|
ITEM 2.
|
|
MANAGEMENT’S
DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
|
Forward-Looking
Statements
This management’s
discussion and analysis and other portions of this report, contain
forward-looking statements within the
meaning of the Securities and Exchange Act of 1934, as amended, including
statements of goals, intentions, and
expectations as to future trends, plans, events or results of Company
operations and policies and regarding general economic conditions. In some
cases, forward-looking statements can be identified by use of words such as “may,”
“will,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,”
“continue,” “should,” and similar words or phrases. These statements are based
upon current and anticipated economic conditions, nationally and in the Company’s
market, interest rates and interest rate policy, competitive factors, and other
conditions which by their nature, are not susceptible to accurate forecast, and
are subject to significant uncertainty. Because of these uncertainties and the
assumptions on which this discussion and the forward-looking statements are
based, actual future operations and results may differ materially from those
indicated herein. Readers are cautioned against placing undue reliance on any
such forward-looking statements. The Company’s past results are not necessarily
indicative of future performance.
Non-GAAP Presentations
This management’s
discussion and analysis refers to the efficiency ratio, which is computed by
dividing non-interest expense by the sum of net interest income on a tax
equivalent basis and non-interest income. This is a non-GAAP financial measure
that we believe provides investors with important information regarding our
operational efficiency. Comparison of our efficiency ratio with those of other
companies may not be possible because other companies may calculate the
efficiency ratio differently. The Company, in referring to its net income, is
referring to income under accounting principals generally accepted in the
United States, or “GAAP”.
General
The following presents
management’s discussion and analysis of the consolidated financial condition
and results of operations of Virginia Commerce Bancorp, Inc. and subsidiaries
(the “Company”) as of the dates and for the periods indicated. This discussion
should be read in conjunction with the Company’s Consolidated Financial
Statements and the Notes thereto, and other financial data appearing elsewhere
in this report. The Company is the parent bank holding company for Virginia
Commerce Bank (the “Bank”), a Virginia state-chartered bank that commenced
operations in May 1988. The Bank pursues a traditional community banking
strategy, offering a full range of business and consumer banking services
through twenty-three branch offices, two residential mortgage offices and two
investment services offices.
Headquartered in
Arlington, Virginia, Virginia Commerce serves the Northern Virginia suburbs of
Washington, D.C., including Arlington, Fairfax, Fauquier, Loudoun, Prince
William, Spotsylvania and Stafford Counties and the cities of Alexandria,
Fairfax, Falls Church, Fredricksburg, Manassas and Manassas Park. Its service
area also covers, to a lesser extent, Washington, D.C. and the nearby Maryland
counties of Montgomery and Prince Georges. The Bank’s customer base includes
small-to-medium size businesses including firms that have contracts with the
U.S. government, associations, retailers and industrial businesses,
professionals and their firms, business executives, investors and consumers.
Additionally, the Bank has strong market niches in commercial real estate and
construction lending, and operates its residential mortgage lending division as
its only other business segment.
Critical Accounting
Policies
During the quarter ended
September 30, 2007, there were no changes in the Company’s critical accounting
policies as reflected in the last report.
The
Company’s financial statements are prepared in accordance with accounting
principles generally accepted in the United States (“GAAP”). The financial
information contained within our statements is, to a significant extent,
financial information that is based on measures of the financial effects of
transactions and events that have already occurred. A variety of factors could
affect the ultimate value that is obtained either when earning income,
recognizing an expense, recovering an asset or relieving a liability. We use
historical loss factors as one factor in
12
determining
the inherent loss that may be present in our loan portfolio. Actual losses
could differ significantly from the historical factors that we use. In
addition, GAAP itself may change from one previously acceptable method to
another method. Although the economics of our transactions would be the same,
the timing of events that would impact our transactions could change.
The allowance for loan losses is an estimate of the losses
that are inherent in our loan portfolio. The allowance is based on two basic
principles of accounting: (i) SFAS 5, Accounting
for Contingencies, which requires that losses be accrued when they are
probable of occurring and estimatable and (ii) SFAS 114, Accounting by Creditors for Impairment of a
Loan, 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.
Our
allowance for loan losses has three basic components: the specific allowance, the formula allowance
and the unallocated allowance. Each of these components is determined based
upon estimates that can and do change when the actual events occur. The
specific allowance is used to individually allocate an allowance for loans
identified as impaired. Impairment testing includes consideration of the
borrower’s overall financial condition, resources and payment record, support
available from financial guarantors and the fair market value of collateral. These
factors are combined to estimate the probability and severity of inherent
losses. When impairment is identified, then a specific reserve is established
based on the Company’s calculation of the loss embedded in the individual loan.
Large groups of smaller balance, homogeneous loans are collectively evaluated
for impairment. Accordingly, the Company does not separately identify
individual consumer and residential loans for impairment. The formula allowance
is used for estimating the loss on internally risk rated loans exclusive of
those identified as impaired. The loans meeting the criteria for substandard,
doubtful and loss, as well as impaired loans are segregated from performing
loans within the portfolio. Internally classified loans are then grouped by
loan type (commercial, commercial real estate, commercial construction,
residential real estate, residential construction or installment). Each loan
type is assigned an allowance factor based on management’s estimate of the
associated risk, complexity and size of the individual loans within the
particular loan category. Classified loans are assigned a higher allowance
factor than non-rated loans due to management’s concerns regarding
collectibility or management’s knowledge of particular elements surrounding the
borrower. Allowance factors grow with the worsening of the internal risk
rating. The unallocated formula is used to estimate the loss of non-classified
loans. These un-criticized loans are also segregated by loan type and allowance
factors are assigned by management based on delinquencies, loss history, trends
in volume and terms of loans, effects of changes in lending policy, the
experience and depth of management, national and local economic trends,
concentrations of credit, quality of the loan review system and the effect of
external factors (i.e. competition and regulatory requirements). The factors
assigned differ by loan type. The unallocated allowance captures losses whose
impact on the portfolio has occurred but has yet to be recognized in either the
formula or specific allowance. Allowance factors and the overall size of the
allowance may change from period to period based on management’s assessment of
the above described factors and the relative weights given to each factor.
Further information regarding the allowance for loan losses is provided under
the caption:
Allowance for Loan Losses/Provision for Loan Loss Expense
,
later in this report.
The
Company’s 1998 Stock Option Plan, as amended (the “Plan”), which is
shareholder-approved, permits the grant of share options to its directors and
officers for up to 2.3 million shares of common stock, as adjusted for the 10%
stock dividend paid on May 1, 2007. Option awards are generally granted with an
exercise price equal to the market price of the Company’s stock at the date of
grant, generally vest based on 5 years of continuous service and have 10-year
contractual terms. The fair value of each option award is estimated on the date
of grant using a Black-Scholes option pricing model that currently uses
historical volatility of the Company’s stock based on a 7.5 year expected term,
before exercise, for the options granted, and a risk-free interest rate based
on the U.S. Treasury curve in effect at the time of the grant to estimate total
stock-based compensation expense. Expected term is calculated using the
simplified method identified in Staff Accounting Bulletin No. 107. This amount
is then amortized on a straight-line basis over the requisite service period,
currently 5 years, to salaries and benefits expense. Changes in the expected
outstanding term for all awards based on historical exercise behavior could
affect the estimated value of future grants. See Note 5 to the Consolidated
Financial Statements for additional information regarding the Stock Option Plan
and related expense.
13
Results of Operations
For the nine months ended
September 30, 2007, the Bank experienced strong growth in assets, loans and
deposits, opened three new branch locations raising the total number to
twenty-three, and increased earnings by $2.1 million, or 11.6%, over the same
period in 2006. Total assets increased $279.2 million, or 14.3%, from $1.95
billion at December 31, 2006, to $2.23 billion at September 30, 2007, as
deposits grew $199.8 million, or 12.4%, from $1.60 billion at December 31,
2006, to $1.80 billion. On a diluted per share basis, earnings for the nine
months ended September 30, 2007, were $0.81 compared to $0.73 for the same
period in 2006, an increase of 11.0%. The year-over-year increase was due to an
8.8% increase in net interest income, a 14.6% increase in non-interest income,
and a 53.6% decline in loan loss provisions due to declines in nonperforming
loans and loans 90+ days past due and
slower loan growth. The increase in non-interest income was affected by
two one-time items resulting in an aggregate increase of $251 thousand. The
first item, a pre-tax loss of $387 thousand, resulted from a partial
restructuring of the investment securities portfolio, and the second item, a
pre-tax gain of $638 thousand, reflects the gain on sale of a foreclosed
property which had secured a nonperforming loan.
Loans, net of the
allowance for loan losses, increased $186.5 million, or 11.4%, from $1.63
billion at December 31, 2006, to $1.81 billion at September 30, 2007, and
represented 100.6% of total deposits at September 30, 2007, compared to 101.5%
at December 31, 2006. The majority of the growth in loans occurred in non-farm,
non-residential real estate loans, which rose $123.1 million, or 17.9%, from
$689.1 million at December 31, 2006, to $812.2 million at September 30, 2007,
while loans secured by one-to-four family residential real estate represented
the second largest increase, rising $40.7 million, or 21.1%. Commercial loans
also experienced strong growth, increasing $30.2 million, or 15.9%, while real
estate-construction loans declined over the nine month period by $2.9 million.
Loan growth in 2007 has been impacted by a higher level of run-off, principally
in construction loans, with total run-off year-to-date of $277.5 million
compared to $118.3 million in for the nine months ended September 30, 2006.
Total deposit growth of
$199.8 million included an increase in demand deposits of $11.9 million, or
6.4%, from $186.9 million at December 31, 2006, to $198.9 million at September
30, 2007, an increase in savings and interest-bearing demand deposits of $70.1
million, and an increase in time deposits of $117.8 million, or 12.3%, from
$959.5 million at December 31, 2006, to $1.08 billion. The majority of the Bank’s
deposits are attracted from individuals and businesses in the Northern Virginia
and the Metropolitan Washington, D.C. area, and the interest rates the Bank
pays are generally near the top of the local market. Growth in deposits has
been supported by continued promotions for new savings and money market
products as well as special advertised rates on time deposits in local
newspapers.
Repurchase agreements and
Federal funds purchased increased $31.7 million, or 21.3%, from $148.9 million
at December 31, 2006, to $180.6 million at September 30, 2007. Of the total
increase, Federal funds purchased are up $32.0 million, while repurchase
agreements, the majority of which represent funds of significant demand deposit
customers of the Bank, declined $320 thousand.
Other borrowed funds
represent a $25 million advance from the Federal Home Loan Bank of Atlanta. The
advance, which is secured by qualifying one-to-four family residential first
and second liens in the Bank’s portfolio, has an initial rate of 3.21%, which
resets quarterly at three-month Libor less 200 basis points, and then converts
to a fixed rate of 4.25% in March 2008, for a remaining term of 4.5 years,
unless called.
As noted, for the nine
months ended September 30, 2007, net income increased $2.1 million, or 11.6%,
from $18.1 million for the nine months ended September 30, 2006, to $20.2
million, as net interest income increased $4.5 million, or 8.8%, non-interest
income increased $773 thousand, or 14.6%, and provisions for loan losses were
down $1.8 million, or 53.6%. Diluted earnings per share, adjusted giving effect
to a 10% stock dividend in May 2007, of $0.81 were up $0.08, or 11.0%, from
$0.73 for the comparable period in 2006. The Company’s annualized return on
average assets and return on average equity were 1.30% and 17.99% for the
current nine month period compared to 1.43% and 19.80% for the nine months
ended September 30, 2006.
For the three months
ended September 30, 2007, net income of $6.8 million increased $743 thousand,
or 12.2%, compared to $6.1 million for the same period in 2006 as net interest
income rose $1.4 million, or 8.2%, non-interest income was up $382 thousand, or
20.7%, and provisions for loan losses were down $510 thousand, or 35.9%, again
due to declines in nonperforming loans and loans 90+ days past due, slower loan
growth and a shift in loan mix to loan types requiring smaller reserve
allocations. Also, as noted above, the increase in non-interest income was
14
affected by two one-time
items resulting in an aggregate increase of $251 thousand. The first item, a
pre-tax loss of $387 thousand, resulted from a partial restructuring of the
investment securities portfolio, and the second item, a pre-tax gain of $638 thousand,
reflects the gain on sale of a foreclosed property which had secured a
nonperforming loan, both were recognized in the third quarter. Diluted earnings
per share increased $0.02, or 8.0%, from $0.25 for the three months ended
September 30, 2006, to $0.27 for the three month period ended September 30,
2007. The return on average assets and return on average equity were 1.25% and
17.25% for the three months ended September 30, 2007, compared to 1.35% and
18.72% for the same period in 2006.
Stockholders’ equity
increased $21.7 million, or 15.5%, from $139.9 million at December 31, 2006, to
$161.6 million at September 30, 2007, on earnings of $20.2 million, a $759
thousand increase in other comprehensive income, and $786 thousand in proceeds
and tax benefits related to the exercise of stock options by directors and
officers, and employees and stock option expense credits. In May 2007, the
Company paid a 10% stock dividend increasing the number of shares outstanding
to 23.9 million.
Net Interest Income
Net interest income is
the excess of interest earned on loans and investments over the interest paid
on deposits and borrowings, and is the Company’s primary revenue source. Net
interest income is thereby affected by balance sheet growth, changes in interest
rates and changes in the mix of investments, loans, deposits and borrowings.
Net interest income increased $4.5 million, or 8.8%, from $50.9 million for the
nine months ended September 30, 2006, to $55.4 million for the nine month
period ended September 30, 2007, and increased $1.4 million, or 8.2%, from
$17.5 million for the three months ended September 30, 2006, to $18.9 million
for the three months ended September 30, 2007. Increases for both periods were
due to overall balance sheet growth as the net interest margin declined from
4.16% for the nine months ended September 30, 2006, to 3.69% for the current
nine-month period and from 4.01% for the three months ended September 30, 2006,
to 3.58% for the three months ended September 30, 2007.
The year-over-year
declines in the net interest margin continue to be primarily the result of
significantly higher short-term rates on savings, money market and time deposit
accounts, a shift of funds in 2006 from lower rate interest-bearing checking
accounts to the higher rate accounts, and ongoing strong competition for
deposits in the local market. These factors resulted in a 62 basis point
increase in the cost of interest-bearing liabilities year-over-year, compared
to a 16 basis point increase in the yield on interest-earning assets. For the
three month period ended September 30, 2007, the cost of interest-bearing
liabilities rose 39 basis points over the comparable period in 2006, while the
yield on interest-earning assets declined by one basis point.
Despite the Federal Open
Market Committee’s recent reductions in the Fed funds target rate, management
expects the margin to decline somewhat further in the fourth quarter of 2007 as
approximately 32% of the Company’s loan portfolio immediately repriced downward
with the prime rate dropping 50 basis points, while approximately 20% of
deposit liabilities were able to be repriced down 25 to 50 basis points.
However, over the near-term, as the Bank’s $1.1 billion in time deposits, which
have an average term of 6.7 months as of September 30, 2007, mature or are
replaced at lower market rates, the margin is expected to improve. As a result,
management anticipates the margin to range from 3.50% to 3.70% for the
foreseeable future.
The following tables show
the average balance sheets for each of the three months and nine months ended
September 30, 2007 and 2006. In addition, the amounts of interest earned on
earning assets, with related yields on a tax-equivalent basis, and interest
expense on interest-bearing liabilities, with related rates, are shown. Loans
placed on a non-accrual status are included in the average balances. Net loan
fees and late charges included in interest income on loans totaled $1.4 million
and $1.1 million for the three month period ended September 30, 2007 and 2006,
respectively, and totaled $4.2 million and $4.0 million for the nine month
periods.
15
|
|
|
Three months ended September 30,
|
|
|
|
|
2007
|
|
2006
|
|
|
(Dollars in thousands)
|
|
Average
Balance
|
|
Interest
Income-
Expense
|
|
Average
Yields
/Rates
|
|
Average
Balance
|
|
Interest
Income-
Expense
|
|
Average
Yields
/Rates
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities (1)
|
|
$
|
289,115
|
|
$
|
3,614
|
|
5.09
|
%
|
$
|
207,479
|
|
$
|
2,336
|
|
4.54
|
%
|
|
Loans, net of
unearned income
|
|
1,783,272
|
|
35,441
|
|
7.90
|
%
|
1,510,936
|
|
30,063
|
|
7.79
|
%
|
|
Interest-bearing
deposits in other banks
|
|
1,230
|
|
17
|
|
5.48
|
%
|
1,060
|
|
13
|
|
5.03
|
%
|
|
Federal funds
sold
|
|
31,502
|
|
405
|
|
5.03
|
%
|
9,567
|
|
125
|
|
5.11
|
%
|
|
Total
interest-earning assets
|
|
$
|
2,105,119
|
|
$
|
39,477
|
|
7.46
|
%
|
$
|
1,729,042
|
|
$
|
32,537
|
|
7.47
|
%
|
|
Other assets
|
|
67,157
|
|
|
|
|
|
55,203
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
2,172,276
|
|
|
|
|
|
$
|
1,784,245
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW accounts
|
|
$
|
154,587
|
|
$
|
669
|
|
1.72
|
%
|
$
|
165,986
|
|
$
|
684
|
|
1.64
|
%
|
|
Money market
accounts
|
|
219,190
|
|
2,207
|
|
4.00
|
%
|
214,004
|
|
1,977
|
|
3.66
|
%
|
|
Savings accounts
|
|
136,230
|
|
1,533
|
|
4.47
|
%
|
22,753
|
|
109
|
|
1.90
|
%
|
|
Time deposits
|
|
1,080,603
|
|
13,821
|
|
5.07
|
%
|
851,280
|
|
9,914
|
|
4.62
|
%
|
|
Total
interest-bearing deposits
|
|
$
|
1,590,610
|
|
$
|
18,230
|
|
4.55
|
%
|
$
|
1,254,023
|
|
$
|
12,684
|
|
4.01
|
%
|
|
Securities sold
under agreements to repurchase and federal funds purchased
|
|
162,312
|
|
1,563
|
|
3.82
|
%
|
125,358
|
|
1,313
|
|
4.15
|
%
|
|
Other borrowed
funds
|
|
2,717
|
|
22
|
|
3.21
|
%
|
20,652
|
|
290
|
|
5.49
|
%
|
|
Trust preferred
capital notes
|
|
43,000
|
|
787
|
|
7.16
|
%
|
43,000
|
|
799
|
|
7.28
|
%
|
|
Total
interest-bearing liabilities
|
|
$
|
1,798,639
|
|
$
|
20,602
|
|
4.54
|
%
|
$
|
1,443,033
|
|
$
|
15,086
|
|
4.15
|
%
|
|
Demand deposits
and other liabilities
|
|
216,654
|
|
|
|
|
|
212,235
|
|
|
|
|
|
|
Total
liabilities
|
|
$
|
2,015,293
|
|
|
|
|
|
$
|
1,655,268
|
|
|
|
|
|
|
Stockholders’
equity
|
|
156,983
|
|
|
|
|
|
128,977
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
2,172,276
|
|
|
|
|
|
$
|
1,784,245
|
|
|
|
|
|
|
Interest rate
spread
|
|
|
|
|
|
2.92
|
%
|
|
|
|
|
3.32
|
%
|
|
Net interest
income and margin
|
|
|
|
$
|
18,875
|
|
3.58
|
%
|
|
|
$
|
17,451
|
|
4.01
|
%
|
(1) Yields on securities available-for-sale have been calculated on the
basis of historical cost and do not give effect to changes in the fair value of
those securities, which are reflected as a component of stockholders’ equity. Average
yields on securities are stated on a tax equivalent basis, using a 35% rate.
16
|
|
|
Nine months ended September 30,
|
|
|
|
|
2007
|
|
2006
|
|
|
(Dollars in thousands)
|
|
Average
Balance
|
|
Interest
Income-
Expense
|
|
Average
Yields
/Rates
|
|
Average
Balance
|
|
Interest
Income-
Expense
|
|
Average
Yields
/Rates
|
|
|
Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Securities (1)
|
|
$
|
263,790
|
|
$
|
9,603
|
|
4.86
|
%
|
$
|
192,212
|
|
$
|
6,180
|
|
4.29
|
%
|
|
Loans, net of
unearned income
|
|
1,728,996
|
|
102,756
|
|
7.95
|
%
|
1,429,660
|
|
83,529
|
|
7.81
|
%
|
|
Interest-bearing
deposits in other banks
|
|
1,252
|
|
52
|
|
5.59
|
%
|
1,049
|
|
39
|
|
4.99
|
%
|
|
Federal funds
sold
|
|
24,492
|
|
952
|
|
5.12
|
%
|
17,421
|
|
624
|
|
4.72
|
%
|
|
Total
interest-earning assets
|
|
$
|
2,018,530
|
|
$
|
113,363
|
|
7.53
|
%
|
$
|
1,640,342
|
|
$
|
90,372
|
|
7.37
|
%
|
|
Other assets
|
|
63,736
|
|
|
|
|
|
54,029
|
|
|
|
|
|
|
Total
Assets
|
|
$
|
2,082,266
|
|
|
|
|
|
$
|
1,694,371
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Liabilities
and Stockholders’ Equity
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest-bearing
deposits:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
NOW accounts
|
|
$
|
157,086
|
|
$
|
1,990
|
|
1.69
|
%
|
$
|
181,869
|
|
$
|
2,250
|
|
1.65
|
%
|
|
Money market
accounts
|
|
227,926
|
|
6,755
|
|
3.96
|
%
|
183,062
|
|
4,610
|
|
3.37
|
%
|
|
Savings accounts
|
|
107,011
|
|
3,512
|
|
4.39
|
%
|
19,490
|
|
157
|
|
1.08
|
%
|
|
Time deposits
|
|
1,036,200
|
|
38,919
|
|
5.02
|
%
|
810,467
|
|
26,217
|
|
4.32
|
%
|
|
Total
interest-bearing deposits
|
|
$
|
1,528,223
|
|
$
|
51,176
|
|
4.48
|
%
|
$
|
1,194,888
|
|
$
|
33,234
|
|
3.72
|
%
|
|
Securities sold
under agreement to repurchase and federal funds purchased
|
|
151,355
|
|
4,399
|
|
3.89
|
%
|
112,087
|
|
3,378
|
|
4.03
|
%
|
|
Other borrowed
funds
|
|
916
|
|
22
|
|
3.21
|
%
|
13,004
|
|
506
|
|
5.13
|
%
|
|
Trust preferred
capital notes
|
|
43,000
|
|
2,346
|
|
7.19
|
%
|
43,000
|
|
2,303
|
|
7.06
|
%
|
|
Total
interest-bearing liabilities
|
|
$
|
1,723,494
|
|
$
|
57,943
|
|
4.49
|
%
|
$
|
1,362,979
|
|
$
|
39,421
|
|
3.87
|
%
|
|
Demand deposits
and other liabilities
|
|
208,770
|
|
|
|
|
|
209,324
|
|
|
|
|
|
|
Total
liabilities
|
|
$
|
1,932,264
|
|
|
|
|
|
$
|
1,572,303
|
|
|
|
|
|
|
Stockholders’
equity
|
|
150,002
|
|
|
|
|
|
122,068
|
|
|
|
|
|
|
Total
liabilities and stockholders’ equity
|
|
$
|
2,082,266
|
|
|
|
|
|
$
|
1,694,371
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest rate
spread
|
|
|
|
|
|
3.04
|
%
|
|
|
|
|
3.50
|
%
|
|
Net interest
income and margin
|
|
|
|
$
|
55,420
|
|
3.69
|
%
|
|
|
$
|
50,951
|
|
4.16
|
%
|
(1) Yields on securities available-for-sale have been calculated on the
basis of historical cost and do not give effect to changes in the fair value of
those securities, which are reflected as a component of stockholders’ equity. Average
yields on securities are stated on a tax equivalent basis, using a 35% rate.
17
Allowance for Loan Losses
/ Provision for Loan Loss Expense
The provision for loan
losses is based upon management’s estimate of the amount required to maintain
an adequate allowance for loan losses reflective of the risks in the loan
portfolio. For the nine months ended September 30, 2007, provisions for loan
losses were $1.6 million compared to $3.4 million in the same period in 2006.
This was due to lower net loan growth of $186.5 million in 2007 as compared to
growth of $274.6 million in 2006, a decline in non-performing loans and loans
90+ days past due from $3.9 million at December 31, 2006, to $1.9 million and a
significant decrease in other identified potential problem loans, which,
although well-secured and currently performing, but requiring higher reserve
levels, fell from $11.6 million at December 31, 2006, to $4.0 million at
September 30, 2007. As a result, the allowance for loan losses to total loans
dropped from 1.10% at December 31, 2006, to 1.06% as of September 30, 2007. See
“Risk Elements and Non-performing Assets” for additional discussion relating to
the increase in non-performing assets and potential problem loans.
Management feels that
the allowance for loan losses is adequate at September 30, 2007. However, there
can be no assurance that additional provisions for loan losses will not be
required in the future, including as a result of possible changes in the
economic assumptions underlying management’s estimates and judgments, adverse
developments in the economy, on a national basis or in the Company’s market
area, or changes in the circumstances of particular borrowers.
The Company generates a
quarterly analysis of the allowance for loan losses, with the objective of
quantifying portfolio risk into a dollar figure of inherent losses, thereby
translating the subjective risk value into an objective number. Emphasis is
placed on semi-annual independent external loan reviews and monthly internal
reviews. The determination of the allowance for loan losses is based on
applying and summing the results of eight qualitative factors and one
quantitative factor to each category of loans along with any specific allowance
for impaired and adversely classified loans within the particular category.
Each factor is assigned a percentage weight and that total weight is applied to
each loan category. The resulting sum from each loan category is then combined
to arrive at a total allowance for all categories. Factors are different for
each loan category. Qualitative factors include: levels and trends in
delinquencies and non-accruals, trends in volumes and terms of loans, effects
of any changes in lending policies, the experience, ability and depth of
management, national and local economic trends and conditions, concentrations
of credit, quality of the Company’s loan review system, and regulatory
requirements. The total allowance required thus changes as the percentage
weight assigned to each factor is increased or decreased due to its particular
circumstance, as the various types and categories of loans change as a
percentage of total loans and as specific allowances are required due to an
increase in impaired and adversely classified loans.
The following schedule
summarizes the changes in the allowance for loan losses:
|
|
|
Nine Months
|
|
Nine Months
|
|
Twelve Months
|
|
|
|
|
Ended
|
|
Ended
|
|
Ended
|
|
|
|
|
September 30, 2007
|
|
September 30, 2006
|
|
December 31, 2006
|
|
|
|
|
(In Thousands of Dollars)
|
|
|
|
|
|
|
|
|
|
|
|
Allowance, at
beginning of period
|
|
$
|
18,101
|
|
$
|
13,821
|
|
$
|
13,821
|
|
|
Provision
charged against income
|
|
1,570
|
|
3,380
|
|
4,406
|
|
|
Recoveries:
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
22
|
|
45
|
|
63
|
|
|
Losses charged
to reserve:
|
|
|
|
|
|
|
|
|
Consumer loans
|
|
—
|
|
(45
|
)
|
(77
|
)
|
|
Commercial loans
|
|
(99
|
)
|
(101
|
)
|
(112
|
)
|
|
Net
(charge-offs) recoveries
|
|
(77
|
)
|
(101
|
)
|
(126
|
)
|
|
Allowance, at
end of period
|
|
$
|
19,594
|
|
$
|
17,100
|
|
$
|
18,101
|
|
|
|
|
|
|
|
|
|
|
|
Ratio of net
charge-offs to average loans outstanding during period
|
|
.004
|
%
|
.01
|
%
|
.01
|
%
|
|
Allowance for
loan losses to total loans
|
|
1.06
|
%
|
1.09
|
%
|
1.10
|
%
|
18
Risk Elements and Non-performing Assets
Non-performing assets
consist of non-accrual loans, impaired loans, restructured loans, and other
real estate owned (foreclosed real properties). For the nine months ended
September 30, 2007, total non-performing assets and loans 90+ days past due
decreased $2.0 million from $3.9 million at December 31, 2006, to $1.9 million
at September 30, 2007, and decreased $5.9 million from $7.8 million at
September 30, 2006. As a result, the ratio of non-performing assets and loans
90+ days past due to total loans decreased from 0.24% at December 31, 2006, to
0.10% at September 30, 2007, and decreased from 0.50% at September 30, 2006.
The Company expects its ratio of non-performing assets to total loans to remain
low relative to its peers; however, it could increase due to an aggregate of
$4.0 million in other identified potential problem loans as of September 30,
2007, for which management has identified risk factors that may result in them
not being repaid in accordance with their terms although the loans are
generally well-secured and are currently performing. At December 31, 2006, this
same category of other identified potential problem loans was $11.6 million.
Loans are placed in
non-accrual status when in the opinion of management the collection of
additional interest is unlikely or a specific loan meets the criteria for
non-accrual status established by regulatory authorities. No interest is taken
into income on non-accrual loans. A loan remains on non-accrual status until
the loan is current as to both principal and interest or the borrower
demonstrates the ability to pay and remain current, or both.
Foreclosed real
properties include properties that have been substantively repossessed or
acquired in complete or partial satisfaction of debt. Such properties, which
are held for resale, are carried at the lower of cost or fair value, including
a reduction for the estimated selling expenses, or principal balance of the
related loan. In July 2007, the Company foreclosed on a $1.8 million
non-performing loan and subsequently sold the collateral property in September
2007 for a pre-tax gain of $638 thousand. As of September 30, 2007, the Company
held no foreclosed properties.
Total non-performing
assets consist of the following:
|
|
|
September 30, 2007
|
|
September 30, 2006
|
|
December 31, 2006
|
|
|
|
|
(dollars in thousands)
|
|
|
|
|
|
|
|
|
|
|
|
Non-accrual
loans
|
|
$
|
270
|
|
$
|
341
|
|
$
|
10
|
|
|
Impaired loans
|
|
1,589
|
|
2,639
|
|
3,910
|
|
|
Total
non-performing assets
|
|
$
|
1,859
|
|
$
|
2,980
|
|
$
|
3,920
|
|
|
Loans past due
90 days and still Accruing
|
|
—
|
|
4,818
|
|
—
|
|
|
Total
non-performing assets and loans past due 90 days and still accruing
|
|
$
|
1,859
|
|
$
|
7,798
|
|
$
|
3,920
|
|
|
|
|
|
|
|
|
|
|
|
As a percentage
of total loans
|
|
0.10
|
%
|
0.50
|
%
|
0.24
|
%
|
|
As a percentage
of total assets
|
|
0.08
|
%
|
0.42
|
%
|
0.20
|
%
|
19
Concentrations of Credit
Risk
The Bank does a general
banking business, serving the commercial and personal banking needs of its
customers. The Bank’s market area consists of the Northern Virginia suburbs of
Washington, D.C., including Arlington, Fairfax, Fauquier, Loudoun, Prince
William, Stafford and Spotsylvania counties and the cities of Alexandria, Fairfax,
Falls Church, Fredricksburg, Manassas and Manassas Park, and to some extent the
Maryland suburbs and the city of Washington, D.C. Substantially all of the
Company’s loans are made within its market area.
The ultimate
collectibility of the Bank’s loan portfolio and the ability to realize the
value of any underlying collateral, if needed, are influenced by the economic
conditions of the market area. The Company’s operating results are therefore
closely related to the economic conditions and trends in the Metropolitan
Washington, D.C. area.
At September 30, 2007,
the Company had $1.38 billion, or 74.9%, of total loans concentrated in
commercial real estate. Commercial real estate for purposes of this discussion
includes all construction loans, loans secured by multi-family residential
properties and loans secured by non-farm, non-residential properties. At
December 31, 2006, commercial real estate loans were $1.26 billion, or 76.4%,
of total loans. Total construction loans of $512.1 million at September 30,
2007, represented 27.8% of total loans, loans secured by multi-family
residential properties of $54.0 million represented 2.9% of total loans, and
loans secured by non-farm, non-residential properties of $812.2 million
represented 44.1%.
Construction loans at
September 30, 2007, included $311.5 million in loans to commercial builders of
single family residential property and $23.4 million to individuals on single
family residential property, representing 16.9% and 1.3% of total loans,
respectively, and together representing 18.2% of total loans, down from 22.1%
at December 31, 2006. These loans are made to a number of unrelated entities
and generally have a term of twelve to eighteen months. In addition the Company
had $177.2 million of construction loans on non-residential commercial property
at September 30, 2007, representing 9.6% of total loans, up from 9.0% at
December 31, 2006. These total construction loans of $512.1 million include
$214.4 million in land acquisition and or development loans on residential
property and $88.9 million in land acquisition and or development loans on
commercial property, together totaling $303.3 million, or 16.5% of total loans,
and are down from 16.9% at December 31, 2006. Adverse developments in the
Northern Virginia real estate market or economy including substantial increases
in mortgage interest rates, slower housing sales, and increased commercial
property vacancy rates could have an adverse impact on these groups of loans
and the Bank’s income and financial position. At September 30, 2007, the
Company had no other concentrations of loans in any one industry exceeding 10%
of its total loan portfolio. An industry for this purpose is defined as a group
of counterparties that are engaged in similar activities and have similar
economic characteristics that would cause their ability to meet contractual
obligations to be similarly affected by changes in economic or other
conditions.
The Bank has established
formal policies relating to the credit and collateral requirements in loan
originations including policies that establish limits on various loan types as
a percentage of total loans and total capital. Loans to purchase real property
are generally collateralized by the related property with limitations based on
the property’s appraised value. Credit approval is primarily a function of
collateral and the evaluation of the creditworthiness of the individual
borrower, guarantors and/or the individual project. Management considers the
concentration of credit risk to be minimal due to the diversification of
borrowers over numerous businesses and industries.
Non-Interest Income
Non-interest income
increased $773 thousand, or 14.6%, from $5.3 million for the nine months ended
September 30, 2006, to $6.1 million for the same period ended September 30,
2007, with increases in all categories, except a slight decline in fees and net
gains on mortgage loans held-for-sale. Increases included a $185 thousand
increase in investment services commissions, a $270 thousand increase in income
from bank-owned life insurance, which is included in other income, and two
one-time items, a gain on the sale of other real estate owned of $638 thousand
and a loss on the sale of investment securities of $387 thousand. For the three
months ended September 30, 2007, non-interest income was up $382 thousand, or
20.7%. Increases were again in all categories, except for another small decline
in mortgage lending related fees and net gains; however, the two one-time items
noted above combined for the majority of the increase. Management expects
fourth quarter non-interest income could be less with lower fees and net gains
from mortgage lending activities, as more originations are held in portfolio
rather than sold, due to a
20
reduction in available
loan products in the secondary market (fee income on portfolio loans is
required to be recognized over the loan term, rather than recognized
immediately as income).
Loans classified as
held-for-sale represent loans on one-to-four family residential real estate,
originated on a pre-sold and servicing released basis to various investors, and
carried on the balance sheet at the lower of cost or market. Adverse changes in
the local real estate market, consumer confidence, and interest rates could
adversely impact the level of loans originated and sold, and the resulting fees
and earnings thereon. In terms of the quality of our residential mortgage
originations, the Bank is primarily a prime lender. Only $2.5 million, or 1.4%,
of total production in 2006 was subprime and carried no risk of repurchase due
to early payment default or foreclosure, as the loans were sold to one of the
Bank’s primary investors under a surety program. Approximately 15-20% of our
mortgage loans were Alt A and were all sold in the secondary market with no
foreclosures to date or significant delinquency problems.
Non-Interest Expense
For the nine months ended
September 30, 2007, non-interest expense increased $4.1 million, or 16.1%,
compared to the same period in 2006, and increased $1.3 million, or 15.8%, from
$8.6 million for the three months ended September 30, 2006, to $9.9 million for
the three months ended September 30, 2007. The year-over-year increases were
due to the opening of four new branch locations since August 2006, the hiring
of additional loan and business development officers, other staffing and
facilities expansion to support loan and deposit growth, and the resumption of
FDIC insurance premiums in the second quarter of 2007. As a result of these
increases in expenses, the efficiency ratio rose from 44.3% in the third
quarter of 2006 to 46.9% in the current period and to 47.6% on a year-to-date
basis. Management expects higher levels in all non-interest expense categories
in the fourth quarter with one more new branch location to be opened in early
November. However, it is expected the efficiency ratio will remain in the high
forties.
Provision for Income
Taxes
The Company’s income tax
provisions are adjusted for non-deductible expenses and non-taxable interest
after applying the U.S. federal income tax rate of 35%. The provision for
income taxes totaled $3.5 million and $3.2 million for the three months ended
September 30, 2007 and 2006, respectively, and totaled $10.4 million and $9.6
million for the nine month periods. The effects of non-deductible expenses and
non-taxable income on the Company’s income tax provisions are minimal.
Liquidity
The Company’s principal
sources of liquidity and funding are its deposit base. The level of deposits
necessary to support the Company’s lending and investment activities is
determined through monitoring loan demand. Considerations in managing the
Company’s liquidity position include, but are not limited to, scheduled cash
flows from existing loans and investment securities, anticipated deposit
activity including the maturity of time deposits, and projected needs from
anticipated extensions of credit. The Company’s liquidity position is monitored
daily by management to maintain a level of liquidity conducive to efficiently
meet current needs and is evaluated for both current and longer term needs as
part of the asset/liability management process.
The Company measures
total liquidity through cash and cash equivalents, securities
available-for-sale, mortgage loans held-for-sale, other loans and investment
securities maturing within one year, less securities pledged as collateral for
repurchase agreements, public deposits and other purposes, and less any
outstanding federal funds purchased. These liquidity sources increased $46.6
million, or 8.6%, from $544.3 million at December 31, 2006, to $590.9 million
at September 30, 2007, due primarily to a $76 million increase in unpledged
available-for-sale securities.
Additional sources of
liquidity available to the Company include the capacity to borrow funds through
established short-term lines of credit with various correspondent banks, and
the Federal Home Loan Bank of Atlanta. Available funds from these liquidity
sources were approximately $392.0 million and $366.6 million at September 30,
2007, and December 31, 2006, respectively. The Bank’s line of credit with the
Federal Home Loan Bank of Atlanta, which requires the pledging of collateral in
the form of certain loans and/or securities, is $309.0 million of the $392.0
million in available lines-of-credit as of September 30, 2007.
21
Off-Balance Sheet
Arrangements
The Company enters into
certain off-balance sheet arrangements in the normal course of business to meet
the financing needs of its customers. These off-balance sheet arrangements
include commitments to extend credit, standby letters of credit and financial
guarantees which would impact the Company’s liquidity and capital resources to
the extent customer’s accept and or use these commitments. These instruments
involve, to varying degrees, elements of credit and interest rate risk in
excess of the amount recognized in the balance sheet. With the exception of
these off-balance sheet arrangements, and the Company’s obligations in
connection with its trust preferred securities, the Company has no off-balance
sheet arrangements that have or are reasonably likely to have a current or
future effect on the Company’s financial condition, changes in financial
condition, revenues or expenses, results of operations, liquidity, capital
expenditures, or capital resources, that is material to investors.
Commitments to extend
credit, which amounted to $572.5 million at September 30, 2007, and $500.4
million at December 31, 2006, represent legally binding agreements to lend to a
customer as long as there is no violation of any condition established in the
contract. Commitments generally have fixed expiration dates or other
termination clauses and may require payment of a fee. Since many of the
commitments are expected to expire without being drawn upon, the total
commitment amounts do not necessarily represent future cash requirements.
Standby letters of credit
are conditional commitments issued by the Company guaranteeing the performance
of a customer to a third party. Those guarantees are primarily issued to
support public and private borrowing arrangements. At September 30, 2007, and
December 31, 2006, the Company had $51.8 million and $29.4 million,
respectively, in outstanding standby letters of credit.
Contractual Obligations
Since December 31, 2006,
there have been no significant changes in the Company’s contractual obligations
other than additional leases entered into for new branch locations.
Capital
The assessment of capital
adequacy depends on a number of factors such as asset quality, liquidity,
earnings performance, changing competitive conditions and economic forces, and
the overall level of growth. The adequacy of the Company’s current and future
capital is monitored by management on an ongoing basis. 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.
Both the Company’s and
the Bank’s capital levels continue to meet regulatory requirements. The primary
indicators relied on by bank regulators in measuring the capital position are
the Tier 1 risk-based capital, total risk-based capital, and leverage ratios. Tier
1 capital consists of common and qualifying preferred stockholders’ equity less
goodwill. Total risk-based capital consists of Tier 1 capital, qualifying
subordinated debt, and a portion of the allowance for loan losses. Risk-based
capital ratios are calculated with reference to risk-weighted assets. The
leverage ratio compares Tier 1 capital to total average assets for the most
recent quarter end. The Bank’s Tier 1 risk-based capital ratio was 8.03% at
September 30, 2007, compared to 7.83% at December 31, 2006, and its total
risk-based capital ratio was 11.23% at September 30, 2007, compared to 11.34%
at December 31, 2006. These ratios are in excess of the mandated minimum
requirement of 4.00% and 8.00%, respectively. The Bank’s leverage ratio was
7.26% at September 30, 2007, compared to 7.18% at December 31, 2006, and is
also in excess of the mandated minimum requirement of 4.00%. Based on these
ratios, the Bank is considered “well capitalized” under regulatory prompt
corrective action guidelines. The Company’s Tier 1 risk-based capital ratio,
total risk-based capital ratio, and leverage ratio was 10.44%, 11.44% and
9.41%, respectively, at September 30, 2007. Both the Company’s and Bank’s
capital positions reflect proceeds of the issuance of $43 million in trust
preferred securities. The Company has given notice of its intention to redeem $3
million of the trust preferred securities in the fourth quarter of 2007, as they
become redeemable at the Company’s option for the first time. The Company has
elected not to redeem the additional $15 million of trust preferred securities
which became redeemable at the Company's option in the fourth quarter, due to
current credit market conditions and pricing, and not to issue additional trust
preferred securities at this time. The
Company will be able to redeem the additional $15 million of trust preferred
securities which are now subject to redemption on any semi-annual distribution
payment date.
The ability of the
Company to continue to grow is dependent on its earnings and the ability to
obtain additional funds for contribution to the Bank’s capital, through
borrowing, the sale of additional common stock, or through the
22
issuance of additional
trust preferred securities or other qualifying securities. In the event that
the Company is unable to obtain additional capital for the Bank on a timely
basis, the growth of the Company and the Bank may be curtailed, and the Company
and the Bank may be required to reduce their level of assets in order to maintain
compliance with regulatory capital requirements. Under those circumstances, net
income and the rate of growth of net income may be adversely affected. The
Company believes that its current capital and access to sources of additional
capital is sufficient to meet anticipated growth over the next year, although
there can be no assurance.
Guidance by the federal
banking regulators provides that banks which have concentrations in
construction, land development or commercial real estate loans (other than loans
for majority owner occupied properties) would be expected to maintain higher
levels of risk management and, potentially, higher levels of capital. It is
possible that we may be required to maintain higher levels of capital than we
would otherwise be expected to maintain as a result of our levels of
construction, development and commercial real estate loans, which may require
us to obtain additional capital.
The Federal Reserve has
revised the capital treatment of trust preferred securities in light of recent
accounting pronouncements and interpretations regarding variable interest
entities, which have been read to encompass the subsidiary trusts established
to issue trust preferred securities, and to which the Company issued
subordinated debentures. As a result, the capital treatment of trust preferred
securities has been revised to provide that in the future, such securities can
be counted as Tier 1 capital at the holding company level, together with other
restricted core capital elements, up to 25% of total capital (net of goodwill),
and any excess as Tier 2 capital up to 50% of Tier 1 capital. At September 30,
2007, trust preferred securities represented 21.0% of the Company’s Tier 1
capital and 19.2% of its total qualifying capital. Should future trust preferred
issuances to increase holding company capital levels not be available to the
same extent as currently, the Company may be required to raise additional
equity capital, through the sale of common stock or other means, sooner than it
would otherwise do so.
Recent Accounting
Pronouncements
In September 2006, the
Financial Accounting Standards Board (FASB) issued Statement of Financial
Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157
defines fair value, establishes a framework for measuring fair value in
generally accepted accounting principles, and expands disclosures about fair
value measurements. SFAS 157 does not require any new fair value measurements
but may change current practice for some entities. This Statement is effective
for financial statements issued for fiscal years beginning after November 15,
2007 and interim periods within those years. The Company does not expect the
implementation of SFAS 157 to have a material impact on its consolidated
financial statements.
In February 2007, the
FASB issued Statement of Financial Accounting Standards No. 159, “The Fair
Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This
statement permits entities to choose to measure many financial instruments and
certain other items at fair value. The objective of this Statement is to
improve financial reporting by providing entities with the opportunity to
mitigate volatility in reported earnings caused by measuring related assets and
liabilities differently without having to apply complex hedge accounting
provisions. The fair value option established by this Statement permits all
entities to choose to measure eligible items at fair value at specified
election dates. A business entity shall report unrealized gains and losses on
items for which the fair value option has been elected in earnings at each
subsequent reporting date. The fair value option may be applied instrument by
instrument and is irrevocable. SFAS 159 is effective as of the beginning of an
entity’s first fiscal year that begins after November 15, 2007. The Company is
in the process of evaluating the impact SFAS 159 may have on its consolidated
financial statements.
Internet Access To
Company Documents
The Company provides
access to its SEC filings through the Bank’s Web site at www.vcbonline.com.
After accessing the Web site, the filings are available upon selecting “about
us/stock information/financial information.” Reports available include the
annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on
Form 8-K, and all amendments to those reports as soon as reasonably practicable
after the reports are electronically filed or furnished to the SEC.
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