retail, office, multi-family, office warehouse, and hotel as well as avoiding concentrations to any one business or industry.

 

Raw land and lot loans are loans generally made to residential home builders to support their land and lot inventory needs. Repayment relies upon the successful performance of the underlying residential real estate project. This type of lending carries a higher level of risk as compared to other commercial lending. This class of lending manages risks related to residential real estate market conditions, a functioning first and secondary market in which to sell residential properties, and the borrower’s ability to manage inventory and run projects. The Company manages this risk by lending to experienced builders and developers, by using specific underwriting policies and procedures for these types of loans, and by avoiding concentrations with any particular customer or geographic region.

 

Single family investment real estate loans are term loans made to real estate investors to support permanent financing for single family residential income producing properties that rely on the successful operation of the property for repayment. This management mainly involves property maintenance and collection of rents due from tenants. This type of lending carries a lower level of risk as compared to other commercial lending. The Company manages this risk by avoiding concentrations with any particular customer or geographic region.

 

Commercial and industrial loans generally support our borrowers need for equipment/vehicle purchases and other short-term or seasonal cash flow needs. Repayment relies upon the successful operation of the business. This type of lending carries a lower level of commercial credit risk as compared to other commercial lending within this segment of lending. The Company manages this risk by using general underwriting policies and procedures for these types of loans and by avoiding concentrations to any one business or industry.

 

Other commercial loans generally support small business lines of credit and agricultural lending neither of which are a material source of business for the Company.

 

The consumer loan portfolio segment is comprised of seven classes; mortgage, consumer construction, indirect auto, indirect marine, HELOCs, credit card, and other consumer. These are generally small loans spread across many borrowers, supported by computer-based loan approval systems and business line policies and procedures that aid in managing risk. The Company’s consumer portfolio consists principally of loans secured by real estate, followed by indirect auto lending and indirect marine lending.

 

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The Company manages the unique risks related to consumer construction to acceptable levels through certain policies and procedures, such as limiting loan-to-value ratios at loan origination, requiring standards for appraisers, and not making subprime loans under any circumstances.

 

The indirect auto lending generally carries certain risks associated with the values of the collateral that management must mitigate. The Company focuses its indirect auto lending on one to two year old used vehicles where substantial depreciation has already occurred thereby minimizing the risk of significant loss of collateral values in the future. This type of lending places reliance on computer-based loan approval systems to supplement other underwriting standards.

 

The indirect marine lending is to borrowers that are well qualified with ample capacity to repay and typically lends against large marine vessels (i.e., yachts). Risks in this class of lending are generally related to the borrower’s ability to guard against the effects of economic downturns or sustained levels of unemployment. This type of lending places reliance on computer-based loan approval systems to supplement other underwriting standards.

 

Nonaccruals, Past Dues, and Charge-offs

 

The policy for placing commercial loans on nonaccrual status is generally when the loan is 90 days delinquent unless the credit is well secured and in process of collection but, in any event, no later than 180 days past due. Consumer loans are typically charged-off when management judges the loan to be uncollectible or the borrower files for bankruptcy but no later than 120 days past due and generally not placed on nonaccrual status prior to charge off. Commercial loans are typically written down to net realizable value when it is determined that the Company will be unable to collect the principal amount in full and the amount is a confirmed loss, in any event no later than 180 days past due. All classes of loans are considered past due or delinquent when a contractual payment has not been satisfied. In all cases, loans are placed on nonaccrual status or charged off at an earlier date if collection of principal and interest is considered doubtful and in accordance with regulatory requirements.

 

For both the commercial and consumer loan segments, all interest accrued but not collected for loans placed on nonaccrual status or charged-off is reversed against interest income and accrual of interest income is terminated. Payments and interest on these loans are accounted for using the cost-recovery method by applying all payments received as a reduction to the outstanding principal balance until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The determination of future payments being reasonably assured varies depending on the circumstances present with the loan; however, the timely payment of contractual amounts owed for six consecutive months is a primary indicator. In addition, the return of a loan to accrual status is considered and approved by the Company’s Special Assets Loan Committee.

 

Allowance for Loan Losses

 

The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans are charged against the allowance when management believes the collectability of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on an evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance based on their judgments about information available to them at the time of their examination.

 

The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. The credit reviews consist of reviews by its Internal Audit group and reviews performed by an independent third party. Upon origination, each commercial loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk, and this risk rating scale is the Company’s primary credit quality indicator. Consumer loans are generally not risk rated; the primary credit quality indicator for this portfolio segment is delinquency status. The Company has various committees that review and ensure that the allowance for loan losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.

 

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The Company’s ALL consists of specific, general, and unallocated components.

 

Specific Reserve Component - The specific reserve component relates to impaired loans. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Upon being identified as impaired, for loans not considered to be collateral dependent, an allowance is established when the discounted cash flows of the impaired loan are lower than the carrying value of that loan. Nonaccrual loans under $100,000 and other impaired loans under $500,000 are aggregated based on similar risk characteristics. The level of credit impairment within the pool(s) is determined based on historical loss factors for loans with similar risk characteristics, taking into consideration environmental factors specifically related to the underlying pool. The impairment of collateral dependent loans is measured based on the fair value of the underlying collateral (based on independent appraisals), less selling costs, compared to the carrying value of the loan. If the Company determines that the value of an impaired collateral dependent loan is less than the recorded investment in the loan, it either recognizes an impairment reserve as a specific component to be provided for in the allowance for loan losses or charges off the deficiency if it is determined that such amount represents a confirmed loss. Typically, a loss is confirmed when the Company is moving towards foreclosure (or final disposition) of the underlying collateral, the collateral deficiency has not improved for two consecutive quarters, or when there is a payment default of 180 days, whichever occurs first.

 

The Company obtains independent appraisals from a pre-approved list of independent, third party appraisal firms located in the market in which the collateral is located. The Company’s approved appraiser list is continuously maintained to ensure the list only includes such appraisers that have the experience, reputation, character, and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is currently licensed in the state in which the property is located, experienced in the appraisal of properties similar to the property being appraised, has knowledge of current real estate market conditions and financing trends, and is reputable. The Company’s internal Real Estate Valuation Group, which reports to the Risk and Compliance Group, performs either a technical or administrative review of all appraisals obtained. A technical review will ensure the overall quality of the appraisal, while an administrative review ensures that all of the required components of an appraisal are present. Generally, independent appraisals are updated every 12 to 24 months or as necessary. The Company’s impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Adjustments to appraisals generally include discounts for continued market deterioration subsequent to the appraisal date. Any adjustments from the appraised value to carrying value are documented in the impairment analysis, which is reviewed and approved by senior credit administration officers and the Special Assets Loan Committee. External appraisals are the primary source to value collateral dependent loans; however, the Company may also utilize values obtained through broker price opinions or other valuations sources. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed, and approved on a quarterly basis at or near the end of each reporting period.

 

General Reserve Component - The general reserve component covers non-impaired loans and is derived from an estimate of credit losses adjusted for various environmental factors applicable to both commercial and consumer loan segments. The estimate of credit losses is a function of the product of net charge-off historical loss experience to the loan balance of the loan portfolio averaged during the preceding twelve quarters, as management has determined this to adequately reflect the losses inherent in the loan portfolio. The environmental factors consist of national, local, and portfolio characteristics and are applied to both the commercial and consumer segments. The following table shows the types of environmental factors management considers:

 

ENVIRONMENTAL FACTORS
Portfolio   National   Local
Experience and ability of lending team   Interest rates   Level of economic activity
Depth of lending team   Inflation   Unemployment
Pace of loan growth   Unemployment   Competition
Franchise expansion   Gross domestic product   Military/government impact
Execution of loan risk rating process   General market risk and other concerns    
Degree of oversight / underwriting standards   Legislative and regulatory environment    
Value of real estate serving as collateral        
Delinquency levels in portfolio        
Charge-off levels in portfolio        
Credit concentrations / nature and volume of the portfolio        

 

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Unallocated Component - This component may be used to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Together, the specific, general, and any unallocated allowance for loan loss represents management’s estimate of losses inherent in the current loan portfolio. Though provisions for loan losses may be based on specific loans, the entire allowance for loan losses is available for any loan management deems necessary to charge-off. At December 31, 2013, there were no material amounts considered unallocated as part of the allowance for loan losses.

 

Impaired Loans

 

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. A loan that is classified substandard or worse is considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The impairment loan policy is the same for each of the seven classes within the commercial portfolio segment.

 

For the consumer loan portfolio segment, large groups of smaller balance homogeneous loans are collectively evaluated for impairment. This evaluation subjects each of the Company’s homogenous pools to a historical loss factor derived from net charge-offs experienced over the preceding twelve quarters.

 

The Company applies payments received on impaired loans to principal and interest based on the contractual terms until they are placed on nonaccrual status at which time all payments received are applied to reduce the principal balance and recognition of interest income is terminated as previously discussed.

 

Troubled Debt Restructurings - In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a TDR. Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, extension of terms that are considered to be below market, conversion to interest only, and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may subsequently be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. The Company reviews previously restructured loans quarterly in order to determine whether any have performed, subsequent to the restructure, at a level that would allow for them to be removed from TDR status. The Company generally would consider a change in this classification if the loan has performed under the restructured terms for a consecutive twelve month period and is no longer considered to be impaired. Loans removed from TDR status are collectively evaluated for impairment and due to the significant improvement in the expected future cash flows, these loans are grouped based on their primary risk characteristics, typically using the Company’s internal risk rating system as its primary credit quality indicator, and impairment is measured based on historical loss experience taking into consideration environmental factors.

 

Bank Premises and Equipment - Land is carried at cost. Bank premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method based on the type of asset involved. The Company’s policy is to capitalize additions and improvements and to depreciate the cost thereof over their estimated useful lives ranging from 3 to 40 years. Leasehold improvements are amortized over the shorter of the life of the related lease or the estimated life of the related asset. Maintenance, repairs, and renewals are expensed as they are incurred.

 

Goodwill and Intangible Assets - The Company’s intangible assets are comprised of goodwill and other intangible assets that were acquired in business combinations. ASC 350, Intangibles-Goodwill and Other, prescribes accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of ASC 350 discontinue the amortization of goodwill and intangible assets with indefinite lives but require at least an annual impairment review and more frequently if certain impairment indicators are in evidence. The Company has determined that core deposit intangibles have a finite life, and therefore, will continue to be amortized over their estimated useful life.

 

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The Company performed its annual impairment testing in the second quarter of 2013 and determined that there was no impairment to its goodwill or intangible assets. Subsequently, the Company determined that an additional evaluation was necessary at year-end due to potential indicators based on the net losses recorded at the mortgage company during the last two quarters of the year. Based on this additional testing, the Company still has recorded no impairment charges to date for goodwill or intangible assets.

 

Other Real Estate Owned - Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at fair value less selling costs at the date of foreclosure, establishing a new cost basis. When the carrying amount exceeds the acquisition date fair value less selling costs, the excess is charged off against the allowance for loan losses. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell, any valuation adjustments occurring from post acquisition reviews are charged to expense as incurred. Revenue and expenses from operations and changes in the valuation allowance are included in OREO and credit-related costs disclosed in Note 14, “Other Operating Expenses.”

 

Transfers of Financial Assets - Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.

 

Bank Owned Life Insurance - The Company has purchased life insurance on certain key employees and directors. These policies are recorded at their cash surrender value ($86.8 million and $54.8 million at December 31, 2013 and 2012, respectively) and are included in “Other assets” on the Consolidated Balance Sheet. Income generated from polices is recorded as noninterest income.

 

Derivatives - Derivatives are recognized as assets and liabilities on the Consolidated Balance Sheet and measured at fair value. The Company’s derivatives are interest rate swap agreements. For asset/liability management purposes, the Company uses interest rate swap agreements to hedge various exposures or to modify the interest rate characteristics of various balance sheet accounts. For those derivatives designated as a cash flow hedge, the effective portion of the derivative’s unrealized gain or loss is recorded as a component of other comprehensive income. For the Company’s loan swaps, offsetting fair values are recorded in other assets and other liabilities with no net effect on other operating income.

 

Loan Fees - Fees collected and certain costs incurred related to loan originations are deferred and amortized as an adjustment to interest income over the life of the related loans. Deferred fees and costs are recorded as an adjustment to loans outstanding using a method that approximates a constant yield.

 

Stock Compensation Plan - The Company has adopted ASC 718, Compensation – Stock Compensation, which requires the costs resulting from all stock-based payments to employees be recognized in the financial statements. For stock options, compensation cost is estimated at the date of grant, using the Black-Scholes option valuation model for determining fair value of stock options. No options were granted in 2013. The market price of the Company’s common stock at the date of grant is used for nonvested stock awards. The Black–Scholes model employs the following assumptions:

Dividend yield - calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant;
Expected life (term of the option) - based on the average of the contractual life and vesting schedule for the respective option;
Expected volatility - based on the monthly historical volatility of the Company’s stock price over the expected life of the options; and
Risk-free interest rate - based upon the Treasury bill yield curve, for periods within the contractual life of the option, in effect at the time of grant.
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ASC 718 requires the Company to estimate forfeitures when recognizing compensation expense and that this estimate of forfeitures be adjusted over the requisite service period or vesting schedule based on the extent to which actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up adjustment, which is recognized in the period of change, and also will affect the amount of estimated unamortized compensation expense to be recognized in future periods.

 

For more information and tables refer to Note 13, “Employee Benefits.”

 

Income Taxes - Deferred income tax assets and liabilities are determined using the asset and liability (or balance sheet) method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Deferred taxes are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

 

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50% likely to be realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying Consolidated Balance Sheet along with any associated interest and penalties that would be payable to the taxing authorities upon examination.

 

Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the Consolidated Statements of Income. The Company did not record any material interest or penalties for the periods ending December 31, 2013, 2012, or 2011 related to tax positions taken. As of December 31, 2013 and 2012 there were no accruals for uncertain tax positions. The Company and its wholly-owned subsidiaries file a consolidated income tax return. Each entity provides for income taxes based on its contribution to income or loss of the consolidated group. The Internal Revenue Service has examined the Company’s 2010 and 2009 tax returns.

 

Advertising Costs - The Company follows a policy of charging the cost of advertising to expense as incurred. Advertising costs are disclosed in Note 14, “Other Operating Expenses.”

 

Earnings Per Common Share – Basic EPS is computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the year. Net income available to common stockholders deducts from net income the dividends and discount accretion on preferred stock. Diluted earnings per common share reflect additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and nonvested stock and are determined using the treasury stock method.

 

Comprehensive Income (Loss) - Comprehensive income (loss) represents all changes in equity that result from recognized transactions and other economic events of the period. Other comprehensive income (loss) refers to revenues, expenses, gains, and losses under GAAP that are included in comprehensive income but excluded from net income, such as unrealized gains and losses on certain investments in debt and equity securities and interest rate swaps.

 

Off Balance Sheet Credit Related Financial Instruments - In the ordinary course of business, the Company has entered into commitments to extend credit and standby letters of credit. Such financial instruments are recorded when they are funded.

 

Rate Lock Commitments - The Company enters into commitments to originate mortgage loans whereby the interest rate on the loan is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment, closing, and sale of the loan generally ranges from 30 to 120 days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to material losses and will not realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is high due to their similarity.

 

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The market value of rate lock commitments and best efforts contracts is not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded in stand-alone markets. The Company determines the fair value of rate lock commitments and best efforts contracts by measuring the change in the value of the underlying asset while taking into consideration the probability that the rate lock commitments will close. Because of the high correlation between rate lock commitments and best efforts contracts, no material gain or loss occurs on the rate lock commitments.

 

Asset Prepayment Rates - The Company purchases amortizing loan pools and investment securities in which the underlying assets are residential mortgage loans subject to prepayments. The actual principal reduction on these assets varies from the expected contractual principal reduction due to principal prepayments resulting from the borrowers’ election to refinance the underlying mortgage based on market and other conditions. The purchase premiums and discounts associated with these assets are amortized or accreted to interest income over the estimated life of the related assets. The estimated life is calculated by projecting future prepayments and the resulting principal cash flows until maturity. Prepayment rate projections utilize actual prepayment speed experience and available market information on similar instruments. The prepayment rates form the basis for income recognition of premiums and discounts on the related assets. Changes in prepayment estimates may cause the earnings recognized on these assets to vary over the term that the assets are held, creating volatility in the net interest margin. Prepayment rate assumptions are monitored monthly and updated periodically to reflect actual activity and the most recent market projections.

 

Concentrations of Credit Risk - Most of the Company’s activities are with customers located in portions of Central and Tidewater Virginia. Securities available for sale and loans also represent concentrations of credit risk and are discussed in Note 2 “Securities” and Note 3 “Loans and Allowance for Loan Losses,” respectively.

 

Recent Accounting Pronouncements - In December 2011, FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of ASU 2011-11 did not have a material impact on the Company's consolidated financial statements.

 

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The adoption of ASU 2012-02 did not have a material impact on the Company's consolidated financial statements.

 

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements, and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of ASU 2013-01 did not have a material impact on the Company's consolidated financial statements.

 

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

 

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In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this ASU permit the Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the LIBOR. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate under Topic 815. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of ASU 2013-10 did not have a material impact on the Company's consolidated financial statements.

 

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this ASU provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company does not expect the adoption of ASU 2013-11 to have a material impact on its consolidated financial statements.

 

In January 2014, the FASB issued ASU 2014-01, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company is currently assessing the impact that ASU 2014-01 will have on its consolidated financial statements.

 

In January 2014, the FASB issued ASU 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

 

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2.SECURITIES

 

The amortized cost, gross unrealized gains and losses, and estimated fair values of investment securities as of December 31, 2013 and 2012 are summarized as follows (dollars in thousands):

 

   Amortized   Gross Unrealized   Estimated 
   Cost   Gains   (Losses)   Fair Value 
December 31, 2013                    
U.S. government and agency securities  $1,654   $499   $-   $2,153 
Obligations of states and political subdivisions   255,335    6,107    (6,612)   254,830 
Corporate and other bonds   9,479    115    (160)   9,434 
Mortgage-backed securities   405,389    4,954    (2,981)   407,362 
Other securities   3,617    26    (74)   3,569 
Total securities  $675,474   $11,701   $(9,827)  $677,348 
                     
December 31, 2012                    
U.S. government and agency securities  $2,581   $268   $-   $2,849 
Obligations of states and political subdivisions   214,980    15,123    (325)   229,778 
Corporate and other bonds   7,353    173    (314)   7,212 
Mortgage-backed securities   335,327    7,383    (536)   342,174 
Other securities   3,277    92    -    3,369 
Total securities  $563,518   $23,039   $(1,175)  $585,382 

 

Due to restrictions placed upon the Company’s common stock investment in the Federal Reserve Bank of Richmond and FHLB, these securities have been classified as restricted equity securities and carried at cost. These restricted securities are not subject to the investment security classifications and are included as a separate line item on the Company’s Consolidated Balance Sheet. The FHLB requires the Bank to maintain stock in an amount equal to 4.5% of outstanding borrowings and a specific percentage of the Bank’s total assets. The Federal Reserve Bank of Richmond requires the Company to maintain stock with a par value equal to 6% of its outstanding capital. Restricted equity securities consist of Federal Reserve Bank stock in the amount of $6.7 million and $6.8 million as of December 31, 2013 and 2012 and FHLB stock in the amount of $19.3 million and $13.9 million as of December 31, 2013 and 2012, respectively.

 

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The following table shows the gross unrealized losses and fair value (in thousands) of the Company’s investments with unrealized losses that are not deemed to be other-than-temporarily impaired. These are aggregated by investment category and length of time that the individual securities have been in a continuous unrealized loss position.

  

   Less than 12 months   More than 12 months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
December 31, 2013                              
Obligations of states and political subdivisions  $80,368   $(5,504)  $8,886   $(1,108)  $89,254   $(6,612)
Mortgage-backed securities   168,297    (2,806)   24,254    (175)   192,551    (2,981)
Corporate bonds and other securities   6,804    (80)   1,720    (154)   8,524    (234)
Totals  $255,469   $(8,390)  $34,860   $(1,437)  $290,329   $(9,827)
                               
December 31, 2012                              
Obligations of states and political subdivisions  $22,397   $(283)  $649   $(42)  $23,046   $(325)
Mortgage-backed securities   86,183    (536)   -    -    86,183    (536)
Corporate bonds and other securities   -    -    1,555    (314)   1,555    (314)
Totals  $108,580   $(819)  $2,204   $(356)  $110,784   $(1,175)

 

The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the Company through readily saleable financial instruments. The portfolio includes fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes, and credit risk changes, to see if adjustments are needed. The primary cause of temporary impairments was the increase in spreads over comparable Treasury bonds. As of December 31, 2013, there were $34.9 million, or 23 issues, of individual securities that had been in a continuous loss position for more than 12 months. Additionally, these securities had an unrealized loss of $1.4 million and consisted of municipal obligations, mortgage-backed securities, corporate bonds, and other securities. As of December 31, 2012, there were $2.2 million, or 2 issues, of individual securities that had been in a continuous loss position for more than 12 months. Additionally, these securities had an unrealized loss of $356,000 and consisted of municipal obligations and corporate bonds.

 

The following table presents the amortized cost and estimated fair value of securities as of December 31, 2013 and 2012, by contractual maturity (dollars in thousands). Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

  

   December 31, 2013   December 31, 2012 
   Amortized   Estimated   Amortized   Estimated 
   Cost   Fair Value   Cost   Fair Value 
Due in one year or less  $6,791   $6,796   $5,623   $5,741 
Due after one year through five years   21,666    22,497    16,413    17,016 
Due after five years through ten years   116,735    119,269    69,164    73,501 
Due after ten years   530,282    528,786    472,318    489,124 
Total securities available for sale  $675,474   $677,348   $563,518   $585,382 

 

Securities with an amortized cost of $186.6 million and $183.7 million as of December 31, 2013 and 2012, respectively, were pledged to secure public deposits, repurchase agreements, and for other purposes.

 

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During each quarter the Company conducts an assessment of the securities portfolio for OTTI consideration. The assessment considers factors such as external credit ratings, delinquency coverage ratios, market price, management’s judgment, expectations of future performance, and relevant industry research and analysis. An impairment is other-than-temporary if any of the following conditions exist: the entity intends to sell the security; it is more likely than not that the entity will be required to sell the security before recovery of its amortized cost basis; or the entity does not expect to recover the security’s entire amortized cost basis (even if the entity does not intend to sell). If a credit loss exists, but an entity does not intend to sell the impaired debt security and is not more likely than not to be required to sell before recovery, the impairment is other-than-temporary and should be separated into a credit portion to be recognized in earnings and the remaining amount relating to all other factors recognized as other comprehensive loss. Based on the assessment for the year ended December 31, 2013, and in accordance with the guidance, no OTTI was recognized.

 

Based on the assessment for the quarter ended September 30, 2011 and in accordance with the guidance, the Company determined that a single issuer trust preferred security incurred credit-related OTTI of $400,000, which was recognized in earnings for the quarter ended September 30, 2011. There is a possibility that the Company will sell the security before recovering all unamortized costs. The significant inputs the Company considered in determining the amount of the credit loss are as follows:

 

·The assessment of security credit rating agencies and research performed by third parties;
·The continued interest payment deferral by the issuer;
·The lack of improving asset quality of the issuer and worsening economic conditions; and
·The security is thinly traded and trading at its historical low, below par.

 

OTTI recognized for the periods presented is summarized as follow (dollars in thousands):

 

   OTTI Losses 
Cumulative credit losses on investment securities, through December 31, 2012  $400 
Cumulative credit losses on investment securities   - 
Additions for credit losses not previously recognized   - 
Cumulative credit losses on investment securities, through December 31, 2013  $400 

 

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3.LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans are stated at their face amount, net of unearned income, and consist of the following at December 31, 2013 and 2012 (dollars in thousands):

 

   2013   2012 
Commercial:          
Commercial Construction  $213,675   $202,344 
Commercial Real Estate - Owner Occupied   500,764    513,671 
Commercial Real Estate - Non-Owner Occupied   755,905    682,760 
Raw Land and Lots   187,529    205,726 
Single Family Investment Real Estate   237,640    233,395 
Commercial and Industrial   215,702    217,661 
Other Commercial   52,490    47,551 
Consumer:          
Mortgage   237,414    220,567 
Consumer Construction   48,984    33,969 
Indirect Auto   174,843    157,518 
Indirect Marine   38,633    36,586 
HELOCs   281,579    288,092 
Credit Card   23,211    21,968 
Other Consumer   70,999    105,039 
Total  $3,039,368   $2,966,847 

 

The following table shows the aging of the Company’s loan portfolio, by class, at December 31, 2013 (dollars in thousands):

 

   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater Than
90 Days and
still Accruing
   Purchased
Impaired (net
of credit mark)
   Nonaccrual   Current   Total Loans 
Commercial:                                   
Commercial Construction  $-   $-   $-   $-   $1,596   $212,079   $213,675 
Commercial Real Estate - Owner Occupied   514    -    258    -    2,037    497,955    500,764 
Commercial Real Estate - Non-Owner Occupied   185    42    1,996    -    175    753,507    755,905 
Raw Land and Lots   922    545    -    2,457    2,560    181,045    187,529 
Single Family Investment Real Estate   1,783    277    563    275    1,689    233,053    237,640 
Commercial and Industrial   348    152    220    -    3,848    211,134    215,702 
Other Commercial   87    1    50    -    126    52,226    52,490 
Consumer:                                   
Mortgage   6,779    1,399    1,141    -    2,446    225,649    237,414 
Consumer Construction   -    -    208    -    -    48,776    48,984 
Indirect Auto   2,237    252    349    7    -    171,998    174,843 
Indirect Marine   459    -    -    -    288    37,886    38,633 
HELOCs   2,124    422    1,190    787    43    277,013    281,579 
Credit Card   105    133    281    -    -    22,692    23,211 
Other Consumer   888    124    490    96    227    69,174    70,999 
Total  $16,431   $3,347   $6,746   $3,622   $15,035   $2,994,187   $3,039,368 

 

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The following table shows the aging of the Company’s loan portfolio, by class, at December 31, 2012 (dollars in thousands):

 

   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater Than
90 Days and
still Accruing
   Purchased
Impaired (net
of credit mark)
   Nonaccrual   Current   Total Loans 
Commercial:                                   
Commercial Construction  $-   $-   $-   $-   $5,781   $196,563   $202,344 
Commercial Real Estate - Owner Occupied   2,105    153    1,711    247    2,206    507,249    513,671 
Commercial Real Estate - Non-Owner Occupied   866    63    207    -    812    680,812    682,760 
Raw Land and Lots   277    -    75    2,942    8,760    193,672    205,726 
Single Family Investment Real Estate   1,819    261    756    326    3,420    226,813    233,395 
Commercial and Industrial   506    270    441    79    2,036    214,329    217,661 
Other Commercial   70    182    1    -    193    47,105    47,551 
Consumer:                                   
Mortgage   5,610    2,244    3,017    -    747    208,949    220,567 
Consumer Construction   157    -    -    -    235    33,577    33,969 
Indirect Auto   2,504    276    329    21    -    154,388    157,518 
Indirect Marine   67    -    114    -    158    36,247    36,586 
HELOCs   3,063    640    1,239    845    1,325    280,980    288,092 
Credit Card   269    101    397    -    -    21,201    21,968 
Other Consumer   1,525    487    556    105    533    101,833    105,039 
Total  $18,838   $4,677   $8,843   $4,565   $26,206   $2,903,718   $2,966,847 

 

Nonaccrual loans totaled $15.0 million, $26.2 million, and $44.8 million at December 31, 2013, 2012, and 2011, respectively. Had these loans performed in accordance with their original terms, interest income of approximately $778,000, $1.3 million, and $1.3 million would have been recorded in 2013, 2012, and 2011, respectively. There were no nonaccrual loans excluded from impaired loan disclosure in 2013 or 2012. Loans past due 90 days or more and accruing interest totaled $6.7 million and $8.8 million at December 31, 2013 and 2012, respectively.

 

The following table shows purchased impaired commercial and consumer loan portfolios, by class and their delinquency status, at December 31, 2013 (dollars in thousands):

 

   30-89 Days
Past Due
   Greater than
90 Days
   Current   Total 
Commercial:                    
Raw Land and Lots  $-   $-   $2,457   $2,457 
Single Family Investment Real Estate   -    -    275    275 
Consumer:                    
Indirect Auto   -    -    7    7 
HELOCs   -    31    756    787 
Other Consumer   40    -    56    96 
Total  $40   $31   $3,551   $3,622 

  

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The following table shows purchased impaired commercial and consumer loan portfolios, by class and their delinquency status, at December 31, 2012 (dollars in thousands):

 

   30-89 Days
Past Due
   Greater than
90 Days
   Current   Total 
Commercial:                    
Commercial Real Estate - Owner Occupied  $-   $193   $54   $247 
Raw Land and Lots   -    81    2,861    2,942 
Single Family Investment Real Estate   -    14    312    326 
Commercial and Industrial   -    79    -    79 
Consumer:                    
Indirect Auto   3    2    16    21 
HELOCs   -    51    794    845 
Other Consumer   -    -    105    105 
Total  $3   $420   $4,142   $4,565 

  

The Company measures the amount of impairment by evaluating loans either in their collective homogeneous pools or individually. The following table shows the Company’s impaired loans, by class, at December 31, 2013 (dollars in thousands):

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Investment
   Interest
Income
Recognized
 
Loans without a specific allowance                         
Commercial:                         
Commercial Construction  $10,520   $10,523   $-   $9,073   $282 
Commercial Real Estate - Owner Occupied   4,281    4,648    -    4,845    206 
Commercial Real Estate - Non-Owner Occupied   15,012    15,100    -    15,288    572 
Raw Land and Lots   52,259    52,551    -    61,606    2,024 
Single Family Investment Real Estate   5,520    6,021    -    6,396    261 
Commercial and Industrial   4,035    6,835    -    7,083    195 
Other Commercial   55    134    -    134    - 
Consumer:                         
Mortgage   1,361    1,361    -    1,374    60 
Indirect Auto   11    19    -    26    - 
Indirect Marine   495    874    -    887    42 
HELOCs   1,604    1,755    -    1,921    11 
Other Consumer   162    211    -    214    - 
Total impaired loans without a specific allowance  $95,315   $100,032   $-   $108,847   $3,653 
                          
Loans with a specific allowance                         
Commercial:                         
Commercial Construction  $357   $692   $135   $1,136   $9 
Commercial Real Estate - Owner Occupied   3,797    3,937    284    4,000    181 
Commercial Real Estate - Non-Owner Occupied   549    597    76    616    40 
Raw Land and Lots   1,875    1,905    83    1,985    101 
Single Family Investment Real Estate   3,389    3,676    335    3,894    114 
Commercial and Industrial   2,722    3,086    204    3,214    84 
Other Commercial   255    269    35    254    6 
Consumer:                         
Mortgage   4,041    4,147    660    4,183    123 
Other Consumer   321    343    151    350    10 
Total impaired loans with a specific allowance  $17,306   $18,652   $1,963   $19,632   $668 
Total impaired loans  $112,621   $118,684   $1,963   $128,479   $4,321 

 

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The following table shows the Company’s impaired loans, by class, at December 31, 2012 (dollars in thousands):

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Investment
   Interest
Income
Recognized
 
Loans without a specific allowance                         
Commercial:                         
Commercial Construction  $28,212   $28,696   $-   $28,925   $1,237 
Commercial Real Estate - Owner Occupied   13,573    13,665    -    14,579    787 
Commercial Real Estate - Non-Owner Occupied   14,319    14,398    -    15,482    790 
Raw Land and Lots   40,421    40,485    -    43,162    1,538 
Single Family Investment Real Estate   5,487    6,185    -    7,031    253 
Commercial and Industrial   2,201    2,232    -    2,757    154 
Other Commercial   189    189    -    191    11 
Consumer:                         
Mortgage   857    857    -    892    43 
Indirect Auto   35    42    -    56    - 
Indirect Marine   158    283    -    283    3 
HELOCs   1,592    1,748    -    1,802    6 
Other Consumer   286    329    -    332    - 
Total impaired loans without a specific allowance  $107,330   $109,109   $-   $115,492   $4,822 
                          
Loans with a specific allowance                         
Commercial:                         
Commercial Construction  $4,057   $4,104   $643   $4,914   $177 
Commercial Real Estate - Owner Occupied   4,100    4,239    921    4,300    124 
Commercial Real Estate - Non-Owner Occupied   15,084    15,121    848    15,209    851 
Raw Land and Lots   10,715    10,953    2,472    11,741    190 
Single Family Investment Real Estate   3,341    3,437    711    3,643    147 
Commercial and Industrial   4,511    4,728    1,000    4,938    110 
Other Commercial   714    722    153    686    33 
Consumer:                         
Mortgage   2,801    2,805    545    2,851    72 
Consumer Construction   235    262    106    230    - 
HELOCs   1,620    1,687    952    1,897    27 
Other Consumer   867    910    273    916    17 
Total impaired loans with a specific allowance  $48,045   $48,968   $8,624   $51,325   $1,748 
Total impaired loans  $155,375   $158,077   $8,624   $166,817   $6,570 

 

For the years ended December 31, 2013, 2012, and 2011, the average investment in impaired loans was $128.5 million, $166.8 million, and $264.5 million, respectively. The interest income recorded on impaired loans was approximately $4.3 million, $6.6 million, and $10.6 million in 2013, 2012, and 2011, respectively.

 

The Company considers TDRs to be impaired loans. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession that it would not otherwise consider to the borrower for economic or legal reasons related to the borrower’s financial difficulties. TDRs totaled $41.8 million and $63.5 million as of December 31, 2013 and December 31, 2012, respectively. All loans that are considered to be TDRs are evaluated for impairment in accordance with the Company’s allowance for loan loss methodology. For the year ended December 31, 2013, the recorded investment in restructured loans prior to modifications was not materially impacted by the modification.

 

- 78 -
 

 

The following table provides a summary, by class, of modified loans that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing, and modified loans that have been placed in nonaccrual status, which are considered to be nonperforming, as of December 31, 2013 and 2012 (dollars in thousands):

 

   December 31, 2013   December 31, 2012 
   No. of
Loans
   Recorded
Investment
   Outstanding
Commitment
   No. of
Loans
   Recorded
Investment
   Outstanding
Commitment
 
Performing                              
Commercial:                              
Commercial Construction   1   $684   $-    5   $4,549   $73 
Commercial Real Estate - Owner Occupied   4    2,278    -    11    6,009    - 
Commercial Real Estate - Non-Owner Occupied   6    3,771    -    10    13,103    - 
Raw Land and Lots   15    20,741    -    13    22,886    - 
Single Family Investment Real Estate   13    3,497    -    6    928    - 
Commercial and Industrial   7    1,125    -    5    1,041    - 
Other Commercial   -    -    -    1    236    - 
Consumer:                              
Mortgage   10    2,318    -    12    2,256    - 
Other Consumer   3    106    -    4    460    - 
Total performing   59   $34,520   $-    67   $51,468   $73 
                               
Nonperforming                              
Commercial:                              
Commercial Construction   3   $947   $-    4    4,260    - 
Commercial Real Estate - Owner Occupied   3    283    -    3    1,079    - 
Commercial Real Estate - Non-Owner Occupied   -    -    -    2    514    - 
Raw Land and Lots   2    3,973    -    2    4,032    - 
Single Family Investment Real Estate   1    50    -    2    427    - 
Commercial and Industrial   8    1,195    -    7    1,251    - 
Consumer:                              
Mortgage   2    794    -    1    202    - 
Indirect Marine   -    -    -    1    158    - 
Other Consumer   1    62    -    1    68    - 
Total nonperforming   20   $7,304   $-    23   $11,991   $- 
                               
Total performing and nonperforming   79   $41,824   $-    90   $63,459   $73 

 

- 79 -
 

 

The Company considers a default of a restructured loan to occur when the borrower is 90 days past due following the restructure or a foreclosure and repossession of the applicable collateral occurs. The following table shows, by class and modification type, TDRs that occurred during the year ended December 31, 2013 as well as TDRs that had a payment default during 2013 that had been restructured during the twelve month period preceding the default (dollars in thousands):

 

       Restructurings with 
   All Restructurings   payment default 
   No. of
Loans
   Recorded
investment at
period end
   No. of
Loans
   Recorded
investment at
period end
 
Modified to interest only, at a market rate                    
Commercial:                    
Raw Land and Lots   1   $43    1   $43 
Consumer:                    
Mortgage   2    730    -    - 
Total interest only at market rate of interest   3   $773    1   $43 
                     
Term modification, at a market rate                    
Commercial:                    
Commercial Construction   2   $697    -   $- 
Commercial Real Estate - Owner Occupied   2    1,085    -    - 
Commercial Real Estate - Non-Owner Occupied   1    745    -    - 
Raw Land and Lots   3    378    -    - 
Single Family Investment Real Estate   7    2,488    -    - 
Commercial and Industrial   5    649    -    - 
Consumer:                    
Mortgage   3    707    -    - 
Other Consumer   1    34    -    - 
Total loan term extended at a market rate   24   $6,783    -   $- 
                     
Term modification, below market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   1   $115    -   $- 
Commercial and Industrial   1    8    -    - 
Consumer:                    
Mortgage   1    154    -    - 
Total loan term extended at a below market rate   3   $277    -   $- 
Total   30   $7,833    1   $43 

 

- 80 -
 

 

The following table shows, by class and modification type, TDRs that occurred during the year ended December 31, 2012 as well as TDRs that had a payment default during 2012 that had been restructured during the twelve month period preceding the default (dollars in thousands):

 

       Restructurings with 
   All Restructurings   payment default 
   No. of
Loans
   Recorded
investment at
period end
   No. of
Loans
   Recorded
investment at
period end
 
Modified to interest only, at a market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   1   $216    -   $- 
Commercial Real Estate - Non-Owner Occupied   2    759    -    - 
Raw Land and Lots   3    257    -    - 
Single Family Investment Real Estate   2    173    -    - 
Consumer:                    
Mortgage   1    124    -    - 
Indirect Marine   1    158    1    158 
Total interest only at market rate of interest   10   $1,687    1   $158 
                     
Term modification, at a market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   5   $5,328    2   $1,356 
Commercial Real Estate - Non-Owner Occupied   2    715    -    - 
Raw Land and Lots   1    595    -    - 
Commercial and Industrial   6    408    -    - 
Consumer:                    
Mortgage   5    858    -    - 
Indirect Marine   -    -    1    26 
Other Consumer   4    460    -    - 
Total loan term extended at a market rate   23   $8,364    3   $1,382 
                     
Term modification, below market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   4   $647    -   $- 
Raw Land and Lots   1    59    -    - 
Consumer:                    
Mortgage   1    64    -    - 
Other Consumer   1    68    -    - 
Total loan term extended at a below market rate   7   $838    -   $- 
                     
Interest rate modification, below market rate                    
Commercial:                    
Commercial Real Estate - Non-Owner Occupied   2   $2,390    -   $- 
Total interest only at below market rate of interest   2   $2,390    -   $- 
Total   42   $13,279    4   $1,540 

 

- 81 -
 

 

The following table shows the allowance for loan loss activity, balances for allowance for credit losses, and loans based on impairment methodology by portfolio segment for the year ended December 31, 2013. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories (dollars in thousands):

 

   Commercial   Consumer   Unallocated   Total 
Allowance for loan losses:                    
Balance, beginning of the year  $24,821   $10,107   $(12)  $34,916 
Recoveries credited to allowance   1,496    1,285    -    2,781 
Loans charged off   (8,534)   (5,084)   -    (13,618)
Provision charged to operations   2,073    3,919    64    6,056 
Balance, end of period  $19,856   $10,227   $52   $30,135 
                     
Ending Balance, ALL:                    
Loans individually evaluated for impairment  $1,152   $811   $-   $1,963 
Loans collectively evaluated for impairment   18,704    9,416    52    28,172 
Loans acquired with deteriorated credit quality   -    -    -    - 
Total  $19,856   $10,227   $52   $30,135 
                     
Ending Balance, Loans:                    
Loans individually evaluated for impairment  $101,894   $7,105   $-   $108,999 
Loans collectively evaluated for impairment   2,059,079    867,668    -    2,926,747 
Loans acquired with deteriorated credit quality   2,732    890    -    3,622 
Total  $2,163,705   $875,663   $-   $3,039,368 

 

The following table shows the allowance for loan loss activity, balances for allowance for credit losses, and loans based on impairment methodology by portfolio segment for the year ended December 31, 2012. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories (dollars in thousands):

 

   Commercial   Consumer   Unallocated   Total 
Allowance for loan losses:                    
Balance, beginning of the year  $27,891   $11,498   $81   $39,470 
Recoveries credited to allowance   589    1,122    -    1,711 
Loans charged off   (12,852)   (5,613)   -    (18,465)
Provision charged to operations   9,193    3,100    (93)   12,200 
Balance, end of period  $24,821   $10,107   $(12)  $34,916 
                     
Ending Balance, ALL:                    
Loans individually evaluated for impairment  $6,626   $1,876   $-   $8,502 
Loans collectively evaluated for impairment   18,073    8,231    (12)   26,292 
Loans acquired with deteriorated credit quality   122    -    -    122 
Total  $24,821   $10,107   $(12)  $34,916 
                     
Ending Balance, Loans:                    
Loans individually evaluated for impairment  $143,330   $7,480   $-   $150,810 
Loans collectively evaluated for impairment   1,956,184    855,288    -    2,811,472 
Loans acquired with deteriorated credit quality   3,594    971    -    4,565 
Total  $2,103,108   $863,739   $-   $2,966,847 

 

- 82 -
 

 

The following table shows the allowance for loan loss activity, balances for allowance for credit losses, and loans based on impairment methodology by portfolio segment for the year ended December 31, 2011. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories (dollars in thousands):

 

   Commercial   Consumer   Unallocated   Total 
Allowance for loan losses:                    
Balance, beginning of the year  $28,255   $10,189   $(38)  $38,406 
Recoveries credited to allowance   924    1,206    -    2,130 
Loans charged off   (10,891)   (6,975)   -    (17,866)
Provision charged to operations   9,603    7,078    119    16,800 
Balance, end of period  $27,891   $11,498   $81   $39,470 
                     
Ending Balance, ALL:                    
Loans individually evaluated for impairment  $10,127   $1,278   $-   $11,405 
Loans collectively evaluated for impairment   17,679    10,220    81    27,980 
Loans acquired with deteriorated credit quality   85    -    -    85 
Total  $27,891   $11,498   $81   $39,470 
                     
Ending Balance, Loans:                    
Loans individually evaluated for impairment  $239,853   $5,334   $-   $245,187 
Loans collectively evaluated for impairment   1,707,560    855,939    -    2,563,499 
Loans acquired with deteriorated credit quality   8,828    1,069    -    9,897 
Total  $1,956,241   $862,342   $-   $2,818,583 

 

The Company uses the past due status and trends as the primary credit quality indicator for the consumer loan portfolio segment while a risk rating system is utilized for commercial loans. Commercial loans are graded on a scale of 1 through 9. A general description of the characteristics of the risk grades follows:

 

·Risk rated 1 loans have little or no risk and are generally secured by cash or cash equivalents;
·Risk rated 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;
·Risk rated 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;
·Risk rated 4 loans are satisfactory loans with borrowers not as strong as risk rated 3 loans and may exhibit a greater degree of financial risk based on the type of business supporting the loan;
·Risk rated 5 loans are watch loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay;
·Risk rated 6 loans have increasing potential weaknesses beyond those at which the loan originally was granted and if not addressed could lead to inadequately protecting the Company’s credit position;
·Risk rated 7 loans are substandard loans and are inadequately protected by the current sound worth or paying capacity of the obligor or the collateral pledged; these have well defined weaknesses that jeopardize the liquidation of the debt with the distinct possibility the Company will sustain some loss if the deficiencies are not corrected;
·Risk rated 8 loans are doubtful of collection and the possibility of loss is high but pending specific borrower plans for recovery, its classification as a loss is deferred until its more exact status is determined; and
·Risk rated 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as bankable assets is not warranted.

 

- 83 -
 

 

The following table shows all loans, excluding purchased impaired loans, in the commercial portfolios by class with their related risk rating current as of December 31, 2013 (dollars in thousands):

  

   1-3   4   5   6   7   8   Total 
Commercial Construction  $24,399   $148,251   $20,370   $13,772   $6,883   $-   $213,675 
Commercial Real Estate - Owner Occupied   149,632    324,394    10,017    10,926    5,795    -    500,764 
Commercial Real Estate - Non-Owner Occupied   224,702    453,279    21,953    46,084    9,887    -    755,905 
Raw Land and Lots   8,648    98,927    14,132    16,439    46,926    -    185,072 
Single Family Investment Real Estate   38,327    168,564    12,302    11,522    6,650    -    237,365 
Commercial and Industrial   68,748    123,585    8,254    8,752    3,822    2,541    215,702 
Other Commercial   18,593    23,160    8,529    1,897    311    -    52,490 
Total  $533,049   $1,340,160   $95,557   $109,392   $80,274   $2,541   $2,160,973 

 

The following table shows all loans, excluding purchased impaired loans, in the commercial portfolios by class with their related risk rating current as of December 31, 2012 (dollars in thousands):

 

   1-3   4   5   6   7   8   Total 
Commercial Construction  $5,504   $117,769   $14,637   $33,815   $30,619   $-   $202,344 
Commercial Real Estate - Owner Occupied   145,977    321,486    15,197    19,051    11,713    -    513,424 
Commercial Real Estate - Non-Owner Occupied   161,343    417,412    48,840    34,646    20,519    -    682,760 
Raw Land and Lots   3,943    114,053    13,260    29,194    42,148    186    202,784 
Single Family Investment Real Estate   43,705    156,636    12,111    13,150    7,467    -    233,069 
Commercial and Industrial   68,308    120,442    10,584    12,064    6,045    139    217,582 
Other Commercial   14,189    18,260    10,710    3,489    844    59    47,551 
Total  $442,969   $1,266,058   $125,339   $145,409   $119,355   $384   $2,099,514 

 

The following table shows only purchased impaired loans in the commercial portfolios by class with their related risk rating and credit quality indicator information current as of December 31, 2013 (dollars in thousands):

 

   4   5   6   7   8   Total 
Raw Land and Lots  $-   $653   $-   $1,804   $-   $2,457 
Single Family Investment Real Estate   275    -    -    -    -    275 
Total  $275   $653   $-   $1,804   $-   $2,732 

 

The following table shows only purchased impaired loans in the commercial portfolios by class with their related risk rating and credit quality indicator information current as of December 31, 2012 (dollars in thousands):

 

   5   6   7   8   Total 
Commercial Real Estate - Owner Occupied  $-   $-   $247   $-   $247 
Raw Land and Lots   -    -    2,942    -    2,942 
Single Family Investment Real Estate   312    -    14    -    326 
Commercial and Industrial   -    -    79    -    79 
Total  $312   $-   $3,282   $-   $3,594 

 

Loans acquired are originally recorded at fair value, with certain loans being identified as impaired at the date of purchase. The fair values were determined based on the credit quality of the portfolio, expected future cash flows, and timing of those expected future cash flows.

 

- 84 -
 

 

The following shows changes in the Company’s acquired impaired loan portfolio and accretable yield for ASC 310-30 loans and the acquired performing loan portfolio and remaining discount for ASC 310-20 loans for the years ended December 31, 2013 and 2012 (dollars in thousands):

 

 

   December 31, 2013   December 31, 2012 
   ASC 310-30 Loans   ASC 310-20 Loans   ASC 310-30 Loans   ASC 310-20 Loans 
   Accretable
Yield
   Carrying
Amount of
Loans
   Remaining
Discount
   Carrying
Amount of
Loans
   Accretable
Yield
   Carrying
Amount of
Loans
   Remaining
Discount
   Carrying
Amount of
Loans
 
Balance at beginning of period  $3,147   $4,565   $5,350   $473,283   $5,140   $9,897   $9,010   $663,510 
Additions   -    -    -    -    -    -    -    - 
Accretion   (55)   -    (2,009)   -    (353)   -    (3,660)   - 
Charge-offs   (112)   (96)   -    (1,774)   (1,640)   (412)   -    (2,320)
Transfers to OREO   -    (201)   -    (207)   -    (2,371)   -    (2,895)
Payments received, net   -    (646)   -    (96,806)   -    (2,549)   -    (185,012)
Balance at end of period  $2,980   $3,622   $3,341   $374,496   $3,147   $4,565   $5,350   $473,283 

 

4.BANK PREMISES AND EQUIPMENT

 

Bank premises and equipment as of December 31, 2013 and 2012 are as follows (dollars in thousands):

 

   2013   2012 
Land  $23,652   $24,493 
Land improvements and buildings   62,329    62,721 
Leasehold improvements   5,313    5,290 
Furniture and equipment   36,133    37,707 
Equipment lease   62    62 
Construction in progress   9,323    6,634 
Total   136,812    136,907 
Less accumulated depreciation and amortization   53,997    51,498 
Bank premises and equipment, net  $82,815   $85,409 

 

Depreciation expense for 2013, 2012, and 2011 was $6.0 million, $6.6 million, and $6.7 million, respectively. Future minimum rental payments required under non-cancelable operating leases for bank premises that have initial or remaining terms in excess of one year as of December 31, 2013 are as follows for the years ending (dollars in thousands):

 

2014  $5,380 
2015   4,985 
2016   4,232 
2017   3,967 
2018   3,807 
Thereafter   10,410 
Total of future payments  $32,781 

 

The leases contain options to extend for periods up to 20 years. Rental expense for the years ended December 31, 2013, 2012, and 2011 totaled $5.7 million, $5.9 million, and $4.9 million, respectively.

 

- 85 -
 

 

5.INTANGIBLE ASSETS

 

The Company’s intangible assets consist of core deposits, trademarks, and goodwill arising from previous acquisitions. The Company has determined that core deposit intangibles and trademarks have a finite life and amortizes them over their estimated useful life. Core deposit intangible assets are being amortized over the period of expected benefit, which ranges from 4 to 14 years, using an accelerated method. The trademark intangible, acquired through previous acquisitions, was amortized over three years using the straight-line method. In accordance with ASC 350, Intangibles-Goodwill and Other, the Company reviews the carrying value of indefinite lived intangible assets at least annually or more frequently if certain impairment indicators exist. The Company performed its annual impairment testing in the second quarter of 2013 and determined that there was no impairment to its goodwill or intangible assets. Subsequently, the Company determined that an additional evaluation was necessary at year-end due to potential indicators based on the net losses recorded at the mortgage company during the last two quarters of the year. Based on this additional testing, the Company still has recorded no impairment charges to date for goodwill or intangible assets.

 

Information concerning intangible assets with a finite life is presented in the following table (dollars in thousands):

 

   Gross Carrying
Value
   Accumulated
Amortization
   Net Carrying
Value
 
December 31, 2013               
Amortizable core deposit intangibles  $46,615   $34,635   $11,980 
Trademark intangible   1,200    1,200    - 
                
December 31, 2012               
Amortizable core deposit intangibles  $46,615   $30,837   $15,778 
Trademark intangible   1,200    1,167    33 

 

Amortization expense of core deposit intangibles for the years ended December 31, 2013, 2012, and 2011 totaled $3.8 million, $4.9 million, and $6.1 million, respectively. Amortization expense of the trademark intangibles for the year ended December 31, 2013 was $33,000 and for both years ended December 31, 2012 and 2011 totaled $400,000. As of December 31, 2013, the estimated remaining amortization expense of core deposit intangibles is as follows (dollars in thousands):

 

2014  $2,898 
2015   2,463 
2016   1,862 
2017   1,437 
2018   906 
Thereafter   2,414 
Total estimated amortization expense  $11,980 

 

6.DEPOSITS

 

The major types of interest-bearing deposits are as follows for the years ending (dollars in thousands):

 

   2013   2012 
Interest-bearing deposits:          
NOW accounts  $498,068   $454,150 
Money market accounts   940,215    957,130 
Savings accounts   235,034    207,846 
Time deposits of $100,000 and over   427,597    508,630 
Other time deposits   444,254    524,110 
Total interest-bearing deposits  $2,545,168   $2,651,866 

 

- 86 -
 

 

As of December 31, 2013, the scheduled maturities of time deposits are as follows for the years ending (dollars in thousands):

 

2014  $563,788 
2015   141,329 
2016   76,595 
2017   37,814 
2018   52,325 
Total scheduled maturities of time deposits  $871,851 

 

The amount of time deposits held in CDARS accounts was $32.0 million and $36.7 million as of December 31, 2013 and 2012, respectively. These deposits had a maturity of less than one year.

 

The Company classifies deposit overdrafts as other consumer loans. As of December 31, 2013 and 2012, these deposits totaled $1.8 million and $5.7 million, respectively.

 

7.BORROWINGS

 

Short-term Borrowings

 

Total short-term borrowings consist of securities sold under agreements to repurchase, which are secured transactions with customers and generally mature the day following the date sold. Also included in total short-term borrowings are federal funds purchased, which are secured overnight borrowings from other financial institutions, and short-term FHLB advances. Total short-term borrowings consist of the following as of December 31, 2013 and 2012 (dollars in thousands):

 

   2013   2012 
Securities sold under agreements to repurchase  $52,455   $54,270 
Other short-term borrowings   211,500    78,000 
Total short-term borrowings  $263,955   $132,270 
           
Maximum month-end outstanding balance  $263,955   $154,116 
Average outstanding balance during the period   119,433    91,993 
Average interest rate during the period   0.30%   0.31%
Average interest rate at end of period   0.30%   0.28%
           
Other short-term borrowings:          
Federal Funds purchased  $31,500   $38,000 
FHLB  $180,000   $40,000 

 

The Bank maintains federal funds lines with several correspondent banks; the remaining available balance was $93.5 million and $87.0 million at December 31, 2013 and 2012, respectively. The Company has certain restrictive covenants related to certain asset quality, capital, and profitability metrics associated with these lines and is considered to be in compliance with these covenants. Additionally, the Company had a collateral dependent line of credit with the FHLB of up to $805.2 million and $802.2 million at December 31, 2013 and 2012, respectively.

 

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Long-term Borrowings

 

In connection with two bank acquisitions prior to 2006, the Company issued trust preferred capital notes to fund the cash portion of those acquisitions, collectively totaling $58.5 million. The trust preferred capital notes currently qualify for Tier 1 capital of the Company for regulatory purposes.

 

   Principal   Investment(1)   Spread to 
3-Month LIBOR
   Rate   Maturity
Trust Preferred Capital Note - Statutory Trust I  $22,500,000   $696,000    2.75%   3.00%  6/17/2034
Trust Preferred Capital Note - Statutory Trust II   36,000,000    1,114,000    1.40%   1.65%  6/15/2036
Total  $58,500,000                   

 

(1) reported as 'Other Assets' within the Consolidated Balance Sheets

 

As part of a prior acquisition, the Company assumed subordinated debt with terms of LIBOR plus 1.45% and a maturity date of April 2016. At December 31, 2013, the carrying value of the subordinated debt, net of the purchase accounting discount, was $16.4 million.

 

On August 23, 2012, the Company modified its fixed rate FHLB advances to floating rate advances which resulted in reducing the Company’s FHLB borrowing costs. In connection with this modification, the Company incurred a prepayment penalty of $19.6 million on the original advances, which is included as a component of long-term borrowings in the Company’s Consolidated Balance Sheet. In accordance with ASC 470-50, Modifications and Extinguishments, the Company will amortize this prepayment penalty over the term of the modified advances using the effective rate method. The amortization expense is included as a component of interest expense on long-term borrowings in the Company’s Consolidated Income Statement. Amortization expense for the years ended December 31, 2013 and 2012 was $1.7 million and $612,000, respectively.

 

As of December 31, 2013, the advances from the FHLB consist of the following (dollars in thousands):

 

Long Term Type  Spread to 
3-Month LIBOR
   Interest
Rate
   Maturity
Date
  Conversion
Date
  Option
Frequency
  Advance
Amount
 
                      
Adjustable Rate Credit   0.44%   0.69%  8/23/2022  n/a  n/a  $55,000 
Adjustable Rate Credit   0.45%   0.70%  11/23/2022  n/a  n/a   65,000 
Adjustable Rate Credit   0.45%   0.70%  11/23/2022  n/a  n/a   10,000 
Adjustable Rate Credit   0.45%   0.70%  11/23/2022  n/a  n/a   10,000 
                      $140,000 

 

As of December 31, 2012, the advances from the FHLB consisted of the following (dollars in thousands):

 

Long Term Type  Spread to 
3-Month LIBOR
   Interest
Rate
   Maturity
Date
  Conversion
Date
  Option
Frequency
  Advance
Amount
 
                      
Adjustable Rate Credit   0.44%   0.75%  8/23/2022  n/a  n/a  $55,000 
Adjustable Rate Credit   0.45%   0.76%  11/23/2022  n/a  n/a   65,000 
Adjustable Rate Credit   0.45%   0.76%  11/23/2022  n/a  n/a   10,000 
Adjustable Rate Credit   0.45%   0.76%  11/23/2022  n/a  n/a   10,000 
                      $140,000 

 

The carrying value of the loans and securities pledged as collateral for FHLB advances totaled $1.1 billion and $1.0 billion as of December 31, 2013 and 2012, respectively.

 

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As of December 31, 2013, the contractual maturities of long-term debt are as follows for the years ending (dollars in thousands):

 

   Subordinated
Debt
   FHLB
Advances
   Prepayment
Penalty
   Total Long-term
Borrowings
 
2014  $-   $-   $(1,787)  $(1,787)
2015   -    -    (1,831)   (1,831)
2016   16,359    -    (1,882)   14,477 
2017   -    -    (1,923)   (1,923)
2018   -    -    (1,969)   (1,969)
Thereafter   -    140,000    (7,918)   132,082 
Total long-term borrowings  $16,359   $140,000   $(17,310)  $139,049 

  

8.COMMITMENTS AND CONTINGENCIES

 

Litigation Matters

In the ordinary course of its operations, the Company and its subsidiaries are parties to various legal proceedings. Based on the information presently available, and after consultation with legal counsel, management believes that the ultimate outcome in such proceedings, in the aggregate, will not have a material adverse effect on the business or the financial condition or results of operations of the Company.

 

Litigation Relating to the StellarOne Acquisition

 

In a joint press release issued on June 10, 2013, the Company announced the signing of a definitive merger agreement for the acquisition of StellarOne Corporation. The Company closed the acquisition of StellarOne on January 1, 2014. On June 14, 2013, in response to the initial announcement of the definitive merger agreement, Jaclyn Crescente, individually and on behalf of all other StellarOne shareholders, filed a class action complaint against StellarOne, its current directors, StellarOne Bank, and the Company, in the U.S. District Court for the Western District of Virginia, Charlottesville Division (Case No. 3:13-cv-00021-NKM) (the “District Court”). The complaint alleges that the StellarOne directors breached their fiduciary duties by approving the merger with the Company and that the Company aided and abetted in such breaches of duty. The complaint seeks, among other things, equitable relief and/or money damages in the event that the transaction is completed. StellarOne and the Company believe that the claims are without merit; however, in order to eliminate the expense and uncertainties of further litigation, StellarOne, the Company, and the other defendants have entered into a memorandum of understanding with the plaintiffs in order to settle the litigation. Under the terms of the memorandum of understanding, plaintiffs agree to settle the lawsuit and release the defendants from all claims relating to the acquisition of StellarOne, subject to approval by the District Court. On February 3, 2014, the District Court granted preliminary approval to the memorandum of understanding and to a class action settlement in the case. If the District Court grants final approval, the lawsuit will be dismissed.

 

Financial Instruments with 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 financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the Consolidated Balance Sheet. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support off-balance sheet financial instruments with credit risk.

 

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Commitments to extend credit are agreements to lend to customers as long as there are no violations of any conditions established in the contracts. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

Letters of credit written are conditional commitments issued by the Company to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

UMG, a wholly owned subsidiary of the Bank, uses rate lock commitments during the origination process and for loans held for sale. These commitments to sell loans are designed to mitigate UMG’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale. At December 31, 2013, the Company held approximately $2.0 million in loans available for sale in which the related rate lock commitment had expired; accordingly, a valuation adjustment of $94,000 was recorded to properly reflect the lower of cost or market value of these loans. This valuation adjustment was recorded within the mortgage segment; there was a $92,000 valuation adjustment in the prior year.

 

The following table presents the balances of commitments and contingencies (dollars in thousands):

 

   2013   2012 
Commitments with off-balance sheet risk:          
Commitments to extend credit (1)  $891,680   $844,766 
Standby letters of credit   48,107    45,536 
Mortgage loan rate lock commitments   54,834    133,326 
Total commitments with off-balance sheet risk  $994,621   $1,023,628 
Commitments with balance sheet risk:          
Loans held for sale  $53,185   $167,698 
Total other commitments  $1,047,806   $1,191,326 

 

(1) Includes unfunded overdraft protection.

 

The Company must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act. For the final weekly reporting period in the periods ended December 31, 2013 and 2012, the aggregate amount of daily average required reserves was approximately $16.0 million and $14.2 million, respectively.

 

The Company has approximately $9.6 million in deposits in other financial institutions, of which $3.1 million serves as collateral for the trust swap further discussed in Note 9 “Derivatives.” The Dodd-Frank Act, which was signed into law on July 21, 2010, provided unlimited deposit insurance coverage for transaction accounts, but such provision expired on December 31, 2012. As of January 1, 2013, the deposit insurance coverage for transaction accounts is up to at least $250,000. The Company had approximately $5.6 million in deposits in other financial institutions that were uninsured at December 31, 2013. On an annual basis, the Company’s management evaluates the loss risk of its uninsured deposits in financial counter-parties.

 

For asset/liability management purposes, the Company uses interest rate swap agreements to hedge various exposures or to modify the interest rate characteristics of various balance sheet accounts. See Note 9 “Derivatives” in these “Notes to the Consolidated Financial Statements” for additional information.

 

As disclosed in the Company’s Form 10-Q as of September 30, 2013, UMG has identified errors with respect to disclosures made to certain customers during the period from November 2011 through August 2013 in connection with certain loans originated pursuant to insured loan programs administered by the United States Department of Agriculture and Federal Housing Administration.  These disclosure errors understated to the borrowers the amount of mortgage insurance premiums that were required to be assessed over the life of the loans under guidelines enacted by these loan programs.  The Company has, however, taken certain remedial action with respect to the affected borrowers to address the disclosure errors as permitted under applicable law. Virtually all of these loans were sold to third parties prior to the identification of the errors.  At December 31, 2013, the Company accrued $966,000 for contractual indemnification claims specifically related to these errors in mortgage insurance premium calculations. In the ordinary course of business, the Company records an indemnification reserve relating to mortgage loans previously sold based on historical statistics and loss rates and as of December 31, 2013 and 2012, the Company’s indemnification reserve was $627,000 and $446,000, respectively.

 

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9.DERIVATIVES

 

During the second quarter of 2010, the Company entered into an interest rate swap agreement (the “trust swap”) as part of the management of interest rate risk. The Company designated the trust swap as a cash flow hedge intended to protect against the variability of cash flows associated with the aforementioned Statutory Trust II preferred capital securities. The trust swap hedges the interest rate risk, wherein the Company receives interest of LIBOR from a counterparty and pays a fixed rate of 3.51% to the same counterparty calculated on a notional amount of $36.0 million. The term of the trust swap is six years with a fixed rate that started June 15, 2011. The trust swap was entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provisions protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant. At December 31, 2013, the Company pledged $3.1 million of cash as collateral for the trust swap.

 

During the third quarter of 2013, the Company entered into eight interest rate swap agreements (the “prime loan swaps”) as part of the management of interest rate risk. The Company designated the prime loan swaps as cash flow hedges intended to protect the Company against the variability in the expected future cash flows on the designated variable rate loan products. The prime loan swaps hedge the underlying cash flows, wherein the Company receives a fixed interest rate ranging from 4.71% to 6.09% from counterparty and pays interest based on the Wall Street Journal prime index, with a spread of up to 1%, to the same counterparty calculated on a notional amount of $100.0 million. Four of the eight prime loan swaps contain floor rates ranging from 4.00% to 5.00%. The term of the prime loan swaps is six years with a fixed rate that started September 17, 2013. The prime loan swaps were entered into with a counterparty that met the Company’s credit standards and the agreement contains collateral provision protecting the at-risk party. The Company believes that the credit risk inherent in the contract is not significant. At December 31, 2013, the Company pledged securities with a market value of $5.7 million as collateral for the prime loan swaps.

 

Amounts receivable or payable are recognized as accrued under the terms of the agreements. In accordance with ASC 815, Derivatives and Hedging, the Company has designated the previously discussed derivatives as cash flow hedges, with the effective portions of the derivatives’ unrealized gains or losses recorded as a component of other comprehensive income. The ineffective portions of the unrealized gains or losses, if any, would be recorded in other expense. The Company has assessed the effectiveness of each hedging relationship by comparing the changes in cash flows on the designated hedged item. The Company’s cash flow hedges are deemed to be effective. At December 31, 2013, the fair value of the Company’s cash flow hedges was an unrealized loss of $3.6 million, the amount the Company would have expected to pay if the contract was terminated. The below asset and liability are recorded as a component of other comprehensive income recorded in the Company’s Consolidated Statements of Comprehensive Income.

 

Shown below is a summary of the derivatives designated as cash flow hedges at December 31, 2013 and 2012 (dollars in thousands):

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of December 31, 2013                                   
Pay fixed - receive floating interest rate swaps   1   $36,000   $-   $3,046    0.25%   3.51%   3.46 
                                    
Receive fixed - pay floating interest rate swaps   8   $100,000   $-   $516    5.17%*   3.89%*   5.72 

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of December 31, 2012                                   
Pay fixed - receive floating interest rate swaps   1   $36,000   $-   $4,489    0.31%   3.51%   4.46 

 

*This receive rate is a weighted average rate for the 8 loan swaps that have a receive rate range from 4.71% to 6.09%. The pay rate is a weighted average rate taking into consideration the floor rates discussed above.

 

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During the normal course of business, the Company enters into interest rate swap loan relationships (“loan swaps”) with borrowers to meet their financing needs. Upon entering into the loan swaps, the Company enters into offsetting positions with counterparties in order to minimize interest rate risk. These back-to-back loan swaps qualify as financial derivatives with fair values reported in other assets and other liabilities. Shown below is a summary regarding loan swap derivative activities at December 31, 2013 and 2012 (dollars in thousands):

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of December 31, 2013                                   
Receive fixed - pay floating interest rate swaps   1   $718   $33   $-    4.58%   2.92%   8.59 
Pay fixed - receive floating interest rate swaps   1   $718   $-   $33    2.92%   4.58%   8.59 

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of December 31, 2012                                   
Receive fixed - pay floating interest rate swaps   1   $744   $18   $-    4.58%   2.96%   9.59 
Pay fixed - receive floating interest rate swaps   1   $744   $-   $18    2.96%   4.58%   9.59 

 

10.ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The change in accumulated other comprehensive income (loss) for the year ended December 31, 2013 is summarized as follows, net of tax (dollars in thousands):

  

   Unrealized
Gains (losses)
on Securities
   Change in
FV of Cash
Flow Hedges
   Total 
Balance - December 31, 2012  $14,573   $(4,489)  $10,084 
                
Other comprehensive income (loss)   (13,367)   583    (12,784)
Amounts reclassified from accumulated other comprehensive income   (14)   524    510 
Net current period other comprehensive income (loss)   (13,381)   1,107    (12,274)
                
Balance - December 31, 2013  $1,192   $(3,382)  $(2,190)

 

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The change in accumulated other comprehensive income (loss) for the year ended December 31, 2012 is summarized as follows, net of tax (dollars in thousands):

 

   Unrealized
Gains (losses)
on Securities
   Change in
FV of Cash
Flow Hedge
   Total 
Balance - December 31, 2011  $13,943   $(4,293)  $9,650 
                
Other comprehensive income (loss)   753    (922)   (169)
Amounts reclassified from accumulated other comprehensive income   (123)   726    603 
Net current period other comprehensive income (loss)   630    (196)   434 
                
Balance - December 31, 2012  $14,573   $(4,489)  $10,084 

 

The change in accumulated other comprehensive income (loss) for the year ended December 31, 2011 is summarized as follows, net of tax (dollars in thousands):

 

   Unrealized
Gains (losses)
on Securities
   Change in
FV of Cash
Flow Hedge
   Total 
Balance - December 31, 2010  $5,046   $(1,475)  $3,571 
                
Other comprehensive income (loss)   9,231    (3,233)   5,998 
Amounts reclassified from accumulated other comprehensive income   (334)   415    81 
Net current period other comprehensive income (loss)   8,897    (2,818)   6,079 
                
Balance - December 31, 2011  $13,943   $(4,293)  $9,650 

 

Reclassifications of unrealized gains (losses) on available-for-sale securities are reported in the Consolidated Income Statement as "Gains on securities transactions, net" with the corresponding income tax effect being reflected as a component of income tax expense. The Company reported gains of $21,000, $190,000, and $913,000 for the years ended December 31, 2013, 2012, and 2011, respectively, related to gains/losses on the sale of securities. As discussed in Note 2 “Securities”, the Company determined that a single issuer trust preferred security incurred credit-related OTTI of $400,000 during the year ended December 31, 2011, which is included in the reclassification above. The tax effect of these transactions during the years ended December 31, 2013, 2012, and 2011 were $7,000, $67,000, and $179,000, respectively, which were included as a component of income tax expense.

 

Reclassifications of the change in fair value of cash flow hedges are reported in interest income and interest expense in the Consolidated Income Statement with the corresponding income tax effect being reflected as a component of income tax expense. The Company reported net interest expense of $805,000, $1.1 million, and $638,000 for the years ended December 31, 2013, 2012, and 2011, respectively. The tax effect of these transactions during the years ended December 31, 2013, 2012, and 2011 were $281,000, $391,000, and $223,000, respectively, which were included as a component of income tax expense.

 

11.REGULATORY MATTERS AND CAPITAL

 

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on financial statements of the Company and the subsidiary bank. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to financial holding companies and bank holding companies, but only to their bank subsidiaries.

 

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Quantitative measures established by regulation to ensure capital adequacy require the Company and Bank to maintain minimum amounts and ratios of total risk-weighted assets (as defined) and Tier 1 capital (as defined) to average assets (as defined) and risk-weighted assets.

 

As of December 31, 2013, the most recent notification from the Federal Reserve Bank categorized the Bank as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well-capitalized,” an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since that notification that management believes have changed the Bank’s category.

 

The Company and the Bank’s capital amounts and ratios are also presented in the following table at December 31, 2013 and 2012 (dollars in thousands):

 

   Actual   Required for Capital
Adequacy Purposes
   Required in Order to Be
Well Capitalized Under
PCA
 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
As of December 31, 2013                              
Total capital to risk weighted assets:                              
Consolidated  $465,360    14.17%  $262,730    8.00%            NA    NA 
Union First Market Bank   442,784    13.56%   261,229    8.00%  $326,537    10.00%
Tier 1 capital to risk weighted assets:                              
Consolidated   428,490    13.05%   131,338    4.00%            NA    NA 
Union First Market Bank   405,925    12.43%   130,628    4.00%   195,941    6.00%
Tier 1 capital to average adjusted assets:                              
Consolidated   428,490    10.70%   160,183    4.00%             NA    NA 
Union First Market Bank   405,925    10.19%   159,342    4.00%   199,178    5.00%
                               
As of December 31, 2012                              
Total capital to risk weighted assets:                              
Consolidated  $454,444    14.57%  $249,487    8.00%            NA    NA 
Union First Market Bank   438,860    14.14%   248,294    8.00%  $310,367    10.00%
Tier 1 capital to risk weighted assets:                              
Consolidated   409,879    13.14%   124,743    4.00%            NA    NA 
Union First Market Bank   394,296    12.70%   124,147    4.00%   186,220    6.00%
Tier 1 capital to average adjusted assets:                              
Consolidated   409,879    10.29%   159,408    4.00%            NA    NA 
Union First Market Bank   394,296    9.94%   158,631    4.00%   198,288    5.00%

 

In February 2012, the Company repurchased 335,649 shares of its common stock for an aggregate purchase price of $4,363,437, or $13.00 per share. The repurchase was funded with cash on hand. The Company transferred 115,384 of the repurchased shares to its ESOP for $13.00 per share. The remaining 220,265 shares were retired. In December 2012, the Company repurchased and retired 750,000 shares of its common stock for an aggregate purchase price of $11,580,000, or $15.44 per share. The repurchase was funded with cash on hand. In the first quarter 2013, the Company repurchased 500,000 shares of its common stock for an aggregate purchase price of $9,500,000, or $19.00 per share. The repurchase was funded with cash on hand and the shares were retired.

 

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In July 2013, the FRB issued a final rule that makes technical changes to its market risk capital rule to align it with the Basel III regulatory capital framework and meet certain requirements of the Dodd-Frank Act. The final new capital rules require the Company to comply with the following new minimum capital ratios, effective January 1, 2015: (1) a new common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (2) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the current requirement of 4%); (3) a total capital ratio of 8% of risk-weighted assets (unchanged from current requirement); and, (4) a leverage ratio of 4% of total assets.

 

If the new capital ratios described above had been effective as of December 31, 2013, based on management’s interpretation and understanding of the new rules, the Company would have remained “well capitalized” as of such date.

 

12.FAIR VALUE MEASUREMENTS

 

The Company follows ASC 820, Fair Value Measurements and Disclosures, (“ASC 820”) to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This codification clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between willing market participants.

 

ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:

 

  Level 1     Valuation is based on quoted prices in active markets for identical assets and liabilities.
       
  Level 2   Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the markets.
       
  Level 3     Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market. These unobservable inputs reflect the Company’s assumptions about what market participants would use and information that is reasonably available under the circumstances without undue cost and effort.

 

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements.

 

Derivative instruments

 

As discussed in Note 9 “Derivatives,” the Company records derivative instruments at fair value on a recurring basis. The Company utilizes derivative instruments as part of the management of interest rate risk to modify the repricing characteristics of certain portions of the Company’s interest-bearing assets and liabilities. The Company has contracted with a third party vendor to provide valuations for derivatives using standard valuation techniques and therefore classifies such valuations as Level 2. Third party valuations are validated by the Company using Bloomberg Valuation Service’s derivative pricing functions. The Company has considered counterparty credit risk in the valuation of its derivative assets and has considered its own credit risk in the valuation of its derivative liabilities.

 

Securities available for sale

 

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data (Level 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity then the security would fall to the lowest level of the hierarchy (Level 3).

 

- 95 -
 

 

The Company’s investment portfolio is primarily valued using fair value measurements that are considered to be Level 2. The Company has contracted with a third party portfolio accounting service vendor for valuation of its securities portfolio. The vendor’s primary source for security valuation is Interactive Data Corporation (“IDC”), which evaluates securities based on market data. IDC utilizes evaluated pricing models that vary by asset class and include available trade, bid, and other market information. Generally, the methodology includes broker quotes, proprietary models, vast descriptive terms and conditions databases, as well as extensive quality control programs.

 

The vendor utilizes proprietary valuation matrices for valuing all municipals securities. The initial curves for determining the price, movement, and yield relationships within the municipal matrices are derived from industry benchmark curves or sourced from a municipal trading desk. The securities are further broken down according to issuer, credit support, state of issuance, and rating to incorporate additional spreads to the industry benchmark curves.

 

The Company uses Bloomberg Valuation Service, an independent information source that draws on quantitative models and market data contributed from over 4,000 market participants, to validate third party valuations. Any material differences between valuation sources are researched by further analyzing the various inputs that are utilized by each pricing source. No material differences were identified during the validation as of December 31, 2013 and 2012.

 

The carrying value of restricted Federal Reserve Bank and FHLB stock approximates fair value based on the redemption provisions of each entity and is therefore excluded from the following table.

 

- 96 -
 

 

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at December 31, 2013 and 2012 (dollars in thousands):

 

   Fair Value Measurements at December 31, 2013 using 
   Quoted Prices in
Active Markets for
Identical Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Interest rate swap - loans  $-   $33   $-   $33 
Securities available for sale:                    
U.S. government and agency securities   -    2,153    -    2,153 
Obligations of states and political subdivisions   -    254,830    -    254,830 
Corporate and other bonds   -    9,434    -    9,434 
Mortgage-backed securities   -    407,362    -    407,362 
Other securities   -    3,569    -    3,569 
                     
LIABILITIES                    
Interest rate swap - loans  $-   $33   $-   $33 
Cash flow hedge - prime loan swap   -    516    -    516 
Cash flow hedge - trust preferred   -    3,046    -    3,046 

 

   Fair Value Measurements at December 31, 2012 using 
   Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Interest rate swap - loans  $-   $18   $-   $18 
Securities available for sale:                    
U.S. government and agency securities   -    2,849    -    2,849 
Obligations of states and political subdivisions   -    229,778    -    229,778 
Corporate and other bonds   -    7,212    -    7,212 
Mortgage-backed securities   -    342,174    -    342,174 
Other securities   -    3,369    -    3,369 
                     
LIABILITIES                    
Interest rate swap - loans  $-   $18   $-   $18 
Cash flow hedge - trust preferred   -    4,489    -    4,489 

 

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

 

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements.

 

Loans held for sale

Loans held for sale are carried at the lower of cost or market value. These loans currently consist of residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. Nonrecurring fair value adjustments of $363,000 and $0 were recorded on loans held for sale during the years ended December 31, 2013 and 2012, respectively. Gains and losses on the sale of loans are recorded within the mortgage segment and are reported on a separate line item in the Consolidated Statements of Income.

 

- 97 -
 

 

Impaired loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreements will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral dependent loans are reported at the fair value of the underlying collateral if repayment is solely from the underlying value of the collateral. 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. When evaluating the fair value, management may discount the appraisal further if, based on their understanding of the market conditions, it is determined the collateral is further impaired below the appraised value (Level 3). The value of business equipment is based upon an outside appraisal, of one year or less, if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Collateral dependent impaired loans allocated to the allowance for loan losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

 

Other real estate owned

Fair values of OREO are carried at fair value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral, or management’s estimation of the value of the collateral. 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 Level 3 valuation. Total valuation expenses related to OREO properties for the years ended December 31, 2013 and 2012 were $791,000 and $301,000, respectively.

 

The following tables summarize the Company’s financial assets that were measured at fair value on a nonrecurring basis at December 31, 2013 and 2012 (dollars in thousands):

 

   Fair Value Measurements at December 31, 2013 using 
   Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Loans held for sale  $-   $53,185   $-   $53,185 
Impaired loans   -    -    7,985    7,985 
Other real estate owned   -    -    34,116    34,116 
                     
   Fair Value Measurements at December 31, 2012 using 
   Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
     
   Level 1   Level 2   Level 3   Balance 
ASSETS                    
Loans held for sale  $-   $167,698   $-   $167,698 
Impaired loans   -    -    30,104    30,104 
Other real estate owned   -    -    32,834    32,834 

 

- 98 -
 

 

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2013 (dollars in thousands):

 

   Fair Value Measurements at December 31, 2013 
   Fair Value   Valuation Technique(s)  Unobservable Inputs  Weighted
Average
 
ASSETS                
Commercial Construction  $219   Market comparables  Discount applied to market comparables (1)   0%
Commercial Real Estate - Owner Occupied   2,043   Market comparables  Discount applied to market comparables (1)   17%
Raw Land and Lots   908   Market comparables  Discount applied to market comparables (1)   10%
Single Family Investment Real Estate   1,332   Market comparables  Discount applied to market comparables (1)   0%
Commercial and Industrial   1,719   Market comparables  Discount applied to market comparables (1)   28%
Other (2)   1,764   Market comparables  Discount applied to market comparables (1)   0%
Total Impaired Loans   7,985            
                 
Other real estate owned   34,116   Market comparables  Discount applied to market comparables (1)   33%
Total  $42,101            

 

(1) A discount percentage (in addition to expected selling costs) is applied based on age of independent appraisals, current market conditions, and experience within the local market.

 

(2) The "Other" category of the impaired loans section from the table above consists of Other Commercial, Mortgage, Consumer Construction, HELOCs, and Other Consumer.

 

The following table displays quantitative information about Level 3 Fair Value Measurements for December 31, 2012 (dollars in thousands):

 

   Fair Value Measurements at December 31, 2012 
   Fair Value   Valuation Technique(s)  Unobservable Inputs  Weighted
Average
 
ASSETS                
Commercial Construction  $3,190   Market comparables  Discount applied to market comparables (1)   6%
Commercial Real Estate - Owner Occupied   2,001   Market comparables  Discount applied to market comparables (1)   13%
Commercial Real Estate - Non-Owner Occupied   13,100   Market comparables  Discount applied to market comparables (1)   9%
Raw Land and Lots   7,300   Market comparables  Discount applied to market comparables (1)   6%
Single Family Investment Real Estate   1,241   Market comparables  Discount applied to market comparables (1)   6%
Commercial and Industrial   1,810   Market comparables  Discount applied to market comparables (1)   23%
Other (2)   1,462   Market comparables  Discount applied to market comparables (1)   27%
Total Impaired Loans   30,104            
                 
Other real estate owned   32,834   Market comparables  Discount applied to market comparables (1)   33%
Total  $62,938            

 

(1) A discount percentage (in addition to expected selling costs) is applied based on age of independent appraisals, current market conditions, and experience within the local market.

 

(2) The "Other" category of the impaired loans section from the table above consists of Other Commercial, Mortgage, Consumer Construction, HELOCs, and Other Consumer.

 

- 99 -
 

 

ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

 

Cash and cash equivalents

For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

 

Loans

The fair value of performing loans is estimated by discounting expected future cash flows using a yield curve that is constructed by adding a loan spread to a market yield curve. Loan spreads are based on spreads currently observed in the market for loans of similar type and structure. Fair value for impaired loans and their respective level within the fair value hierarchy, are described in the previous disclosure related to fair value measurements of assets that are measured on a nonrecurring basis.

 

Deposits

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of certificates of deposit is estimated by discounting the future cash flows using the rates currently offered for deposits of similar remaining maturities.

 

Borrowings

The carrying value of the Company’s repurchase agreements is a reasonable estimate of fair value. Other borrowings are discounted using the current yield curve for the same type of borrowing. For borrowings with embedded optionality, a third party source is used to value the instrument. The Company validates all third party valuations for borrowings with optionality using Bloomberg’s derivative pricing functions.

 

Accrued interest

The carrying amounts of accrued interest approximate fair value.

 

Commitments to extend credit and standby letters of credit

The fair value of commitments is estimated using the fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the present creditworthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates. The fair value of letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. At December 31, 2013 and 2012, the fair value of loan commitments and standby letters of credit was immaterial.

 

- 100 -
 

 

The carrying values and estimated fair values of the Company’s financial instruments as of December 31, 2013 and 2012 are as follows (dollars in thousands):

 

       Fair Value Measurements at December 31, 2013 using 
       Quoted Prices in
Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
   Total Fair
Value
 
   Carrying Value   Level 1   Level 2   Level 3   Balance 
ASSETS                         
Cash and cash equivalents  $73,023   $73,023   $-   $-   $73,023 
Securities available for sale   677,348    -    677,348    -    677,348 
Restricted stock   26,036    -    26,036    -    26,036 
Loans held for sale   53,185    -    53,185    -    53,185 
Net loans   3,009,233    -    -    3,035,504    3,035,504 
Interest rate swap - loans   33    -    33    -    33 
Accrued interest receivable   15,000    -    15,000    -    15,000 
                          
LIABILITIES                         
Deposits  $3,236,843   $-   $3,238,777   $-   $3,238,777 
Borrowings   463,314    -    443,237    -    443,237 
Accrued interest payable   902    -    902    -    902 
Cash flow hedge - prime loan swap   516    -    516    -    516 
Cash flow hedge - trust preferred   3,046    -    3,046    -    3,046 
Interest rate swap - loans   33    -    33    -    33 
                          
       Fair Value Measurements at December 31, 2012 using 
       Quoted Prices in
 Active Markets
for Identical
Assets
   Significant
Other
Observable
Inputs
   Significant
Unobservable
Inputs
   Total Fair
Value
 
   Carrying Value   Level 1   Level 2   Level 3   Balance 
ASSETS                         
Cash and cash equivalents  $82,902   $82,902   $-   $-   $82,902 
Securities available for sale   585,382    -    585,382    -    585,382 
Restricted stock   20,687    -    20,687    -    20,687 
Loans held for sale   167,698    -    167,698    -    167,698 
Net loans   2,931,931    -    -    2,956,339    2,956,339 
Interest rate swap - loans   18    -    18    -    18 
Accrued interest receivable   19,663    -    19,663    -    19,663 
                          
LIABILITIES                         
Deposits  $3,297,767   $-   $3,309,149   $-   $3,309,149 
Borrowings   329,395    -    309,019    -    309,019 
Accrued interest payable   1,414    -    1,414    -    1,414 
Cash flow hedge – trust preferred   4,489    -    4,489    -    4,489 
Interest rate swap - loans   18    -    18    -    18 

 

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

 

- 101 -
 

 

13.EMPLOYEE BENEFITS

 

The Company has a 401(k) Plan that allows employees to make contributions for retirement. The 401(k) Plan provides for the Company to match employee contributions based on each employee’s contribution percentage. For each employee’s 1% through 3% dollar contributions, the Company will match 100% of such dollar contributions, and for each employee’s 4% through 5% dollar contributions, the Company will match 50% of such dollar contributions. The Bank also has an ESOP. All full and part-time employees of the Bank with 1,000 hours of service are eligible to participate in the ESOP. The Company makes discretionary profit sharing contributions into the 401(k) Plan, ESOP, and in cash. Company discretionary contributions to both the 401(k) Plan and the ESOP are allocated to participant accounts in proportion to each participant’s compensation and vest over five and six year periods, respectively. Employee contributions to the ESOP are not allowed.

 

The following were payments made to the Company’s employees, in accordance with the plans described above, in 2013, 2012, and 2011 (dollars in thousands):

 

   2013   2012   2011 
   Bank   UMG   Bank   UMG   Bank   UMG 
401(k) Plan  $2,002   $569   $1,427   $588   $1,374   $355 
ESOP   1,774    -    1,896    -    1,700    - 
Cash   482    -    314    -    315    - 
Total  $4,258   $569   $3,637   $588   $3,389   $355 

 

The Company had an obligation to certain members of the Bank’s Board of Directors under deferred compensation plans in the amount of $903,000 and $957,000 at December 31, 2013 and 2012, respectively. The expenses related to the deferred compensation plans were $86,000, $84,000, and $80,000 for the years ended December 31, 2013, 2012, and 2011, respectively. The Company owns life insurance policies on plan beneficiaries as an informal funding vehicle to meet future benefit obligations.

 

The Company’s Board of Directors has approved an annual incentive compensation plan (the Management Incentive Plan, or “MIP”) as a means of attracting, rewarding, and retaining key executives. Each annual MIP, as it may be amended from time to time, is based on both corporate and individual objectives established annually for each participant. Each participant is evaluated within these two categories to determine eligibility and rate of incentive compensation based on performance. Salaries and benefits expense for incentive compensation under the MIP was $939,000, $835,000, and $711,000 for the years ended December 31, 2013, 2012, and 2011, respectively.

 

The Company’s 2011 Stock Incentive Plan (the “2011 Plan”) provides, and the 2003 Stock Incentive Plan (the “2003 Plan”) provided until it expired in June 2013, for the granting of stock-based awards in the form of incentive stock options intended to comply with the requirements of Section 422 of the Internal Revenue Code of 1986 (“incentive stock options”), non-statutory stock options, and nonvested stock to key employees of the Company and its subsidiaries. The Company issues new shares to satisfy stock-based awards. Under both plans, the option price cannot be less than the fair market value of the stock on the grant date, and the stock option’s maximum term is ten years from the date of grant and vests in equal annual installments of 20% over a five year vesting schedule. The 2011 Plan became effective on January 1, 2011 after its approval by shareholders at the annual meeting of shareholders held on April 26, 2011. The following table summarizes the shares available in the 2011 Plan as of December 31, 2013:

 

   2011 Plan 
Beginning Authorization   1,000,000 
Granted   (387,594)
Expired, forfeited, or cancelled   26,857 
Remaining available for grant   639,263 

 

- 102 -
 

 

For the year ended December 31, 2013, the Company recognized stock-based compensation expense (included in salaries and benefits expense) of approximately $889,000 (or $708,000 net of tax), or $0.04 per common share. For years ended December 31, 2012 and 2011, respectively, the Company recognized stock-based compensation expense of approximately $1.3 million and $717,000 ($943,000 and $552,000, net of tax), or approximately $0.05 per common share for the year ended December 31, 2012 and approximately $0.02 for the year ended December 31, 2011.

 

Stock Options

 

The following table summarizes the stock option activity for the last three years:

 

   Stock
Options
(shares)
   Weighted
Average
Exercise Price
   Options
Exercisable
(shares)
   Weighted
Average
Exercise Price
 
Balance, December 31, 2010   324,776   $19.38    183,544   $20.90 
Granted   134,046    12.11           
Exercised   (29,625)   10.21           
Forfeited   (6,447)   17.22           
Balance, December 31, 2011   422,750    17.70    184,985    22.28 
Granted   131,657    14.40           
Exercised   (2,376)   12.11           
Forfeited   (51,453)   17.11           
Balance, December 31, 2012   500,578    16.92    218,825    20.59 
Granted   -    -           
Exercised   (50,119)   18.45           
Forfeited   (47,513)   19.04           
Balance, December 31, 2013   402,946    16.48    200,904    18.96 

 

A summary of the options outstanding at December 31, 2013 is as follows:

 

                  Options Outstanding     Options Exercisable  
Range of Exercise Prices     Number
Outstanding
(shares)
    Weighted Average
Remaining
Contractual Life
    Weighted
Average
Exercise Price
    Number
Exercisable
(shares)
    Weighted
Average
Exercise Price
 
                $ 12.11       113,045       6.87 yrs   $ 12.11       45,044     $ 12.11  
$ 12.59       -     $ 14.08       4,558       5.75     $ 13.18       3,188     $ 13.10  
                $ 14.40       114,887       8.15     $ 14.40       21,569     $ 14.40  
                $ 14.82       1,000       6.42     $ 14.82       600     $ 14.82  
                $ 16.45       91,088       6.32     $ 16.45       52,135     $ 16.45  
$ 20.41       -     $ 22.65       22,335       0.72     $ 22.29       22,335     $ 22.29  
                $ 23.50       17,813       1.07     $ 23.50       17,813     $ 23.50  
                $ 27.51       3,750       1.58     $ 27.51       3,750     $ 27.51  
                $ 27.62       15,995       3.15     $ 27.62       15,995     $ 27.62  
                $ 31.57       18,475       2.15     $ 31.57       18,475     $ 31.57  
$ 12.11       -     $ 31.57       402,946       6.09 yrs   $ 16.48       200,904     $ 18.96  

 

- 103 -
 

 

The Company issues shares upon option exercise from the Company’s authorized but unissued shares, and the Company expects to issue an insignificant amount of shares for option exercises during 2014.

 

The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model that uses the assumptions noted in the following table for the years ended December 31, 2013, 2012, and 2011. No options have been granted since February of 2012:

 

   2013   2012   2011 
Dividend yield(1)   -    2.47%   2.36%
Expected life in years(2)   -    7.0    7.0 
Expected volatility(3)   -    41.53%   41.02%
Risk-free interest rate(4)   -    1.24%   2.71%
                
Weighted average fair value per option granted  $-   $4.76   $4.31 

 

(1) Calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant.

(2) Based on the average of the contractual life and vesting schedule for the respective option.

(3) Based on the monthly historical volatility of the Company’s stock price over the expected life of the options.

(4) Based upon the U.S. Treasury bill yield curve, for periods within the contractual life of the option, in effect at the time of grant.

 

The following table summarizes information concerning stock options issued to the Company’s employees that are vested or are expected to vest and stock options exercisable as of December 31, 2013:

 

   Stock Options
Vested or
Expected to Vest
   Exercisable 
Stock options (number of shares)   393,582    200,904 
Weighted average remaining contractual life in years   6.05    4.67 
Weighted average exercise price on shares above water  $15.12   $16.48 
Aggregate intrinsic value  $3,433,532   $1,355,386 

 

During the year ended December 31, 2013, there were 30 stock option awards exercised with a total intrinsic value (the amount by which the stock price exceeds the exercise price) and fair value of approximately $268,000 and $1.2 million, respectively. Cash received from the exercise of stock options for the year ended December 31, 2013 was approximately $927,000, and the tax benefit realized from tax deductions associated with options exercised during the year was $54,000.

 

The fair value of all stock options vested during 2013 was approximately $335,000 and the total intrinsic value of all stock options outstanding was $3.5 million.

 

During the year ended December 31, 2012, there were two stock option awards exercised with a total intrinsic value and fair value of approximately $7,400 and $36,000, respectively. Cash received from the exercise of stock options for the year ended December 31, 2012 was approximately $29,000, and the tax benefit realized from tax deductions associated with options exercised during the year was $2,600.

 

The fair value of all stock options vested during 2012 was approximately $279,000 and the total intrinsic value of all stock options outstanding was $623,000.

 

During the year ended December 31, 2011, the total intrinsic value for stock options exercised was $88,000. The total intrinsic value of stock options outstanding was $1,000. The fair value of stock options vested was approximately $238,000. Cash received from the exercise of stock options for the year ended December 31, 2011 was approximately $302,000, and the tax benefits realized from tax deductions associated with options exercised during the year were $15,000.

 

Nonvested Stock

The 2011 Plan permits, and the 2003 Plan permitted until it expired in June 2013, the granting of nonvested stock but are limited to one-third of the aggregate number of total awards granted. This equity component of compensation is divided between restricted (time-based) stock grants and performance-based stock grants. Generally, the restricted stock vests 50% on each of the third and fourth anniversaries from the date of the grant. The performance-based stock is subject to vesting based on achieving certain performance metrics; the grant of performance-based stock is subject to approval by the Company’s Compensation Committee at its sole discretion. The value of the nonvested stock awards was calculated by multiplying the fair market value of the Company’s common stock on grant date by the number of shares awarded. Employees have the right to vote the shares and to receive cash or stock dividends (restricted stock), if any, except for the nonvested stock under the performance-based component (performance stock).

 

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The following table summarizes the nonvested stock activity for the year ended December 31, 2013:

 

   Number of
Shares of
Restricted Stock
   Weighted
Average Grant-
Date Fair Value
 
Balance, December 31, 2012   187,700   $13.15 
Granted   126,172    18.80 
Vested   (19,763)   13.26 
Forfeited   (33,346)   15.22 
Balance, December 31, 2013   260,763    16.47 

 

The estimated unamortized compensation expense, net of estimated forfeitures, related to nonvested stock and stock options issued and outstanding as of December 31, 2013 that will be recognized in future periods is as follows (dollars in thousands):

 

   Stock Options   Restricted Stock   Total 
2014  $315   $1,194   $1,509 
2015   241    960    1,201 
2016   143    342    485 
2017   27    44    71 
Total  $726   $2,540   $3,266 

 

At December 31, 2013, there was $3.3 million of total unrecognized compensation cost related to nonvested stock-based compensation arrangements granted under the plan. The cost is expected to be recognized through 2017.

 

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14.OTHER OPERATING EXPENSES

 

The following table presents the Consolidated Statement of Income line “Other Operating Expenses” broken into greater detail for the years ended December 31, 2013, 2012 and 2011, respectively (dollars in thousands):

 

   2013   2012   2011 
Printing, postage, and supplies  $2,970   $2,649   $2,179 
Communications expense   2,681    3,070    2,931 
Technology and data processing   7,754    7,510    7,795 
Professional services   3,419    3,035    2,989 
Marketing and advertising expense   4,312    5,473    5,869 
FDIC assessment premiums and other insurance   3,110    2,373    4,936 
Other taxes   3,181    3,017    2,838 
Loan related expenses   2,447    2,254    2,058 
OREO and credit-related expenses(1)   4,880    4,639    5,668 
Amortization of intangible assets   3,831    5,336    6,522 
Acquisition and conversion costs   2,132    -    426 
Other expenses   7,776    6,074    5,715 
Total other operating expenses  $48,493   $45,430   $49,926 

 

(1) OREO related costs include foreclosure related expenses, gains/losses on the sale of OREO, valuation reserves, and asset resolution related legal expenses.

 

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15.INCOME TAXES

 

The Company files income tax returns in the U.S., the Commonwealth of Virginia, and other states. With few exceptions, the Company is no longer subject to U.S. federal or state income tax examinations by tax authorities for years prior to 2010.

 

Net deferred tax assets and liabilities consist of the following components as of December 31, 2013 and 2012 (dollars in thousands):

 

   2013   2012 
Deferred tax assets:          
Allowance for loan losses  $10,657   $12,221 
Benefit plans   1,385    1,429 
Nonaccrual loans   983    1,148 
Acquisition accounting   2,252    2,980 
Stock grants   1,379    1,232 
Other real estate owned   3,282    2,709 
Securities available for sale   901    - 
Other   1,777    1,018 
Total deferred tax assets  $22,616   $22,737 
           
Deferred tax liabilities:          
Acquisition accounting  $5,232   $6,057 
Securities available for sale   -    6,101 
Other   747    899 
Total deferred tax liabilities   5,979    13,057 
Net deferred tax asset  $16,637   $9,680 

 

In assessing the ability to realize deferred tax assets, management considers the scheduled reversal of temporary differences, projected future taxable income, and tax planning strategies. At December 31, 2013, management believed that it is not likely that the Company would realize its deferred tax asset related to net operating losses generated at the state level and accordingly established a valuation allowance of $828,000. The Company’s bank subsidiary is not subject to a state income tax in its primary place of business (Virginia). The Company’s other subsidiaries are subject to state income taxes and have generated losses for state income tax purposes for which the Company is currently not able to utilize. The primary change in management’s estimate of the recoverability of the state net operating loss is related to the recent performance of the Company’s mortgage segment. State net operating loss carryovers will begin to expire after 2026.

 

The provision for income taxes charged to operations for the years ended December 31, 2013, 2012, and 2011 consists of the following (dollars in thousands):

 

   2013   2012   2011 
             
Current tax expense  $12,251   $14,528   $11,879 
Deferred tax expense (benefit)   262    (195)   (615)
Income tax expense  $12,513   $14,333   $11,264 

 

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The income tax expense differs from the amount of income tax determined by applying the U.S. federal income tax rate to pretax income for the years ended December 31, 2013, 2012, and 2011, due to the following (dollars in thousands):

 

 

   2013   2012   2011 
                
Computed "expected" tax expense  $16,453   $17,411   $14,600 
(Decrease) in taxes resulting from:               
Tax-exempt interest income, net   (3,308)   (2,614)   (2,681)
Other, net   (632)   (464)   (655)
Income tax expense  $12,513   $14,333   $11,264 

 

The effective tax rates were 26.6%, 28.8%, and 27.1%, for years ended December 31, 2013, 2012, and 2011, respectively. Tax credits totaled approximately $306,000, $217,000, and $203,000 for the years ended December 31, 2013, 2012, and 2011, respectively.

 

16.EARNINGS PER SHARE

 

Basic EPS was computed by dividing net income available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted EPS is computed using the weighted average number of common shares outstanding during the period, including the effect of dilutive potential common shares outstanding attributable to stock awards.

 

There were approximately 104,126 shares underlying anti-dilutive options as of December 31, 2013, compared to 309,952 and 383,101 shares as of December 31, 2012, and 2011, respectively, which were excluded from the calculation of diluted EPS.

 

The following is a reconciliation of the denominators of the basic and diluted EPS computations for the years ended December 31, 2013, 2012, and 2011 (in thousands except per share data):

 

   Net Income
Available to
Common
Stockholders
(Numerator)
   Weighted Average
Shares
(Denominator)
   Per Share
Amount
 
For the Year Ended December 31, 2013               
Basic EPS  $34,496    24,975   $1.38 
Effect of dilutive stock awards   -    56    - 
Diluted EPS  $34,496    25,031   $1.38 
                
For the Year Ended December 31, 2012               
Basic EPS  $35,411    25,872   $1.37 
Effect of dilutive stock awards   -    29    - 
Diluted EPS  $35,411    25,901   $1.37 
                
For the Year Ended December 31, 2011               
Basic EPS  $27,769    25,981   $1.07 
Effect of dilutive stock awards   -    29    - 
Diluted EPS  $27,769    26,010   $1.07 

 

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17.SEGMENT REPORTING DISCLOSURES

 

The Company has two reportable segments: a traditional full service community bank and a mortgage loan origination business. The community bank business for 2013 includes one subsidiary bank, which provides loan, deposit, investment, and trust services to retail and commercial customers throughout its 90 retail locations in Virginia. The mortgage segment includes one mortgage company, which provides a variety of mortgage loan products principally in Virginia, North Carolina, South Carolina, Maryland, and the Washington D.C. metro area. These loans are originated and sold primarily in the secondary market through purchase commitments from investors, which serves to mitigate the Company’s exposure to interest rate risk.

 

Profit and loss is measured by net income after taxes including realized gains and losses on the Company’s investment portfolio. The accounting policies of the reportable segments are the same as those described in the summary of significant accounting policies. Inter-segment transactions are recorded at cost and eliminated as part of the consolidation process.

 

Both of the Company’s reportable segments are service-based. The mortgage business is a fee-based business while the bank is driven principally by net interest income. The bank segment provides a distribution and referral network through its customers for the mortgage loan origination business. The mortgage segment offers a more limited referral network for the bank segment, due largely to the minimal degree of overlapping geographic markets.

 

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The community bank segment provides the mortgage segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the mortgage banking segment interest at the three month LIBOR rate plus 1.5%, floor of 2%. These transactions are eliminated in the consolidation process. A management fee for operations and administrative support services is charged to all subsidiaries and eliminated in the consolidated totals.

 

Information about reportable segments and reconciliation of such information to the consolidated financial statements for years ended December 31, 2013, 2012, and 2011 is as follows (dollars in thousands):

 

   Community Bank   Mortgage   Eliminations   Consolidated 
For the Year Ended December 31, 2013                    
Net interest income  $149,975   $1,651   $-   $151,626 
Provision for loan losses   6,056    -    -    6,056 
Net interest income after provision for loan losses   143,919    1,651    -    145,570 
Noninterest income   27,492    11,906    (670)   38,728 
Noninterest expenses   120,256    17,703    (670)   137,289 
Income before income taxes   51,155    (4,146)   -    47,009 
Income tax expense   14,000    (1,487)   -    12,513 
Net income  $37,155   $(2,659)  $-   $34,496 
Total assets  $4,170,682   $63,715   $(57,826)  $4,176,571 
                     
For the Year Ended December 31, 2012                    
Net interest income  $153,024   $1,331   $-   $154,355 
Provision for loan losses   12,200    -    -    12,200 
Net interest income after provision for loan losses   140,824    1,331    -    142,155 
Noninterest income   24,876    16,660    (468)   41,068 
Noninterest expenses   119,976    13,971    (468)   133,479 
Income before income taxes   45,724    4,020    -    49,744 
Income tax expense   12,858    1,475    -    14,333 
Net income  $32,866   $2,545   $-   $35,411 
Total assets  $4,081,544   $187,836   $(173,515)  $4,095,865 
                     
For the Year Ended December 31, 2011                    
Net interest income  $155,045   $1,315   $-   $156,360 
Provision for loan losses   16,800    -    -    16,800 
Net interest income after provision for loan losses   138,245    1,315    -    139,560 
Noninterest income   22,382    11,050    (468)   32,964 
Noninterest expenses   121,490    9,793    (468)   130,815 
Income before income taxes   39,137    2,572    -    41,709 
Income tax expense   10,304    960    -    11,264 
Net income  $28,833   $1,612   $-   $30,445 
Total assets  $3,904,013   $84,445   $(81,371)  $3,907,087 

 

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18.RELATED PARTY TRANSACTIONS

 

The Company, through its subsidiaries, has entered into loan transactions with its directors, principal officers, and affiliated companies in which they are principal stockholders. Such transactions were made in the ordinary course of business on substantially the same terms, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other customers, and did not, in the opinion of management, involve more than normal credit risk or present other unfavorable features. There were no changes in terms or loan modifications from the preceding period. The following schedule summarizes the changes in loan amounts outstanding to these persons during the periods indicated (dollars in thousands):

 

   2013   2012 
Loans outstanding at January 1  $51,543   $29,416 
New loans and advances   8,496    29,132 
Loan repayments   (7,440)   (7,005)
Reclassification(1)   (17,716)   - 
Balance at December 31  $34,883   $51,543 

 

(1)Primarily loans of $17.5 million to two former directors who retired from the Board in April 2013 and loans to other persons no longer considered related party or loans that were not considered related party in 2012 that subsequently became related party loans in 2013.

 

The Company, through its subsidiaries, has also entered into deposit transactions with its directors, principal officers, and affiliated companies in which they are principal stockholders, all of which are under the same terms as other customers. The aggregate amount of these deposit accounts was $22.2 million for both years ended December 31, 2013 and 2012, respectively.

 

 In December 2012, the Company received authorization from its Board of Directors to purchase up to 750,000 shares of the Company’s common stock on the open market or in private transactions. The repurchase program was authorized through December 31, 2013. Subsequently, in December 2012, the Company entered into an agreement to purchase 750,000 shares of its common stock from Markel Corporation, then the Company’s largest shareholder, for an aggregate purchase price of $11,580,000, or $15.44 per share. The repurchase was funded with cash on hand. Steven A. Markel, Vice Chairman of Markel Corporation, was a member of the Company’s Board of Directors as of the purchase date. The Company retired the shares. On December 12 and 20, 2012, the Company filed Current Reports on Form 8-K with respect to authorization and repurchase.

 

During the first quarter of 2013, the Company entered into an agreement to purchase 500,000 shares of its common stock from Markel Corporation, for an aggregate purchase price of $9,500,000, or $19.00 per share. The repurchase was funded with cash on hand and the shares were retired. The Company was authorized to repurchase an additional 250,000 shares under the repurchase authorization, but the authorization expired December 31, 2013 with no additional share repurchases.

 

19.PARENT COMPANY FINANCIAL INFORMATION

 

The primary source of funds for the dividends paid by Union First Market Bankshares Corporation (for this note only, the “Parent Company”) is dividends received from its subsidiaries. The payments of dividends by the Bank to the Parent Company are subject to certain statutory limitations which contemplate that the current year earnings and earnings retained for the two preceding years may be paid to the Parent Company without regulatory approval. As of December 31, 2013, the aggregate amount of unrestricted funds, which could be transferred from the Company’s Bank to the Parent Company, without prior regulatory approval, totaled approximately $46.8 million, or 10.7%, of the consolidated net assets.

 

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Financial information for the Parent Company is as follows:

 

PARENT COMPANY

BALANCE SHEETS

AS OF DECEMBER 31, 2013 and 2012

(Dollars in thousands)

 

   2013   2012 
ASSETS          
Cash  $10,092   $6,505 
Bank premises and equipment, net   12,673    13,141 
Other assets   6,662    4,593 
Investment in subsidiaries   486,168    490,199 
Total assets  $515,595   $514,438 
LIABILITIES & STOCKHOLDERS' EQUITY          
Long-term borrowings  $8,750   $9,375 
Trust preferred capital notes   60,310    60,310 
Other liabilities   8,296    8,890 
Total liabilities   77,356    78,575 
           
Common stock   33,020    33,510 
Surplus   170,770    176,635 
Retained earnings   236,639    215,634 
Accumulated other comprehensive income (loss)   (2,190)   10,084 
Total stockholders' equity   438,239    435,863 
Total liabilities and stockholders' equity  $515,595   $514,438 

 

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PARENT COMPANY

STATEMENTS OF INCOME

YEARS ENDED DECEMBER 31, 2013, 2012 and 2011

(Dollars in thousands)

 

   2013   2012   2011 
Income:               
Interest and dividend income  $6   $8   $624 
Dividends received from subsidiaries   31,323    23,141    8,612 
Equity in undistributed net income from subsidiaries   7,685    15,158    23,941 
Gains on sale of securities, net   -    -    430 
Gains (losses) on sale of fixed assets, net   -    -    (1)
Other operating income   1,155    1,155    1,616 
Total income   40,169    39,462    35,222 
Expenses:               
Interest expense  $3,060    3,152    2,627 
Occupancy expenses   583    586    590 
Furniture and equipment expenses   -    -    1,023 
Other operating expenses   2,030    313    537 
Total expenses   5,673    4,051    4,777 
Net income   34,496    35,411    30,445 
Dividends paid on preferred stock  $-    -    1,499 
Amortization of discount on preferred stock  $-    -    1,177 
Net income available to common stockholders  $34,496   $35,411   $27,769 

 

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PARENT COMPANY

CONDENSED STATEMENTS OF CASH FLOWS

YEARS ENDED DECEMBER 31, 2013, 2012 and 2011

(Dollars in thousands)

 

   2013   2012   2011 
Operating activities:               
Net income  $34,496   $35,411   $30,445 
Adjustments to reconcile net income to net cash provided by operating activities:               
Equity in undistributed net income of subsidiaries   (7,685)   (15,158)   (23,941)
Depreciation of bank premises and equipment   468    473    1,089 
Gains on sale of investment securities   -    -    (430)
Tax benefit from exercise of equity-based awards   -    -    15 
Issuance of common stock grants for services   477    565    564 
Net (increase) decrease in other assets   (2,069)   (756)   811 
Net (decrease) increase in other liabilities   1,737    2,781    1,744 
Net cash and cash equivalents provided by operating activities   27,424    23,316    10,297 
Investing activities:               
Sale of securities available for sale   -    -    13,588 
Net decrease (increase) in bank premises and equipment   -    (23)   1,455 
Payments for equity method investment   (2,000)   -    - 
Payments for investments in and advances to subsidiaries   -    -    (2,391)
Net cash and cash equivalents provided by (used in) investing activities   (2,000)   (23)   12,652 
Financing activities:               
Payments on long-term borrowings   (625)   (625)   (625)
Cash dividends paid   (12,535)   (8,969)   (9,245)
Repurchase of preferred stock   -    -    (35,595)
Net Issuance (repurchase) of common stock   (8,677)   (14,469)   574 
Net cash and cash equivalents used in financing activities   (21,837)   (24,063)   (44,891)
Net increase (decrease) in cash and cash equivalents   3,587    (770)   (21,942)
Cash and cash equivalents at beginning of the period   6,505    7,275    29,217 
Cash and cash equivalents at end of the period  $10,092   $6,505   $7,275 

 

20.SUBSEQUENT EVENTS

 

The Company’s management has evaluated subsequent events through March 11, 2014, the date the financial statements were available to be issued.

 

StellarOne Acquisition

 

On January 1, 2014, the Company completed the acquisition of StellarOne, a bank holding company based in Charlottesville, Virginia, in an all stock transaction. StellarOne’s common shareholders received 0.9739 shares of the Company’s common stock in exchange for each share of StellarOne’s common stock, resulting in the Company issuing 22,147,874 common shares at a fair value of $549.5 million. As a result of the transaction, StellarOne’s former bank subsidiary, StellarOne Bank, became a wholly owned bank subsidiary of the Company. The Company expects to operate StellarOne Bank as a separate wholly-owned bank subsidiary until May 2014, at which time StellarOne Bank is expected to be merged with and into the Bank. As part of the acquisition plan and cost control efforts, the Company decided to consolidate 13 overlapping bank branches into nearby locations during 2014.  In all cases, customers can use branches within close proximity or continue to use the Bank’s other delivery channels including online and mobile banking as the Company works to retain and reassign employees affected by the branch closures.

 

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The transaction was accounted for using the acquisition method of accounting and, accordingly, assets acquired, liabilities assumed, and consideration exchanged were recorded at estimated fair values on the acquisition date. Fair values are preliminary and subject to refinement for up to one year after the closing date of the acquisition. The following table provides a preliminary assessment of the assets purchased, liabilities assumed, and the consideration transferred (dollars in thousands, except share and per share data):

 

Preliminary Statement of Net Assets Acquired (at fair value) and consideration transferred:

 

Fair value of assets acquired:     
Cash and cash equivalents  $49,989 
Securities available for sale   460,892 
Loans held for sale   10,922 
Loans   2,239,616 
Bank premise and equipment   80,480 
OREO   4,319 
Core deposit intangible   29,570 
Other assets   95,397 
Total assets  $2,971,185 
      
Fair value of liabilities assumed:     
Deposits  $2,479,874 
Short-term borrowings   4,227 
Long-term borrowings   118,154 
Subordinated debt   25,543 
Other liabilities   22,576 
Total liabilities  $2,650,374 
      
Net identifiable assets acquired  $320,811 
Preliminary Goodwill (1)   228,711 
Net assets acquired  $549,522 
      
Consideration :     
Company's common shares issued   22,147,874 
Purchase price per share of the Company's common stock (2)  $24.81 
Value of Company common stock issued  $549,488 
Value of stock options outstanding   34 
Fair value of total consideration transferred  $549,522 

 

(1) - No goodwill is expected to be deductible for federal income tax purposes. The goodwill will be primarily allocated to the community bank segment.

 

(2) - The value of the shares of common stock exchanged with StellarOne shareholders was based upon the closing price of the Company's common stock at December 31, 2013, the last trading day prior to the date of acquisition.

 

The estimated fair values of the assets acquired and liabilities assumed at the acquisition date, presented in the table above, include some amounts that are based on preliminary fair value estimates. The following factors led to certain balances having preliminary fair value estimates:

 

·The Company engaged third party specialists to assist in valuing certain assets and liabilities and this work (including management’s review and approval) is not yet complete;
·The proximity of the acquisition date (January 1, 2014) and the date that the Company’s financial statements were issued (March 11, 2014); and
·The audit of StellarOne’s opening balance sheet has not been completed.

 

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In many cases, determining the fair value of the acquired assets and assumed liabilities required the Company to estimate cash flows expected to result from those assets and liabilities and to discount those cash flows at appropriate rates of interest. The most significant of those determinations related to the fair valuation of acquired loans. For such loans, the excess of cash flows expected at acquisition over the estimated fair value is recognized as interest income over the remaining lives of the loans. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition reflects the impact of estimated credit losses and other factors, such as prepayments. In accordance with GAAP, there was no carry-over of StellarOne’s previously established allowance for credit losses.

 

The acquired loans were divided into loans with evidence of credit quality deterioration which are accounted for under ASC 310-30, Receivables – Loans and Debt Securities Acquired with Deteriorated Credit Quality, (acquired impaired) and loans that do not meet this criteria, which are accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs, (acquired performing). In addition, the loans are further categorized into different loan pools per loan types. The Company determined expected cash flows on the acquired loans based on the best available information at the date of acquisition. If new information is obtained about facts and circumstances about expected cash flows that existed as of the acquisition date, management will adjust accordingly in accordance with accounting for business combinations.

 

The fair values of the acquired performing loans were $2.1 billion and the fair values of the acquired impaired loans were $137.6 million. The gross contractually required principal and interest payments receivable for acquired performing loans was $2.5 billion. The best estimate of contractual cash flows not expected to be collected related to the acquired performing loans is $35.4 million.

 

The following table presents the acquired impaired loans receivable at the acquisition date (dollars in thousands):

 

 

Contractually required principal and interest payments  $204,503 
Nonaccretable difference   (33,853)
Cash flows expected to be collected   170,650 
Accretable difference   (33,046)
Fair value of loans acquired with a deterioration of credit quality  $137,604 

 

The amounts of StellarOne’s revenue and earnings included in the Company’s Consolidated Statement of Income for the year ended December 31, 2013, and the revenue and earnings of the combined entity had the acquisition date been January 1, 2012, are presented in the pro forma table below. These results combine the historical results of StellarOne into the Company’s Consolidated Statement of Income, and while certain adjustments were made for the estimated impact of certain fair value adjustments and other acquisition-related activity, they are not indicative of what would have occurred had the acquisition taken place on January 1, 2012. In particular, no adjustments have been made to adjust provision for loan losses in 2013 on the acquired loan portfolio and related income taxes. In addition, expenses related to systems conversions and other costs of integration are expected to be recorded during 2014 and those costs will be expensed as incurred. The Company expects to achieve further operating cost savings and other business synergies, including branch closures, as a result of the acquisition which are not reflected in the pro forma amounts below (dollars in thousands):

 

 

   Pro forma for the year ended 
   December 31, 
   2013   2012 
   (unaudited)   (unaudited) 
Total revenues (net interest income plus noninterest income)  $320,162   $333,684 
Net income  $56,223   $57,809 

 

Other Subsequent Events

 

On January 9, 2013, the Bank finalized a forbearance agreement with a borrower in which the Bank acquired 190,152.5 shares of common stock of Virginia National Bankshares Corporation (formerly Virginia National Bank), a national banking association, with an aggregate value of approximately $2.6 million in partial settlement of certain debt owed to the Bank. The common stock served as collateral securing loans made by the Bank to the borrower. On March 6, 2014 the Bank entered into an agreement to sell all of the above-mentioned shares at an aggregate value of $3.8 million. In accordance with the forbearance agreement the proceeds from the sale of the common stock will be applied to the borrower’s contractually obligated loan amount that remains outstanding. The common stock acquired is recorded in Other Assets on the Company’s Consolidated Balance Sheets as of the years ended December 31, 2013 and 2012.

 

On January 30, 2014, the Company’s Board of Directors authorized a share repurchase program to purchase up to $65.0 million worth of the Company’s common stock on the open market or in privately negotiated transactions. The repurchase program is authorized through December 31, 2015.

 

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ITEM 9. - CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE.

 

During the past two years, there have been no changes in or reportable disagreement with the independent registered public accountants for the Company or any of its subsidiaries.

 

ITEM 9A. - CONTROLS AND PROCEDURES.

 

Evaluation of Disclosure Controls and Procedures. The Company maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

Based on their evaluation as of the end of the period covered by this Annual Report on Form 10-K, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective at the reasonable assurance level.

 

Management’s Report on Internal Control over Financial Reporting. Management is responsible for establishing and maintaining adequate internal control over financial reporting as defined in Rule 13a-15(f) of the Exchange Act. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

 

Management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2013. In making this assessment, management used the criteria released in 1992 by the COSO of the Treadway Commission in Internal Control - Integrated Framework. Based on the assessment using those criteria, management concluded that the internal control over financial reporting was effective as of December 31, 2013. On May 14, 2013, the COSO issued a revised version of the Framework which will supersede the original Framework at the end of 2014. The Company does not anticipate any change in internal control effectiveness during transition to the new framework during 2014.

 

The effectiveness of the Company’s internal control over financial reporting as of December 31, 2013 has been audited by Yount, Hyde & Barbour, P.C., the independent registered public accounting firm which also audited the Company’s consolidated financial statements included in this Annual Report on Form 10-K. Yount, Hyde & Barbour, P.C.’s attestation report on the Company’s internal control over financial reporting appears on pages 55 through 56 hereof.

 

Changes in Internal Control over Financial Reporting. There was no change in the internal control over financial reporting that occurred during the quarter ended December 31, 2013 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

 

ITEM 9B. - OTHER INFORMATION. Not applicable.

 

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PART III

 

ITEM 10. - DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE.

 

Information regarding directors, the Company’s audit committee and the audit committee financial expert is incorporated by reference from the Company’s definitive proxy statement for the Company’s 2014 Annual Meeting of Shareholders to be held April 22, 2014 (“Proxy Statement”), under the captions “Election of Directors,” and “Corporate Governance, Board Leadership, and Board Diversity.” The executive officers of the Company, and their respective titles and principal occupations, are listed below:

 

Name (Age)   

Title and Principal Occupation

During at Least the Past Five Years

     
G. William Beale (64)   Chief Executive Officer of the Company since February 1, 2010 and President of the Company since October 1, 2013; Chief Executive Officer of the Company from February 1, 2010 to October 31, 2013; President and Chief Executive Officer of the Company from 1993 to February 1, 2010; President and Chief Executive Officer of Union Bank and Trust Company from 1991 to 2004; Chief Executive Officer of Union First Market Bank as of February 1, 2010.
     
Robert M. Gorman (55)   Executive Vice President and Chief Financial Officer since joining the Company in July 2012; previously with SunTrust Banks, Inc. as Senior Vice President and Director of Corporate Support Services in 2011 and Senior Vice President and Strategic Financial Officer from 2002 until 2011.
     
John C. Neal (64)   President of Union First Market Bank since March 2010; Executive Vice President and Chief Banking Officer of the Company from 2005 to 2012; President and Chief Executive Officer of Union Bank and Trust Company from 2004 to March 22, 2010; Executive Vice President and Chief Operating Officer of Union Bank and Trust Company from 1997 to 2004. Mr. Neal serves on the Board of Directors of the Federal Home Loan Bank of Atlanta.
     
D. Anthony Peay (54)   Executive Vice President and Chief Banking Officer of Union First Market Bank since April 1, 2012; Chief Financial Officer of the Company from 1994 to July 2012; Executive Vice President of the Company since 2003.
     
Elizabeth M. Bentley (53)   Executive Vice President and Director of Retail Banking since 2007; Senior Vice President from 2005 to 2007; Vice President from 2002 to 2005; joined the Company in 1998 as an Assistant Vice President.
     
Rex A. Hockemeyer (60)   Executive Vice President and Director of Operations and Information Technology; joined the Company in April 2008; previously was responsible for information technology at First Financial Bancorp, Cincinnati, Ohio, and served as that holding company’s operations affiliate’s President and Chief Executive Officer beginning in from 1999 to 2008.

 

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Information on Section 16(a) beneficial ownership reporting compliance for the directors and executive officers of the Company is incorporated by reference from the Proxy Statement under the caption “Section 16(a) Beneficial Ownership Reporting Compliance.”

 

The Company has adopted a Code of Business Conduct and Ethics applicable to all employees and directors. The Company has also adopted a Code of Ethics for Senior Financial Officers and Directors, which is applicable to those directors and senior officers who have financial responsibilities.  Both of these codes may be found at http://investors.bankatunion.com. In addition, a copy of either of the codes may be obtained without charge by written request to the Company’s Corporate Secretary.

 

ITEM 11. - EXECUTIVE COMPENSATION.

 

This information is incorporated by reference from the Proxy Statement under the captions “Corporate Governance, Board Leadership, and Board Diversity,” “Named Executive Officers,” “Compensation Discussion and Analysis,” “Report of the Compensation Committee,” “Executive Compensation,” and “Director Compensation.”

 

ITEM 12. - SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS.

 

Other than as set forth below, this information is incorporated by reference from the Proxy Statement under the caption “Ownership of Company Common Stock” and from Note 13 “Employee Benefits” contained in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

The following table summarizes information, as of December 31, 2013, relating to the Company’s equity compensation plans, pursuant to which grants of option to acquire shares of common stock may be awarded from time to time.

 

   Number of securities
to be issued upon
exercise of outstanding
warrants and rights
   Weighted-average
exercise price of
outstanding options,
warrants and rights
   Number of securities
remaining available for
future issuance under
equity compensation
plans (excluding
securities reflected in
column (A))
 
   (A)   (B)   (C)(1) 
             
Equity compensation plans approved by security holders   402,946   $16.48    639,263 
                
Total   402,946   $16.48    639,263 

 

(1) Consists of shares available for future issuance under the Company's 2011 Stock Incentive Plan.

 

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ITEM 13. - CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE.

 

This information is incorporated by reference from the Proxy Statement under the captions “Corporate Governance, Board Leadership, and Board Diversity” and “Interest of Directors and Officers in Certain Transactions.”

 

ITEM 14. - PRINCIPAL ACCOUNTING FEES AND SERVICES.

 

This information is incorporated by reference from the Proxy Statement under the caption “Principal Accounting Fees.”

 

PART IV

 

ITEM 15. - EXHIBITS, FINANCIAL STATEMENT SCHEDULES.

 

The following documents are filed as part of this report:

 

(a)(1) Financial Statements

 

The following consolidated financial statements and reports of independent registered public accountants of the Company are in Part II, Item 8:

Reports of Independent Registered Public Accounting Firm;
Consolidated Balance Sheets - December 31, 2013 and 2012;
Consolidated Statements of Income - Years ended December 31, 2013, 2012, and 2011;
Consolidated Statements of Comprehensive Income – Years ended December 31, 2013, 2012, and 2011;
Consolidated Statements of Changes in Stockholders’ Equity - Years ended December 31, 2013, 2012 and 2011;
Consolidated Statements of Cash Flows - Years ended December 31, 2013, 2012 and 2011;
Notes to Consolidated Financial Statements.

 

(a)(2) Financial Statement Schedules

 

All schedules are omitted since they are not required, are not applicable, or the required information is shown in the consolidated financial statements or notes thereto.

 

(a)(3) Exhibits

 

The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.

 

Exhibit No. 

  Description
       
  2.01   Agreement and Plan of Reorganization, dated as of June 9, 2013, between Union First Market Bankshares Corporation and StellarOne Corporation (incorporated by reference to Exhibit 2.1 to Current Report on Form 8-K filed on June 12, 2013)
       
  3.01   Articles of Incorporation of Union First Market Bankshares Corporation, as amended January 1, 2014 ( incorporated by reference to Exhibit 3.1 to Current Report on Form 8-K filed on January 2, 2014)
       
  3.02   Bylaws of Union First Market Bankshares Corporation, as amended January 1, 2014( incorporated by reference to Exhibit 3.2 to Current Report on Form 8-K filed on January 2, 2014)
       
  4.01   Warrant to Purchase up to 422,636 shares of Common Stock (incorporated by reference to Exhibit 4.1 to Current Report on Form 8-K filed on December 23, 2008)
       
  10.01   Amended and Restated Management Continuity Agreement of G. William Beale (incorporated by reference to Exhibit 10.01 to Annual Report on Form 10-K filed on March 16, 2009)

 

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  10.02   Amended and Restated Employment Agreement of G. William Beale (incorporated by reference to Exhibit 10.02 to Annual Report on Form 10-K filed on March 16, 2009)
       
  10.03   Amended and Restated Management Continuity Agreement of D. Anthony Peay (incorporated by reference to Exhibit 10.03 to Annual Report on Form 10-K filed on March 16, 2009)
       
  10.04   Amended and Restated Management Continuity of John C. Neal (incorporated by reference to Exhibit 10.04 to Annual Report on Form 10-K filed on March 16, 2009)
       
  10.05   Amended and Restated Employment Agreement of John C. Neal (incorporated by reference to Exhibit 10.08 to Annual Report on Form 10-K filed on March 16, 2009)
       
  10.06   Amended and Restated Employment Agreement of D. Anthony Peay (incorporated by reference to Exhibit 10.09 to Annual Report on Form 10-K filed on March 16, 2009)
       
  10.07   Employment Agreement of Elizabeth M. Bentley (incorporated by reference to Exhibit 99.2 to Current Report on Form 8-K filed on October 25, 2011)
       
  10.08   Management Continuity Agreement of Elizabeth M. Bentley (incorporated by reference to Exhibit 99.3 to Current Report on Form 8-K filed on October 25, 2011)
       
  10.09   Amended and Restated Management Continuity Agreement of Robert M. Gorman (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 11, 2012)
       
  10.10   Employment Agreement of Robert M. Gorman (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on July 20, 2012)
       
  10.11   Union Bankshares Corporation 2003 Stock Incentive Plan (incorporated by reference to Exhibit 99.0 to Form S-8 Registration Statement; SEC file no. 333-113839)
       
  10.12   Union First Market Bankshares Corporation 2011 Stock Incentive Plan (incorporated by reference to Form S-8 Registration Statement; SEC file no. 333-175808)
       
  10.13   Union Bankshares Corporation Non-Employee Directors’ Stock Plan (incorporated by reference to Exhibit 99.0 to Form S-8 Registration Statement; SEC file no. 333-113842)
       
  10.14   Letter Agreement, dated December 19, 2008, including the Securities Purchase Agreement – Standard Terms incorporated by reference therein, between Union Bankshares Corporation and the United States Department of the Treasury (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 23, 2008)
       
  10.15  

Registration Rights Agreement, dated February 1, 2010, by and among Union First Market Bankshares Corporation and the shareholders of First Market Bank, FSB (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on February 5, 2010)

       
  10.16   Stock Purchase Agreement, dated as of February 2, 2012, by and between Union First Market Bankshares Corporation, and James E. Ukrop and the Third Amended and Restated James Edward Ukrop Revocable Trust Under Trust Agreement Dated as of September 24, 2007 (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on February 6, 2012)
       
  10.17   Stock Purchase Agreement, dated as of December 20, 2012, by and between Union First Market Bankshares Corporation and Markel Corporation (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on December 21, 2012)

 

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  10.18   Stock Purchase Agreement, dated as of March 7, 2013, by and between Union First Market Bankshares Corporation and Markel Corporation (incorporated by reference to Exhibit 10.1 to Current Report on Form 8-K filed on March 8, 2013)
       
  10.19   Stock Repurchase Authorization, dated as of January 30, 2014, by the Board of Directors of Union First Market Bankshares Corporation (incorporated by reference to Exhibit 99.1 to Current Report on Form 8-K filed on February 3, 2014)
       
  11.03   Statement re: Computation of Per Share Earnings (incorporated by reference to Note 13 of the Notes to Consolidated Financial Statements included in this Annual Report)
       
  21.01   Subsidiaries of the Registrant
       
  23.01   Consent of Yount, Hyde & Barbour, P.C.
       
  31.01   Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
  31.02   Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
       
  32.01   Certification of Chief Executive Officer and Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
       
  101.00   Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of December 31, 2013 and 2012, (ii) the Consolidated Statements of Income for the years ended December 31, 2013, 2012, and 2011, (iii) the Consolidated Statements of Comprehensive Income for the years ended December 31, 2013, 2012, and 2011, (iv) the Consolidated Statements of Changes in Shareholders’ Equity for the years ended December 31, 2013, 2012, and 2011, (v) the Consolidated Statements of Cash Flows for the years ended December 31, 2013 and 2012 and (vi) the Notes to the Consolidated Financial Statements (furnished herewith).

 

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SIGNATURES

 

Pursuant to the requirements of Section 13 or 15(d) 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.

 

Union First Market Bankshares Corporation

 

By: /s/ G. William Beale   Date: March 11, 2014
  G. William Beale
President and
Chief Executive Officer
 

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on March 11, 2014.

 

Signature

Title 

     
/s/ L. Bradford Armstrong   Director
L. Bradford Armstrong    
     
/s/ G. William Beale   President and Chief Executive Officer, and
G. William Beale   Director (principal executive officer)
     
/s/ Glen C. Combs   Director
Glen C. Combs    
     
/s/ Beverley E. Dalton   Director
Beverley E. Dalton    
     
/s/ Gregory L. Fisher   Director
Gregory L. Fisher    
     
/s/ Robert M. Gorman   Executive Vice President and Chief Financial
Robert M. Gorman   Officer (principal financial and accounting officer)
     
/s/ Daniel I. Hansen   Director
Daniel I. Hansen    
     
/s/ Ronald L. Hicks   Vice Chairman of the Board of Directors
Ronald L. Hicks    
     
/s/ Jan S. Hoover   Director
Jan S. Hoover    
     
/s/ Patrick J. McCann   Director
Patrick J. McCann    
     
/s/ R. Hunter Morin   Director
R. Hunter Morin    

 

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Signature

Title 

     
/s/ W. Tayloe Murphy, Jr.   Director
W. Tayloe Murphy, Jr.    
     
/s/ Alan W. Myers   Director
Alan W. Myers    
     
/s/ Thomas P. Rohman   Director
Thomas P. Rohman    
     
/s/ Linda V. Schreiner   Director
Linda V. Schreiner    
     
/s/ Raymond L. Slaughter   Director
Raymond L. Slaughter    
     
/s/ Raymond D. Smoot   Chairman of the Board of Directors
Raymond D. Smoot    
     
/s/ Charles W. Steger   Director
Charles W. Steger    
     
/s/ Ronald L. Tillett   Director
Ronald L. Tillett    
     
/s/ Keith Wampler   Director
Keith L. Wampler    

 

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