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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

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

For the fiscal year ended December 31, 2011

 

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

Commission file number: 0-20293

 

 

UNION FIRST MARKET BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

VIRGINIA     54-1598552
(State or other jurisdiction of     (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)

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

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

 

Title of each class

 

Name of exchange on which registered

Common Stock, par value $1.33 per share   The NASDAQ Global Select Market

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

None

 

 

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

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

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

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

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

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

 

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

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

The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2011 was approximately $287,402,577.

The number of shares of common stock outstanding as of February 29, 2012 was 25,912,947.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the registrant’s definitive proxy statement to be used in conjunction with the registrant’s 2012 Annual Meeting of Shareholders are incorporated by reference into Part III of this Form 10-K.

 

 

 


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UNION FIRST MARKET BANKSHARES CORPORATION

FORM 10-K

INDEX

 

ITEM        PAGE
PART I

Item 1.

  Business    1

Item 1A.

  Risk Factors    12

Item 1B.

  Unresolved Staff Comments    18

Item 2.

  Properties    18

Item 3.

  Legal Proceedings    19

Item 4.

  Mine Safety Disclosures    19

PART II

Item 5.

  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    19

Item 6.

  Selected Financial Data    22

Item 7.

  Management’s Discussion and Analysis of Financial Condition and Results of Operations    23

Item 7A.

  Quantitative and Qualitative Disclosures About Market Risk    48

Item 8.

  Financial Statements and Supplementary Data    49

Item 9.

  Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    109

Item 9A.

  Controls and Procedures..    109

Item 9B.

  Other Information    110

PART III

Item 10.

  Directors, Executive Officers and Corporate Governance    110

Item 11.

  Executive Compensation    110

Item 12.

  Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    110

Item 13.

  Certain Relationships and Related Transactions, and Director Independence    111

Item 14.

  Principal Accounting Fees and Services    111

PART IV

Item 15.

  Exhibits, Financial Statement Schedules    111


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FORWARD-LOOKING STATEMENTS

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

PART I

 

ITEM 1.—BUSINESS.

GENERAL

Union First Market Bankshares Corporation (the “Company”) is a bank holding company organized under Virginia law and registered under the Bank Holding Company Act of 1956. The Company is headquartered in Richmond, Virginia and committed to the delivery of financial services through its community bank subsidiary Union First Market Bank and three non-bank financial services affiliates. The Company’s bank and non-bank financial services affiliates are:

 

Community Bank

Union First Market Bank

   Richmond, Virginia
Financial Services Affiliates

Union Mortgage Group, Inc.

   Annandale, Virginia

Union Investment Services, Inc.

   Ashland, Virginia    

Union Insurance Group, LLC

   Richmond, Virginia

History

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

 

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

 

     Formed      Acquired    Merged  

Union Bank and Trust Company

     1902       n/a      2010   

Northern Neck State Bank

     1909       1993      2010   

King George State Bank

     1974       1996      1999   

Rappahannock National Bank

     1902       1998      2010   

Bay Community Bank

     1999       de novo bank      2008   

Guaranty Bank

     1981       2004      2004   

Prosperity Bank & Trust Company

     1986       2006      2008   

First Market Bank, FSB

     2000       2010      2010   

On February 1, 2010, the Company acquired First Market Bank, FSB, a privately held federally chartered savings bank (“First Market Bank” or “FMB”), in an all stock transaction. In connection with the transaction, the Company changed its name to Union First Market Bankshares Corporation and moved its headquarters to Richmond, Virginia. In addition, First Market Bank became a state chartered commercial bank subsidiary of the Company. First Market Bank merged with Union Bank and Trust Company in March 2010 and the combined bank operates under the name Union First Market Bank.

In October 2010, the Company combined its two other community banks, Northern Neck State Bank and Rappahannock National Bank, into its largest bank affiliate, Union First Market Bank, which now operates as a single bank. This has created a single brand for the Company’s banking franchise offering the same products and services across Virginia.

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

Product Offerings and Market Distribution

The Company is one of the largest community banking organizations based in Virginia and provides full service banking to the Northern, Central, Rappahannock, Shenandoah, Tidewater, and Northern Neck regions of Virginia through Union First Market Bank. At December 31, 2011, Union First Market Bank operates 99 locations in the counties of Albemarle, Caroline, Chesterfield, Essex, Fairfax, Fauquier, Fluvanna, Frederick, Hanover, Henrico, James City, King George, King William, Lancaster, Loudoun, Nelson, Northumberland, Richmond, Spotsylvania, Stafford, Warren, Washington, Westmoreland, York, and the independent cities of Charlottesville, Colonial Heights, Culpeper, Fredericksburg, Harrisonburg, Newport News, Richmond, Staunton, Stephens City, Waynesboro, Williamsburg, and Winchester. Union First Market Bank also operates loan production offices in Staunton, Winchester, and Tappahannock. Union Investment Services, Inc. provides full brokerage services; Union Mortgage Group, Inc. provides a full line of mortgage products; and Union Insurance Group, LLC offers various lines of insurance products. Union First Market Bank also owns a non-controlling interest in Johnson Mortgage Company, L.L.C.

Union First Market Bank (“the Bank”) is a full service community bank offering consumers and businesses a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, as well as loans for commercial, industrial, residential mortgage and consumer purposes. The Bank issues credit cards and delivers automated teller machine (“ATM”) services through the use of reciprocally shared ATMs in the major ATM networks as well as remote ATMs for the convenience of customers and other consumers. The Bank also offers internet banking services and online bill payment for all customers, whether retail or commercial. The Bank also offers private banking and trust services to individuals and corporations through its Financial Guidance Group.

Union Investment Services, Inc. has provided securities, brokerage and investment advisory services since its formation in February 1993. It has 11 offices within the Bank’s trade area and is a full service

 

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investment company handling all aspects of wealth management including stocks, bonds, annuities, mutual funds and financial planning. Securities are offered through a third party contractual arrangement with Raymond James Financial Services, Inc., an independent broker dealer.

Union Mortgage Group, Inc., (“UMG”) has the following offices in Virginia (seven), Maryland (three), North Carolina (three), and South Carolina (two). UMG is also licensed to do business in selected states throughout the Mid-Atlantic and Southeast, as well as Washington, D.C. It provides a variety of mortgage products to customers in those areas. The mortgage loans originated by UMG are generally sold in the secondary market through purchase agreements with institutional investors.

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

SEGMENTS

The Company has two reportable segments: its traditional full service community banking business and its mortgage loan origination business. For more financial data and other information about each of the Company’s operating segments, refer to the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” sections, “Community Bank Segment” and “Mortgage Segment,” and to Note 18 “Segment Reporting” in the “Notes to Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

EXPANSION AND STRATEGIC ACQUISITIONS

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

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

 

   

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

 

   

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

 

   

Staples Mill, Union First Market Bank branch located in Henrico County (February 2009)

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

 

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In June 2011 Union First Market Bank opened seven in-store bank branches in MARTIN’S stores located in Harrisonburg, Waynesboro, Staunton, Winchester (two), Culpeper, and Stephens City, Virginia. The Bank currently operates in-store bank branches in 29 MARTIN’S Food Markets through its acquisition of First Market Bank primarily in the Richmond/Fredericksburg area markets.

During 2011, the Bank conducted a performance and opportunity analysis of its branch network. As a result, the Company decided to consolidate four branches into nearby locations. The four branches are located in Charlottesville, Mechanicsville, Port Royal, and Fredericksburg. In all cases, customers may use branches within close proximity or continue to use the Bank’s other delivery channels including online and mobile banking. It is anticipated that these branch consolidations will be completed by the end of the second quarter of 2012.

EMPLOYEES

As of December 31, 2011, the Company had approximately 1,045 full-time equivalent employees, including executive officers, loan and other banking officers, branch personnel, operations and other support personnel. Of this total, 137 were mortgage segment personnel. None of the Company’s employees are represented by a union or covered under a collective bargaining agreement. The Company’s management routinely conducts employee workplace satisfaction surveys and as a result considers employee relations to be excellent and the key driver of the Company’s success. The Company provides employees with a comprehensive employee benefit program which includes the following: group life, health and dental insurance, paid time off (PTO), educational opportunities, a cash incentive plan, a stock purchase plan, stock incentive plans, deferred compensation plans for officers and key employees, an employee stock ownership plan (“ESOP”) and a 401(k) plan with employer match.

COMPETITION

The financial services industry remains highly competitive and is constantly evolving. The Company experiences strong competition in all aspects of its business. In its market areas, the Company competes with large national and regional financial institutions, credit unions, other independent community banks, as well as consumer finance companies, mortgage companies, loan production offices, mutual funds and life insurance companies. Competition has increasingly come from out-of-state banks through their acquisitions of Virginia-based banks. Competition for deposits and loans is affected by various factors including interest rates offered, the number and location of branches and types of products offered, and the reputation of the institution. Credit unions have been allowed to increasingly expand their membership definitions and, because they enjoy a favorable tax status, have been able to offer more attractive loan and deposit pricing. The Company’s non-bank affiliates also operate in highly competitive environments. The Company is headquartered in Richmond, Virginia and, at $3.9 billion in assets, is among the largest independent community bank holding companies based in Virginia. The Company believes its community bank framework and philosophy provide a competitive advantage, particularly with regard to larger national and regional institutions, allowing the Company to compete effectively. The Company’s community bank segment generally has strong market shares within the markets it serves. The Company’s deposit market share in Virginia was 1.98% as of December 31, 2011.

ECONOMY

While the economy showed some signs of improvement during 2011, the continued weakness in employment and real estate markets, a flatter yield curve, continued low rates, legislative and regulatory responses in the aftermath of the most recent financial crisis, and general uncertainty of a global economic recovery made for a challenging 2011 for community banks and the Company. Unemployment levels remain relatively high in Virginia, but lower than the national average, with jobs shed principally in the Richmond and Virginia Beach-Norfolk metropolitan statistical areas. During 2011, management continued to focus significant attention to managing nonperforming assets and worked with borrowers to mitigate and protect against risk of loss.

 

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SUPERVISION AND REGULATION

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

Regulatory Reform – The Dodd-Frank Act

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”). The Dodd-Frank Act significantly restructures the financial regulatory regime in the United States and has a broad impact on the financial services industry. While some rulemaking under the Dodd-Frank Act has occurred, many of the act’s provisions require study or rulemaking by federal agencies, a process which will take years to implement fully.

Among other things, the Dodd-Frank Act provides for new capital standards that eliminate the treatment of trust preferred securities as Tier 1 capital. Existing trust preferred securities are grandfathered for banking entities with less than $15 billion of assets, such as the Company. The Dodd-Frank Act permanently raises deposit insurance levels to $250,000, and provides unlimited deposit insurance coverage for transaction accounts through December 31, 2012. Pursuant to modifications under the Dodd-Frank Act, deposit insurance assessments will be calculated based on an insured depository institution’s assets rather than its insured deposits and the minimum reserve ratio of the Federal Deposit Insurance Corporation’s (“FDIC”) Deposit Insurance Fund is to be raised to 1.35%. The payment of interest on business demand deposit accounts is permitted by the Dodd-Frank Act. Further, the Dodd-Frank Act bars banking organizations, such as the Company, from engaging in proprietary trading and from sponsoring and investing in hedge funds and private equity funds, except as permitted under certain limited circumstances.

The Dodd-Frank Act established the Bureau of Consumer Financial Protection (“CFPB”) as an independent bureau of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The CFPB has the exclusive authority to prescribe rules governing the provision of consumer financial products and services, which in the case of the Bank will be enforced by the Federal Reserve. The Dodd-Frank Act also provides that debit card interchange fees must be reasonable and proportional to the cost incurred by the card issuer with respect to the transaction. This provision is known as the “Durbin Amendment.” In June 2011, the Federal Reserve adopted regulations setting the maximum permissible interchange fee as the sum of 21 cents per transaction and 5 basis points multiplied by the value of the transaction, with an additional adjustment of up to one cent per transaction if the card issuer implements certain fraud-prevention standards.

The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Sections 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained. These requirements became effective on July 21, 2011. The Dodd-Frank Act also provides that the appropriate federal regulators must establish standards prohibiting as an unsafe and unsound practice any compensation plan of a bank holding company or other “covered financial institution” that provides an insider or other employee with “excessive compensation” or compensation that gives rise to excessive risk or could lead to a material financial loss to such firm. In June 2010, prior to the Dodd-Frank Act, the bank regulatory agencies promulgated the Interagency Guidance on Sound Incentive Compensation Policies, which requires that financial institutions establish metrics for measuring the impact of activities to achieve incentive compensation with the related risk to the financial institution of such behavior.

 

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Although a significant number of the rules and regulations mandated by the Dodd-Frank Act have been finalized, many of the new requirements have yet to be implemented and will likely be subject to implementing regulations over the course of several years. Given the uncertainty associated with the manner in which the provisions of the Dodd-Frank Act will be implemented by the various regulatory agencies, the full extent of the impact such requirements will have on the operations of the Company and the Bank is unclear. The changes resulting from the Dodd-Frank Act may affect the profitability of business activities, require changes to certain business practices, impose more stringent capital requirements, liquidity and leverage ratio requirements, or otherwise adversely affect the business of the Company and the Bank. These changes may also require the Company to invest significant management attention and resources to evaluate and make necessary changes to comply with new statutory and regulatory requirements.

The Company

General. As a bank holding company registered under the Bank Holding Company Act of 1956 (the “BHCA”), the Company is subject to supervision, regulation, and examination by the Federal Reserve. The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation, and examination by the Virginia State Corporation Commission (the “SCC”).

Permitted Activities. A bank holding company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition, and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

Banking Acquisitions; Changes in Control. The BHCA requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the Community Reinvestment Act of 1977 (the “CRA”).

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

 

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Securities Exchange Act of 1934 (the “Exchange Act”) or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock is registered under Section 12 of the Exchange Act.

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

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

Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the Federal Deposit Insurance Corporation (“FDIC”) insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Company Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

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

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

Limits on Dividends and Other Payments. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the revenues of the Company result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company and to the payment of dividends by the Company to its shareholders. The Bank is subject to various statutory restrictions on its ability to pay dividends to the Company. Under the current supervisory practices of the Bank’s regulatory agencies, prior approval from those agencies is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two

 

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preceding years. The payment of dividends by the Bank or the Company may be limited by other factors, such as requirements to maintain capital above regulatory guidelines. Bank regulatory agencies have the authority to prohibit the Bank or the Company from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending on the financial condition of the Bank, or the Company, could be deemed to constitute such an unsafe or unsound practice.

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

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

Under federal law, the Bank may not, subject to certain limited exceptions, make loans or extensions of credit to, or investments in the securities of, the Company or take securities of the Company as collateral for loans to any borrower. The Bank is also subject to collateral security requirements for any loans or extensions of credit permitted by such exceptions.

Gramm-Leach-Bliley Act. The Gramm-Leach Bliley Act (the “GLB Act”) allows a bank holding company or other company to certify its status as a financial holding company, thereby allowing such company to engage in activities that are financial in nature, that are incidental to such activities, or are complementary to such activities. The GLB Act enumerates certain activities deemed financial in nature, such as underwriting insurance or acting as an insurance principal, agent or broker; underwriting; dealing in or making markets in securities; and engaging in merchant banking under certain restrictions. It also authorizes the Federal Reserve to determine by regulation what other activities are financial in nature, or incidental or complementary thereto.

For a bank holding company to be eligible for financial holding company status, each of its subsidiary banks must be “well capitalized” and “well managed” and have at least a satisfactory rating on its most recent Community Reinvestment Act (“CRA”) review. A bank holding company seeking to become a financial holding company must file a declaration with the Federal Reserve that it elects to become a financial holding company. If, after becoming a financial holding company, any of its subsidiary banks should fail to continue to meet these requirements, the financial holding company would be prohibited from engaging in activities not permissible for bank holding companies unless it was able to return to compliance within a specified period of time. Although the Bank, the Company’s sole banking subsidiary, meets the capital, management, and CRA requirements, the Company has not made a declaration to elect to become a financial holding company and at this time has no plans to do so.

The Bank

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

 

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Capital Requirements. The Federal Reserve and the other federal banking agencies have issued risk-based and leverage capital guidelines applicable to U. S. banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Under the risk-based capital requirements of the Federal Reserve, the Company and the Bank are required to maintain a minimum ratio of total capital to risk-weighted assets of at least 8.0%. At least half of the total capital is required to be “Tier 1 capital,” which consists principally of common and certain qualifying preferred shareholders’ equity (including grandfathered trust preferred securities), less certain intangibles and other adjustments. The remainder (“Tier 2 capital”) consists of a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments) and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company were 12.85% and 14.51%, respectively, as of December 31, 2011, thus exceeding the minimum requirements. The Tier 1 and total capital to risk-weighted asset ratios of the Bank were 12.36% and 14.02%, respectively, as of December 31, 2011, also exceeding the minimum requirements.

Each of the federal regulatory agencies has established a minimum leverage capital ratio of Tier 1 capital to average adjusted assets (“Tier 1 leverage ratio”). These guidelines provide for a minimum Tier 1 leverage ratio of 4% for banks and bank holding companies that meet certain specified criteria, including having the highest regulatory examination rating and are not contemplating significant growth or expansion. As of December 31, 2011, the Tier 1 leverage ratios of the Company and the Bank were 10.14% and 9.78%, respectively, well above the minimum requirements. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets.

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

The FDIA, as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating. On February 27, 2009, the FDIC introduced three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50% of an institution’s assessment rate before the increase for secured liabilities in excess of 25% of domestic deposits; and (iii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10% of domestic deposits. In 2011 and 2010, the Company paid only the base assessment rate for “well capitalized” institutions, which totaled $4.7 million and $5.0 million, respectively, in regular deposit insurance assessments.

On May 22, 2009, the FDIC issued a final rule that levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution’s total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits. The special assessment was part of the FDIC’s efforts to rebuild the DIF. Deposit insurance expense during 2009 for the Company included an additional $1.2 million recognized in the second quarter related to the special assessment. On November 12, 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. In December 2009, the Company paid $12.6 million in prepaid risk-based assessments, which will be expensed in the appropriate periods through December 31, 2012.

 

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In November 2010, the FDIC issued a final rule to implement provisions of the Dodd-Frank Act that provide for temporary unlimited coverage for non-interest-bearing transaction accounts. The separate coverage for non-interest-bearing transaction accounts became effective on December 31, 2010 and terminates on December 31, 2012.

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

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

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

Prompt Corrective Action. Immediately upon becoming “undercapitalized,” a depository institution becomes subject to the provisions of Section 38 of the FDIA, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions. The Bank meets the definition of being “well capitalized” as of December 31, 2011.

 

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Community Reinvestment Act. The Bank is subject to the requirements of the Community Reinvestment Act of 1977. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of the local communities, including low and moderate income neighborhoods. If the Bank receives a rating from the Federal Reserve of less than satisfactory under the CRA, restrictions on operating activities would be imposed. The Bank currently has a “satisfactory” CRA rating.

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

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

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

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

The Federal Reserve will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Company, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2011, the Company had not been made aware of any instances of non-compliance with the new guidance.

 

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Effect of Governmental Monetary Policies

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

Filings with the SEC

The Company files annual, quarterly, and other reports under the Securities Exchange Act of 1934 with the SEC. These reports and this Form 10-K are posted and available at no cost on the Company’s investor relations website, http://investors.bankatunion.com, as soon as reasonably practicable after the Company files such documents with the SEC. The information contained on the Company’s website is not a part of this Form 10-K. The Company’s filings are also available through the SEC’s website at www.sec.gov.

ITEM 1A.—RISK FACTORS

Risks Related To The Company’s Business

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

The community banking industry is directly affected by national, regional, and local economic conditions. Although economic conditions showed some signs of improvement in 2011, certain sectors, such as real estate, remain weak and unemployment remains high. Local governments and many businesses are still experiencing difficulty as a result of the recent economic downturn and protracted recovery. Management allocates significant resources to mitigate and respond to risks associated with the current volatile economic conditions, however, such conditions cannot be predicted or controlled. Therefore, such conditions, including a flatter yield curve and extended low interest rates, could adversely affect the credit quality of the Company’s loans, and/or the Company’s results of operations and financial condition. The Company’s financial performance is dependent on the business environment in the markets where the Company operates—in particular, the ability of borrowers to pay interest on and repay principal of outstanding loans and the value of collateral securing those loans, as well as demand for loans and other products and services the Company offers. In addition, the Company holds securities which can be significantly affected by various factors including credit ratings assigned by third parties; an adverse credit rating in securities held by the Company could result in a reduction of the fair value of its securities portfolio and have an adverse impact on its financial condition. While general economic conditions in Virginia and the U.S. continued to improve in 2011, there can be no assurance that this improvement will continue.

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

Like all financial institutions, the Company maintains an allowance for loan losses to provide for loans that its borrowers may not repay in their entirety. The Company believes that it maintains an allowance for loan losses at a level adequate to absorb probable losses inherent in the loan portfolio as of the corresponding balance sheet date and in compliance with applicable accounting and regulatory guidance. However, the allowance for loan losses may not be sufficient to cover actual loan losses and future provisions for loan losses could materially and adversely affect the Company’s operating results. The Company continues to have an elevated level of potential problem loans in its loan portfolio with higher

 

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than normal risk. The Company expects to receive more frequent requests from borrowers to modify loans. Accounting measurements related to impairment and the loan loss allowance require significant estimates that are subject to uncertainty and changes relating to new information and changing circumstances. The significant uncertainties surrounding the Company’s borrowers’ abilities to execute their business models successfully through changing economic environments, competitive challenges and other factors complicate the Company’s estimates of the risk of loss and amount of loss on any loan. Because of the degree of uncertainty and susceptibility of these factors to change, the actual losses may vary from current estimates. The Company expects fluctuations in the loan loss provisions due to the uncertain economic conditions.

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

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

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

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

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

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

The Company’s nonperforming assets adversely affect its net income in various ways. Until economic and market conditions stabilize, the Company expects to continue to incur additional losses relating to volatility in nonperforming loans. The Company does not record interest income on non-accrual loans, which adversely affects its income and increases loan administration costs. When the Company receives collateral through foreclosures and similar proceedings, it is required to mark the related loan to the then fair market value of the collateral less estimated selling costs, which may result in a loss. An increase in the level of nonperforming assets also increases the Company’s risk profile and may affect the capital levels regulators believe are appropriate in light of such risks. The Company utilizes various techniques

 

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such as workouts, restructurings, and loan sales to manage problem assets. Increases in or negative adjustments in the value of these problem assets, the underlying collateral, or in the borrowers’ performance or financial condition, could adversely affect the Company’s business, results of operations and financial condition. In addition, the resolution of nonperforming assets requires significant commitments of time from management and staff, which can be detrimental to the performance of their other responsibilities, including origination of new loans. There can be no assurance that the Company will avoid further increases in nonperforming loans in the future.

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

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

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

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

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

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

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

 

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

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

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

The carrying value of goodwill may be adversely affected.

When the Company completes an acquisition, often times, goodwill is recorded on the date of acquisition as an asset. Current accounting guidance requires goodwill to be tested for impairment; the Company performs such impairment analysis at least annually rather than amortizing it over a period of time. A significant adverse change in expected future cash flows or sustained adverse change in the Company’s common stock could require the asset to become impaired. If impaired, the Company would incur a charge to earnings that would have a significant impact on the results of operations. The Company’s carrying value of goodwill was approximately $59.4 million at December 31, 2011.

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

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

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

In the ordinary course of business, The Company collects and stores sensitive data, including proprietary business information and personally identifiable information of its customers and employees in systems and on networks. The secure processing, maintenance and use of this information is critical to operations and the Company’s business strategy. The Company has invested in accepted technologies, and

 

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continually reviews processes and practices that are designed to protect its networks, computers and data from damage or unauthorized access. Despite these security measures, The Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations, and damage to the Company’s reputation, which could adversely affect our business.

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

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

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

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

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

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

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

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

 

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Changes in accounting standards could impact reported earnings.

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

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

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

Risks Related To The Company’s Securities

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

The Company is a bank holding company that conducts substantially all of its operations through the Bank and other subsidiaries. As a result, the Company’s ability to make dividend payments on its common stock depends primarily on certain federal regulatory considerations and the receipt of dividends and other distributions from its subsidiaries. There are various regulatory restrictions on the ability of the Bank to pay dividends or make other payments to the Company.

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

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

 

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

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

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

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

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

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

ITEM 1B.—UNRESOLVED STAFF COMMENTS.

The Company does not have any unresolved staff comments to report for the year ended December 31, 2011.

ITEM  2.—PROPERTIES.

The Company, through its subsidiaries, owns or leases buildings that are used in the normal course of business. Effective October 31, 2011, the corporate headquarters was relocated from 111 Virginia Street, Suite 200, Richmond, Virginia to 1051 East Cary Street, Suite 1200, Richmond, Virginia. The Company’s subsidiaries own or lease various other offices in the counties and cities in which they operate. At December 31, 2011, Union First Market Bank operated 99 branches throughout Virginia. All of the offices of Union Mortgage are leased. The vast majority of the offices of Union Investment Services, Inc. are located within the retail branch properties. The Company’s operations center is in Ruther Glen, Virginia. See the Note 1 “Summary of Significant Accounting Policies” and Note 5 “Bank Premises and Equipment” in the “Notes to the Consolidated Financial Statements” of this Form 10-K for information with respect to the amounts at which Bank premises and equipment are carried and commitments under long-term leases.

 

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ITEM 3.—LEGAL PROCEEDINGS.

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

ITEM 4.—MINE SAFETY DISCLOSURES.

None.

PART II

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

The following performance graph does not constitute soliciting material and should not be deemed filed or incorporated by reference into any other Company filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent the Company specifically incorporates the performance graph by reference therein.

Five-Year Stock Performance Graph

The following chart compares the yearly percentage change in the cumulative shareholder return on the Company’s common stock during the five years ended December 31, 2011, with (1) the Total Return Index for the NASDAQ Stock Market and (2) the Total Return Index for NASDAQ Bank Stocks. This comparison assumes $100 was invested on December 31, 2006 in the Company’s common stock and the comparison groups and assumes the reinvestment of all cash dividends prior to any tax effect and retention of all stock dividends.

 

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LOGO

 

     Period Ending  

Index

   12/31/06      12/31/07      12/31/08      12/31/09      12/31/10      12/31/11  

Union First Market Bankshares Corporation

     100.00         71.33         86.76         44.28         53.81         49.54   

NASDAQ Composite

     100.00         110.66         66.42         96.54         114.06         113.16   

NASDAQ Bank

     100.00         80.09         62.84         52.60         60.04         53.74   

Information on Common Stock, Market Prices and Dividends

There were 26,134,830 shares of the Company’s common stock outstanding at the close of business on December 31, 2011, which were held by 2,446 shareholders of record. The closing price of the Company’s common stock on December 31, 2011 was $13.29 per share compared to $14.78 on December 31, 2010.

The Company completed a follow-on equity raise on September 16, 2009 of 4,725,000 shares of common stock at a price of $13.25 per share. In addition, on February 1, 2010, the Company issued 7,477,273 shares of common stock in connection with its acquisition of First Market Bank, FSB.

The following table summarizes the high and low sales prices and dividends declared for quarterly periods during the years ended December 31, 2011 and 2010.

 

     Sales Prices      Dividends
Declared
 
     2011      2010      2011      2010  
     High      Low      High      Low                

First Quarter

   $ 15.21       $ 10.82       $ 15.52       $ 11.79       $ 0.070       $ 0.060   

Second Quarter

     13.23         11.29         17.93         12.25         0.070         0.060   

Third Quarter

     13.18         9.93         14.73         11.19         0.070         0.060   

Fourth Quarter

     13.79         10.06         15.61         11.98         0.070         0.070   
              

 

 

    

 

 

 
               $ 0.280       $ 0.250   
              

 

 

    

 

 

 

 

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Regulatory restrictions on the ability of the Bank to transfer funds to the Company at December 31, 2011 are set forth in Note 17, “Parent Company Financial Information,” contained in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K. A discussion of certain limitations on the ability of the Bank to pay dividends to the Company and the ability of the Company to pay dividends on its common stock, is set forth in Part I., Item 1—Business, of this Form 10-K under the headings “Supervision and Regulation - Limits on Dividends and Other Payments.”

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

Stock Repurchase Program

In December 2011, the Company was authorized to repurchase up to 350,000 shares of its common stock in the open market at prices that management determines to be prudent. No shares were repurchased during 2011. In February, 2012 the Company repurchased 335,649 shares of its common stock for an aggregate purchase price of $4,363,437, or $13.00 per share. The repurchase was funded with cash on hand.

 

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ITEM 6. – SELECTED FINANCIAL DATA.

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

 

    2011     2010     2009     2008     2007  

Results of Operations

         

Interest and dividend income

  $ 189,073      $ 189,821      $ 128,587      $ 135,095      $ 140,996   

Interest expense

    32,713        38,245        48,771        57,222        65,251   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

    156,360        151,576        79,816        77,873        75,745   

Provision for loan losses

    16,800        24,368        18,246        10,020        1,060   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income after provision for loan losses

    139,560        127,208        61,570        67,853        74,685   

Noninterest income

    43,777        47,298        32,967        30,555        25,105   

Noninterest expenses

    141,628        143,001        85,287        79,636        73,550   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

    41,709        31,505        9,250        18,772        26,240   

Income tax expense

    11,264        8,583        890        4,258        6,484   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

  $ 30,445      $ 22,922      $ 8,360      $ 14,514      $ 19,756   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Financial Condition

         

Assets

  $ 3,907,087      $ 3,837,247      $ 2,587,272      $ 2,551,932      $ 2,301,397   

Loans, net of unearned income

    2,818,583        2,837,253        1,874,224        1,874,088        1,747,820   

Deposits

    3,175,105        3,070,059        1,916,364        1,926,999        1,659,578   

Stockholders’ equity

    421,639        428,085        282,088        273,798        212,082   

Ratios

         

Return on average assets

    0.79     0.61     0.32     0.61     0.91

Return on average equity

    6.90     5.50     2.90     6.70     9.61

Cash basis return on average assets (1)

    0.92     0.76     0.38     0.68     1.00

Cash basis return on average tangible common equity (1)

    10.64     9.35     5.54     10.69     14.88

Efficiency ratio (2)

    70.77     71.91     75.62     73.45     72.93

Equity to assets

    10.79     11.16     10.90     10.73     9.22

Tangible common equity / tangible assets

    8.91     8.22     8.64     6.10     6.45

Asset Quality

         

Allowance for loan losses

  $ 39,470      $ 38,406      $ 30,484      $ 25,496      $ 19,336   

Nonaccrual loans

  $ 44,834      $ 61,716      $ 22,348      $ 14,412      $ 9,436   

Other real estate owned

  $ 32,263      $ 36,122      $ 22,509      $ 7,140      $ 693   

Allowance for loan losses / total outstanding loans

    1.40     1.35     1.63     1.36     1.11

Allowance for loan losses / nonperforming loans

    88.04     62.23     136.41     176.91     204.92

NPAs / total outstanding loans

    2.74     3.45     2.39     1.15     0.58

Net charge-offs / total outstanding loans

    0.56     0.58     0.71     0.21     0.05

Per Share Data

         

Earnings per share, basic

  $ 1.07      $ 0.83      $ 0.19      $ 1.08      $ 1.48   

Earnings per share, diluted

    1.07        0.83        0.19        1.07        1.47   

Cash basis earnings per share, diluted (1)

    1.33        1.10        0.63        1.16        1.56   

Cash dividends paid

    0.280        0.250        0.300        0.740        0.725   

Market value per share

    13.29        14.78        12.39        24.80        21.14   

Book value per common share

    16.17        15.16        15.34        16.03        15.82   

Price to earnings ratio, diluted

    12.42        17.81        65.21        23.18        14.38   

Price to book value ratio

    0.82        0.98        0.81        1.55        1.34   

Dividend payout ratio

    26.17     30.12     157.89     69.16     49.32

Weighted average shares outstanding, basic

    25,981,222        25,222,565        15,160,619        13,477,760        13,341,741   

Weighted average shares outstanding, diluted

    26,009,839        25,268,216        15,201,993        13,542,948        13,422,139   

 

(1) Refer to “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations”, section “Non GAAP Measures” for a reconciliation.
(2) The efficiency ratio is calculated by dividing noninterest expense over the sum of net interest income plus noninterest income.

 

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

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

CRITICAL ACCOUNTING POLICIES

General

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

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

The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions, and judgments.

Allowance for Loan Losses

The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on two basic principles of accounting: (a) ASC 450 Contingencies, which requires that losses be accrued when occurrence is probable and can be reasonably estimated, and (b) ASC 310 Receivables, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.

The Company’s allowance for loan losses is the accumulation of various components that are calculated based on independent methodologies. All components of the allowance represent an estimation performed pursuant to applicable GAAP. Management’s estimate of each homogenous pool component is based on certain observable data that management believes are most reflective of the underlying credit losses being estimated. This evaluation includes credit quality trends; collateral values; loan volumes; geographic, borrower, and industry concentrations; seasoning of the loan portfolio; the findings of internal credit quality assessments and results from external bank regulatory examinations. These factors, as well as historical losses and current economic and business conditions, are used in developing estimated loss factors used in the calculations.

Applicable GAAP requires that the impairment of loans that have been separately identified for evaluation are measured based on the present value of expected future cash flows or, alternatively, the observable market price of the loans or the fair value of the collateral. However, for those loans that are collateral dependent (that is, if repayment of those loans is expected to be provided solely by the underlying collateral) and for which management has determined foreclosure is probable, the measure of impairment

 

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is to be based on the net realizable value of the collateral. This statement also requires certain disclosures about investments in impaired loans and the allowance for loan losses and interest income recognized on impaired loans.

Reserves for commercial loans are determined by applying estimated loss factors to the portfolio based on historical loss experience and management’s evaluation and “risk grading” of the commercial loan portfolio. Reserves are provided for noncommercial loan categories using historical loss factors applied to the total outstanding loan balance of each loan category. Additionally, environmental factors based on national and local economic conditions, as well as portfolio-specific attributes, are considered in estimating the allowance for loan losses.

While management uses the best information available to establish the allowance for loan and lease losses, future adjustments to the allowance may be necessary if future economic conditions differ substantially from the assumptions used in making the valuations or, if required by regulators, based upon information available to them at the time of their examinations. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

Mergers and Acquisitions

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

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

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

Goodwill and Intangible Assets

The Company follows ASC 805, Business Combinations, using the acquisition method of accounting for business combinations and ASC 350, Goodwill and Other Intangible Assets, which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of this guidance discontinued the amortization of goodwill and intangible assets with indefinite lives but require an impairment review at least annually and more frequently if certain impairment indicators are evident.

Goodwill totaled $59.4 million and $57.6 million for the years ended December 31, 2011 and 2010, respectively. Changes in goodwill in the Company’s consolidated balance sheet from December 31, 2011 were attributable to the acquisition of the Harrsionburg branch. Based on the testing of goodwill for impairment, there were no impairment charges for 2011, 2010, or 2009.

 

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The Company used the acquisition method of accounting when acquiring First Market Bank and recorded $26.4 million of core deposit intangible, $1.2 million of trademark intangible and $1.1 million in goodwill. None of the goodwill recognized will be deductible for income tax purposes. Core deposit intangible assets are being amortized over the periods of expected benefit, which range from 5 to 14 years. The core deposit intangible on that acquisition is being amortized over an average of 4.3 years using an accelerated method and the trademark intangible is being amortized over three years using the straight-line method.

In connection with the acquisition of the Harrisonburg branch, the Company recorded $1.8 million of goodwill and $9,500 of core deposit intangibles. The core deposit intangible of $9,500 was expensed in the second quarter of 2011. The recorded goodwill was allocated to the community banking segment of the Company and is deductible for tax purposes.

Total core deposit intangibles, net of amortization, amounted to $20.7 million and $26.8 million as of December 31, 2011 and 2010, respectively.

Amortization expense of core deposit intangibles for the years ended December 31, 2011, 2010, and 2009 totaled $6.1 million, $7.3 million, and $1.9 million, respectively. Amortization expense of the trademark intangible for the years ended December 31, 2011 and 2010 was $400,000 and $367,000, respectively. The Company had no trademark intangible prior to 2010.

RESULTS OF OPERATIONS

Net Income

For the year ended December 31, 2011 compared to the year ended December 31, 2010, net income increased $7.5 million, or 32.8%, from $22.9 million to $30.4 million. Net income available to common shareholders, which deducts from net income the dividends and discount accretion on preferred stock, was $27.8 million for the year ended December 31, 2011 compared to $21.0 million a year ago. This represented an increase in earnings per common share, on a diluted basis, of $0.24, to $1.07 from $0.83. The repayment of the preferred stock assumed in the FMB acquisition accelerated the amortization of the related discount of approximately $982,000, which reduced earnings available to common shareholders by $0.02 per share. Return on average common equity for the year ended December 31, 2011 was 6.90%, while return on average assets was 0.79%, compared to 5.50% and 0.61%, respectively, for the year ended December 31, 2010.

The $7.5 million increase in net income for the year ended December 31, 2011 was largely attributable to increases in net interest income, the absence of nonrecurring prior year acquisition costs, and a decline in provision for loan loss.

For the year ended December 31, 2010 compared to the year ended December 31, 2009, net income increased $14.6 million, or 174.2%, from $8.4 million to $22.9 million. Net income available to common shareholders, was $21.0 million for the year ended December 31, 2010 compared to $22.9 million for 2009. This represents an increase in earnings per share, on a diluted basis, of $0.64, to $0.83 from $0.19. Return on average common equity for the year ended December 31, 2010 was 5.50%, while return on average assets was 0.61%, compared to 2.90% and 0.32%, respectively, for the year ended December 31, 2009. The $14.6 million increase in net income for the year ended December 31, 2010 was largely attributable to the addition of FMB and improvement in the net interest margin, partially offset by nonrecurring acquisition costs and increased credit costs.

 

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Net Interest Income

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

The decline in the general level of interest rates over the last four years has placed downward pressure on the Company’s earning asset yields and related interest income. The decline in earning asset yields, however, has been offset principally by repricing of money market deposit accounts and certificates of deposits. The Federal Open Market Committee’s commitment to keep rates exceptionally low for an extended period and the resulting flatter yield curve (i.e., longer term interest rates not significantly higher than short term rates) could negatively affect the Bank’s net interest margin as lower deposit rates may not offset lower earning asset yields. Should the existing rate environment hold for future quarters, the Company could experience continued pressure on net interest margin.

For the year ended December 31, 2011, tax-equivalent net interest income increased $5.0 million, or 3.2%, when compared to last year. The tax-equivalent net interest margin increased 1 basis point to 4.57% from 4.56% in the prior year. The change in the net interest margin was a result of improvement in the cost of funds primarily related to declining rates on certificates of deposit and money market accounts, partially offset by declining yields on loans and loans held for sale, and aided by the increase in interest-earning assets resulting from the acquisition of FMB in the first quarter of 2010 and the acquisition of the Harrisonburg branch in the second quarter of 2011.

The following table shows the volume, interest income and expense and related yields and costs of the Company’s interest-earning assets and interest-bearing liabilities (dollars in thousands):

 

     Year-over-year results
Dollars in thousands
Year Ended
 
     12/31/11     12/31/10     Change  

Average interest-earning assets

   $ 3,518,643      $ 3,412,495      $ 106,148   

Interest income

   $ 193,399      $ 193,904      $ (505

Yield on interest-earning assets

     5.50     5.68     (18 ) bps 

Average interest-bearing liabilities

   $ 2,875,242      $ 2,838,200      $ 37,042   

Interest expense

   $ 32,713      $ 38,245      $ (5,532

Cost of interest-bearing liabilities

     1.14     1.35     (21 ) bps 

Acquisition Activity

The favorable impact of acquisition accounting fair value adjustments on net interest income was $7.0 million ($6.2 million – FMB; $748,000 – Harrisonburg branch) for the year ended December 31, 2011, respectively. If not for this favorable impact, the net interest margin for 2011 would have been 4.37%, compared to 4.24% for 2010.

The Harrisonburg branch

The acquired loan portfolio of the Harrisonburg branch was marked-to-market with a fair value discount to market rates. Performing loan discount accretion is recognized as interest income over the estimated remaining life of the loans. The Company also assumed certificates of deposit at a premium to market. These were marked-to-market with estimates of fair value on the acquisition date. The resulting premium to market is amortized as a decrease to interest expense over the estimated lives of the certificates of deposit.

 

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FMB

The acquired loan and investment security portfolios of FMB were marked-to-market with a fair value discount to market rates. Performing loan and investment security discount accretion is recognized as interest income over the estimated remaining life of the loans and investment securities. The Company also assumed borrowings (Federal Home Loan Bank of Atlanta (“FHLB”) and subordinated debt) and certificates of deposit. These liabilities were marked-to-market with estimates of fair value on acquisition date. The resulting discount/premium to market is accreted/amortized as an increase/decrease to net interest income over the estimated lives of the liabilities. Additional credit quality deterioration above the original credit mark is recorded as additional provisions for loan losses.

The fourth quarter, year-to-date, and remaining estimated discount/premium are reflected in the following table as they impact net interest income (dollars in thousands):

 

     Harrisonburg Branch      First Market Bank  
     Loan
Accretion
     Certificates
of Deposit
     Loan
Accretion
     Investment
Securities
     Borrowings     Certificates
of Deposit
 

For the quarter ended December 31, 2011

   $ 239       $ 35       $ 1,146       $ 93       $ (122   $ 140   

For the year ended December 31, 2011

     625         123         5,571         387         (489     763   

For the years ending:

                

2012

     589         11         3,624         201         (489     222   

2013

     148         7         2,377         15         (489     —     

2014

     37         4         1,478         —           (489     —     

2015

     26         —           570         —           (489     —     

2016

     27         —           28         —           (163     —     

Thereafter

     143         —           —           —           —          —     

Acquisition Activity – Other Operating Expenses

Acquisition related expenses associated with the acquisition of the Harrisonburg branch were $426,000 for the year ended December 31, 2011 and are recorded in “Other operating expenses” in the Company’s condensed consolidated statements of income. Such costs principally included system conversion and operations integration charges that have been expensed as incurred. There were no acquisition related expenses related to the Harrisonburg branch in 2010 or in the third and fourth quarters of 2011. The Company expects no further expenses related to the Harrisonburg branch acquisition.

 

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

 

     For the Year Ended December 31,  
     2011     2010     2009  
     Average
Balance
    Interest
Income /
Expense
     Yield /
Rate (1)
    Average
Balance
    Interest
Income /
Expense
     Yield /
Rate (1)
    Average
Balance
    Interest
Income /
Expense
     Yield /
Rate (1)
 
     (Dollars in thousands)  

Assets:

                     

Securities:

                     

Taxable

   $ 427,443      $ 13,387         3.13   $ 407,975      $ 13,958         3.42   $ 261,078      $ 10,606         4.06

Tax-exempt

     167,818        10,897         6.49     142,099        9,569         6.73     118,676        8,506         7.17
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total securities (2)

     595,261        24,284         4.08     550,074        23,527         4.28     379,754        19,112         5.03

Loans, net (3) (4)

     2,818,022        166,869         5.92     2,750,756        167,615         6.09     1,873,606        111,139         5.93

Loans held for sale

     53,463        2,122         3.97     68,414        2,671         3.90     46,454        1,931         4.16

Federal funds sold

     351        1         0.24     12,910        17         0.13     313        1         0.20

Money market investments

     96        —           0.00     171        —           0.00     135        —           0.00

Interest-bearing deposits in other banks

     51,450        123         0.24     29,444        74         0.25     50,994        135         0.26

Other interest-bearing deposits

     —          —           0.00     726        —           0.00     2,598        —           0.00
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total earning assets

     3,518,643        193,399         5.50     3,412,495        193,904         5.68     2,353,854        132,318         5.62
    

 

 

        

 

 

        

 

 

    

Allowance for loan losses

     (40,105          (34,539          (29,553     

Total non-earning assets

     383,090             374,613             254,507        
  

 

 

        

 

 

        

 

 

      

Total assets

   $ 3,861,628           $ 3,752,569           $ 2,578,808        
  

 

 

        

 

 

        

 

 

      

Liabilities and Stockholders’ Equity:

                     

Interest-bearing deposits:

                     

Checking

   $ 385,715        621         0.16   $ 345,927      $ 765         0.22   $ 201,520        314         0.16

Money market savings

     849,676        5,430         0.64     724,802        6,422         0.89     429,501        7,905         1.84

Regular savings

     172,627        638         0.37     151,169        560         0.37     99,914        384         0.38

Certificates of deposit: (5)

                     

$100,000 and over

     573,276        9,045         1.58     639,406        12,000         1.88     456,644        15,063         3.30

Under $100,000

     604,172        8,613         1.43     645,110        10,995         1.70     492,186        15,786         3.21
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing deposits

     2,585,466        24,347         0.94     2,506,414        30,742         1.23     1,679,765        39,452         2.35

Other borrowings (6)

     289,776        8,366         2.89     331,786        7,503         2.26     300,739        9,320         3.10
  

 

 

   

 

 

      

 

 

   

 

 

      

 

 

   

 

 

    

Total interest-bearing liabilities

     2,875,242        32,713         1.14     2,838,200        38,245         1.35     1,980,504        48,772         2.46
    

 

 

        

 

 

        

 

 

    

Noninterest-bearing liabilities:

                     

Demand deposits

     513,352             468,631             289,769        

Other liabilities

     31,994             29,161             20,292        
  

 

 

        

 

 

        

 

 

      

Total liabilities

     3,420,588             3,335,992             2,290,565        

Stockholders’ equity

     441,040             416,577             288,243        
  

 

 

        

 

 

        

 

 

      

Total liabilities and stockholders’ equity

   $ 3,861,628           $ 3,752,569           $ 2,578,808        
  

 

 

        

 

 

        

 

 

      

Net interest income

     $ 160,686           $ 155,659           $ 83,546      
    

 

 

        

 

 

        

 

 

    

Interest rate spread (7)

          4.36          4.33          3.16

Interest expense as a percent of average earning assets

          0.93          1.12          2.07

Net interest margin

          4.57          4.56          3.55

 

(1) Rates and yields are annualized and calculated from actual, not rounded amounts in thousands, which appear above.
(2) Interest income on securities includes $387 thousand in accretion of the fair market value adjustments related to the acquisition of FMB.
(3) Nonaccrual loans are included in average loans outstanding.
(4) Interest income on loans includes $5.6 million in accretion of the fair market value adjustments related to the acquisition of FMB and $625 thousand related to the Harrisonburg branch.
(5) Interest expense on certificates of deposits includes $763 thousand in accretion of the fair market value adjustments related to the acquisition of FMB and $123 thousand related to the Harrisonburg branch.
(6) Interest expense on borrowings includes $489 thousand in amortization of the fair market value adjustments related to the acquisition of FMB.
(7) Income and yields are reported on a taxable equivalent basis using the statutory federal corporate tax rate of 35%.

 

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

 

     2011 vs. 2010 Increase (Decrease)
Due to Change in:
    2010 vs. 2009 Increase (Decrease)
Due to Change in:
 
     Volume     Rate     Total     Volume     Rate     Total  

Earning Assets:

            

Securities:

            

Taxable

   $ 646      $ (1,217   $ (571   $ 5,228      $ (1,876   $ 3,352   

Tax-exempt

     1,679        (351     1,328        1,604        (541     1,063   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total securities

     2,325        (1,568     757        6,832        (2,417     4,415   

Loans, net

     4,018        (4,764     (746     53,402        3,074        56,476   

Loans held for sale

     (596     47        (549     867        (127     740   

Federal funds sold

     (23     7        (16     16        —          16   

Interest-bearing deposits in other banks

     52        (3     49        (57     (4     (61
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total earning assets

   $ 5,776      $ (6,281   $ (505   $ 61,060      $ 526      $ 61,586   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest-Bearing Liabilities:

            

Interest-bearing deposits:

            

Checking

   $ 80      $ (224   $ (144   $ 301      $ 150      $ 451   

Money market savings

     999        (1,991     (992     3,831        (5,314     (1,483

Regular savings

     78        —          78        186        (10     176   

Certificates of deposit:

            

$100,000 and over

     (1,162     (1,793     (2,955     4,765        (7,828     (3,063

Under $100,000

     (682     (1,700     (2,382     4,031        (8,822     (4,791
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing deposits

     (687     (5,708     (6,395     13,114        (21,824     (8,710

Other borrowings

     (1,037     1,900        863        898        (2,715     (1,817
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     (1,724     (3,808     (5,532     14,012        (24,539     (10,527
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Change in net interest income

   $ 7,500      $ (2,473   $ 5,027      $ 47,048      $ 25,065      $ 72,113   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Interest Sensitivity

An important element of earnings performance and the maintenance of sufficient liquidity is proper management of the interest sensitivity gap and liquidity gap. The interest sensitivity gap is the difference between interest-sensitive assets and interest-sensitive liabilities in a specific time interval. This gap can be managed by repricing assets or liabilities, which are variable rate instruments, by replacing an asset or liability at maturity or by adjusting the interest rate during the life of the asset or liability. Matching the amounts of assets and liabilities maturing in the same time interval helps to hedge interest rate risk and to minimize the impact of rising or falling interest rates on net interest income.

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

At December 31, 2011, the Company was in an asset-sensitive position. Management’s earnings simulation model indicates net interest income will increase as rates increase and decrease when rates decrease. An asset-sensitive company generally will be impacted favorably by increasing interest rates while a liability-sensitive company’s net interest margin and net interest income generally will be impacted favorably by declining interest rates.

 

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Earnings Simulation Analysis

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

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

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

The following table represents the interest rate sensitivity on net interest income for the Company across the rate paths modeled for balances ended December 31, 2011 (dollars in thousands):

 

     Change In Net Interest Income  
     %     $  

Change in Yield Curve:

    

+300 basis points

     4.01   $ 6,250   

+200 basis points

     2.68        4,176   

+100 basis points

     1.24        1,932   

Most likely rate scenario

     0.00        —     

-100 basis points

     (1.05     (1,645

-200 basis points

     (1.71     (2,671

-300 basis points

     (1.83     (2,847

Economic Value Simulation

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

 

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The following chart reflects the estimated change in net economic value over different rate environments using economic value simulation for the balances at the period ended December 31, 2011 (dollars in thousands):

 

     Change In Economic Value Of Equity  
     %     $  

Change in Yield Curve:

    

+300 basis points

     (3.73 )%    $ (19,212

+200 basis points

     (0.51     (2,608

+100 basis points

     0.80        4,119   

Most likely rate scenario

     0.00        —     

-100 basis points

     (6.45     (33,196

-200 basis points

     (10.72     (55,167

-300 basis points

     (10.66     (54,865

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

Noninterest Income

For the year ended December 31, 2011, noninterest income decreased $3.5 million, or 7.4%, to $43.8 million from $47.3 million in 2010. Gains on sales of bank premises declined $1.4 million. Of this amount, the Company recorded a current year loss on disposal of $351,000 of bank owned property and a current year loss on sale of $626,000 of a branch building, and a prior year gain on sale of an investment property of $448,000. Gains on sales of other real estate owned (“OREO”) declined $1.3 million primarily related to current year losses on sales of property. Gains on sales of mortgage loans decreased $2.3 million driven by lower origination volume in the mortgage company. Also during the year, the Company incurred a credit related other than temporary impaired (“OTTI”) loss of $400,000, which was recognized in earnings. Account service charges and other fees increased $1.2 million. Other charges and fees increased $1.4 million, primarily related to an increase in debit card fees of $763,000, ATM fees of $463,000, and brokerage commissions of $273,000, offset by a decline in account service charges of $279,000, largely related to overdraft fee volume. Also during the year, the Company recorded gains on sales of securities of $913,000.

 

     For the year ended  
     12/31/11     12/31/10      $     %  

Noninterest income:

         

Service charges on deposit accounts

   $ 8,826      $ 9,105       $ (279     (3.1

Other service charges, commissions and fees

     12,825        11,395         1,430        12.5   

Gains on securities transactions, net

     913        58         855        1,474.1   

Other-than-temporary impairment losses

     (400     —           (400     —     

Gains on sales of loans

     19,840        22,151         (2,311     (10.4

Gains (losses) on sales of other real estate owned and bank premises, net

     (2,060     628         (2,688     (428.0

Other operating income

     3,833        3,961         (128     (3.2
  

 

 

   

 

 

    

 

 

   

 

 

 

Total noninterest income

   $ 43,777      $ 47,298       $ (3,521     (7.4
  

 

 

   

 

 

    

 

 

   

For the year ended December 31, 2010, noninterest income increased $14.3 million, or 43.5%, to $47.3 million from $33.0 million in 2009, and reflects the FMB acquisition for eleven months since the acquisition date. Other service charges and fees increased $5.4 million, primarily related to increases in debit card income, ATM income, and brokerage commissions and letter of credit fees. Mortgage

 

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originations increased $105.0 million from $703.7 million to $808.7 million, or 14.9%, over 2009, as gains on the sale of loans increased $5.5 million, or 33.0%. Gains on the sale of loans were driven by increased originations in addition to the contribution of newer branches originating loans at favorable margins, adjustments to loan fee and pricing policies and volume related revenue incentives. Other operating income increased $2.0 million which was related to revenue from the acquired FMB trust operations and bank owned life insurance investment income. Account service charges increased $853,000 from overdraft and returned check charges and fees on commercial and savings accounts. During the 2010, the Company recorded non-recurring gains on sales of OREO of $628,000.

Beginning in the third quarter of 2010, a new rule (i.e., updating Regulation E) issued by the Federal Reserve prohibited financial institutions from charging consumers fees for paying overdrafts on ATM and one-time debit card transactions, unless a consumer consents, or opts in, to the overdraft service for those types of transactions. Consumers must be provided a notice that explains the financial institution’s overdraft services, including the fees associated with the service, and the consumer’s choices. Although the Company experienced lower fee volume in 2011 as a result of Regulation E, exposure was minimal and in line with the Company’s expectations. The Company does not believe Regulation E will have additional impact in the future but cannot provide any definitive assurance as to the amount of overdraft/insufficient funds charges reported in future periods as a result of the rule.

Noninterest Expense

For the year ended December 31, 2011, noninterest expense decreased $1.4 million, or 1.0%, to $141.6 million, from $143.0 million in 2010. Other operating expenses decreased $5.1 million, or 9.0%. Included in the reduction of other operating expenses were prior year costs associated with the acquisitions and mergers of $8.7 million during 2010 compared to $426,000 in 2011, lower amortization on the acquired deposit portfolio of $1.1 million, and lower FDIC assessment expense of $340,000 due to the lower assessment base and rate. Increases in current year other operating expenses included valuation adjustments and higher costs to maintain the Company’s portfolio of OREO of $1.6 million, higher franchises taxes of $1.2 million levied to include all of the former FMB branches, and higher communication expenses of $1.0 million related to additional branch locations, increased online banking, customer activity and implementation of mobile banking. Salary and benefits expense increased $3.7 million, primarily related to additional personnel, offset by lower origination volume related commission expense in the mortgage segment. Excluding mortgage segment operations and current and prior year acquisition costs, noninterest expense increased $8.4 million, or 7.3%, from 2010 to 2011.

 

     For the year ended  
     12/31/11     12/31/10     $     %  

Noninterest expense:

        

Salaries and benefits

   $ 71,652      $ 67,913      $ 3,739        5.5   

Occupancy expenses

     11,104        11,417        (313     (2.7

Furniture and equipment expenses

     6,920        6,594        326        4.9   

Other operating expenses

     51,952        57,077        (5,125     (9.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest expense

   $ 141,628      $ 143,001      $ (1,373     (1.0

Mortgage segment operations

   $ (18,581   $ (19,360   $ 779        31.2   

Acquisition and conversion costs

     (426     (8,715     8,289        32.8   

Other non-recurring costs

     —          (708     708        —     

Intercompany eliminations

     468        469        (1     —     
  

 

 

   

 

 

   

 

 

   

 

 

 
   $ 123,089      $ 114,687      $ 8,402        7.3   
  

 

 

   

 

 

   

 

 

   

For the year ended December 31, 2010, noninterest expense increased $57.7 million, or 67.7%, to $143.0 million from $85.3 million for the year ended December 31, 2009 and reflects the FMB acquisition for the eleven months since acquisition date. Other operating expenses increased $26.7 million. This increase included increases in acquisition costs of $7.9 million, increases in amortization of acquired deposit

 

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intangible assets of $5.7 million, increases in marketing and advertising expenses of $2.9 million related to multi-media brand awareness campaigns and Loyalty Banking® premiums for Union First Market Bank, and increases in communications expenses of $3.0 million. Data processing fees increased $2.0 million principally as a result of increases in acquired loans and deposits volumes. Additional other increases of $1.5 million related to ATM, bank card and overdraft losses. Professional fees increased $1.0 million primarily as a result of higher legal fees for continuing problem loan work outs and foreclosure activity. Due to maintenance of the Company’s portfolio of OREO and collection efforts on problem loans, loan expenses increased $1.4 million. Salaries and benefits expense increased $24.6 million primarily due to higher salaries expense of $17.2 million related to additional personnel from the FMB acquisition, higher profit sharing expense of $3.0 million from improved profitability, higher group insurance costs of $1.9 million from higher current year premiums, and additional personnel. Commissions in the mortgage segment increased $2.5 million, or 31.2%, as a result of increased originations. Occupancy costs increased $4.4 million and primarily related to additional rental expense and operations of acquired branches. Furniture and equipment expense increased $2.0 million resulting from higher depreciation and amortization expense related to acquired fixed assets and maintenance and equipment service contracts.

Total costs associated with the acquisition of FMB were $7.9 million and $1.5 million for the years ended December 31, 2010 and 2009, respectively. Costs included legal and accounting fees, lease and contract termination expenses, system conversion, operations integration, and employee severances, which were expensed as incurred. The costs are reported as a component of “Other operating expenses” within the Company’s “Consolidated Statements of Income.” Total acquisition costs incurred from the date the Company announced the acquisition of FMB in 2009 through December 31, 2010 were $9.4 million, $1.4 million below the initial estimate of $10.8 million. Other nonrecurring costs of $843,000 were incurred relating to merging two affiliate banks, Rappahannock National Bank and Northern Neck State Bank, into Union First Market Bank. The consolidation was completed on October 12, 2010 and no additional costs were incurred.

SEGMENT INFORMATION

Community Bank Segment

2011 compared to 2010

For the year ended December 31, 2011, net income for the community bank segment increased $9.0 million, or 45.7%, to $28.8 million compared to $19.8 million at December 31, 2010, principally a result of favorable net interest income and the absence of nonrecurring prior year acquisition costs. These improvements were partially offset by losses on sales of OREO and bank premises. All comparative results to the prior year exclude FMB results for the month of January 2010. Net interest income increased $5.7 million, or 3.8%, driven by declining costs on interest bearing liabilities, primarily certificates of deposit. The tax-equivalent net interest margin increased 1 basis point to 4.57% from 4.55% in the prior year. The change in the net interest margin was a result of improvement in the cost of funds primarily related to declining rates on certificates of deposit and money market accounts, partially offset by yields on loans and loans held for sale and aided by the increase in interest-earning assets due to the acquisition of FMB in the first quarter of 2010 and the acquisition of the Harrisonburg branch in the second quarter of 2011. Provision for loan loss decreased $7.6 million due to continued improvement in asset quality. Net interest income after provision for loan loss increased $13.3 million or 10.6%.

Noninterest income decreased $1.2 million, or 4.7%, to $24.4 million from $25.6 million in 2010. Gains on sales of bank owned property declined $1.4 million. Of this amount, the Company recorded a current year loss on disposal of bank owned property of $351,000 and a current year loss on sale of a branch building of $626,000, and a prior year gain on sale of an investment property of $448,000. Gains on sales of OREO declined $1.3 million primarily related to current year losses on sales of property. Also during the year, the Company incurred a credit-related, OTTI loss of $400,000, which was recognized in earnings. Account service charges and other fees increased $1.2 million. Of this amount, other charges

 

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and fees increased $1.4 million, primarily related to an increase in debit card fees of $763,000, ATM fees of $463,000, and brokerage commissions of $273,000, offset by a decline in account service charges of $279,000, largely related overdraft fee volume. Also during the year, the Company recorded gains on sales of securities of $913,000.

For the year ended December 31, 2011, noninterest expense decreased $595,000, or 0.5%, to $123.5 million, from $124.1 million a year ago. Other operating expenses decreased $5.4 million, or 9.9%. Included in the reduction of other operating expenses were prior year costs associated with the acquisition and merger of $8.7 million during 2010 compared to $426,000 in 2011, lower amortization on the acquired deposit portfolio of $1.1 million, and lower FDIC assessment expense of $340,000 due to the lower assessment base and rate. Increases in current year other operating expenses included valuation adjustments and higher costs to maintain the Company’s portfolio of OREO of $1.3 million, higher franchises taxes of $1.2 million levied to include all of the former FMB branches, higher communication expenses related to increased online customer activity and additional branch locations of $930,000, higher marketing and advertising costs of $444,000 primarily related to customer loyalty rewards programs, and higher professional fees related to continuing collection activity and problem loan workouts of $413,000, Salary and benefits expense increased $5.0 million, primarily related to additional personnel. Furniture and equipment expenses increased $274,000, primarily related to additional equipment, supplies and related maintenance contracts, and additional depreciation on acquired equipment. Occupancy costs decreased $391,000 primarily related to lower custodial costs.

2010 compared to 2009

For the year ended December 31, 2010, net income for the community banking segment increased approximately $13.9 million, or 234.3%, to $19.8 million compared to $5.9 million at December 31, 2009, largely attributable to the addition of FMB and improvement in the net interest margin, partially offset by nonrecurring acquisition costs. Net interest income increased $71.0 million, or 90.7%. This improvement was principally attributable to a decline in cost of interest-bearing liabilities and increased interest-earning assets related to the acquisition of FMB. The tax-equivalent net interest margin increased 100 basis points to 4.55 % from 3.55% in the prior year. The improvement in the cost of funds was principally a result of declining costs on certificates of deposit and money market accounts, fair value adjustments from acquisition accounting and lower costs related to FHLB borrowings. Provision for loan loss increased $6.1 million during 2010. Net interest income after the provision for loan losses increased $64.9 million, or 108.1%.

Noninterest income increased $9.0 million, or 53.8%, to $25.6 million from $16.6 million in the same period in 2009, and reflects the FMB acquisition for eleven months since the acquisition date. Other service charges and fees increased $5.4 million, primarily related to increases in debit and ATM card income, brokerage commissions and letter of credit fees. Other operating income increased $2.2 million and related to revenue from the acquired FMB trust operations and bank owned life insurance investment income. Account service charges increased $821,000 from overdraft and returned check charges and fees on commercial and deposit accounts. During the year, the Company recorded non-recurring gains on sales of OREO of $628,000.

For the year ended December 31, 2010, noninterest expense increased $52.9 million, or 74.3%, to $124.1 million from $71.2 million for the year ended December 31, 2009 and reflects the FMB acquisition for the eleven months since acquisition date. Other operating expenses increased $26.1 million. This increase included increases in acquisition costs of $7.4 million, increases in amortization of acquired deposit intangible assets of $5.7 million, increases in marketing and advertising expenses of $2.9 million related to Loyalty Banking® premiums and multi-media brand awareness campaigns for Union First Market Bank, and increases in communications expenses of $2.8 million. Data processing fees increased $2.0 million principally as a result of increases in acquired loans and deposits volumes. Additional other increases of $1.4 million related to ATM, bank card and overdraft losses. Professional fees increased $947,000 primarily as a result of higher legal fees for continuing problem loan work outs and foreclosure activity. Due to maintenance of the Company’s portfolio of other real estate owned and collection efforts on problem loans, these types of expenses increased $1.1 million.

 

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Salaries and benefits expense increased $20.7 million primarily due to higher salaries expense of $14.0 million related principally to additional personnel from the FMB acquisition, higher profit sharing expense of $2.8 million from improved profitability, higher group insurance costs of $1.7 million from higher 2010 premiums and additional personnel. Occupancy costs increased $4.1 million primarily related to additional rental expense and operations of acquired branches. Furniture and equipment expense increased $1.9 million resulting from higher depreciation and amortization expense related to acquired fixed assets and maintenance and equipment service contracts.

Mortgage Segment

2011 compared to 2010

For the year ended December 31, 2011, the mortgage segment net income decreased $1.5 million, or 48.5%, to $1.6 million from $3.1 million during the same period in 2010. Originations decreased by $149.3 million from $808.7 million to $659.4 million, or 18.5%, compared to 2010 due to declines in residential mortgage activity and an evolving regulatory environment, which increased demands on production. Gains on the sale of loans decreased $2.3 million, or 10.5%, driven largely by the decline in origination volume. Refinanced loans represented 37.4% of originations during the year compared to 43.1% for 2010. Net interest income declined $907,000, or 40.8%, from the prior year as a result of an increase to the warehouse line of credit borrowing rate by the Bank. This impact was eliminated in consolidation. Salary and benefit expenses decreased $1.2 million primarily due to lower commission expense on decreased origination volume, partially offset by higher salaries expense required to meet evolving regulatory, compliance, and production demands. Other operating expenses increased $322,000, or 12.5%, primarily related to increased costs associated with the processing, underwriting, and compliance components of origination.

In early 2012, the Company hired approximately 28 loan originators in four of its existing mortgage offices and three offices in new markets. These originators were formerly employed by a national mortgage company that announced in November 2011 it was exiting the mortgage origination business. While the timing and volume of the loan production which may result from the addition of these producers is unknown, management anticipates mortgage loan production from these originators of as much as $175 million.

2010 compared to 2009

For the year ended December 31, 2010, the mortgage segment net income increased $688,000, or 28.2%, to $3.1 million from $2.4 million in 2009. Originations increased $104.9 million from $703.7 million to $808.7 million, or 14.9%, compared to 2009, as gains on the sale of loans increased $5.5 million, or 33.1%. Gains on the sale of loans were driven by increased originations in addition to the contribution of newer branches originating loans at favorable margins, adjustments to loan fee and pricing policies and volume related revenue incentives. Noninterest expenses increased $5.0 million. Of this amount, salaries and benefits increased $3.8 million primarily related to increased commissions generated by loan originations as well as costs associated with additional branch office and corporate support personnel required to support production growth. Other operating expenses increased $756,000 principally due to origination related increased underwriting costs and loan expenses, investments in technology and additions to the branch office network.

BALANCE SHEET

Balance Sheet Overview

At December 31, 2011, total cash and cash equivalents were $96.7 million, a decrease of $53.1 million from September 30, 2011, and an increase of $35.5 million from December 31, 2010. During the fourth quarter, the Company paid the Treasury $35.7 million to redeem the Preferred Stock issued to the U.S. Treasury which was assumed in the FMB acquisition and increased investment in securities $34.3 million. At December 31, 2011, net loans were $2.8 billion, a decrease of $2.8 million, virtually unchanged from 2010. Net loans decreased $19.7 million, or 0.7%, from December 31, 2010. Mortgage loans held for sale was $74.8 million, almost unchanged from $74.9 million at December 31, 2010. At December 31, 2011, total assets were $3.9 billion, an increase of $69.8 million from $3.8 billion at December 31, 2010.

 

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Total deposits grew $105.0 million, or 3.4%, for the year ended December 31, 2011, and grew $40.2 million, or 1.3%, during the fourth quarter. Of this amount, interest bearing deposits increased $48.4 million compared to the third quarter driven by higher volumes in money market and NOW accounts partially offset by runoff in certificates of deposit under $100,000. Similarly, interest bearing deposits increased $55.4 million from December 31, 2010, as money market and NOW account balance increases were partially offset by runoff in certificates of deposit. Total borrowings, including repurchase agreements, decreased $7.3 million on a linked quarter basis and decreased $29.5 million from December 31, 2010 as the Company reduced reliance on short-term sources of funds.

During the fourth quarter of 2011, the Company received approval from the Treasury and its regulators to redeem the Preferred Stock issued to the Treasury and assumed by the Company as part of the 2010 acquisition of FMB. On December 7, 2011, the Company paid approximately $35.7 million to the Treasury in full redemption of the Preferred Stock. The repayment will allow the Company to retain capital of approximately $1.8 million annually that had been previously paid to the Treasury in a dividend on the preferred shares redeemed.

The Company’s management remains focused on maintaining adequate levels of liquidity and capital at all times and believes sound risk management practices in underwriting and lending will enable it to successfully weather continued economic uncertainty in the marketplace.

Securities Available for Sale

At December 31, 2011, the Company had securities available for sale, at fair value, in the amount of $640.8 million, or 16.4% of total assets, as compared to $572.4 million, or 14.9%, of total assets at December 31, 2010. The Company seeks to diversify its portfolio to minimize risk. It focuses on purchasing mortgage-backed securities for cash flow and reinvestment opportunities and securities issued by states and political subdivisions due to the tax benefits and the higher yield offered from these securities. All of the Company’s mortgage-backed securities are investment grade. The investment portfolio has a high percentage of municipals and mortgage-backed securities; therefore a higher taxable equivalent yield exists on the portfolio compared to its peers. The Company does not engage in structured derivative or hedging activities within the investment portfolio.

The following table sets forth a summary of the securities available for sale, at fair value as of December 31, (dollars in thousands):

 

     2011      2010      2009  

U.S. government and agency securities

   $ 4,284       $ 9,961       $ 5,763   

Obligations of states and political subdivisions

     200,207         175,032         124,126   

Corporate and other bonds

     12,240         15,065         15,799   

Mortgage-backed securities

     400,318         344,038         236,005   

Federal Reserve Bank stock

     6,714         6,716         3,683   

Federal Home Loan Bank stock

     13,947         18,345         14,958   

Other securities

     3,117         3,284         257   
  

 

 

    

 

 

    

 

 

 

Total securities available for sale, at fair value

   $ 640,827       $ 572,441       $ 400,591   
  

 

 

    

 

 

    

 

 

 

During each quarter and at year end, the Company conducts an assessment of the securities portfolio for OTTI consideration. The Company determined that a single issuer Trust Preferred security incurred credit-related OTTI of $400,000 during the year ended December 31, 2011. No OTTI was recognized in 2010 or 2009. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes and credit risk changes, to see if adjustments are needed. The primary cause of temporary impairments was the increase in spreads over comparable Treasury bonds.

Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

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The following table summarizes the contractual maturity of securities available for sale, at fair value and their weighted average yields as of December 31, 2011 (dollars in thousands):

 

     1 Year or
Less
    1 - 5 Years     5 - 10 Years     Over 10
Years and
Equity
Securities
    Total  

U.S. government and agency securities:

          

Amortized cost

   $ —        $ 3,873      $ —        $ 60      $ 3,933   

Fair value

     —          4,094        —          190        4,284   

Weighted average yield (1)

     —          2.81     —          —          2.81

Mortgage backed securities:

          

Amortized cost

   $ 816      $ 6,568      $ 40,791      $ 342,155      $ 390,330   

Fair value

     828        6,847        42,900        349,743        400,318   

Weighted average yield (1)

     4.60     3.99     3.92     3.23     3.32

Obligations of states and political subdivisions:

          

Amortized cost

   $ 4,730      $ 6,813      $ 34,427      $ 143,148      $ 189,118   

Fair value

     4,767        7,073        36,468        151,900        200,208   

Weighted average yield (1)

     4.92     4.48     4.49     4.11     4.21

Other securities:

          

Amortized cost

   $ 500      $ 1,517      $ 826      $ 33,700      $ 36,543   

Fair value

     503        1,393        847        33,273        36,016   

Weighted average yield (1)

     5.05     5.35     4.67     5.18     5.18

Total securities available for sale:

          

Amortized cost

   $ 6,046      $ 18,771      $ 76,044      $ 519,063      $ 619,924   

Fair value

     6,098        19,407        80,215        535,106        640,827   

Weighted average yield (1)

     4.88     4.04     4.18     3.60     3.70

 

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

As of December 31, 2011, the Company maintained a diversified municipal bond portfolio with approximately 75% of its holdings in general obligation issues and the remainder backed by revenue bonds. Issuances within the Commonwealth of Virginia represented 12% and the State of Texas represented 25% of the municipal portfolio. No other state had a concentration above 10%. Approximately 87% of municipal holdings are considered investment grade by Moody’s or Standard & Poor. The non-investment grade securities are principally insured Texas municipalities with no underlying rating. When purchasing municipal securities, the Company focuses on strong underlying ratings for general obligation issuers or bonds backed by essential service revenues.

Loan Portfolio

Loans, net of unearned income were $2.8 billion at both December 31, 2011 and 2010. Loans secured by real estate continue to represent the Company’s largest category, comprising 84.2% of the total loan portfolio.

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

 

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    2011     2010     2009     2008     2007  

Mortgage loans on real estate:

                   

Residential 1-4 family

  $ 447,544        15.9   $ 431,614        15.2   $ 349,277        18.6   $ 292,003        15.6   $ 281,847        16.1

Commercial

    985,934        34.9     924,548        32.6     596,773        31.8     550,680        29.4     500,118        28.6

Construction, land development and other land loans

    444,739        15.8     489,601        17.3     307,726        16.4     403,502        21.5     396,928        22.7

Second mortgages

    55,630        2.0     64,534        2.3     34,942        1.9     38,060        2.0     37,875        2.2

Equity lines of credit

    304,320        10.8     305,741        10.8     182,449        9.7     162,740        8.7     128,897        7.4

Multifamily

    108,260        3.8     91,397        3.2     46,581        2.5     37,321        2.0     32,970        1.9

Farm land

    26,962        1.0     26,787        0.9     26,191        1.4     30,727        1.6     18,958        1.1
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total real estate loans

    2,373,389        84.2     2,334,222        82.3     1,543,939        82.4     1,515,033        80.8     1,397,593        80.0

Commercial Loans

    169,695        6.0     180,840        6.4     126,157        6.7     146,827        7.8     136,317        7.8

Consumer installment loans

                   

Personal

    241,753        8.6     277,184        9.8     148,811        7.9     160,161        8.5     173,650        9.9

Credit cards

    19,006        0.7     19,308        0.6     17,743        0.9     15,723        0.8     13,108        0.7
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total consumer installment loans

    260,759        9.3     296,492        10.4     166,554        8.8     175,884        9.3     186,758        10.6

All other loans

    14,740        0.5     25,699        0.9     37,574        2.0     36,344        1.9     27,152        1.6
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Gross loans

    2,818,583        100.0     2,837,253        100.0     1,874,224        100.0     1,874,088        100.0     1,747,820        100.0
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

The following table presents the remaining maturities and type of rate (variable or fixed) on commercial and real estate constructions loans as of December 31, 2011 (dollars in thousands):

 

                   Variable Rate      Fixed Rate  
     Total
Maturities
     Less than
1 year
     Total      1-5 years      More than
5 years
     Total      1-5 years      More than
5 years
 

Construction, land development and other land loans

   $ 444,739       $ 334,921       $ 2,261       $ 2,238       $ 23       $ 107,557       $ 102,420       $ 5,137   

Commercial

   $ 169,695       $ 84,661       $ 2,893       $ 2,893       $ —         $ 82,141       $ 65,884       $ 16,257   

While the current economic environment is challenging, the Company remains committed to originating soundly underwritten loans to qualifying borrowers within its markets. The Company is focused on providing community-based financial services and discourages the origination of portfolio loans outside of its principal trade areas. To manage the growth of the real estate loans in the loan portfolio, facilitate asset/liability management and generate additional fee income, the Company sells a portion of conforming first mortgage residential real estate loans to the secondary market as they are originated. Union Mortgage serves as a mortgage brokerage operation, selling the majority of its loan production in the secondary market or selling loans to meet Union First Market Bank’s current asset/liability management needs. This venture has provided Union First Market Bank’s customers with enhanced mortgage products and the Company with improved efficiencies through the consolidation of this function.

Asset Quality

Overview

The Company experienced substantial improvement in asset quality during 2011. The reduction in levels of nonperforming loans and OREO was favorable even though current economic conditions did not improve materially. While future economic conditions remain uncertain, the Company’s downward trends in levels of past due and nonaccrual loans, improved allowance to nonperforming loans coverage ratio, and continued lower levels of provisions for loan losses demonstrate that its dedicated efforts to improve asset quality are having a positive impact. The magnitude of any change in the real estate market and its impact on the Company is still largely dependent upon continued recovery of commercial real estate and residential housing, and the pace at which the local economies in the Company’s operating markets recover.

The Company’s continued proactive efforts to effectively manage its loan portfolio as well as strategic decisions to reduce levels of OREO have contributed to the improvement in asset quality. Efforts include identifying existing problem credits as well as generating new business relationships. Through early identification and diligent monitoring of specific problem credits where the uncertainty has been realized, or conversely, has been reduced or eliminated, the Company’s management has been able to quantify the credit risk in its loan portfolio, adjust collateral dependent credits to appropriate reserve levels, and further identify those credits not recoverable. The Company continues to refrain from originating or purchasing loans from foreign entities or loans classified by regulators as highly leveraged transactions. The

 

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Company’s loan portfolio does not include exposure to option adjustable rate mortgage products, high loan-to-value ratio mortgages, interest only mortgage loans, subprime mortgage loans or mortgage loans with initial teaser rates, which are all considered higher risk instruments. During the fourth quarter of 2011, the Company made strategic decisions to take losses on the sale of some of its of OREO to take advantage of several opportunities to reduce its OREO balance as the market for those particular pieces of OREO changed or worsened.

Troubled Debt Restructurings (“TDRs”)

On July 1, 2011 the Company adopted the amendments in Accounting Standards Update No. 2011-02 Determination of Whether a Restructuring is a Troubled Debt Restructuring (“ASU 2011-02”). As a result of adopting the amendments in ASU 2011-02, the Company reassessed all loans that were renewed on or after January 1, 2011 for identification as a troubled debt restructuring (“TDR”). The total recorded investment in TDRs as of December 31, 2011 is $112.6 million of which $103.8 million were restructured during the year ended December 31, 2011 under the new guidance of ASU 2011-02. Under this enhanced guidance, the borrower must be experiencing financial difficulty and the bank must have made a concession to such borrower. While it did not reduce the interest rate on these loans, the Company took the position that the renewal of such loans and the lack of an active market for such loans suggested these loans were made at below market terms and resulted in their classification as TDRs. Of the $103.8 million of newly identified TDRs during the year ended December 31, 2011, $80.0 million, or 77.1%, had previously been reported as being impaired with appropriate impairment allowances previously established. The Company had four loans with a recorded investment of $2.2 million, or 2.1% of restructurings during the previous twelve months, which have subsequently defaulted. This low default rate indicates that the modifications made by the Company have been successful in assisting its customers and mitigating the risk in the overall loan portfolio. The impact of this new guidance did not have a material impact on the Company’s non-performing assets, allowance for loan losses, earnings, or capital.

To appropriately manage risk, the Company tends to keep the maturity of classified loans relatively short; therefore, under this new guidance, the Company anticipates that loans already considered to be impaired will likely be designated as TDRs if renewed at their current terms and no concession from the borrower is received. The primary reason for this is that the new guidance places greater emphasis on whether the modification is at market terms given the risk characteristics of the borrower. In this economic environment, the market for a borrower’s experiencing financial difficulty has contracted significantly and thus the borrower is not likely to be able to obtain similar alternative financing. Such a designation of previously impaired loans will have no impact on the Company’s consolidated financial statements because these loans are already being individually evaluated for impairment in accordance with the Company’s allowance for loan loss methodology.

The Company generally does not provide concession on interest rates, with the primary concession being an extension of the term of the loan from the original maturity date. Restructured loans for which there was no rate concession, and therefore made at a market rate of interest, may be eligible to be removed from TDR status in periods subsequent to the restructuring depending on the performance of the loan. The Company reviews previously restructured loans quarterly in order to determine whether any has performed, subsequent to the restructure, at a level that would allow for it to be removed from TDR status. The Company generally would consider a change in this classification if the loan has performed under the restructured terms for a consecutive twelve month period. At December 31, 2011, the Company had approximately $93.4 million, or 83% of total restructured loans, that were restructured at a market rate of interest and thus will be included in the aforementioned quarterly review process for possible removal.

The Company considers restructured loans that continue to accrue interest under the terms of the restructuring agreement to be performing and restructured loans that have been placed in nonaccrual status as nonperforming. Of the total loans designated as TDRs at December 31, 2011, approximately $98.8 million, or 87.7%, are considered to be performing.

 

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Nonperforming Assets (“NPAs”)

At December 31, 2011, nonperforming assets totaled $77.1 million, a decrease of $20.7 million from the prior year-end. The decrease in NPAs during the year related to net decreases in both nonaccrual loans, excluding purchased impaired loans, of $16.9 million and OREO of $3.8 million. In addition, nonperforming assets as a percentage of total outstanding loans declined 71 basis points from 3.45% at the end of the prior year to 2.74% at December 31, 2011. The majority of the net decrease in nonperforming loans was principally related to commercial and land loans. The majority of the net decrease in OREO was attributable to the sale of commercial real estate, as the net activity related to residential real estate and raw land was minimal.

The following table presents a five-year comparison of nonperforming assets as of December 31, (dollars in thousands):

 

     2011     2010     2009     2008     2007  

Nonaccrual loans (excluding purchased impaired)

   $ 44,834      $ 61,716      $ 22,348      $ 14,412      $ 9,436   

Foreclosed properties

     31,243        35,101        21,489        6,511        217   

Real estate investment

     1,020        1,020        1,020        629        476   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 77,097      $ 97,838      $ 44,857      $ 21,552      $ 10,129   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans past due 90 days and accruing interest

   $ 19,911      $ 15,332      $ 7,296      $ 3,082      $ 905   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming assets to loans

     2.74     3.45     2.39     1.15     0.58

Nonperforming assets to loans, foreclosed properties & real estate investments

     2.70     3.40     2.36     1.15     0.58

Allowance for loan losses to nonaccrual loans

     88.04     62.23     136.41     176.91     204.92

Nonperforming assets at December 31, 2011 included $44.8 million in nonaccrual loans (excluding purchased impaired loans), a net decrease of $16.9 million, or 27.39%, from the prior year. The decrease was a result of net customer pay downs of approximately $18.7 million, charge-offs of $8.7 million, transfers to OREO of $5.8 million, and loans returning to accruing status of $3.6 million, partially offset by additions of $19.9 million. The majority of the net reduction in nonperforming loans during the year was related to the commercial loan portfolio.

Nonaccrual loans include land loans of $13.3 million, other commercial loans of $10.6 million, commercial construction loans of $10.3 million, commercial real estate loans of $7.9 million, and other loans of $2.7 million. At December 31, 2011, the coverage ratio of the allowance for loan losses to nonperforming loans was 88.0%, an increase from 62.2% a year earlier. Impairment analyses provided appropriate reserves on these nonperforming loans while appropriate reserves on homogenous pools continue to be maintained. The increase in the coverage ratio is primarily related to a decline in nonperforming loans.

Nonperforming assets at December 31, 2011 also included $32.3 million in OREO, a net decrease of $3.8 million, or 10.53%, from the prior year. The net decrease was a result of sales of $14.2 million at a net loss of $1.1 million, additions, including capital improvements, of $12.2 million, and write-downs of $707,000. The additions were principally related to residential real estate, including single-family residences and developed lots, as well as raw land sales; sales from OREO were principally related to residential real estate, including single-family residences, developed lots, and multi-unit rental properties, commercial property, and raw land.

The OREO portfolio is composed of land development of $11.3 million, residential real estate of $11.0 million, land of $6.4 million, commercial real estate of $2.6 million, and land previously held for development of bank branch sites of $1.0 million. Included in land development is $8.8 million related to a residential community in the Northern Neck region of Virginia, which includes developed residential lots, a golf course and undeveloped land. Foreclosed properties were adjusted to their fair values at the time of each foreclosure and any losses were taken as loan charge-offs against the allowance for loan losses at that time. OREO asset valuations are also evaluated at least quarterly and any necessary write down to fair value is recorded as impairment and charged against earnings.

 

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The following provides a roll-forward of the OREO activity from the past three years ended December 31, (dollars in thousands):

 

     2011     2010     2009  

Beginning Balance

   $ 36,122      $ 22,509      $ 7,140   

Additions

     11,625        24,791        19,594   

Capitalized Improvements

     528        404        374   

Valuation Adjustments

     (707     (43     (61

Proceeds from sales

     (14,240     (11,747     (4,452

Gains (losses) from sales, net

     (1,065     207        (86
  

 

 

   

 

 

   

 

 

 

Ending Balance

   $ 32,263      $ 36,122      $ 22,509   
  

 

 

   

 

 

   

 

 

 

Charge-offs and delinquencies

For the year ended December 31, 2011, net charge-offs were $15.7 million, or 0.56% of average loans, compared to $16.4 million, or 0.58%, last year. Net charge-offs in the current year included commercial loans of $6.8 million, other consumer loans of $4.2 million, commercial construction of $3.2 million, and home equity lines of credits of $1.5 million. At December 31, 2011, total accruing past due loans were $39.3 million, or 1.40%, of total loans, a decrease from 1.95% a year ago.

Provision/Allowance for loan losses

The provision for loan losses for the year ended December 31, 2011 was $16.8 million, a decrease of $7.6 million from December 31, 2010. The lower provision for loan losses compared to last year reflects improvements in asset quality, tempered by higher reserves on remaining impaired loans, as other impaired loans were charged off. The current level of the allowance for loan losses reflects specific reserves related to nonperforming loans, current risk ratings on loans, net charge-off activity, loan growth, delinquency trends, and other credit risk factors that the Company considers in assessing the adequacy of the allowance for loan losses.

The allowance for loan losses as a percentage of the total loan portfolio, including net loans acquired in the FMB and the Harrisonburg branch acquisitions, was 1.40% at December 31, 2011 and 1.35% for the period ended December 31, 2010. The allowance for loan losses as a percentage of the total loan portfolio, adjusted to remove acquired loans which were separately marked to their fair value at the date of acquisition, was 1.83% at December 31, 2011, a decrease from 1.88% a year ago. While the allowance for loan losses as a percentage of the adjusted loan portfolio declined, the coverage ratios significantly improved, which further shows that management’s proactive diligence in working through problem credits is having a significant impact on asset quality. The lower allowance for loan losses as a percentage of loans compared to the loan portfolio, adjusted for acquired loans, is related to the elimination of FMB’s and the Harrisonburg branch’s allowance for loan losses at acquisition. In acquisition accounting, there is no carryover of previously established allowance for loan losses.

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

 

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     2011     2010     2009     2008     2007  

Balance, beginning of year

   $ 38,406      $ 30,484      $ 25,496      $ 19,336      $ 19,148   

Loans charged-off:

          

Commercial

     2,183        2,205        2,039        1,638        207   

Real estate

     12,669        12,581        8,702        18        —     

Consumer

     3,014        3,763        3,667        2,544        1,005   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total loans charged-off

     17,866        18,549        14,408        4,200        1,212   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Commercial

     413        551        71        52        30   

Real estate

     571        628        807        —          —     

Consumer

     1,146        924        272        288        310   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     2,130        2,103        1,150        340        340   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     15,736        16,446        13,258        3,860        872   

Provision for loan losses

     16,800        24,368        18,246        10,020        1,060   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of year

   $ 39,470      $ 38,406      $ 30,484      $ 25,496      $ 19,336   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Allowance for loan losses to loans

     1.40     1.35     1.63     1.36     1.11

Allowance-to-legacy loans (Non-GAAP)

     1.83     1.88     N/A        N/A        N/A   

Net charge-offs to average loans

     0.56     0.58     0.71     0.21     0.05

The following table shows an allocation of the allowance for loan losses among loan categories based upon analysis of the loan portfolio’s composition, historical loan loss experience and other factors, as well as the ratio of the related outstanding loan balances to total loans as of December 31, (dollars in thousands).

 

     2011     2010     2009     2008     2007  
     $      % (1)     $      % (1)     $      % (1)     $      % (1)     $      % (1)  

Commercial, financial and agriculture

   $ 9,322         6.1   $ 9,071         6.4   $ 7,200         6.7   $ 6,022         8.1   $ 4,567         8.0

Real estate construction

     21,922         15.8     21,331         17.3     16,931         16.4     14,161         21.5     10,740         22.7

Real estate mortgage

     1,249         68.4     1,215         65.0     964         66.0     806         59.3     611         57.3

Consumer & other

     6,977         9.7     6,789         11.3     5,389         10.9     4,507         11.1     3,418         12.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total

   $ 39,470         100.0   $ 38,406         100.0   $ 30,484         100.0   $ 25,496         100.0   $ 19,336         100.0
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

 

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

Deposits

As of December 31, 2011, total average deposits were $3.1 billion, up $123.8 million from December 31, 2010. Total interest-bearing deposits consist principally of certificates of deposit (“CDs”) and money market account balances. Total certificates of deposit and money market accounts were $1.1 billion and $904.9 million, respectively, or 77.6% of total interest-bearing deposits. During 2011, the Company experienced a shift from longer term CDs into lower cost transaction (NOW, savings and money market) accounts. This shift was driven by the Company’s focus on acquiring low cost deposits in a historically low interest rate environment and contributed to significant improvement in the net interest margin.

The average deposits and rates paid for the past three years and maturities of certificates of deposit of $100,000 and over as of December 31 are as follows (dollars in thousands):

 

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     2011     2010     2009  
     Amount      Rate     Amount      Rate     Amount      Rate  

Noninterest-bearing demand deposits

   $ 513,352         $ 468,631         $ 289,769      

Interest-bearing deposits:

               

NOW accounts

     385,715         0.16     345,927         0.22     201,520         0.16

Money market accounts

     849,676         0.64     724,802         0.89     429,501         1.84

Savings accounts

     172,627         0.37     151,169         0.37     99,914         0.38

Time deposits of $100,000 and over

     573,276         1.58     639,406         1.88     447,659         3.36

Brokered CDs

     —           0.00     —           0.00     8,985         2.75

Other time deposits

     604,172         1.43     645,110         1.70     492,186         3.16
  

 

 

      

 

 

      

 

 

    

Total interest-bearing

     2,585,466         0.94     2,506,414         1.23     1,679,765         2.35
  

 

 

      

 

 

      

 

 

    

Total average deposits

   $ 3,098,818         $ 2,975,045         $ 1,969,534      
  

 

 

      

 

 

      

 

 

    

 

     Within 3
Months
     3 - 6
Months
     6 - 12
Months
     Over 12
Months
     Total      Percent Of
Total
Deposits
 

Maturities of time deposits of $100,000 and over

   $ 88,153       $ 42,216       $ 138,325       $ 242,920       $ 511,614         16.11

Capital Resources

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

The Federal Reserve and the FDIC have adopted capital guidelines to supplement the existing definitions of capital for regulatory purposes and to establish minimum capital standards. Specifically, the guidelines categorize assets and off-balance sheet items into four risk-weighted categories. The minimum ratio of qualifying total assets is 8.0%, of which 4.0% must be Tier 1 capital, consisting of common equity, retained earnings and a limited amount of perpetual preferred stock, less certain intangible items. The Company had a ratio of total capital to risk-weighted assets of 14.51% and 14.68% at December 31, 2011 and 2010, respectively. The Company’s ratio of Tier 1 capital to risk-weighted assets was 12.85% and 12.95% at December 31, 2011 and 2010, respectively, allowing the Company to meet the definition of “well-capitalized” for regulatory purposes. Both of these ratios exceeded the fully phased-in capital requirements in 2011 and 2010. The Company’s equity to asset ratio at December 31, 2011, 2010 and 2009 were 10.79%, 11.16% and 10.90%, respectively. The decline in the equity to assets ratio during 2011 was due to the Company’s redemption of the preferred stock issued to the Treasury.

In connection with two bank acquisitions, Prosperity Bank & Trust Company and Guaranty Financial Corporation, the Company has issued trust preferred capital notes to fund the cash portion of those acquisitions, collectively totaling $58.5 million. The total of the trust preferred capital notes currently qualify for Tier 1 capital of the Company for regulatory purposes.

On December 19, 2008, the Company entered into a Letter Agreement with Treasury, pursuant to which it issued 59,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (the “Series A Preferred Stock”) for $59 million. The issuance was made pursuant to the Treasury’s Capital Purchase Program (the “CPP”) under the Troubled Asset Relief Program. In November 2009, the Company redeemed the Series A Preferred Stock, by repaying, with accumulated dividends, the $59 million it received in December 2008. Additionally, in December 2009, the Company entered into a Warrant Repurchase Letter Agreement (“Warrant Repurchase”) with the Treasury to repurchase a warrant to purchase 211,318 shares of the Company’s common stock that was issued in connection with the Company’s sale of its Series A Preferred Stock. As a result of the Warrant Repurchase, the Company had no securities issued or outstanding to the Treasury and was no longer participating in the Treasury’s CPP as of November 18, 2009.

 

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The Company’s outstanding series of preferred stock as of December 31, 2010 resulted from the acquisition of First Market Bank. On February 6, 2009, First Market Bank issued and sold to the Treasury 33,900 shares of its Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B and a warrant to purchase up to 1,695 shares of its Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series C. The Treasury immediately exercised the warrant for the entire 1,695 shares. In connection with the Company’s acquisition of FMB, the Company’s Board of Directors established a series of preferred stock with substantially identical preferences, rights and limitations to the First Market Bank preferred stock, except as explained below. Pursuant to the closing of the acquisition, each share of First Market Bank Series B and Series C preferred stock was exchanged for one share of the Company’s Series B Preferred Stock. The Series B Preferred Stock of the Company pays cumulative dividends to the Treasury at a rate of 5.19% per annum for the first five years and thereafter at a rate of 9.0% per annum. The 5.19% dividend rate is a blended rate comprised of the dividend rate of the 33,900 shares of First Market Bank 5% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series B and 1,695 shares of First Market Bank 9% Fixed Rate Non-Cumulative Perpetual Preferred Stock, Series A. The Series B Preferred Stock of the Company is non-voting and each share has a liquidation preference of $1,000. During the fourth quarter of 2011, the Company received approval from the Treasury and its regulators to redeem the Preferred Stock issued to the Treasury and assumed by the Company as part of the 2010 merger with FMB. On December 7, 2011, the Company paid approximately $35.7 million, from cash, to the Treasury in full redemption of the Preferred Stock.

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

 

    2011     2010     2009  

Tier 1 capital:

     

Preferred stock—liquidity value

  $ —        $ 35,595      $ —     

Common stock—par value

    34,672        34,532        24,462   

Surplus

    187,493        185,763        98,136   

Retained earnings

    189,824        169,801        155,047   

Discount on preferred stock

    —          (1,177     —     
 

 

 

   

 

 

   

 

 

 

Total equity

    411,989        424,514        277,645   

Plus: qualifying trust preferred capital notes

    58,500        58,500        58,500   

Less: core deposit intangibles/goodwill/unrealized gain(loss) on AFS

    79,866        84,849        63,797   
 

 

 

   

 

 

   

 

 

 

Total Tier 1 capital

    390,623        398,165        272,348   
 

 

 

   

 

 

   

 

 

 

Tier 2 capital:

     

Subordinated debt

    12,305        14,892        —     

Allowance for loan losses

    38,007        38,406        25,374   
 

 

 

   

 

 

   

 

 

 

Total Tier 2 capital

    50,312        53,298        25,374   
 

 

 

   

 

 

   

 

 

 

Total risk-based capital

  $ 440,935      $ 451,463      $ 297,722   
 

 

 

   

 

 

   

 

 

 

Risk-weighted assets

  $ 3,039,099      $ 3,075,330      $ 2,024,824   
 

 

 

   

 

 

   

 

 

 

Capital ratios:

     

Tier 1 risk-based capital ratio

    12.85     12.95     13.45

Total risk-based capital ratio

    14.51     14.68     14.70

Leverage ratio (Tier 1 capital to average adjusted assets)

    10.14     10.55     10.86

Equity to total assets

    10.79     11.16     10.90

Tangible common equity to tangible assets

    8.91     8.22     8.64

Commitments and off-balance sheet obligations

In the normal course of business, the Company is a party to financial instruments with off-balance sheet risk to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments. For more information pertaining to these commitments, reference Note 11 “Financial Instruments with Off-Balance Sheet Risk” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of this Form 10-K.

 

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Table of Contents

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

At December 31, 2011, Union Mortgage had rate lock commitments to originate mortgage loans amounting to $45.8 million and loans held for sale of $74.8 million. Union Mortgage has entered into corresponding mandatory commitments on a best-efforts basis to sell loans on a servicing-released basis totaling approximately $120.6 million. These commitments to sell loans are designed to eliminate the mortgage company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.

The following table represents the Company’s other commitments with balance sheet or off-balance sheet risk as of December 31, 2011 and 2010 (dollars in thousands):

 

     2011      2010  

Commitments with off-balance sheet risk:

     

Commitments to extend credit (1)

   $ 720,317       $ 782,782   

Standby letters of credit

     38,068         38,347   

Mortgage loan rate lock commitments

     105,284         111,655   
  

 

 

    

 

 

 

Total commitments with off-balance sheet risk

   $ 863,669       $ 932,784   
  

 

 

    

 

 

 

Commitments with balance sheet risk:

     

Loans held for sale

   $ 74,823       $ 73,974   
  

 

 

    

 

 

 

Total commitments with balance sheet risk

   $ 74,823       $ 73,974   
  

 

 

    

 

 

 

Total other commitments

   $ 938,492       $ 1,006,758   
  

 

 

    

 

 

 

 

(1) Includes unfunded overdraft protection.

The following table presents the Company’s contractual obligations and scheduled payment amounts due at the various intervals over the next five years and beyond as of December 31, 2011 (dollars in thousands):

 

     Total      Less than
1 year
     1-3 years      4-5 years      More than
5 years
 

Long-term debt

   $ 215,691       $ —         $ —         $ —         $ 215,691   

Operating leases

     33,440         4,445         7,816         6,506         14,673   

Other short-term borrowings

     12,337         12,337         —           —           —     

Repurchase agreements

     50,658         50,658         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual obligations

   $ 312,126       $ 67,440       $ 7,816       $ 6,506       $ 230,364   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

For more information pertaining to the previous table, reference Note 5 “Bank Premise and Equipment” and Note 8 “Borrowings” in the “Notes to the Consolidated Financial Statements” contained in Item 8 of the Form 10-K.

 

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Table of Contents

Liquidity

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

The Company completed a follow-on equity raise on September 16, 2009, which generated cash and capital of approximately $58.8 million, net of underwriting discounts, commissions and estimated offering expenses from the issuance of 4,725,000 shares of common stock at a price of $13.25 per share. During the fourth quarter of 2009, the Company redeemed the Preferred Stock and warrant issued to the Treasury by repaying $59 million received in December 2008 under the Capital Purchase Program. In the fourth quarter of 2011, the Company redeemed $35.7 million of Preferred Stock issued to the Treasury that was assumed in the 2010 acquisition of FMB. Management considers the Company’s overall liquidity to be sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs.

At December 31, 2011, cash and cash equivalents and securities classified as available for sale comprised 18.9% of total assets, compared to 16.5% at December 31, 2010. Asset liquidity is also provided by managing loan and securities maturities and cash flows.

Additional sources of liquidity available to the Company include its capacity to borrow additional funds when necessary. The community bank segment maintains Federal funds lines with several regional banks totaling $113.0 million as of December 31, 2011. As of December 31, 2011, there were no outstanding balances on these Federal funds lines. The Company had outstanding borrowings pursuant to securities sold under agreements to repurchase transactions with a maturity of one day of $63.0 million as of December 31, 2011 compared to $69.5 million as of December 31, 2010. Lastly, the Company had a collateral dependent line of credit with the FHLB for up to $776.8 million as of December 31, 2011. There was approximately $141.0 million outstanding under this line at December 31, 2011.

As of December 31, 2011, cash, interest-bearing deposits in other banks, money market investments, Federal funds sold, loans held for sale, investment securities, and loans that mature within one year totaled $1.2 billion, or 34.4%, of total earning assets. As of December 31, 2011, approximately $979 million, or 34.7%, of total loans are scheduled to mature within one year.

NON GAAP MEASURES

In reporting the results of 2011 and 2010, the Company has provided supplemental performance measures on an operating or tangible basis. Such measures exclude amortization expense related to intangible assets, such as core deposit and trademark intangibles. The Company believes these measures are useful to investors as they exclude non-operating adjustments resulting from acquisition activity and allow investors to see the combined economic results of the organization. Cash basis operating earnings per share was $1.33 for the year ended December 31, 2011 compared to $1.10 in 2010. Cash basis return on average tangible common equity and assets for the year ended December 31, 2011 was 10.64% and 0.92%, respectively, compared to 9.35% and 0.76%, respectively, in 2010.

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

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

 

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Table of Contents
     2011     2010  

Net income

   $ 30,445      $ 22,922   

Plus: core deposit intangible amortization, net of tax

     3,979        4,721   

Plus: trademark intangible amortization, net of tax

     260        239   
  

 

 

   

 

 

 

Cash basis operating earnings

     34,684        27,882   
  

 

 

   

 

 

 

Average assets

     3,861,628        3,752,569   

Less: average trademark intangible

     631        933   

Less: average goodwill

     58,494        57,566   

Less: average core deposit intangibles

     23,654        28,470   
  

 

 

   

 

 

 

Average tangible assets

     3,778,849        3,665,600   
  

 

 

   

 

 

 

Average equity

     441,040        416,577   

Less: average trademark intangible

     631        933   

Less: average goodwill

     58,494        57,566   

Less: average core deposit intangibles

     23,654        28,470   

Less: average preferred equity

     32,171        31,387   
  

 

 

   

 

 

 

Average tangible common equity

   $ 326,090      $ 298,221   
  

 

 

   

 

 

 

Weighted average shares outstanding, diluted

     26,009,839        25,268,216   

Cash basis earnings per share, diluted

   $ 1.33      $ 1.10   

Cash basis return on average tangible assets

     0.92     0.76

Cash basis return on average tangible common equity

     10.64     9.35

The allowance for loan losses as a percentage of the total loan portfolio includes net loans acquired in the FMB and the Harrisonburg branch acquisitions. The acquired loans discount or premium to market is accreted/amortized as an increase/decrease to net interest income over the estimated lives of the liabilities. Additional credit quality deterioration above the original credit mark is recorded as additional provisions for loan losses. The following table shows the allowance for loan losses as a percentage of the total loan portfolio, adjusted to remove acquired loans.

 

     For the year ended December 31,  
     2011     2010  

Gross loans

   $ 2,818,583      $ 2,837,253   

Less: acquired loans without additional credit deterioration

     (663,510     (793,730
  

 

 

   

 

 

 

Gross loans, net of acquired

   $ 2,155,073      $ 2,043,523   

Allowance for loan losses

   $ 39,470      $ 38,406   
  

 

 

   

 

 

 

Allowance for loan losses ratio

     1.40     1.35

Allowance for loan losses ratio, net of acquired

     1.83     1.88

 

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Table of Contents

QUARTERLY RESULTS

The following table presents the Company’s quarterly performance for the years ended December 31, 2011 and 2010 (dollars in thousands, except per share amounts):

 

     Quarter         
     First      Second      Third      Fourth      Total (1)  

For the Year 2011

              

Interest and dividend income

   $ 47,392       $ 47,756       $ 47,606       $ 46,319       $ 189,073   

Interest expense

     8,592         8,133         8,160         7,828         32,713   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     38,800         39,623         39,446         38,491         156,360   

Provision for loan losses

     6,300         4,500         3,600         2,400         16,800   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     32,500         35,123         35,846         36,091         139,560   

Noninterest income

     10,547         9,963         11,544         11,723         43,777   

Noninterest expenses

     34,767         35,872         34,637         36,352         141,628   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     8,280         9,214         12,753         11,462         41,709   

Income tax expense

     2,086         2,394         3,682         3,102         11,264   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 6,194       $ 6,820       $ 9,071       $ 8,360       $ 30,445   

Dividends paid and accumulated on preferred stock

     462         462         462         113         1,499   

Accretion of discount on preferred stock

     64         65         66         983         1,177   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income available to common shareholders

   $ 5,668       $ 6,293       $ 8,543       $ 7,264       $ 27,769   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Earnings per share, basic

   $ 0.22       $ 0.24       $ 0.33       $ 0.28       $ 1.07   

Earnings per share, diluted

   $ 0.22       $ 0.24       $ 0.33       $ 0.28       $ 1.07   

For the Year 2010

              

Interest and dividend income

   $ 43,318       $ 49,295       $ 48,440       $ 48,768       $ 189,821   

Interest expense

     9,158         9,755         9,791         9,541         38,245   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income

     34,160         39,540         38,649         39,227         151,576   

Provision for loan losses

     5,001         3,955         5,912         9,500         24,368   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net interest income after provision for loan losses

     29,159         35,585         32,737         29,727         127,208   

Noninterest income

     9,739         12,128         12,353         13,078         47,298   

Noninterest expenses

     36,800         35,148         33,984         37,069         143,001   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Income before income taxes

     2,098         12,565         11,106         5,736         31,505   

Income tax expense (benefit)

     399         3,839         3,033         1,312         8,583   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income

   $ 1,699       $ 8,726       $ 8,073       $ 4,424       $ 22,922   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Dividends paid and accumulated on preferred stock

     303         462         462         462         1,689   

Accretion of discount on preferred stock

     51         50         62         63         225   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Net income (loss) available to common shareholders

   $ 1,345       $ 8,214       $ 7,549       $ 3,899       $ 21,008