UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

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

 

For the Quarterly Period Ended June 30, 2014

 

OR

 

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

 

Commission File Number: 0-20293

 

UNION BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

 

VIRGINIA 54-1598552
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

1051 East Cary Street

Suite 1200

Richmond, Virginia 23219

(Address of principal executive offices) (Zip Code)

 

(804) 633-5031

(Registrant’s telephone number, including area code)

 

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

 

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

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer    ¨ Accelerated filer                     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 Exchange Act).
                                                                                                                                                      Yes
¨ No x

 

The number of shares of common stock outstanding as of August 1, 2014 was 45,634,905.

 

 
 

  

UNION BANKSHARES CORPORATION

FORM 10-Q

INDEX

 

ITEM   PAGE
     
  PART I - FINANCIAL INFORMATION  
     
Item 1. Financial Statements  
     
  Consolidated Balance Sheets as of June 30, 2014 and December 31, 2013 2
     
  Consolidated Statements of Income for the three and six months ended June 30, 2014 and 2013 3
     
  Consolidated Statements of Comprehensive Income for the three and six months ended June 30, 2014 and 2013 4
     
  Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2014 and 2013 5
     
  Consolidated Statements of Cash Flows for the six months ended June 30, 2014 and 2013 6
     
  Notes to Consolidated Financial Statements 7
     
  Report of Independent Registered Public Accounting Firm 46
     
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 47
     
Item 3. Quantitative and Qualitative Disclosures About Market Risk 72
     
Item 4. Controls and Procedures 74
     
  PART II - OTHER INFORMATION  
     
Item 1. Legal Proceedings 75
     
Item 1A. Risk Factors 76
     
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 76
     
Item 6. Exhibits 77
     
  Signatures 78

 

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 Company Union Bankshares Corporation
Dodd-Frank Act Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010
EPS Earnings per share
Exchange Act Securities Exchange Act of 1934
FASB Financial Accounting Standards Board
Federal Reserve Bank Federal Reserve Bank of Richmond
FDIC Federal Deposit Insurance Corporation
FHLB Federal Home Loan Bank of Atlanta
FRB or Federal Reserve Board of Governors of the Federal Reserve System
GAAP Accounting principles generally accepted in the United States
HELOC Home equity line of credit
LIBOR London Interbank Offered Rate
NPA Nonperforming assets
OREO Other real estate owned
OTTI Other than temporary impairment
PCI Purchased credit impaired
SEC Securities and Exchange Commission
StellarOne StellarOne Corporation
TDR Troubled debt restructuring
UMG Union Mortgage Group, Inc.

 

 
 

  

PART I – FINANCIAL INFORMATION

Item 1 – Financial Statements

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except share data)

 

   June 30,   December 31, 
   2014   2013 
   (Unaudited)   (Audited) 
ASSETS          
Cash and cash equivalents:          
Cash and due from banks  $136,799   $66,090 
Interest-bearing deposits in other banks   21,769    6,781 
Money market investments   1    1 
Federal funds sold   311    151 
Total cash and cash equivalents   158,880    73,023 
           
Securities available for sale, at fair value   1,094,777    677,348 
Restricted stock, at cost   47,204    26,036 
           
Loans held for sale, net   63,622    53,185 
           
Loans, net of unearned income   5,233,069    3,039,368 
Less allowance for loan losses   31,379    30,135 
Net loans   5,201,690    3,009,233 
           
Bank premises and equipment, net   145,662    82,815 
Other real estate owned, net of valuation allowance   38,494    34,116 
Core deposit intangibles, net   36,479    11,980 
Goodwill   296,876    59,400 
Other assets   223,396    149,435 
Total assets  $7,307,080   $4,176,571 
           
LIABILITIES          
Noninterest-bearing demand deposits   1,198,919    691,674 
Interest-bearing deposits   4,535,644    2,545,168 
Total deposits   5,734,563    3,236,842 
           
Securities sold under agreements to repurchase   42,276    52,455 
Other short-term borrowings   200,000    211,500 
Long-term borrowings   298,786    199,359 
Other liabilities   54,486    38,176 
Total liabilities   6,330,111    3,738,332 
           
Commitments and contingencies          
           
STOCKHOLDERS' EQUITY          
Common stock, $1.33 par value, shares authorized 100,000,000 and 36,000,000, respectively; issued and outstanding, 45,874,662 shares and 24,976,434 shares, respectively.   60,731    33,020 
Surplus   659,179    170,770 
Retained earnings   246,178    236,639 
Accumulated other comprehensive income (loss)   10,881    (2,190)
Total stockholders' equity   976,969    438,239 
           
Total liabilities and stockholders' equity  $7,307,080   $4,176,571 

 

See accompanying notes to consolidated financial statements.

 

-2 -
 

  

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share amounts)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30,   June 30,   June 30, 
   2014   2013   2014   2013 
   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited) 
Interest and dividend income:                    
Interest and fees on loans  $61,386   $38,687   $122,655   $77,912 
Interest on federal funds sold   -    -    -    1 
Interest on deposits in other banks   9    6    21    11 
Interest and dividends on securities:                    
Taxable   3,860    1,939    7,508    4,008 
Nontaxable   3,379    2,054    6,658    4,041 
Total interest and dividend income   68,634    42,686    136,842    85,973 
                     
Interest expense:                    
Interest on deposits   2,550    3,701    4,806    7,663 
Interest on federal funds purchased   23    21    46    36 
Interest on short-term borrowings   146    54    265    108 
Interest on long-term borrowings   2,200    1,507    4,252    3,009 
Total interest expense   4,919    5,283    9,369    10,816 
                     
Net interest income   63,715    37,403    127,473    75,157 
Provision for loan losses   1,500    1,000    1,500    3,050 
Net interest income after provision for loan losses   62,215    36,403    125,973    72,107 
                     
Noninterest income:                    
Service charges on deposit accounts   4,525    2,346    8,822    4,618 
Other service charges, commissions and fees   5,412    3,222    10,083    6,029 
Gains on securities transactions, net   426    53    455    42 
Gains on sales of mortgage loans, net of commissions   3,030    4,668    5,328    8,520 
Losses on sales of bank premises   (71)   (34)   (304)   (330)
Other operating income   3,382    1,044    6,520    2,254 
Total noninterest income   16,704    11,299    30,904    21,133 
                     
Noninterest expenses:                    
Salaries and benefits   28,040    17,912    57,666    35,878 
Occupancy expenses   5,102    2,764    10,282    5,619 
Furniture and equipment expenses   2,637    1,741    5,505    3,585 
Communications expense   1,351    675    2,450    1,372 
Technology and data processing   2,792    2,021    5,866    3,765 
Professional services   1,442    663    2,497    1,387 
Marketing and advertising expense   1,692    1,108    2,757    2,160 
FDIC assessment premiums and other insurance   1,593    756    2,986    1,546 
OREO and credit-related expenses   2,244    984    3,694    1,558 
Amortization of intangible assets   2,455    921    5,071    1,990 
Acquisition and conversion costs   4,661    919    17,829    919 
Other expenses   5,466    3,819    10,653    8,004 
Total noninterest expenses   59,475    34,283    127,256    67,783 
                     
Income before income taxes   19,444    13,419    29,621    25,457 
Income tax expense   4,664    3,956    7,026    7,011 
Net income  $14,780   $9,463   $22,595   $18,446 
Earnings per common share, basic  $0.32   $0.38   $0.49   $0.74 
Earnings per common share, diluted  $0.32   $0.38   $0.48   $0.74 

 

See accompanying notes to consolidated financial statements.

 

-3 -
 

  

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Dollars in thousands)

 

   Three Months Ended   Six Months Ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited) 
Net income  $14,780   $9,463   $22,595   $18,446 
Other comprehensive income (loss):                    
Cash flow hedges:                    
Change in fair value of cash flow hedges   (778)   658    (203)   756 
Reclassification adjustment for losses included in net income (net of tax, $117 and $103 for the three months and $142 and $204 for the six months ended June 30, 2014 and 2013)   217    191    264    379 
Unrealized gains (losses) on securities:                    
Unrealized holding gains (losses) arising during period (net of tax, $3,625 and $5,233 for the three months and $7,024 and $6,368 for the six months ended June 30, 2014 and 2013)   6,733    (9,720)   13,046    (11,827)
Reclassification adjustment for (gains) losses included in net income (net of tax, $9 and $19 for the three months and $19 and $15 for the six months ended June 30, 2014 and 2013)   (17)   (34)   (36)   (27)
Other comprehensive income (loss)   6,155    (8,905)   13,071    (10,719)
Comprehensive income  $20,935   $558   $35,666   $7,727 

 

See accompanying notes to consolidated financial statements.

 

-4 -
 

  

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY

SIX MONTHS ENDED JUNE 30, 2014 AND 2013

(Dollars in thousands, except share amounts)

 

   Common
Stock
   Surplus   Retained
Earnings
   Accumulated
Other
Comprehensive
Income (Loss)
   Total 
   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited)   (Unaudited) 
Balance - December 31, 2012  $33,510   $176,635   $215,634   $10,084   $435,863 
Net income - 2013             18,446         18,446 
Other comprehensive loss (net of tax, $6,383)                  (10,719)   (10,719)
Dividends on Common Stock ($.26 per share)             (6,063)        (6,063)
Stock purchased under stock repurchase plan (500,000 shares)   (664)   (8,835)             (9,499)
Issuance of common stock under Dividend Reinvestment Plan (25,177 shares)   33    421    (454)        - 
Issuance of common stock under Equity Compensation Plans (13,365 shares)   17    79              96 
Vesting of restricted stock under Equity Compensation Plans (6,177 shares)   8    (8)             - 
Net settle for taxes on Restricted Stock Awards (2,563 shares)   (3)   (17)             (20)
Stock-based compensation expense        325              325 
Balance - June 30, 2013  $32,901   $168,600   $227,563   $(635)  $428,429 
                          
Balance - December 31, 2013  $33,020   $170,770   $236,639   $(2,190)  $438,239 
Net income - 2014             22,595         22,595 
Other comprehensive income (net of tax, $7,147)                  13,071    13,071 
Issuance of Common Stock in regard to acquisition (22,147,874 shares)   29,457    520,066              549,523 
Dividends on Common Stock ($.28 per share)             (12,503)        (12,503)
Stock purchased under stock repurchase plan (1,342,075 shares)   (1,785)   (32,121)             (33,906)
Issuance of common stock under Dividend Reinvestment Plan (23,187 shares)   31    522    (553)        - 
Issuance of common stock under Equity Compensation Plans (60,470 shares)   80    863              943 
Vesting of restricted stock under Equity Compensation Plans (8,254 shares)   11    (11)             - 
Net settle for taxes on Restricted Stock Awards (62,287 shares)   (83)   (1,464)             (1,547)
Stock-based compensation expense        554              554 
Balance - June 30, 2014  $60,731   $659,179   $246,178   $10,881   $976,969 

 

See accompanying notes to consolidated financial statements.

 

-5 -
 

 

UNION BANKSHARES CORPORATION AND SUBSIDIARIES

CONSOLIDATED STATEMENTS OF CASH FLOWS

SIX MONTHS ENDED JUNE 30, 2014 AND 2013

(Dollars in thousands)

 

   2014   2013 
   (Unaudited)   (Unaudited) 
Operating activities:          
Net income  $22,595   $18,446 
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:          
Depreciation of bank premises and equipment   5,470    3,046 
Writedown of OREO   1,073    - 
Amortization, net   12,201    2,598 
Accretion and amortization related to acquisition, net   (4,766)   - 
Provision for loan losses   1,500    3,050 
Gains on securities transactions, net   (455)   (42)
Decrease in loans held for sale, net   940    58,303 
Gains on sales of other real estate owned, net   (30)   (142)
Losses on bank premises, net   304    330 
Stock-based compensation expenses   554    325 
Net decrease in other assets   12,907    2,151 
Net (decrease) increase in other liabilities   (3,399)   2,813 
Net cash and cash equivalents provided by operating activities   48,894    90,878 
Investing activities:          
Purchases of securities available for sale   (291,070)   (106,188)
Proceeds from sales of securities available for sale   259,077    15,585 
Proceeds from maturities, calls and paydowns of securities available for sale   68,448    78,050 
Net decrease (increase) in loans   41,555    (42,027)
Net increase in bank premises and equipment   (4,879)   (1,812)
Proceeds from sales of other real estate owned   7,713    3,391 
Improvements to other real estate owned   (59)   (194)
Cash acquired in bank acquisitions   49,989    - 
Net cash and cash equivalents provided by (used in) investing activities   130,774    (53,195)
Financing activities:          
Net increase in noninterest-bearing deposits   95,205    22,402 
Net (decrease) increase in interest-bearing deposits   (71,978)   (54,206)
Net decrease in short-term borrowings   (70,906)   (2,852)
Net increase in long-term borrowings (1)   881    1,104 
Cash dividends paid - common stock   (12,503)   (6,063)
Repurchase of common stock   (33,906)   (9,499)
Issuance of common stock   943    96 
Taxes paid related to net share settlement of equity awards   (1,547)   (20)
Net cash and cash equivalents (used in) provided by financing activities   (93,811)   (49,038)
Increase in cash and cash equivalents   85,857    (11,355)
Cash and cash equivalents at beginning of the period   73,023    82,902 
Cash and cash equivalents at end of the period  $158,880   $71,547 
           
Supplemental Disclosure of Cash Flow Information          
Cash payments for:          
Interest  $13,788   $11,166 
Income taxes   5,800    4,600 
           
Supplemental schedule of noncash investing and financing activities          
Unrealized gain (loss) on securities available for sale  $20,015   $(18,237)
Changes in fair value of interest rate swap loss   61    1,135 
Transfers from loans to other real estate owned   2,704    4,386 
Transfers from bank premises to other real estate owned   6,052    988 
           
Transactions related to bank and branch acquisitions          
Assets acquired   2,959,212    - 
Liabilities assumed   2,647,165    - 

 

(1) See Note 6 "Borrowings" related to 2014 activity.

See accompanying notes to consolidated financial statements.

 

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UNION BANKSHARES CORPORATION AND SUBSIDIARIES

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2014

 

1.ACCOUNTING POLICIES

 

Effective April 25, 2014, the Company changed its corporate name from Union First Market Bankshares Corporation to Union Bankshares Corporation. The name change was approved at the Company’s annual meeting of shareholders held April 22, 2014. The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. Significant inter-company accounts and transactions have been eliminated in consolidation.

 

The unaudited consolidated financial statements have been prepared in accordance with GAAP for interim financial information and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all the information and footnotes required by GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year.

 

These financial statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company’s 2013 Annual Report on Form 10-K. If needed, certain previously reported amounts have been reclassified to conform to current period presentation.

 

Recent Accounting Pronouncements

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.

 

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-08 to have a material impact on its consolidated financial statements.

 

-7 -
 

  

In June 2014, the FASB issued ASU No. 2014-09, “Revenue from Contracts with Customers: Topic 606”. This ASU applies to any entity using U.S. GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition requirements in Topic 605, “Revenue Recognition”, most industry-specific guidance, and some cost guidance included in Subtopic 605-35, “Revenue Recognition—Construction-Type and Production-Type Contracts”. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To be in alignment with the core principle, an entity must apply a five step process including: identification of the contract(s) with a customer, identification of performance obligations in the contract(s), determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue when (or as) the entity satisfies a performance obligation. Additionally, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer have also been amended to be consistent with the guidance on recognition and measurement. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-09 will have on its consolidated financial statements.

 

In June 2014, the FASB issued ASU No. 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures”. This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014; however, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-11 will have on its consolidated financial statements.

 

In June 2014, the FASB issued ASU No. 2014-12, “Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period”. The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation – Stock Compensation (Topic 718)”, should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.

 

-8 -
 

 

2.ACQUISITIONS

 

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. On May 9, 2014, StellarOne Bank was merged with and into Union First Market Bank. As part of the acquisition plan and cost control efforts, the Company decided to consolidate 13 overlapping bank branches into nearby locations during the first six months of 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.

 

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):

 

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   11,377 
Loans   2,238,981 
Bank premises and equipment   69,618 
OREO   4,319 
Core deposit intangible   29,570 
Other assets   94,466 
Total assets  $2,959,212 
      
Fair value of liabilities assumed:     
Deposits  $2,479,874 
Short-term borrowings   49,227 
Long-term borrowings   98,697 
Other liabilities   19,367 
Total liabilities  $2,647,165 
      
Net identifiable assets acquired  $312,047 
Preliminary Goodwill (1)   237,476 
Net assets acquired  $549,523 
      
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  $549,489 
Value of stock options outstanding   34 
Fair value of total consideration transferred  $549,523 

 

(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.

 

-9 -
 

  

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

 

Loans

 

The acquired loans were recorded at fair value at the acquisition date without carryover of StellarOne’s previously established allowance for loan losses. The fair value of the loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then applying a market-based discount rate to those cash flows. In this regard, the acquired loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type, purpose, and lien position. Credit risk characteristics included risk rating groups (pass rated loans and adversely classified loans), updated loan-to-value ratios and past due status. For valuation purposes, these pools were further disaggregated by maturity, pricing characteristics (e.g., fixed-rate, adjustable-rate) and re-payment structure (e.g., interest only, fully amortizing, balloon). If new information is obtained regarding facts and circumstances about expected cash flows that existed as of the acquisition date, management will adjust in accordance with accounting for business combinations.

 

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 or PCI) and loans that do not meet this criteria, which are accounted for under ASC 310-20, Receivables – Nonrefundable Fees and Other Costs, (acquired performing). The fair values of the acquired performing loans were $2.1 billion and the fair values of the acquired impaired loans were $145.5 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  $214,803 
Nonaccretable difference   (34,696)
Cash flows expected to be collected   180,107 
Accretable difference   (34,653)
Fair value of loans acquired with a deterioration of credit quality  $145,454 

 

Bank Premises

 

The fair value of StellarOne’s premises, including land, buildings, and improvements, was determined based upon independent third party appraisals performed by licensed appraisers in the market in which the premises are located. These appraisals were based upon the highest and best use of the underlying asset(s) with final values determined based upon an analysis of the cost, sales comparison, and income capitalization approaches for each property appraised. The Company also engaged independent appraisers to value the leasehold interests. The fair value of the leasehold interest was not material to the consolidated financial statements.

 

Core Deposit Intangible

 

The fair value of the core deposit intangible was determined based on a blended market approach and discounted cash flow analysis using a discount rate based on the estimated cost of capital for a market participant. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the cost of alternative funding sources available through the FHLB. The life of the deposit base and projected deposit attrition rates were determined using StellarOne’s historical deposit data.

 

Time Deposits

 

The fair value adjustment of time deposits represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar-term time deposits. The premium is being accreted into income using the sum-of-years digits method over the weighted average remaining life.

 

-10 -
 

  

Long-term Borrowings

 

The Company assumed long-term borrowings in the form of FHLB advances and trust preferred capital notes. The fair value of the trust preferred capital notes assumed was valued using an income approach with consideration of the market approach. The contractual cash flows were projected and discounted using a prevailing market rate. The market rate was developed using a third party broker opinion, implied market yields for recent subordinated debt sales, and new subordinated debt issuances for instruments with similar durations and pricing characteristics. The fair value of FHLB advances represents contractual repayments discounted using interest rates currently available on borrowings with similar characteristics and remaining maturities.

 

Deferred Tax Assets and Liabilities

 

Deferred tax assets and liabilities were established for acquisition accounting fair value adjustments as the future amortization/accretion of these adjustments represent temporary differences between book income and taxable income.

 

The following table presents certain pro forma information as if StellarOne had been acquired on January 1, 2013. These results combine the historical results of StellarOne in the Company's Consolidated Statements 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, 2013. In particular, no adjustments have been made to eliminate the amount of StellarOne’s provision for credit losses that would not have been necessary had the acquired loans been recorded at fair value as of January 1, 2013. 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):

 

   Three months ended   Six months ended 
   June 30, 2013   June 30, 2013 
   (unaudited)   (unaudited) 
Total revenues (net interest income plus noninterest income)  $83,116   $164,792 
Net income  $19,344   $37,007 

 

Acquisition-related expenses associated with the acquisition of StellarOne were $4.7 million and $17.8 million for the three and six months ended June 30, 2014, and $919,000 for both the three and six months ended June 30, 2013, respectively.  Such costs include legal and accounting fees, lease and contract termination expenses, system conversion, integrating operations, and employee severances, which have been expensed as incurred. 

 

A summary of acquisition-related expenses associated with the StellarOne acquisition included in the Consolidated Statements of Income is as follows (dollars in thousands): 

 

   For the three months ended   For the six months ended 
   June 30,   June 30, 
   2014   2013   2014   2013 
   (unaudited)   (unaudited)   (unaudited)   (unaudited) 
Salaries and employee benefits  $1,158   $-   $7,988   $- 
Professional services   124    900    3,595    900 
Other costs of operations   3,379    19    6,246    19 
Total  $4,661   $919   $17,829   $919 

 

-11 -
 

  

3.SECURITIES

 

The amortized cost, gross unrealized gains and losses, and estimated fair values of securities available for sale as of June 30, 2014 and December 31, 2013 are summarized as follows (dollars in thousands):

 

   Amortized   Gross Unrealized   Estimated 
   Cost   Gains   (Losses)   Fair Value 
June 30, 2014                    
U.S. government and agency securities  $1,466   $1,649   $-   $3,115 
Obligations of states and political subdivisions   420,297    14,960    (2,360)   432,897 
Corporate and other bonds   79,379    335    (476)   79,238 
Mortgage-backed securities   558,424    9,108    (1,331)   566,201 
Other securities   13,321    33    (28)   13,326 
Total securities  $1,072,887   $26,085   $(4,195)  $1,094,777 
                     
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 

 

Due to restrictions placed upon the Bank’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 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 requires the Bank 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 $23.8 million and $6.7 million as of June 30, 2014 and December 31, 2013 and FHLB stock in the amount of $23.4 million and $19.3 million as of June 30, 2014 and December 31, 2013, respectively.

 

-12 -
 

  

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 
June 30, 2014                              
Obligations of states and political subdivisions  $2,193   $(9)  $57,211   $(2,351)  $59,404   $(2,360)
Mortgage-backed securities   95,680    (230)   50,516    (1,101)   146,196    (1,331)
Corporate bonds and other securities   28,852    (197)   4,482    (307)   33,334    (504)
Totals  $126,725   $(436)  $112,209   $(3,759)  $238,934   $(4,195)
                               
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)

 

As of June 30, 2014, there were $112.2 million, or 82 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 $3.8 million and consisted of municipal obligations, mortgage-backed securities, corporate bonds, and other securities. 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.

 

The following table presents the amortized cost and estimated fair value of securities as of June 30, 2014 and December 31, 2013, 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. 

 

   June 30, 2014   December 31, 2013 
   Amortized   Estimated   Amortized   Estimated 
   Cost   Fair Value   Cost   Fair Value 
Due in one year or less  $24,572   $24,688   $6,791   $6,796 
Due after one year through five years   43,770    44,894    21,666    22,497 
Due after five years through ten years   286,198    292,184    116,735    119,269 
Due after ten years   718,347    733,011    530,282    528,786 
Total securities available for sale  $1,072,887   $1,094,777   $675,474   $677,348 

 

Securities with an amortized cost of $348.8 million and $186.6 million as of June 30, 2014 and December 31, 2013, respectively, were pledged to secure public deposits, repurchase agreements, and for other purposes.

 

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 quarter ended June 30, 2014, and in accordance with the guidance, no OTTI was recognized.

 

-13 -
 

  

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. During the quarter ended June 30, 2014, the trust preferred security was called at a premium.  As a result, the Company recognized a gain on sale of the previously written down security of $400,000.

 

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

 

   OTTI Losses 
Cumulative credit losses on investment securities, through December 31, 2013  $400 
Reductions for securities sold during the period (realized)   (400)
Cumulative credit losses on investment securities, through June 30, 2014  $- 

 

-14 -
 

  

4.LOANS AND ALLOWANCE FOR LOAN LOSSES

 

Loans are stated at their face amount, net of unearned income, and consist of the following at June 30, 2014 and December 31, 2013 (dollars in thousands):

 

   June 30,   December 31, 
   2014   2013 
Commercial:          
Commercial Construction  $295,503   $213,675 
Commercial Real Estate - Owner Occupied   870,742    500,764 
Commercial Real Estate - Non-Owner Occupied   1,455,369    755,905 
Raw Land and Lots   212,475    187,529 
Single Family Investment Real Estate   397,186    237,640 
Commercial and Industrial   390,682    215,702 
Other Commercial   80,337    52,490 
Consumer:          
Mortgage   505,004    237,414 
Consumer Construction   75,815    48,984 
Indirect Auto   185,319    174,843 
Indirect Marine   40,189    38,633 
HELOCs   498,280    281,579 
Credit Card   23,432    23,211 
Other Consumer   202,736    70,999 
 Total  $5,233,069   $3,039,368 

 

The following table shows the aging of the Company’s loan portfolio, by class, at June 30, 2014 (dollars in thousands):

 

   30-59 Days
Past Due
   60-89 Days
Past Due
   Greater Than
90 Days and
still Accruing
   PCI (net of
credit mark)
   Nonaccrual   Current   Total Loans 
Commercial:                                   
Commercial Construction  $-   $-   $-   $5,446   $1,065   $288,992   $295,503 
Commercial Real Estate - Owner Occupied   1,684    1,436    161    31,619    682    835,160    870,742 
Commercial Real Estate - Non-Owner Occupied   1,379    1,160    45    41,412    169    1,411,204    1,455,369 
Raw Land and Lots   346    43    44    9,453    5,921    196,668    212,475 
Single Family Investment Real Estate   742    343    77    19,661    5,737    370,626    397,186 
Commercial and Industrial   661    321    322    4,944    3,794    380,640    390,682 
Other Commercial   706    66    -    2,358    121    77,086    80,337 
Consumer:                                   
Mortgage   13,837    3,043    3,861    10,974    4,360    468,929    505,004 
Consumer Construction   208    -    -    533    -    75,074    75,815 
Indirect Auto   1,526    130    312    -    -    183,351    185,319 
Indirect Marine   155    -    -    -    327    39,707    40,189 
HELOCs   4,293    1,066    1,026    2,847    557    488,491    498,280 
Credit Card   180    55    182    -    -    23,015    23,432 
Other Consumer   2,424    567    840    1,860    366    196,679    202,736 
Total  $28,141   $8,230   $6,870   $131,107   $23,099   $5,035,622   $5,233,069 

 

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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
   PCI (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 

 

Nonaccrual loans totaled $23.1 million and $15.0 million at June 30, 2014 and December 31, 2013, respectively. There were no nonaccrual loans excluded from impaired loan disclosure in 2014 or 2013. Loans past due 90 days or more and accruing interest totaled $6.9 million and $6.7 million at June 30, 2014 and December 31, 2013, respectively.

 

The following table shows the PCI commercial and consumer loan portfolios, by class and their delinquency status, at June 30, 2014 (dollars in thousands):

 

   30-89 Days
Past Due
   Greater than
90 Days
   Current   Total 
Commercial:                    
Commercial Construction  $72   $692   $4,682   $5,446 
Commercial Real Estate - Owner Occupied   1,694    984    28,941    31,619 
Commercial Real Estate - Non-Owner Occupied   4,079    2,404    34,929    41,412 
Raw Land and Lots   478    158    8,817    9,453 
Single Family Investment Real Estate   968    1,537    17,156    19,661 
Commercial and Industrial   418    373    4,153    4,944 
Other Commercial   434    772    1,152    2,358 
Consumer:                    
Mortgage   3,475    4,061    3,438    10,974 
Consumer Construction   -    533    -    533 
HELOCs   285    767    1,795    2,847 
Other Consumer   68    304    1,488    1,860 
Total  $11,971   $12,585   $106,551   $131,107 

 

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The following table shows the PCI 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 

 

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, excluding PCI loans related to the StellarOne acquisition, by class at June 30, 2014 (dollars in thousands): 

 

   Recorded
Investment
   Unpaid
Principal
Balance
   Related
Allowance
   YTD
Average
Investment
   Interest
Income
Recognized
 
Loans without a specific allowance                         
Commercial:                         
Commercial Construction  $5,777   $5,893   $-   $6,106   $117 
Commercial Real Estate - Owner Occupied   3,844    3,867    -    3,877    99 
Commercial Real Estate - Non-Owner Occupied   21,230    21,325    -    21,586    483 
Raw Land and Lots   48,231    50,969    -    59,498    1,307 
Single Family Investment Real Estate   3,198    3,614    -    3,634    74 
Commercial and Industrial   3,817    6,843    -    6,923    17 
Other Commercial   711    796    -    808    20 
Consumer:                         
Mortgage   4,213    4,293    -    4,305    13 
Indirect Auto   -    13    -    15    - 
HELOCs   1,287    1,928    -    1,898    4 
Other Consumer   101    224    -    222    - 
Total impaired loans without a specific allowance  $92,409   $99,765   $-   $108,872   $2,134 
                          
Loans with a specific allowance                         
Commercial:                         
Commercial Construction  $679   $679   $91   $677   $8 
Commercial Real Estate - Owner Occupied   3,240    3,691    281    3,723    74 
Commercial Real Estate - Non-Owner Occupied   336    336    33    343    12 
Raw Land and Lots   5,209    5,252    290    5,304    60 
Single Family Investment Real Estate   7,830    8,076    1,023    8,115    86 
Commercial and Industrial   2,798    3,077    393    3,186    48 
Other Commercial   66    81    6    83    - 
Consumer:                         
Mortgage   2,444    2,470    199    2,485    30 
Indirect Marine   526    730    88    733    8 
HELOCs   100    100    10    100    - 
Other Consumer   276    276    102    279    5 
Total impaired loans with a specific allowance  $23,504   $24,768   $2,516   $25,028   $331 
Total impaired loans  $115,913   $124,533   $2,516   $133,900   $2,465 

 

-17 -
 

  

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 

 

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 $34.2 million and $41.8 million as of June 30, 2014 and December 31, 2013, 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 quarter ended June 30, 2014, the recorded investment in restructured loans prior to modifications was not materially impacted by the modification.

 

-18 -
 

 

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 June 30, 2014 and December 31, 2013 (dollars in thousands):

 

   June 30, 2014   December 31, 2013 
   No. of
Loans
   Recorded
Investment
   Outstanding
Commitment
   No. of
Loans
   Recorded
Investment
   Outstanding
Commitment
 
Performing                              
Commercial:                              
Commercial Construction   2   $1,357   $686    1   $684   $- 
Commercial Real Estate - Owner Occupied   4    1,467    -    4    2,278    - 
Commercial Real Estate - Non-Owner Occupied   4    3,125    112    6    3,771    - 
Raw Land and Lots   13    20,026    5,721    15    20,741    - 
Single Family Investment Real Estate   8    1,902    -    13    3,497    - 
Commercial and Industrial   7    751    -    7    1,125    - 
Other Commercial   1    221    -    -    -    - 
Consumer:                              
Mortgage   8    1,609    -    10    2,318    - 
Other Consumer   3    103    -    3    106    - 
Total performing   50   $30,561   $6,519    59   $34,520   $- 
                               
Nonperforming                              
Commercial:                              
Commercial Construction   2   $518   $-    3   $947   $- 
Commercial Real Estate - Owner Occupied   2    161    -    3    283    - 
Raw Land and Lots   1    937    -    2    3,973    - 
Single Family Investment Real Estate   -    -    -    1    50    - 
Commercial and Industrial   8    1,085    -    8    1,195    - 
Other Commercial   1    66    -    -    -    - 
Consumer:                              
Mortgage   2    783    -    2    794    - 
Other Consumer   1    60    -    1    62    - 
Total nonperforming   17   $3,610   $-    20   $7,304   $- 
                               
Total performing and nonperforming   67   $34,171   $6,519    79   $41,824   $- 

 

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. During the three and six months ended June 30, 2014, the Company identified one loan, totaling approximately $24,000, that went into default that had been restructured in the twelve-month period prior to the time of default. This loan was a mortgage loan which had a term modification at a market rate. During the three and six months ended June 30, 2013, the Company identified one loan, totaling approximately $43,000, that went into default that had been restructured in the twelve-month period prior to the time of default. This loan was a raw land and lot loan which was modified to an interest only loan with a market rate of interest.

 

-19 -
 

  

The following table shows, by class and modification type, TDRs that occurred during the three and six months ended June 30, 2014 (dollars in thousands):

 

   Three months ended   Six months ended 
   June 30, 2014   June 30, 2014 
   No. of
Loans
   Recorded
investment at
period end
   No. of
Loans
   Recorded
investment at
period end
 
Term modification, at a market rate                    
Commercial:                    
Single Family Investment Real Estate   -   $-    1   $111 
Commercial and Industrial   1    35    1    35 
Other Commercial   -    -    2    287 
Total loan term extended at a market rate   1   $35    4   $433 
                     
Total   1   $35    4   $433 

 

-20 -
 

 

The following table shows, by class and modification type, TDRs that occurred during the three and six months ended June 30, 2013 (dollars in thousands):

 

   Three months ended   Six months ended 
   June 30, 2013   June 30, 2013 
   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 
Single Family Investment Real Estate   -    -    1    210 
Consumer:                    
Mortgage   -    -    1    603 
Total interest only at market rate of interest   1   $43    3   $856 
                     
Term modification, at a market rate                    
Commercial:                    
Commercial Construction   2   $704    2   $704 
Commercial Real Estate - Owner Occupied   1    933    1    933 
Commercial Real Estate - Non-Owner Occupied   1    753    1    753 
Raw Land and Lots   3    386    3    386 
Single Family Investment Real Estate   5    1,326    6    1,953 
Commercial and Industrial   4    1,125    5    1,180 
Consumer:                    
Mortgage   1    525    2    690 
Total loan term extended at a market rate   17   $5,752    20   $6,599 
                     
Term modification, below market rate                    
Commercial:                    
Commercial Real Estate - Owner Occupied   -   $-    1   $206 
Commercial and Industrial   -    -    1    9 
Consumer:                    
Mortgage   1    155    1    155 
Total loan term extended at a below market rate   1   $155    3   $370 
Total   19   $5,950    26   $7,825 

 

-21 -
 

  

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 six months ended June 30, 2014. 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  $19,856   $10,227   $52   $30,135 
Recoveries credited to allowance   1,599    572    -    2,171 
Loans charged off   (1,068)   (1,359)   -    (2,427)
Provision charged to operations   294    1,296    (90)   1,500 
Balance, end of period  $20,681   $10,736   $(38)  $31,379 
                     
Ending Balance, ALL:                    
Loans individually evaluated for impairment  $2,117   $399   $-   $2,516 
Loans collectively evaluated for impairment   18,564    10,337    (38)   28,863 
Loans acquired with deteriorated credit quality   -    -    -    - 
Total  $20,681   $10,736   $(38)  $31,379 
                     
Ending Balance, Loans:                    
Loans individually evaluated for impairment  $104,620   $8,047   $-   $112,667 
Loans collectively evaluated for impairment   3,482,781    1,506,514    -    4,989,295 
Loans acquired with deteriorated credit quality   114,893    16,214    -    131,107 
Total  $3,702,294   $1,530,775   $-   $5,233,069 

 

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 

 

-22 -
 

  

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 six months ended June 30, 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   944    611    -    1,555 
Loans charged off   (2,970)   (2,218)   -    (5,188)
Provision charged to operations   1,713    1,303    34    3,050 
Balance, end of period  $24,508   $9,803   $22   $34,333 
                     
Ending Balance, ALL:                    
Loans individually evaluated for impairment  $6,075   $1,502   $-   $7,577 
Loans collectively evaluated for impairment   18,426    8,301    22    26,749 
Loans acquired with deteriorated credit quality   7    -    -    7 
Total  $24,508   $9,803   $22   $34,333 
                     
Ending Balance, Loans:                    
Loans individually evaluated for impairment  $120,659   $9,140   $-   $129,799 
Loans collectively evaluated for impairment   2,007,816    859,267    -    2,867,083 
Loans acquired with deteriorated credit quality   3,039    934    -    3,973 
Total  $2,131,514   $869,341   $-   $3,000,855 

 

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.

 

-23 -
 

  

The following table shows all loans, excluding PCI loans, in the commercial portfolios by class with their related risk rating current as of June 30, 2014 (dollars in thousands):

 

   1-3   4   5   6   7   8   Total 
Commercial Construction  $17,940   $243,431   $11,967   $13,592   $3,127   $-   $290,057 
Commercial Real Estate - Owner Occupied   166,893    633,295    13,738    19,447    5,750    -    839,123 
Commercial Real Estate - Non-Owner Occupied   283,010    1,058,033    30,891    21,288    20,735    -    1,413,957 
Raw Land and Lots   11,191    116,476    21,565    6,394    47,396    -    203,022 
Single Family Investment Real Estate   49,224    299,884    9,794    8,671    9,952    -    377,525 
Commercial and Industrial   126,221    239,941    7,368    5,960    6,248    -    385,738 
Other Commercial   31,599    36,203    6,845    2,556    776    -    77,979 
Total  $686,078   $2,627,263   $102,168   $77,908   $93,984   $-   $3,587,401 

 

The following table shows all loans, excluding PCI 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 only PCI loans in the commercial portfolios by class with their related risk rating and credit quality indicator information current as of June 30, 2014 (dollars in thousands):

 

    4    5    6    7    8    Total 
Commercial Construction  $-   $-   $3,927   $1,052   $467   $5,446 
Commercial Real Estate - Owner Occupied   538    3,507    9,459    18,115    -    31,619 
Commercial Real Estate - Non-Owner Occupied   695    1,125    15,236    24,356    -    41,412 
Raw Land and Lots   1,435    2,156    2,092    3,770    -    9,453 
Single Family Investment Real Estate   1,671    1,277    7,121    9,592    -    19,661 
Commercial and Industrial   495    -    1,296    3,051    102    4,944 
Other Commercial   -    -    368    1,990    -    2,358 
Total  $4,834   $8,065   $39,499   $61,926   $569   $114,893 

 

The following table shows only PCI 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 

 

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.

 

-24 -
 

 

The following shows changes in the Company’s PCI loan portfolio and accretable yield for loans accounted for under ASC 310-30 for the periods presented (dollars in thousands):

 

   For the Six Months Ended   For the Six Months Ended 
   June 30, 2014   June 30, 2013 
   Accretable
Yield
   Carrying
Amount of
Loans
   Accretable
Yield
   Carrying
Amount of
Loans
 
Balance at beginning of period  $2,980   $3,622   $3,147   $4,565 
Additions   34,653    145,454    -    - 
Accretion   (3,677)   -    -    - 
Charge-offs   -    -    (54)   (96)
Transfers to OREO   -    (294)   -    (201)
Payments received, net   -    (17,675)   -    (295)
Other, net   (1,365)   -    -    - 
Balance at end of period  $32,591   $131,107   $3,093   $3,973 

 

Loans in the Company’s acquired performing loan portfolio, accounted for under ASC 310-20, totaled $2.2 billion at June 30, 2014 and $377.8 million at December 31, 2013; the remaining discount on these loans totaled $25.7 million and $3.3 million, respectively.

 

5.INTANGIBLE ASSETS

 

The Company’s intangible assets consist of core deposits and goodwill arising from previous acquisitions. The Company has determined that core deposit intangibles 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. On January 1, 2014, the Company completed the acquisition of StellarOne and acquired intangible assets of $29.6 million and recorded $237.5 million of goodwill. See Note 2 “Acquisitions” in the “Notes to Consolidated Financial Statements” for additional information.

 

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 2014 and determined that there was no impairment to its 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
 
June 30, 2014               
Amortizable core deposit intangibles  $76,185   $39,706   $36,479 
                
December 31, 2013               
Amortizable core deposit intangibles  $46,615   $34,635   $11,980 
                
June 30, 2013               
Amortizable core deposit intangibles  $46,615   $32,794   $13,821 

 

-25 -
 

  

Amortization expense of core deposit intangibles for the three and six months ended June 30, 2014 totaled $2.5 million and $5.1 million, respectively, for the three and six months ended June 30, 2013 totaled and $921,000 and $2.0 million, respectively, and for the year ended December 31, 2013 was $3.8 million. As of June 30, 2014, the estimated remaining amortization expense of core deposit intangibles is as follows (dollars in thousands):

 

For the remaining six months of 2014  $4,725 
For the year ending December 31, 2015   8,444 
For the year ending December 31, 2016   6,932 
For the year ending December 31, 2017   5,589 
For the year ending December 31, 2018   4,144 
For the year ending December 31, 2019   3,093 
Thereafter   3,552 
Total estimated amortization expense  $36,479 

 

6.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 overnight borrowings from other financial institutions, and short-term FHLB advances. Total short-term borrowings consist of the following as of June 30, 2014 and December 31, 2013 (dollars in thousands):

 

   June 30,   December 31, 
   2014   2013 
Securities sold under agreements to repurchase  $42,276   $52,455 
Other short-term borrowings   200,000    211,500 
Total short-term borrowings  $242,276   $263,955 
           
Maximum month-end outstanding balance  $274,281   $263,955 
Average outstanding balance during the period   263,282    119,433 
Average interest rate during the period   0.24%   0.30%
Average interest rate at end of period   0.34%   0.30%
           
Other short-term borrowings:          
Federal funds purchased  $35,000   $31,500 
FHLB  $165,000   $180,000 

 

The Bank maintains federal funds lines with several correspondent banks; the remaining available balance was $90.0 million and $93.5 million at June 30, 2014 and December 31, 2013, 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 Bank had a collateral dependent line of credit with the FHLB of up to $1.5 billion and $805.2 million at June 30, 2014 and December 31, 2013, respectively.

 

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Long-term Borrowings

In connection with certain 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. In connection with the acquisition of StellarOne, the Company acquired trust preferred capital notes totaling $32.0 million with a remaining fair value discount of $7.3 million at June 30, 2014. 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%   2.98%  6/17/2034
Trust Preferred Capital Note - Statutory Trust II   36,000,000    1,114,000    1.40%   1.63%  6/15/2036
VFG Limited Liability Trust I Indenture   20,000,000    619,000    2.73%   2.96%  3/18/2034
FNB Statutory Trust II Indenture   12,000,000    372,000    3.10%   3.33%  6/26/2033
Total  $90,500,000   $2,801,000              

 

(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 June 30, 2014, the carrying value of the subordinated debt was $17.5 million, with a remaining fair value discount of $897,000.

 

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 three and six months ended June 30, 2014 and 2013 was $444,000 and $881,000 and $433,000 and $859,000, respectively.

 

In connection with the StellarOne acquisition, the Company assumed $70.0 million in long-term borrowings with the FHLB with a remaining fair value premium of $2.6 million at June 30, 2014. As of June 30, 2014, the advances from the FHLB consisted of the following (dollars in thousands):

 

Long Term Type  Spread to
3-Month LIBOR
   Interest Rate   Maturity Date  Advance Amount 
                   
Adjustable Rate Credit   0.44%   0.67%  8/23/2022  $55,000 
Adjustable Rate Credit   0.45%   0.68%  11/23/2022   65,000 
Adjustable Rate Credit   0.45%   0.68%  11/23/2022   10,000 
Adjustable Rate Credit   0.45%   0.68%  11/23/2022   10,000 
Fixed Rate   -    3.62%  11/28/2017   10,000 
Fixed Rate   -    3.44%  7/28/2015   10,000 
Fixed Rate   -    3.75%  7/30/2018   5,000 
Fixed Rate   -    3.97%  7/30/2018   5,000 
Fixed Rate Hybrid   -    2.11%  10/5/2016   25,000 
Fixed Rate Hybrid   -    0.91%  7/25/2016   15,000 
                $210,000 

 

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

 

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

 

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The carrying value of the loans and securities pledged as collateral for FHLB advances totaled $1.5 billion and $1.1 billion as of June 30, 2014 and December 31, 2013, respectively.

 

As of June 30, 2014, the contractual maturities of long-term debt are as follows for the years ending (dollars in thousands):

 

   Trust
Preferred
Capital Notes
   Subordinated
Debt
   FHLB
Advances
   Fair Value
Premium
(Discount)
   Prepayment
Penalty
   Total Long-term
Borrowings
 
Remaining six months in 2014  $-   $-   $-   $150   $(907)  $(757)
2015   -    -    10,000    175    (1,831)   8,344 
2016   -    17,500    40,000    271    (1,882)   55,889 
2017   -    -    10,000    170    (1,923)   8,247 
2018   -    -    10,000    (143)   (1,969)   7,888 
2019   -    -    -    (286)   (2,018)   (2,304)
Thereafter   93,301    -    140,000    (5,923)   (5,899)   221,479 
Total long-term borrowings  $93,301   $17,500   $210,000   $(5,586)  $(16,429)  $298,786 

 

7.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, the financial condition, or results of operations of the Company.

 

Litigation Relating to the StellarOne Acquisition

 

In a press release issued on June 10, 2013, the Company announced the signing of a definitive merger agreement for the acquisition of StellarOne. 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 (the “District Court”) (Case No. 3:13-cv-00021-NKM). The complaint alleged 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 sought, among other things, money damages. StellarOne and the Company believe that the claims were without merit; however, in order to eliminate the expense and uncertainties of further litigation, all the defendants entered into a memorandum of understanding with the plaintiffs in order to settle the litigation prior to the merger. Under the terms of the memorandum of understanding, the plaintiffs agreed to settle the lawsuit and release the defendants from all claims, subject to approval by the District Court. On May 19, 2014, the District Court approved the memorandum of understanding and the class action settlement in the case.

 

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 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. The Company held approximately $3.3 million and $2.0 million in loans available for sale in which the related rate lock commitment had expired as of June 30, 2014 and December 31, 2013, respectively. At June 30, 2014 and December 31, 2013, the reserves associated with these loans held for sale were $104,000 and $94,000, respectively, and are reflected on the balance sheet of the mortgage segment.

 

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

 

   June 30,   December 31, 
   2014   2013 
Commitments with off-balance sheet risk:          
Commitments to extend credit (1)  $1,376,268   $891,680 
Standby letters of credit   128,030    48,107 
Mortgage loan rate lock commitments   71,587    54,834 
Total commitments with off-balance sheet risk  $1,575,885   $994,621 
Commitments with balance sheet risk:          
Loans held for sale  $63,622   $53,185 
Total other commitments  $1,639,507   $1,047,806 

 

(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 June 30, 2014 and December 31, 2013, the aggregate amount of daily average required reserves was approximately $47.4 million and $16.0 million, respectively.

 

The Company has approximately $12.3 million in deposits in other financial institutions, of which $5.7 million serves as collateral for the trust swaps discussed in Note 8 “Derivatives” in the “Notes to Consolidated Financial Statements.” The Company had approximately $5.5 million in deposits in other financial institutions that were uninsured at June 30, 2014. 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 8 “Derivatives” in the “Notes to 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 under 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 taken remedial action with respect to the affected borrowers to address the disclosure errors. 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 estimated claims related to the errors. 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; as of June 30, 2014 and December 31, 2013, the Company’s indemnification reserve was $1.2 million and $627,000, respectively.

 

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8.DERIVATIVES

 

The Company has three interest rate swap agreements (the “trust swaps”) as part of the management of interest rate risk related to the trust preferred capital notes further described in Note 6 "Borrowings" in the “Notes to Consolidated Financial Statements”. The Company designated the trust swaps as a cash flow hedge intended to protect against the variability of cash flows associated with the aforementioned preferred capital securities. The trust swaps hedge the interest rate risk, wherein the Company receives interest of LIBOR from a counterparty and pays a weighted average fixed rate of 2.77% to the same counterparty calculated on a notional amount of $68.0 million. The terms of the trust swaps range from three to six years.

 

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. During the first quarter of 2014, the Company discontinued four of the prime loan swaps with a total notional amount of $45.0 million, which were in place at December 31, 2013. The unrealized gain reclassified to earnings related to these four prime loan swaps were not material to the Company’s consolidated financial statements. The remaining four prime loan swaps hedge the underlying cash flows, wherein the Company receives a fixed interest rate ranging from 4.71% to 5.20% from the counterparty and pays interest based on the Wall Street Journal prime index, with a spread of up to 1.00%, to the same counterparty calculated on a notional amount of $55.0 million. One of the four prime loan swaps contains a floor rate of 4.00%. The terms of the four prime loan swaps is six years with a fixed rate that started September 17, 2013.

 

During the second quarter of 2014, the Company entered into two swaps (“FHLB advance swaps”) with a total notional amount of $120.0 million. The Company designated the FHLB advance swaps as a cash flow hedge intended to protect against the variability in the expected future cash flows on the designated variable rate FHLB borrowings. The FHLB advance swaps hedge the interest rate risk, wherein the Company will receive an interest rate based on the three month LIBOR from the counterparty and pays interest of 3.46% to the same counterparty calculated on the notional amount. The swaps are deferred starting swaps with terms of six years and five years and effective dates of February 23, 2017 and February 23, 2018, respectively.

 

All swaps were entered into with counterparties 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. As of June 30, 2014, the Company had $5.7 million of cash pledged as collateral for the trust swaps and securities with a market value of $5.2 million pledged as collateral for the prime loan swaps and FHLB advance 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 trust swaps, prime loan swaps, and FHLB advance swaps 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” in the Consolidated Statements of Income. 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 June 30, 2014, the fair value of the Company’s cash flow hedges was an unrealized loss of $4.7 million, the amount the Company would have expected to pay if the contract was terminated. The below liability is recorded as a component of other comprehensive income recorded in the Company’s Consolidated Statements of Comprehensive Income.

 

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Shown below is a summary of the derivatives designated as cash flow hedges at June 30, 2014 and December 31, 2013 (dollars in thousands):

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of June 30, 2014                                   
Pay fixed - receive floating interest rate swaps   5   $188,000   $-   $5,102    0.23%(1)   2.77%(1)   2.23(1)
                                    
Receive fixed - pay floating interest rate swaps   4   $55,000   $420   $-    4.93%   3.55%   5.22 

 

(1) Due to their deferred nature, the rates and the life exclude the two FHLB advance swaps entered into in the 2nd quarter of 2014.

 

       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 

 

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” in the Consolidated Balance Sheet. As of June 30, 2014, the Company had securities with a market value of $1.8 million pledged as collateral for the loan swaps. Shown below is a summary regarding loan swap derivative activities at June 30, 2014 and December 31, 2013 (dollars in thousands):

 

       Notional           Receive   Pay   Life 
   Positions   Amount   Asset   Liability   Rate   Rate   (Years) 
As of June 30, 2014                                   
Receive fixed - pay floating interest rate swaps   31   $111,106   $1,279   $-    4.30%   2.57%   7.53 
Pay fixed - receive floating interest rate swaps   31   $111,106   $-   $1,279    2.57%   4.30%   7.53 

 

       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 

 

In the ordinary course of business, 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.  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. 

 

During the first quarter of 2014, and in connection with the acquisition of StellarOne, the Company began recording the rate lock commitments derivative on its balance sheet at fair value.  Because the amounts associated with the rate lock commitments were determined to be immaterial, the Company did not record the value of the rate locks in any period prior to January 1, 2014.  While the rate lock commitment derivative is still considered immaterial to the consolidated financial statements, the Company began recording this asset on its Consolidated Balance Sheet within “Loans held for sale, net” post-acquisition when integrating the acquired mortgage operations of StellarOne.  The Company’s derivative related to rate lock commitments had a notional amount of $71.6 million at June 30, 2014 with a fair value of $731,000.  This derivative instrument does not qualify for hedge accounting; as a result, changes in fair value are recognized in current period earnings as a component of “Gain on sale of mortgage loans, net of commissions.”

 

9.ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS)

 

The change in accumulated other comprehensive income (loss) for the three and six months ended June 30, 2014 is summarized as follows, net of tax (dollars in thousands):

 

   Unrealized
Gains (Losses)
on Securities
   Change in Fair
Value of Cash
Flow Hedge
   Total 
Balance - March 31, 2014  $7,486   $(2,760)  $4,726 
                
Other comprehensive income (loss)   6,733    (778)   5,955 
Amounts reclassified from accumulated other comprehensive income   (17)   217    200 
Net current period other comprehensive income (loss)   6,716    (561)   6,155 
                
Balance - June 30, 2014  $14,202   $(3,321)  $10,881 

 

   Unrealized
Gains (Losses)
on Securities
   Change in Fair
Value of Cash
Flow Hedges
   Total 
Balance - December 31, 2013  $1,192   $(3,382)  $(2,190)
                
Other comprehensive income   13,046    (203)   12,843 
Amounts reclassified from accumulated other comprehensive income   (36)   264    228 
Net current period other comprehensive income   13,010    61    13,071 
                
Balance - June 30, 2014  $14,202   $(3,321)  $10,881 

 

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The change in accumulated other comprehensive income (loss) for the three and six months ended June 30, 2013 is summarized as follows, net of tax (dollars in thousands):

 

   Unrealized
Gains (Losses)
on Securities
   Change in Fair
Value of Cash
Flow Hedge
   Total 
Balance - March 31, 2013  $12,473   $(4,203)  $8,270 
                
Other comprehensive income (loss)   (9,720)   658    (9,062)
Amounts reclassified from accumulated other comprehensive income   (34)   191    157 
Net current period other comprehensive income (loss)   (9,754)   849    (8,905)
                
Balance - June 30, 2013  $2,719   $(3,354)  $(635)

 

   Unrealized
Gains (Losses)
 on Securities
   Change in Fair
Value of Cash
Flow Hedges
   Total 
Balance - December 31, 2012  $14,573   $(4,489)  $10,084 
                
Other comprehensive income (loss)   (11,827)   756    (11,071)
Amounts reclassified from accumulated other comprehensive income   (27)   379    352 
Net current period other comprehensive income (loss)   (11,854)   1,135    (10,719)
                
Balance - June 30, 2013  $2,719   $(3,354)  $(635)

 

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. Excluding OTTI recovery of $400,000 in the second quarter of 2014, the Company reported gains of $26,000 and $55,000 for the three and six months ended June 30, 2014, respectively, and gains of $53,000 and $42,000 for the three and six months ended June, 30, 2013, respectively, related to gains/losses on the sale of securities. The tax effect of these transactions during the three and six months ended June 30, 2014 and 2013 were $9,000 and $19,000 and $19,000 and $15,000, 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 $334,000 and $406,000 and $294,000 and $583,000 for the three and six months ended June 30, 2014 and 2013, respectively. The tax effect of these transactions during the three and six months ended June 30, 2014 and 2013 were $117,000 and $142,000 and $103,000 and $204,000, respectively, which were included as a component of income tax expense.

 

10.FAIR VALUE MEASUREMENTS

 

The Company follows ASC 820, Fair Value Measurements and Disclosures, 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.

 

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  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 8 “Derivatives” in the “Notes to Consolidated Financial Statements,” 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.

 

During the ordinary course of business, the Company enters into interest rate lock commitments related to the origination of mortgage loans held for sale that are recorded at estimated fair value based on the value of the underlying loan, which in turn is based on quoted prices for similar loans in the secondary market. However, this value is adjusted by a pull-through rate which considers the likelihood that the loan in a lock position will ultimately close. The pull-through rate is derived from the Company’s internal data and is adjusted using significant management judgment. The pull-through rate is largely dependent on the loan processing stage that a loan is currently in and the change in prevailing interest rates from the time of the rate lock. As such, interest rate lock commitments are classified as Level 3. The Company used a weighted average pull-through rate of approximately 90%. As of June 30, 2014, this derivative is recorded as a component of “Loans held for sale, net” on the Consolidated Balance Sheet

 

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).

 

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 June 30, 2014 and December 31, 2013.

 

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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.

 

The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis at June 30, 2014 and December 31, 2013 (dollars in thousands):

 

   Fair Value Measurements at June 30, 2014 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  $-   $1,279   $-   $1,279 
Cash flow hedges   -    420    -    420 
Interest rate lock commitments   -    -    731    731 
Securities available for sale:                    
U.S. government and agency securities   -    3,115    -    3,115 
Obligations of states and political subdivisions   -    432,897    -    432,897 
Corporate and other bonds   -    79,238    -    79,238 
Mortgage-backed securities   -    566,201    -    566,201 
Other securities   -    13,326    -    13,326 
                     
LIABILITIES                    
Interest rate swap  $-   $1,279   $-   $1,279 
Cash flow hedges   -    5,102    -    5,102 

 

   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  $-   $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  $-   $33   $-   $33 
Cash flow hedges   -    3,562    -    3,562 

 

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.

 

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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 for the three and six months ended June 30, 2014 totaled $42,000 and $86,000, respectively, and for both the three and six months ended June 30, 2013 was $186,000. 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.

 

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 three and six months ended June 30, 2014 totaled $817,000 and $1.1 million, respectively, and for both the three and six months ended June 30, 2013 was $0.

 

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The following tables summarize the Company’s financial assets that were measured at fair value on a nonrecurring basis at June 30, 2014 and December 31, 2013 (dollars in thousands):

  

   Fair Value Measurements at June 30, 2014 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  $-   $62,891   $-   $62,891 
Impaired loans   -    -    13,690    13,690 
Other real estate owned   -    -    38,494    38,494 

 

   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 

 

The following table displays quantitative information about Level 3 Fair Value Measurements at June 30, 2014 (dollars in thousands):

 

   Fair Value Measurements at June 30, 2014 
   Fair Value   Valuation Technique(s)  Unobservable Inputs  Weighted
Average
 
ASSETS                
Commercial Construction  $447   Market comparables  Discount applied to market comparables (1)   75%
Commercial Real Estate - Owner Occupied   1,786   Market comparables  Discount applied to market comparables (1)   8%
Raw Land and Lots   3,942   Market comparables  Discount applied to market comparables (1)   22%
Single Family Investment Real Estate   5,360   Market comparables  Discount applied to market comparables (1)   19%
Commercial and Industrial   1,073   Market comparables  Discount applied to market comparables (1)   31%
Other (2)   1,082   Market comparables  Discount applied to market comparables (1)   10%
Total Impaired Loans   13,690            
                 
Other real estate owned   38,494   Market comparables  Discount applied to market comparables (1)   30%
Total  $52,184            

 

(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, Indirect Marine, HELOCs, and Other Consumer.

 

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The following table displays quantitative information about Level 3 Fair Value Measurements at 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.

  

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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 June 30, 2014 and December 31, 2013, the fair value of loan commitments and standby letters of credit was immaterial.

 

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The carrying values and estimated fair values of the Company’s financial instruments at June 30, 2014 and December 31, 2013 are as follows (dollars in thousands):

 

       Fair Value Measurements at June 30, 2014 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  $158,880   $158,880   $-   $-   $158,880 
Securities available for sale   1,094,777    -    1,094,777    -    1,094,777 
Restricted stock   47,204    -    47,204    -    47,204 
Interest rate lock commitments   731    -    -    731    731 
Loans held for sale   62,891    -    62,891    -    62,891 
Net loans   5,201,690    -    -    5,227,335    5,227,335 
Interest rate swap   1,279    -    1,279    -    1,279 
Cash flow hedges   420    -    420    -    420 
Accrued interest receivable   22,179    -    22,179    -    22,179 
                          
LIABILITIES                         
Deposits  $5,734,563   $-   $5,737,808   $-   $5,737,808 
Borrowings   541,062    -    522,106    -    522,106 
Accrued interest payable   2,013    -    2,013    -    2,013 
Interest rate swap   1,279    -    1,279    -    1,279 
Cash flow hedges   5,102    -    5,102    -    5,102 

 

       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   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 
Interest rate swap   33    -    33    -    33 
Cash flow hedges   3,562    -    3,562    -    3,562 

 

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.

 

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11.STOCK-BASED COMPENSATION

 

The Company’s 2011 Stock Incentive Plan (the “2011 Plan”) provides for the granting of stock-based awards in the form of incentive stock options (“incentive stock options,” intended to comply with the requirements of Section 422 of the Internal Revenue Code of 1986), non-statutory stock options, and nonvested stock to attract, retain, and reward key employees of the Company and its subsidiaries. The Company issues new shares to satisfy stock-based awards. Under the plan, 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 June 30, 2014:

 

   2011 Plan 
Beginning Authorization   1,000,000 
Granted   (510,050)
Expired, forfeited, or cancelled   39,041 
Remaining available for grant   528,991 

 

In connection with the acquisition of StellarOne, each outstanding option to acquire StellarOne common stock, whether or not exercisable, was assumed by the Company and converted into an option to acquire the same number of whole shares of the Company’s common stock, subject to the exchange ratio of 0.9739. The exercise price per share of each new option was equal to the price under the original StellarOne option divided by the exchange ratio of 0.9739. Each converted StellarOne stock option has the same terms and conditions that were in effect prior to the completion of the acquisition. Restricted StellarOne stock awards, which were unvested and outstanding prior to the merger, were accelerated and converted into restricted stock awards of the Company on the same basis as stock options. Restricted common stock of the Company was issued from StellarOne stock incentive plans assumed in the acquisition, and subsequent awards from the Company will be issued from the 2011 Plan.

 

For the three months ended June 30, 2014 and 2013, respectively, the Company recognized stock-based compensation expense (included in salaries and benefits expense) of approximately $180,000 and $7,500 ($144,000 and $34,000 net of tax) and for the six months ended June 30, 2014 and 2013, recognized $554,000 and $325,000 ($414,000 and $269,000 net of tax), respectively. Stock-based compensation expense represents approximately $0.01 per common share for both the six months ended June 30, 2014 and 2013.

 

Stock Options

 

The following table summarizes the stock option activity for the six months ended June 30, 2014:

 

   Number of Stock
Options
   Weighted Average
Exercise Price
 
Options outstanding, December 31, 2013   402,946   $16.48 
Options converted upon StellarOne acquisition   124,217    20.88 
Exercised   (60,470)   16.74 
Expired   (51,887)   23.57 
Options outstanding, June 30, 2014   414,806    16.87 
Options exercisable, June 30, 2014   284,921    18.25 

 

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The fair value of each stock option grant is estimated on the date of grant using the Black-Scholes option valuation model. The model uses variables which include the historical dividend yield of the Company’s common stock, the average contractual life and vesting schedule of the option, the historic volatility of the Company’s common stock price, and the risk-free interest rate at the time the option was granted. Other than options that were assumed and converted upon completion of the StellarOne merger, the Company has not granted incentive compensation in the form of options since February 2012.

 

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 June 30, 2014:

 

   Stock Options
Vested or
Expected to Vest
   Exercisable 
Stock options (number of shares)   418,005    284,921 
Weighted average remaining contractual life in years   5.40    4.61 
Weighted average exercise price on shares above water  $15.14   $15.83 
Aggregate intrinsic value  $3,789,016   $2,284,944 
           

Nonvested Stock

The 2011 Plan permits the granting of nonvested stock but limits such grants 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 grant date. 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 in its sole discretion. The value of the nonvested stock awards is calculated by multiplying the fair market value of the Company’s common stock on the grant date by