f10qvillage093013.htm


 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

__________

FORM 10-Q/A
Amendment No. 1
QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

oTRANSITION REPORT UNDER SECTION 13 OR 15(d)
OF THE EXCHANGE ACT

For the transition period from ______ to ______

____________


Commission file number: 0-50765

VILLAGE BANK AND TRUST FINANCIAL CORP.
(Exact name of registrant as specified in its charter)

Virginia
 
16-1694602
(State or other jurisdiction of
 
(I.R.S. Employer
incorporation or organization)
 
Identification No.)
     
15521 Midlothian Turnpike, Midlothian, Virginia
23113
(Address of principal executive offices)
 
(Zip code)
     
804-897-3900
(Registrant’s telephone number, including area code)

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes S     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 £
Non-Accelerated Filer £  (Do not check if smaller reporting company)
Smaller Reporting Company x

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

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date.
4,251,795 shares of common stock, $4.00 par value, outstanding as of November 1, 2013
 


 
 
 
EXPLANATORY NOTE
 
Village Bank and Trust Financial Corp. (the “Company”) hereby amends its Quarterly Report on Form 10-Q for the period ended September 30, 2013 as set forth in this Quarterly Report on Form 10-Q/A (Amendment No. 1) (the “Amendment”).  The signature of the Company’s principal financial officer was inadvertently omitted from the EDGAR version of Exhibit 32.1 in the original filing.  The Amendment is being filed solely for the purpose of providing a new Exhibit 32.1 reflecting the principal financial officer’s signature.
 
No other information in the Form 10-Q for the period ended September 30, 2013 is being amended by the Amendment, and the filing continues to speak as of the period ending date in the original filing.  For convenience, the entire Quarterly Report on Form 10-Q for the period ended September 30, 2013 has been re-filed in this Amendment.  Pursuant to SEC Rule 12b-15, in connection with this filing, we have also re-filed Exhibits 31.1 and 31.2.


 
 
1


 
 

 

 
 

Village Bank and Trust Financial Corp.
Form 10-Q

TABLE OF CONTENTS

     
   
     
   
 
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2


PART I – FINANCIAL INFORMATION

ITEM 1 – FINANCIAL STATEMENTS

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Balance Sheets
September 30, 2013 (Unaudited) and December 31, 2012
             
   
September 30,
   
December 31,
 
   
2013
   
2012
 
Assets
           
Cash and due from banks
  $ 13,142,811     $ 13,945,105  
Federal funds sold
    20,632,216       39,185,837  
Total cash and cash equivalents
    33,775,027       53,130,942  
Investment securities available for sale
    59,112,521       25,154,046  
Loans held for sale
    14,526,577       24,188,384  
Loans
               
Outstandings
    303,001,827       354,910,266  
Allowance for loan losses
    (8,627,944 )     (10,807,827 )
Deferred fees and costs
    690,947       787,823  
      295,064,830       344,890,262  
Premises and equipment, net
    23,672,984       25,815,342  
Accrued interest receivable
    1,517,519       1,676,518  
Bank owned life insurance
    6,718,678       6,575,018  
Other real estate owned
    19,651,654       20,203,691  
Other assets
    5,680,845       8,453,169  
                 
    $ 459,720,635     $ 510,087,372  
                 
Liabilities and Stockholders' Equity
               
Liabilities
               
Deposits
               
Noninterest bearing demand
  $ 59,172,655     $ 57,049,348  
Interest bearing
    342,423,760       379,273,614  
Total deposits
    401,596,415       436,322,962  
Federal Home Loan Bank advances
    18,000,000       28,000,000  
Long-term debt - trust preferred securities
    8,764,000       8,764,000  
Other borrowings
    3,289,463       4,851,811  
Accrued interest payable
    1,054,233       911,635  
Other liabilities
    5,762,908       6,272,163  
Total liabilities
    438,467,019       485,122,571  
                 
Stockholders' equity
               
Preferred stock, $4 par value, $1,000 liquidation preference,
               
1,000,000 shares authorized, 14,738 shares issued and outstanding
    58,952       58,952  
Common stock, $4 par value - 10,000,000 shares authorized;
               
4,251,795 shares issued and outstanding at September 30, 2013
               
4,251,795 shares issued and outstanding at December 31, 2012
    17,007,180       17,007,180  
Additional paid-in capital
    40,711,221       40,705,257  
Retained earnings (deficit)
    (34,026,563 )     (33,173,525 )
Common stock warrant
    732,479       732,479  
Discount on preferred stock
    (87,392 )     (198,993 )
Accumulated other comprehensive loss
    (3,142,261 )     (166,549 )
Total stockholders' equity
    21,253,616       24,964,801  
                 
    $ 459,720,635     $ 510,087,372  
                 
See accompanying notes to consolidated financial statements
               


 
3




Village Bank and Trust Financial Corp. and Subsidiary
 
 
Three and NIne Months Ended September 30 2013 and 2012
 
(Unaudited)
 
                         
                         
   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2013
   
2012
   
2013
   
2012
 
Interest income
                       
Loans
  $ 4,459,368     $ 5,488,927     $ 14,224,369     $ 17,002,398  
Investment securities
    323,763       166,684       750,678       532,229  
Federal funds sold
    18,145       11,570       71,159       44,123  
Total interest income
    4,801,276       5,667,181       15,046,206       17,578,750  
                                 
Interest expense
                               
Deposits
    850,206       1,187,060       2,842,814       3,791,427  
Borrowed funds
    167,249       263,747       610,594       798,868  
Total interest expense
    1,017,455       1,450,807       3,453,408       4,590,295  
                                 
Net interest income
    3,783,821       4,216,374       11,592,798       12,988,455  
Provision for loan losses
    -       700,000       823,000       9,095,000  
Net interest income (loss) after provision
                               
for loan losses
    3,783,821       3,516,374       10,769,798       3,893,455  
                                 
Noninterest income
                               
Service charges and fees
    645,499       604,377       1,790,785       1,652,355  
Gain on sale of loans
    2,126,263       2,394,138       6,454,380       6,336,030  
Gain on sale of assets
    -       -       598,182       -  
Gain on sale of investment securities
    -       556,805       216,879       820,482  
Rental income
    213,736       187,839       657,224       557,920  
Other
    99,485       285,723       396,093       497,927  
Total noninterest income
    3,084,983       4,028,882       10,113,543       9,864,714  
                                 
Noninterest expense
                               
Salaries and benefits
    3,633,542       3,484,073       10,592,092       9,888,166  
Occupancy
    501,951       513,278       1,588,646       1,579,976  
Equipment
    166,287       231,556       523,416       710,522  
Supplies
    100,057       125,514       323,639       322,727  
Professional and outside services
    499,676       708,554       1,823,453       2,077,845  
Advertising and marketing
    49,917       48,362       192,478       172,408  
Expenses related to foreclosed real estate
    1,301,423       1,724,348       3,575,924       3,520,971  
Other operating expenses
    882,777       915,333       2,452,456       2,946,054  
Total noninterest expense
    7,135,630       7,751,018       21,072,104       21,218,669  
                                 
Net income (loss) before income taxes
    (266,826 )     (205,762 )     (188,763 )     (7,460,500 )
Income tax expense (benefit)
    -       161,315       -       4,043,229  
                                 
Net income (loss)
    (266,826 )     (367,077 )     (188,763 )     (11,503,729 )
                                 
Preferred stock dividends and amortization of discount
    221,531       221,142       664,275       627,031  
                                 
Net income (loss) available to common shareholders
  $ (488,357 )   $ (588,219 )   $ (853,038 )   $ (12,130,760 )
                                 
Earnings (loss) per share, basic
  $ (0.11 )   $ (0.14 )   $ (0.20 )   $ (2.85 )
Earnings (loss) per share, diluted
  $ (0.11 )   $ (0.14 )   $ (0.20 )   $ (2.85 )
                                 
See accompanying notes to consolidated financial statements
                               
 
 
4

Village Bank and Trust Financial Corp. and Subsidiary
Three and Nine Months Ended September 30, 2013 and 2012
(Unaudited)
 
   
Three Months Ended September 30,
 
   
2013
   
2012
 
         
Tax
               
Tax
       
         
Expense
               
Expense
       
   
Amount
   
(Benefit)
   
Total
   
Amount
   
(Benefit)
   
Total
 
                                     
Net income (loss)
  $ (266,826 )   $ -     $ (266,826 )   $ (205,762 )   $ 161,315     $ (367,077 )
Other comprehensive income (loss)
                                               
Unrealized holding gains (losses) arising during
                                               
the period
    (596,664 )     (202,866 )     (393,798 )     (62,063 )     (21,101 )     (40,962 )
Reclassification adjustment for (gains) losses
                                               
realized in income
    -       -       -       (556,805 )     (189,314 )     (367,491 )
Minimum pension adjustment
    3,250       1,105       2,145       3,250       1,105       2,145  
Total other comprehensive income (loss)
    (593,414 )     (201,761 )     (391,653 )     (615,618 )     (209,310 )     (406,308 )
                                                 
        Total comprehensive income (loss)
  $ (860,240 )   $ (201,761 )   $ (658,479 )   $ (821,380 )   $ (47,995 )   $ (773,385 )
                                                 
                                                 
 
   
Nine Months Ended September 30,
 
   
2013
   
2012
 
         
Tax
               
Tax
       
         
Expense
               
Expense
       
   
Amount
   
(Benefit)
   
Total
   
Amount
   
(Benefit)
   
Total
 
                                     
Net income (loss)
  $ (188,763 )   $ -     $ (188,763 )   $ (7,460,500 )   $ 4,043,229     $ (11,503,729 )
Other comprehensive income (loss)
                                               
Unrealized holding gains (losses) arising during
                                               
the period
    (4,301,526 )     (1,462,519 )     (2,839,007 )     603,865       205,314       398,551  
Reclassification adjustment for (gains) losses
                                               
realized in income
    (216,879 )     (73,739 )     (143,140 )     (820,482 )     (278,964 )     (541,518 )
Minimum pension adjustment
    9,750       3,315       6,435       9,750       3,315       6,435  
Total other comprehensive income (loss)
    (4,508,655 )     (1,532,943 )     (2,975,712 )     (206,867 )     (70,335 )     (136,532 )
                                                 
        Total comprehensive income (loss)
  $ (4,697,418 )   $ (1,532,943 )   $ (3,164,475 )   $ (7,667,367 )   $ 3,972,894     $ (11,640,261 )
                                                 
                                                 
See accompanying notes to consolidated financial statements.
                                         
                                                 



 
5


Village Bank and Trust Financial Corp. and Subsidiary
Nine Months Ended September, 2013 and 2012
(Unaudited)
 
                                                 
                                       
Accumulated
       
               
Additional
   
Retained
         
Discount on
   
Other
       
   
Preferred
   
Common
   
Paid-in
   
Earnings
         
Preferred
   
Comprehensive
       
   
Stock
   
Stock
   
Capital
   
(Deficit)
   
Warrant
   
Stock
   
Income (loss)
   
Total
 
                                                 
                                                 
Balance, December 31, 2012
  $ 58,952     $ 17,007,180     $ 40,705,257     $ (33,173,525 )   $ 732,479     $ (198,993 )   $ (166,549 )   $ 24,964,801  
Amortization of preferred stock
                                                               
discount
    -                       (111,601 )     -       111,601               -  
Preferred stock dividend
    -       -               (552,674 )     -       -       -       (552,674 )
Stock based compensation
    -       -       5,964       -       -       -       -       5,964  
Minimum pension adjustment
                                                               
(net of income taxes of $3,315)
    -       -       -       -       -       -       6,435       6,435  
Net income
    -       -       -       (188,763 )     -       -       -       (188,763 )
Change in unrealized gain (loss) on
                                                               
investment securities available-for-sale,
                                                               
net of reclassification and tax effect
    -       -       -       -       -       -       (2,982,147 )     (2,982,147 )
                                                                 
Balance, September 30, 2013
  $ 58,952     $ 17,007,180     $ 40,711,221     $ (34,026,563 )   $ 732,479     $ (87,392 )   $ (3,142,261 )   $ 21,253,616  
                                                                 
Balance, December 31, 2011
  $ 58,952     $ 16,973,512     $ 40,732,178     $ (21,895,557 )   $ 732,479     $ (346,473 )   $ (7,449 )   $ 36,247,642  
Amortization of preferred stock
                                                               
discount
    -                       (110,469 )     -       110,469               -  
Preferred stock dividend
    -       -               (513,562 )     -       -       -       (513,562 )
Issuance of common stock
    -       33,668       (33,668 )     -       -       -       -       -  
Stock based compensation
    -       -       6,506       -       -       -       -       6,506  
Minimum pension adjustment
                                                               
(net of income taxes of $3,315)
    -       -       -       -       -       -       6,435       6,435  
Net loss
    -       -       -       (11,503,729 )     -       -       -       (11,503,729 )
Change in unrealized gain (loss) on
                                                               
investment securities available-for-sale,
                                                               
net of reclassification and tax effect
    -       -       -       -       -       -       (142,967 )     (142,967 )
                                                                 
Balance, September 30, 2012
  $ 58,952     $ 17,007,180     $ 40,705,016     $ (34,023,317 )   $ 732,479     $ (236,004 )   $ (143,981 )   $ 24,100,325  
                                                                 
                                                                 
See accompanying notes to consolidated financial statements.
                                                 
 
 
6


Village Bank and Trust Financial Corp. and Subsidiary
Nine Months Ended September 30, 2013 and 2012
(Unaudited)
 
   
2013
   
2012
 
             
Cash Flows from Operating Activities
           
Net income (loss)
  $ (188,763 )   $ (11,503,729 )
Adjustments to reconcile net income to net
               
cash provided by (used in) operating activities:
               
Depreciation and amortization
    981,157       1,030,061  
Deferred income taxes
    (40,518 )     (6,584,167 )
Valuation allowance
    -       10,513,053  
Provision for loan losses
    823,000       9,095,000  
Write-down of other real estate owned
    1,281,611       1,157,613  
Gain on securities sold
    (216,879 )     (820,483 )
Gain on loans sold
    (6,454,380 )     (6,336,030 )
Gain on sale of premises and equipment
    (598,182 )     -  
Loss on sale of other real estate owned
    325,791       137,252  
Stock compensation expense
    5,964       6,506  
Proceeds from sale of mortgage loans
    235,276,016       224,700,116  
Origination of mortgage loans for sale
    (219,159,829 )     (224,722,414 )
Amortization of premiums and accretion of discounts on securities, net
    312,679       237,964  
(Increase) decrease in interest receivable
    158,999       245,652  
Increase in bank owned life insurance
    (143,660 )     (460,533 )
Decrease  in other assets
    4,355,535       3,961,133  
Increase in interest payable
    142,598       224,107  
Decrease in other liabilities
    (1,061,929 )     (1,438,512 )
Net cash provided by (used in) operating activities
    15,799,210       (557,411 )
                 
Cash Flows from Investing Activities
               
Purchases of available for sale securities
    (54,106,582 )     (62,813,678 )
Proceeds from the sale or calls of available for sale securities
    15,533,902       57,581,103  
Proceeds from maturities and principal payments of  available for sale securities
    -       2,345,817  
Net decrease in loans
    43,821,628       25,205,931  
Proceeds from sale of other real estate owned
    4,125,439       2,501,486  
Purchases of premises and equipment
    77,759       (274,756 )
Proceeds from sale of premises and equipment
    1,681,624       -  
Net cash provided by  investing activities
    11,133,770       24,545,903  
                 
Cash Flows from Financing Activities
               
Net decrease in deposits
    (34,726,547 )     (50,378,915 )
Net decrease in Federal Home Loan Bank Advances
    (10,000,000 )     (9,750,000 )
Net decrease in other borrowings
    (1,562,348 )     (427,268 )
Net cash used in financing activities
    (46,288,895 )     (60,556,183 )
                 
Net decrease in cash and cash equivalents
    (19,355,915 )     (36,567,691 )
Cash and cash equivalents, beginning of period
    53,130,942       62,786,016  
                 
Cash and cash equivalents, end of period
  $ 33,775,027     $ 26,218,325  
                 
Supplemental Schedule of Non Cash Activities
               
Real estate owned assets acquired in settlement of loans
  $ 5,180,804     $ 15,195,148  
Dividends on preferred stock accrued
  $ 552,674     $ 513,562  
                 
See accompanying notes to consolidated financial statements.
               


 
7


Village Bank and Trust Financial Corp. and Subsidiary
Notes to Condensed Consolidated Financial Statements
Three and Nine Months Ended September 30, 2013 and 2012
 (Unaudited)

Note 1 - Principles of presentation

Village Bank and Trust Financial Corp. (the “Company”) is the holding company of Village Bank (the “Bank”).  The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s three wholly-owned subsidiaries, Village Bank Mortgage Company, Village Insurance Agency, Inc., and Village Financial Services Company.  All material intercompany balances and transactions have been eliminated in consolidation.

In the opinion of management, the accompanying condensed consolidated financial statements of the Company have been prepared on the accrual basis in accordance with generally accepted accounting principles for interim financial information.  Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements.  However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included.  The results of operations for the three and nine month periods ended September 30, 2013 are not necessarily indicative of the results to be expected for the full year ending December 31, 2013.  The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 as filed with the Securities and Exchange Commission.

Note 2 - Use of estimates

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and statements of income for the period.  Actual results could differ significantly from those estimates.  A material estimate that is particularly susceptible to significant change in the near term relates to the determination of the allowance for loan losses and the related provision.

Note 3 - Earnings (loss) per common share

The following table presents the basic and diluted earnings per share computations:

   
Three Months Ended September 30,
   
Nine Months Ended September 30,
 
   
2013
   
2012
   
2013
   
2012
 
Numerator
                       
Net income (loss) - basic and diluted
  $ (266,826 )   $ (367,077 )   $ (188,763 )   $ (11,503,729 )
Preferred stock dividend and accretion
    221,531       221,142       664,275       627,031  
Net income (loss) available to common
                               
shareholders
  $ (488,357 )   $ (588,219 )   $ (853,038 )   $ (12,130,760 )
                                 
Denominator
                               
Weighted average shares outstanding - basic
    4,251,795       4,250,990       4,251,795       4,250,990  
Dilutive effect of common stock options and
                               
      restricted stock awards
    13,185       -       13,185       -  
                                 
Weighted average shares outstanding - diluted
    4,264,980       4,250,990       4,264,980       4,250,990  
                                 
Earnings (loss) per share - basic and diluted
                               
Earnings (loss) per share - basic
  $ (0.11 )   $ (0.14 )   $ (0.20 )   $ (2.85 )
Effect of dilutive common stock options
    -       -       -       -  
                                 
Earnings (loss) per share - diluted
  $ (0.11 )   $ (0.14 )   $ (0.20 )   $ (2.85 )

 
8


Outstanding options and warrants to purchase common stock were considered in the computation of diluted earnings per share for the periods presented.  Stock options for 256,130 and 266,530 shares of common stock were not included in computing diluted earnings per share for the three and nine months ended September 30, 2013 and 2012 respectively because their effects were anti-dilutive.  Warrants for 499,029 shares of common stock were not included in computing earnings per share in 2013 and 2012 because their effects were also anti-dilutive.

Note 4 – Investment securities available for sale

At September 30, 2013 and December 31, 2012, all of our securities were classified as available for sale.  The following table presents the composition of our investment portfolio at the dates indicated (dollars in thousands).

               
Gross
   
Gross
   
Estimated
       
   
Par
   
Amortized
   
Unrealized
   
Unrealized
   
Fair
   
Average
 
   
Value
   
Cost
   
Gains
   
Losses
   
Value
   
Yield
 
September 30, 2013
                                   
                                     
US Treasury
                                   
Five to ten years
  $ 8,000     $ 7,820     $ -     $ (408 )   $ 7,412       2.13 %
Total
    8,000       7,820       -       (408 )     7,412       2.13 %
US Government Agencies
                                               
One to Five years
    3,000       2,006       -       (67 )     1,939       0.85 %
Five to ten years
    30,625       33,777       -       (2,486 )     31,291       1.77 %
More than ten years
    2,000       1,982       -       (210 )     1,772       2.22 %
Total
    35,625       37,765       -       (2,763 )     35,002       1.74 %
Mortgage-backed securities
                                               
More than ten years
    2,979       2,997       5       (31 )     2,971       2.08 %
Total
    2,979       2,997       5       (31 )     2,971       2.08 %
Municipals
                                               
Five to ten years
    6,155       6,706       -       (581 )     6,125       2.72 %
More than ten years
    6,780       8,452       -       (849 )     7,603       3.34 %
Total
    12,935       15,158       -       (1,430 )     13,728       3.06 %
                                                 
Total investment securities
  $ 59,539     $ 63,740     $ 5     $ (4,632 )   $ 59,113       2.11 %
                                                 
December 31, 2012
                                               
                                                 
US Government Agencies
                                               
More than ten years
  $ 10,500     $ 11,394     $ 8     $ (15 )   $ 11,387       2.27 %
Total
    10,500       11,394       8       (15 )     11,387       2.27 %
Mortgage-backed securities
                                               
More than ten years
    1,744       1,830       1       (2 )     1,829       0.97 %
Total
    1,744       1,830       1       (2 )     1,829       0.97 %
Municipals
                                               
One to five years
    1,000       1,100       -       (22 )     1,078       3.25 %
Five to ten years
    3,500       4,031       -       (47 )     3,984       2.29 %
More than ten years
    5,280       6,908       10       (42 )     6,876       2.70 %
Total
    9,780       12,039       10       (111 )     11,938       2.61 %
                                                 
Total investment securities
  $ 22,024     $ 25,263     $ 19     $ (128 )   $ 25,154       2.34 %
                                                 
 
 
9


Investment securities available for sale that have an unrealized loss position at September 30, 2013 and December 31, 2012 are detailed below (dollars in thousands).

   
Securities in a loss
   
Securities in a loss
             
   
Position for less than
   
Position for more than
             
   
12 Months
   
12 Months
   
Total
 
   
Fair
   
Unrealized
   
Fair Value
   
Unrealized
   
Fair
   
Unrealized
 
   
Value
   
Losses
   
(Loss)
   
Losses
   
Value
   
Losses
 
       
September 30, 2013
                                   
Investment securities
                                   
available for sale
                                   
US Treasuries
  $ 42,414     $ (3,171 )   $ -     $ -     $ 42,414     $ (3,171 )
Municipals
    11,125       (1,243 )     2,603       (187 )     13,728       (1,430 )
Mortgage-backed securities
    1,929       (30 )     149       (1 )     2,078       (31 )
                                                 
Total
  $ 55,468     $ (4,444 )   $ 2,752     $ (188 )   $ 58,220     $ (4,632 )
                                                 
December 31, 2012
     
Investment securities
                                               
available for sale
                                               
US Treasuries
  $ 4,378     $ (15 )   $ -     $ -     $ 4,378     $ (15 )
Municipals
    8,064       (111 )     -       -       8,064       (111 )
Mortgage-backed securities
    167       (2 )     -       -       167       (2 )
                                                 
Total
  $ 12,609     $ (128 )   $ -     $ -     $ 12,609     $ (128 )
                                                 

Management does not believe that any individual unrealized loss as of September 30, 2013 and December 31, 2012 is other than a temporary impairment.  These unrealized losses are attributable to changes in interest rates.  As of September 30, 2013, management does not have the intent to sell any of the securities classified as available for sale and management believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.

 
 
10

 
Note 5 – Loans and allowance for loan losses

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated (dollars in thousands).
   
September 30, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
Construction and land development
                       
Residential
  $ 3,597,711       1.19 %   $ 2,845,594       0.80 %
Commercial
    31,516,394       10.40 %     41,209,831       11.61 %
    Total construction and land development
    35,114,105       11.59 %     44,055,425       12.41 %
Commercial real estate
                               
Farmland
    1,919,288       0.63 %     2,581,297       0.73 %
Commercial real estate - owner occupied
    72,494,729       23.93 %     92,772,532       26.14 %
Commercial real estate - non-owner occupied
    46,758,475       15.43 %     54,550,817       15.37 %
Multifamily
    11,593,977       3.83 %     7,978,389       2.25 %
    Total commercial real estate
    132,766,469       43.82 %     157,883,035       44.49 %
Consumer real estate
                               
Home equity lines
    21,855,368       7.22 %     25,521,397       7.19 %
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    71,935,655       23.74 %     80,788,425       22.76 %
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    8,784,143       2.89 %     9,517,245       2.68 %
   Total consumer real estate
    102,575,166       33.85 %     115,827,067       32.63 %
Commercial and industrial loans
                               
(except those secured by real estate)
    30,374,673       10.02 %     34,384,117       9.69 %
Consumer and other
    2,171,414       0.72 %     2,760,622       0.78 %
                                 
Total loans
    303,001,827       100.0 %     354,910,266       100.0 %
Deferred loan cost (unearned income), net
    690,947               787,823          
Less:  Allowance for loan losses
    (8,627,944 )             (10,807,827 )        
                                 
    $ 295,064,830             $ 344,890,262          

The Company assigns risk rating classifications to its loans.  These risk ratings are divided into the following groups:

 
·
Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating.  1-4 assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;
 
·
Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;
 
·
Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;
 
·
Risk rated 7 loans have all the weaknesses inherent in risk rated 6 loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.
 
 
11

The following tables provide information on the risk rating of loans at the dates indicated:

   
September 30, 2013
 
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Total
 
      1-4       5       6       7    
Loans
 
                                       
Construction and land development
                                     
Residential
  $ 3,387,941     $ 209,770     $ -     $ -     $ 3,597,711  
Commercial
    18,872,141       2,183,558       10,078,612       382,083       31,516,394  
    Total construction and land development
    22,260,082       2,393,328       10,078,612       382,083       35,114,105  
Commercial real estate
                                       
Farmland
    1,354,495               -       564,793       1,919,288  
Commercial real estate - owner occupied
    51,567,488       12,927,673       7,999,568       -       72,494,729  
Commercial real estate - non-owner occupied
    30,214,409       6,185,443       10,358,623       -       46,758,475  
Multifamily
    10,002,231       1,591,746       -       -       11,593,977  
    Total commercial real estate
    93,138,623       20,704,862       18,358,191       564,793       132,766,469  
Consumer real estate
                                       
Home equity lines
    17,921,068       874,579       3,059,721       -       21,855,368  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    49,204,650       7,427,413       15,303,592       -       71,935,655  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    6,541,571       213,540       2,029,032       -       8,784,143  
   Total consumer real estate
    73,667,289       8,515,532       20,392,345       -       102,575,166  
Commercial and industrial loans
                                       
(except those secured by real estate)
    21,984,571       3,594,882       4,795,220       -       30,374,673  
Consumer and other
    1,910,429       141,552       119,433       -       2,171,414  
                                         
Total Loans
  $ 212,960,994     $ 35,350,156     $ 53,743,801     $ 946,876     $ 303,001,827  
                                         
                                         
   
December 31, 2012
 
                                         
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Risk Rated
   
Total
 
      1-4       5       6       7    
Loans
 
                                         
Construction and land development:
                                       
Residential
  $ 2,173,885     $ 671,709     $ -     $ -     $ 2,845,594  
Commercial
    17,638,646       7,496,950       16,074,235       -       41,209,831  
    Total construction and land development
    19,812,531       8,168,659       16,074,235       -       44,055,425  
                                         
Commercial real estate:
                                       
Farmland
    1,531,808       -       1,049,489       -       2,581,297  
Commercial real estate - owner occupied
    63,772,277       19,273,229       9,727,026       -       92,772,532  
Commercial real estate - non-owner occupied
    24,199,053       15,671,633       14,170,546       509,585       54,550,817  
Multifamily
    5,438,427       1,739,283       800,679       -       7,978,389  
    Total commercial real estate
    94,941,565       36,684,145       25,747,740       509,585       157,883,035  
Consumer real estate:
                                       
Home equity lines
    20,180,206       2,015,248       3,325,943       -       25,521,397  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    49,659,724       11,235,261       19,893,440       -       80,788,425  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    7,385,394       342,770       1,789,081       -       9,517,245  
   Total consumer real estate
    77,225,324       13,593,279       25,008,464       -       115,827,067  
Commercial and industrial loans
                                       
(except those secured by real estate)
    26,712,028       2,590,735       5,081,354       -       34,384,117  
Consumer and other
    2,446,304       261,140       53,178       -       2,760,622  
                                         
Total Loans
  $ 221,137,752     $ 61,297,958     $ 71,964,971     $ 509,585     $ 354,910,266  
                                         
 
 
12


The following table presents the aging of the recorded investment in past due loans and leases as of the dates indicated:
                                           
   
September 30, 2013
 
                                       
Recorded
 
               
Greater
                     
Investment >
 
   
30-59 Days
   
60-89 Days
   
Than
   
Total Past
         
Total
   
90 Days and
 
   
Past Due
   
Past Due
   
90 Days
   
Due
   
Current
   
Loans
   
Accruing
 
                                           
                                           
Construction and land development
                                         
Residential
  $ -     $ -     $ -     $ -     $ 3,597,711     $ 3,597,711     $ -  
Commercial
    2,143       -       -       2,143       31,514,251       31,516,394       -  
    Total construction and land development
    2,143       -       -       2,143       35,111,962       35,114,105       -  
Commercial real estate
                                                       
Farmland
    -       -       -       -       1,919,288       1,919,288       -  
Commercial real estate - owner occupied
    -       -       -       -       72,494,729       72,494,729       -  
Commercial real estate - non-owner occupied
    -       -       -       -       46,758,475       46,758,475       -  
Multifamily
    222,558       -       -       222,558       11,371,419       11,593,977       -  
    Total commercial real estate
    222,558       -       -       222,558       132,543,911       132,766,469       -  
Consumer real estate
                                                       
Home equity lines
    49,990       25,000       -       74,990       21,780,378       21,855,368       -  
Secured by 1-4 family residential,
                                                       
secured by first deeds of trust
    950,426       347,350       -       1,297,776       70,637,879       71,935,655       -  
Secured by 1-4 family residential,
                                                       
secured by second deeds of trust
    58,071       -       -       58,071       8,726,072       8,784,143       -  
   Total consumer real estate
    1,058,487       372,350       -       1,430,837       101,144,329       102,575,166       -  
Commercial and industrial loans
                                                       
(except those secured by real estate)
    2,529,797       -       -       2,529,797       27,844,876       30,374,673       -  
Consumer and other
    5,085       970       -       6,055       2,165,359       2,171,414       -  
                                                         
Total loans
  $ 3,818,070     $ 373,320     $ -     $ 4,191,390     $ 298,810,437     $ 303,001,827     $ -  
                                                         
                                                         
   
December 31, 2012
 
                                                   
Recorded
 
                   
Greater
                           
Investment >
 
   
30-59 Days
   
60-89 Days
   
Than
   
Total Past
           
Total
   
90 Days and
 
   
Past Due
   
Past Due
   
90 Days
   
Due
   
Current
   
Loans
   
Accruing
 
                                                         
                                                         
Construction and land development:
                                                       
Residential
  $ -     $ -     $ -     $ -     $ 2,845,594     $ 2,845,594     $ -  
Commercial
    76,351       10,709       -       87,060       41,122,771       41,209,831       -  
    Total construction and land development
    76,351       10,709       -       87,060       43,968,365       44,055,425       -  
                                                         
Commercial real estate:
                                                       
Farmland
    -       -       -       -       2,581,297       2,581,297       -  
Commercial real estate - owner occupied
    708,278       377,563       -       1,085,841       91,686,691       92,772,532       -  
Commercial real estate - non-owner occupied
    1,094,906       714,655       -       1,809,561       52,741,256       54,550,817       -  
Multifamily
    -       -       -       -       7,978,389       7,978,389       -  
    Total commercial real estate
    1,803,184       1,092,218       -       2,895,402       154,987,633       157,883,035       -  
Consumer real estate:
                                                       
Home equity lines
    110,614       24,746       16,130       151,490       25,369,907       25,521,397       16,130  
Secured by 1-4 family residential,
                                                       
secured by first deeds of trust
    645,807       1,507,073       -       2,152,880       78,635,545       80,788,425       -  
Secured by 1-4 family residential,
                                                       
secured by second deeds of trust
    157,816       50,016       50,000       257,832       9,259,413       9,517,245       50,000  
   Total consumer real estate
    914,237       1,581,835       66,130       2,562,202       113,264,865       115,827,067       66,130  
Commercial and industrial loans
                                                       
(except those secured by real estate)
    40,171       31,057       49,139       120,367       34,263,750       34,384,117       49,139  
Consumer and other
    4,286       36,030       -       40,316       2,720,306       2,760,622       -  
                                                         
Total Loans
  $ 2,838,229     $ 2,751,849     $ 115,269     $ 5,705,347     $ 349,204,919     $ 354,910,266     $ 115,269  
                                                         

Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.  Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans.  If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.  Impaired loans are set forth in the following table as of the dates indicated
 
 
13

   
September 30, 2013
 
                   
         
Unpaid
       
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
 
                   
With no related allowance recorded
                 
Construction and land development
                 
Commercial
  $ 5,239,636     $ 7,416,295     $ -  
    Total construction and land development
    5,239,636       7,416,295       -  
Commercial real estate
                       
Commercial real estate - owner occupied
    11,142,720       11,425,337       -  
Commercial real estate - non-owner occupied
    11,188,393       11,386,393       -  
Multifamily
    2,385,796       2,385,796       -  
    Total commercial real estate
    24,716,909       25,197,526       -  
Consumer real estate
                       
Home equity lines
    1,093,103       1,191,959       -  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    12,875,639       13,477,859       -  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    973,479       1,143,136       -  
   Total consumer real estate
    14,942,221       15,812,954       -  
Commercial and industrial loans
                       
(except those secured by real estate)
    468,908       745,448       -  
Consumer and other
    93,876       93,876       -  
      45,461,550       49,266,099       -  
                         
With an allowance recorded
                       
Construction and land development:
                       
Commercial
    1,458,303       1,458,303       219,633  
    Total construction and land development
    1,458,303       1,458,303       219,633  
Commercial real estate:
                       
Farmland
    564,793       1,012,793       448,000  
Commercial real estate - non-owner occupied
    1,084,608       1,084,608       251,108  
    Total commercial real estate
    1,649,401       2,097,401       699,108  
Consumer real estate:
                       
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    1,843,732       1,843,732       353,313  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    133,335       133,335       33,307  
   Total consumer real estate
    1,977,067       1,977,067       386,620  
Commercial and industrial loans
                       
(except those secured by real estate)
    416,765       416,765       233,611  
Consumer and other
    -       -       -  
      5,501,536       5,949,536       1,538,972  
                         
Total
                       
Construction and land development
                       
Commercial
    6,697,939       8,874,598       219,633  
    Total construction and land development
    6,697,939       8,874,598       219,633  
Commercial real estate
                       
Farmland
    564,793       1,012,793       448,000  
Commercial real estate - owner occupied
    11,142,720       11,425,337       -  
Commercial real estate - non-owner occupied
    12,273,001       12,471,001       251,108  
Multifamily
    2,385,796       2,385,796       -  
    Total commercial real estate
    26,366,310       27,294,927       699,108  
Consumer real estate
                       
Home equity lines
    1,093,103       1,191,959       -  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    14,719,371       15,321,591       353,313  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    1,106,814       1,276,471       33,307  
   Total consumer real estate
    16,919,288       17,790,021       386,620  
Commercial and industrial loans
                       
(except those secured by real estate)
    885,673       1,162,213       233,611  
Consumer and other
    93,876       93,876       -  
    $ 50,963,086     $ 55,215,635     $ 1,538,972  
                         

 
14


   
December 31, 2012
 
                   
         
Unpaid
       
   
Recorded
   
Principal
   
Related
 
   
Investment
   
Balance
   
Allowance
 
                   
With no related allowance recorded
                 
Construction and land development
                 
Commercial
  $ 8,254,440     $ 13,625,670     $ -  
    Total construction and land development
    8,254,440       13,625,670       -  
Commercial real estate
                       
Farmland
    1,049,489       1,049,489       -  
Commercial real estate - owner occupied
    8,250,071       8,715,684       -  
Commercial real estate - non-owner occupied
    13,777,787       14,124,016       -  
Multifamily
    2,825,274       2,825,274       -  
    Total commercial real estate
    25,902,621       26,714,463       -  
Consumer real estate
                       
Home equity lines
    1,939,020       1,938,005       -  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    10,686,435       10,928,024       -  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    601,805       861,158       -  
   Total consumer real estate
    13,227,260       13,727,187       -  
Commercial and industrial loans
                       
(except those secured by real estate)
    858,136       1,421,196       -  
Consumer and other
    50,415       50,390       -  
      48,292,872       55,538,906       -  
                         
With an allowance recorded
                       
Construction and land development
                       
Commercial
    430,828       430,828       62,643  
    Total construction and land development
    430,828       430,828       62,643  
Commercial real estate:
                       
Farmland
                       
Commercial real estate - owner occupied
    2,940,647       3,261,584       663,330  
Commercial real estate - non-owner occupied
    1,434,195       1,434,195       508,704  
Multifamily
    -       -       -  
    Total commercial real estate
    4,374,842       4,695,779       1,172,034  
Consumer real estate:
                       
Home equity lines
    -       -       -  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    1,155,027       1,155,027       20,896  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    338,345       386,629       43,456  
   Total consumer real estate
    1,493,372       1,541,656       64,352  
Commercial and industrial loans
                       
(except those secured by real estate)
    182,840       182,840       39,243  
Consumer and other
    -       -       -  
      6,481,882       6,851,103       1,338,272  
                         
Total
                       
Construction and land development
                       
Commercial
    8,685,268       14,056,498       62,643  
    Total construction and land development
    8,685,268       14,056,498       62,643  
Commercial real estate
                       
Farmland
    1,049,489       1,049,489       -  
Commercial real estate - owner occupied
    11,190,718       11,977,268       663,330  
Commercial real estate - non-owner occupied
    15,211,982       15,558,211       508,704  
Multifamily
    2,825,274       2,825,274       -  
    Total commercial real estate
    30,277,463       31,410,242       1,172,034  
Consumer real estate
                       
Home equity lines
    1,939,020       1,938,005       -  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    11,841,462       12,083,051       20,896  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    940,150       1,247,787       43,456  
   Total consumer real estate
    14,720,632       15,268,843       64,352  
Commercial and industrial loans
                       
(except those secured by real estate)
    1,040,976       1,604,036       39,243  
Consumer and other
    50,415       50,390       -  
    $ 54,774,754     $ 62,390,009     $ 1,338,272  
                         

 
15

 
The following is a summary of average recorded investment in impaired loans with and without a valuation allowance and interest income recognized on those loans for the periods indicated:

   
For the Three Months
   
For the Nine Months
 
   
Ended September 30, 2013
   
Ended September 30, 2013
 
                         
   
Average
   
Interest
   
Average
   
Interest
 
   
Recorded
   
Income
   
Recorded
   
Income
 
   
Investment
   
Recognized
   
Investment
   
Recognized
 
                         
Impaired loans with no related allowance recorded
                       
Construction and land development
                       
Commercial
  $ 5,748,852     $ 67,825     $ 6,611,912     $ 217,609  
    Total construction and land development
    5,748,852       67,825       6,611,912       217,609  
Commercial real estate
                               
Farmland
    -       -       -          
Commercial real estate - owner occupied
    11,032,736       177,308       10,479,360       418,677  
Commercial real estate - non-owner occupied
    11,237,516       137,085       11,314,963       412,108  
Multifamily
    2,390,160       36,196       2,402,140       113,704  
    Total commercial real estate
    24,660,412       350,589       24,196,463       944,489  
Consumer real estate
                               
Home equity lines
    1,093,363       7,002       1,093,153       35,725  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    14,478,717       127,917       14,531,360       477,654  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    974,441       11,773       977,596       37,181  
   Total consumer real estate
    16,546,521       146,692       16,602,109       550,560  
Commercial and industrial loans
                               
(except those secured by real estate)
    471,890       9,443       429,502       21,894  
Consumer and other
    138,297       1,732       141,847       6,987  
      47,565,972       576,281       47,981,833       1,741,539  
                                 
Impaired loans with an allowance recorded
                               
Commercial
    1,523,371       -       1,524,661       6,494  
    Total construction and land development
    1,523,371       -       1,524,661       6,494  
Commercial real estate:
                               
Farmland
    564,793       -       569,043       1,100  
Commercial real estate - owner occupied
    -       -       -       -  
Commercial real estate - non-owner occupied
    1,089,464       12,571       1,089,464       44,147  
Multifamily
    -       -       -       -  
    Total commercial real estate
    1,654,257       12,571       1,658,507       45,247  
Consumer real estate:
                               
Home equity lines
    -       -       -       -  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    236,917       -       268,917       -  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    136,177       2,314       136,253       4,261  
   Total consumer real estate
    373,094       2,314       405,170       4,261  
Commercial and industrial loans
                               
(except those secured by real estate)
    418,094       4,451       246,408       7,483  
Consumer and other
    -       -       -       -  
    $ 3,968,816     $ 19,336     $ 3,834,746     $ 63,485  
                                 
Total
                               
Construction and land development
                               
Commercial
    7,272,223       67,825       8,136,573       224,103  
    Total construction and land development
    7,272,223       67,825       8,136,573       224,103  
Commercial real estate
                               
Farmland
    564,793       -       569,043       1,100  
Commercial real estate - owner occupied
    11,032,736       177,308       10,479,360       418,677  
Commercial real estate - non-owner occupied
    12,326,980       149,656       12,404,427       456,255  
Multifamily
    2,390,160       36,196       2,402,140       113,704  
    Total commercial real estate
    26,314,669       363,160       25,854,970       989,736  
Consumer real estate
                               
Home equity lines
    1,093,363       7,002       1,093,153       35,725  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    14,715,634       127,917       14,800,277       477,654  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    1,110,618       14,087       1,113,849       41,442  
   Total consumer real estate
    16,919,615       149,006       17,007,279       554,821  
Commercial and industrial loans
                               
(except those secured by real estate)
    889,984       13,894       675,910       29,377  
Consumer and other
    138,297       1,732       141,847       6,987  
    $ 51,534,788     $ 595,617     $ 51,816,579     $ 1,805,024  
                                 

 
16


   
For the Three Months
   
For the Nine Months
 
   
Ended September 30, 2012
   
Ended September 30, 2012
 
                         
   
Average
   
Interest
   
Average
   
Interest
 
   
Recorded
   
Income
   
Recorded
   
Income
 
   
Investment
   
Recognized
   
Investment
   
Recognized
 
                         
Impaired loans with no related allowance recorded
                       
Construction and land development
                       
Residential
  $ 248,422     $ 3,050     $ 191,544     $ 14,791  
Commercial
    12,460,662       89,431       10,188,879       270,464  
    Total construction and land development
    12,709,084       92,481       10,380,423       285,255  
Commercial real estate
                               
Farmland
    1,049,489       2,000       1,049,489       17,405  
Commercial real estate - owner occupied
    7,770,119       213,499       8,631,653       439,458  
Commercial real estate - non-owner occupied
    12,778,883       437,034       13,340,847       677,127  
Multifamily
    1,361,630       44,333       1,580,204       71,631  
    Total commercial real estate
    22,960,121       696,866       24,602,193       1,205,621  
Consumer real estate
                               
Home equity lines
    1,454,661       22,556       1,175,339       55,535  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    9,222,570       78,162       9,142,698       308,917  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    674,842       4,677       646,695       22,789  
   Total consumer real estate
    11,352,073       105,395       10,964,732       387,241  
Commercial and industrial loans
                               
(except those secured by real estate)
    876,549       5,416       816,643       27,325  
Consumer and other
    45,710       1,006       54,754       2,099  
      47,943,537       901,164       46,818,745       1,907,541  
                                 
Impaired loans with an allowance recorded
                               
Construction and land development:
                               
Residential
    -       -       -       -  
Commercial
    4,896,911       -       5,929,859       1,373  
    Total construction and land development
    4,896,911       -       5,929,859       1,373  
Commercial real estate:
                               
Farmland
    -                          
Commercial real estate - owner occupied
    7,380,990       398       7,362,455       52,668  
Commercial real estate - non-owner occupied
    4,482,345       -       4,304,172       26,222  
Multifamily
    -       -       -       -  
    Total commercial real estate
    11,863,335       398       11,666,627       78,890  
Consumer real estate:
                               
Home equity lines
    431,298       -       406,192       6,814  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    3,233,526       -       2,315,032       52,470  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    117,246       -       117,388       1,684  
   Total consumer real estate
    3,782,070       -       2,838,612       60,968  
Commercial and industrial loans
                               
(except those secured by real estate)
    1,436,105       -       1,362,576       32,587  
Consumer and other
    -       -       -       -  
      21,978,421       398       21,797,674       173,818  
                              -  
Total
                               
Construction and land development
                               
Residential
    248,422       3,050       191,544       14,791  
Commercial
    17,357,573       89,431       16,118,738       271,837  
    Total construction and land development
    17,605,995       92,481       16,310,282       286,628  
Commercial real estate
                               
Farmland
    1,049,489       2,000       1,049,489       17,405  
Commercial real estate - owner occupied
    15,151,109       213,897       15,994,108       492,126  
Commercial real estate - non-owner occupied
    17,261,228       437,034       17,645,019       703,349  
Multifamily
    1,361,630       44,333       1,580,204       71,631  
    Total commercial real estate
    34,823,456       697,264       36,268,820       1,284,511  
Consumer real estate
                               
Home equity lines
    1,885,959       22,556       1,581,531       62,349  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    12,456,096       78,162       11,457,730       361,387  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    792,088       4,677       764,083       24,473  
   Total consumer real estate
    15,134,143       105,395       13,803,344       448,209  
Commercial and industrial loans
                               
(except those secured by real estate)
    2,312,654       5,416       2,179,219       59,912  
Consumer and other
    45,710       1,006       54,754       2,099  
    $ 69,921,958     $ 901,562     $ 68,616,419     $ 2,081,359  
                                 
 
 
17

 
Included in impaired loans are loans classified as troubled debt restructurings (TDRs).  A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrowers financial difficulties that it would not otherwise consider.  For loans classified as impaired TDRs, the Company further evaluates the loans as performing or nonaccrual.  To restore a nonaccrual loan that has been formally restructured in a TDR to accrual status, we perform a current, well-documented credit analysis supporting a return to accrual status based on the borrower’s financial condition and prospects for repayment under the revised terms. Otherwise, the TDR must remain in nonaccrual status. The analysis considers the borrower’s sustained historical repayment performance for a reasonable period prior to the return-to-accrual date, but may take into account payments made for a reasonable period prior to the restructuring if the payments are consistent with the modified terms. A sustained period of repayment performance generally would be a minimum of six months and would involve payments in the form of cash or cash equivalents.

An accruing loan that is modified in a TDR can remain in accrual status if, based on a current, well-documented credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured, and the borrower has demonstrated sustained historical repayment performance for a reasonable period before the modification.  The following is a summary of performing and nonaccrual TDRs and the related specific valuation allowance by portfolio segment as of the dates indicated:
 
   
September 30, 2013
 
                           
Specific
 
                           
Valuation
 
   
Total
   
Performing
   
Nonaccrual
   
Allowance
 
                                 
Construction and land development
                               
Commercial
  $ 4,977,801     $ 3,253,743     $ 1,724,058     $ -  
    Total construction and land development
    4,977,801       3,253,743       1,724,058       -  
Commercial real estate
                               
Commercial real estate - owner occupied
    9,580,489       8,508,801       1,071,688       -  
Commercial real estate - non-owner occupied
    9,911,774       9,911,774       -       -  
Multifamily
    2,385,797       2,385,797       -       -  
    Total commercial real estate
    21,878,060       20,806,372       1,071,688       -  
Consumer real estate
                               
Home equity lines
    -       -       -       -  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    7,932,921       3,938,354       3,994,567       353,313  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    511,025       353,205       157,820       -  
   Total consumer real estate
    8,443,946       4,291,559       4,152,387       353,313  
Commercial and industrial loans
                               
(except those secured by real estate)
    641,363       122,457       518,906       200,000  
    $ 35,941,170     $ 28,474,131     $ 7,467,039     $ 553,313  
                                 
                                 

   
December 31, 2012
 
                     
Specific
 
                     
Valuation
 
   
Total
   
Performing
   
Nonaccrual
   
Allowance
 
                         
Construction and land development
                       
Commercial
  $ 6,116,248     $ 3,728,403     $ 2,387,845     $ -  
Total construction and land development
    6,116,248       3,728,403       2,387,845       -  
Commercial real estate
                               
Commercial real estate - owner occupied
    8,881,257       6,373,122       2,508,135       3,321  
Commercial real estate - non-owner occupied
    13,266,992       12,805,727       461,265       -  
Multifamily
    2,825,274       2,825,274       -       -  
Total commercial real estate
    24,973,523       22,004,123       2,969,400       3,321  
Consumer real estate
                               
Home equity lines
    -       -       -       -  
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    7,011,329       3,431,124       3,580,205       15,633  
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    338,344       -       338,344       43,456  
Total consumer real estate
    7,349,673       3,431,124       3,918,549       59,089  
Commercial and industrial loans
                               
(except those secured by real estate)
    380,427       5,803       374,624       39,243  
                                 
Total
  $ 38,819,871     $ 29,169,453     $ 9,650,418     $ 101,653  
                                 
 
The following table provides information about TDRs identified during the three months ended September 30, 2013:

   
Three Months Ended
 
   
September 30, 2013
 
         
Pre-
   
Post-
 
         
Modification
   
Modification
 
   
Number of
   
Recorded
   
Recorded
 
   
Loans
   
Balance
   
Balance
 
                   
Commercial real estate
                 
Commercial real estate - owner occupied
    4     $ 2,256,390     $ 2,256,390  
    Total commercial real estate
    4       2,256,390       2,256,390  
Consumer real estate:
                       
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    5       715,110       715,110  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    2       161,833       161,833  
   Total consumer real estate
    7       876,943       876,943  
      11     $ 3,133,333     $ 3,133,333  

 
19


   
Three Months Ended
 
   
September 30, 2012
 
         
Pre-
   
Post-
 
         
Modification
   
Modification
 
   
Number of
   
Recorded
   
Recorded
 
   
Loans
   
Balance
   
Balance
 
                   
Construction and land development
                 
Commercial
    1     $ 39,769     $ 39,769  
    Total construction and land development
    1       39,769       39,769  
Commercial real estate:
                       
Commercial real estate - non-owner occupied
    7       4,737,776       4,737,776  
Multifamily
    1       634,594       634,594  
    Total commercial real estate
    8       5,372,370       5,372,370  
Consumer real estate
                       
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    4       1,042,595       1,042,595  
   Total consumer real estate
    4       1,042,595       1,042,595  
Commercial and industrial loans
                       
(except those secured by real estate)
    1       199,964       199,964  
      14     $ 6,654,698     $ 6,654,698  


   
Nine Months Ended
 
   
September 30, 2013
 
         
Pre-
   
Post-
 
         
Modification
   
Modification
 
   
Number of
   
Recorded
   
Recorded
 
   
Loans
   
Balance
   
Balance
 
                   
Construction and land development
                 
Commercial
    6     $ 2,991,415     $ 2,991,415  
    Total construction and land development
    6       2,991,415       2,991,415  
Commercial real estate
                       
Commercial real estate - owner occupied
    4       1,087,390       1,087,390  
    Total commercial real estate
    4       1,087,390       1,087,390  
Consumer real estate
                       
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    16       2,265,830       2,265,830  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    2       161,832       161,832  
   Total consumer real estate
    18       2,427,662       2,427,662  
Commercial and industrial loans
                       
(except those secured by real estate)
    1       382,083       382,083  
      29     $ 6,888,550     $ 6,888,550  

 
20


   
Nine Months Ended
 
   
September 30, 2012
 
         
Pre-
   
Post-
 
         
Modification
   
Modification
 
   
Number of
   
Recorded
   
Recorded
 
   
Loans
   
Balance
   
Balance
 
                   
Construction and land development
                 
Residential
    3     $ 191,544     $ 191,544  
Commercial
    12       3,938,672       3,938,672  
    Total construction and land development
    15       4,130,216       4,130,216  
Commercial real estate:
                       
Farmland
            -       -  
Commercial real estate - owner occupied
    1       1,388,851       1,388,851  
Commercial real estate - non-owner occupied
    9       9,665,791       9,665,791  
Multifamily
    1       634,594       634,594  
    Total commercial real estate
    11       11,689,236       11,689,236  
Consumer real estate:
                       
Home equity lines
    1       349,192       349,192  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    39       4,505,468       4,505,468  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    1       69,815       69,815  
   Total consumer real estate
    41       4,924,475       4,924,475  
Commercial and industrial loans
                       
(except those secured by real estate)
    6       456,028       456,028  
Consumer and other
    -       -       -  
      73     $ 21,199,955     $ 21,199,955  

   
Year Ended
 
   
December 31, 2012
 
         
Pre-
   
Post-
 
         
Modification
   
Modification
 
   
Number of
   
Recorded
   
Recorded
 
   
Loans
   
Balance
   
Balance
 
                   
Construction and land development
                 
Commercial
    6     $ 653,612     $ 653,612  
    Total construction and land development
    6       653,612       653,612  
Commercial real estate
                    -  
Commercial real estate - owner occupied
    1       522,715       522,715  
Commercial real estate - non-owner occupied
    6       2,102,231       2,102,231  
    Total commercial real estate
    7       2,624,946       2,624,946  
Consumer real estate
                       
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    25       5,570,245       5,570,245  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    1       338,344       338,344  
   Total consumer real estate
    26       5,908,589       5,908,589  
Commercial and industrial loans
                       
(except those secured by real estate)
    1       117,813       117,813  
Consumer and other
    -       -       -  
      40     $ 9,304,960     $ 9,304,960  
 

 
 
21

The following is a summary of performing and nonaccrual TDRs and the related specific valuation allowance by portfolio segment three months ended September 30, 2013:

   
Three Months Ended September 30, 2013
 
                     
Specific
 
                     
Valuation
 
   
Total
   
Performing
   
Nonaccrual
   
Allowance
 
                         
Commercial real estate
                       
Commercial real estate - owner occupied
  $ 2,256,390     $ 2,256,390     $ -     $ -  
Total commercial real estate
    2,256,390       2,256,390       -       -  
Consumer real estate
                               
Secured by 1-4 family residential, secured by first deeds of trust
    715,110       308,454       406,656       29,813  
Secured by 1-4 family residential, secured by second deeds of trust
    161,832       4,012       157,820          
Total consumer real estate
    876,942       312,466       564,476       29,813  
    $ 3,133,332     $ 2,568,856     $ 564,476     $ 29,813  

The following tables summarize defaults on TDRs for the periods indicated:

   
Three Months Ended
 
   
September 30, 2013
 
   
Number of
   
Recorded
 
Defaults on TDRs
 
Loans
   
Balance
 
Commercial real estate
           
Commercial real estate - owner occupied
    2     $ 2,756,976  
Total commercial real estate
    2       2,756,976  
Consumer real estate
               
Secured by 1-4 family residential,
               
secured by first deeds of trust
    2       272,185  
Total consumer real estate
    2       272,185  
Total
    4     $ 3,029,161  
 

   
Three Months Ended
 
   
September 30, 2012
 
   
Number of
   
Recorded
 
Defaults on TDRs
 
Loans
   
Balance
 
Construction and land development
           
Commercial
    1     $ 39,769  
    Total construction and land development
    1       39,769  
Commercial real estate
               
Commercial real estate - non-owner occupied
    1       461,265  
Multifamily
    1       461,265  
    Total commercial real estate
               
Commercial and industrial loans
               
(except those secured by real estate)
    1       119,964  
Total
    3     $ 620,998  

 
22


   
Nine Months Ended
 
   
September 30, 2013
 
   
Number of
   
Recorded
 
Defaults on TDRs
 
Loans
   
Balance
 
Commercial real estate
           
Commercial real estate - owner occupied
    2     $ 2,756,976  
Multifamily
    2       2,756,976  
    Total commercial real estate
               
Consumer real estate
               
Secured by 1-4 family residential,
               
secured by first deeds of trust
    5       1,481,050  
   Total consumer real estate
    5       1,481,050  
Total
    7     $ 4,238,026  


   
Year Ended
 
   
December 31, 2012
 
   
Number of
   
Recorded
 
Defaults on TDRs
 
Loans
   
Balance
 
Construction and land development
           
Commercial
    8     $ 2,387,845  
    Total construction and land development
    8       2,387,845  
Commercial real estate
               
Farmland
               
Commercial real estate - owner occupied
    2       2,053,276  
Commercial real estate - non-owner occupied
    1       461,265  
Multifamily
    3       2,514,541  
    Total commercial real estate
               
Consumer real estate
               
Secured by 1-4 family residential,
               
secured by first deeds of trust
    8       3,302,827  
Secured by 1-4 family residential,
               
secured by second deeds of trust
    1       338,344  
   Total consumer real estate
    9       3,641,171  
Commercial and industrial loans
               
(except those secured by real estate)
    4       257,136  
Total
    24     $ 8,800,693  


 
23


Activity in the allowance for loan losses is as follows for the periods indicated:

   
Allowance for Loan Losses
 
   
Beginning
   
Provision for
               
Ending
 
   
Balance
   
Loan Losses
   
Charge-offs
   
Recoveries
   
Balance
 
Three Months Ended September 30, 2013
                             
Construction and land development
                             
Residential
  $ 595,642     $ -     $ -     $ 300     $ 595,942  
Commercial
    4,777,533       -       (175,019 )     34,138       4,636,652  
Commercial real estate
                                       
Farmland
    808,000       -       (448,000 )     -       360,000  
Commercial real estate - owner occupied
    1,126,134       -       (128,617 )     -       997,517  
Commercial real estate - non-owner occupied
    307,267       -       -       -       307,267  
Multifamily
    23,434       -       -       -       23,434  
Consumer real estate
                    -                  
Home equity lines
    414,671       -       (22,455 )     9,350       401,566  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    504,142       -       (126,839 )     1,016       378,319  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    13,868       -       -       239       14,107  
Commercial and industrial loans
                                       
(except those secured by real estate)
    946,414       -       (114,642 )     24,186       855,958  
Consumer and other
    92,672       -       (37,992 )     2,502       57,182  
                                         
Total
  $ 9,609,777     $ -     $ (1,053,564 )   $ 71,731     $ 8,627,944  
                                         
Three Months Ended September 30, 2012
                                       
Construction and land development
                                       
Residential
  $ 599,554     $ (146,645 )   $ (2,500 )   $ 43,883     $ 494,292  
Commercial
    4,562,330       1,907,303       (1,732,520 )     4,095       4,741,208  
Commercial real estate
                                       
Farmland
    -       -       -       -       -  
Commercial real estate - owner occupied
    2,520,907       (710,375 )     (375,184 )     -       1,435,348  
Commercial real estate - non-owner occupied
    1,400,093       (465,241 )     (118,000 )     -       816,852  
Multifamily
    92,728       (59,331 )     -       -       33,397  
Consumer real estate
                                       
Home equity lines
    776,732       461,686       (389,585 )     7,144       855,977  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    2,038,947       (55,146 )     (456,559 )     -       1,527,242  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    375,552       298,168       (231,273 )     -       442,447  
Commercial and industrial loans
                                       
(except those secured by real estate)
    2,345,245       (480,271 )     (272,059 )     12,496       1,605,411  
Consumer and other
    153,633       (50,148 )     (1,374 )     1,559       103,670  
                                         
Total
  $ 14,865,721     $ 700,000     $ (3,579,054 )   $ 69,177     $ 12,055,844  

 
24

 
   
Allowance for Loan Losses
 
   
Beginning
   
Provision for
               
Ending
 
   
Balance
   
Loan Losses
   
Charge-offs
   
Recoveries
   
Balance
 
Nine Months Ended September 30, 2013
                             
Construction and land development
                             
Residential
  $ 494,742     $ -     $ -     $ 101,200     $ 595,942  
Commercial
    4,611,410       15,000       (270,354 )     280,596       4,636,652  
Commercial real estate
                                       
Farmland
    -       808,000       (448,000 )     -       360,000  
Commercial real estate - owner occupied
    1,358,863       -       (403,996 )     42,650       997,517  
Commercial real estate - non-owner occupied
    816,852       -       (509,585 )     -       307,267  
Multifamily
    23,434       -       -       -       23,434  
Consumer real estate
                    -                  
Home equity lines
    658,135       -       (266,119 )     9,550       401,566  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    1,358,102       -       (1,001,833 )     22,050       378,319  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    223,307       -       (214,720 )     5,520       14,107  
Commercial and industrial loans
                                       
(except those secured by real estate)
    1,161,654       -       (465,885 )     160,189       855,958  
Consumer and other
    101,328       -       (52,219 )     8,073       57,182  
                                         
Total
  $ 10,807,827     $ 823,000     $ (3,632,711 )   $ 629,828     $ 8,627,944  
                                         
Nine Months Ended September 30, 2012
                                       
Construction and land development
                                       
Residential
  $ 704,728     $ 542,067     $ (797,286 )   $ 44,783     $ 494,292  
Commercial
    6,798,177       3,444,160       (5,505,724 )     4,595       4,741,208  
Commercial real estate
                                       
Farmland
    -       -       -       -       -  
Commercial real estate - owner occupied
    1,496,466       623,552       (684,670 )     -       1,435,348  
Commercial real estate - non-owner occupied
    1,548,899       (300,898 )     (431,354 )     205       816,852  
Multifamily
    406,635       (373,238 )     -       -       33,397  
Consumer real estate
                                       
Home equity lines
    860,307       668,614       (681,405 )     8,461       855,977  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    1,881,470       2,610,905       (3,045,937 )     80,804       1,527,242  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    397,504       468,192       (427,882 )     4,633       442,447  
Commercial and industrial loans
                                       
(except those secured by real estate)
    1,655,713       1,230,555       (1,427,841 )     146,984       1,605,411  
Consumer and other
    321,525       181,091       (403,680 )     4,734       103,670  
                                         
Total
  $ 16,071,424     $ 9,095,000     $ (13,405,779 )   $ 295,199     $ 12,055,844  
                                         


 
25


   
Allowance for Loan Losses
 
   
Beginning
   
Provision for
               
Ending
 
   
Balance
   
Loan Losses
   
Charge-offs
   
Recoveries
   
Balance
 
Year Ended December 31, 2012
                             
Construction and land development
                             
Residential
  $ 704,728     $ 542,067     $ (797,286 )   $ 45,233     $ 494,742  
Commercial
    6,798,177       3,444,160       (5,645,064 )     14,137       4,611,410  
Commercial real estate
                                       
Farmland
    -       -       -       -       -  
Commercial real estate - owner occupied
    1,496,466       623,552       (961,155 )     200,000       1,358,863  
Commercial real estate - non-owner occupied
    1,548,899       (300,898 )     (431,354 )     205       816,852  
Multifamily
    406,635       (373,238 )     (9,963 )     -       23,434  
Consumer real estate
                                       
Home equity lines
    860,307       668,614       (883,848 )     13,062       658,135  
Secured by 1-4 family residential,
                                       
secured by first deeds of trust
    1,881,470       2,610,905       (3,220,072 )     85,799       1,358,102  
Secured by 1-4 family residential,
                                       
secured by second deeds of trust
    397,504       468,192       (663,135 )     20,746       223,307  
Commercial and industrial loans
                                       
(except those secured by real estate)
    1,655,713       1,230,555       (1,879,517 )     154,903       1,161,654  
Consumer and other
    321,525       181,091       (408,302 )     7,014       101,328  
                                         
Total
  $ 16,071,424     $ 9,095,000     $ (14,899,696 )   $ 541,099     $ 10,807,827  


 
26


Loans were evaluated for impairment as follows for the periods indicated:


   
Loans Evaluated for Impairment
 
   
Individually
   
Collectively
   
Total
 
Nine Months Ended September 30, 2013
                 
Construction and land development
                 
Residential
  $ 575,874     $ 3,021,837     $ 3,597,711  
Commercial
    19,726,638       11,789,756       31,516,394  
Commercial real estate
                       
Farmland
    781,927       1,137,361       1,919,288  
Commercial real estate - owner occupied
    51,072,925       21,421,804       72,494,729  
Commercial real estate - non-owner occupied
    35,956,512       10,801,963       46,758,475  
Multifamily
    9,442,862       2,151,115       11,593,977  
Consumer real estate
    -                  
Home equity lines
    1,334,700       20,520,668       21,855,368  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    12,630,505       59,305,150       71,935,655  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    539,279       8,244,864       8,784,143  
Commercial and industrial loans
                       
(except those secured by real estate)
    13,202,379       17,172,294       30,374,673  
Consumer and other
    -       2,171,414       2,171,414  
                         
Total
  $ 145,263,601     $ 157,738,226     $ 303,001,827  
                         
Year Ended December 31, 2012
                       
Construction and land development
                       
Residential
  $ 1,247,709     $ 1,597,885     $ 2,845,594  
Commercial
    27,351,857       13,857,974       41,209,831  
Commercial real estate
                       
Farmland
    1,391,501       1,189,796       2,581,297  
Commercial real estate - owner occupied
    67,167,587       25,604,945       92,772,532  
Commercial real estate - non-owner occupied
    41,801,577       12,749,240       54,550,817  
Multifamily
    6,461,639       1,516,750       7,978,389  
Consumer real estate
                       
Home equity lines
    2,185,040       23,336,357       25,521,397  
Secured by 1-4 family residential,
                       
secured by first deeds of trust
    15,526,551       65,261,874       80,788,425  
Secured by 1-4 family residential,
                       
secured by second deeds of trust
    557,600       8,959,645       9,517,245  
Commercial and industrial loans
                       
(except those secured by real estate)
    15,101,291       19,282,826       34,384,117  
Consumer and other
    -       2,760,622       2,760,622  
                         
Total
  $ 178,792,352     $ 176,117,914     $ 354,910,266  


 
27

 
Note 6 – Deposits

Deposits as of June 30, 2013 and December 31, 2012 were as follows:

   
September 30, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
                         
Demand accounts
  $ 59,172,655       14.7 %   $ 57,049,348       13.1 %
Interest checking accounts
    44,546,350       11.1 %     45,861,199       10.5 %
Money market accounts
    63,156,132       15.7 %     66,007,160       15.1 %
Savings accounts
    20,780,476       5.2 %     20,922,112       4.8 %
Time deposits of $100,000 and over
    99,168,163       24.7 %     113,332,481       26.0 %
Other time deposits
    114,772,639       28.6 %     133,150,662       30.5 %
                                 
Total
  $ 401,596,415       100.0 %   $ 436,322,962       100.0 %


Note 7 – Trust preferred securities

During the first quarter of 2005, Southern Community Financial Capital Trust I, a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable securities.  On February 24, 2005, $5.2 million of Trust Preferred Capital Notes were issued through a pooled underwriting.  The securities have a LIBOR-indexed floating rate of interest (three-month LIBOR plus 2.15%) which adjusts, and is payable, quarterly. The interest rate at September 30, 2013 was 2.40%. The securities were redeemable at par beginning on March 15, 2010 and each quarter after such date until the securities mature on March 15, 2035.  No amounts have been redeemed at September 30, 2013 and there are no plans to do so.  The principal asset of the Trust is $5.2 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

During the third quarter of 2007, Village Financial Statutory Trust II, a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable securities.  On September 20, 2007, $3.6 million of Trust Preferred Capital Notes were issued through a pooled underwriting.  The securities have a five year fixed interest rate of 6.29% payable quarterly, converting after five years to a LIBOR-indexed floating rate of interest (three-month LIBOR plus 1.40%) which adjusts, and is also payable, quarterly.  The securities may be redeemed at par at any time commencing in December 2012 until the securities mature in 2037.  The principal asset of the Trust is $3.6 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion.  The portion of the Trust Preferred Capital Notes not considered as Tier 1 capital may be included in Tier 2 capital.

The obligations of the Company with respect to the issuance of the Trust Preferred Capital Notes constitute a full and unconditional guarantee by the Company of the Trust’s obligations with respect to the Trust Preferred Capital Notes.  Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related Trust Preferred Capital Notes and require a deferral of common dividends.  In consideration of our agreements with our regulators, which require regulatory approval to make interest payments on
 
 
28

 
these securities, the Company has deferred an aggregate of $807,316 in interest payments on the junior subordinated debt securities as of September 30, 2013.  The Company has been deferring interest payments since June 2011.  The Company can defer up to twenty quarterly interest payments on the junior subordinated debt securities before it is considered in default.  Although we elected to defer payment of the interest due, the amount has been accrued and is included in interest expense in the consolidated statement of operations.

Note 8 – Stock incentive plan

The Company has a stock incentive plan which authorizes the issuance of up to 555,000 shares of common stock to assist the Company in recruiting and retaining key personnel.

The following table summarizes stock options outstanding under the stock incentive plan at the indicated dates:

   
Nine Months Ended September 30,
   
2013
 
2012
         
Weighted
                 
Weighted
         
         
Average
                 
Average
         
         
Exercise
   
Fair Value
 
Intrinsic
       
Exercise
   
Fair Value
 
Intrinsic
   
Options
   
Price
   
Per Share
 
Value
 
Options
   
Price
   
Per Share
 
Value
                                         
Options outstanding,
                                       
beginning of period
    255,630     $ 9.48     $ 4.70         264,980     $ 9.48     $ 4.70    
Granted
    42,205       1.58       0.61         5,000       1.00       1.08    
Forfeited
    (3,000 )     7.70       4.99         (3,450 )     4.98       3.12    
Exercised
    -       -       -         -       -       -    
Options outstanding,
                                                   
end of period
    294,835     $ 9.40     $ 4.06  
 $                     -
    266,530     $ 9.71     $ 4.66  
 $                      -
Options exercisable,
                                                   
end of period
    256,130                         261,530                    

The fair value of the stock is calculated under the same methodology as stock options and the expense is recognized over the vesting period.  Unamortized stock-based compensation related to nonvested share based compensation arrangements granted under the Incentive Plan as of September 30, 2013 and 2012 was $115,764 and $2,734 respectively.  The time based unamortized compensation of $115,764 is expected to be recognized over a weighted average period of 2.82 years.

Stock-based compensation expense was $5,964 and $6,506 for the nine months ended September 30, 2013 and 2012, respectively.

Note 9 — Fair value

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction between market participants.  A fair value measurement assumes that the transaction to sell the asset or transfer the liability occurs in the principal market for the asset or liability or, in the absence of a principal market, the most advantageous market for the asset or liability.  The price in the principal (or most advantageous) market used to measure the fair value of the asset or liability shall not be adjusted for transaction costs.  An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and
 
 
29

 
customary for transaction involving such assets and liabilities; it is not a forced transaction.  Market participants are buyers and sellers in the principal market that are independent, knowledgeable, able to transact and willing to transact.

FASB Codification Topic 820: Fair Value Measurements and Disclosures establishes a hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.  The fair values hierarch is as follows:

Level 1 Inputs — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.

Level 2 Inputs — Significant other observable inputs other than Level 1 prices such as 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.

Level 3 Inputs- Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.

The Company used the following methods to determine the fair value of each type of financial instrument:

Securities: Fair values for securities available-for-sale are obtained from an independent pricing service.  The prices are not adjusted.  The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures.  Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating.  Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Levels 1 and 2).

Impaired loans: The fair values of impaired loans are measured for impairment using the fair value of the collateral for collateral-dependent loans on a nonrecurring basis. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. The vast majority of the Company’s collateral is real estate.  The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2).  However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than two years old, then a Level 3 valuation is considered to measure the fair value.   The value of business equipment is based upon an outside appraisal if deemed significant using observable market data.  Likewise, values for inventory and account receivables collateral are based on financial statement balances or aging reports (Level 3).  Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
 
 
 
30

 
Real Estate Owned: Real estate owned assets are adjusted to fair value upon transfer of the loans to foreclosed assets.  Subsequently, real estate owned assets are carried at net realizable value.  Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral.  When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2.  When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring level 3.

Assets and liabilities measured at fair value under Topic 820 on a recurring and non-recurring basis are summarized below for the indicated dates:

   
Fair Value Measurement
 
   
at September 30, 2013 Using
 
   
(In thousands)
 
         
Quoted Prices
             
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
   
Carrying
   
Identical Assets
   
Inputs
   
Inputs
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial Assets - Recurring
                       
US Government Agencies
  $ 42,414     $ -     $ 42,414     $ -  
MBS
    2,970       -       1,261       -  
Municipals
    13,728       -       13,894       -  
Residential loans held for sale
    14,527       -       14,527       -  
                      -          
Financial Assets - Non-Recurring
                               
Impaired loans
    50,964       -       43,824       7,140  
Other real estate owned
    19,652       -       18,290       1,362  


   
Fair Value Measurement
 
   
at December 31, 2012 Using
 
   
(In thousands)
 
         
Quoted Prices
             
         
in Active
   
Other
   
Significant
 
         
Markets for
   
Observable
   
Unobservable
 
   
Carrying
   
Identical Assets
   
Inputs
   
Inputs
 
   
Value
   
(Level 1)
   
(Level 2)
   
(Level 3)
 
Financial Assets - Recurring
                       
US Government Agencies
  $ 11,387     $ 5,000     $ 6,387     $ -  
MBS
    1,829       -       1,829       -  
Municipals
    11,938       2,918       9,020       -  
Residential loans held for sale
    24,188       -       24,188       -  
                                 
Financial Assets - Non-Recurring
                               
Impaired loans
    54,775       -       47,016       7,759  
Other real estate owned
    20,204       -       18,675       1,529  


 
31

 
The following table presents qualitative information about level 3 fair value measurements for financial instruments measured at fair value at September 30, 2013:

               
Range
   
Fair Value
 
Valuation
 
Unobservable
 
(Weighted
   
 Estimate
 
Techniques
 
Input
 
Average)
   
(In thousands)
                 
Impaired Loans  -Real Estate Secured
 
 $      6,030
 
Appraisal (1) or
Internal Valuation (2)
 
Appraisal Adjustments
Liquidation Expenses (3)
 
10%-30%
Impaired Loans - Non-Real Estate Secured
 
 $      1,110
 
Appraisal (1) or
Discounted Cash Flow
 
Appraisal Adjustments
Liquidation Expenses (3)
 
10%-20%
Other Real Estate Owned
 
 $      1,362
 
Appraisal (1) or
Internal Valuation (2)
 
Appraisal Adjustments
Liquidation Expenses (3)
 
7%-30%
                 
(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally
     included various level 3 inputs which are not identifiable
       
(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances
(3) Appraisals may be adjusted by management for qualitative factors such as economic conditions and estimated
     liquidation expenses
       

The following table presents the changes in the Level 3 fair value category for the nine months ended September 30, 2013.

   
Impaired
   
Real Estate
       
   
Loans
   
Owned
   
Total Assets
 
   
(In thousands)
 
                   
Balance at December 31, 2012
  $ 7,759     $ 1,529     $ 9,288  
                         
Total realized and unrealized gains (losses)
                       
Included in earnings
    -       (326 )     (326 )
Included in other comprehensive income
    -       -       -  
Net transfers in and/or out of Level 3
    (619 )     159       (460 )
                         
Balance at September 30, 2013
  $ 7,140     $ 1,362     $ 8,502  

In general, fair value of securities is based upon quoted market prices, where available.  If such quoted market prices are not available, fair value is based upon market prices determined by an outside, independent entity that primarily uses as inputs, observable market-based parameters.   Fair value of loans held for sale is based upon internally developed models that primarily use as inputs, observable market-based parameters.  Valuation adjustments may be made to ensure that financial instruments are recorded at fair value.  These adjustments may include amounts to reflect counterparty credit quality, among other things, as well as unobservable parameters.  Any such valuation adjustments are applied consistently over time.  The Company valuation methodologies may produce a fair value calculation that may not be indicative of net realizable value or reflective of future fair values.  While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date.  Transfers between levels of the fair value hierarchy are recognized on the actual date of the event or circumstances that caused the transfer, which generally coincides with the Company’s monthly and or quarter valuation process.

 
32

Cash and cash equivalents – The carrying amount of cash and cash equivalents approximates fair value.

Investment securities – The fair value of investment securities available-for-sale is estimated based on bid quotations received from independent pricing services for similar assets.  The carrying amount of other investments approximates fair value.

Loans – For variable rate loans that reprice frequently and have no significant change in credit risk, fair values are based on carrying values.  For all other loans, fair values are calculated by discounting the contractual cash flows using estimated market discount rates which reflect the credit and interest rate risk inherent in the loans, or by using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities.

Deposits – The fair value of deposits with no stated maturity, such as demand, interest checking and money market, and savings accounts, is equal to the amount payable on demand at year-end.  The fair value of certificates of deposit is based on the discounted value of contractual cash flows using the rates currently offered for deposits of similar remaining maturities.

Borrowings – The fair value of borrowings is based on the discounted value of contractual cash flows using the rates currently offered for borrowings of similar remaining maturities

Accrued interest – The carrying amounts of accrued interest receivable and payable approximate fair value.

Village Bank
Fair Value - Financial Instruments Summary
September 30, 2013
 
                           
     
September 30,
   
December 31,
 
     
2013
   
2012
 
 
Level in Fair
                       
 
Value
 
Carrying
   
Estimated
   
Carrying
   
Estimated
 
 
Hierarchy
 
Value
   
Fair Value
   
Value
   
Fair Value
 
                           
Financial assets
                         
Cash
Level 1
  $ 13,142,811     $ 13,142,811     $ 13,945,105     $ 13,945,105  
Cash equivalents
Level 2
    20,632,216       20,632,216       39,185,837       39,185,837  
Investment securities available for sale
Level 1
    -       -       7,918,420       7,918,420  
Investment securities available for sale
Level 2
    59,112,521       59,112,521       17,235,626       17,235,626  
Federal Home Loan Bank stock
Level 2
    1,642,300       1,642,300       2,121,900       2,121,900  
Loans held for sale
Level 2
    14,526,577       14,526,577       24,188,384       24,188,384  
Loans
Level 2
    244,101,136       247,933,319       290,115,508       294,476,846  
Impaired loans
Level 2
    43,824,127       43,824,127       47,016,065       47,016,065  
Impaired loans
Level 3
    7,139,567       7,139,567       7,758,689       7,758,689  
Other real estate owned
Level 2
    18,603,822       18,603,822       18,675,164       18,675,164  
Other real estate owned
Level 3
    1,361,832       1,361,832       1,528,527       1,528,527  
Bank owned life insurance
Level 3
    6,718,678       6,718,678       6,575,018       6,575,018  
Accrued interest receivable
Level 2
    1,517,519       1,517,519       1,676,518       1,676,518  
                                   
Financial liabilities
                                 
Deposits
Level 2
    401,596,415       402,889,752       436,322,962       437,644,329  
FHLB borrowings
Level 2
    18,000,000       18,249,300       28,000,000       28,424,029  
Trust preferred securities
Level 2
    8,764,000       7,274,120       8,764,000       7,537,040  
Other borrowings
Level 2
    3,289,463       3,289,463       4,851,811       4,851,811  
Accrued interest payable
Level 2
    1,054,233       1,054,233       911,635       911,635  


 
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Note 10 – Capital Purchase Program

On May 1, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 (“EESA”), the Company entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 14,738 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $4.00 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant (the “Warrant”) to purchase 499,029 shares of the Company’s common stock at an initial exercise price of $4.43 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $14,738,000 in cash.  The fair value of the preferred stock was estimated using discounted cash flow methodology at an assumed market equivalent rate of 13%, with 20 quarterly payments over a five year period.  The fair value of the warrant was estimated using the Black-Scholes option pricing model, with assumptions of 25% volatility, a risk-free rate of 2.03%, a yield of 6.162% and an estimated life of 5 years.  The value attributed to the warrant is being accreted as a discount on the preferred stock using the effective interest rate method over five years.

The Preferred Stock qualifies as Tier 1 capital and will pay cumulative dividends at a rate of 5% until May 1, 2014 and 9% thereafter, unless the shares are redeemed by the Company.  The Preferred Stock is generally non-voting, other than on certain matters that could adversely affect the Preferred Stock.

The Warrant is immediately exercisable.  The Warrant provides for the adjustment of the exercise price and the number of shares of 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 common stock, and upon certain issuances of common stock at or below a specified price relative to the then-current market price of common stock.  The Warrant expires ten years from the issuance date.  Pursuant to the Purchase Agreement, the Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

As required by the Federal Reserve Bank of Richmond, the Company notified the U.S. Treasury in May 2011 that the Company was going to defer the payment of the quarterly cash dividend of $184,225 due on May 16, 2011, and subsequent quarterly payments, on the Fixed Rate Cumulative Perpetual Preferred Stock, Series A.  The total arrearage on such preferred stock as of September 30, 2013 was $1,934,362.  This amount has been accrued for and is included in other liabilities in the consolidated balance sheet.

In June 2012 the Treasury asked to allow an observer at the Company’s meetings of its board of directors.  The observer started attending board meetings in August 2012.  The Treasury has the contractual right to nominate up to two members to the board of directors upon the Company’s sixth missed dividend payment.  The Company has deferred ten dividend payments as of September 30, 2013.  However, Treasury has not indicated that it will nominate two directors to the board of directors.

The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies.  Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements.  Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices.  The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
 
 
34


Note 11 – Commitments and contingencies

Off-balance-sheet risk – The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers.  These financial instruments include commitments to extend credit and standby letters of credit.  These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the financial statements.  The contract amounts of these instruments reflect the extent of involvement that the Company has in particular classes of instruments.

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, and to potential credit loss associated with letters of credit issued, is represented by the contractual amount of those instruments.  The Company uses the same credit policies in making commitments and conditional obligations as it does for loans and other such on-balance sheet instruments.

The Company had outstanding the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk at the dates indicated:

   
September 30,
   
December 31,
 
   
2013
   
2012
 
             
Undisbursed credit lines
  $ 35,536,000     $ 35,780,000  
Commitments to extend or originate credit
    20,252,000       25,016,000  
Standby letter of credit
    2,672,000       3,314,000  
                 
Total commitments to extend credit
  $ 58,460,000     $ 64,110,000  


Commitments to extend credit are 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 the payment of a fee.  Historically, many commitments expire without being drawn upon; therefore, the total commitment amounts shown in the above table are not necessarily indicative of future cash requirements.  The Company evaluates each customer’s creditworthiness on a case-by-case basis.  The amount of collateral obtained, as deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the customer.  Collateral held varies but may include personal or income-producing commercial real estate, accounts receivable, inventory and equipment.

Concentrations of credit risk – All of the Company’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area.  Although the Company is building a diversified loan portfolio, a substantial portion of its clients’ ability to honor contracts is reliant upon the economic stability of the Richmond, Virginia area, including the real estate markets in the area.  The concentrations of credit by type of loan are set forth in Note 5.  The distribution of commitments to extend credit approximates the distribution of loans outstanding.
 
 
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Consent Order – In February 2012, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order (“Consent Agreement”) with the Federal Deposit Insurance Corporation and the Virginia Bureau of Financial Institutions (the “Supervisory Authorities”), and the Supervisory Authorities have issued the related Consent Order (the “Order”) effective February 3, 2012.  The description of the Consent Agreement and the Order is set forth below:

Management. The Order requires that the Bank have and retain qualified management, including at a minimum a chief executive officer, senior lending officer and chief operating officer, with qualifications and experience commensurate with their assigned duties and responsibilities within 90 days from the effective date of the order.  Within 30 days of the effective date of the Order, the Bank must retain a bank consultant to develop a written analysis and assessment of the Bank’s management and staffing needs for the purpose of providing qualified management for the Bank.  Within 30 days from receipt of the consultant’s management report, the Bank must formulate a written management plan that incorporates the findings of the management report, a plan of action in response to each recommendation contained in the management report, and a timeframe for completing each action.

Capital Requirements. Within 90 days from the effective date of the Order and during the life of the Order, the Bank must have Tier 1 capital equal to or greater than 8 percent of its total assets, and total risk-based capital equal to or greater than 11 percent of the Bank’s total risk-weighted assets.  Within 90 days from the effective date of the Order, the Bank must submit a written capital plan to the Supervisory Authorities.  The capital plan must include a contingency plan in the event that the Bank fails to maintain the minimum capital ratios required in the Order, submit a capital plan that is acceptable to the Supervisory Authorities, or implement or adhere to the capital plan.

Charge-offs. The Order requires the Bank to eliminate from its books, by charge-off or collection, all assets or portions of assets classified “Loss” and 50 percent of those classified “Doubtful”.  If an asset is classified “Doubtful”, the Bank may, in the alternative, charge off the amount that is considered uncollectible in accordance with the Bank’s written analysis of loan or lease impairment.  The Order also prevents the Bank from extending, directly or indirectly, any additional credit to, or for the benefit of, any borrower who has a loan or other extension of credit from the Bank that has been charged off or classified, on whole or in part, “loss” or “doubtful” and is uncollected.  The Bank may not extend, directly or indirectly, any additional credit to any borrower who has a loan or other extension of credit from the Bank that has been classified “substandard.”  These limitations do not apply if the Bank’s failure to extend further credit to a particular borrower would be detrimental to the best interests of the Bank.

Asset Growth. While the Order is in effect, the Bank must notify the Supervisory Authorities at least 60 days prior to undertaking asset growth that exceeds 10% or more per year or initiating material changes in asset or liability composition.  The Bank’s asset growth cannot result in noncompliance with the capital maintenance provisions of the Order unless the Bank receives prior written approval from the Supervisory Authorities.

Restriction on Dividends and Other Payments. While the Order is in effect, the Bank cannot declare or pay dividends, pay bonuses, or pay any form of payment outside the ordinary course of business resulting in a reduction of capital without the prior written approval of the Supervisory Authorities.  In addition, the Bank cannot make any distributions of interest, principal, or other sums on subordinated debentures without prior written approval of the Supervisory Authorities.

 
36

 
Brokered Deposits. The Order provides that the Bank may not accept, renew, or roll over any brokered deposits unless it is in compliance with the requirements of the FDIC regulations governing brokered deposits.  These regulations prohibit undercapitalized institutions from accepting, renewing, or rolling over any brokered deposits and also prohibit undercapitalized institutions from soliciting deposits by offering an effective yield that exceeds by more than 75 basis points the prevailing effective yields on insured deposits of comparable maturity in the institution’s market area. An “adequately capitalized” institution may not accept, renew, or roll over brokered deposits unless it has applied for and been granted a waiver by the FDIC.

Written Plans and Other Material Terms. Under the terms of the Order, the Bank is required to prepare and submit the following written plans or reports to the FDIC and the Commissioner:
     
 
·Plan to improve liquidity, contingency funding, interest rate risk, and asset liability management
     
 
·Plan to reduce assets of $250,000 or greater classified “doubtful” and “substandard”
     
 
·Revised lending and collection policy to provide effective guidance and control over the Bank’s lending and credit administration functions

     
·Effective internal loan review and grading system
 
     
·Policy for managing the Bank’s other real estate
 
     
·Business/strategic plan covering the overall operation of the Bank
 
     
·Plan and comprehensive budget for all categories of income and expense for the year 2011
 
     
·Policy and procedures for managing interest rate risk
 
     
·Assessment of the Bank’s information technology function
 
Under the Order, the Bank’s board of directors has agreed to increase its participation in the affairs of the Bank, including assuming full responsibility for the approval of policies and objectives for the supervision of all of the Bank’s activities. The Bank must also establish a board committee to monitor and coordinate compliance with the Order.

The Order will remain in effect until modified or terminated by the Supervisory Authorities.

While subject to the Consent Order, we expect that our management and board of directors will be required to focus considerable time and attention on taking corrective actions to comply with the terms.  In addition, certain provisions of the Consent Order described above could adversely impact the Company’s businesses and results of operations.

Written Agreement – In June 2012, the Company entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (“Reserve Bank”).  Under the terms of the Written Agreement, the Company has agreed to develop and submit to the Reserve Bank for approval within the time periods specified therein written plans to maintain sufficient capital and correct any violations of section 23A of the Federal Reserve Act and Regulation W.  In addition, the Company will submit a written statement of its planned sources and uses of cash for debt service, operation expenses, and other purposes.

 
37

 
The Company also has agreed that it will not, without prior regulatory approval:
 
·
pay or declare any dividends;
 
·
take any other form of payment representing a reduction in Bank’s capital;
 
·
make any distributions of interest, principal or other sums on subordinated debentures or trust preferred securities;
 
·
incur, increase or guarantee any debt;
 
·
purchase or deem any shares of its stock.

Since entering into the Order and the Written Agreement, the Company has taken numerous steps to comply with the terms of the agreements.

In March 2013, the Special Inspector General for the Troubled Asset Relief Program (“SIGTARP”) notified the Company that it was conducting an investigation of the Company and has issued three subpoenas requesting the Company to produce certain documents and other information.  The Company is cooperating fully with SIGTARP and has produced all the documents and other information requested thus far by SIGTARP.  The Company cannot predict the duration or the outcome of the investigation, including the effect the investigation and the costs associated with the investigation could have on the Company’s business, financial condition, or results of operations.

Note 12 – Income Taxes

The net deferred tax asset is included in other assets on the balance sheet.  Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results.  In making such judgments, significant weight is given to evidence that can be objectively verified.  The deferred tax assets are analyzed quarterly for changes affecting realization.  Management determined that as of September 30, 2013, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance for all of the net deferred tax asset that is dependent on future earnings of the Company of approximately $10,158,000.

Note 13 – Recent accounting pronouncements

In February 2013, the Financial Accounting Standards Board (FASB) issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other required disclosures that provide additional detail about those amounts. This ASU is effective prospectively in the first quarter of 2013.  The company adopted ASU 2013-02 in the first quarter of 2013 by adding the required disclosure.  The adoption of ASU 2013-02 did not have a material effect on the Company’s financial condition and results of operations.


 
38


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

Caution about forward-looking statements

In addition to historical information, this report may contain forward-looking statements.  For this purpose, any statement, that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy and financial and other goals.  Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning.  You can also identify them by the fact that they do not relate strictly to historical or current facts.  Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to:

 
·
the inability of the Bank to comply with the requirements of agreements with its regulators;
 
·
the inability to reduce nonperforming assets consisting of nonaccrual loans and foreclosed real estate;
 
·
our inability to improve our regulatory capital position;
 
·
the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
 
·
changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;
 
·
changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;
 
·
risks inherent in making loans such as repayment risks and fluctuating collateral values;
 
·
a decline in loan volume of Village Bank Mortgage Corporation as a result of the activity in the residential real estate market or increasing interest rates;
 
·
legislative and regulatory changes, including the Dodd-Frank Act Wall Street Reform and Consumer Protection Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
 
·
exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
 
·
the effects of future economic, business and market conditions;
 
·
governmental monetary and fiscal policies;
 
·
changes in accounting policies, rules and practices;
 
·
maintaining capital levels adequate to remain well capitalized;
 
·
reliance on our management team, including our ability to attract and retain key personnel;
 
·
competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
 
·
demand, development and acceptance of new products and services;
 
·
problems with technology utilized by us;
 
·
changing trends in customer profiles and behavior; and
 
·
other factors described from time to time in our reports filed with the SEC.
 
 
39

 
These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements.  Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.  In addition, past results of operations are not necessarily indicative of future results.

General

The Company’s primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk.  The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company’s results of operations and financial condition.

Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions.  If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income.  Over the last four years, the Company has recorded record provisions for loan losses due primarily to deteriorating quality of loans collateralized by real estate located in its principal market area.

There is intense competition in all areas in which the Company conducts its business. The Company competes with banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions.  Many of these competitors have substantially greater resources and lending limits and provide a wider array of banking services.  To a limited extent, the Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.  Competition is based on a number of factors, including prices, interest rates, services, availability of products and geographic location.

Beginning in 2012, our business strategy included efforts to reduce our total assets and liabilities due to a continued depressed economy as well as capital limitations at the time.  These efforts resulted in declines of approximately $72 million in total assets and approximately $60 million in total liabilities in 2012.  With the sale of a branch completed in the first quarter of 2013, we further reduced our total assets by approximately $26 million and liabilities by approximately $23 million.  In the second and third quarters we experienced a continued decline in total assets, primarily as a result of a declining loan portfolio accompanied by declines in higher cost deposits and FHLB advances.  This strategy helped strengthen our regulatory capital ratios in 2012 and through the third quarter of 2013.  While we do not anticipate significant growth for the remainder of 2013, we do not expect to continue our efforts to reduce total assets and liabilities.

Results of operations

The following represents management’s discussion and analysis of the financial condition of the Company at September 30, 2013 and December 31, 2012 and the results of operations for the Company for the three and nine months ended September 30, 2013 and 2012.  This discussion should be read in conjunction with the Company’s condensed consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly report.

 
40

 
Income statement analysis

Summary

For the three months ended September 30, 2013, the Company had a net loss of $(267,000) and net loss available to common shareholders of $(488,000) or $(0.11) per fully diluted share, compared to net loss of $(367,000) and net loss available to common shareholders of $(588,000), or $(0.14) per fully diluted share, for the same period in 2012.  For the nine months ended September 30, 2013, the Company had a net loss totaling $(189,000) and a net loss available to common shareholders of $(853,000), or $(0.20) per fully diluted share, compared to net loss totaling $(11,504,000) and a net loss available to common shareholders of $(12,131,000), or $(2.85) per share on a fully diluted share, for the same period in 2012.  These results reflect improvements in net income before the accrual of preferred stock dividends of $100,000 and $11,315,000, for the three and nine month periods, respectively.

The components of these increases in net income before accrual of preferred stock dividends are presented following:

   
Three Months
   
Nine Months
 
   
Ended
   
Ended
 
   
September 30, 2013
   
September 30, 2013
 
             
Decrease in net interest income
  $ (432,000 )   $ (1,396,000 )
Decrease in provision for loan losses
    700,000       8,272,000  
Increase (decrease) in noninterest income
    (944,000 )     249,000  
Decrease in noninterest expense
    615,000       147,000  
Decrease in income tax expense
    161,000       4,043,000  
                 
    $ 100,000     $ 11,315,000  
 
Although we experienced a net loss for the three and nine month periods ended September 30, 2013, our results showed improvement from the same periods in 2012 primarily due to the decline in the provision for loan losses and the decrease in tax expense.  The decrease in the provision for loan losses was attributable to an improving loan portfolio as well as a decline in need due to the decline in total loans.  This is consistent with the previous quarters of 2013.  However, as we resolve nonperforming loans through foreclosure, costs associated with foreclosed real estate will continue to be a significant expense.  The decrease in income tax expense was due to management’s determination in 2012 that a valuation allowance was necessary on its deferred tax asset which resulted in income tax expense in 2012.

The decrease in net interest income was primarily a result of a decline in our loan portfolio in line with our asset reduction strategy.  The decrease in noninterest income for the three month period is primarily attributable to declines in gains on securities sales of $557,000 and in gains on sales of loans of $268,000.  The primary factors affecting noninterest income for the nine month period were the gain on sale of the Robious branch of $598,000 in 2013 as well as a decline in gains on securities sales of $604,000.  The decrease in noninterest expense for the three month period was attributable to declines in professional services of $209,000 and expenses related to foreclosed real estate of $423,000.
 
 
41

 
Net interest income

Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company’s primary source of earnings.  Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholder’s equity.  Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities.  The net yield on interest-earning assets (“net interest margin”) is calculated by dividing tax equivalent net interest income by average interest-earning assets.  Generally, the net interest margin will exceed the net interest spread because a portion of interest earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing deposits and shareholders’ equity.

Net interest income for the third quarter of $3,784,000 represents a decrease of $(432,000), or 10%, compared to the third quarter of 2012, and an increase of $64,000, or 2%, compared to the second quarter of 2013.

Compared to the third quarter of 2012, average interest-earning assets for the third quarter of 2013 decreased by $45,477,000, or 10%.  The decrease in interest-earning assets was due primarily to decreases in portfolio loans of $82,464,000, offset by increases in investment securities of $27,314,000 and federal funds sold of $11,250,000.  This decline in average interest earning assets is consistent with our asset reduction strategy.

Net interest income of $11,593,000 for the first nine months of 2013 represents a decrease of $(1,396,000), or 11%, compared to the same period in 2012.

Compared to the first nine months of 2012, average interest-earning assets for the same period of 2013 decreased by $53,937,000, or 11%.  The decrease in interest-earning assets was due primarily to decreases in portfolio loans of $81,994,000, offset by increases in investment securities of $11,447,000 and federal funds sold of $15,854,000.  This decline in average interest earning assets is consistent with our asset reduction strategy.

Average interest-bearing liabilities for the third quarter of 2013 decreased by $41,921,000, or 10%, compared to the third quarter of 2012, and by $40,850,000, or 9%, for the comparative nine month periods.  The decrease in interest-bearing liabilities was due to declines in average deposits of $32,935,000 and $32,696,000, respectively.  The average cost of interest-bearing liabilities for the three months ended September 30, 2013 decreased to 1.06% from 1.36% for the same period in 2012, and to 1.16% from 1.40% for the comparative nine month periods.  The principal reason for the decrease in liability costs was the maintenance of short-term interest rates at a low level by the Federal Reserve.  The continuing low interest rates have allowed us to reduce our costs of funds as certificates of deposit and borrowings mature.  See our discussion of interest rate sensitivity below for more information.

 
42

 
The Company’s net interest margin is not a measurement under accounting principles generally accepted in the United States, but it is a common measure used by the financial services industry to determine how profitably earning assets are funded.  Our net interest margin over the last several quarters is provided in the following table:

   
Net
   
Interest
Quarter Ended
 
Margin
     
September 30, 2012
 
3.70%
December 31, 2012
 
4.25%
March 31, 2013
 
3.79%
June 30, 2013
 
3.50%
September 30, 2013
 
3.69%


The significant increase in the net interest margin in the fourth quarter of 2012 is attributable to the recapture of interest on returning approximately $14.4 million of nonaccrual loans to accrual status during the quarter.  The decline in the net interest margin for the second quarter of 2013 is primarily a result of a decline in portfolio loans of $18,388,000 during the period.  Portfolio loans are our highest yielding asset and the current lending environment is very competitive.  The increase in the net interest margin in the third quarter of 2013 is attributable to an increase in the yield on loans held for sale as mortgage interest rates increased in the third quarter and a decline of 12 basis points in our cost of funds.

The following table illustrates average balances of total interest-earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, shareholders' equity and related income, expense and corresponding weighted-average yields and rates.  The average balances used in these tables and other statistical data were calculated using daily average balances.  We had no tax exempt assets for the periods presented.


 
43


Average Balance Sheets
 
(in thousands)
 
                                     
   
Three Months Ended September 30, 2013
   
Three Months Ended September 30, 2012
 
         
Interest
   
Annualized
         
Interest
   
Annualized
 
   
Average
   
Income/
   
Yield
   
Average
   
Income/
   
Yield
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
                                     
                                     
Loans net of deferred fees
  $ 303,866     $ 4,293       5.61 %   $ 386,330     $ 5,344       5.49 %
Loans held for sale
    14,798       166       4.45 %     16,375       145       3.51 %
Investment securities
    58,054       324       2.21 %     30,740       167       2.16 %
Federal funds and other
    30,097       18       0.24 %     18,847       11       0.23 %
Total interest earning assets
    406,815       4,801       4.68 %     452,292       5,667       4.97 %
                                                 
Allowance for loan losses and deferred fees
    (9,381 )                     (14,094 )                
Cash and due from banks
    11,649                       13,540                  
Premises and equipment, net
    23,743                       26,183                  
Other assets
    36,499                       36,769                  
                                                 
Total assets
  $ 469,325                     $ 514,690                  
                                                 
Interest bearing deposits
                                               
Interest checking
  $ 42,261     $ 20       0.19 %   $ 43,779     $ 36       0.33 %
Money market
    64,776       33       0.20 %     64,693       59       0.36 %
Savings
    20,995       10       0.19 %     18,652       22       0.47 %
Certificates
    220,202       787       1.42 %     254,045       1,070       1.67 %
Total
    348,234       850       0.97 %     381,169       1,187       1.24 %
Borrowings
    33,609       167       1.97 %     42,595       264       2.46 %
Total interest bearing liabilities
    381,843       1,017       1.06 %     423,764       1,451       1.36 %
Noninterest bearing deposits
    58,614                       56,983                  
Other liabilities
    6,739                       6,087                  
Total liabilities
    447,196                       486,834                  
Equity capital
    22,129                       27,856                  
Total liabilities and capital
  $ 469,325                     $ 514,690                  
                                                 
Net interest income before provision for
                                               
loan losses
          $ 3,784                     $ 4,216          
                                                 
Interest spread - average yield on interest
                                               
earning assets, less average rate on
                                               
interest bearing liabilities
                    3.62 %                     3.61 %
                                                 
Annualized net interest margin (net
                                               
interest income expressed as
                                               
percentage of average earning assets)
                    3.69 %                     3.70 %
                                                 
 
 
 
44


Average Balance Sheets
 
(in thousands)
 
                                     
   
Nine Months Ended September 30, 2013
   
Nine Months Ended September 30, 2012
 
         
Interest
   
Annualized
         
Interest
   
Annualized
 
   
Average
   
Income/
   
Yield
   
Average
   
Income/
   
Yield
 
   
Balance
   
Expense
   
Rate
   
Balance
   
Expense
   
Rate
 
                                     
                                     
Loans net of deferred fees
  $ 321,721     $ 13,746       5.71 %   $ 403,715     $ 16,560       5.48 %
Loans held for sale
    15,963       478       4.00 %     15,207       442       3.89 %
Investment securities
    44,203       751       2.27 %     32,756       532       2.17 %
Federal funds and other
    41,683       71       0.23 %     25,829       44       0.23 %
Total interest earning assets
    423,570       15,046       4.74 %     477,507       17,578       4.92 %
                                                 
Allowance for loan losses and deferred fees
    (9,925 )                     (13,381 )                
Cash and due from banks
    12,324                       14,199                  
Premises and equipment, net
    24,370                       26,439                  
Other assets
    37,074                       35,826                  
                                                 
Total assets
  $ 487,413                     $ 540,590                  
                                                 
Interest bearing deposits
                                               
Interest checking
  $ 42,654     $ 81       0.25 %   $ 42,889     $ 112       0.35 %
Money market
    65,453       143       0.29 %     68,976       205       0.40 %
Savings
    20,734       50       0.32 %     17,534       65       0.50 %
Certificates
    232,216       2,568       1.48 %     264,354       3,409       1.72 %
Total
    361,057       2,842       1.05 %     393,753       3,791       1.29 %
Borrowings
    37,486       611       2.18 %     45,640       799       2.34 %
Total interest bearing liabilities
    398,543       3,453       1.16 %     439,393       4,590       1.40 %
Noninterest bearing deposits
    57,484                       61,503                  
Other liabilities
    7,289                       4,983                  
Total liabilities
    463,316                       505,879                  
Equity capital
    24,097                       34,711                  
Total liabilities and capital
  $ 487,413                     $ 540,590                  
                                                 
Net interest income before provision for
                                               
loan losses
          $ 11,593                     $ 12,988          
                                                 
Interest spread - average yield on interest
                                               
earning assets, less average rate on
                                               
interest bearing liabilities
                    3.59 %                     3.53 %
                                                 
Annualized net interest margin (net
                                               
interest income expressed as
                                               
percentage of average earning assets)
                    3.66 %                     3.63 %
                                                 


 
45


Provision for loan losses

The Company did not record a provision for loan losses for the three months ended September 30, 2013 compared to $700,000 for the three months ended September 30, 2012.  The provision for loan losses for the nine months ended September 30, 2013 was $823,000 compared to $9,095,000 for the nine months ended September 30, 2012.  The declines in the provision for loan losses for the three and nine month periods were primarily driven by a $68 million decline in loans outstanding from September 30, 2012 to September 30, 2013 as well as a decline in the impairment on specific nonperforming loans.  While we are encouraged by this decline in the provision for loan losses, overall asset quality continues to be a concern as there continues to be uncertainty in the economy and the level of nonperforming assets remains significant.

Noninterest income

Noninterest income decreased from $4,028,000 for the three months ended September 30, 2012 to $3,085,000 for the three months ended September 30, 2013, a decrease of $943,000, or 23%.  The decrease in noninterest income is primarily a result of lower gains on loan sales from decreased loan originations by our mortgage banking subsidiary of $268,000, and a decrease in gain on sale of securities of $557,000.  Noninterest income increased from $9,865,000 for the first nine months of 2012 to $10,114,000 for the first nine months of 2013, an increase of $249,000, or 3%.  The increase in noninterest income is primarily a result of higher gains on sale of loans of $118,000 due to mortgage originations in the first and second quarters of 2013 and the gain on the sale of the Robious branch of $598,000 in the first quarter of 2013, offset by a decrease in the gain on sale of securities of $604,000.

Mortgage loan originations by our mortgage company decreased by $5,563,000, or 2%, for the first nine months of 2013 compared to the same period in 2012.  However, proceeds from the sale of mortgage loans increased by $12,934,000 for the same comparative periods.  If rates were to continue to increase in 2013, mortgage production could be adversely affected, primarily through a reduction in mortgage loan refinancings.  Of the total loan production in 2013, approximately 35% were refinancings of existing mortgages and 65% were for new home purchases.

Noninterest expense

Noninterest expense for the three months ended September 30, 2013 was $7,136,000 compared to $7,751,000 for the three months ended September 30, 2012, a decrease of $615,000, or 8%.  The more significant decreases in noninterest expense occurred in expenses related to foreclosed real estate of $423,000, professional and outside services of $209,000, and equipment expense of $65,000.  These declines were offset by increases in salaries and benefits of $149,000.

Noninterest expense for the nine months ended September 30, 2013 totaled $21,072,000, a decrease of $147,000, or 0.7%, from $21,219,000 for the nine months ended September 30, 2012.  The more significant decreases in noninterest expense occurred in professional and outside services of $254,000, equipment of $187,000, loan underwriting of $245,000 and FDIC assessment of $135,000 offset by an increase in salaries and benefits of $704,000.

 
46

 
Income taxes

Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit.  Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

The net deferred tax asset is included in other assets on the balance sheet.  Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard.  Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results.  In making such judgments, significant weight is given to evidence that can be objectively verified.  The deferred tax assets are analyzed quarterly for changes affecting realization.  Management determined that as of December 31, 2012, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance on its net deferred tax asset of approximately $10,158,000.  Based on quarterly analysis for changes affecting realization of the net deferred tax asset management believes that the valuation allowance established at December 31, 2012 is adequate and did not recognize any additional valuation allowance on its net deferred tax asset at September 30, 2013.  The net operating losses available to offset future taxable income amounted to approximately $14,210,000 at September 30, 2013 and expire through 2030.

Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes.  Instead, they are subject to a franchise tax based on bank capital.  The Company recorded a franchise tax expense of $123,000 the nine months ended September 30, 2012.  Due to the Company’s adjusted capital level we were not subject to franchise tax expense in the first nine months of 2013.

Balance Sheet Analysis

Our total assets decreased to $459,721,000 at September 30, 2013 from $510,087,000 at December 31, 2012, a decrease of $50,366,000, or 10%.  The branch sale discussed previously accounted for approximately half of this decline.  The remaining amount of the decline was attributable to management’s strategy to decrease our level of assets to improve our regulatory capital ratios and reduce our overhead expenses.  Net portfolio loans decreased by $49,825,000 during 2013 (of which approximately $12,000,000 was sold as part of the branch sale), loans held for sale decreased by $9,662,000 and other real estate owned decreased by $552,000, while liquid assets (cash and due from banks, federal funds sold and investment securities available for sale) increased by $14,603,000.

Loans

One of management’s primary objectives is to maintain the quality of the loan portfolio.  The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower.  The portfolio strategies include seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar.

 
47

 
The Company’s real estate loan portfolios, which represent approximately 89% of all loans, are secured by mortgages on real property located principally in the Commonwealth of Virginia.  Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral.  The Company’s commercial loan portfolio represents approximately 10% of all loans.  Loans in this category are typically made to individuals, small and medium-sized businesses and range between $250,000 and $2.5 million.  Based on underwriting standards, commercial and industrial loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory, and real property.  The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions.  The remainder of our loan portfolio is in consumer loans which represent 1% of the total.

The following table presents the composition of our loan portfolio (excluding mortgage loans held for sale) at the dates indicated (dollars in thousands).

   
September 30, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
Construction and land development
                       
Residential
  $ 3,598       1.19 %   $ 2,845       0.80 %
Commercial
    31,516       10.40 %     41,210       11.61 %
    Total construction and land development
    35,114       11.59 %     44,055       12.41 %
Commercial real estate
                               
Farmland
    1,919       0.63 %     2,581       0.73 %
Commercial real estate - owner occupied
    72,495       23.93 %     92,773       26.14 %
Commercial real estate - non-owner occupied
    46,759       15.43 %     54,551       15.37 %
Multifamily
    11,594       3.83 %     7,979       2.25 %
    Total commercial real estate
    132,767       43.82 %     157,884       44.49 %
Consumer real estate
                               
Home equity lines
    21,855       7.22 %     25,521       7.19 %
Secured by 1-4 family residential,
                               
secured by first deeds of trust
    71,936       23.74 %     80,788       22.76 %
Secured by 1-4 family residential,
                               
secured by second deeds of trust
    8,784       2.89 %     9,517       2.68 %
   Total consumer real estate
    102,575       33.85 %     115,826       32.63 %
Commercial and industrial loans
                               
(except those secured by real estate)
    30,375       10.02 %     34,384       9.69 %
Consumer and other
    2,171       0.72 %     2,761       0.78 %
                                 
Total loans
    303,002       100.0 %     354,910       100.0 %
Deferred loan cost (unearned income), net
    691               788          
Less:  Allowance for loan losses
    (8,628 )             (10,808 )        
                                 
    $ 295,065             $ 344,890          

The decline in our total loan portfolio was primarily due to the branch sale which included the sale of approximately $12 million in loans, as well as management’s strategy to decrease our level of assets to improve our regulatory capital ratios and reduce our overhead expenses.

 
48

 
The Company assigns risk rating classifications to its loans.  These risk ratings are divided into the following groups:

 
·
Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating.  1-4 assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;
 
·
Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;
 
·
Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any, and;
 
·
Risk rated 7 loans have all the weaknesses inherent in risk rated 6 loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments.  Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans.  If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral.  Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.

Allowance for loan losses

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance:  the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables.  Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type.  A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical net charge-off rates, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 
49

 
The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses.  This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made.  If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates.  We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

The allowance for loan losses at September 30, 2013 was $8,628,000, compared to $10,808,000 at December 31, 2012.  The ratio of the allowance for loan losses to gross portfolio loans (net of unearned income and excluding mortgage loans held for sale) at September 30, 2013 and December 31, 2012 was 2.78% and 3.04%, respectively.  The decrease in the allowance for loan losses for the first nine months of 2013 was primarily a result of the decline in portfolio loans of $49,825,000 as well as significant charge-offs recognized during the quarter for which specific provisions for loan losses had been previously provided.  We believe the amount of the allowance for loan losses at September 30, 2013 is adequate to absorb the losses that can reasonably be anticipated from the loan portfolio at that date.

 
50

The following table presents an analysis of the changes in the allowance for loan losses for the periods indicated (in thousands).

   
Nine Months Ended
 
   
September
 
   
2013
   
2012
 
             
Beginning balance
  $ 10,808     $ 16,071  
Provision for loan losses
    823       9,095  
Charge-offs
               
Construction and land development
               
Residential
    -       (797 )
Commercial
    (270 )     (5,506 )
Commercial real estate
               
Farmland
    (448 )     -  
Commercial real estate - owner occupied
    (404 )     (685 )
Commercial real estate - non-owner occupied
    (510 )     (431 )
Multifamily
               
Consumer real estate
               
Home equity lines
    (266 )     (681 )
Secured by 1-4 family residential,
               
secured by first deeds of trust
    (1,002 )     (3,046 )
Secured by 1-4 family residential,
               
secured by second deeds of trust
    (215 )     (428 )
Commercial and industrial loans
               
(except those secured by real estate)
    (466 )     (1,428 )
Consumer and other
    (52 )     (404 )
      (3,633 )     (13,406 )
Recoveries
               
Construction and land development
               
Residential
    101       45  
Commercial
    280       5  
Commercial real estate
               
Farmland
    -       -  
Commercial real estate - owner occupied
    43       -  
Commercial real estate - non-owner occupied
    -       -  
Multifamily
               
Consumer real estate
               
Home equity lines
    10       8  
Secured by 1-4 family residential,
               
secured by first deeds of trust
    22       81  
Secured by 1-4 family residential,
               
secured by second deeds of trust
    6       5  
Commercial and industrial loans
               
(except those secured by real estate)
    160       147  
Consumer and other
    8       5  
      630       296  
Net charge-offs
    (3,003 )     (13,110 )
                 
Ending balance
  $ 8,628     $ 12,056  
                 
Loans outstanding at end of period (1)
  $ 303,693     $ 375,127  
Ratio of allowance for loan losses as
               
a percent of loans outstanding at
               
end of period
    2.84 %     3.21 %
                 
Average loans outstanding for the period (1)
  $ 321,721     $ 403,715  
Ratio of net charge-offs to average loans
               
outstanding for the period
    0.93 %     3.25 %
                 
(1) Loans are net of unearned income.
               
                 

 
51


The allowance for loan losses as a percentage of net loans decreased from 3.21% at September 30, 2012 to 2.78% at September 30, 2013 primarily as a result of significant charge-offs recognized during the prior year for which specific provisions for loan losses had been previously provided.

Asset quality

The following table summarizes asset quality information at the dates indicated (dollars in thousands).

   
September 30,
   
December 31,
   
September 30,
 
   
2013
   
2012
   
2012
 
                   
Nonaccrual loans
  $ 22,490     $ 25,605     $ 40,760  
Foreclosed properties
    19,652       20,204       20,576  
Total nonperforming assets
  $ 42,142     $ 45,809     $ 61,336  
                         
Restructured loans still accruing
  $ 28,474     $ 38,820     $ 22,105  
                         
Loans past due 90 days and still accruing
                       
(not included in nonaccrual loans above)
  $ -     $ 115     $ 482  
                         
Nonperforming assets to loans at end of period(1)
    13.9 %     12.9 %     16.4 %
                         
Nonperforming assets to total assets
    9.2 %     9.0 %     12.1 %
                         
Allowance for loan losses to nonaccrual loans
    38.4 %     42.2 %     29.6 %
                         
(1) Loans are net of deferred fees and costs.
                       


The following table presents an analysis of the changes in nonperforming assets for the nine months ended September 30, 2013 (in thousands).

   
Nonaccrual
   
Foreclosed
       
   
Loans
   
Properties
   
Total
 
                   
Balance December 31, 2012
  $ 25,605     $ 20,204     $ 45,809  
Additions, net
    11,425       322       11,747  
Transfers to OREO
    (6,473 )     6,473       -  
Repayments
    (4,428 )     -       (4,428 )
Charge-offs
    (3,639 )     (2,448 )     (6,087 )
Sales
    -       (4,899 )     (4,899 )
                         
Balance September 30, 2013
  $ 22,490     $ 19,652     $ 42,142  

 
52


The following table presents an analysis of the changes in nonperforming assets for the twelve months ended September 30, 2013 (in thousands).

   
Nonaccrual
   
Foreclosed
       
   
Loans
   
Properties
   
Total
 
                   
Balance September 30, 2012
  $ 40,760     $ 20,576     $ 61,336  
Additions, net
    11,090       834       11,924  
Transfers to OREO
    (10,985 )     10,985       -  
Repayments
    (13,447 )     -       (13,447 )
Charge-offs
    (4,928 )     (3,005 )     (7,933 )
Sales
            (9,738 )     (9,738 )
                         
Balance September 30, 2013
  $ 22,490     $ 19,652     $ 42,142  


Until a nonperforming restructured loan has performed in accordance with its restructured terms for a minimum of six months, it will remain on nonaccrual status.

Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful.  Commercial and unsecured consumer loans are designated as non-accrual when the Company considers collection of expected principal and interest doubtful.  Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and interest is not significant.  When loans are placed in non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received.  Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

Of the total nonaccrual loans of $22,490,000 at September 30, 2013 that were considered impaired, 8 loans totaling $4,965,000 had specific allowances for loan losses totaling $1,539,000.  This compares to $25,605,000 in nonaccrual loans at December 31, 2012 of which 15 loans totaling $4,648,000 had specific allowances for loan losses of $1,338,000.

Cumulative interest income that would have been recorded had nonaccrual loans been performing would have been approximately $1,980,000 and $1,931,000 for the nine months ended September 30, 2013 and 2012, respectively.

 
53

 
Deposits

Deposits as of September 30, 2013 and December 31, 2012 were as follows:

   
September 30, 2013
   
December 31, 2012
 
   
Amount
   
%
   
Amount
   
%
 
                         
Demand accounts
  $ 59,172,655       14.7 %   $ 57,049,348       13.1 %
Interest checking accounts
    44,546,350       11.1 %     45,861,199       10.5 %
Money market accounts
    63,156,132       15.7 %     66,007,160       15.1 %
Savings accounts
    20,780,476       5.2 %     20,922,112       4.8 %
Time deposits of $100,000 and over
    99,168,163       24.7 %     113,332,481       26.0 %
Other time deposits
    114,772,639       28.6 %     133,150,662       30.5 %
                                 
Total
  $ 401,596,415       100.0 %   $ 436,322,962       100.0 %


Total deposits decreased by $34,727,000, or 8%, from $436,323,000 at December 31, 2012 to $401,596,000 at September 30, 2013, as compared to a decrease of $50,379,000, or 10%, during the first nine months of 2012.  Checking and savings accounts increased by $667,000, money market accounts decreased by $2,851,000 and time deposits decreased by $32,542,000.  The decline in time deposits was a result of the branch sale as well as repricing maturing time deposits at rates below market for noncore depositors.  The cost of our interest-bearing deposits declined to 1.05% for the first nine months of 2013 compared to 1.29% for the first nine months of 2012.

The variety of deposit accounts that we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility to, although not to eliminate, the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities).  Our ability to attract and retain deposits, and our cost of funds, has been, and is expected to continue to be, significantly affected by money market conditions.
 
Borrowings

We utilize borrowings to supplement deposits when they are available at a lower overall cost to us or they can be invested at a positive rate of return.

As a member of the Federal Home Loan Bank of Atlanta (“FHLB”), the Bank is required to own capital stock in the FHLB and is authorized to apply for borrowings from the FHLB.  Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities.  The FHLB may prescribe the acceptable uses to which the advances may be put, as well as on the size of the advances and repayment provisions.  Borrowings from the FHLB were $18,000,000 and $28,000,000 at September 30, 2013 and December 31, 2012 respectively.  The FHLB advances are secured by the pledge of residential mortgage loans, investment securities and our FHLB stock.

 
54

 
Capital resources

Stockholders’ equity at September 30, 2013 was $21,254,000, compared to $24,965,000 at December 31, 2012.  On May 1, 2009, the Company received a $14,738,000 investment by the United States Department of the Treasury under its Capital Purchase Program (the TARP Program), pursuant to which the Company issued to the Treasury $14,738,000 of preferred stock and warrants to purchase 499,030 shares of the Company’s common stock at a purchase price of $4.43 per share. The preferred stock issued by the Company under the TARP Capital Purchase Program carries a 5% dividend until May 1, 2014, and 9% thereafter, unless the shares are redeemed by the Company.  The $(3,711,000) decrease in equity during the first nine months of 2013 was primarily due to an unrealized loss of $(3,054,000) related to a decline in the market value of available for sale investments.  This decline in the market value of available for sale securities is attributable to an increase in interest rates during the second quarter.  As of September 30, 2013, we do not have the intent to sell any of these securities and we believe that it is more likely than not that we will not have to sell these securities before a recovery of cost.  The Bank has significant resources of liquidity other than these securities that will allow us to hold them.  Additionally, the securities could be pledged to obtain loans for liquidity if needed.

During the first quarter of 2005, the Company issued $5.2 million in Trust Preferred Capital Notes to increase its regulatory capital and to help fund its expected growth in 2005.  During the third quarter of 2007, the Company issued $3.6 million in Trust Preferred Capital Notes to partially fund the construction of an 80,000 square foot building completed in 2008.  The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion.

The Company is currently prohibited by its Written Agreement with the Reserve Bank from making dividend or interest payments on the TARP program preferred stock or trust preferred capital notes without prior regulatory approval.  In addition, the Consent Order with the FDIC and BFI provides that the Bank will not pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction in capital, without regulatory approval.  At September 30, 2013, the aggregate amount of the Company’s total accrued but deferred dividend payments on TARP was $1,934,362 and the interest payments on trust preferred capital notes was $807,316.

In June 2012 as a result of the unpaid dividends, Treasury requested that an observer appointed by Treasury be allowed to attend the Company’s meetings of its board of directors.  The observer started attending board meetings commencing in August 2012.  Treasury has the contractual right to nominate up to two members to the board of directors upon the Company’s sixth deferred dividend payment.  The Company has deferred ten dividend payments as of September 30, 2013.  However, Treasury has not indicated at this time it will nominate two directors to our board.

The Company is currently evaluating potential sources of additional capital, with the objective to become compliant with the capital requirements of the Consent Order as soon as practically possible.  In addition the Company is considering various alternatives for the repayment of the preferred stock issued under the TARP Program.  However, no assurance can be given that sources of new capital will be received.

 
55

 
The following table presents the composition of regulatory capital and the capital ratios for the Company at the dates indicated (dollars in thousands).

   
September 30,
   
December 31,
 
   
2013
   
2012
 
             
Tier 1 capital
           
Preferred stock
  $ 59     $ 59  
Common stock
    17,007       17,007  
Additional paid-in capital
    40,711       40,705  
Retained earnings (deficit)
    (34,026 )     (33,174 )
Warrant Surplus
    732       732  
Discount on preferred stock
    (87 )     (199 )
Qualifying trust preferred securities
    3,024       3,306  
Less intangible assets
    (320 )     (393 )
Total equity
    27,100       28,043  
Total Tier 1 capital
    27,100       28,043  
                 
Tier 2 capital
               
Qualifying trust preferred securities
    5,740       5,458  
Allowance for loan losses
    4,285       4,795  
Total Tier 2 capital
    10,025       10,253  
                 
Total risk-based capital
    37,125       38,296  
                 
Risk-weighted assets
  $ 338,467     $ 377,572  
                 
Average assets
  $ 469,717     $ 505,046  
                 
Capital ratios
               
Leverage ratio (Tier 1 capital to
               
average assets)
    5.77 %     5.55 %
Tier 1 capital to risk-weighted assets
    8.01 %     7.43 %
Total capital to risk-weighted assets
    10.97 %     10.14 %
Equity to total assets
    4.62 %     4.89 %

 
56



The following table presents the composition of regulatory capital and the capital ratios for the Bank at the dates indicated (dollars in thousands).

   
September 30,
   
December 31,
 
   
2013
   
2012
 
             
Tier 1 capital
           
Common stock
  $ 6,849     $ 6,849  
Additional paid-in capital
    55,412       55,406  
Retained earnings (deficit)
    (28,816 )     (28,925 )
Less intangible assets
    (320 )     (393 )
Total equity
    33,125       32,937  
Total Tier 1 capital
    33,125       32,937  
                 
Tier 2 capital
               
Allowance for loan losses
    4,259       4,769  
Total Tier 2 capital
    4,259       4,769  
                 
Total risk-based capital
    37,384       37,706  
                 
Risk-weighted assets
  $ 336,348     $ 375,451  
                 
Average assets
  $ 469,673     $ 505,150  
                 
Capital ratios
               
Leverage ratio (Tier 1 capital to
               
average assets)
    7.05 %     6.52 %
Tier 1 capital to risk-weighted assets
    9.85 %     8.77 %
Total capital to risk-weighted assets
    11.11 %     10.04 %
Equity to total assets
    6.62 %     6.55 %



Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized.  The Bank met the ratio requirements to be categorized “well capitalized” institution as of September 30, 2013 and December 31, 2012.  However, due to the minimum capital ratios required by the Consent Order, the Bank currently is considered “adequately capitalized”.  The Consent Order requires the Bank to maintain a leverage ratio of at least 8% and a total capital to risk-weighted assets ratio of at least 11%.  At September 30, 2013, the Bank’s leverage ratio was 7.05% and the total capital to risk weighted assets ratio was 11.11%.  As required by the Consent Order, the Bank has provided a capital plan to the FDIC and BFI that demonstrates how the Bank will come into compliance with the required minimum capital ratios set forth in the Consent Order.  When capital falls below the “well capitalized” requirement, consequences can include: new branch approval could be withheld; more frequent examinations by the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC; and other potential limitations as described in FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section 29.  In addition, the FDIC insurance assessment increases when an institution falls below the “well capitalized” classification.

Liquidity

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities.  Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits.  Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made.  However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 
57

 
At September 30, 2013, our liquid assets, consisting of cash, cash equivalents and investment securities available for sale totaled $92,888,000, or 20% of total assets.  Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.  However, approximately $7,051,000 of these securities are pledged against borrowings.  Therefore, the related borrowings would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

Our holdings of liquid assets plus the ability to maintain and expand our deposit base and borrowing capabilities serve as our principal sources of liquidity.  We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings.  In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities.  We maintain two federal funds lines of credit with correspondent banks totaling $22 million for which there were no borrowings against the lines at September 30, 2013.

At September 30, 2013, we had commitments to originate $58,460,000 of loans.  Fixed commitments to incur capital expenditures were less than $25,000 at September 30, 2013.  Certificates of deposit scheduled to mature in the 12-month period ending September 30, 2014 totaled $87,606,000.  We believe that a significant portion of such deposits will remain with us. We further believe that deposit growth, loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs.

Interest rate sensitivity

An important element of asset/liability management is the monitoring of our sensitivity to interest rate movements.  In order to measure the effects of interest rates on our net interest income, management takes into consideration the expected cash flows from the securities and loan portfolios and the expected magnitude of the repricing of specific asset and liability categories.  We evaluate interest sensitivity risk and then formulate guidelines to manage this risk based on management’s outlook regarding the economy, forecasted interest rate movements and other business factors.  Our goal is to maximize and stabilize the net interest margin by limiting exposure to interest rate changes.

Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolio.  The average lives of mortgage loans are substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which gives us the right to declare a loan immediately due and payable in the event, among other things, the borrower sells the real property subject to the mortgage and the loan is not repaid.  In addition, certain borrowers increase their equity in the security property by making payments in excess of those required under the terms of the mortgage.

The sale of fixed rate loans is intended to protect us from precipitous changes in the general level of interest rates. The valuation of adjustable rate mortgage loans is not as directly dependent on the level of interest rates as is the value of fixed rate loans.  As with other investments, we regularly monitor the appropriateness of the level of adjustable rate mortgage loans in our portfolio and may decide from time to time to sell such loans and reinvest the proceeds in other adjustable rate investments.

 
58

 
The data in the following table reflects repricing or expected maturities of various assets and liabilities at September 30, 2013.  The gap analysis represents the difference between interest-sensitive assets and liabilities in a specific time interval.  Interest sensitivity gap analysis presents a position that existed at one particular point in time, and assumes that assets and liabilities with similar repricing characteristics will reprice at the same time and to the same degree.
 

   
Within 3
   
3 to 6
   
6 to 12
   
13 to 36
   
More than
       
   
Months
   
Months
   
Months
   
Months
   
36 Months
   
Total
 
Interest Rate Sensitive Assets
                                   
Loans (1)
                                   
Fixed rate
  $ 8,049     $ 7,147     $ 10,428     $ 18,097     $ 74,774     $ 118,495  
Variable rate
    43,205       13,752       23,883       24,500       79,167       184,507  
Investment securities
    -       -               -       59,113       59,113  
Loans held for sale
    14,527       -       -       -       -       14,527  
Federal funds sold
    20,632       -       -       -       -       20,632  
                                                 
Total rate sensitive assets
    86,413       20,899       34,311       42,597       213,054       397,274  
Cumulative rate sensitive assets
    86,413       107,312       141,623       184,220       397,274          
                                                 
Interest Rate Sensitive Liabilities
                                               
Interest checking
    -       -       -       44,546       -       44,546  
Money market accounts
    63,156       -       -       -       -       63,156  
Savings
    -       -       -       20,780       -       20,780  
Certificates of deposit
    23,268       19,506       44,832       89,914       36,422       213,942  
FHLB advances
    -       1,000       7,000       10,000       -       18,000  
Trust Preferred Securities
    -       -       -               8,764       8,764  
Other borrowings
    3,289       -       -       -       -       3,289  
                                                 
Total rate sensitive liabilities
    89,713       20,506       51,832       165,240       45,186       372,477  
Cumulative rate sensitive liabilities
    89,713       110,219       162,051       327,291       372,477          
                                                 
Rate sensitivity gap for period
  $ (3,300 )   $ 393     $ (17,521 )   $ (122,643 )   $ 167,868     $ 24,797  
Cumulative rate sensitivity gap
  $ (3,300 )   $ (2,907 )   $ (20,428 )   $ (143,071 )   $ 24,797          
                                                 
Ratio of cumulative gap to total assets
    (0.7 )%     (0.6 )%     (4.5 )%     (31.1 )%     5.4 %        
Ratio of cumulative rate sensitive
                                               
assets to cumulative rate sensitive
                                               
liabilities
    96.3 %     97.4 %     87.4 %     56.3 %     106.7 %        
Ratio of cumulative gap to cumulative
                                               
rate sensitive assets
    (3.8 )%     (2.7 )%     (14.4 )%     (77.7 )%     6.2 %        
                                                 
                                                 
                                                 
(1) Includes nonaccrual loans of approximately $22,490,000, which are spread throughout the categories.
                 

At September 30, 2013, our balance sheet is liability sensitive for the next 36 months, meaning that our liabilities reprice more quickly than our assets during that period, and assets sensitive after 36 months, meaning that our assets will reprice more quickly than our liabilities during that period, with a ratio of cumulative gap to total assets ranging from a negative gap of (0.7)% for the first three months to a negative gap of (31.1)% for thirteen to thirty six month period.  A negative gap can adversely affect earnings in periods of increasing interest rates.  Given the Federal Reserve’s recent announcement that it will maintain short-term interest rates at current levels until the end of 2014, we do not expect interest rates to increase in the foreseeable future.  However, we believe our balance sheet should be asset sensitive and, accordingly, we have adopted pricing policies to lengthen the maturities/repricing of our liabilities relative to the maturities/repricing of our assets.

 
59

 
Critical accounting policies

General

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

The more critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses, troubled debt restructurings, real estate acquired in settlement of loans, and income taxes.  The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations.

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

Allowance for loan losses

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio.  We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance:  the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables.   Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management.  The evaluations are based upon discounted expected cash flows or collateral valuations.  If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type.  A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan.  The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including:  borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 
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The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses.  This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made.  If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates.  If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses.  We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high.  If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

Troubled debt restructurings

A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider.  A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions.  Troubled debt restructurings can be in either accrual or nonaccrual status.  Nonaccrual troubled debt restructurings are included in nonperforming loans.  Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected.  Troubled debt restructurings generally remain categorized as nonperforming loans and leases until a six-month payment history has been maintained.

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans.  Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described above under Allowance for loan losses.  Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies.  Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

Real estate acquired in settlement of loans

Real estate acquired in settlement of loans represents properties acquired through foreclosure or physical possession.  Write-downs to fair value less cost to sell of foreclosed assets at the time of transfer are charged to allowance for loan losses.  Subsequent to foreclosure, the Company periodically evaluates the value of foreclosed assets held for sale and records an impairment charge for any subsequent declines in fair value less selling costs.  Subsequent declines in value are charged to operations.  Fair value is based on an assessment of information available at the end of a reporting period and depends upon a number of factors, including historical experience, economic conditions, and issues specific to individual properties.  The evaluation of these factors involves subjective estimates and judgments that may change.

 
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Income taxes

The Company uses the asset and liability method of accounting for income taxes.  Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established.  Management considers the determination of this valuation allowance to be a critical accounting policy due to the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income.  These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.  A valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, or if management projects lower levels of future taxable income.  Management determined that as of December 31, 2012 and September 30, 2013, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance of $10,158,000 and $10,190,000, respectively, representing all the net deferred tax asset that is dependent on future earnings of the Company at the indicated date.

New accounting standards

In February 2013, the Financial Accounting Standards Board (FASB) issued ASU 2013-02, Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income, which is intended to improve the reporting of reclassifications out of accumulated other comprehensive income. The ASU requires an entity to report, either on the face of the income statement or in the notes to the financial statements, the effect of significant reclassifications out of accumulated other comprehensive income on the respective line items in the income statement if the amount being reclassified is required to be reclassified in its entirety to net income. For other amounts that are not required to be reclassified in their entirety to net income in the same reporting period, an entity is required to cross-reference other required disclosures that provide additional detail about those amounts. This ASU is effective prospectively in the first quarter of 2013. The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

Impact of inflation and changing prices

The Company’s consolidated financial statements included herein have been prepared in accordance with generally accepted accounting principles in the United States, which require the Company to measure financial position and operating results primarily in terms of historical dollars.  Changes in the relative value of money due to inflation or recession are generally not considered.  The primary effect of inflation on the operations of the Company is reflected in increased operating costs.  In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate.  While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate.  Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.



 
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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not Applicable.


ITEM 4 – CONTROLS AND PROCEDURES

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of June 30, 2013.  Based on that evaluation, management concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2013 in ensuring that all material information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed summarized and reported with the time periods specified in SEC rules and regulations and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act.  There were no changes in our internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 
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PART II – OTHER INFORMATION


ITEM 1 – LEGAL PROCEEDINGS

Not applicable.

ITEM 1A. – RISK FACTORS

There were no material changes to the Company’s risk factors as disclosed in its Annual Report on Form 10-K for the year ended December 31, 2012.

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

Not applicable.
 
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

In consideration of our agreements with our regulators, which require regulatory approval to make dividend payments on our preferred stock, the Company notified the U.S. Treasury in May 2011 that the Company was going to defer the payment of the quarterly cash dividend of $184,225 due on May 16, 2011, and subsequent quarterly payments, on the Preferred Stock.  The total arrearage on such preferred stock as of September 30, 2013 was $1,934,362.
 
ITEM 4 – MINE SAFETY DISCOLOSURES

None

ITEM 5 – OTHER INFORMATION

Not applicable.
 
ITEM 6 – EXHIBITS
 
  10.1
Employment Agreement, dated August 8, 2013, by and between the Company and William G. Foster, Jr. (included as Exhibit 10.1 to the Current Report in Form 8-K filed August 19, 2013 and incorporated by reference herein).
     
  10.2
Employment Agreement, dated August 9, 2013, by and between the Company and Thomas W. Winfree (included as Exhibit 10.2 to the Current Report on Form 8-K filed August 19, 2013 and incorporated by reference herein).
     
 
31.1
Certification of Chief Executive Officer
     
 
31.2
Certification of Chief Financial Officer
     
 
32.1
Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
     
 
101
The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Stockholders' Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements


 
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SIGNATURES

In accordance with 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.


     
VILLAGE BANK AND TRUST FINANCIAL CORP.
       
(Registrant)
           
           
Date:
November 26, 2013
 
By:
/s/ Thomas W. Winfree
 
       
Thomas W. Winfree
 
       
President and
 
       
Chief Executive Officer
 
           
           
Date:
November 26, 2013
 
By:
/s/ C. Harril Whitehurst, Jr.
 
       
C. Harril Whitehurst, Jr.
 
       
Senior Vice President and
 
       
Chief Financial Officer
 



 
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Exhibit Index


Exhibit
 
Number
Document
   
10.1
Employment Agreement, dated August 8, 2013, by and between the Company and William G. Foster, Jr. (included as Exhibit 10.1 to the Current Report in Form 8-K filed August 19, 2013 and incorporated by reference herein).
   
10.2
Employment Agreement, dated August 9, 2013, by and between the Company and Thomas W. Winfree (included as Exhibit 10.2 to the Current Report on Form 8-K filed August 19, 2013 and incorporated by reference herein).
   
31.1
Certification of Chief Executive Officer
   
31.2
Certification of Chief Financial Officer
   
32.1
Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
   
101
The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Stockholders' Equity, (iv) Consolidated Statements of Cash Flows, and (v) Notes to Condensed Consolidated Financial Statements.