VCBI Virginia Commerce Bancorp (MM)

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

 

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

June 30, 2011 For the quarterly period ended June 30, 2011

or

 

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

For the transition period from                 to                 

Commission File Number: 000-28635

 

 

VIRGINIA COMMERCE BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

VIRGINIA		54-1964895
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

5350 LEE HIGHWAY, ARLINGTON, VIRGINIA 22207

(Address of principal executive offices) (Zip Code)

703-534-0700

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

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

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

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

 

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

Indicate by check mark whether the registrant is a shell company (as defined in Rule12b-2 of the Exchange Act).    Yes   ¨     No   x

As of August 3, 2011, the number of outstanding shares of registrant’s common stock, par value $1.00 per share, was: 29,734,802.

 

 

 

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TABLE OF CONTENTS

 

				Page
PART I – FINANCIAL INFORMATION
ITEM 1.		FINANCIAL STATEMENTS
		Consolidated Balance Sheets – June 30, 2011 (unaudited) and December 31, 2010			3
		Consolidated Statements of Income (unaudited) – Three and six months ended June 30, 2011 and 2010			4
		Consolidated Statements of Changes in Stockholders’ Equity (unaudited) – Six months ended June 30, 2011 and 2010			5
		Consolidated Statements of Cash Flows (unaudited) – Six months ended June 30, 2011 and 2010			6
		Notes to Consolidated Financial Statements (unaudited)			7
ITEM 2.		MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			25
ITEM 3.		QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			45
ITEM 4.		CONTROLS AND PROCEDURES			46
PART II – OTHER INFORMATION
ITEM 1.		LEGAL PROCEEDINGS			46
ITEM 1A.		RISK FACTORS			46
ITEM 2.		UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS			46
ITEM 3.		DEFAULTS UPON SENIOR SECURITIES			46
ITEM 4.		(REMOVED AND RESERVED)			46
ITEM 5.		OTHER INFORMATION			46
ITEM 6 .		EXHIBITS			46
SIGNATURES					48

 

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PART I. FINANCIAL INFORMATION

 

ITEM 1.

FINANCIAL STATEMENTS

VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

(In thousands of dollars, except share and per share data)

 

		(Unaudited) June 30, 2011				(Audited) December 31, 2010
Assets
Cash and due from banks		$	40,170			$	36,932
Federal funds sold			39,973				10,455
Investment securities (fair value: 2011, $513,014; 2010, $412,653)			511,052				411,761
Restricted stocks, at cost			11,486				11,751
Loans held-for-sale			7,667				10,049
Loans, net of allowance for loan losses of $53,217 in 2011 and $62,442 in 2010			2,094,949				2,149,591
Bank premises and equipment, net			11,326				12,000
Accrued interest receivable			10,023				10,003
Other real estate owned, net of valuation allowance of $6,808 in 2011 and $6,782 in 2010			14,690				17,165
Other assets			56,439				71,941
Total assets		$	2,797,775			$	2,741,648
Liabilities and Stockholders’ Equity
Deposits
Demand deposits		$	293,093			$	264,744
Savings and interest-bearing demand deposits			1,182,006				1,201,288
Time deposits			778,643				781,169
Total deposits		$	2,253,742			$	2,247,201
Securities sold under agreement to repurchase and federal funds purchased			179,105				152,726
Other borrowed funds			25,000				25,000
Trust preferred capital notes			66,442				66,314
Accrued interest payable			2,600				2,751
Other liabilities			3,762				2,062
Commitments and contingencies			—				—
Total liabilities		$	2,530,651			$	2,496,054
Stockholders’ Equity
Preferred stock, net of discount, $1.00 par, 1,000,000 shares authorized, Series A; $1,000 stated value; 71,000 issued and outstanding in 2011 and 2010		$	66,334			$	65,445
Common stock, $1.00 par, 50,000,000 shares authorized, issued and outstanding 2011, 29,687,183 including 41,248 in unvested restricted stock issued; 2010, 28,962,935 including 9,335 in unvested restricted stock issued			29,646				28,954
Surplus			108,142				105,056
Warrants			8,520				8,520
Retained earnings			50,348				39,208
Accumulated other comprehensive income (loss), net			4,134				(1,589	)
Total stockholders’ equity		$	267,124			$	245,594
Total liabilities and stockholders’ equity		$	2,797,775			$	2,741,648

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF INCOME

(In thousands of dollars except per share data)

(Unaudited)

 

		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Interest and dividend income:
Interest and fees on loans		$	31,765			$	33,236			$	63,688			$	66,141
Interest and dividends on investment securities:
Taxable			3,131				3,311			$	5,992				6,591
Tax-exempt			592				476				1,184				902
Dividend on restricted stocks			96				88				192				176
Interest on federal funds sold			54				50				99				78
Total interest and dividend income		$	35,638			$	37,161			$	71,155			$	73,888
Interest expense:
Deposits		$	6,670			$	8,431			$	13,693			$	17,859
Securities sold under agreement to repurchase and federal funds purchased			960				1,010				1,894				1,999
Other borrowed funds			268				268				534				534
Trust preferred capital notes			952				1,231				2,063				2,459
Total interest expense		$	8,850			$	10,940			$	18,184			$	22,851
Net interest income		$	26,788			$	26,221			$	52,971			$	51,037
Provision for loan losses			1,434				4,200				7,277				8,438
Net interest income after provision for loan losses		$	25,354			$	22,021			$	45,694			$	42,599
Non-interest income:
Service charges and other fees		$	799			$	838			$	1,591			$	1,714
Non-deposit investment services commissions			460				178				713				307
Fees and net gains on loans held-for-sale			534				483				1,055				829
Gain on sale of securities available-for-sale			—				139				503				139
Total other-than-temporary impairment losses			—				(3,230	)			(2,948	)			(4,081	)
Portion of loss recognized in other comprehensive income			—				2,562				2,216				2,562
Net impairment losses			—				(668	)			(732	)			(1,519	)
Other			463				118				602				225
Total non-interest income		$	2,256			$	1,088			$	3,732			$	1,695
Non-interest expense:
Salaries and employee benefits		$	6,426			$	5,991			$	13,085			$	11,986
Occupancy expense			2,243				2,410				4,713				5,120
FDIC insurance			1,241				1,332				2,530				2,641
Loss on other real estate owned			320				1,060				476				1,978
Franchise tax expense			774				718				1,546				1,435
Data processing			635				579				1,290				1,253
Other operating expense			2,881				2,698				5,330				5,082
Total non-interest expense		$	14,520			$	14,788			$	28,970			$	29,495
Income before taxes		$	13,090			$	8,321			$	20,456			$	14,799
Provision for income taxes			4,254				2,750				6,653				4,759
Net income		$	8,836			$	5,571			$	13,803				10,040
Effective dividend on preferred stock			1,348				1,251			$	2,663				2,502
Net income available to common stockholders		$	7,488			$	4,320			$	11,140			$	7,538
Earnings per common share, basic		$	0.25			$	0.16			$	0.38			$	0.28
Earnings per common share, diluted		$	0.24			$	0.15			$	0.36			$	0.26

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

For the six months ended June 30, 2011 and 2010

(In thousands of dollars)

(Unaudited)

 

		Preferred Stock				Common Stock				Surplus				Warrants				Retained Earnings				Accumulated Other Comprehensive Income (Loss)				Comprehensive Income				Total Stockholders’ Equity
Balance, January 1, 2010		$	63,993			$	26,745			$	96,588			$	8,520			$	22,671			$	351							$	218,868
Comprehensive Income:
Net income																			10,040							$	10,040				10,040
Other comprehensive income:
reclassification adjustment for impairment loss on securities (net of tax of $532)																							987				987				987
reclassification adjustment for gain on securities (net of tax of $49)																							(90	)			(90	)			(90	)
unrealized holding gains arising during the period (net of tax of $880)																							1,633				1,633				1,633
Total comprehensive income																										$	12,570
Stock options exercised			—				195				141				—				—				—								336
Stock option expense			—				—				332				—				—				—								332
Discount on preferred stock			726				—				—				—				(726	)			—								—
Dividend on preferred stock			—				—				—				—				(1,775	)			—								(1,775	)
Balance, June 30, 2010		$	64,719			$	26,940			$	97,061			$	8,520			$	30,210			$	2,881							$	230,331
Balance, January 1, 2011		$	65,445			$	28,954			$	105,056			$	8,520			$	39,208			$	(1,589	)						$	245,594
Comprehensive Income:
Net income																			13,803								13,803			$	13,803
Other comprehensive income:
reclassification adjustment for impairment loss on securities (net of tax of $256)																							476				476				476
reclassification adjustment for gain on securities (net of tax of $176)																							(327	)			(327	)			(327	)
unrealized holding gains arising during the period (net of tax of $2,998)																							5,574				5,574				5,574
Total comprehensive income																										$	19,526
Common stock issued			—				426				2,075				—				—				—								2,501
Stock options exercised			—				266				727				—				—				—								993
Stock option expense			—				—				284				—				—				—								284
Discount on preferred stock			889				—				—				—				(889	)			—								—
Dividend on preferred stock			—				—				—				—				(1,774	)			—								(1,774	)
Balance, June 30, 2011		$	66,334			$	29,646			$	108,142			$	8,520			$	50,348			$	4,134							$	267,124

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands of dollars)

(Unaudited)

 

		Six Months Ended June 30,
CASH FLOWS FROM OPERATING ACTIVITIES:			2011				2010
Net income		$	13,803			$	10,040
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			1,108				1,356
Provision for loan losses			7,277				8,438
Stock based compensation expense			284				332
Deferred tax expense (benefit)			4,664				(2,957	)
Accretion of trust preferred securities discount			128				128
Amortization of premiums and accretion of security discounts, net			400				142
Origination of loans held-for-sale			(53,500	)			(52,976	)
Sales of loans			56,798				50,484
Gain on sale of loans			(916	)			(635	)
Loss on other real estate owned			476				1,978
Gain on sale of securities			(503	)			(139	)
Impairment loss on securities			732				1,519
Changes in other assets and other liabilities:
(Increase) decrease in accrued interest receivable			(20	)			220
Decrease in other assets			7,252				3,753
Increase (decrease) in other liabilities			1,700				(1,566	)
Decrease in accrued interest payable			(151	)			—
Net Cash Provided By Operating Activities		$	39,532			$	20,117
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease in loans		$	42,502			$	13,712
Purchase of securities available-for-sale			(173,676	)			(123,830	)
Proceeds from principal payments on securities available-for-sale			20,714				27,512
Proceeds from principal payments on securities held-to-maturity			2,486				4,208
Proceeds from calls and maturities of securities available-for-sale			46,645				53,887
Proceeds from calls and maturities of securities held-to-maturity			575				1,247
Proceeds from sale of securities available-for-sale			12,645				—
Proceeds from sale of securities held-to-maturity			—				8,717
Proceeds from redemption of FHLB stock			265				—
Purchase of bank premises and equipment			(434	)			(300	)
Proceeds from sale of other real estate owned			6,862				—
Net Cash Used In Investing Activities		$	(41,416	)		$	(14,847	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in deposits		$	6,541			$	84,759
Net increase in repurchase agreements and federal funds purchased			26,379				6,727
Net proceeds from exercise of stock options and warrants			993				336
Net proceeds from issuance of common stock			2,501				—
Dividend paid on preferred stock			(1,774	)			(1,775	)
Net Cash Used In Financing Activities		$	34,640			$	90,047
Net Increase In Cash and Cash Equivalents			32,756				95,317
CASH AND CASH EQUIVALENTS – BEGINNING OF PERIOD			47,387				25,211
CASH AND CASH EQUIVALENTS – END OF PERIOD		$	80,143			$	120,528
Supplemental Schedule of Noncash Investing Activities:
Unrealized gain on available-for-sale securities		$	8,801			$	3,893
Tax benefits on stock options exercised			37				32
Other real estate owned transferred from loans			4,863				1,934
Supplemental Disclosure of Cash Flow Information:
Taxes Paid		$	—			$	4,022
Interest Paid			18,335				23,571

Notes to consolidated financial statements are an integral part of these statements.

 

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VIRGINIA COMMERCE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. General

The accompanying unaudited consolidated financial statements of Virginia Commerce Bancorp, Inc. and its subsidiaries (the “Company”) have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. All significant intercompany balances and transactions have been eliminated. In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments and reclassifications consisting of a normal and recurring nature considered necessary to present fairly the financial positions as of June 30, 2011 and December 31, 2010, the results of operations for the three and six months ended June 30, 2011 and 2010, and statements of cash flows and stockholders’ equity for the three and six months ended June 30, 2011 and 2010. These statements should be read in conjunction with the Company’s annual report on Form 10-K for the year ended December 31, 2010. In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued. Management has concluded there were no material subsequent events to be disclosed at this time.

Operating results for the three and six month periods ended June 30, 2011, are not necessarily indicative of the results that may be expected for the year ending December 31, 2011, or any other period.

Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. In accordance with the “Fair Value Measurements and Disclosures” Topic 820 of Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”), the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The recent fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there had been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities and certain non-financial assets generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

 

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Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of fair value requires significant management judgment or estimation.

An asset or liability’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

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

Securities available for sale : Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).

The following table summarizes the Company’s financial assets measured at fair value on a recurring basis for June 30, 2011 and December 31, 2010, respectively:

 

						Fair Value Measurements at June 30, 2011 Using
(in thousands) Description		Balance as of June  30, 2011				Quoted Prices in Active Markets  for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Available-for-sale securities
U.S. Government Agency obligations		$	410,431			$	—			$	410,431			$	—
Pooled trust preferred securities		$	450			$	—			$	450			$	—
Obligations of states and political subdivisions		$	66,080			$	—			$	66,080			$	—
(in thousands) Description		Balance as of December 31, 2010				Fair Value Measurements at December 31, 2010 Using
						Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Available-for-sale securities
U.S. Government Agency obligations		$	310,610			$	—			$	310,610			$	—
Pooled trust preferred securities		$	430			$	—			$	430			$	—
Obligations of states and political subdivisions		$	63,463			$	—			$	63,463			$	—

At June 30, 2011 and December 31, 2010, the Company did not have any liabilities measured at fair value on a recurring basis.

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets. The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

 

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Loans held for sale : Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level 2). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the periods ended June 30, 2011, and December 31, 2010. Gains and losses on the sale of loans are recognized in fees and net gains on loans held-for-sale on the Consolidated Statements of Income.

Impaired Loans : Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate, financial assets, personal or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company, using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant, using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans are measured at fair value on a nonrecurring basis through the allowance for loan losses. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

Other Real Estate Owned / Foreclosed Assets: Assets acquired through, or in lieu of, loan foreclosure are held-for-sale and are initially recorded at the lesser of book value or fair value less cost to sell at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation are included in net expenses for foreclosed assets.

The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis for June 30, 2011 and December 31, 2010, respectively:

 

						Carrying value at June 30, 2011
(in thousands) Description		Balance as of June  30, 2011				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans		$	92,979			$	—			$	80,295			$	12,684
Other real estate owned		$	14,690			$	—			$	12,056			$	2,634

 

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						Carrying value at December 31, 2010
(in thousands) Description		Balance as of December  31, 2010				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Assets:
Impaired loans		$	88,764			$	—			$	77,061			$	11,703
Other real estate owned		$	17,165			$	—			$	17,127			$	38

The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value:

Cash and Short-Term Investments

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

Securities

For securities held for investment purposes, fair values are based upon quoted market prices, when available. If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data. The carrying value of restricted stock approximates fair value based on the redemption provisions of the issuers.

Loans Held-for-Sale

Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale.

Loan Receivables

For certain homogeneous categories of loans, such as some residential mortgages, and other consumer loans, fair value is estimated using the quoted market prices for securities backed by similar loans, adjusted for differences in loan characteristics. The fair value of other types of loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits and Borrowings

The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. For all other deposits and borrowings, the fair value is determined using the discounted cash flow method. The discount rate was equal to the rate currently offered on similar products.

Accrued Interest

The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Financial Instruments

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

 

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At June 30, 2011 and December 31, 2010, the fair value of loan commitments and stand-by letters of credit were deemed immaterial, and therefore, are not included in the table below.

The carrying amounts and estimated fair values of the Company’s financial instruments are as follows:

 

		June 30, 2011								December 31, 2010
(Dollars in thousands)		Carrying Amount				Estimated Fair Value				Carrying Amount				Estimated Fair Value
Financial assets:
Cash and short-term investments		$	80,143			$	80,143			$	47,387			$	47,387
Securities			511,052				513,014				411,761				412,653
Restricted stock			11,486				11,486				11,751				11,751
Loans held-for-sale			7,667				7,667				10,049				10,049
Loan receivables			2,094,949				2,116,653				2,149,591				2,224,687
Accrued interest receivable			10,023				10,023				10,003				10,003

 

		June 30, 2011								December 31, 2010
(Dollars in thousands)		Carrying Amount				Estimated Fair Value				Carrying Amount				Estimated Fair Value
Financial liabilities:
Deposits		$	2,253,742			$	2,203,423			$	2,247,201			$	2,206,542
Securities sold under agreements to repurchase and federal funds purchased			179,105				198,262				152,726				173,105
Other borrowed funds			25,000				25,393				25,000				25,533
Trust preferred capital notes			66,442				80,946				66,314				81,461
Accrued interest payable			2,600				2,600				2,751				2,751

In the normal course of business, the Company is subject to market risk which includes interest rate risk (the risk that general interest rate levels will change). As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize this risk.

2. Investment Securities

Amortized cost and fair value of the securities available-for-sale and held-to-maturity as of June 30, 2011 and December 31, 2010, are as follows (dollars in thousands):

 

June 30, 2011		Amortized Cost				Gross Unrealized Gains				Gross Unrealized (Losses)				Fair Value
Available-for-sale:
U.S. Government Agency obligations		$	401,613			$	9,066			$	(248	)		$	410,431
Pooled trust preferred securities			5,353				51				(4,954	)			450
Obligations of states and political subdivisions			63,634				2,568				(122	)			66,080
		$	470,600			$	11,685			$	(5,324	)		$	476,961
Held-to-maturity:
U.S. Government Agency obligations		$	4,864			$	265			$	—			$	5,129
Obligations of state and political subdivisions			29,227				1,697				—				30,924
		$	34,091			$	1,962			$	—			$	36,053

 

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December 31, 2010		Amortized Cost				Gross Unrealized Gains				Gross Unrealized (Losses)				Fair Value
Available-for-sale:
U.S. Government Agency obligations		$	307,973			$	5,527			$	(2,890	)		$	310,610
Pooled trust preferred securities			5,919				—				(5,489	)			430
Obligations of states and political subdivisions			63,051				1,077				(665	)			63,463
		$	376,943			$	6,604			$	(9,044	)		$	374,503
Held-to-maturity:
U.S. Government Agency obligations		$	6,113			$	309			$	—			$	6,422
Obligations of state and political subdivisions			31,145				827				(244	)			31,728
		$	37,258			$	1,136			$	(244	)		$	38,150

The amortized cost of securities pledged as collateral for repurchase agreements, certain public deposits, and other purposes was $207.8 million and $258.2 million at June 30, 2011 and December 31, 2010, respectively.

Management evaluates securities for other-than-temporary impairment at least on a quarterly basis, and more frequently when economic or market concerns warrant such evaluation. An impairment is considered to be other-than-temporary if the Company (1) intends to sell the security, (2) more likely than not will be required to sell the security before recovering its cost, or (3) does not expect to recover the security’s entire amortized cost basis.

Provided below is a summary of all securities which were in an unrealized loss position at June 30, 2011 and December 31, 2010, that were evaluated for other-than-temporary impairment, and deemed to not have an other-than-temporary impairment. Presently, the Company does not intend to sell any of these securities, does not expect to be required to sell these securities, and expects to recover the entire amortized cost of all the securities. For U.S. Government Agency obligations and obligations of states and political subdivisions, the unrealized losses result from market or interest rate risk, while the unrealized losses pertaining to the pooled trust preferred securities are due to both performance and credit ratings, as well as interest rate risk.

 

June 30, 2011		Less Than 12 Months								12 Months or Longer								Total
(Dollars in thousands)		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Available-for-sale:
U.S. Government Agency obligations		$	51,520			$	(248	)		$	—			$	—			$	51,520			$	(248	)
Pooled trust preferred securities			—				—				269				(2,625	)			269				(2,625	)
Obligations of states and political subdivisions			3,445				(122	)			—				—				3,445				(122	)
		$	54,965			$	(370	)		$	269			$	(2,625	)		$	55,234			$	(2,995	)
December 31, 2010		Less Than 12 Months								12 Months or Longer								Total
(Dollars in thousands)		Fair Value				Unrealized Losses				Fair Value				Unrealized Losses				Fair Value				Unrealized Losses
Available-for-sale:
U.S. Government Agency obligations		$	124,111			$	(2,890	)		$	—			$	—			$	124,111			$	(2,890	)
Pooled trust preferred securities			—				—				267				(2,611	)			267				(2,611	)
Obligations of states and political subdivisions			22,579				(665	)			—				—				22,579				(665	)
		$	146,690			$	(3,555	)		$	267			$	(2,611	)		$	146,957			$	(6,166	)
Held-to-maturity:
Obligations of states and political subdivisions		$	4,608			$	(244	)		$	—			$	—			$	4,608			$	(244	)

 

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As of June 30,2011 the Company had three pooled trust preferred securities that were deemed to be other-than-temporarily impaired (“OTTI”) based on a present value analysis of expected future cash flows. The following table provides further information on these three securities for the six months ended June 30, 2011 (in thousands):

 

Security		Class		Current Moody’s Ratings (Lowest Assigned Rating)		Par Value				Book Value/ Fair Value				Unrealized Loss/ (Gain)				Current Defaults and Deferrals				% of Current Defaults and Deferrals to Current Collateral				Excess Sub (1)				Estimated Incremental Defaults Required to Break Yield (2)				Cumulative Other Comprehensive (Income) Loss (3)				Amount of OTTI Related to Credit Loss (3)
PreTSL VI		Mez		Ca		$	380			$	140			$	240			$	30,000				73.6	%			-62.2	%			BROKEN			$	(43	)		$	283
PreTSL X		B-1		C			927				30				897				217,595				46.5	%			-59.1	%			BROKEN				448				449
PreTSL XXVI		C-2		C			1,822				11				1,811				267,500				27.7	%			-82.8	%			BROKEN				1,811				—
Total						$	3,129			$	181			$	2,948																			$	2,216			$	732

 

(1)

Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.

(2)

A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.

(3)

Pre-tax.

As of June 30, 2011, the Company had one pooled trust preferred security that was deemed to be temporarily impaired based on a present value analysis of expected future cash flows. The security had a fair value of $269 thousand. The following table provides further information on this security as of June 30, 2011 (in thousands):

 

Security		Class		Current Moody’s Ratings (Lowest Assigned Rating)		Par Value				Book Value/ Fair Value				Unrealized Loss				Current Defaults and Deferrals				% of Current Defaults and Deferrals to Current Collateral				Excess Sub (1)				Estimated Incremental Defaults Required to Break Yield (2)				Cumulative Other Comprehensive Loss (3)				Amount of OTTI Related to Credit Loss (3)
PreTSL XXVII		B		Ca		$	2,894			$	269			$	2,625			$	91,800				28.1	%			-3.40	%		$	47,000			$	2,625			$	—

 

(1)

Excess subordination is the difference between the remaining performing collateral and the amount of bonds outstanding that are pari passu and senior to the class the Company owns. Negative excess subordination indicates there is not enough performing collateral in the pool to cover the outstanding balance of all classes senior to those the Company owns.

(2)

A break in yield for a given class means that defaults/deferrals have reached such a level that the class would not receive all of its contractual cash flows (principal and interest) by maturity (so that it is not just a temporary interest shortfall, but an actual loss in yield on the investment). This represents additional defaults beyond those assumed in our cash flow modeling.

(3)

Pre-tax.

These securities had a fair value of $181 thousand and a cumulative other-than-temporary impairment loss of $6.4 million, of which $2.2 million has been recognized in other comprehensive loss, and $4.2 million has been recognized in earnings (in prior periods). The following table presents a roll-forward of the credit loss component amount of OTTI recognized in earnings:

 

(in thousands)
Amount recognized through December 31, 2010		$	3,468
Additions:
Initial credit impairments			—
Subsequent credit impairments			732
Amount recognized through June 30, 2011		$	4,200

 

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Management has evaluated each of these securities for potential impairment under ASC 325 “Investments-Other” and the most recently issued related guidance, and has reviewed each of the issues’ collateral participants’ most recent earnings, capital and loan loss reserve levels, and non-performing loan levels to estimate a future deferral and default rate in basis points for the remaining life of each security. As of June 30, 2011, we used 25 basis points for PreTSLs VI and X following an internal credit assessment of one bank holding company whose issues were significant in relationship to the totals outstanding in each pool. The result was a down grading of that issuer from deferral to default. We used 75 basis points for PreTSL XXVI and 25 basis points for PreTSL XXVII in expected deferrals and defaults as a percentage of remaining collateral for future periods. In performing a detailed present value cash flow analysis for each security, the deferral and default rate was treated the same. If this analysis results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, a credit loss exists), an OTTI is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed used discount rates equal to the credit spread at the time of purchase for each security and then added the current 3-month LIBOR spot rate. The analysis also assumed 15% recoveries on deferrals after two years and prepayments of 1% per year on each security. As of June 30, 2011, there were 3 out of 5 performing issuers in PreTSL VI, 33 out of 53 in PreTSL X, 49 out of 72 in PreTSL XXVI, and 33 out of 49 in PreTSL XXVII.

Our investment in Federal Home Loan Bank (“FHLB”) stock totaled $5.7 million at June 30, 2011. FHLB stock is generally viewed as a long-term investment and as a restricted security, which is carried at cost, because there is no market for the stock, other than FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Despite the FHLB’s temporary suspension of repurchases of excess stock in 2010, in light of the FHLB’s consistent payment of dividends in 2010 and consistent net income since the quarter ended June 30, 2009 through the first quarter of 2011, we do not consider this investment to be other-than-temporarily impaired at June 30, 2011, and no impairment has been recognized. FHLB stock is shown in restricted stocks on the Consolidated Balance Sheets and is not part of the available-for-sale securities portfolio.

3. Loans

Major classes of loans, excluding loans held-for-sale, are summarized at June 30, 2011 and December 31, 2010 as follows (dollars in thousands):

 

		June 30, 2011				December 31, 2010
Commercial		$	233,052			$	218,600
Real estate 1-to-4 family residential:
Permanent first and second			261,336				269,514
Home equity loans and lines			125,886				131,397
Total Real estate 1-to-4 family residential		$	387,222			$	400,911
Real estate multi-family residential			85,667				77,316
Real estate non-farm/non-residential:
Owner occupied			454,960				464,368
Non-owner occupied			648,619				674,448
Total Real estate non-farm/non-residential		$	1,103,579			$	1,138,816
Real estate construction:
Residential			151,214				177,582
Commercial			178,144				187,028
Total Real estate construction		$	329,358			$	364,610
Consumer			10,438				12,557
Farmland			2,498				2,418
Total Loans		$	2,151,814			$	2,215,228
Less unearned income			3,648				3,195
Less allowance for loan losses			53,217				62,442
Loans, net		$	2,094,949			$	2,149,591

 

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Classes of loans by risk rating as of June 30, 2011, excluding loans held-for-sale, are summarized as follows (dollars in thousands):

 

Internal Risk Rating Grades		Pass				Watch				Special Mention				Substandard				Doubtful				Total Loans
Commercial		$	154,569			$	43,933			$	3,438			$	28,968			$	2,144			$	233,052
Real estate 1-to-4 family residential:
Permanent first and second			208,915				19,211				10,508				22,702				—				261,336
Home equity loans and lines			110,193				5,506				1,647				8,287				253				125,886
Total Real estate 1-to-4 family residential		$	319,108			$	24,717			$	12,155			$	30,989			$	253			$	387,222
Real estate multi-family residential			69,055				16,117				—				495				—				85,667
Real estate non-farm/non-residential:
Owner occupied			353,551				46,774				20,762				33,873				—				454,960
Non-owner occupied			448,743				129,748				10,351				59,777				—				648,619
Total Real estate non-farm/non-residential		$	802,294			$	176,522			$	31,113			$	93,650			$	—			$	1,103,579
Real estate construction:
Residential			61,617				34,239				6,927				48,431				—				151,214
Commercial			57,315				68,237				25,487				27,105				—				178,144
Total Real estate construction		$	118,932			$	102,476			$	32,414			$	75,536			$	—			$	329,358
Consumer			9,993				243				94				108				—				10,438
Farmland			2,498				—				—				—				—				2,498
Total		$	1,476,449			$	364,008			$	79,214			$	229,746			$	2,397			$	2,151,814

Classes of loans by risk rating as of December 31, 2010, excluding loans held-for-sale, are summarized as follows (dollars in thousands):

 

Internal Risk Rating Grades		Pass				Watch				Special Mention				Substandard				Doubtful				Total Loans
Commercial		$	135,287			$	34,544			$	16,332			$	30,305			$	2,132			$	218,600
Real estate 1-to-4 family residential:
Permanent first and second			214,844				12,832				14,294				25,944				1,600				269,514
Home equity loans and lines			113,600				6,685				1,736				9,118				258				131,397
Total Real estate 1-to-4 family residential		$	328,444			$	19,517			$	16,030			$	35,062			$	1,858			$	400,911
Real estate multi-family residential			62,651				14,665				—				—				—				77,316
Real estate non-farm/non-residential:
Owner occupied			351,744				46,026				27,652				38,946				—				464,368
Non-owner occupied			455,172				122,993				36,997				59,286				—				674,448
Total Real estate non-farm/non-residential		$	806,916			$	169,019			$	64,649			$	98,232			$	—			$	1,138,816
Real estate construction:
Residential			55,646				34,123				34,649				53,164				—				177,582
Commercial			52,286				52,006				52,169				30,567				—				187,028
Total Real estate construction		$	107,932			$	86,129			$	86,818			$	83,731			$	—			$	364,610
Consumer			12,153				170				67				167				—				12,557
Farmland			2,418				—				—				—				—				2,418
Total		$	1,455,801			$	324,044			$	183,896			$	247,497			$	3,990			$	2,215,228

Loan risk-ratings for the Bank are defined as follows:

Pass. Loans to persons or entities with a strong to acceptable financial condition, adequate collateral margins, adequate cash flow to service long-term debt, adequate liquidity and sound net worth. These entities are profitable now, with projections indicating continued profitability into the foreseeable future. Closely held corporations or businesses where a majority of the profits are withdrawn by the owners or paid in dividends are included in this rating category. Overall, these loans are basically sound.

 

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Watch. These loans are characterized by greater than average risk. Borrowers may have marginal cash flow, marginal profitability, or have experienced an unprofitable year and a declining financial condition. The borrower has in the past satisfactorily handled debts with the Bank, but in recent months has either been late, delinquent in making payments, or made sporadic payments. While the Bank continues to be adequately secured, margins have decreased or are decreasing, despite the borrower’s continued satisfactory condition. Other characteristics of borrowers in this class may include inadequate credit or financial information. This classification includes loans to established borrowers that are reasonably margined by collateral, but where potential for improvement in financial capacity appears limited.

Special Mention. Loans in this category have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses can result in deteriorating prospects for the asset or in the institution’s credit position at some future date. Other assets especially mentioned (“OAEMs”) are not adversely classified and do not expose an institution to sufficient risk to warrant adverse classification.

Substandard. A loan classified as substandard is inadequately protected by the sound worth and paying capacity of the borrower or the collateral pledged. Loss potential, while existing in the aggregate amount of substandard loans, does not have to exist in individual assets.

Doubtful. A loan classified as doubtful has all the weaknesses inherent in a loan classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. These are poor quality loans in which neither the collateral, if any, nor the financial condition of the borrower presently ensure collectability in full in a reasonable period of time; in fact, there is permanent impairment in the collateral securing the Bank’s loan. These loans are in a work-out status and have a defined work-out strategy.

Loss. Loans classified as loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. The Bank takes losses in the period in which they become uncollectible.

As of June 30, 2011 and 2010, there were $295 thousand and $457 thousand, respectively, in checking account overdrafts that were reclassified on the consolidated balance sheets as loans.

4. Allowance for Loan Losses

An analysis of the allowance for loan losses for the six months ended June 30, 2011, and the year ended December 31, 2010 is shown below (dollars in thousands):

 

		June 30, 2011				December 31, 2010
Allowance, at beginning of period		$	62,442			$	65,152
Provision charged against income			7,277				20,594
Recoveries added to reserve			587				4,174
Losses charged to reserve			(17,089	)			(27,478	)
Allowance, at end of period		$	53,217			$	62,442

 

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Allowance for Loan Losses - By Segment (dollars in thousands) For the six months ended June 30, 2011		Commercial				Non-Farm, Non-Res. Real Estate				Real Estate Construction				Consumer				Real Estate 1-4 Family Residential				Real Estate Multi- Family				Farmland				Unallocated				Total
2011
Allowance for credit losses:
Beginning Balance		$	9,972			$	16,453			$	26,584			$	373			$	8,337			$	619			$	63			$	41			$	62,442
Charge-offs			(1,214	)			(4,634	)			(8,542	)			(48	)			(2,651	)			—				—				—				(17,089	)
Recoveries			345				5				117				12				108				—				—				—				587
Provision			1,127				2,315				(428	)			8				3,764				62				(6	)			435				7,277
Ending Balance		$	10,230			$	14,139			$	17,731			$	345			$	9,558			$	681			$	57			$	476			$	53,217
Ending Balance:
Individually evaluated for impairment			4,823				6,086				10,026				60				4,753				—				—				—				25,748
Collectively evaluated for impairment			5,407				8,053				7,705				285				4,805				681				57				476				27,469
Financing Receivables:
Ending Balance		$	233,052			$	1,103,579			$	329,358			$	10,438			$	387,222			$	85,667			$	2,498			$	—			$	2,151,814
Ending Balance:
Individually evaluated for impairment			31,112				97,004				81,844				111				31,310				495				—				—				241,876
Collectively evaluated for impairment		$	201,940			$	1,006,575			$	247,514			$	10,327			$	355,912			$	85,172			$	2,498			$	—			$	1,909,938
Allowance for Loan Losses - By Segment (dollars in thousands) For the twelve months ended December 31, 2010		Commercial				Non-Farm, Non-Res. Real Estate				Real Estate Construction				Consumer				Real Estate 1-4 Family Residential				Real Estate Multi- Family				Farmland				Unallocated				Total
2010
Allowance for credit losses:
Ending Balance		$	9,972			$	16,453			$	26,584			$	373			$	8,337			$	619			$	63			$	41			$	62,442
Ending Balance:
Individually evaluated for impairment			4,009				9,689				14,999				60				3,423				—				—				—				32,180
Collectively evaluated for impairment			5,963				6,764				11,585				313				4,914				619				63				41				30,262
Financing Receivables:
Ending Balance		$	218,600			$	1,138,816			$	364,610			$	12,557			$	400,911			$	77,316			$	2,418			$	—			$	2,215,228
Ending Balance:
Individually evaluated for impairment			33,660				105,756				90,444				167				37,628				—				—				—				267,655
Collectively evaluated for impairment		$	184,940			$	1,033,060			$	274,166			$	12,390			$	363,283			$	77,316			$	2,418			$	—			$	1,947,573

 

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Information about impaired loans as of and for the six months ended June 30, 2011 and the year ended December 31, 2010 is as follows (dollars in thousands):

 

		June 30, 2011				December 31, 2010
Non-accrual loans for which a specific allowance has been provided		$	41,458			$	27,717
Non-accrual loans for which no specific allowance has been provided			17,285				29,441
Other impaired loans for which a specific allowance has been provided			77,269				93,227
Other impaired loans for which no specific allowance has been provided			105,864				117,270
Total impaired loans		$	241,876			$	267,655
Allowance provided for impaired loans, included in the allowance for loan losses		$	25,748			$	32,180
Average balance in impaired loans		$	253,827			$	254,014
Interest income recognized		$	5,680			$	10,977

A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on non-accrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on non-accrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across our loan portfolio.

Included in certain loan categories in the impaired loans are troubled debt restructurings that were classified as impaired. At June 30, 2011, the Company had $27.7 million in real estate construction, $5.0 million in real estate permanent one-to-four- family, $38.7 million in non-farm/non-residential and $9.7 million in commercial that were modified in troubled debt restructurings and considered impaired. Included in this amount of $81.1 million, the Bank had troubled debt restructurings that were performing in accordance with their modified terms of $80.1 million at June 30, 2011.

Information about past due loans and impaired loans as of June 30, 2011 and December 31, 2010, is as follows (dollars in thousands):

 

June 30, 2011 Non-Accrual and Past Due by Class		30-59 Days Past Due				60-89 Days Past Due				90+ Days Past Due				Total Past Due				Current (1)				Total Loans				90+ Days Past Due and Still Accruing				Non- Accrual Loans
Commercial		$	1,800			$	323			$	4,480			$	6,603			$	226,449			$	233,052			$	—			$	4,932
Real estate 1-to-4 family residential:
Permanent first and second			253				3,225				68				3,546				257,790				261,336				—				1,982
Home equity loans and lines			339				54				2,320				2,713				123,173				125,886				—				2,990
Total real estate 1-to-4 family residential		$	592			$	3,279			$	2,388			$	6,259			$	380,963			$	387,222			$	—			$	4,972
Real estate multi-family residential			—				—				495				495				85,172				85,667				—				495
Real estate non-farm/non-residential:
Owner occupied			219				4,952				7,040				12,211				442,749				454,960				—				6,516
Non-owner occupied			—				4,688				7,273				11,961				636,658				648,619				350				7,831
Total real estate non-farm/non-residential		$	219			$	9,640			$	14,313			$	24,172			$	1,079,407			$	1,103,579			$	350			$	14,347
Real estate-construction
Residential			574				2,609				14,202				17,385				133,829				151,214				957				25,393
Commercial			—				—				8,586				8,586				169,558				178,144				—				8,586
Total Real estate construction		$	574			$	2,609			$	22,788			$	25,971			$	303,387			$	329,358			$	957			$	33,979
Consumer			31				4				—				35				10,403				10,438				—				18
Farmland			—				—				—				—				2,498				2,498				—				—
Total Loans		$	3,216			$	15,855			$	44,464			$	63,535			$	2,088,279			$	2,151,814			$	1,307			$	58,743

 

(1)	For the purposes of this table, loans 1-29 days past due are included in the balance of “Current” loans.

 

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December 31, 2010 Non-Accrual and Past Due by Class		30-59 Days Past Due				60-89 Days Past Due				90+ Days Past Due				Total Past Due				Current (1)				Total Loans				90+ Days Past Due and Still Accruing				Non- Accrual Loans
Commercial		$	2,642			$	157			$	3,542			$	6,341			$	212,259			$	218,600			$	—			$	3,719
Real estate 1-to-4 family residential:
Permanent first and second			734				4,028				4,631				9,393				260,121				269,514								5,285
Home equity loans and liens			2,225				679				1,472				4,376				127,021				131,397				242				1,529
Total real estate 1-to-4 family residential		$	2,959			$	4,707			$	6,103			$	13,769			$	387,142			$	400,911			$	242			$	6,814
Real estate multi-family residential			—				—				—				—				77,316				77,316				—				—
Real estate nonfarm, nonresidential:
Owner occupied			1,909				—				8,942				10,851				453,517				464,368				—				8,942
Non-owner occupied			—				—				4,114				4,114				670,334				674,448				—				4,114
Total real estate nonfarm/nonresidential		$	1,909			$	—			$	13,056			$	14,965			$	1,123,851			$	1,138,816			$	—			$	13,056
Real estate-construction
Residential			—				—				27,189				27,189				150,393				177,582				—				27,189
Commercial			—				—				6,361				6,361				180,667				187,028				—				6,361
Total Real estate-construction		$	—			$	—			$	33,550			$	33,550			$	331,060			$	364,610			$	—			$	33,550
Consumer			347				—				19				366				12,191				12,557				—				19
Farmland			—				—				—				—				2,418				2,418				—				—
Total Loans		$	7,857			$	4,864			$	56,270			$	68,991			$	2,146,237			$	2,215,228			$	242			$	57,158

 

(1)	For the purposes of this table, loans 1-29 days past due are included in the balance of “Current” loans.

 

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Impaired Loans as of 6/30/2011		Recorded Investment (Bank Balance)				Unpaid Principal Balance (Customer Balance)				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance:
Commercial		$	11,782			$	11,856			$	—			$	14,187			$	317
Real estate 1-4 family
Permanent first and second			12,318				12,447				—				13,788				309
Home equity loans and lines			3,179				3,182				—				3,425				77
Real estate multi-family residential			495				495				—				248				6
Real estate non-farm/non-residential
Owner occupied			25,715				26,072				—				28,811				645
Non-owner occupied			30,050				30,067				—				30,243				677
Real estate construction
Residential			11,514				11,516				—				13,871				310
Commercial			28,094				28,109				—				28,557				639
Consumer			2				2				—				3,114				70
With an allowance recorded:
Commercial		$	19,330			$	19,352			$	4,823			$	17,729			$	397
Real estate 1-4 family
Permanent first and second			10,643				10,676				3,561				11,507				257
Home equity loans and lines			5,170				5,202				1,192				5,093				114
Real estate multi-family residential			—				—				—				—				—
Real estate non-farm/non-residential
Owner occupied			8,158				8,173				1,485				5,962				133
Non-owner occupied			33,081				33,127				4,601				33,836				757
Real estate construction
Residential			36,918				37,026				9,076				38,320				857
Commercial			5,318				5,329				950				4,996				112
Consumer			109				111				60				140				3
Total :
Commercial		$	31,112			$	31,208			$	4,823			$	31,916			$	714
Real estate 1-4 family			31,310				31,507				4,753				33,813				757
Real estate multi-family residential			495				495				—				248				6
Real estate non-farm/non-residential			97,004				97,439				6,086				98,852				2,212
Construction			81,844				81,980				10,026				85,744				1,918
Consumer			111				113				60				3,254				73
Total Impaired Loans		$	241,876			$	242,742			$	25,748			$	253,827			$	5,680

 

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Impaired Loans as of 12/31/10		Recorded Investment (Bank Balance)				Unpaid Principal Balance (Customer Balance)				Related Allowance				Average Recorded Investment				Interest Income Recognized
With no related allowance:
Commercial		$	24,054			$	30,794			$	—			$	14,916			$	645
Real estate 1-4 family
Permanent first and second			17,743				20,462				—				13,852				599
Home equity loans and lines			3,878				3,878				—				2,846				123
Real estate multi-family residential			—				—				—				799				35
Real estate non-farm/non-residential
Owner occupied			36,130				36,738				—				26,259				1,135
Non-owner occupied			29,823				30,734				—				23,124				999
Real estate construction
Residential			14,042				19,947				—				20,069				867
Commercial			21,020				21,070				—				14,300				618
Consumer			21				21				—				30				1
With an allowance recorded:
Commercial		$	9,602			$	9,614			$	4,009			$	15,180			$	656
Real estate 1-4 family
Permanent first and second			10,508				10,925				2,236				12,024				520
Home equity loans and lines			5,498				5,634				1,187				4,367				189
Real estate multi-family residential			—				—				—				—				—
Real estate non-farm/non-residential
Owner occupied			7,345				8,211				2,197				9,409				407
Non-owner occupied			32,459				32,831				7,492				31,090				1,344
Real estate construction
Residential			39,824				47,602				10,071				48,009				2,079
Commercial			15,559				17,959				4,928				17,398				752
Consumer			149				151				60				257				11
Total :
Commercial		$	33,660			$	40,408			$	4,009			$	30,096			$	1,301
Real estate 1-4 family			37,628				40,899				3,423				33,088				1,430
Real estate multi-family residential			—				—				—				799				35
Real estate non-farm/non-residential			105,756				108,081				9,689				89,880				3,884
Construction			90,444				107,011				14,999				99,865				4,316
Consumer			167				248				60				287				12
Total Impaired Loans		$	267,655			$	296,647			$	32,180			$	254,014			$	10,977

In performing a specific reserve analysis on all impaired loans as of June 30, 2011, current third party appraisals were used with respect to approximately 60% of impaired loans to assist with the evaluation of collateral values for the purpose of establishing specific reserves. When a loan is identified as impaired and collateral dependent, a current evaluation of collateral value via third party appraisal or other valuation methodology is conducted within the calendar quarter of identification when possible, but not less than 90 days after identification. Charge-offs and specific reserves are established upon determination of collateral value. During the interim between identification of an impaired loan and receipt of a current appraisal of the related collateral, specific reserves are established based upon interim methodologies including discounted cash flow analysis, tax assessment values and review of market comparables. In general, variances between charge-offs and fair value of collateral is limited to estimates of projected costs of sale. Costs of sale are estimated at 10% of value. Partially charged-off loans remain non-performing until such time as a viable restructuring plan is developed. Upon execution of a forbearance agreement including modified terms, an impaired loan will be re-classified from non-performing to a troubled debt restructuring, but will continue to be identified as impaired until the loan performs under the modified terms for the remainder of the calendar year in which it was restructured, but not less than 90 days. As noted above, in the

 

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majority of cases, external appraisals are used to establish fair value of the related collateral. In the interim prior to receipt of a current appraisal or in those situations where a current appraisal is not deemed practical or necessary, discounted cash flow analysis, tax assessment values, review of market comparables and other methodologies are used to establish fair value. Impaired loans which do not have a specific reserve are those loans which have been identified to have sufficient collateral coverage, based upon the fair value of collateral, to repay the entire principal balance due from collateral liquidation.

5. Earnings Per Common Share

The following shows the weighted average number of shares used in computing earnings per common share and the effect on the weighted average number of shares of dilutive potential common stock. As of June 30, 2011, and 2010, there were 5,417,730 and 1,001,476 anti-dilutive stock options and warrants outstanding, respectively.

 

		Three Months Ended																Six Months Ended
		June 30, 2011								June 30, 2010								June 30, 2011								June 30, 2010
		Shares				Per Share Amount				Shares				Per Share Amount				Shares				Per Share Amount				Shares				Per Share Amount
Basic earnings per share			29,643,226			$	0.25				26,945,284			$	0.16				29,453,918			$	0.38				26,939,603			$	0.28
Effect of dilutive securities:
Stock options			1,084,410								1,608,623								1,111,944								1,342,789
Diluted earnings per share			30,727,636			$	0.24				28,553,907			$	0.15				30,565,862			$	0.36				28,282,392			$	0.26

6. Stock Compensation Plan

At June 30, 2011, the Company had two stock-based compensation plans, the 1998 Stock Option Plan and the Company’s 2010 Equity Plan (the “2010 Plan”). The 2010 Plan replaced the 1998 Stock Option Plan and as such no further options may be granted under the 1998 Stock Option Plan. Included in salaries and employee benefits expense for the six months ended June 30, 2011 and 2010, is $284 thousand and $332 thousand, respectively, of stock-based compensation expense which is based on the estimated fair value of 999,870 options granted between January 2006 and June 2011, as adjusted for stock dividends, amortized on a straight-line basis over a five year requisite service period. As of June 30, 2011, there was $1.5 million remaining of total unrecognized compensation expense related to these option awards which will be recognized over the remaining requisite service periods.

The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted average assumptions for grants in 2011 and 2010:

 

		2011		2010
Expected volatility		32.21%		32.21%
Expected dividends		0.00%		0.00%
Expected term (in years)		7.2		7.2
Risk-free rate		2.78% to 2.81%		3.1% to 3.50%

Stock option plan activity for the six months ended June 30, 2011, is summarized below:

 

		Number of Shares				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term				Aggregate Intrinsic Value
Outstanding at January 1, 2011			1,685,178			$	8.69
Granted			179,827				6.05
Exercised			(135,389	)			1.56
Forfeited			(24,735	)			14.59
Outstanding at June 30, 2011			1,704,881			$	8.90				4.6 years			$	—
Exercisable at June 30, 2011			1,282,814			$	9.48				3.3 years			$	—

The total value of in-the-money options exercised during the six months ended June 30, 2011 was $591 thousand.

 

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Restricted stock awards generally vest in equal installments over five years. The compensation expense associated with these awards is based on the grant date fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized as expense ratably over the requisite service period.

A summary of the non-vested restricted stock activity under the 2010 Plan for the six months ended June 30, 2011 is summarized below:

 

		Number of Shares				Weighted- Average Exercise Price				Aggregate Intrinsic Value
Non-vested at the beginning of year			9,335			$	6.65
Granted			31,913				6.00
Vested			—				—
Forfeited			—				—
Non-vested at end of the period			41,248			$	6.15			$	243,776

We recognized share-based compensation expense associated with shares of restricted stock of $23 thousand for the six months ended June 30, 2011.

7. Capital Requirements

A comparison of the June 30, 2011 capital ratios of the Company and its wholly-owned subsidiary, Virginia Commerce Bank (the “Bank”), with the minimum regulatory guidelines is as follows:

 

		Actual Capital				Minimum Capital Requirements				Minimum to  be “Well-Capitalized” Under Prompt Corrective Action Provisions
Total Risk-Based Capital:
Company			15.60	%			8.00	%			—
Bank			15.24	%			8.00	%			10.00	%
Tier 1 Risk-Based Capital:
Company			14.35	%			4.00	%			—
Bank			13.99	%			4.00	%			6.00	%
Leverage Ratio:
Company			11.67	%			4.00	%			—
Bank			11.41	%			4.00	%			5.00	%

8. Other Borrowed Funds and Lines of Credit

The Bank maintains a $442.2 million line of credit with the FHLB of Atlanta. The interest rate and term of each advance from the line is dependent upon the advance and commitment type. Advances on the line are secured by all of the Bank’s qualifying first liens and home equity lines-of-credit on one-to-four unit single-family dwellings. As of June 30, 2011, the book value of these qualifying loans totaled approximately $236.4 million and the amount of available credit using this collateral was $134.7 million. Advances on the line of credit in excess of this amount require pledging of additional assets, including other types of loans and investment securities. As of June 30, 2011 and December 31, 2010, the Bank had $25.0 million in advances outstanding that mature on September 21, 2012, but are callable by the FHLB on any quarterly interest payment date. The Bank has additional short-term lines of credit totaling $47.0 million with nonaffiliated banks at June 30, 2011, on which there were no amounts outstanding.

 

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9. Trust Preferred Capital Notes

On December 19, 2002, the Company completed a private placement issuance of $15.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust II) which issued $470 thousand in common equity to the Company. These securities bear a floating rate of interest, adjusted semi-annually, of 330 basis points over six month LIBOR, which as of August 7, 2011 was 3.76%. These securities have been callable at par since December 30, 2007, on any semi-annual interest payment date, but have not been redeemed to date. On December 20, 2005, the Company completed a private placement of $25.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust III) which issued $774 thousand in common equity to the Company. These securities had a fixed rate of interest of 6.19% until February 23, 2011, at which time they converted to a floating rate, adjusted quarterly, of 142 basis points over three month LIBOR, which as of August 7, 2011 was 1.67%. These securities became callable at par beginning February 23, 2011.

On September 24, 2008, the Company completed a private placement, to its directors and certain executive officers, of $25.0 million of trust preferred securities through a newly formed, wholly-owned, subsidiary trust (VCBI Capital Trust IV) which issued $775 thousand in common equity to the Company. These securities bear a fixed rate of interest of 10.20% and are callable at par beginning September 24, 2013. In connection with the issuance of the trust preferred securities, the Company also issued warrants to purchase an aggregate of 1.5 million shares of common stock to the purchasers. The warrants have a five year term and an exercise price of $6.83 per share.

The principal asset of each trust is a similar amount of the Company’s junior subordinated debt securities with an approximately 30 year term from issuance and like interest rates to the trust preferred securities. The obligations of the Company with respect to the trust preferred securities constitute a full and unconditional guarantee by the Company of each trust’s obligations with respect to the trust preferred securities to the extent set forth in the related guarantees. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, resulting in a deferral of distribution payments on the related trust preferred securities. If the Company defers interest payments on the junior subordinated debt securities, or otherwise is in default of the obligations in respect to the trust preferred securities, the Company would be prohibited from making dividend payments to its shareholders, and from most purchases, redemptions or acquisitions of the Company’s common stock.

The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy purposes up to 25.0% of Tier 1 capital after its inclusion. The portion of the trust preferred securities not qualifying as Tier 1 capital may be included as part of total qualifying capital in Tier 2 capital, subject to limitation.

10. Preferred Stock and Warrant

On December 12, 2008, the Company entered into a Letter Agreement (“Agreement”) with the United States Department of the Treasury (“Treasury”) under the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, whereby the Company issued and sold to the Treasury 71,000 shares of fixed rate cumulative perpetual preferred stock with a par value of $1.00 and a liquidation amount of $1,000 per share, for a total price of $71.0 million. In addition, the Treasury received a warrant to purchase 2,696,203 shares of the Company’s common stock at an exercise price of $3.95 per share. Subject to certain restrictions, the preferred stock and the warrant are transferable by the Treasury. The allocated carrying values at June 30, 2011, of the preferred stock and the warrant, based on their relative fair values, were $62.5 million and $8.5 million, respectively.

The preferred stock pays dividends quarterly, beginning February 2009, at a rate of 5% per year for the first five years, then increases to 9% thereafter. The Company may redeem the preferred stock at any time, subject to approval by the Treasury after consultation with the Board of Governors of the Federal Reserve System (the “Federal Reserve”), at the liquidation amount of $1,000 per share plus any accrued and unpaid dividends. Approval from the Treasury is required to pay common stock dividends or to repurchase shares of the Company’s common stock prior to December 12, 2011, unless the preferred stock has been fully redeemed.

The warrant has a ten year term and is immediately exercisable. Pursuant to the terms of the Agreement, the Treasury will not exercise voting rights with respect to any shares of common stock it acquires upon exercise of the warrant; voting rights may be exercised by any other holder.

 

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Note Regarding 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 (the “Exchange Act”), including statements of goals, intentions, and expectations as to future trends, plans, events or results of Company operations and policies, including but not limited to our outlook on earnings, and statements regarding asset quality, concentrations of credit risk, the adequacy of the allowance for loan losses, projected growth, capital position, our plans regarding and expected future levels of our non-performing assets, business opportunities in our markets, strategic initiatives to capitalize on those opportunities and general economic conditions. When we use words such as “may,” “will,” “anticipates,” “believes,” “expects,” “plans,” “estimates,” “potential,” “continue,” “should,” and similar words or phrases, you should consider them as identifying forward-looking statements. These forward-looking statements are not guarantees of future performance. 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.

Our forward-looking statements are subject to the following principal risks and uncertainties:

 

•

adverse governmental or regulatory policies may be enacted;

 

•

the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) could increase our regulatory compliance burden and associated costs, place restrictions on certain products and services, and limit our future capital raising strategies;

 

•

the interest rate environment may compress margins and adversely affect net interest income;

 

•

adverse effects may be caused by changes to credit quality;

 

•

competition from other financial services companies in our markets could adversely affect operations;

 

•

our concentrations of commercial, commercial real estate and construction loans, may adversely affect our earnings and results of operations;

 

•

an economic slowdown could adversely affect credit quality, loan originations and the value of collateral securing the Company’s loans; and

 

•

social and political conditions such as war, political unrest and terrorism or natural disasters could have unpredictable negative effects on our businesses and the economy.

Other factors, risks and uncertainties that could cause our actual results to differ materially from estimates and projections contained in these forward-looking statements are discussed under “Risk Factors” in the Company’s annual report on Form 10-K for the year ended December 31, 2010.

Readers are cautioned against placing undue reliance on any such forward-looking statements. The Company disclaims any obligation to update or revise publicly or otherwise any forward-looking statements to reflect subsequent events, new information or future circumstances.

Non-GAAP Presentations

The Company prepares its financial statements under accounting principles generally accepted in the United States, or “GAAP”. However, this financial report also refers to certain non-GAAP financial measures that we believe, when considered together with GAAP financial measures, provide investors with important information regarding our operational performance. An analysis of any non-GAAP financial measure should be used in conjunction with results presented in accordance with GAAP.

 

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Core operating earnings is a non-GAAP financial measure that reflects net income excluding taxes, loan loss provisions, losses on other real estate owned, impairment losses on securities, gain on sale of securities and death benefits received from bank-owned life insurance. These excluded items are difficult to predict and we believe that core operating earnings provides the Company and investors with a valuable measure of the Company’s operational performance and a valuable tool to evaluate the Company’s financial results. Calculation of core operating earnings for the three months ended June 30, 2011, June 30, 2010, and March 31, 2011, is as follows:

 

		Three Months Ended June 30,								Three Months Ended March 31,
(in thousands)		2011				2010				2011
Net Income		$	8,836			$	5,571			$	4,966
Adjustments to net income:
Provision for loan losses			1,434				4,200				5,843
Loss on other real estate owned			320				1,060				156
Impairment loss on securities			—				668				732
Gain on sale of securities			—				(139	)			(503	)
Provision for income taxes			4,254				2,750				2,400
Death benefits received from bank-owned life insurance			(361	)			—				—
Core Operating Earnings		$	14,483			$	14,110			$	13,594

The adjusted efficiency ratio is a non-GAAP financial measure that is computed by dividing non-interest expense, by the sum of net interest income on a tax equivalent basis and non-interest income before impairment losses on securities, gain on sale of securities and death benefits received from bank-owned life insurance. We believe that this measure provides investors with important information about our operating efficiency. Comparison of our adjusted efficiency ratio with those of other companies may not be possible because other companies may calculate the adjusted efficiency ratio differently. Calculation of the adjusted efficiency ratio for the three months and six months ended June 30, 2011 and June 30, 2010 is as follows:

 

(in thousands)		Three Months Ended June 30,								Six Months Ended June 30,
		2011				2010				2011				2010
Summary Operating Results:
Non-interest expense		$	14,520			$	14,788			$	28,970			$	29,495
Net interest income		$	26,788			$	26,221			$	52,971			$	51,037
Non-interest income			2,256				1,088				3,732				1,695
Impairment loss on securities			—				668				732				1,519
Gain on sale of securities			—				(139	)			(503	)			(139	)
Death benefits received from bank-owned life insurance			(361	)			—				(361	)			—
Total		$	28,683			$	27,838			$	56,571			$	54,112
Efficiency Ratio, adjusted			50.0	%			52.6	%			50.5	%			53.9	%

The tangible common equity ratio is a non-GAAP financial measure representing the ratio of tangible common equity to tangible assets. Tangible common equity and tangible assets are non-GAAP financial measures derived from GAAP-based amounts. We calculate tangible common equity for the Company by excluding the balance of intangible assets and outstanding preferred stock issued to the U.S. Treasury from total stockholders’ equity. We calculate tangible assets by excluding the balance of intangible assets from total assets. We had no intangible assets for the periods presented. We believe that this is consistent with the treatment by bank regulatory agencies, which exclude intangible assets from the calculation of regulatory capital ratios. Accordingly, we believe that these non-GAAP financial measures provide information that is important to investors and that is useful in understanding our capital position and ratios. However, these non-GAAP financial measures are supplemental and are not substitutes for an analysis based on a GAAP measure. As other companies may use different calculations for non-GAAP measures, our presentation may not be comparable to other similarly titled measures reported by other companies. Calculation of the Company’s tangible common equity ratio as of June 30, 2011 and 2010, March 31, 2011 and December 31, 2010 is as follows:

 

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(in thousands)		As of June 30,								March 31,				December 31,
		2011				2010				2011				2010
Tangible common equity:
Total stockholders’ equity		$	267,124			$	230,331			$	253,373			$	245,594
Less:
Outstanding TARP senior preferred stock			66,334				64,719				65,873				65,445
Intangible assets			—				—				—				—
Tangible common equity		$	200,790			$	165,612			$	187,500			$	180,149
Total tangible assets		$	2,797,775			$	2,826,807			$	2,783,633			$	2,741,648
Tangible common equity ratio			7.18	%			5.86	%			6.74	%			6.57	%

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-eight branch offices, one residential mortgage office and one wealth management office.

Headquartered in Arlington, Virginia, the Bank 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, Fredericksburg, 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 sized 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.

Critical Accounting Policies

For the period ended June 30, 2011, there were no changes in the Company’s critical accounting policies as reflected in the Company’s most recent annual report.

The Company’s financial statements are prepared in accordance with 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 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) “Accounting for Contingencies” (ASC 450, “Contingencies”), which requires that losses be accrued when they are probable of occurring and estimable and (ii) “Accounting by Creditors for Impairment of a Loan” (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.

Our allowance for loan losses has two basic components: the specific allowance and the general 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 impaired loans. 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 based on the Company’s calculation of the loss embedded in the individual loan. Large groups of smaller balance, homogeneous loans, representing 1-4 family residential first and second trusts, including home equity lines-of-credit, are collectively evaluated for impairment based upon factors such as levels and trends in delinquencies, trends in loss and problem loan identification, trends in volumes and concentrations, local and national economic trends and conditions including estimated levels of housing price depreciation/homeowners’ loss of equity, competitive factors and other considerations. These factors are converted into reserve percentages and applied against the homogenous loan pool

 

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balances. Impaired loans which meet the criteria for substandard, doubtful and loss 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). The general 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 general allowance recognizes potential losses whose impact on the portfolio has yet to be recognized by a 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 and in Note 4 to the Consolidated Financial Statements.

The Company’s 1998 Stock Option Plan (the “1998 Plan”), which is stockholder-approved, permitted the grant of share options to its directors and officers for up to 2.3 million shares of common stock. The Company’s 2010 Equity Plan (the “2010 Plan”), which is also stockholder-approved and replaces the 1998 Plan, permits the grant of share-based awards in the form of stock options, stock appreciation rights, restricted and unrestricted stock, performance units, options and other awards to its directors, officers and employees for up to 1.5 million shares of common stock. To date, the Company has granted stock options and restricted stock under the 2010 Plan. The Company also has option awards outstanding under the 1998 Plan, but since May 2, 2010, the effective date of the 2010 Plan, no new awards can be granted under the 1998 Plan. The Company recognizes expense for its share-based compensation based on the fair value of the awards that are granted.

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 7.2 year expected term, before exercise, for the options granted, and a risk-free interest rate based on the United States Department of the Treasury (the “Treasury”) curve in effect at the time of the grant to estimate total stock-based compensation expense. This amount is then amortized on a straight-line basis over the requisite service period, currently 5 years, to salaries and benefits expense. Restricted stock awards generally vest in equal installments over 5 years. The compensation expense associated with these awards is based on the grant date fair value of the award. The value of the portion of the award that is ultimately expected to vest is recognized ratably over the requisite service period. See Note 6 to the Consolidated Financial Statements for additional information regarding the plans and related expense.

On a quarterly basis the Company reviews any securities which are considered to be impaired as defined by accounting guidance, to determine if the impairment is deemed to be other-than-temporary. If it is determined that the impairment is other-than-temporary, i.e. impaired because of credit issues rather than interest rate, the investment is written down through the Consolidated Statements of Income in accordance with accounting guidance. See Note 2 to the Consolidated Financial Statements for additional information regarding security impairments deemed to be other than temporary.

Results of Operations

For the six months ended June 30, 2011, the Company recorded net income of $13.8 million. After an effective dividend of $2.7 million to the U.S. Treasury on preferred stock, the Company reported net income available to common stockholders of $11.1 million, or $0.36 per diluted common share, compared to net income available to common stockholders of $7.5 million, or $0.26 per diluted common share for the first six months of 2010. Net income available to common stockholders increased 47.8 % in the six months ended June 30, 2011 when compared to the same period in 2010. In the second quarter of 2011 compared to the second quarter of 2010, the Company recorded a 58.6% increase in net income and a 73.3% increase in net income available to common stockholders. Net income available to common stockholders was $7.5 million for the quarter ending June 30, 2011 compared to $4.3

 

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million in the second quarter of 2010. Diluted earnings per share increased from $0.15 for the quarter ended June 30, 2010 to $0.24 for the quarter ended June 30, 2011. The year-over-year earnings improvement was largely attributable to an increase of $2.0 million in non-interest income in the six month period ended June 30, 2011 compared to the same period in 2010, and an increase in net interest income of $1.9 million and a reduction in the provision for loan losses of $1.2 million over the same periods.

Total assets increased $56.1 million, or 2.1%, from $2.74 billion at December 31, 2010, to $2.80 billion at June 30, 2011, as total investment securities grew $99.3 million, or 24.1%, from $411.8 million to $511.1 million. The investment securities portfolio grew significantly during the six months ended June 30, 2011, as the Company purchased investment securities with excess liquidity that could not be used to originate new loans. The growth of the securities portfolio is primarily attributable to an increase of $99.8 million of U.S. Government Agency obligations in the Company’s available-for-sale securities portfolio. Loans, net of allowance for loan losses, decreased $54.6 million or 2.5% from $2.15 billion on December 31, 2010 to $2.09 billion on June 30, 2011. Year over year non-farm, non-residential real estate loans decreased $37.4 million, or 3.3%, multifamily real estate loans increased $1.2 million, or 1.4%, acquisition, development and construction (“ADC”) loans fell by $49.6 million, or 13.1%, and commercial and industrial (“C&I”) loans were up $15.2 million, or 7.0%. Loan production has been negatively impacted over the last year by lower economic activity and demand for credit in both the business and consumer sectors, a reallocation of lending personnel to problem loan identification and resolution, a strategic decision to restrict acquisition, development and construction lending and an increased emphasis on deposit generation and non-credit products. Lending efforts in 2011 are being focused on building greater market share in commercial lending, especially in sectors forecast for growth, such as government contract lending, professional practices and associations and select service industries, with strategic hiring, marketing campaigns, calling efforts and sales management restructuring. Progress with this strategy was evident in the first six months of 2011 with commercial loans increasing $14.52 million, while ADC loans decreased $35.2 million and non-farm, non-residential loans also decreased $35.2 million.

For the six months ended June 30, 2011, total deposits remained relatively unchanged compared to year end 2010 at $2.25 billion. However, the Company’s deposit mix improved as demand deposits increased $28.3 million or 10.7%, savings and interest-bearing demand accounts decreased $19.3 million or 1.6% and time deposits decreased $2.5 million or 0.3%. While opportunities for balance sheet growth have been limited in recent periods as loan demand and production have been negatively impacted by economic conditions, the Company has focused on improving deposit mix. Demand deposit growth has been the top priority, with the year-over-year increase in demand deposits primarily due to the successful efforts of the Company’s team of eight business development officers, who are focused on acquisition and retention of commercial operating funds, treasury management services and other related cross-sales. In other deposit categories, strategic pricing and customer preference for liquidity has resulted in a desired reduction in time deposits. The decrease in NOW, savings and money market accounts, which remain desirable deposit products, is considered nominal and can be attributed to end of period fluctuations. At June 30, 2011, the Bank had no brokered certificates of deposit, down from $60.1 million at June 30, 2010.

As noted, for the six months ended June 30, 2011, the Company recorded net income available to common stockholders of $11.1 million compared to $7.5 million for the six months ended June 30, 2010, as non-interest income increased and provisions for loan losses decreased compared to the same period in 2010. The Company’s return on average assets and return on average equity were 1.00% and 10.94%, respectively, for the six months ended June 30, 2011, compared to 0.72% and 9.01%, respectively, for the same period in 2010.

On March 31, 2011, the Company issued 426,000 shares of its common stock at a price of $5.87 per share in a registered direct placement with a Company director for total gross proceeds of approximately $2.5 million. In addition, the Company issued to the investor warrants exercisable for shares of common stock, which, if fully exercised, would provide an additional $4.8 million in gross proceeds to the Company. The warrants each have an exercise price of $5.62 per share. The Series A warrants, exercisable for a total of 426,000 shares of common stock, are exercisable for a period of seven months following the closing date. The Series B warrants, also exercisable for a total of 426,000 shares of common stock, are exercisable for a period of twelve months following the closing date.

On September 29, 2010, the Company issued 1,904,766 shares of its common stock at a price of $5.25 per share in a registered direct placement with several institutional investors for total gross proceeds of $10.0 million. In addition, the Company issued to the investors warrants exercisable for shares of common stock. The warrants each have an exercise price of $6.00 per share, which represents a 14.3% premium to the offering price of the shares of common stock sold in the registered direct placement. The Series A warrants were exercisable through April 30, 2011, and 130,851 were exercised. The outstanding Series B warrants are exercisable for a total of 952,383 shares of common stock through September 29, 2011. As of August 8, 2011, Series B warrants to acquire 47,619 shares of common stock have been exercised.

 

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Stockholders’ equity increased $36.8 million, or 16.0% from $230.3 million at June 30, 2010, to $267.1 million at June 30, 2011, with approximately $11.8 million in net proceeds from the above referenced stock issuances, net income to common stockholders of $20.1 million over the twelve-month period, a $1.3 million increase in other comprehensive income related to the investment securities portfolio, and $3.6 million in proceeds and tax benefits related to the exercise of options by the Company’s directors and officers and stock option expense credits. As a result of these changes, the Company’s Tier 1 capital ratio increased from 12.13% at June 30, 2010, to 14.35% at June 30, 2011, and its total qualifying capital ratio increased from 13.38% to 15.60%. The Bank’s ratios increased by similar levels. Sequentially, the Company’s Tier 1 and total qualifying capital ratios are each up 39 basis points, and its tangible common equity ratio is up 44 basis points from March 31, 2011, to 7.18% as of June 30, 2011.

Net Interest Income

Net interest income is the excess of interest earned on loans and investments over the interest paid on deposits and borrowings as well as the Company’s primary revenue source. Net interest income is thereby affected by overall balance sheet growth, changes in interest rates and changes in the mix of investments, loans, deposits and borrowings. Net interest income of $26.8 million for the second quarter of 2011 was up $567 thousand, or 2.2% over the same quarter last year, due primarily to lower interest expense attributable to changes in deposit mix and interest rate adjustments, which were partially offset by lower interest and dividend income. Interest expense decreased $2.1 million for the quarter ended June 30, 2011, from the same period in 2010 and decreased $4.7 million for the six months ended June 30, 2011 compared to the first half of 2010. These reductions offset decreases in interest and fee income on loans of $1.5 million and $2.7 million, respectively, for the three and six-month periods ended June 30, 2011, as compared to the same periods in 2010. The decline in interest and fee income on loans is attributable to lower outstanding loan balances of $27.4 million for the three months and $54.6 million for the six months ended June 30, 2011. Year-to-date net interest income of $53.0 million was up 3.8%, compared to $51.0 million in the same period of 2010. On a sequential basis, the margin was unchanged at 3.99%. The year-over-year increases in the net interest margin were driven by lower deposit costs due to significant reductions in the level of time deposits and increased levels of demand deposits and lower rate interest-bearing transaction accounts. As a result, the average cost of interest-bearing deposits fell from 1.65% in the second quarter of 2010 to 1.36% in the second quarter of 2011, while the yield on interest-earning assets declined twenty basis points from 5.50% to 5.30%. Management anticipates the net interest margin will range between 3.70% and 3.90% over the next two quarters, but may come under some pressure later in the year if short-term interest rates begin to rise.

The following tables show the average balance sheets for each of the three and six months ended June 30, 2011 and 2010. In addition, the amounts of interest earned on interest-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 $1.3 million and $539 thousand for the three months ended June 30, 2011 and 2010, respectively and $2.0 million and $1.3 million for the six months ended June 30, 2011 and 2010, respectively.

 

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		Three Months Ended June 30,
		2011												2010
(Dollars in thousands)		Average Balance				Interest Income- Expense				Average Yields /Rates				Average Balance				Interest Income- Expense				Average Yields /Rates
Assets
Securities (1)		$	443,906			$	3,723				3.49	%		$	362,411			$	3,787				4.30	%
Restricted stock			11,658				96				3.31	%			11,752				88				3.00	%
Loans, net of unearned income (2)			2,180,131				31,765				5.85	%			2,266,145				33,236				5.89	%
Interest-bearing deposits in other banks			498				—				0.05	%			186				—				0.06	%
Federal funds sold			81,105				54				0.27	%			85,797				50				0.23	%
Total interest-earning assets		$	2,717,298			$	35,638				5.30	%		$	2,726,291			$	37,161				5.50	%
Other assets			89,123												87,131
Total Assets		$	2,806,421											$	2,813,422
Liabilities and Stockholders’ Equity
Interest-bearing deposits:
NOW accounts		$	322,378			$	595				0.74	%		$	369,336			$	817				0.89	%
Money market accounts			196,946				515				1.05	%			155,482				479				1.23	%
Savings accounts			669,476				1,597				0.96	%			638,407				2,480				1.56	%
Time deposits			777,509				3,963				2.04	%			885,828				4,655				2.11	%
Total interest-bearing deposits		$	1,966,309			$	6,670				1.36	%		$	2,049,053			$	8,431				1.65	%
Securities sold under agreement to repurchase and federal funds purchased			184,290				960				2.09	%			185,343				1,010				2.18	%
Other borrowed funds			25,000				268				4.25	%			25,000				268				4.25	%
Trust preferred capital notes			66,406				952				5.67	%			66,154				1,231				7.36	%
Total interest-bearing liabilities		$	2,242,005			$	8,850				1.58	%		$	2,325,550			$	10,940				1.89	%
Demand deposits and other liabilities			305,258												260,285
Total liabilities		$	2,547,263											$	2,585,835
Stockholders’ equity			259,158												227,587
Total liabilities and stockholders’ equity		$	2,806,421											$	2,813,422
Interest rate spread											3.72	%											3.61	%
Net interest income and margin						$	26,788				3.99	%						$	26,221				3.89	%

 

(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.

(2)	Loans placed on non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $1.3 million and $539 thousand for the three months ended June 30, 2011 and 2010, respectively.

 

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		Six Months Ended June 30,
		2011												2010
(Dollars in thousands)		Average Balance				Interest Income- Expense				Average Yields /Rates				Average Balance				Interest Income- Expense				Average Yields /Rates
Assets
Securities (1)		$	425,301			$	7,176				3.54	%		$	350,391			$	7,493				4.42	%
Restricted Stock			11,705				192				3.31	%			11,752				176				3.02	%
Loans, net of unearned income (2)			2,191,560				63,688				5.87	%			2,273,538				66,141				5.88	%
Interest-bearing deposits in other banks			443				—				0.08	%			114				—				0.07	%
Federal funds sold			74,401				99				0.27	%			67,367				78				0.23	%
Total interest-earning assets		$	2,703,410			$	71,155				5.35	%		$	2,703,162			$	73,888				5.54	%
Other assets			83,770												87,845
Total Assets		$	2,787,180											$	2,791,007
Liabilities and Stockholders’ Equity
Interest-bearing deposits:
NOW accounts		$	321,973			$	1,248				0.78	%		$	325,483			$	1,630				1.01	%
Money market accounts			187,119				984				1.06	%			151,070				971				1.30	%
Savings accounts			680,998				3,513				1.04	%			621,150				4,977				1.62	%
Time deposits			780,469				7,948				2.05	%			943,597				10,281				2.20	%
Total interest-bearing deposits		$	1,970,559			$	13,693				1.40	%		$	2,041,300			$	17,859				1.76	%
Securities sold under agreement to repurchase and federal funds purchased			175,331				1,894				2.18	%			183,659				1,999				2.19	%
Other borrowed funds			25,000				534				4.25	%			25,000				534				4.25	%
Trust preferred capital notes			66,378				2,063				6.18	%			66,122				2,459				7.39	%
Total interest-bearing liabilities		$	2,237,268			$	18,184				1.64	%		$	2,316,081			$	22,851				1.99	%
Demand deposits and other liabilities			295,467												250,128
Total liabilities		$	2,532,735											$	2,566,209
Stockholders’ equity			254,445												224,798
Total liabilities and stockholders’ equity		$	2,787,180											$	2,791,007
Interest rate spread											3.71	%											3.55	%
Net interest income and margin						$	52,971				3.99	%						$	51,037				3.84	%

 

(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.

(2)	Loans placed on non-accrual status are included in the average balances. Net loan fees and late charges included in interest income on loans totaled $2.0 million and $1.3 million for the six months ended June 30, 2011 and 2010, respectively.

 

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Allowance for Loan Losses / Provision for Loan Loss Expense

Provisions for loan losses were $1.4 million for the quarter ended June 30, 2011, compared to $4.2 million in the same period in 2010. Net charge-offs for the second quarter of 2011 were $4.7 million compared to $7.0 million in the second quarter of the prior year. For the six months ended June 30, 2011, provisions for loan losses totaled $7.3 million compared to $8.4 million for the prior year period, with 2011 year-to-date net charge-offs amounting to $16.5 million compared to $11.2 million in the first half of 2010. The higher net charge-off amount in the first half of 2011 compared to 2010, is reflective of a continuing proactive effort to address marginal credit situations which were unable to survive in a prolonged economic recovery. The lower provisions for loan losses in 2011 compared to 2010, are reflective of charge-offs predominantly representing specific reserves and are indicative, management believes, of an improving overall quality of the loan portfolio.

Total non-performing assets and loans 90+ days past due declined from $91.6 million at June 30, 2010, to $74.7 million at June 30, 2011, and increased $1.2 million sequentially from $73.5 million at March 31, 2011. The sequential increase was primarily in loans 90+ days past due and still accruing, as non-performing assets remained mostly unchanged at $73.4 million. As of June 30, 2011, the allowance for loan losses represented 2.47% of total loans, down from 2.59% at March 31, 2011, with the allowance covering 88.6% of total non-performing loans. See “Risk Elements and Non-Performing Assets” later in this discussion for more information on non-performing assets and loans 90+ days past due and other impaired loans. Although the allowance for loan losses as of June 30, 2011 represents a slightly lower percentage of total loans and total non-performing loans when compared to March 31, 2011, as discussed in more detail below management has concluded that the allowance is appropriate in light of the credit quality and anticipated risk of loss in the loan portfolio.

Management believes that the allowance for loan losses is adequate at June 30, 2011. 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, and the residential real estate market in particular, 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 at least 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 a historical loss 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 historical loss factors are updated, as the various types and categories of loans change as a percentage of total loans and as specific allowances are required on impaired loans and charge-offs occur. The decision to specifically reserve for or to charge-off or partially charge-off an impaired loan balance is based upon an evaluation of that loan’s potential to improve, based upon near term change in financial or market conditions, which would enable collection of the portion of the loan determined to be impaired. If these conditions are determined to be favorable, a specific reserve would be established as opposed to a charge-off. For further information regarding the allowance for loan losses see Note 4 to the Consolidated Financial Statements.

 

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The following schedule summarizes the changes in the allowance for loan losses:

 

		Six Months Ended June 30, 2011				Six Months Ended June 30, 2010				Twelve Months Ended December 31, 2010
		(Dollars in thousands)
Allowance, at beginning of period		$	62,442			$	65,152			$	65,152
Provision charged against income			7,277				8,438				20,594
Recoveries:
Consumer loans			12				4				20
Commercial			345				2,324				2,858
Real estate one-to-four family residential:
Permanent first and second			106				7				42
Home equity loans and lines			2				277				289
Real estate-non-farm, non-residential			5				54				58
Real estate-construction			117				450				907
Losses charged to reserve:
Consumer loans			(48	)			(141	)			(345	)
Commercial loans			(1,214	)			(6,073	)			(7,761	)
Real Estate one-to-four family residential:
Permanent first and second			(1,883	)			(2,257	)			(3,445	)
Home equity loans and liens			(768	)			(365	)			(543	)
Real estate-multi-family residential			—				—				(1,050	)
Real estate-non-farm, non-residential			(4,634	)			(2,662	)			(5,260	)
Real estate-construction			(8,542	)			(2,863	)			(9,075	)
Net charge-offs			(16,502	)			(11,245	)			(23,304	)
Allowance, at end of period		$	53,217			$	62,345			$	62,442
Ratio of net charge-offs to average total loans outstanding during period			0.75	%			0.49	%			1.03	%
Allowance for loan losses to total loans			2.47	%			2.77	%			2.82	%

The following schedule provides a breakdown of general reserves and specific reserves by loan type:

 

		June 30, 2011				June 30, 2010				December 31, 2010
		(Dollars in thousands)
Allocation of the allowance for loan losses:
Real estate – mortgage-general		$	13,539			$	6,374			$	12,296
Real estate – mortgage-specific			10,839				3,904				13,112
Real estate – construction-general (1)			7,762				21,079				11,648
Real estate – construction-specific			10,026				20,605				15,000
Commercial-general			5,407				6,930				5,963
Commercial-specific			4,823				2,994				4,009
Consumer-general			285				303				313
Consumer-specific			60				156				60
Unallocated			476				0				41
Total		$	53,217			$	62,345			$	62,442

 

(1)	Includes Farmland.

 

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Risk Elements and Non-Performing Assets

Non-performing assets consist of non-accrual loans and OREO (foreclosed properties). For the six months ended June 30, 2011, total non-performing assets and loans 90+ days past due and still accruing interest increased slightly from $74.6 million at December 31, 2010, to $74.7 million at June 30, 2011, and have increased $1.2 million from $73.5 million at March 31, 2011. The ratio of non-performing assets and loans 90+ days past due and still accruing to total assets decreased from 3.24% at June 30, 2010, to 2.67% at June 30, 2011, and decreased from 2.72% of total assets at December 31, 2010. 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.

Our underwriting for new acquisition, development, and construction loans always includes the interest cost for the loan whether an interest reserve is approved or not. In other words, the equity requirement in the new loan is established reflecting the amount of interest required to serve the project. We continually monitor the adequacy of reserve requirements, including interest reserves, during the draw process to ensure the project is being completed on time and within budget. We have restructured loans due to the slow market, re-underwriting each loan based on time and cost to complete. We do not continue funding interest reserves just to keep the loan from becoming non-performing. We consider whether the loan to value ratio will support current and future advances and whether the project is meeting certain completion criteria necessary to successfully complete the project. Once a loan becomes non-performing, we do not allow draws on interest reserves.

Other impaired loans, that are currently performing, and troubled debt restructurings, performing in accordance with their modified terms, decreased from $297.3 million at December 31, 2010, to $183.1 million at June 30, 2011. These loans have been identified by the Company as having certain weaknesses as a result of the Company’s specific knowledge about the customer or recent credit events, and are classified as substandard and subject to impairment testing at each balance sheet date.

Troubled debt restructurings which represented $81.1 million of other impaired loans as of June 30, 2011, were down from $103.0 million at December 31, 2010. These loans, which have been provided concessions such as rate reductions, payment deferrals, and in some cases forgiveness of principal, are all on accrual status. If the loan was on non-accrual at the time of the concession it is the Company’s policy that it remain on non-accrual status and perform in accordance with the modified terms for a period of six months. As of June 30, 2011, all troubled debt restructurings were accruing interest. The Company does not report any non-accrual loans as troubled debt restructurings.

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 book value or fair value, including a reduction for the estimated selling expenses, or principal balance of the related loan. Reviews and discussions with regard to value and disposition of each foreclosed property are conducted monthly by the Company’s Special Asset Committee. The carrying value of a foreclosed asset is immediately adjusted down when new information is obtained, including a potentially acceptable offer, the sale of a similar property in the vicinity of one of the Company’s assets, and/or a change in the price the property is being listed for. The Company also uses the advice of outside consultants and real estate agents with knowledge of the markets the properties are located in. Appraisals are ordered when the property is foreclosed on, but are not routinely updated at each balance sheet date. The Company confirms that it performed the above noted procedures and made the proper impairment adjustments, if any, at the balance sheet date.

 

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Total non-performing assets as of the dates indicated consisted of the following:

 

		June 30, 2011				June 30, 2010				December 31, 2010
		(In Thousands of Dollars)
Non-accrual loans:
Commercial		$	4,932			$	5,346			$	3,719
Real estate-one-to-four family residential:
Closed end first and seconds			1,982				4,369				5,285
Home equity lines			2,990				630				1,529
Total real estate-one-to-four family residential		$	4,972			$	4,999			$	6,814
Real estate-multi-family residential			495				—				—
Real estate-non-farm, non-residential:
Owner occupied			6,516				8,045				8,942
Non-owner occupied			7,831				8,298				4,114
Total real estate-non-farm, non-residential		$	14,347			$	16,343			$	13,056
Real estate-construction:
Residential-owner occupied			—				—				—
Residential-builder			25,393				30,877				27,189
Commercial			8,586				6,911				6,361
Total real estate-construction:		$	33,979			$	37,788			$	33,550
Consumer			18				122				19
Total non-accrual loans			58,743			$	64,598				57,158
OREO			14,690				26,477				17,165
Total non-performing assets		$	73,433			$	91,075			$	74,323
Loans 90+ days past due and still accruing:
Commercial		$	—			$	264			$	—
Real estate-one-to-four family residential:
Closed end first and seconds			—				280				—
Home equity lines			—				—				242
Total real estate-one-to-four family residential		$	—			$	280			$	242
Real estate multi-family residential			—				—				—
Real estate-non-farm, non-residential:
Owner occupied			—				—				—
Non-owner occupied			350				—				—
Total real estate-non-farm, non-residential		$	350			$	—			$	—
Real estate-construction:
Residential-owner occupied			393				—				—
Residential-builder			564				—				—
Commercial			—				—				—
Total real estate-construction:		$	957			$	—			$	—
Consumer			—				—				—
Total loans past due 90+ days and still accruing		$	1,307			$	544			$	242
Total non-performing assets and past due loans		$	74,740			$	91,619			$	74,565

 

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		June 30, 2011				June 30, 2010				December 31, 2010
		(In Thousands of Dollars)
Non-performing assets
to total loans:			3.41	%			4.04	%			3.36	%
to total assets:			2.62	%			3.22	%			2.71	%
Non-performing assets and 90+ days past due loans
to total loans:			3.47	%			4.06	%			3.37	%
to total assets:			2.67	%			3.24	%			2.72	%
Allowance for loan losses to total loans			2.47	%			2.77	%			2.82	%
Allowance for loan losses to non-performing loans			88.62	%			95.71	%			108.79	%
Troubled debt restructurings:
Commercial		$	9,733			$	11,815			$	12,175
Real estate-one-to-four family residential:
Closed end first and seconds			5,006				5,330				5,437
Home equity lines			—				—				—
Total Real estate-one-to-four family residential		$	5,006			$	5,330			$	5,437
Real estate multi-family residential			—				—				—
Real estate-non-farm, non-residential:
Owner occupied			6,662				18,921				14,667
Non-owner occupied			32,006				28,272				35,001
Total Real estate-non-farm, non-residential		$	38,668			$	47,193			$	49,668
Real estate-construction:
Residential-Owner occupied			—				—				—
Residential-Builder			7,220				12,504				9,760
Commercial			20,406				20,074				25,908
Total Real estate-construction:		$	27,626			$	32,578			$	35,668
Consumer			37				60				48
Total troubled debt restructurings		$	81,070			$	96,976			$	102,996

Non-performing loans continue to be concentrated in residential and commercial construction and land development loans in outer sub-markets hardest hit by the residential downturn and commercial and consumer credits experiencing the after shocks in sub-contracting businesses and workforce employment. Overall, as of June 30, 2011, $34.0 million, or 57.8%, of non-performing loans represented acquisition, development and construction (“ADC”) loans, $14.3 million, or 24.4%, represented non-farm, non-residential loans, $5.0 million, or 8.5%, represented loans on one-to-four family residential properties, and $4.9 million, or 8.4%, represented commercial and industrial (“C&I”) loans. Interest actually received on non-accrual loans was $250 thousand for the six months ended June 30, 2011 and $305 thousand for the six months ended June 30, 2010. See Note 4 to the Consolidated Financial Statements for additional information regarding the Company’s non-performing loans.

 

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The following provides a breakdown of the construction and non-farm/non-residential loan portfolios by location, including loans on non-accrual status, with dollars in thousands:

 

		As of June 30, 2011
Residential, Acquisition, Development and Construction By County/Jurisdiction of Origination:		Total Outstandings				Percentage of Total				Non-accrual Loans				Non-accruals as a % of Outstandings				Net charge- offs as a % of Outstandings
District of Columbia		$	5,975				4.0	%		$	—				—				—
Montgomery, MD			1,609				1.1	%			—				—				—
Prince Georges, MD			19,605				13.0	%			12,689				8.4	%			0.2	%
Other Counties in MD			5,404				3.6	%			—				—				—
Arlington/Alexandria, VA			28,652				18.9	%			1,400				0.9	%			—
Fairfax, VA			41,739				27.6	%			826				0.5	%			0.1	%
Culpeper/Fauquier, VA			1,276				0.8	%			528				0.3	%			0.2	%
Frederick, VA			—				—				6,250				4.1	%			—
Loudoun, VA			15,178				10.0	%			—				—				0.7	%
Prince William, VA			9,601				6.3	%			1,036				0.7	%			—
Spotsylvania, VA			201				0.1	%			—				—				—
Stafford, VA			14,640				9.7	%			2,664				1.8	%			—
Other Counties in VA			7,229				4.8	%			—				—				—
Outside VA, D.C. & MD			105				0.1	%			—				—				—
		$	151,214				100.0	%		$	25,393				16.8	%			1.2	%

 

		As of June 30, 2011
Commercial, Acquisition, Development and Construction By County/Jurisdiction of Origination:		Total Outstandings				Percentage of Total				Non-accrual Loans				Non-accruals as a % of Outstandings				Net charge-offs (recoveries) as a % of Outstandings
District of Columbia		$	6,196				3.5	%		$	—				—				—
Montgomery, MD			—				—				—				—				—
Prince Georges, MD			12,491				7.0	%			—				—				—
Other Counties in MD			2,233				1.3	%			—				—				—
Arlington/Alexandria, VA			9,302				5.2	%			3,143				1.7	%			—
Fairfax, VA			27,538				15.5	%			2,800				1.6	%			—
Culpeper/Fauquier, VA			3,020				1.7	%			—				—				—
Frederick, VA			5,325				3.0	%			—				—				—
Henrico, VA			878				0.5	%			—				—				—
Loudoun, VA			22,129				12.4	%			579				0.3	%			2.5	%
Prince William, VA			53,529				30.0	%			2,064				1.2	%			1.2	%
Spotsylvania, VA			1,740				1.0	%			—				—
Stafford, VA			28,464				16.0	%			—				—				—
Other Counties in VA			5,299				3.0	%			—				—				—
Outside VA, D.C. & MD			—				—				—				—				—
		$	178,144				100.0	%		$	8,586				4.8	%			3.7	%

 

		As of June 30, 2011
Non-Farm/Non-Residential By County/Jurisdiction of Origination:		Total Outstandings				Percentage of Total				Non-accrual Loans				Non-accruals as a % of Outstandings				Net charge- offs as a % of Outstandings
District of Columbia		$	79,753				7.2	%		$	—				—				—
Montgomery, MD			27,664				2.5	%			—				—				—
Prince Georges, MD			46,396				4.2	%			—				—				—
Other Counties in MD			53,279				4.8	%			—				—				—
Arlington/Alexandria, VA			192,867				17.5	%			1,284				0.1	%			—
Fairfax, VA			265,476				24.1	%			4,847				0.4	%			—
Culpeper/Fauquier, VA			3,797				0.3	%			—				—				—
Frederick, VA			4,335				0.4	%			—				—				—
Henrico, VA			24,309				2.2	%			—				—				0.3	%
Loudoun, VA			107,122				9.7	%			3,710				0.3	%			0.1	%
Prince William, VA			199,659				18.1	%			909				0.1	%			—
Spotsylvania, VA			16,703				1.5	%			—				—				—
Stafford, VA			19,751				1.8	%			—				—				—
Other Counties in VA			54,714				5.0	%			3,597				0.3	%			—
Outside VA, D.C. & MD			7,754				0.7	%			—				—				—
		$	1,103,579				100.0	%		$	14,347				1.3	%			0.4	%

 

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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, Spotsylvania and Stafford Counties, the cities of Alexandria, Fairfax, Falls Church, Fredericksburg, Manassas and Manassas Park, and, to a lesser extent, certain Maryland suburbs and the city of Washington, D.C. Substantially all of the Company’s loans are made within its market area.

The ultimate collectability 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 June 30, 2011, the Company had $1.52 billion, or 70.6%, 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, 2010, commercial real estate loans were $1.58 billion, or 71.4%, of total loans. Total construction loans of $329.4 million at June 30, 2011 represented 15.3% of total loans, loans secured by multi-family residential properties of $85.7 million represented 4.0% of total loans, and loans secured by non-farm, non-residential properties of $1.1 billion represented 51.3%.

Construction loans at June 30, 2011, included $134.0 million in loans to commercial builders of single family residential property and $17.2 million to individuals on single family residential property, together representing 7.0% of total loans. 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 $178.1 million of construction loans on non-residential commercial property at June 30, 2011, representing 8.3% of total loans. Total construction loans of $329.4 million include $102.1 million in land acquisition and/or development loans on residential property and $92.1 million in land acquisition and/or development loans on commercial property, together totaling $194.2 million, or 9.0% of total loans. Potential 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 June 30, 2011, 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 and guarantors and/or the individual project, to include an analysis of cash flows and secondary repayment sources.

The federal banking regulators have issued guidance for those institutions which are deemed to have concentrations in commercial real estate lending. Pursuant to the supervisory criteria contained in the guidance for identifying institutions with a potential commercial real estate concentration risk, institutions which have (1) total reported loans for construction, land development, and other land which represent in total 100% or more of an institutions total risk-based capital; or (2) total commercial real estate loans representing 300% or more of the institutions total risk-based capital and the institution’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months are identified as having potential commercial real estate concentration risk. Institutions which are deemed to have concentrations in commercial real estate lending are expected to employ heightened levels of risk management with respect to their commercial real estate portfolios and may be required to hold higher levels of capital. The Company, like many community banks, has a concentration in commercial real estate loans. Management has extensive experience in commercial real estate lending and has implemented and continues to maintain heightened portfolio monitoring and reporting, and strong underwriting criteria with respect to its commercial real estate portfolio. The Company is well-capitalized. Nevertheless, it is possible that the Company could be required to maintain higher levels of capital as a result of our commercial real estate concentration, which could require us to obtain additional capital, and may adversely affect stockholder returns.

 

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Non-Interest Income

For the three months ended June 30, 2011, the Company recognized $2.3 million in non-interest income, a 107.4% increase compared to non-interest income of $1.1 million for the three months ended June 30, 2010. The Company recognized non-interest income of $3.7 million for the six months ended June 30, 2011, compared to non-interest income of $1.7 million for the same period in 2010. Non-deposit investment services commissions for the second quarter 2011 increased $282 thousand, or 158.4%, over the second quarter of 2010. Fees and net gains on loans held-for-sale were up for the second quarter 2011 on a year-over-year basis by $51 thousand, or 10.6%. Non-interest income for the second quarter also included a bank-owned life insurance death benefit of $361 thousand and a reduction of $668 thousand in impairment losses on securities year-over-year. For the six months ended June 30, 2011, non-interest income included an impairment loss on securities of $732 thousand, which was partially offset by a gain on sale of securities of $503 thousand as well as the aforementioned bank-owned life insurance death benefit, while non-interest income for the six months ended June 30, 2010, included a $1.5 million impairment loss on securities. Management is carefully monitoring its holdings of the securities which caused the impairment losses and at this time can not be assured that there will not be additional losses in the future. Management, except for the possibility of future impairment losses, expects non-interest income to generally remain at levels realized in the second quarter.

Non-Interest Expense

Non-interest expense decreased $268 thousand, or 1.8%, from $14.8 million in the second quarter of 2010 to $14.5 million in the second quarter of 2011, and was down $525 thousand, or 1.8%, from $29.5 million for the six months ended June 30, 2010, to $29.0 million year-to-date as of June 30, 2011. Compared to the first quarter of 2011, non-interest expense was up $70 thousand. The year-over-year decrease was due primarily to the lower loss on other real estate owned, although this decrease was partially offset as salaries and employee benefits expense increased year-over-year for the three- and six-month periods ended June 30, 2011. As a result of a minimal increase in overhead and higher levels of non-interest income, the efficiency ratio improved from 52.6% in the second quarter of 2010 to 50.0% in the second quarter of 2011. Non-interest expense in future periods may be impacted by new regulatory complexity and compliance costs related to recent legislation passed by Congress and rules and regulations implemented by federal regulatory agencies.

Provision for Income Taxes

The Company’s income tax provisions are adjusted for non-deductible expenses and non-taxable income before applying the U.S. federal income tax rate of 35%. For the six months ended June 30, 2011, the Company recorded an income tax provision of $6.7 million compared to a provision of $4.8 million for the same period in 2010.

Liquidity

The Company’s principal source of liquidity and funding is 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 that can 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 $108.3 million, or 18.5%, from $585.1 million at December 31, 2010, to $693.4 million at June 30, 2011, due to a $102.59 million increase in available-for-sale securities. Additional sources of liquidity available to the Bank 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. See Note 8 to the Consolidated Financial Statements for further information regarding these additional liquidity sources.

 

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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 customers 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 $503.0 million at June 30, 2011, and $436.3 million at December 31, 2010, 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 June 30, 2011, and December 31, 2010, the Company had $25.7 million and $28.8 million, respectively, in outstanding standby letters of credit.

Contractual Obligations

Since December 31, 2010, there have been no significant changes in the Company’s contractual obligations.

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, and for the Company includes certain minority interests relating to bank subsidiary issued shares, and a limited amount of restricted core capital elements. Restricted core capital elements include qualifying cumulative preferred stock interests, certain minority interests in subsidiaries and qualifying trust preferred securities. All of the $71 million in preferred stock interests issued to the Treasury under the Capital Purchase Program qualify as Tier 1 capital. Total risk-based capital consists of Tier 1 capital, qualifying subordinated debt, and a portion of the allowance for loan losses, and for the Company, a limited amount of excess restricted core capital elements. Risk-based capital ratios are calculated with reference to risk-weighted assets. The leverage ratio compares Tier 1 capital to total average assets. The Bank’s Tier 1 risk-based capital ratio was 13.99% at June 30, 2011, compared to 12.87% at December 31, 2010, and its total risk-based capital ratio was 15.24% at June 30, 2011, compared to 14.12% at December 31, 2010. These ratios are in excess of the mandated minimum requirement of 4.00% and 8.00%, respectively. The Bank’s leverage ratio was 11.41% at June 30, 2011, compared to 10.76% at December 31, 2010, and in excess of the mandated minimum requirement of 4.00%. The Company’s Tier 1 risk-based capital ratio, total risk-based capital ratio, and leverage ratio was 14.35%, 15.60% and 11.67%, respectively, at June 30, 2011, compared to 13.20%, 14.45%, and 11.07% at December 31, 2010. The increases in these capital ratios in 2011 are due to additional capital, improved financial performance and lower levels of high weight risk assets (loans) and higher levels of lower weighted risk assets (securities).

The ability of the Company to continue to maintain its overall asset size, or to grow, is dependent on its earnings and the ability to obtain additional funds for contribution to the Bank’s capital, through earnings, borrowing, the sale of additional common stock, or through the issuance of additional 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

 

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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 stockholders’ equity may be adversely affected.

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.

Pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act, the Federal Reserve has revised the capital treatment of trust preferred securities to provide that, beginning in 2011, 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, subject to limitation. At June 30, 2011, trust preferred securities represented 19.7% of the Company’s Tier 1 capital and 18.1% of its total risk-based capital. See Note 9 to the Consolidated Financial Statements for further information regarding trust preferred securities.

Capital Issuances. As noted above, during 2008, the Company accepted an investment by Treasury under the Capital Purchase Program. In connection with that investment, the Company entered into and consummated a Securities Purchase Agreement with the Treasury, pursuant to which the Company issued 71,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A (“Series A Preferred Stock”), having a liquidation amount per share equal to $1,000, for a total purchase price of $71 million. The Series A Preferred Stock pays cumulative dividends at a rate of 5% per year for the first five years and thereafter at a rate of 9% per year. Subject to consultation with the Company’s and Bank’s federal regulators, the Company may, at its option, redeem the Series A Preferred Stock at the liquidation amount plus accrued and unpaid dividends. The Series A Preferred Stock is non-voting, except in limited circumstances. Prior to the third anniversary of issuance, unless the Company has redeemed all of the Series A Preferred Stock or the Treasury has transferred all of the Series A Preferred Stock to a third party, the consent of the Treasury will be required for the Company to commence paying a cash common stock dividend or repurchase its common stock or other equity or capital securities, other than in connection with benefit plans consistent with past practice and certain other circumstances specified in the Securities Purchase Agreement.

In connection with the purchase of the Series A Preferred Stock, the Treasury was issued a warrant (the “Warrant”) to purchase 2,696,203 shares of the Company’s common stock at an initial exercise price of $3.95 per share. The Warrant provides for the adjustment of the exercise price and the number of shares of the common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of the common stock, and upon certain issuances of the common stock (or securities exercisable or exchangeable for, or convertible into, common stock) at or below 90% of the market price of the common stock on the trading day prior to the date of the agreement on pricing such securities. The Warrant expires ten years from the date of issuance. If the Company redeems the Series A Preferred Stock in full prior to exercise of the Warrant, the Warrant will be liquidated based upon the then current fair market value of the common stock. The Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

On March 31, 2011, the Company issued 426,000 shares of its common stock at a price of $5.87 per share in a registered direct placement with a Company director for total gross proceeds of approximately $2.5 million. In addition, the Company issued to the investor warrants exercisable for shares of common stock, which, if fully exercised, would provide an additional $4.8 million in gross proceeds to the Company. The warrants each have an exercise price of $5.62 per share. The Series A warrants, exercisable for a total of 426,000 shares of common stock, are exercisable for a period of seven months following the closing date. The Series B warrants, also exercisable for a total of 426,000 shares of common stock, are exercisable for a period of twelve months following the closing date.

On September 29, 2010, the Company issued 1,904,766 shares of its common stock at a price of $5.25 per share in a registered direct placement with several institutional investors for total gross proceeds of $10.0 million. In addition, the Company issued to the investors warrants exercisable for shares of common stock. The warrants each have an exercise price of $6.00 per share, which represents a 14.3% premium to the offering price of the shares of common stock sold in the registered direct placement. The Series A warrants were exercisable through April 30, 2011, and 130,851 were exercised. The outstanding Series B warrants are exercisable for a total of 952,383 shares of common stock through September 29, 2011. As of August 8, 2011, Series B warrants to acquire 47,619 shares of common stock have been exercised.

 

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Please refer to Note 9 to the Consolidated Financial Statements for additional information regarding the issuance of $25 million of trust preferred securities and warrants to purchase 1.5 million shares to certain directors and executive officers of the Company.

Recent Accounting Pronouncements

In January 2010, the FASB issued Accounting Standards Update (“ASU”) No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures and require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll-forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2010, the FASB issued ASU 2010-20, “Receivables (Topic 310) – Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.

In December 2010, the FASB issued ASU 2010-28, “Intangible – Goodwill and Other (Topic 350) – When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In December 2010, the FASB issued ASU 2010-29, “Business Combinations (Topic 805) – Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

The Securities Exchange Commission (SEC) issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting.” The rule requires companies to submit financial statements in extensible business reporting language (XBRL) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011. The Company is complying with this rule as of June 30, 2011.

In March 2011, the SEC issued Staff Accounting Bulletin (SAB) 114. This SAB revises or rescinds portions of the interpretive guidance included in the codification of the Staff Accounting Bulletin Series. This update is intended to make the relevant interpretive guidance consistent with current authoritative accounting guidance issued as a part of the FASB’s Codification. The principal changes involve revision or removal of accounting guidance references and other conforming changes to ensure consistency of referencing through the SAB Series. The effective date for SAB 114 is March 28, 2011. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

 

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In April 2011, the FASB issued ASU 2011-02, “Receivables (Topic 310) – A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” The amendments in this ASU clarify the guidance on a creditor’s evaluation of whether it has granted a concession to a debtor. They also clarify the guidance on a creditor’s evaluation of whether a debtor is experiencing financial difficulty. The amendments in this ASU are effective for the first interim or annual period beginning on or after June 15, 2011. Early adoption is permitted. Retrospective application to the beginning of the annual period of adoption for modifications occurring on or after the beginning of the annual adoption period is required. As a result of applying these amendments, an entity may identify receivables that are newly considered to be impaired. For purposes of measuring impairment of those receivables, an entity should apply the amendments prospectively for the first interim or annual period beginning on or after June 15, 2011. The Company will adopt ASU 2011-02 and include the required disclosures in its consolidated financial statements effective July 1, 2011.

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU are effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.

In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and IASB to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and IFRSs. The amendments are effective for interim and annual periods beginning after December 15, 2011 with prospective application. Early application is not permitted. The Company is currently assessing the impact that ASU 2011-04 will have on its consolidated financial statements.

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The objective of this ASU is to improve the comparability, consistency and transparency of financial reporting and to increase the prominence of items reported in other comprehensive income by eliminating the option to present components of other comprehensive income as part of the statement of changes in stockholders’ equity. The amendments require that all non-owner changes in stockholders’ equity be presented either in a single continuous statement of comprehensive income or in two separate but consecutive statements. The single statement of comprehensive income should include the components of net income, a total for net income, the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. In the two-statement approach, the first statement should present total net income and its components followed consecutively by a second statement that should present all the components of other comprehensive income, a total for other comprehensive income, and a total for comprehensive income. The amendments do not change the items that must be reported in other comprehensive income, the option for an entity to present components of other comprehensive income either net of related tax effects or before related tax effects, or the calculation or reporting of earnings per share. The amendments in this ASU should be applied retrospectively. The amendments are effective for fiscal years and interim periods within those years beginning after December 15, 2011. Early adoption is permitted because compliance with the amendments is already permitted. The amendments do not require transition disclosures. The Company is currently assessing the impact that ASU 2011-05 will have on its consolidated financial statements.

 

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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 VCB/Investor Relations/SEC Filings.” 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 are made available as soon as reasonably practicable after the reports are electronically filed or furnished to the SEC.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

In the normal course of business, the Company is exposed to market risk, or interest rate risk, as its net income is largely dependent on its net interest income. Market risk is managed by the Company’s Asset/Liability Management Committee that formulates and monitors the performance of the Company based on established levels of market risk as dictated by policy. In setting tolerance levels, or limits on market risk, the Committee considers the impact on earnings and capital, the level and general direction of interest rates, liquidity, local economic conditions and other factors. Interest rate risk, or sensitivity, can be defined as the amount of forecasted net interest income that may be gained or lost due to favorable or unfavorable movements in interest rates. Interest rate risk, or sensitivity, arises when the maturity or repricing of interest-earning assets differs from the maturing or repricing of interest-bearing liabilities and as a result of the difference between total interest-earning assets and interest-bearing liabilities. The Company seeks to manage interest rate sensitivity while enhancing net interest income by periodically adjusting this asset/liability position. In order to closely monitor and measure interest rate sensitivity, the Company uses earnings simulation models on a quarterly basis.

We use a duration gap of equity approach to manage our long term interest rate risk. This approach uses a model which generates estimates of the change in our market value of portfolio equity (“MVPE”) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets and liabilities using various assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.

Our short term interest rate sensitivity is managed through the use of a model that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. The model assumes that the composition of interest sensitive assets and liabilities existing at June 30, 2011, remains constant over a two year period (base case) and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities.

The following table provides an analysis of our interest rate risk as measured by the estimated change in MVPE and net interest income from the base case, resulting from instantaneous and sustained parallel shifts in interest rates as of June 30, 2011, (in thousands):

 

		Sensitivity of Market Value of Portfolio Equity June 30, 2011																Sensitivity of Net Interest Income June 30, 2011
						Market Value of Portfolio Equity												Net Interest Income								Net Interest Margin
Interest Rate Scenario		Amount				$ Change from Base				Percent				% of Total Assets				Amount				$ Change from Base				Percent				% Change from Base
Up 300 bps		$	215,540			$	(97,021	)			-31.04	%			7.62	%		$	216,702			$	6,541				3.94	%			3.11	%
Up 200 bps			246,251				(66,310	)			-21.22	%			8.71	%			214,786				4,625				3.91	%			2.21	%
Base Case			312,561				—				—				11.05	%			210,161				—				3.82	%			—
Down 100 bps			322,370				9,809				3.14	%			11.40	%			199,718				(10,443	)			3.64	%			-4.89	%

Management believes the modeled results are consistent with the short duration of the Company’s balance sheet and given the many variables that affect the actual timing of when assets and liabilities will reprice and the extent of that repricing. In shocking the current two year projection upward, interest-bearing liabilities are repricing slightly higher than interest-earning assets; however, that decline in interest income is being offset by a higher level of interest-earning assets relative to interest-bearing liabilities. Since the earnings model uses numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows and customer behavior, the model cannot precisely estimate net income and the effect on net income from sudden changes in interest rates. Actual results will differ from the simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors.

 

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ITEM 4. CONTROLS AND PROCEDURES

The Company’s management, with the participation of the Company’s Chief Executive Officer and Interim Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Exchange Act) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Interim Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2011, to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Interim Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). There was no change in the Company’s internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II. OTHER INFORMATION

Item 1. LEGAL PROCEEDINGS – None

Item 1A. RISK FACTORS

There have been no material changes in the risk factors faced by the Company from those disclosed in the Company’s annual report on Form 10-K for the year ended December 31, 2010.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

(a)

Sales of Unregistered Securities. – None

 

(b)

Use of Proceeds.– Not Applicable.

 

(c)

Issuer Purchases of Securities. – None

Item  3 . DEFAULTS UPON SENIOR SECURITIES – None

Item 4. (REMOVED AND RESERVED)

Item 5. OTHER INFORMATION

 

(a)

Required 8-K Disclosures. None

 

(b)

Changes in Procedures for Director Nominations by Securityholders. None

Item 6. EXHIBITS

 

Exhibit No.		Description
3.1		Articles of Incorporation of Virginia Commerce Bancorp, Inc., as amended (incorporated by reference to Exhibit 3.1 to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2006)
3.2		Articles of Amendment to the Articles of Incorporation relating to the Series A Preferred Stock (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed on December 15, 2008)

 

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	3.3			Amended and Restated By-laws of Virginia Commerce Bancorp, Inc. (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed on July 27, 2007)
	3.4			Amendment to the Amended and Restated By-laws of Virginia Commerce Bancorp, Inc. (incorporated by reference to exhibit 3.4 to the Company’s Current Report on Form 8-K filed on January 28, 2011)
	31.1			Certification of Peter A. Converse, President and Chief Executive Officer
	31.2			Certification of Wilmer L. Tinley, Jr., Interim Chief Financial Officer
	32.1			Certification of Peter A. Converse, President and Chief Executive Officer
	32.2			Certification of Wilmer L. Tinley, Jr., Interim Chief Financial Officer
	101			The following materials from Virginia Commerce Bancorp, Inc.’s quarterly report on Form 10-Q for the quarter ended June 30, 2011, formatted in XBRL (Extensible Business Reporting Language), furnished herewith: (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Changes in Stockholders’ Equity (unaudited), (iv) Consolidated Statements of Cash Flows (unaudited), and (v) Notes to Consolidated Financial Statements (unaudited)

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		Virginia Commerce Bancorp, Inc.
		(Registrant)
Date: August 8, 2011		BY		/s/ Peter A. Converse
		Peter A. Converse, President and Chief Executive Officer (Principal Executive Officer)
Date: August 8, 2011		BY		/s/ Wilmer L. Tinley, Jr.
		Wilmer L. Tinley, Jr., Interim Chief Financial Officer (Principal Financial Officer)

 

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