6.COMMITMENTS AND CONTINGENCIES

Litigation Matters

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

Litigation Relating to the StellarOne Acquisition

In a joint press release issued on June 10, 2013, the Company announced the signing of a definitive merger agreement for the acquisition of StellarOne Corporation (“StellarOne”).  The Company expects to close the merger on or around January 1, 2014, subject to customary closing conditions, including shareholder approval.  On June 14, 2013, Jaclyn Crescente, individually and on behalf of all other StellarOne shareholders, filed a class action complaint against StellarOne, its current directors, StellarOne Bank, and the Company, in the U.S. District Court for the Western District of Virginia, Charlottesville Division (Case No. 3:13-cv-00021-NKM).  The complaint alleges that the StellarOne directors breached their fiduciary duties by approving the merger with the Company and that the Company aided and abetted in such breaches of duty.  The complaint seeks, among other things, an order enjoining the defendants from proceeding with or consummating the merger, as well as other equitable relief and/or money damages in the event that the transaction is completed.  StellarOne and the Company believe that the claims are without merit.

Financial Instruments with Off-Balance Sheet Risk 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets.  The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.

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

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

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

Union Mortgage Group, Inc., a wholly owned subsidiary of the Bank, uses rate lock commitments during the origination process and for loans held for sale.  These commitments to sell loans are designed to mitigate the mortgage company’s exposure to fluctuations in interest rates in connection with rate lock commitments and loans held for sale.  At September 30, 2013, the Company held approximately $1.9 million of the loans available for sale in which the related rate lock commitment had expired; accordingly, a valuation adjustment of $120,000 was recorded to properly reflect the lower of cost or market value of these loans.  This valuation adjustment was recorded within the mortgage segment; there was no valuation adjustment recorded in the prior year.

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

The Company must maintain a reserve against its deposits in accordance with Regulation D of the Federal Reserve Act.  For the final weekly reporting period in the periods ended September 30, 2013 and December 31, 2012, the aggregate amount of daily average required reserves was approximately $15.4 million and $14.2 million, respectively.

The Company has approximately $8.6 million in deposits in other financial institutions, of which $3.4 million serves as collateral for the trust swap further discussed in Note 7 “Derivatives.” The Dodd-Frank Act, which was signed into law on July 21, 2010, provided unlimited deposit insurance coverage for transaction accounts, but such provision expired on December 31, 2012.  As of January 1, 2013, the deposit insurance coverage for transaction accounts is up to at least $250,000.   The Company had approximately $4.5 million in deposits in other financial institutions that were uninsured at September 30, 2013.   On an annual basis, the Company’s management evaluates the loss risk of its uninsured deposits in financial counter-parties.

For asset/liability management purposes, the Company uses interest rate swap agreements to hedge various exposures or to modify the interest rate characteristics of various balance sheet accounts. See Note 7 “Derivatives” in these “Notes to the Consolidated Financial Statements” for additional information. 

Union Mortgage Group, Inc. has identified errors with respect to Truth in Lending Act disclosures made to certain customers during the period from November 2011 through August 2013 in connection with certain loans originated pursuant to insured loan programs administered by the United States Department of Agriculture and Federal Housing Administration.  These disclosure errors understated to the borrowers the amount of mortgage insurance premiums that were required to be assessed over the life of the loans under guidelines enacted by these loan programs.  The Company has, however, taken certain remedial action with respect to the affected borrowers to address the disclosure errors as permitted under applicable law.  Virtually all of these loans were sold to third parties prior to the identification of the errors.  Under the terms of the purchase agreements entered into in connection with the sale of such loans, amongst other remedies, these third parties have the right to require the Company to repurchase any such loans because of the errors.  The Company is in the process of assessing whether these errors will have an impact on its financial statements and has concluded that not all of the relevant facts are available in order to reasonably estimate potential liability, if any. In the ordinary course of business, the Company records an indemnification reserve relating to mortgage loans previously sold based on historical statistics and loss rates.  As of September 30, 2013 and December 31, 2012, the Company’s indemnification reserve was $564,000 and $446,000, respectively.