Eastern Virginia Bankshares (EVBS) 10-Q 2013 Q3 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

x          QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2013

or

¨           TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission File Number: 000-23565

EASTERN VIRGINIA BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA	54-1866052
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

330 Hospital Road, Tappahannock, Virginia	22560
(Address of principal executive offices)	(Zip Code)

(804) 443-8400

(Registrant’s telephone number, including area code)

N/A

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.Yes xNo ¨

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 x 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 a 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

The number of shares of the registrant’s Common Stock outstanding as of November 12, 2013 was 11,824,367.

EASTERN VIRGINIA BANKSHARES, INC.

INDEX

PART I.	FINANCIAL INFORMATION
Item 1.	Financial Statements
	Consolidated Balance Sheets as of September 30, 2013 (unaudited) and December 31, 2012	2
	Consolidated Statements of Operations (unaudited) for the Three Months Ended September 30, 2013 and September 30, 2012	3
	Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Three Months Ended September 30, 2013 and September 30, 2012	4
	Consolidated Statements of Operations (unaudited) for the Nine Months Ended September 30, 2013 and September 30, 2012	5
	Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Nine Months Ended September 30, 2013 and September 30, 2012	6
	Consolidated Statements of Shareholders’ Equity (unaudited) for the Nine Months Ended September 30, 2013 and September 30, 2012	7
	Consolidated Statements of Cash Flows (unaudited) for the Nine Months Ended September 30, 2013 and September 30, 2012	8
	Notes to the Interim Consolidated Financial Statements (unaudited)	9
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	69
Item 4.	Controls and Procedures	69
PART II.	OTHER INFORMATION
Item 1.	Legal Proceedings	69
Item 1A.	Risk Factors	69
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	72
Item 3.	Defaults Upon Senior Securities	72
Item 4.	Mine Safety Disclosures	72
Item 5.	Other Information	72
Item 6.	Exhibits	73
	SIGNATURES	74

1

 

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollars in thousands, except share and per share amounts)

	September 30,  2013		December 31,  2012
	(unaudited)
Assets:
Cash and due from banks	$	13,460	$	16,687
Interest bearing deposits with banks		5,205		29,837
Federal funds sold		195		75
Securities available for sale, at fair value		269,456		276,913
Restricted securities, at cost		6,150		9,251
Loans, net of allowance for loan losses of $16,894 and $20,338, respectively		645,731		664,330
Deferred income taxes, net		18,814		10,687
Bank premises and equipment, net		21,528		21,656
Accrued interest receivable		4,114		4,223
Other real estate owned, net of valuation allowance of $485 and $811, respectively		1,203		4,747
Goodwill		15,970		15,970
Other assets		31,231		21,177
Total assets	$	1,033,057	$	1,075,553
Liabilities and Shareholders' Equity:
Liabilities
Noninterest-bearing demand accounts	$	136,835	$	116,717
Interest-bearing deposits		690,182		721,656
Total deposits		827,017		838,373
Federal funds purchased and repurchase agreements		3,770		2,942
Short-term borrowings		55,289		-
Long-term borrowings		-		117,500
Trust preferred debt		10,310		10,310
Accrued interest payable		1,253		1,673
Other liabilities		4,785		5,044
Total liabilities		902,424		975,842
Shareholders' Equity
Preferred stock, $2 par value per share, authorized 10,000,000 shares, issued and outstanding:
Series A; $1,000 stated value per share, 24,000 shares fixed rate cumulative perpetual preferred		24,000		24,000
Series B; 5,240,192 shares non-voting mandatorily convertible non-cumulative preferred		10,480		-
Common stock, $2 par value per share, authorized 50,000,000 shares, issued      and outstanding 11,824,367 and 6,069,551 including 38,700 and 39,400      nonvested shares in 2013 and 2012, respectively		23,571		12,060
Surplus		42,746		19,521
Retained earnings		37,396		42,517
Warrant		1,481		1,481
Discount on preferred stock		(76)		(304)
Accumulated other comprehensive (loss) income, net		(8,965)		436
Total shareholders' equity		130,633		99,711
Total liabilities and shareholders' equity	$	1,033,057	$	1,075,553

The accompanying notes are an integral part of the consolidated financial statements.

2

 

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Operations (unaudited)

(dollars in thousands, except per share amounts)

	Three Months Ended
	September 30,
	2013		2012
Interest and Dividend Income
Interest and fees on loans	$	8,926	$	9,988
Interest on investments:
Taxable interest income		1,296		1,140
Tax exempt interest income		212		23
Dividends		83		72
Interest on deposits with banks		35		6
Total interest and dividend income		10,552		11,229
Interest Expense
Deposits		1,118		1,520
Federal funds purchased and repurchase agreements		5		10
Short-term borrowings		12		1
Long-term borrowings		597		1,200
Trust preferred debt		89		91
Total interest expense		1,821		2,822
Net interest income		8,731		8,407
Provision for Loan Losses		350		625
Net interest income after provision for loan losses		8,381		7,782
Noninterest Income
Service charges and fees on deposit accounts		847		815
Debit/credit card fees		391		463
Gain on sale of available for sale securities, net		-		135
Gain (loss) on sale of bank premises and equipment		223		(1)
Gain on sale of loans		-		197
Other operating income		334		275
Total noninterest income		1,795		1,884
Noninterest Expenses
Salaries and employee benefits		4,418		3,910
Occupancy and equipment expenses		1,333		1,273
Telephone		293		242
FDIC expense		225		586
Consultant fees		268		229
Collection, repossession and other real estate owned		195		190
Marketing and advertising		132		145
Loss (gain) on sale of other real estate owned		668		(12)
Impairment losses on other real estate owned		437		769
Loss on extinguishment of debt		11,453		-
Other operating expenses		1,133		1,204
Total noninterest expenses		20,555		8,536
Income (loss) before income taxes		(10,379)		1,130
Income Tax Expense (Benefit)		(3,733)		269
Net Income (Loss)	$	(6,646)	$	861
Effective dividend on Series A Preferred Stock		376		375
Net income (loss) available to common shareholders	$	(7,022)	$	486
Income (loss) per common share: basic	$	(0.60)	$	0.08
Income (loss) per common share: diluted	$	(0.60)	$	0.08
Dividends paid per share, common	$	-	$	-

The accompanying notes are an integral part of the consolidated financial statements.

3

 

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) (unaudited)

(dollars in thousands)

	Three Months Ended
	September 30,
	2013		2012
Net income (loss)	$	(6,646)	$	861
Other comprehensive (loss), net of tax:
Unrealized securities (losses) gains arising during period (net of tax,     $1,473 and $38, respectively)		(2,858)		73
Less: reclassification adjustment for securities gains included in net income     (loss) (net of tax, $0 and $46, respectively)		-		(89)
Other comprehensive (loss)		(2,858)		(16)
Comprehensive (loss) income	$	(9,504)	$	845

The accompanying notes are an integral part of the consolidated financial statements.

4

 

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Operations (unaudited)

(dollars in thousands, except per share amounts)

	Nine Months Ended
	September 30,
	2013		2012
Interest and Dividend Income
Interest and fees on loans	$	26,934	$	30,091
Interest on investments:
Taxable interest income		4,025		3,274
Tax exempt interest income		451		434
Dividends		252		228
Interest on deposits with banks		100		32
Total interest and dividend income		31,762		34,059
Interest Expense
Deposits		3,618		5,041
Federal funds purchased and repurchase agreements		15		23
Short-term borrowings		12		1
Long-term borrowings		2,958		3,575
Trust preferred debt		263		271
Total interest expense		6,866		8,911
Net interest income		24,896		25,148
Provision for Loan Losses		1,550		4,783
Net interest income after provision for loan losses		23,346		20,365
Noninterest Income
Service charges and fees on deposit accounts		2,342		2,374
Debit/credit card fees		1,099		1,143
Gain on sale of available for sale securities, net		525		3,498
Gain (loss) on sale of bank premises and equipment		249		(1)
Gain on sale of loans		-		197
Other operating income		978		762
Total noninterest income		5,193		7,973
Noninterest Expenses
Salaries and employee benefits		12,713		11,624
Occupancy and equipment expenses		3,860		3,784
Telephone		858		818
FDIC expense		1,408		1,761
Consultant fees		697		615
Collection, repossession and other real estate owned		447		845
Marketing and advertising		612		566
Loss on sale of other real estate owned		823		105
Impairment losses on other real estate owned		580		1,676
Loss on extinguishment of debt		11,453		-
Other operating expenses		3,265		3,417
Total noninterest expenses		36,716		25,211
Income (loss) before income taxes		(8,177)		3,127
Income Tax Expense (Benefit)		(3,284)		604
Net Income (Loss)	$	(4,893)	$	2,523
Effective dividend on Series A Preferred Stock		1,128		1,125
Net income (loss) available to common shareholders	$	(6,021)	$	1,398
Income (loss) per common share: basic	$	(0.72)	$	0.23
Income (loss) per common share: diluted	$	(0.72)	$	0.23
Dividends paid per share, common	$	-	$	-

The accompanying notes are an integral part of the consolidated financial statements.

5

 

Eastern Virginia Bankshares, Inc. and Subsidiaries 

Consolidated Statements of Comprehensive Income (Loss) (unaudited) 

(dollars in thousands)

	Nine Months Ended
	September 30,
	2013		2012
Net income (loss)	$	(4,893)	$	2,523
Other comprehensive income (loss), net of tax:
Unrealized securities (losses) gains arising during      period (net of tax, $4,665 and $1,222, respectively)		(9,055)		2,374
Less: reclassification adjustment for securities gains      included in net income (loss) (net of tax, $179 and $1,189, respectively)		(346)		(2,309)
Other comprehensive (loss) income		(9,401)		65
Comprehensive (loss) income	$	(14,294)	$	2,588

The accompanying notes are an integral part of the consolidated financial statements.

6

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity (unaudited) 

For the Nine Months Ended September 30, 2013 and 2012 

(dollars in thousands)

											Accumulated
			Preferred		Preferred						Other
	Common		Stock		Stock				Retained		Comprehensive
	Stock		Series A (1)		Series B		Surplus		Earnings		Income (Loss)		Total
Balance, December 31, 2011	$	12,022	$	24,877	$	-	$	19,446	$	39,365	$	(587)	$	95,123
Net income for the nine months ended      September 30, 2012										2,523				2,523
Other comprehensive income												65		65
Preferred stock discount				225						(225)				-
Stock based compensation								46						46
Director stock grant		12						11						23
Restricted common stock vested		1						(1)						-
Issuance of common stock under dividend      reinvestment and employee stock plans		23		-		-		14		-		-		37
Balance, September 30, 2012	$	12,058	$	25,102	$	-	$	19,516	$	41,663	$	(522)	$	97,817
Balance, December 31, 2012	$	12,060	$	25,177	$	-	$	19,521	$	42,517	$	436	$	99,711
Net (loss) for the nine months ended      September 30, 2013										(4,893)				(4,893)
Other comprehensive (loss)												(9,401)		(9,401)
Preferred stock discount				228						(228)				-
Stock based compensation								21						21
Director stock grant		12						20						32
Restricted common stock vested		1						(1)						-
Issuance of common stock in private      placements and rights offering		11,498						12,105						23,603
Issuance of preferred stock in private      placements		-		-		10,480		11,080		-		-		21,560
Balance, September 30, 2013	$	23,571	$	25,405	$	10,480	$	42,746	$	37,396	$	(8,965)	$	130,633

(1) For the purposes of this table, Preferred Stock Series A includes the effect of the warrant issued in connection with the sale of the Series A Preferred Stock and the discount on such preferred stock. 

The accompanying notes are an integral part of the consolidated financial statements.

7

 

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

(dollars in thousands)

	Nine Months Ended
	September 30,
	2013		2012
Operating Activities:
Net (loss) income	$	(4,893)	$	2,523
Adjustments to reconcile net (loss) income to net cash (used in) provided by      operating activities:
Provision for loan losses		1,550		4,783
Depreciation and amortization		1,566		1,583
Stock based compensation		21		46
Net amortization of premiums and accretion of      discounts on securities available for sale, net		3,246		3,797
(Gain) realized on securities available for sale transactions, net		(525)		(3,498)
(Gain) on sale of loans		-		(197)
(Gain) loss on sale of bank premises and equipment		(249)		1
Loss on sale of other real estate owned		823		105
Impairment losses on other real estate owned		580		1,676
Loss on LLC investments		66		115
Deferred income taxes		(3,283)		680
Net change in:
Accrued interest receivable		109		(637)
Other assets		(120)		1,658
Accrued interest payable		(420)		127
Other liabilities		(259)		1,058
Net cash (used in) provided by operating activities		(1,788)		13,820
Investing Activities:
Purchase of securities available for sale		(63,708)		(211,122)
Purchase of restricted securities		(1,343)		(325)
Purchases of bank premises and equipment		(1,485)		(1,825)
Purchases of bank owned life insurance		(10,000)		-
Net change in loans		15,374		17,035
Proceeds from:
Maturities, calls, and paydowns of securities available for sale		21,806		43,021
Sales of securities available for sale		32,393		158,627
Sale of restricted securities		4,444		512
Sale of loans		-		3,046
Sale of bank premises and equipment		296		3
Sale of other real estate owned		3,816		3,676
Net cash provided by investing activities		1,593		12,648
Financing Activities:
Net change in:
Demand, interest-bearing demand and savings deposits		10,938		9,655
Time deposits		(22,294)		(20,317)
Federal funds purchased and repurchase agreements		828		1,519
Short-term borrowings		55,289		-
Long-term borrowings		(117,500)		-
Issuance of common stock under dividend reinvestment      and employee stock plans		-		37
Director stock grant		32		23
Net proceeds from issuance of common stock in private placements      and rights offering		23,603		-
Net proceeds from issuance of preferred stock in private placements		21,560		-
Net cash used in financing activities		(27,544)		(9,083)
Net (decrease) increase in cash and cash equivalents		(27,739)		17,385
Cash and cash equivalents, January 1		46,599		24,566
Cash and cash equivalents, September 30	$	18,860	$	41,951
Supplemental disclosure:
Interest paid	$	7,286	$	8,874
Supplemental disclosure of noncash investing and financing activities:
Unrealized (losses) gains on securities available for sale	$	(14,245)	$	98
Loans transferred to other real estate owned	$	(1,675)	$	(4,708)

The accompanying notes are an integral part of the consolidated financial statements.

8

 

EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES

Notes to the Interim Consolidated Financial Statements

(unaudited)

Note 1. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying unaudited consolidated financial statements of Eastern Virginia Bankshares, Inc. (the “Parent”) and its subsidiaries, EVB Statutory Trust I (the “Trust”), and EVB (the “Bank”) and its subsidiaries, are in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results that may be expected for the year ending December 31, 2013. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012 (the “2012 Form 10-K”).

The accompanying unaudited consolidated financial statements include the accounts of the Parent, the Bank and its subsidiaries, collectively referred to as “the Company.” All significant intercompany balances and transactions have been eliminated in consolidation. In addition, the Parent owns the Trust which is an unconsolidated subsidiary. The subordinated debt owed to this trust is reported as a liability of the Parent.

Nature of Operations

Eastern Virginia Bankshares, Inc. is a bank holding company headquartered in Tappahannock, Virginia that was organized and chartered under the laws of the Commonwealth of Virginia on September 5, 1997 and commenced operations on December 29, 1997. The Company conducts its primary operations through its wholly-owned bank subsidiary, EVB. Two of EVB’s three predecessor banks, Bank of Northumberland, Inc. and Southside Bank, were established in 1910. The third bank, Hanover Bank, was established as a de novo bank in 2000. In April 2006, these three banks were merged and the surviving bank was re-branded as EVB. The Bank provides a full range of banking and related financial services to individuals and businesses through its network of retail branches. With twenty-two retail branches, the Bank serves diverse markets that primarily are in the counties of Essex, Gloucester, Hanover, Henrico, King and Queen, King William, Lancaster, Middlesex, New Kent, Richmond, Northumberland, Southampton, Surry, Sussex and the City of Colonial Heights. On October 18, 2013, the Bank closed its Old Church branch located in Hanover County. The decision to close this branch was due to declining branch activity and an absence of community or business initiatives for economic expansion in or around the area in the near future. Customers of the branch received notification of the planned branch closure on or around July 15, 2013. The Bank operates under a state bank charter and as such is subject to regulation by the Virginia State Corporation Commission-Bureau of Financial Institutions (the “Bureau”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”).

The Bank owns EVB Financial Services, Inc., which in turn has a 100% ownership interest in EVB Investments, Inc. and through March 31, 2011 a 50% ownership interest in EVB Mortgage, LLC. EVB Investments, Inc. is a full-service brokerage firm offering a comprehensive range of investment services. EVB Mortgage, LLC was formed to originate and sell residential mortgages. Due to the uncertainties surrounding potential regulatory pressures regarding the origination and funding of mortgage loans on one to four family residences, the Company decided in March 2011 to cease the operations of EVB Mortgage, LLC as a joint venture with Southern Trust Mortgage, LLC. On April 1, 2011, the Company entered into an independent contractor agreement with Southern Trust Mortgage, LLC. Under the terms of this agreement, the Company will advise and consult with Southern Trust Mortgage, LLC and facilitate the marketing and brand recognition of their mortgage business. In addition, the Company will provide Southern Trust Mortgage, LLC with offices at five retail branches in the Company’s market area and access to office equipment at these locations during normal work hours. For its services, the Company shall receive fixed monthly compensation from Southern Trust Mortgage, LLC in the amount of $1 thousand, which is adjustable on a quarterly basis going forward. The Bank has a 75% ownership interest in EVB Title, LLC, which primarily sells title insurance to the mortgage loan customers of the Bank and EVB Mortgage, LLC. The Bank has a 2.33% ownership in Bankers Insurance, LLC, which primarily sells insurance products to customers of the Bank, and other financial institutions that have an equity interest in the agency. The Bank also has a 100% ownership interest in Dunston Hall LLC, POS LLC, Tartan Holdings LLC and ECU-RE LLC which were formed to hold the title to real estate acquired by the Bank upon foreclosure on property of real estate secured loans. The financial position and operating results of all of these subsidiaries are not significant to the Company as a whole and are not considered principal activities of the Company at this time. The Company’s stock trades on the NASDAQ Global Select Market under the symbol “EVBS.”

9

Basis of Presentation

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, impairment of loans, impairment of securities, the valuation of other real estate owned, the projected benefit obligation under the defined benefit pension plan, the valuation of deferred taxes, goodwill impairment and fair value of financial instruments. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these interim financial statements, have been made. Certain prior year amounts have been reclassified to conform to the 2013 presentation. These reclassifications have no effect on previously reported net income.

Recent Accounting Pronouncements

In December 2011, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, “Derivatives and Hedging,” including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company has included the required disclosures from ASU 2013-02 in the consolidated financial statements.

10

In July 2013, the FASB issued ASU 2013-10, “Derivatives and Hedging (Topic 815): Inclusion of the Fed Funds Effective Swap Rate (or Overnight Index Swap Rate) as a Benchmark Interest Rate for Hedge Accounting Purposes.” The amendments in this ASU permit the Fed Funds Effective Swap Rate (also referred to as the Overnight Index Swap Rate) to be used as a U.S. benchmark interest rate for hedge accounting purposes under Topic 815, in addition to interest rates on direct Treasury obligations of the U.S. government and the London Interbank Offered Rate. The amendments also remove the restriction on using different benchmark rates for similar hedges. The amendments apply to all entities that elect to apply hedge accounting of the benchmark interest rate under Topic 815. The amendments are effective prospectively for qualifying new or redesignated hedging relationships entered into on or after July 17, 2013. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

In July 2013, the FASB issued ASU 2013-11, “Income Taxes (Topic 740): Presentation of an Unrecognized Tax Benefit When a Net Operating Loss Carryforward, a Similar Tax Loss, or a Tax Credit Carryforward Exists.” The amendments in this Update provide guidance on the financial statement presentation of an unrecognized tax benefit when a net operating loss carryforward, similar tax loss, or tax credit carryforward exists. An unrecognized tax benefit, or a portion of an unrecognized tax benefit, should be presented in the financial statements as a reduction to a deferred tax asset for a net operating loss carryforward, a similar tax loss, or a tax credit carryforward, except as follows. To the extent a net operating loss carryforward, a similar tax loss, or a tax credit carryforward is not available at the reporting date under the tax law of the applicable jurisdiction to settle any additional income taxes that would result from the disallowance of a tax position or the tax law of the applicable jurisdiction does not require the entity to use, and the entity does not intend to use, the deferred tax asset for such purpose, the unrecognized tax benefit should be presented in the financial statements as a liability and should not be combined with deferred tax assets. The amendments in this ASU are effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted. The amendments should be applied prospectively to all unrecognized tax benefits that exist at the effective date. Retrospective application is permitted. The Company anticipates that adoption of the new guidance will not have a material impact on its consolidated financial statements.

Note 2. Investment Securities

The amortized cost and estimated fair value, with gross unrealized gains and losses, of securities at September 30, 2013 and December 31, 2012 were as follows:

(dollars in thousands)	September 30, 2013
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
Available for Sale:	Cost		Gains		Losses		Value
Obligations of U.S. Government agencies	$	14,989	$	-	$	1,361	$	13,628
SBA Pool securities		95,498		200		3,513		92,185
Agency mortgage-backed securities		29,458		121		805		28,774
Agency CMO securities		54,925		96		1,703		53,318
Non agency CMO securities		1,454		3		1		1,456
State and political subdivisions		83,915		208		5,685		78,438
Pooled trust preferred securities		470		280		-		750
FNMA and FHLMC preferred stock		77		830		-		907
Total	$	280,786	$	1,738	$	13,068	$	269,456

11

(dollars in thousands)	December 31, 2012
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
Available for Sale:	Cost		Gains		Losses		Value
Obligations of U.S. Government agencies	$	13,495	$	10	$	38	$	13,467
SBA Pool securities		81,500		1,515		264		82,751
Agency mortgage-backed securities		31,384		349		19		31,714
Agency CMO securities		61,710		583		357		61,936
Non agency CMO securities		2,200		1		2		2,199
State and political subdivisions		82,536		1,229		548		83,217
Pooled trust preferred securities		506		253		-		759
FNMA and FHLMC preferred stock		77		199		-		276
Corporate securities		590		4		-		594
Total	$	273,998	$	4,143	$	1,228	$	276,913

There are no securities classified as “Held to Maturity” or “Trading” at September 30, 2013 or December 31, 2012. The Company’s mortgage-backed securities consist entirely of residential mortgage-backed securities. The Company does not hold any commercial mortgage-backed securities. The Company’s mortgage-backed securities are all agency backed and rated Aaa and AA+ by Moody and S&P, respectively, with no subprime issues.

The Company’s pooled trust preferred securities include one senior issue of Preferred Term Securities XXVII which is current on all payments and on which the Company took an impairment charge in the third quarter of 2009 to reduce the Company’s book value to the market value at September 30, 2009. As of September 30, 2013, that security has an estimated fair value that is $280 thousand greater than its amortized cost after impairment. During the second quarter of 2010, the Company recognized an impairment charge in the amount of $77 thousand on the Company’s investment in Preferred Term Securities XXIII mezzanine tranche, thus reducing the book value of this investment to $0. The decision to recognize the other-than-temporary impairment was based upon an analysis of the market value of the discounted cash flow for the security as provided by Moody’s at June 30, 2010, which indicated that the Company was unlikely to recover any of its remaining investment in these securities.

The amortized cost and estimated fair values of securities at September 30, 2013, by the earlier of contractual maturity or expected maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties. 

	September 30, 2013
(dollars in thousands)	Amortized Cost		Estimated Fair Value
Due in one year or less	$	5,472	$	5,045
Due after one year through five years		63,020		62,122
Due after five years through ten years		192,924		182,274
Due after ten years		19,370		20,015
Total	$	280,786	$	269,456

Proceeds from the sales of securities available for sale for the nine months ended September 30, 2013 and 2012 were $32.4 million and $158.6 million, respectively. Net realized gains on the sales of securities available for sale for the nine months ended September 30, 2013 and 2012 were $525 thousand and $3.5 million, respectively. Proceeds from maturities, calls and paydowns of securities available for sale for the nine months ended September 30, 2013 and 2012 were $21.8 million and $43.0 million, respectively.

The Company pledges securities to secure public deposits, balances with the Federal Reserve Bank and repurchase agreements. Securities with an aggregate book value of $64.5 million and an aggregate fair value of $62.4 million were pledged at September 30, 2013. Securities with an aggregate book value of $104.3 million and an aggregate fair value of $105.8 million were pledged at December 31, 2012.

12

Securities in an unrealized loss position at September 30, 2013, by duration of the period of the unrealized loss, are shown below:

	September 30, 2013
(dollars in thousands)	Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
Obligations of U.S. Government agencies	$	12,260	$	1,231	$	1,368	$	130	$	13,628	$	1,361
SBA Pool securities		73,595		3,212		5,458		301		79,053		3,513
Agency mortgage-backed securities		20,676		805		-		-		20,676		805
Agency CMO securities		33,353		1,566		4,141		137		37,494		1,703
Non agency CMO securities		71		1		-		-		71		1
State and political subdivisions		66,500		4,993		6,236		692		72,736		5,685
Total	$	206,455	$	11,808	$	17,203	$	1,260	$	223,658	$	13,068

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment that may result due to adverse economic conditions and associated credit deterioration. A determination as to whether a security’s decline in market value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors the Company may consider in the other-than-temporary impairment analysis include the length of time the security has been in an unrealized loss position, changes in security ratings, financial condition of the issuer, as well as security and industry specific economic conditions. In addition, the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds, and the value of any underlying collateral. For certain securities in unrealized loss positions, the Company will enlist independent third-party firms to prepare cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

Based on the Company’s evaluation, management does not believe any unrealized loss at September 30, 2013, represents an other-than-temporary impairment as these unrealized losses are primarily attributable to current financial market conditions for these types of investments, particularly changes in interest rates, which rose between December 31, 2012 and September 30, 2013 causing bond prices to decline, and are not attributable to credit deterioration. At September 30, 2013, there are 180 debt securities with fair values totaling $223.7 million considered temporarily impaired. Of these debt securities, 163 with fair values totaling $206.5 million were in an unrealized loss position of less than 12 months and 17 with fair values totaling $17.2 million were in an unrealized loss position of 12 months or more. Because the Company intends to hold these investments in debt securities until recovery of the amortized cost basis and it is more likely than not that the Company will not be required to sell these investments before a recovery of unrealized losses, the Company does not consider these investments to be other-than-temporarily impaired at September 30, 2013 and no impairment has been recognized. At September 30, 2013, there are no equity securities in an unrealized loss position.

Securities in an unrealized loss position at December 31, 2012, by duration of the period of the unrealized loss, are shown below.

	December 31, 2012
(dollars in thousands)	Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
Obligations of U.S. Government agencies	$	8,957	$	38	$	-	$	-	$	8,957	$	38
SBA Pool securities		16,782		264		-		-		16,782		264
Agency mortgage-backed securities		4,268		19		-		-		4,268		19
Agency CMO securities		21,767		357		-		-		21,767		357
Non agency CMO securities		750		2		-		-		750		2
State and political subdivisions		27,241		548		-		-		27,241		548
Total	$	79,765	$	1,228	$	-	$	-	$	79,765	$	1,228

As of December 31, 2012, there were no corporate securities in an unrealized loss position.

13

 

The table below presents a roll forward of the credit loss component recognized in earnings (referred to as “credit-impaired debt securities”) on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income during 2009. Changes in the credit loss component of credit-impaired debt securities were:

	Nine Months Ending
(dollars in thousands)	September 30, 2013
Balance, beginning of period	$	339
Additions
Initial credit impairments		-
Subsequent credit impairments		-
Reductions
Subsequent chargeoff of previously impaired credits		-
Balance, end of period	$	339

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $3.8 million and $6.9 million at September 30, 2013 and December 31, 2012, respectively. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Because the FHLB generated positive net income for each quarterly period beginning January 1, 2010, and ending September 30, 2013, the Company does not consider this investment to be other-than-temporarily impaired at September 30, 2013 and no impairment has been recognized. FHLB stock is included in a separate line item on the consolidated balance sheets (Restricted securities, at cost) and is not part of the Company’s securities available for sale portfolio.

14

 

Note 3. Loan Portfolio

The following table sets forth the composition of the Company’s loan portfolio in dollar amounts and as a percentage of the Company’s total gross loans at the dates indicated:

	September 30, 2013					December 31, 2012
(dollars in thousands)	Amount		Percent			Amount		Percent
Commercial, industrial and agricultural	$	48,343		7.30	%	$	51,881		7.58	%
Real estate - one to four family residential:
Closed end first and seconds		224,724		33.91	%		239,002		34.91	%
Home equity lines		98,569		14.88	%		99,698		14.56	%
Total real estate - one to four family residential		323,293		48.79	%		338,700		49.47	%
Real estate - multifamily residential		18,225		2.75	%		15,801		2.31	%
Real estate - construction:
One to four family residential		16,699		2.52	%		20,232		2.96	%
Other construction, land development and other land		21,842		3.30	%		34,555		5.04	%
Total real estate - construction		38,541		5.82	%		54,787		8.00	%
Real estate - farmland		8,043		1.21	%		8,558		1.25	%
Real estate - non-farm, non-residential:
Owner occupied		128,800		19.44	%		119,824		17.50	%
Non-owner occupied		76,661		11.57	%		71,741		10.48	%
Total real estate - non-farm, non-residential		205,461		31.01	%		191,565		27.98	%
Consumer		17,766		2.67	%		20,173		2.94	%
Other		2,953		0.45	%		3,203		0.47	%
Total loans		662,625		100.00	%		684,668		100.00	%
Less allowance for loan losses		(16,894)					(20,338)
Loans, net	$	645,731				$	664,330

The following table presents the aging of the recorded investment in past due loans as of September 30, 2013 by class of loans:

(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Total Current*		Total Loans
Commercial, industrial and agricultural	$	657	$	92	$	172	$	921	$	47,422	$	48,343
Real estate - one to four family residential:
Closed end first and seconds		6,929		906		1,511		9,346		215,378		224,724
Home equity lines		498		200		361		1,059		97,510		98,569
Total real estate - one to four family residential		7,427		1,106		1,872		10,405		312,888		323,293
Real estate - multifamily residential		-		-		-		-		18,225		18,225
Real estate - construction:
One to four family residential		223		-		292		515		16,184		16,699
Other construction, land development and other land		17		-		227		244		21,598		21,842
Total real estate - construction		240		-		519		759		37,782		38,541
Real estate - farmland		-		133		457		590		7,453		8,043
Real estate - non-farm, non-residential:
Owner occupied		175		3,555		247		3,977		124,823		128,800
Non-owner occupied		-		-		203		203		76,458		76,661
Total real estate - non-farm, non-residential		175		3,555		450		4,180		201,281		205,461
Consumer		376		3		103		482		17,284		17,766
Other		8		-		-		8		2,945		2,953
Total loans	$	8,883	$	4,889	$	3,573	$	17,345	$	645,280	$	662,625

* For purposes of this table only, the "Total Current" column includes loans that are 1-29 days past due.

15

The following table presents the aging of the recorded investment in past due loans as of December 31, 2012 by class of loans:

(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Total Current*		Total  Loans
Commercial, industrial and agricultural	$	352	$	253	$	187	$	792	$	51,089	$	51,881
Real estate - one to four family residential:
Closed end first and seconds		6,169		870		3,904		10,943		228,059		239,002
Home equity lines		604		239		195		1,038		98,660		99,698
Total real estate - one to four family residential		6,773		1,109		4,099		11,981		326,719		338,700
Real estate - multifamily residential		-		-		-		-		15,801		15,801
Real estate - construction:
One to four family residential		164		11		706		881		19,351		20,232
Other construction, land development and other land		23		-		439		462		34,093		34,555
Total real estate - construction		187		11		1,145		1,343		53,444		54,787
Real estate - farmland		-		-		40		40		8,518		8,558
Real estate - non-farm, non-residential:
Owner occupied		619		-		1,177		1,796		118,028		119,824
Non-owner occupied		395		-		855		1,250		70,491		71,741
Total real estate - non-farm, non-residential		1,014		-		2,032		3,046		188,519		191,565
Consumer		328		9		138		475		19,698		20,173
Other		21		-		-		21		3,182		3,203
Total loans	$	8,675	$	1,382	$	7,641	$	17,698	$	666,970	$	684,668

* For purposes of this table only, the "Total Current" column includes loans that are 1-29 days past due.

The following table presents nonaccrual loans, loans past due 90 days and accruing interest, and restructured loans at the dates indicated:

	September 30,		December 31,
(dollars in thousands)	2013		2012
Nonaccrual loans	$	6,352	$	11,874
Loans past due 90 days and accruing interest		-		-
Restructured loans (accruing)		2,767		4,433

At September 30, 2013 and December 31, 2012, there were approximately $2.6 million and $5.1 million, respectively, in troubled debt restructurings (“TDRs”) included in nonaccrual loans.

16

 

The following table presents the recorded investment in nonaccrual loans by class at September 30, 2013 and December 31, 2012:

	Nonaccrual
	September 30,		December 31,
(dollars in thousands)	2013		2012
Commercial, industrial and agricultural	$	172	$	391
Real estate - one to four family residential:
Closed end first and seconds		3,915		6,127
Home equity lines		536		445
Total real estate - one to four family residential		4,451		6,572
Real estate - construction:
One to four family residential		481		900
Other construction, land development and other land		228		439
Total real estate - construction		709		1,339
Real estate - farmland		457		40
Real estate - non-farm, non-residential:
Owner occupied		247		2,526
Non-owner occupied		203		855
Total real estate - non-farm, non-residential		450		3,381
Consumer		113		151
Total loans	$	6,352	$	11,874

At September 30, 2013 and December 31, 2012, the Company did not have any loans past due 90 days and accruing interest.

The following table presents commercial loans by credit quality indicator at September 30, 2013:

(dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Impaired		Total
Commercial, industrial and agricultural	$	40,676	$	4,032	$	1,631	$	5	$	1,999	$	48,343
Real estate - multifamily residential		18,225		-		-		-		-		18,225
Real estate - construction:
One to four family residential		15,428		237		70		-		964		16,699
Other construction, land development and other land		9,185		5,706		215		-		6,736		21,842
Total real estate - construction		24,613		5,943		285		-		7,700		38,541
Real estate - farmland		6,581		339		533		-		590		8,043
Real estate - non-farm, non-residential:
Owner occupied		100,056		11,128		6,438		82		11,096		128,800
Non-owner occupied		51,219		16,690		479		-		8,273		76,661
Total real estate - non-farm, non-residential		151,275		27,818		6,917		82		19,369		205,461
Total commercial loans	$	241,370	$	38,132	$	9,366	$	87	$	29,658	$	318,613

17

The following table presents commercial loans by credit quality indicator at December 31, 2012:

(dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Impaired		Total
Commercial, industrial and agricultural	$	46,705	$	2,454	$	1,602	$	169	$	951	$	51,881
Real estate - multifamily residential		15,801		-		-		-		-		15,801
Real estate - construction:
One to four family residential		17,976		923		883		-		450		20,232
Other construction, land development and other land		9,167		3,449		3,008		-		18,931		34,555
Total real estate - construction		27,143		4,372		3,891		-		19,381		54,787
Real estate - farmland		7,371		1,146		41		-		-		8,558
Real estate - non-farm, non-residential:
Owner occupied		87,058		16,424		10,669		72		5,601		119,824
Non-owner occupied		44,721		15,090		3,821		-		8,109		71,741
Total real estate - non-farm, non-residential		131,779		31,514		14,490		72		13,710		191,565
Total commercial loans	$	228,799	$	39,486	$	20,024	$	241	$	34,042	$	322,592

At September 30, 2013 and December 31, 2012, the Company did not have any loans classified as Loss.

The following table presents consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at September 30, 2013:

(dollars in thousands)	Performing		Nonperforming		Total
Real estate - one to four family residential:
Closed end first and seconds	$	213,159	$	11,565	$	224,724
Home equity lines		97,893		676		98,569
Total real estate - one to four family residential		311,052		12,241		323,293
Consumer		17,355		411		17,766
Other		2,477		476		2,953
Total consumer loans	$	330,884	$	13,128	$	344,012

The following table presents consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at December 31, 2012:

(dollars in thousands)	Performing		Nonperforming		Total
Real estate - one to four family residential:
Closed end first and seconds	$	229,087	$	9,915	$	239,002
Home equity lines		98,343		1,355		99,698
Total real estate - one to four family residential		327,430		11,270		338,700
Consumer		20,010		163		20,173
Other		2,715		488		3,203
Total consumer loans	$	350,155	$	11,921	$	362,076

18

The following table summarizes the activity in the Company’s allowance for loan losses for the periods presented:

	Nine Months Ended		Twelve Months Ended		Nine Months Ended
	September 30,		December 31,		September 30,
(dollars in thousands)	2013		2012		2012
Balance at beginning of period	$	20,338	$	24,102	$	24,102
Provision charged against income		1,550		5,658		4,783
Recoveries of loans charged off		688		1,626		1,200
Loans charged off		(5,682)		(11,048)		(7,982)
Balance at end of period	$	16,894	$	20,338	$	22,103

The following table presents a rollforward of the Company’s allowance for loan losses for the nine months ended September 30, 2013:

	Beginning Balance								Ending Balance
(dollars in thousands)	January 1, 2013		Charge-offs		Recoveries		Provision		September 30, 2013
Commercial, industrial and agricultural	$	2,340	$	(534)	$	277	$	(734)	$	1,349
Real estate - one to four family residential:
Closed end first and seconds		2,876		(1,137)		67		1,256		3,062
Home equity lines		720		(111)		29		77		715
Total real estate - one to four family residential		3,596		(1,248)		96		1,333		3,777
Real estate - multifamily residential		62		-		-		8		70
Real estate - construction:
One to four family residential		419		(57)		58		(159)		261
Other construction, land development and other land		3,897		(1,154)		68		(791)		2,020
Total real estate - construction		4,316		(1,211)		126		(950)		2,281
Real estate - farmland		41		-		-		(2)		39
Real estate - non-farm, non-residential:
Owner occupied		5,092		(514)		-		1,117		5,695
Non-owner occupied		4,093		(1,912)		55		685		2,921
Total real estate - non-farm, non-residential		9,185		(2,426)		55		1,802		8,616
Consumer		215		(165)		94		71		215
Other		583		(98)		40		22		547
Total	$	20,338	$	(5,682)	$	688	$	1,550	$	16,894

19

The following table presents a rollforward of the Company’s allowance for loan losses for the nine months ended September 30, 2012:

	Beginning Balance								Ending Balance
(dollars in thousands)	January 1, 2012		Charge-offs		Recoveries		Provision		September 30, 2012
Commercial, industrial and agricultural	$	4,389	$	(999)	$	464	$	(728)	$	3,126
Real estate - one to four family residential:
Closed end first and seconds		2,856		(1,265)		14		1,167		2,772
Home equity lines		278		(669)		10		1,290		909
Total real estate - one to four family residential		3,134		(1,934)		24		2,457		3,681
Real estate - multifamily residential		29		-		-		35		64
Real estate - construction:
One to four family residential		382		(76)		38		14		358
Other construction, land development and other land		6,861		(1,618)		1		(899)		4,345
Total real estate - construction		7,243		(1,694)		39		(885)		4,703
Real estate - farmland		15		-		-		27		42
Real estate - non-farm, non-residential:
Owner occupied		4,831		(1,443)		120		1,516		5,024
Non-owner occupied		3,172		(1,507)		409		2,492		4,566
Total real estate - non-farm, non-residential		8,003		(2,950)		529		4,008		9,590
Consumer		776		(335)		117		(300)		258
Other		513		(70)		27		93		563
Unallocated		-		-		-		76		76
Total	$	24,102	$	(7,982)	$	1,200	$	4,783	$	22,103

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class based on impairment method as of September 30, 2013:

	Allowance allocated to loans:						Total Loans:
(dollars in thousands)	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total
Commercial, industrial and agricultural	$	218	$	1,131	$	1,349	$	2,000	$	46,343	$	48,343
Real estate - one to four family residential:
Closed end first and seconds		1,331		1,731		3,062		10,054		214,670		224,724
Home equity lines		-		715		715		315		98,254		98,569
Total real estate - one to four family residential		1,331		2,446		3,777		10,369		312,924		323,293
Real estate - multifamily residential		-		70		70		-		18,225		18,225
Real estate - construction:
One to four family residential		184		77		261		964		15,735		16,699
Other construction, land development and other land		-		2,020		2,020		6,736		15,106		21,842
Total real estate - construction		184		2,097		2,281		7,700		30,841		38,541
Real estate - farmland		-		39		39		590		7,453		8,043
Real estate - non-farm, non-residential:
Owner occupied		2,457		3,238		5,695		11,096		117,704		128,800
Non-owner occupied		663		2,258		2,921		8,273		68,388		76,661
Total real estate - non-farm, non-residential		3,120		5,496		8,616		19,369		186,092		205,461
Consumer		88		127		215		308		17,458		17,766
Other		326		221		547		475		2,478		2,953
Total	$	5,267	$	11,627	$	16,894	$	40,811	$	621,814	$	662,625

20

 

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class based on impairment method as of December 31, 2012:

	Allowance allocated to loans:						Total Loans:
(dollars in thousands)	Individually  evaluated for  impairment		Collectively  evaluated for  impairment		Total		Individually  evaluated for  impairment		Collectively  evaluated for  impairment		Total
Commercial, industrial and agricultural	$	402	$	1,938	$	2,340	$	951	$	50,930	$	51,881
Real estate - one to four family residential:
Closed end first and seconds		923		1,953		2,876		6,856		232,146		239,002
Home equity lines		-		720		720		315		99,383		99,698
Total real estate - one to four family residential		923		2,673		3,596		7,171		331,529		338,700
Real estate - multifamily residential		-		62		62		-		15,801		15,801
Real estate - construction:
One to four family residential		268		151		419		450		19,782		20,232
Other construction, land development and other land		928		2,969		3,897		18,931		15,624		34,555
Total real estate - construction		1,196		3,120		4,316		19,381		35,406		54,787
Real estate - farmland		-		41		41		-		8,558		8,558
Real estate - non-farm, non-residential:
Owner occupied		714		4,378		5,092		5,601		114,223		119,824
Non-owner occupied		1,646		2,447		4,093		8,109		63,632		71,741
Total real estate - non-farm, non-residential		2,360		6,825		9,185		13,710		177,855		191,565
Consumer		1		214		215		25		20,148		20,173
Other		348		235		583		488		2,715		3,203
Total	$	5,230	$	15,108	$	20,338	$	41,726	$	642,942	$	684,668

The following table presents loans individually evaluated for impairment by class of loans as of September 30, 2013:

(dollars in thousands)	Recorded  Investment		Unpaid  Principal  Balance		Recorded  Investment With  No Allowance		Recorded  Investment With  Allowance		Related  Allowance		Average  Recorded  Investment		Interest  Income  Recognized
Commercial, industrial and agricultural	$	2,000	$	2,000	$	-	$	2,000	$	218	$	1,626	$	79
Real estate - one to four family residential:
Closed end first and seconds		10,054		10,300		3,025		7,029		1,331		8,736		353
Home equity lines		315		515		315		-		-		390		8
Total real estate - one to four family residential		10,369		10,815		3,340		7,029		1,331		9,126		361
Real estate - construction:
One to four family residential		964		964		654		310		184		830		23
Other construction, land development and other land		6,736		9,288		6,736		-		-		9,484		284
Total real estate - construction		7,700		10,252		7,390		310		184		10,314		307
Real estate - farmland		590		590		590		-		-		295		10
Real estate - non-farm, non-residential:
Owner occupied		11,096		11,096		3,650		7,446		2,457		10,592		393
Non-owner occupied		8,273		8,646		4,931		3,342		663		9,821		325
Total real estate - non-farm, non-residential		19,369		19,742		8,581		10,788		3,120		20,413		718
Consumer		308		308		-		308		88		172		15
Other		475		476		-		475		326		514		-
Total loans	$	40,811	$	44,183	$	19,901	$	20,910	$	5,267	$	42,460	$	1,490

21

  

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2012:

(dollars in thousands)	Recorded  Investment		Unpaid  Principal  Balance		Recorded  Investment With  No Allowance		Recorded  Investment With  Allowance		Related  Allowance		Average  Recorded  Investment		Interest  Income  Recognized
Commercial, industrial and agricultural	$	951	$	1,247	$	408	$	543	$	402	$	907	$	59
Real estate - one to four family residential:
Closed end first and seconds		6,856		7,327		2,127		4,729		923		8,431		386
Home Equity lines		315		515		315		-		-		801		9
Total real estate - one to four family residential		7,171		7,842		2,442		4,729		923		9,232		395
Real estate - construction:
One to four family residential		450		450		-		450		268		402		10
Other construction, land development and other land		18,931		18,931		14,071		4,860		928		20,169		814
Total real estate - construction		19,381		19,381		14,071		5,310		1,196		20,571		824
Real estate - non-farm, non-residential:
Owner occupied		5,601		5,748		380		5,221		714		8,753		304
Non-owner occupied		8,109		8,109		626		7,483		1,646		8,434		457
Total real estate - non-farm, non-residential		13,710		13,857		1,006		12,704		2,360		17,187		761
Consumer		25		25		-		25		1		25		2
Other		488		488		-		488		348		496		-
Total loans	$	41,726	$	42,840	$	17,927	$	23,799	$	5,230	$	48,418	$	2,041

The following tables present, by class of loans, information related to loans modified as TDRs during the three and nine months ended September 30, 2013 and 2012:

	Three Months Ended September 30, 2013					Three Months Ended September 30, 2012
(dollars in thousands)	Number of Loans	Pre- Modification Recorded Balance		Post- Modification Recorded Balance*		Number of Loans	Pre- Modification Recorded Balance		Post- Modification Recorded Balance*
Real estate - one to four family residential:
Closed end first and seconds	1	$	434	$	434	1	$	179	$	179
Total	1	$	434	$	434	1	$	179	$	179

* The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

	Nine Months Ended September 30, 2013					Nine Months Ended September 30, 2012
(dollars in thousands)	Number of  Loans	Pre- Modification  Recorded  Balance		Post- Modification  Recorded  Balance*		Number  of Loans	Pre- Modification  Recorded  Balance		Post- Modification  Recorded  Balance*
Commercial, industrial and agricultural	-	$	-	$	-	1	$	66	$	66
Real estate - one to four family residential:
Closed end first and seconds	3		876		872	3		909		908
Real estate - construction:
One to four family residential	-		-		-	2		371		371
Other construction, land development and other land	-		-		-	2		164		163
Total real estate - construction	-		-		-	4		535		534
Total	3	$	876	$	872	8	$	1,510	$	1,508

* The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

22

The following tables present, by class of loans, information related to loans modified as TDRs that subsequently defaulted (i.e., 90 days or more past due following a modification) during the three and nine months ended September 30, 2013 and 2012 and were modified as TDRs within the 12 months prior to default:

	Three Months Ended   September 30, 2013			Three Months Ended   September 30, 2012
(dollars in thousands)	Number of  Loans	Recorded  Balance		Number of  Loans	Recorded  Balance
Real estate - one to four family residential:
Closed end first and seconds	-	$	-	1	$	149
Real estate - construction:
One to four family residential	-		-	1		240
Total	-	$	-	2	$	389

	Nine Months Ended  September 30, 2013			Nine Months Ended  September 30, 2012
(dollars in thousands)	Number of  Loans		Recorded  Balance	Number of  Loans		Recorded  Balance
Real estate - one to four family residential:
Closed end first and seconds	2	$	234	1	$	149
Real estate - construction:
One to four family residential	-		-	1		240
Real estate - non-farm, non-residential:
Non-owner occupied	1		164	-		-
Total	3	$	398	2	$	389

Note 4. Deferred Income Taxes

As of September 30, 2013 and December 31, 2012, the Company had recorded net deferred income tax assets of approximately $18.8 million and $10.7 million, respectively. The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed. Management’s assessment is primarily dependent on historical taxable income and projections of future taxable income, which are directly related to the Company’s core earnings capacity and its prospects to generate core earnings in the future. Projections of core earnings and taxable income are inherently subject to uncertainty and estimates that may change given the uncertain economic outlook, banking industry conditions and other factors. Further, management has considered future reversals of existing taxable temporary differences and limited, prudent and feasible tax-planning strategies, such as changes in investment security income (tax-exempt to taxable), additional sales of loans and sales of branches/buildings with an appreciated asset value over the tax basis. Based upon an analysis of available evidence, management has determined that it is “more likely than not” that the Company’s deferred income tax assets as of September 30, 2013 will be fully realized and therefore no valuation allowance to the Company’s deferred income tax assets was recorded. However, the Company can give no assurance that in the future its deferred income tax assets will not be impaired because such determination is based on projections of future earnings and the possible effect of certain transactions which are subject to uncertainty and based on estimates that may change due to changing economic conditions and other factors. Due to the uncertainty of estimates and projections, it is possible that the Company will be required to record adjustments to the valuation allowance in future reporting periods.

The Company’s ability to realize its deferred tax assets may be limited if the Company experiences an ownership change as defined by Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). For additional information see Part II, Item 1A. “Risk Factors” in the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013.

23

Due primarily to the net operating loss incurred for the years ended December 31, 2010 and 2009, the Company has recorded income taxes receivable, which have been carried back to prior years, of approximately $2.6 million at both September 30, 2013 and December 31, 2012, which are included in other assets on the accompanying consolidated balance sheets.

 Note 5. Bank Premises and Equipment

Bank premises and equipment are summarized as follows:

	September 30,		December 31,
(dollars in thousands)	2013		2012
Land and improvements	$	6,349	$	6,409
Buildings and leasehold improvements		21,557		21,688
Furniture, fixtures and equipment		19,319		18,416
Construction in progress		1,376		949
		48,601		47,462
Less accumulated depreciation		(27,073)		(25,806)
Net balance	$	21,528	$	21,656

Depreciation and amortization of bank premises and equipment for the nine months ended September 30, 2013 and 2012 amounted to $1.6 million for both periods, respectively.

Note 6. Borrowings

Federal funds purchased and repurchase agreements. The Company has unsecured lines of credit with SunTrust Bank, Community Bankers Bank and Pacific Coast Bankers Bank for the purchase of federal funds in the amount of $20.0 million, $15.0 million and $5.0 million, respectively.These lines of credit have a variable rate based on the lending bank’s daily federal funds sold rate and are due on demand.Repurchase agreements are secured transactions and generally mature the day following the day sold.Customer repurchases are standard transactions that involve a Bank customer instead of a wholesale bank or broker.The Company offers this product as an accommodation to larger retail and commercial customers that request safety for their funds beyond the Federal Deposit Insurance Corporation (“FDIC”) deposit insurance limits.The Company does not use or have any open repurchase agreements with broker-dealers.

24

 

The tables below present selected information on federal funds purchased and repurchase agreements during the nine months ended September 30, 2013 and the year ended December 31, 2012:

Federal funds purchased	September 30,			December 31,
(dollars in thousands)	2013			2012
Balance outstanding at period end	$	-		$	-
Maximum balance at any month end during the period	$	-		$	2
Average balance for the period	$	6		$	163
Weighted average rate for the period		0.87	%		0.75	%
Weighted average rate at period end		0.00	%		0.00	%

Repurchase agreements	September 30,			December 31,
(dollars in thousands)	2013			2012
Balance outstanding at period end	$	3,770		$	2,942
Maximum balance at any month end during the period	$	3,770		$	6,292
Average balance for the period	$	3,430		$	3,486
Weighted average rate for the period		0.60	%		0.89	%
Weighted average rate at period end		0.60	%		0.60	%

Short-term borrowings. Short-term borrowings consist of advances from the FHLB, which are secured by a blanket floating lien on all qualifying closed-end and revolving open-end loans that are secured by 1-4 family residential properties.Short-term advances from the FHLB at September 30, 2013 consisted of $10.3 million using a daily rate credit, which is due on demand, and a $45.0 million fixed rate two week advance.There were no short-term advances outstanding with the FHLB at December 31, 2012.

The table below presents selected information on short-term borrowings during the nine months ended September 30, 2013 and the year ended December 31, 2012:

Short-term borrowings	September 30,			December 31,
(dollars in thousands)	2013			2012
Balance outstanding at period end	$	55,289		$	-
Maximum balance at any month end during the period	$	55,289		$	-
Average balance for the period	$	7,292		$	318
Weighted average rate for the period		0.22	%		0.31	%
Weighted average rate at period end		0.22	%		0.00	%

Long-term borrowings. Long-term borrowings consist of advances from the FHLB, which are secured by a blanket floating lien on all qualifying closed-end and revolving open-end loans that are secured by 1-4 family residential properties.During August2013, the Company restructured its FHLB advances with the prepayment of $107.5 million in higher rate long-term advances.The long-term advances that were extinguished were fixed rate advances with a weighted average remaining maturity of 3.5 years and a current weighted average interest rate of 4.14%; $94.0 million of the prepaid FHLB advances were callable quarterly by the FHLB.The prepayment of the FHLB advances triggered a prepayment penalty of $11.5 million, or $0.67 per fully diluted share at September 30, 2013, all of which was recognized in the third quarter of 2013. The Company also paid off the remaining $10.0 million higher rate long-term FHLB advance at maturity during September 2013.Long-term advances from the FHLB at December 31, 2012 consisted of $107.5 million in convertible advances and a $10.0 million fixed rate hybrid advance.The convertible advances had fixed rates of interest unless the FHLB would have exercised its option to convert the interest on these advances from fixed rate to variable rate.

25

 

The Company’s line of credit with the FHLB can equal up to 25% of the Company’s gross assets or approximately $279.1 million at September 30, 2013.This line of credit totaled $182.1 million with approximately $114.1 million available at September 30, 2013.As of September 30, 2013 and December 31, 2012, loans with a carrying value of $283.8 million and $297.7 million, respectively, are pledged to the FHLB as collateral for borrowings.Additional loans are available that can be pledged as collateral for future borrowings from the FHLB above the current lendable collateral value.Combined short-term and long-term borrowings outstanding under the FHLB line of credit were $55.3 million and $117.5 million as of September 30, 2013 and December 31, 2012, respectively.

Note 7. Earnings (Loss) Per Common Share

The following table shows the weighted average number of common shares used in computing earnings (loss) per common share and the effect on the weighted average number of shares of potential dilutive common stock for the three and nine months ended September 30, 2013 and 2012.Potential dilutive common stock had no effect on earnings (loss) per common share otherwise available to common shareholders for the three and nine months ended September 30, 2013.

	Three Months Ended
	September 30, 2013		September 30, 2012
Weighted average common shares outstanding for basic earnings (loss) per common share		11,776,067		6,069,483
Effect of dilutive securities, stock options		-		-
Effect of dilutive securities, Series B Preferred Stock		-		-
Weighted average common shares outstanding for diluted earnings (loss) per common share		11,776,067		6,069,483
Basic (loss) earnings per common share	$	(0.60)	$	0.08
Diluted (loss) earnings per common share	$	(0.60)	$	0.08

	Nine Months Ended
	September 30, 2013		September 30, 2012
Weighted average common shares outstanding for basic earnings (loss)  per common share		8,316,246		6,044,730
Effect of dilutive securities, stock options		-		-
Effect of dilutive securities, Series B Preferred Stock		-		-
Weighted average common shares outstanding for diluted earnings (loss) per common share		8,316,246		6,044,730
Basic (loss) earnings per common share	$	(0.72)	$	0.23
Diluted (loss) earnings per common share	$	(0.72)	$	0.23

At September 30, 2013 and 2012, options to acquire 155,537 and 185,287 shares of common stock, respectively were not included in computing diluted earnings (loss) per common share because their effects were anti-dilutive.

On June 12, 2013, the Company issued 5,240,192 shares of a new series of non-voting mandatorily convertible non-cumulative preferred stock (the “Series B Preferred Stock”) through private placements to certain investors.For more information related to the conversion rights on these preferred shares, see Note 11 – Preferred Stock and Warrant.For the three and nine months ended September 30, 2013, the weighted average dilutive effect of the Series B Preferred Stock would have been 5,240,192 shares and 2,130,628 shares, respectively, however, these shares were not included in computing diluted earnings (loss) per common share because their effects were anti-dilutive.There was no weighted average dilutive effect of the Series B Preferred Stock for the three and nine months ended September 30, 2012, respectively.

Note 8. Stock Based Compensation Plans

On September 21, 2000, the Company adopted the Eastern Virginia Bankshares, Inc. 2000 Stock Option Plan (the “2000 Plan”) to provide a means for selected key employees and directors to increase their personal financial interest in the Company, thereby stimulating their efforts and strengthening their desire to remain with the Company.Under the 2000 Plan, up to 400,000 shares of Company common stock could be granted in the form of stock options.On April 17, 2003, the shareholders approved the Eastern Virginia Bankshares, Inc. 2003 Stock Incentive Plan, amending and restating the 2000 Plan (the “2003 Plan”) still authorizing the issuance of up to 400,000 shares of common stock under the plan, but expanding the award types available under the plan to include stock options, stock appreciation rights, common stock, restricted stock and phantom stock.Under the terms of the 2003 Plan document, after April 17, 2013 no awards of shares of common stock may be granted under the 2003 Plan.��Any awards previously granted under the 2003 Plan that were outstanding as of April 17, 2013 remain outstanding and will vest, etc. in accordance with their regular terms.

26

 

On April 19, 2007, the Company’s shareholders approved the Eastern Virginia Bankshares, Inc. 2007 Equity Compensation Plan (the “2007 Plan”) to enhance the Company’s ability to recruit and retain officers, directors, employees, consultants and advisors with ability and initiative and to encourage such persons to have a greater financial interest in the Company.The 2007 Plan authorizes the Company to issue up to 400,000 additional shares of common stock pursuant to grants of stock options, stock appreciation rights, common stock, restricted stock, performance shares, incentive awards and stock units.There were 360,000 shares still available to be granted as awards under the 2007 Plan as of September 30, 2013.

Accounting standards require companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options, based on the fair value of those awards at the date of grant.

Accounting standards also require that new awards to employees eligible for retirement prior to the awards becoming fully vested be recognized as compensation cost over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award.The Company’s stock options granted to eligible participants are being recognized, as required, as compensation cost over the vesting period except in the instance where a participant reaches normal retirement age of 65 prior to the normal vesting date.For the three and nine months ended September 30, 2013, there was no stock option compensation expense, compared to stock option compensation expense of $10 thousand and $31 thousand for the same periods of 2012 respectively, which was included in salaries and employee benefits expense in the consolidated statements of operations.

Stock option compensation expense is the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for each stock option award.There were no stock options granted or exercised in the nine months ended September 30, 2013 and 2012.

A summary of the Company’s stock option activity and related information for the nine months ended September 30, 2013 is as follows:

				Remaining	Aggregate
	Options	Weighted Average		Contractual Life	Intrinsic Value
	Outstanding	Exercise Price		(in years)	(in thousands)
Stock options outstanding at January 1, 2013	182,362	$	20.08
Forfeited	(7,500)		18.89
Expired	(19,325)		28.60
Stock options outstanding at September 30, 2013	155,537	$	19.07	2.80	$	-
Stock options exercisable at September 30, 2013	155,537	$	19.07	2.80	$	-

* Intrinsic value is the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date.

As of September 30, 2013, there was no remaining unrecognized compensation expense related to stock options.

The table below summarizes information concerning stock options outstanding and exercisable at September 30, 2013:

Stock Options Outstanding				Stock Options Exercisable
			Weighted
			Average
Exercise		Number	Remaining	Exercise		Number
Price		Outstanding	Term	Price		Exercisable
$	19.92	27,800	0.75 years	$	19.92	27,800
$	20.57	36,662	1.75 years	$	20.57	36,662
$	21.16	39,075	3.00 years	$	21.16	39,075
$	19.25	27,500	4.00 years	$	19.25	27,500
$	12.36	24,500	5.00 years	$	12.36	24,500
$	19.07	155,537	2.80 years	$	19.07	155,537

27

 

The Company issued no restricted stock for the three and nine months ended September 30, 2013. On June 29, 2012, the Company granted 34,000 shares of restricted stock under the 2007 Plan to its executive officers in connection with Troubled Asset Relief Program (“TARP”) compliant restricted stock awards. All of these shares are subject to time vesting over a five year period, and generally vest 40% on the second anniversary of the grant date and 20% on each of the third, fourth and fifth anniversaries of the grant date. On July 1, 2009, the Company awarded 18,000 shares of restricted stock to employees who were not subject to the TARP executive compensation restrictions. One half of these shares are subject to time vesting at 20% per year over a five year period. The other half of the 18,000 restricted shares granted on July 1, 2009 were performance based. On December 16, 2010, the Company cancelled 8,000 shares of restricted stock previously awarded to its Chief Executive Officer on July 1, 2009 as the award did not contain the terms necessary to comply with the TARP executive compensation restrictions and therefore prevented the employee from accruing or vesting in any portion of the award while the TARP executive compensation restrictions apply. In conjunction with this cancellation, the Company granted a TARP compliant restricted stock award to its Chief Executive Officer in an equal amount of shares and in substantially the same form as previously awarded. On June 30, 2012, any of the performance based shares that had not previously been forfeited for other reasons were forfeited because the Company’s financial achievements for the year ended December 31, 2011 did not meet pre-specified targets for earnings per share or return on equity compared to a defined peer group.

For the three and nine months ended September 30, 2013, restricted stock compensation expense was $7 thousand and $21 thousand, respectively, compared to restricted stock compensation expense of $9 thousand and $15 thousand, respectively, for the three and nine months ended September 30, 2012. Restricted stock compensation expense is included in salaries and employee benefits expense in the consolidated statements of operations. Restricted stock compensation expense is accounted for using the fair market value of the Company’s common stock on the date the restricted shares were awarded, which was $3.72 per share for the 2012 award, $3.75 per share for the 2010 award and $8.31 per share for the 2009 awards.

A summary of the status of the Company’s nonvested shares in relation to the Company’s restricted stock awards as of September 30, 2013, and changes during the nine months ended September 30, 2013, is presented below; the weighted average price is the weighted average fair value at the date of grant:

		Weighted-Average
	Shares	Price
Nonvested as of January 1, 2013	39,400	$	3.89
Granted	-		-
Vested	(700)		8.31
Forfeited	-		-
Nonvested as of September 30, 2013	38,700	$	3.81

At September 30, 2013, there was $95 thousand of total unrecognized compensation expense related to restricted stock awards. This unearned compensation is being amortized over the remaining vesting period for the time based shares.

Note 9. Employee Benefit Plan – Pension

The Company has historically maintained a defined benefit pension plan covering substantially all of the Company’s employees. The plan was amended January 28, 2008 to freeze the plan with no additional contributions for a majority of participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan. No additional participants have been added to the plan. The plan was again amended February 28, 2011 to freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants have remained frozen in the plan since such action was taken. Effective January 1, 2012, the plan was amended and restated as a cash balance plan. Under a cash balance plan, participant benefits are stated as an account balance. An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan. Each participants account will be credited with an “interest” credit each year. The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year. Components of net periodic pension cost (benefit) related to the Company’s pension plan were as follows for the periods indicated:

28

 

	Three Months Ended				Nine Months Ended
	September 30,				September 30,
(dollars in thousands)	2013		2012		2013		2012
Components of Net Periodic Pension Cost (Benefit)
Interest cost	$	113	$	123	$	343	$	369
Expected return on plan assets		(175)		(169)		(527)		(507)
Amortization of prior service cost		8		2		12		6
Recognized net actuarial loss		31		31		93		93
Net settlement loss		100		-		100		-
Net periodic pension cost (benefit)	$	77	$	(13)	$	21	$	(39)

The Company made no contributions to the pension plan during 2012. The Company has not determined at this time how much, if any, contributions to the plan will be made for the year ending December 31, 2013.

Note 10. Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

     ·Level 1 – Valuation is based upon quoted prices (unadjusted) for identical instruments traded in active markets.  

     ·Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

     ·Level 3 – Valuation is determined using model-based techniques with significant assumptions not observable in the market. 

·

U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any fair value option elections as of September 30, 2013.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Assets Measured at Fair Value on a Recurring Basis

Securities Available For Sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s available for sale securities are considered to be Level 2 securities.

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The following table summarizes financial assets measured at fair value on a recurring basis as of September 30, 2013 and December 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Assets Measured at Fair Value on a Recurring Basis at September 30, 2013 Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		September 30,
	(Level 1)		(Level 2)		(Level 3)		2013
	(dollars in thousands)
Assets
Securities available for sale
Obligations of U.S. Government agencies	$	-	$	13,628	$	-	$	13,628
SBA Pool securities		-		92,185		-		92,185
Agency mortgage-backed securities		-		28,774		-		28,774
Agency CMO securities		-		53,318		-		53,318
Non agency CMO securities		-		1,456		-		1,456
State and political subdivisions		-		78,438		-		78,438
Pooled trust preferred securities		-		750		-		750
FNMA and FHLMC preferred stock		-		907		-		907
Total securities available for sale	$	-	$	269,456	$	-	$	269,456

Assets Measured at Fair Value on a Recurring Basis at December 31, 2012 Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		December 31,
	(Level 1)		(Level 2)		(Level 3)		2012
	(dollars in thousands)
Assets
Securities available for sale
Obligations of U.S. Government agencies	$	-	$	13,467	$	-	$	13,467
SBA Pool securities		-		82,751		-		82,751
Agency mortgage-backed securities		-		31,714		-		31,714
Agency CMO securities		-		61,936		-		61,936
Non agency CMO securities		-		2,199		-		2,199
State and political subdivisions		-		83,217		-		83,217
Pooled trust preferred securities		-		759		-		759
FNMA and FHLMC preferred stock		-		276		-		276
Corporate securities		-		594		-		594
Total securities available for sale	$	-	$	276,913	$	-	$	276,913

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Assets Measured at Fair Value on a Non-Recurring Basis

Certain assets are measured at fair value on a non-recurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from the application of lower-of-cost-or-fair value accounting or impairment write-downs of individual assets.

Impaired Loans. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a non-recurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of operations.

Other Real Estate Owned. Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a non-recurring basis. Any initial fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the consolidated statements of operations.

The following table summarizes assets measured at fair value on a non-recurring basis as of September 30, 2013 and December 31, 2012, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Assets Measured at Fair Value on a Non-Recurring Basis at September 30, 2013 Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		September 30,
	(Level 1)		(Level 2)		(Level 3)		2013
	(dollars in thousands)
Assets
Impaired loans	$	-	$	-	$	15,643	$	15,643
Other real estate owned	$	-	$	-	$	1,203	$	1,203

Assets Measured at Fair Value on a Non-Recurring Basis at December 31, 2012 Using
	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		December 31,
	(Level 1)		(Level 2)		(Level 3)		2012
	(dollars in thousands)
Assets
Impaired loans	$	-	$	-	$	18,569	$	18,569
Other real estate owned	$	-	$	-	$	4,747	$	4,747

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The following table displays quantitative information about Level 3 Fair Value Measurements as of September 30, 2013 and December 31, 2012:

Quantitative information about Level 3 Fair Value Measurements at September 30, 2013
	Fair Value		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
	(dollars in thousands)
Assets
Impaired loans	$	15,643	Discounted appraised value	Selling cost	0% - 32% (12%)
				Discount for lack of marketability and age of appraisal	0% - 20% (1%)
Other real estate owned	$	1,203	Discounted appraised value	Selling cost	10% (10%)
				Discount for lack of marketability and age of appraisal	0% - 52% (19%)

Quantitative information about Level 3 Fair Value Measurements at December 31, 2012
	Fair Value		Valuation Technique(s)	Unobservable Input	Range (Weighted Average)
	(dollars in thousands)
Assets
Impaired loans	$	18,569	Discounted appraised value	Selling cost	7% - 32% (12%)
				Discount for lack of marketability and age of appraisal	0% - 50% (15%)
Other real estate owned	$	4,747	Discounted appraised value	Selling cost	10% - 15% (10%)
				Discount for lack of marketability and age of appraisal	0% - 56% (6%)

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Fair Value of Financial Instruments

U.S. GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies and assumptions for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies and assumptions for other financial assets and financial liabilities are discussed below:

Cash and Short-Term Investments. For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment Securities. For securities and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted prices for similar securities. All securities prices are provided by independent third party vendors.

Restricted Securities. The carrying amount approximates fair value based on the redemption provisions of the correspondent banks.

Loans. The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans such as the borrower’s creditworthiness and compensating balances and dissimilar types of real estate held as collateral. The fair value of impaired loans is measured as described within the Impaired Loans section of this note.

Deposits. The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using market rates for deposits of similar remaining maturities.

Short-Term Borrowings. The carrying amounts of federal funds purchased and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the current incremental borrowing rates for similar types of borrowing arrangements.

Long-Term Borrowings. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest Receivable and Accrued Interest Payable. The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Financial Instruments. The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The fair value of guarantees of credit card accounts previously sold is based on the estimated cost to settle the obligations with the counterparty at the reporting date. At September 30, 2013 and December 31, 2012, the fair value of loan commitments, standby letters of credit and credit card guarantees are not significant and are not included in the table below.

33

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

			Fair Value Measurements at September 30, 2013 Using
			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable		Balance at
			Identical Assets		Inputs		Inputs		September 30,
	Carrying Amount		(Level 1)		(Level 2)		(Level 3)		2013
	(dollars in thousands)
Assets:
Cash and short-term investments	$	13,655	$	13,655	$	-	$	-	$	13,655
Interest bearing deposits with banks		5,205		5,205		-		-		5,205
Securities available for sale		269,456		-		269,456		-		269,456
Restricted securities		6,150		-		6,150		-		6,150
Loans, net		645,731		-		-		655,061		655,061
Accrued interest receivable		4,114		-		4,114		-		4,114
Total	$	944,311	$	18,860	$	279,720	$	655,061	$	953,641
Liabilities:
Noninterest-bearing demand deposits	$	136,835	$	136,835	$	-	$	-	$	136,835
Interest-bearing deposits		690,182		-		608,528		-		608,528
Short-term borrowings		59,059		59,059		-		-		59,059
Trust preferred debt		10,310		-		10,310		-		10,310
Accrued interest payable		1,253		-		1,253		-		1,253
Total	$	897,639	$	195,894	$	620,091	$	-	$	815,985

			Fair Value Measurements at December 31, 2012 Using
			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable		Balance at
			Identical Assets		Inputs		Inputs		December 31,
	Carrying Amount		(Level 1)		(Level 2)		(Level 3)		2012
	(dollars in thousands)
Assets:
Cash and short-term investments	$	16,762	$	16,762	$	-	$	-	$	16,762
Interest bearing deposits with banks		29,837		29,837		-		-		29,837
Securities available for sale		276,913		-		276,913		-		276,913
Restricted securities		9,251		-		9,251		-		9,251
Loans, net		664,330		-		-		659,818		659,818
Accrued interest receivable		4,223		-		4,223		-		4,223
Total	$	1,001,316	$	46,599	$	290,387	$	659,818	$	996,804
Liabilities:
Noninterest-bearing demand deposits	$	116,717	$	116,717	$	-	$	-	$	116,717
Interest-bearing deposits		721,656		-		717,035		-		717,035
Short-term borrowings		2,942		2,942		-		-		2,942
Long-term borrowings		117,500		-		126,739		-		126,739
Trust preferred debt		10,310		-		10,310		-		10,310
Accrued interest payable		1,673		-		1,673		-		1,673
Total	$	970,798	$	119,659	$	855,757	$	-	$	975,416

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The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of the Company’s normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. The Company attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. The Company monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Note 11. Preferred Stock and Warrant

On January 9, 2009, the Company signed a definitive agreement with the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 to participate in the Treasury’s Capital Purchase Program. Pursuant to this agreement, the Company sold 24,000 shares of its Series A fixed rate cumulative perpetual preferred stock, liquidation value $1,000 per share (the “Series A Preferred Stock”), to the Treasury for an aggregate purchase price of $24 million. The Series A Preferred Stock pays a cumulative dividend at a rate of 5% for the first five years, and if not redeemed, pays a rate of 9% starting at the beginning of the sixth year. As part of its purchase of the Series A Preferred Stock, the Treasury was also issued a warrant to purchase up to 373,832 shares of the Company’s common stock at an initial exercise price of $9.63 per share. If not exercised, the warrant expires after ten years. On October 21, 2013, the Treasury sold all 24,000 shares of Series A Preferred Stock that were held by Treasury. See Note 16 – Subsequent Events.

Accounting for the issuance of the Series A Preferred Stock included entries to the equity portion of the Company’s consolidated balance sheet to recognize the Series A Preferred Stock at the full amount of the issuance, the warrant and discount on the Series A Preferred Stock at values calculated by discounting the future cash flows by a prevailing interest rate that a similar security would receive in the current market environment. At the time of issuance, that discount rate was determined to be 12%. The fair value of the warrant of $950 thousand was calculated using the Black-Scholes model with inputs of 7 year volatility, average rate of quarterly dividends, 7 year Treasury strip rate and the exercise price of $9.63 per share exercisable for up to 10 years. The present value of the Series A Preferred Stock using a 12% discount rate was $14.4 million. The Series A Preferred Stock discount determined by the allocation of discount to the warrant is being accreted quarterly over a 5 year period on a constant effective yield method at a rate of approximately 6.4%. Allocation of the Series A Preferred Stock discount and the warrant as of January 9, 2009 is provided in the tables below:

Warrant Value	2009
Series A Preferred Stock	$	24,000,000
Price	$	9.63
Warrant - shares		373,832
Value per warrant	$	2.54
Fair value of warrant	$	949,533

NPV of Series A Preferred Stock
@ 12% discount rate	(dollars in thousands)
			Relative		Relative
	Fair Value		Value %		Value
$24 million 1/09/2009
NPV of Series A Preferred Stock (12% discount rate)	$	14,446	93.8	%	$	22,519
Fair value of warrant		950	6.2	%		1,481
	$	15,396	100.0	%	$	24,000

35

On February 17, 2011, the Parent and the Bank entered into a written agreement with the Federal Reserve Bank of Richmond (“Reserve Bank”) and the Bureau. The Written Agreement was terminated on July 30, 2013. Under the terms of this written agreement, the Parent and the Bank were subject to additional limitations and regulatory restrictions and could not declare or pay dividends to its shareholders (including payments by the Parent related to trust preferred securities) without prior regulatory approval. See Note 14 – Regulatory Agreements.

On September 5, 2013, the Parent and the Bank entered into a Memorandum of Understanding (the “MOU”) with the Reserve Bank and the Bureau. Under the terms of the MOU, the Parent and the Bank are subject to additional limitations and regulatory restrictions and cannot declare or pay dividends to its shareholders (including payment by the Parent related to trust preferred securities) without prior regulatory approval. See Note 14 – Regulatory Agreements.

On August 15, 2013, the Company deferred its eleventh consecutive dividend on the Series A Preferred Stock. Deferral of dividends on the Series A Preferred Stock does not constitute an event of default. Dividends on the Series A Preferred Stock are, however, cumulative, and the Company has accumulated the dividends in accordance with the terms of the Series A Preferred Stock and U.S. GAAP and reflected the accumulated dividends as a portion of the effective dividend on Series A Preferred Stock on the consolidated statements of operations. As of September 30, 2013, the Company had accumulated $3.3 million for dividends on the Series A Preferred Stock. The Company has notified the holders that it is deferring the November 15, 2013 dividend on the Series A Preferred Stock. In addition, because dividends on the Series A Preferred Stock have not been paid for more than six quarters, the authorized number of directors on the Company’s Board of Directors has increased by two, and the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board of Directors at the next annual meeting (or a special meeting called for that purpose) and each annual meeting until all owed and unpaid dividends on the Series A Preferred Stock have been paid. To date the holders of the Series A Preferred Stock have not yet exercised this right.

In connection with its private placements, on June 12, 2013, the Company issued 5,240,192 shares of its Series B Preferred Stock for a gross purchase price of $23.8 million, or $4.55 per share. The Series B Preferred Stock has no maturity date. The holders of Series B Preferred Stock are entitled to receive dividends if, as and when declared by the Company’s Board of Directors, in an identical form of consideration and at the same time, as those dividends or distributions that would have been payable on the number of whole shares of the Company’s common stock that such shares of Series B Preferred Stock would be convertible into upon satisfaction of certain conditions. The Company will not pay any dividends with respect to its common stock unless an equivalent dividend also is paid to the holders of Series B Preferred Stock. The Series B Preferred Stock ranks junior with regard to dividends to any class or series of capital stock of the Company the terms of which expressly provide that such class or series will rank senior to the common stock or the Series B Preferred Stock as to dividend rights and/or as to rights on liquidation, dissolution or winding up of the Company, including the Series A Preferred Stock.

For a summary of the terms of the Series B Preferred Stock, including the conditions under which shares of Series B Preferred Stock convert into shares of the Company’s common stock, see the Company’s Current Report on Form 8-K filed with the SEC on June 14, 2013 and the exhibits thereto.

Note 12. Trust Preferred Debt

On September 17, 2003, $10 million of trust preferred securities were placed through EVB Statutory Trust I in a pooled underwriting totaling approximately $650 million. The trust issuer has invested the total proceeds from the sale of the trust preferred securities in Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Parent. The trust preferred securities pay cumulative cash distributions quarterly at a variable rate per annum, reset quarterly, equal to the 3-month LIBOR plus 2.95%. As of September 30, 2013 and December 31, 2012, the interest rate was 3.20% and 3.26%, respectively. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities have a mandatory redemption date of September 17, 2033, and became subject to varying call provisions beginning September 17, 2008. The Parent has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Parent’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Parent.

The trust preferred securities 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 securities not considered as Tier 1 capital will be included in Tier 2 capital. At September 30, 2013 and December 31, 2012, all of the trust preferred securities qualified as Tier 1 capital.

36

Subject to certain exceptions and limitations, the Company is permitted to elect from time to time to defer regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities. If the Company defers interest payments on the Junior Subordinated Debentures for more than 20 consecutive quarters, the Company would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable.

On February 17, 2011, the Parent and the Bank entered into a written agreement with the Reserve Bank and the Bureau. The Written Agreement was terminated on July 30, 2013. Under the terms of this written agreement, the Company could not make payments on its outstanding Junior Subordinated Debentures relating to the trust preferred securities without prior regulatory approval. See Note 14 – Regulatory Agreements.

On September 5, 2013, the Parent and the Bank entered into a MOU with the Reserve Bank and the Bureau. Under the terms of the MOU, the Company cannot make payments on its outstanding Junior Subordinated Debentures relating to the trust preferred securities without prior regulatory approval. See Note 14 – Regulatory Agreements.

In June 2011, the Company began deferring its regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities. As of September 30, 2013, the Company had deferred ten quarterly interest payments on its Junior Subordinated Notes.

Note 13. Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

On February 17, 2011, the Parent and the Bank entered into a written agreement with the Reserve Bank and the Bureau. The Written Agreement was terminated on July 30, 2013. Under the terms of this written agreement, the Parent and the Bank were subject to additional limitations and regulatory restrictions and could not declare or pay dividends to its shareholders (including payments by the Parent on its trust preferred securities) and could not purchase or redeem shares of its stock without prior regulatory approval. See Note 14 – Regulatory Agreements.

On September 5, 2013, the Parent and the Bank entered into a MOU with the Reserve Bank and the Bureau. Under the terms of the MOU, the Parent and the Bank are subject to additional limitations and regulatory restrictions and cannot declare or pay dividends to its shareholders (including payments by the Parent or its trust preferred securities) and cannot purchase or redeem shares of its stock without prior regulatory approval. See Note 14 – Regulatory Agreements.

In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and for calculating risk-weighted assets, as modified by the U.S. federal bank regulators (the “Basel III Capital Rules”). The Basel III Capital Rules, when fully implemented, will modify the regulatory capital requirements that apply to the Company and the Bank. For further information about these final rules, refer to Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Basel III Final Rules” in this Quarterly Report on Form 10-Q.

As of September 30, 2013, the most recent notification from the Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Bank’s category. A comparison of the September 30, 2013 and December 31, 2012 capital ratios of the Company and the Bank with minimum regulatory guidelines is as follows:

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							Minimum To Be
							Well-Capitalized
				Minimum			Under Prompt
				Capital			Corrective Action
As of September 30, 2013	Actual Capital			Requirements			Provisions
Total Risk-Based Capital Ratio:
Company		19.12	%		8.00	%		N/A
Bank		11.75	%		8.00	%		10.00	%
Tier 1 Risk-Based Capital Ratio:
Company		17.86	%		4.00	%		N/A
Bank		10.48	%		4.00	%		6.00	%
Leverage Ratio:
Company		11.34	%		4.00	%		N/A
Bank		6.65	%		4.00	%		5.00	%

							Minimum to be
							Well-Capitalized
				Minimum			Under Prompt
				Capital			Corrective Action
As of December 31, 2012	Actual Capital			Requirements			Provisions
Total Risk-Based Capital Ratio:
Company		13.88	%		8.00	%		N/A
Bank		13.32	%		8.00	%		10.00	%
Tier 1 Risk-Based Capital Ratio:
Company		12.64	%		4.00	%		N/A
Bank		12.08	%		4.00	%		6.00	%
Leverage Ratio:
Company		8.13	%		4.00	%		N/A
Bank		7.76	%		4.00	%		5.00	%

Note 14. Regulatory Agreements

Effective February 17, 2011, the Company and the Bank entered into a Written Agreement (the “Written Agreement”) with the Reserve Bank and the Bureau. The Written Agreement was terminated on July 30, 2013.

Under the terms of the Written Agreement, the Bank agreed to develop and submit for approval within the time periods specified therein written plans to address certain aspects of its business. In addition, the Bank agreed that it would: (a) not extend, renew, or restructure any credit that had been criticized by the Reserve Bank or the Bureau absent prior board of directors approval in accordance with the restrictions in the Written Agreement; and (b) eliminate all assets or portions of assets classified as “loss” and thereafter charge off all assets classified as “loss” in a federal or state report of examination, unless otherwise approved by the Reserve Bank. Both the Company and the Bank also agreed to submit capital plans to maintain sufficient capital at the Company, on a consolidated basis, and the Bank, on a stand-alone basis, and to refrain from declaring or paying dividends without prior regulatory approval. The Company agreed that it would not take any other form of payment representing a reduction in the Bank’s capital or make any distributions of interest, principal, or other sums on subordinated debentures or trust preferred securities without prior regulatory approval. The Company could not incur, increase or guarantee any debt without prior regulatory approval and agreed not to purchase or redeem any shares of its stock without prior regulatory approval.

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On September 5, 2013, the Company and the Bank entered into a MOU with the Reserve Bank and the Bureau.

Under the terms of the MOU, the Company and the Bank have agreed that the Company will not, without prior written approval of the Reserve Bank and the Bureau, (a) declare or pay dividends of any kind, or make any payments on the Company’s trust preferred securities; (b) incur or guarantee any debt; or (c) purchase or redeem any shares of the Company’s stock. In addition, under the MOU the Company and the Bank have agreed to review and revise the allowance for loan and lease losses methodology (“ALLL”), and on a quarterly basis submit to the Reserve Bank and the Bureau a copy of the internally calculated ALLL worksheet. The boards of directors of the Company and the Bank will submit quarterly written progress reports to the Reserve Bank and the Bureau detailing the actions taken (and related results) to achieve and/or maintain compliance with the provisions of the MOU.

Management believes, as of September 30, 2013, that the Company and Bank are in full or substantial compliance with the terms of the MOU.

See Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” under the heading “Capital Management and Regulatory Agreements” for more information on the Company’s efforts to comply with the terms of the MOU.

Note 15. Accumulated Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) for the nine months ended September 30, 2013 and 2012 are summarized as follows:

	Unrealized Securities Gains (Losses)		Adjustments Related to Pension Plan		Accumulated Other Comprehensive Income (Loss)
	(dollars in thousands)
Balance at December 31, 2012	$	1,924	$	(1,488)	$	436
Other comprehensive (loss) before reclassification		(9,055)		-		(9,055)
Reclassification adjustment for gains included in net (loss)		(346)		-		(346)
Net current period other comprehensive (loss)		(9,401)		-		(9,401)
Balance at September 30, 2013	$	(7,477)	$	(1,488)	$	(8,965)
Balance at December 31, 2011	$	1,495	$	(2,082)	$	(587)
Other comprehensive income before reclassification		2,374		-		2,374
Reclassification adjustment for gains included in net income		(2,309)		-		(2,309)
Net current period other comprehensive income		65		-		65
Balance at September 30, 2012	$	1,560	$	(2,082)	$	(522)

Reclassifications of gains on securities available for sale are reported in the consolidated statements of operations as “Gain on sale of available for sale securities, net” with the corresponding income tax effect being reflected as a component of income tax expense (benefit). During the three and nine months ended September 30, 2013 and 2012, the Company reported a gain on the sale of available for sale securities of $0 and $525 thousand, compared to a gain of $135 thousand and $3.5 million, respectively; the tax effect of these transactions during the three and nine months ended September 30, 2013 and 2012 was $0 and $179 thousand, compared to $46 thousand and $1.2 million, respectively, which was included as a component of income tax expense (benefit).

Note 16. Subsequent Events

On October 21, 2013, the Treasury completed the sale of all 24,000 shares of Series A Preferred Stock held by the Treasury for proceeds of $26.5 million. The Company did not receive any proceeds from the completion of this sale.

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Item 2.Management’s Discussion and Analysis of Financial Condition and Results of Operations

We present management’s discussion and analysis of financial information to aid the reader in understanding and evaluating our financial condition and results of operations.This discussion provides information about the major components of our results of operations, financial condition, liquidity and capital resources.This discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements presented elsewhere in this report and the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in the 2012 Form 10-K.Operating results include those of all our operating entities combined for all periods presented.

The Company provides a broad range of personal and commercial banking services including commercial, consumer and real estate loans.We complement our lending operations with an array of retail and commercial deposit products and fee-based services.Our services are delivered locally by well-trained and experienced bankers, whom we empower to make decisions at the local level, so they can provide timely lending decisions and respond promptly to customer inquiries.Having been in many of our markets for over 100 years, we have established relationships with and an understanding of our customers.We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.

Internet Access to Corporate Documents

Information about the Company can be found on the Company’s investor relations website at http://www.evb.org.The Company posts its annual reports, quarterly reports, current reports, definitive proxy materials and any amendments to those documents as soon as reasonably practicable after they are electronically filed with or furnished to the SEC.All such filings are available at no charge.The information on the Company’s website is not, and shall not be deemed to be, a part of this Quarterly Report on Form 10-Q or incorporated into any other filings the Company makes with the SEC.

Forward Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q that are not historical facts may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act.Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or Board of Directors, including those relating to products or services, the performance or disposition of portions of the Company’s asset portfolio, future changes to the Bank’s branch network, the payment of dividends, the ability to realize deferred tax assets; (iii) statements of future economic performance; (iv) statements regarding the impact of the MOU on our financial condition, operations and capital strategies, including strategies related to payment of dividends on the Company’s outstanding common and preferred stock, to redemption of the Company’s Series A Preferred Stock and to payment of interest on the Company’s outstanding Junior Subordinated Debentures related to the Company’s trust preferred debt; (v) statements regarding the adequacy of the allowance for loan losses; (vi) statements regarding the effect of future sales of investment securities or foreclosed properties; (vii) statements regarding the Company’s liquidity; (viii) statements of management’s expectations regarding future trends in interest rates, real estate values, and economic conditions generally and in the Company’s markets; (ix) statements regarding future asset quality, including expected levels of charge-offs; (x) statements regarding potential changes to laws, regulations or administrative guidance; (xi) statements regarding our 2013 Capital Initiative (discussed in detail under “2013 Capital Initiative and Strategic Initiatives” below) and business initiatives related to the capital initiative; (xii) statements regarding the expected impact of the Company extinguishing certain long-term FHLB advances, including impacts on the Company’s interest expense and net interest margin in future periods; and (xiii) statements of assumptions underlying such statements.Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

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Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements.Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

q	factors that adversely affect our capital and business initiatives (discussed in detail under “2013 Capital Initiative and Strategic Initiatives” below), including, without limitation, changes in market conditions that adversely affect our ability to dispose of or work out assets adversely classified by us on advantageous terms or at all;
q	our ability and efforts to assess, manage and improve our asset quality;
q	the strength of the economy in our target market area, as well as general economic, market, political, or business factors;
q	changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries, decline in real estate values in our markets, or in the repayment ability of individual borrowers or issuers;
q	the effects of our adjustments to the composition of our investment portfolio;
q	the impact of government intervention in the banking business;
q	an insufficient allowance for loan losses;
q	our ability to meet the capital requirements of our regulatory agencies;
q	changes in laws, regulations and the policies of federal or state regulators and agencies, including rules to implement the Basel III capital framework and for calculating risk weighted assets;
q	adverse reactions in financial markets related to the budget deficit of the United States government or to government borrowing that approaches the national debt limit;
q	changes in the interest rates affecting our deposits and our loans;
q	the loss of any of our key employees;
q	changes in our competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and our ability to compete effectively against other financial institutions in our banking markets;
q	our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth;
q	changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services;
q	our ability to maintain internal control over financial reporting;
q	our ability to raise capital as needed by our business;
q	our reliance on secondary sources, such as FHLB advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet our liquidity needs;
q	the MOU and the terms thereof;
q	possible changes to our Board of Directors, including in connection with the private placements and deferred dividends on our Series A Preferred stock; and
q	other circumstances, many of which are beyond our control.

All of the forward-looking statements made in this report are qualified by these factors, and there can be no assurance that the actual results anticipated by the Company will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, the Company or its business or operations.The reader should refer to risks detailed under Item 1A. “Risk Factors” included in the 2012 Form 10-K and under Part II, Item 1A. “Risk Factors” included in the June 30, 2013 Form 10-Q and in this Form 10-Q and otherwise included in our periodic and current reports filed with the SEC for specific factors that could cause our actual results to be significantly different from those expressed or implied by our forward-looking statements.

We caution the reader that the above list of important factors is not all inclusive.These forward-looking statements are made as of the date of this report, and we may not undertake steps to update these forward-looking statements to reflect the impact of any circumstances or events that arise after the date the forward-looking statements are made.

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Critical Accounting Policies

The preparation of financial statements requires us to make estimates and assumptions.Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.

Allowance for Loan Losses

The Company establishes the allowance for loan losses through charges to earnings in the form of a provision for loan losses.Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely.Subsequent recoveries of losses previously charged against the allowance are credited to the allowance.The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible.Our judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses.This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available.For more information see the section titled “Asset Quality” within this Item 2.

Impairment of Loans

The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due, according to the contractual terms of the loan agreement.The Company does not consider a loan impaired during a period of insignificant payment shortfalls if we expect the ultimate collection of all amounts due.Impairment is measured on a loan by loan basis for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent.Large groups of smaller balance homogeneous loans, representing consumer, one to four family residential first and seconds and home equity lines, are collectively evaluated for impairment.The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment.Troubled debt restructurings (“TDRs”) are also considered impaired loans.A TDR occurs when the Company, for economic or legal reasons related to the borrower’s financial condition, grants a concession (including, without limitation, rate reductions to below-market rates, payment deferrals, forbearance and, in some cases, forgiveness of principal or interest) to the borrower that it would not otherwise consider.For more information see the section titled “Asset Quality” within Item 2.

Impairment of Securities

Impairment of securities occurs when the fair value of a security is less than its amortized cost.For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Company intends to sell the security or (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis.If, however, the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security.If there is no credit loss, there is no other-than-temporary impairment.If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.For equity securities, impairment is considered to be other-than-temporary based on the Company’s ability and intent to hold the investment until a recovery of fair value.Other-than-temporary impairment of an equity security results in a write-down that must be included in net income.The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the Company’s best estimate of the present value of cash flows expected to be collected from debt securities, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.

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Other Real Estate Owned

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at the lower of cost or estimated fair market value of the property, less estimated disposal costs, if any.Any excess of cost over the estimated fair market value less costs to sell at the time of acquisition is charged to the allowance for loan losses.The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings.

Goodwill

Goodwill is not amortized but is subject to impairment tests on at least an annual basis or earlier whenever an event occurs indicating that goodwill may be impaired.In assessing the recoverability of the Company’s goodwill, all of which was recognized in connection with the acquisition of branches in 2003 and 2008, we must make assumptions in order to determine the fair value of the respective assets.Major assumptions used in the impairment analysis were discounted cash flows, merger and acquisition transaction values (including as compared to tangible book value), and stock market capitalization.The Company completed the annual goodwill impairment test during the fourth quarter of 2012 and determined there was no impairment to be recognized in 2012.If the underlying estimates and related assumptions change in the future, the Company may be required to record impairment charges.

Retirement Plan

The Company has historically maintained a defined benefit pension plan.Effective January 28, 2008, the Company took action to freeze the plan with no additional contributions for a majority of participants.Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan.No additional participants have been added to the plan.The plan was again amended on February 28, 2011, to freeze the plan with no additional contributions for grandfathered participants.Benefits for all participants have remained frozen in the plan since such action was taken.Effective January 1, 2012, the plan was amended and restated as a cash balance plan.Under a cash balance plan, participant benefits are stated as an account balance.An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan.Each participant’s account will be credited with an “interest” credit each year.The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year.Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations.The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions.Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases.Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.

Accounting for Income Taxes

Determining the Company’s effective tax rate requires judgment.In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain.In addition, the Company’s tax returns are subject to audit by various tax authorities.Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.

The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed.For more information, see Item 1. “Financial Statements,” under the heading “Note 4. Deferred Income Taxes” in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2013 and Item 8. “Financial Statements and Supplementary Data,” under the heading “Note 1. Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

For further information concerning accounting policies, refer to Item 8. “Financial Statements and Supplementary Data,” under the heading “Note 1. Summary of Significant Accounting Policies” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

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Executive Overview

Eastern Virginia Bankshares, Inc. is committed to delivering strong long-term earnings using a prudent allocation of capital, in business lines where we have demonstrated the ability to compete successfully.During the first nine months of 2013, the national and local economies continued to show limited signs of recovery with the main challenges continuing to be persistent unemployment above historical levels and uneven economic growth.Macro-economic and political issues continue to temper the global economic outlook and as such the Company remains cautiously optimistic regarding the limited signs of improvement seen in our local markets.Despite this, the Company believes that our local markets are poised for stronger growth in the coming months and years than the economic recovery has provided in our markets in recent periods.During the first nine months of 2013, the Company has continued to focus on asset quality and strengthening its balance sheet as it believes these areas are critical to its success in the near term.During 2013, the Company successfully executed on several of its previously disclosed strategic initiatives, including the closing of the private placements with certain institutional investors that raised approximately $45.0 million in aggregate gross proceeds, the closing of the rights offering to existing shareholders that raised approximately $5.0 million in aggregate gross proceeds, the accelerated resolution and disposition of adversely classified assets, the prepayment of higher rate long-term FHLB advances, and the termination of the formal written agreement with the Reserve Bank and the Bureau.Although the Company recorded a net loss during the third quarter and first nine months of 2013 primarily due to the prepayment penalties on the extinguished FHLB advances, this transaction immediately improves the Company’s financial position by eliminating a high cost source of funding, thus improving the Company’s net interest margin in future periods, and is a critical step in the Company’s strategic progression towards optimizing its balance sheet.Asset quality continues to improve, as the current interest rate environment, although elevated since the second quarter of 2013, continues to negatively impact our margins by driving lower yields on our loan portfolio.During the first nine months of 2013, the Company was able to reduce its nonperforming assets by 54.5% and its classified assets by 26.4%.As a result of the Company’s focus on this strategic plan, loan and asset quality metrics continue to improve as evidenced by end of quarter nonperforming loans to total loans of 0.96% and nonperforming assets to total assets of 0.73%.In addition, the Company’s allowance for loan losses continues to remain strong at quarter end producing a ratio of allowance for loan losses to nonperforming loans of 265.95% and a ratio of allowance for loan losses to total loans of 2.55%.Throughout the balance of 2013 and into 2014, the Company plans to continue evaluating and implementing deliberate strategies to strengthen its financial condition and look forward to future growth and opportunities to further increase the value of its franchise.

2013 Capital Initiative and Strategic Initiatives

On June 12, 2013, the Company closed on its previously disclosed private placements (the “Private Placements”) with certain institutional investors which raised aggregate gross proceeds of $45.0 million through Private Placements of approximately 4.6 million shares of common stock and 5.2 million shares of Series B Preferred Stock each at $4.55 per share.For more information, see Item 1. “Financial Statements,” under the heading “Note 11.Preferred Stock and Warrant.”

On July 5, 2013, the Company closed on its previously disclosed rights offering (the “Rights Offering”) to existing shareholders which raised aggregate gross proceeds of $5.0 million through the issuance of 1,098,897 shares of common stock.After issuing these newly subscribed common shares, the Company had approximately 11.8 million total common shares outstanding.

The Company intends to use the gross proceeds from the 2013 Capital Initiative (consisting of the Private Placements and Rights Offering) for general corporate purposes, including strengthening its balance sheet, the accelerated resolution and disposition of assets adversely classified by the Company (consisting of other real estate owned and classified loans), the optimization of the Company’s balance sheet through the restructuring of FHLB advances and the eventual repurchase of the Series A Preferred Stock that was issued to Treasury through TARP, subject to regulatory approval.During the third quarter of 2013, the Company successfully executed on several of its previously disclosed strategic initiatives by prepaying $107.5 million of its long-term FHLB advances and accelerating the resolution and disposition of adversely classified assets.The extinguishment of the higher rate long-term FHLB advances triggered an $11.5 million prepayment penalty that we fully recognized during the third quarter of 2013.On October 21, 2013 the Treasury sold all 24,000 shares of Series A Preferred Stock held by Treasury.During the remainder of 2013 the Company also plans to focus on online and mobile banking options offered to the Bank’s customers, including by introducing or improving the Bank’s portfolio of internet and mobile banking products and services.As the Company executes these business strategies, senior management and the board of directors will continue to evaluate other initiatives that they believe will best position the Company for long-term success.

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Summary of 2013 Year to Date Operating Results and Financial Condition

During the nine months ended September 30, 2013, net loss was ($4.9) million, a decrease of $7.4 million over net income of $2.5 million for the same period of 2012.The net loss year-to-date is primarily due to an $11.5 million prepayment penalty on the extinguishment of $107.5 million in higher rate long-term FHLB advances as discussed in the previous paragraphs.Although the Company expects its net interest margin to improve following the payoff of its long-term FHLB advances, earnings remain constrained due to the protracted low-interest rate environment, lingering credit quality issues and a lack of loan demand resulting from the challenging economic climate, all of which contribute to compressing the Company’s net interest margin.The Company had another strong quarter liquidating its troubled assets, reducing its classified assets and improving its overall asset quality.The Company continues to be aggressive in the liquidation of troubled assets and that approach is evident with the overall reduction as of September 30, 2013 of nonperforming assets by 54.5% compared to December 31, 2012 and 61.1% compared to September 30, 2012 through a combination of successful workouts and write-downs of previously identified impaired loans.The Company’s Special Assets Division, which was formed in the second quarter of 2011 and works closely with our Executive Management Asset Quality Committee, has worked tirelessly in formulating workout strategies and conducting asset dispositions.Despite our aggressive approach in liquidating troubled assets, the Company’s allowance for loan losses remains healthy, producing a ratio of allowance for loan losses to nonperforming loans of 265.95% at September 30, 2013 compared to 171.29% at December 31, 2012.Additionally, the Company was able to reduce its ratio of nonperforming loans to total loans at September 30, 2013 to 0.96%, compared to 1.73% at December 31, 2012 while also reducing its ratio of nonperforming assets to total assets at September 30, 2013 to 0.73%.With an economic outlook consisting of modest growth, elevated unemployment and low interest rates in the near term, the Company continues to believe the primary drivers behind our continued improvement include focusing on asset quality issues, containing noninterest expenses and lowering our cost of funding while maintaining adequate levels of liquidity, reserves for credit losses and capital.

The primary drivers for the Company’s results for the nine months ended September 30, 2013 were the $11.5 million prepayment penalty on the payoff of long-term FHLB advances, the overall compression of its margins, the elevated levels of the provision for loan losses over historical levels, the elevated levels of FDIC insurance premiums over historical levels, professional and collection/repossession expenses related to past due loans and nonperforming assets and losses on the sale of and valuation adjustments on other real estate owned.Sales of available for sale securities to adjust the composition of the Company’s investment portfolio during the first nine months of 2013 generated gains of $525 thousand, a significant decrease from gains of $3.5 million during the first nine months of 2012.The Company experienced a decrease in the amount of net charge-offs during the first nine months of 2013 when compared to the same period in 2012, while the provision for loan losses during the first nine months of 2013 was down approximately 67.6% from the same period of 2012.This was due to improvements in some of the Company’s credit quality metrics, including continued decreases in the level of past due loans and nonperforming assets, and other factors, which are reflective of slowly improving economic conditions.Although the amount of provision declined, the Company’s provision for loan losses remains elevated compared to historical levels as we continue to experience historically high levels of nonperforming assets and charge-offs and aim to maintain an appropriate allowance for potential future loan losses.The Company believes the investments it has made since 2010 to reduce nonperforming assets and enhance our internal monitoring systems will significantly enhance the long-term credit quality of our loan portfolio and properly position us to deliver stronger earnings as we move forward once the economic climate improves.

For the three months ended September 30, 2013, the following key points were significant factors in our reported results:

· Loss of $11.5 million on the extinguishment of $107.5 million in long-term FHLB advances.

· Provision for loan losses of $350 thousand compared to $625 thousand for the same period in 2012.

· Net charge-offs of $1.3 million to write off uncollectible balances on nonperforming assets.

· Decrease in nonperforming assets by $2.1 million during the third quarter of 2013.

· Increase in net interest income by $324 thousand from the same period in 2012.

· Gain of $224 thousand on the sale of our former Bowling Green branch office.

· Impairment losses of $437 thousand related to valuation adjustments on other real estate owned, compared to $769 thousand for the same period in 2012.

· Losses of $668 thousand on the sale of other real estate owned, compared to gains of $12 thousand for the same period in 2012.

· Expenses related to FDIC insurance premiums of $225 thousand, compared to $586 thousand for the same period in 2012.

· Expenses related to collection, repossession and other real estate owned of $195 thousand, compared to $190 thousand for the same period in 2012.

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For the three months ended September 30, 2013 and 2012, the reported net income (loss) of ($6.6) million and $861 thousand, respectively equate to the following performance metrics:

· On net income (loss) available to common shareholders, Annualized Return on Average Assets (ROA) of (2.59%) for the three months ended September 30, 2013 which compares to ROA of 0.18% for the three months ended September 30, 2012.

· On net income (loss) available to common shareholders, Annualized Return on Average Common Shareholders’ Equity (ROE) of (31.51%) for the three months ended September 30, 2013 which compares to ROE of 2.62% for the three months ended September 30, 2012.

· On a per share basis, the diluted and basic income (loss) per common share (EPS) is ($0.60) for the three months ended September 30, 2013 which compares to an EPS of $0.08 for the three months ended September 30, 2012.

For the nine months ended September 30, 2013, the following key points were significant factors in our reported results:

· Loss of $11.5 million on the extinguishment of $107.5 million in long-term FHLB advances.

· Provision for loan losses of $1.6 million compared to $4.8 million for the same period in 2012.

· Net charge-offs of $5.0 million to write off uncollectible balances on nonperforming assets.

· Decrease in nonperforming assets by $9.1 million during the first nine months of 2013.

· Gain on the sale of available for sale securities of $525 thousand resulting from adjustments in the composition of the investment portfolio as part of our overall asset/liability management strategy.

· Decrease in net interest income by $252 thousand from the same period in 2012.

· Gain of $224 thousand on the sale of our former Bowling Green branch office.

· Impairment losses of $580 thousand related to valuation adjustments on other real estate owned, compared to $1.7 million for the same period in 2012.

· Losses of $823 thousand on the sale of other real estate owned, compared to $105 thousand for the same period in 2012.

· Expenses related to FDIC insurance premiums of $1.4 million, compared to $1.8 million for the same period in 2012.

· Expenses related to collection, repossession and other real estate owned of $447 thousand, compared to $845 thousand for the same period in 2012.

For the nine months ended September 30, 2013 and 2012, the reported net income (loss) of ($4.9) million and $2.5 million, respectively equate to the following performance metrics:

· On net income (loss) available to common shareholders, Annualized Return on Average Assets (ROA) of (0.74%) for the nine months ended September 30, 2013 which compares to ROA of 0.18% for the nine months ended September 30, 2012.

· On net income (loss) available to common shareholders, Annualized Return on Average Common Shareholders’ Equity (ROE) of (9.84%) for the nine months ended September 30, 2013 which compares to ROE of 2.56% for the nine months ended September 30, 2012.

· On a per share basis, the diluted and basic income (loss) per common share (EPS) is ($0.72) for the nine months ended September 30, 2013 which compares to an EPS of $0.23 for the nine months ended September 30, 2012.

The Company’s operating results decreased significantly for the nine months ended September 30, 2013, as compared to the same period of 2012, due primarily to the $11.5 million loss on the extinguishment of $107.5 million in long-term FHLB advances.Excluding the loss on extinguishment of debt, the Company’s performance still lags behind its strong earnings history.The Company remains unsatisfied with these financial results and continues to focus on credit quality initiatives.By extinguishing the higher rate long-term FHLB advances during the third quarter of 2013, the Company immediately improved its financial position and future funding costs.Based on data available at September 30, 2013 including costs of other potential funding sources and the size of and expected yield on the Company’s loan portfolio, the Company anticipates eliminating an estimated $4.5 million in annual interest costs related to these extinguished FHLB advances, and improving the Company’s annualized net interest margin by an estimated 65 basis points. The Company believes that these initiatives, in combination with our 2013 Capital Initiative and related business strategies, will ultimately result in an improvement in our asset quality and allow the Company to focus greater resources on growing its franchise and delivering financial results more consistent with its long-term history.As detailed later in this Item 2 under the caption “Asset Quality,” the Company continues to work on the timely resolution of its nonperforming assets but expects that additional charge-offs are likely.However, the Company believes that the loan loss reserves set aside during the first nine months of 2013 should be sufficient to cover its known credit issues under current economic conditions.Any further deterioration of economic conditions or credit quality could possibly require the adjustment of its provision for loan losses to reserve against additional charge-offs.

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Capital Management and Regulatory Agreements

As we first reported in our Quarterly Report on Form 10-Q for March 31, 2011, the Company has taken actions to preserve capital by deferring its regular quarterly cash dividend with respect to its Series A Fixed Rate Cumulative Perpetual Preferred Stock (the “Series A Preferred Stock”) which the Company originally issued to the United States Department of Treasury (the “Treasury”) in connection with the Company’s participation in the Treasury’s Capital Purchase Program in January 2009.On August 15, 2013, the Company deferred its eleventh consecutive dividend on the Series A Preferred Stock.As of September 30, 2013, the Company had accumulated $3.3 million for dividends on the Series A Preferred Stock.On October 21, 2013, the Treasury sold all 24,000 shares of Series A Preferred Stock held by Treasury. The Company has notified holders that it is deferring the November 15, 2013 dividend on the Series A Preferred Stock.In addition, because dividends on the Series A Preferred Stock have not been paid for more than six quarters, the authorized number of directors on the Company’s Board of Directors has increased by two, and the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board of Directors at the next annual meeting (or a special meeting called for that purpose) and each annual meeting until all owed and unpaid dividends on the Series A Preferred Stock have been paid.To date the holders of the Series A Preferred Stock have not yet exercised this right.

Subject to certain exceptions and limitations, the Company is permitted to elect from time to time to defer regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities.If the Company defers interest payments on the Junior Subordinated Debentures for more than 20 consecutive quarters, the Company would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable.During the second quarter of 2011, the Company began deferring its regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities.While the interest expense associated with this source of regulatory capital continues to be reflected in the Company’s earnings, the deferred payments represent a subordinated liability to other creditors of the Company.As of September 30, 2013, the Company has deferred ten quarterly payments totaling $887 thousand for interest on the Junior Subordinated Debentures.

The actions to suspend and defer dividend and interest payments to preserve capital, while difficult, are necessary to ensure the financial strength of the Company.Despite the Company’s significant challenges over the last several years, the Company has maintained its regulatory well capitalized status and it believes that maintaining this status is critically important for the long-term value of the Company.As economic conditions improve, and as the Company is able to generate earnings to support its current and future capital needs, the Company plans to restore dividends on its common stock and Series A and Series B Preferred Stock, as well as interest payments on its Junior Subordinated Debentures.

As previously disclosed, on February 17, 2011, the Company and the Bank entered into a Written Agreement with the Reserve Bank and the Bureau.The purpose of this agreement was to formally document the common goal of the Company, the Bank and the regulatory agencies to maintain the financial soundness of the Company and the Bank.This agreement contained many of the steps that the Company had already initiated during 2010 and 2011 to address its deteriorating asset quality and associated challenges brought on during the economic recession.The Written Agreement was terminated on July 30, 2013.On September 5, 2013, the Company and the Bank entered into a MOU with the Reserve Bank and the Bureau.For additional information, see Note 14 – Regulatory Agreements to the Company’s interim consolidated financial statements in Part I, Item 1. “Financial Statements” of this Quarterly Report on Form 10-Q.

The Company will continue to evaluate its capital management strategies during the remainder of 2013, including as related to executing the 2013 Capital Initiative and related strategic initiatives and deploying proceeds of the 2013 Capital Initiative.

Basel III Final Rules

In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and for calculating risk-weighted assets, as modified by the U.S. federal bank regulators (the “Basel III Capital Rules”).The Basel III Capital Rules are effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain portions of the new rules).

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The Basel III Capital Rules, among other things, (i) introduce a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 Capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most deductions/adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the deductions/adjustments from capital as compared to existing regulations, and particularly as applied to CET1.

Under the Basel III Capital Rules, the initial minimum capital and leverage ratios as of January 1, 2015 will be as follows: 4.5% CET1 to risk-weighted assets; 6.0% Tier 1 capital to risk-weighted assets; 8.0% Total capital to risk-weighted assets; and 4.0% Tier 1 capital to average assets.

In addition to raising minimum capital and leverage ratios, the Basel III Capital Rules also establish a capital conservation buffer that is designed to absorb losses during periods of economic stress. The capital conservation buffer will be phased in from January 1, 2016 to January 1, 2019 in equal annual installments, and when fully implemented the capital conservation buffer will effectively add 2.5% to each of the minimum capital ratios.Banking institutions with a ratio of CET1 to risk-weighted assets above the minimum but below the capital conservation buffer will face constraints on dividends, equity repurchases and compensation based on the amount of the shortfall.

With respect to the Bank, the Basel III Capital Rules also revise the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act, by (i) introducing a CET1 ratio requirement at each level (other than critically undercapitalized), with the required CET1 ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum Tier 1 capital ratio for well-capitalized status being 8% (as compared to the current 6%); and (iii) eliminating the current provision that provides that a bank with a composite supervisory rating of 1 may have a 3% leverage ratio and still be adequately capitalized. The Basel III Capital Rules do not change the total risk-based capital requirement for any prompt corrective action category.

The Basel III Capital Rules prescribe a standardized approach for risk weightings that expand the risk-weighting categories from the current four Basel I-derived categories (0%, 20%, 50% and 100%) to a much larger and more risk-sensitive number of categories, depending on the nature of the assets, generally ranging from 0% for U.S. government and agency securities, to 600% for certain equity exposures, and resulting in higher risk weights for a variety of asset categories.In particular, the Basel III Capital Rules increase risk weights that apply to past-due exposures and high volatility commercial real estate loans.

For a discussion of the risks posed by the Basel III Capital Rules, see Part II, Item 1A. “Risk Factors” of the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2013.

Results of Operations

As discussed under the caption “Executive Overview” above, the Company’s results of operations for the three and nine months ended September 30, 2013 were primarily driven by the $11.5 million prepayment penalty on the extinguishment of $107.5 million in higher rate long-term FHLB advances during August 2013, the maturity of a $10.0 million higher rate long-term FHLB advance during September 2013, the overall compression of its margins, as yields decreased on loans, the largest segment of earning assets, the elevated level of the provision for loan losses and FDIC insurance premiums over historical amounts, gains generated by sales of available for sale securities, professional and collection/repossession expenses related to past due loans and nonperforming assets, and losses on the sale of and valuation adjustments on other real estate owned.Credit quality continues to receive significant management attention to ensure that we continue to identify credit problems and improve the quality of our asset portfolio, with reduced levels of nonperforming assets from December 31, 2011 to September 30, 2013 demonstrating our positive asset quality progress.The Company remains diligent and focused on the management of our credit quality and is fully committed to quickly and aggressively addressing our problem credits.Additional analysis and breakout of our nonperforming assets are presented later in this Item 2 under the caption “Asset Quality”.The remainder of this analysis discusses the results of operations under the component sections of net interest income and net interest margin, noninterest income, noninterest expense and income taxes.

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Net Interest Income and Net Interest Margin

Net interest income, the fundamental source of the Company’s earnings, is defined as the difference between income on earning assets and the cost of funds supporting those assets.Significant categories of earning assets are loans and investment securities, while deposits and long-term borrowings represent the major portion of interest bearing liabilities.The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operations and the yield of our interest earning assets compared to our cost of funding these assets.

Table 1 presents the average interest earning assets and average interest bearing liabilities, the average yields earned on such assets (on a tax equivalent basis) and rates paid on such liabilities, and the net interest margin for the three and nine months ended September 30, 2013 and 2012.

For comparative purposes, income from tax-exempt securities is adjusted to a tax-equivalent basis using the federal statutory tax rate of 34% and adjusted by the Tax Equity and Fiscal Responsibility Act (“TEFRA”) adjustment.This latter adjustment is for the disallowance as a deduction of a portion of total interest expense related to the ratio of average tax-exempt securities to average total assets.By making these adjustments, tax-exempt income and their yields are presented on a comparable basis with income and yields from fully taxable earning assets.The net interest margin is calculated by expressing tax-equivalent net interest income as a percentage of average interest earning assets, and represents the Company’s net yield on its earning assets. Net interest margin is an indicator of the Company’s effectiveness in generating income from its earning assets. The net interest margin is affected by the structure of the balance sheet as well as by competitive pressures, Federal Reserve Board policies and the economy. The spread that can be earned between interest earning assets and interest bearing liabilities is also dependent to a large extent on the slope of the yield curve, which in recent periods has been significantly impacted by initiatives of the Federal Reserve Board intended to depress long-term interest rates.

Net interest income, on a fully tax equivalent basis, increased $406 thousand or 4.8% to $8.8 million for the three months ended September 30, 2013, up from $8.4 million for the three months ended September 30, 2012.Total average earning assets decreased $6.4 million or 0.6% from $995.3 million for the three months ended September 30, 2012 to $988.9 million for the same period of 2013.Total average interest-bearing liabilities decreased $38.9 million or 4.6% from $841.2 million for the three months ended September 30, 2012 to $802.3 million for the same period of 2013.The increase in net interest income was impacted by the change in the mix and pricing of the balance sheet components including the impacts of declining loan balances, increased short term investments and decreasing yields on the Company’s loan portfolio, and partially offset by the Company’s expansion of its investment portfolio funded by excess liquidity and increasing yields on its investment portfolio driven by rebalancing efforts.The impact of these changes was offset by decreases to the cost of all categories of interest-bearing liabilities.These shifts resulted in an increase of 18 basis points in our net interest margin from 3.36% for the three months ended September 30, 2012 to 3.54% for the same period of 2013.The percentage of average earning assets to total average assets decreased slightly to 92.1% for the three months ended September 30, 2013, as compared to 93.6% for the same period of 2012.

Total interest income, on a fully tax equivalent basis, decreased $595 thousand from $11.2 million for the three months ended September 30, 2012 to $10.6 million for the same period of 2013.This was driven by a decline in the yield on average earning assets from 4.49% for the three months ended September 30, 2012 to 4.27% for the same period of 2013.The decreased yield on average earning assets was primarily the result of reduced yields on the loan portfolio, a significant decrease in average loan balances and a significant increase in average short term investments partially offset by higher average balances and yields on investment securities.

Average total loan balances decreased $45.1 million from $713.1 million for the three months ended September 30, 2012 to $668.0 million for the same period of 2013.The yield on loans decreased to 5.30% for the third quarter of 2013 compared to 5.57% for the same period of 2012.This resulted in a $1.1 million drop in interest income generated by our largest earning asset category from the prior year’s income level to $8.9 million for the quarter ended September 30, 2013 compared to $10.0 million for the same period of 2012.Interest income generated by the loan portfolio decreased due to weak loan demand in our markets as a result of the continuing challenging economic conditions, adjustments to our variable rate loans in the low interest rate environment, charge-offs, payment curtailments on outstanding loans and the sale of our credit card portfolio in September 2012.In addition, due to the historically low interest rate environment, although slightly rising beginning in the latter portion of the second quarter of 2013 and into the third quarter of 2013, and intensified loan competition in our markets, loans are being originated at much lower yields which has contributed significantly to lower yields on the loan portfolio.

Average investment security balances increased $12.2 million from $266.2 million for the three months ended September 30, 2012 to $278.4 million for the same period of 2013.The yield on investment securities increased 54 basis points from 1.86% for the third quarter of 2012 to 2.40% for the third quarter of 2013.The higher yield resulted from investment portfolio restructurings, accelerated prepayments on our Agency mortgage-backed and Agency CMO securities, principally due to the low rate environment and incentives for homeowners to refinance higher-rate mortgages, in the prior period compared to the current period, and our decision to invest in the second quarter of 2013 in higher yielding, longer duration municipal securities.Average taxable investment securities decreased $11.9 million from the third quarter of 2012 to the third quarter of 2013 and the yield on taxable investment securities increased from 1.79% for the three months ended September 30, 2012 to 2.13% for the same period of 2013, an increase of 34 basis points.Average tax exempt investment securities increased $26.3 million from the third quarter of 2012 to the third quarter of 2013 and the yield on tax exempt investment securities decreased from 4.51% for the three months ended September 30, 2012 to 4.13% for the same period of 2013, a drop of 38 basis points.

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In addition to deploying excess liquidity into the investment securities portfolio, we also deploy a portion of our excess funds into short term investments.Average interest bearing deposits in other banks increased $26.6 million from $15.8 million for the third quarter of 2012 to $42.4 million for the same period of 2013, and average federal funds sold decreased $32 thousand to $101 thousand during the third quarter of 2013 compared to $133 thousand for the same period of 2012.This increase in excess funds was due to the overall increase in our average total deposits and difficulty strategically deploying excess liquidity (including proceeds from the Private Placements and Rights Offering) in the low interest rate environment including difficulty funding new loans to creditworthy borrowers and identifying investment securities with suitable rates of return.In total, our average excess funds increased $26.6 million from the third quarter of 2012 to the third quarter of 2013.

Average interest-bearing deposits decreased $906 thousand from $708.2 million for the third quarter of 2012 to $707.3 million for the third quarter of 2013.Changes within the mix of these balances and the corresponding decrease in the rates paid on deposits were significant drivers for the reduction in interest expense in the third quarter of 2013 related to interest-bearing deposits and helped to partially offset the contemporaneous decrease in our interest income.Our overall cost of funds decreased $1.0 million from the third quarter of 2012 to the third quarter of 2013, due to the prepayment of $107.5 million in higher rate long-term borrowings during August 2013, the maturity of a $10.0 million higher rate long-term borrowing during September 2013 and the total rate for average interest-bearing deposits decreasing from 0.85% for the three months ended September 30, 2012 to 0.63% for the same period of 2013, a drop of 22 basis points.Retail deposits continued to shift from higher priced certificates of deposit to lower priced checking (or “NOW” accounts) and savings accounts.The largest increase from the third quarter of 2012 to the same period of 2013 was in our NOW accounts with an increase of $16.7 million in average balance and a corresponding rate decrease of 16 basis points from 0.52% to 0.36% from the third quarter of 2012 to the third quarter of 2013.Our savings deposits had an increase of $4.9 million in average balance and a corresponding rate decrease of 16 basis points from 0.30% to 0.14% for the same periods.Average large dollar certificates of deposit decreased $11.5 million from $130.6 million during the third quarter of 2012 to $119.1 million during the third quarter of 2013 and the rate dropped 29 basis points from 1.56% in the third quarter of 2012 to 1.27% for the same period of 2013.The average balance of other certificates of deposit declined $12.4 million from $142.3 million during the third quarter of 2012 to $129.9 million for the same period of 2013, with a simultaneous 31 basis point drop in rate from 1.42% in the third quarter of 2012 to 1.11% for the same period of 2013.Average short-term borrowings increased $20.8 million from $886 thousand during the third quarter of 2012 to $21.6 million during the third quarter of 2013 and the rate fell 23 basis points from 0.45% in the third quarter of 2012 to 0.22% for the same period of 2013.The average balance of long-term borrowings decreased $57.9 million from $117.5 million during the third quarter of 2012 to $59.6 million during the third quarter of 2013 and had a corresponding rate decrease of 8 basis points from 4.06% to 3.98% for the same periods.

Net interest income, on a fully tax equivalent basis, decreased $245 thousand or 1.0% to $25.1 million for the nine months ended September 30, 2013, down from $25.3 million for the nine months ended September 30, 2012.Total average earning assets increased $9.9 million or 1.0% from $998.1 million for the nine months ended September 30, 2012 to $1.0 billion for the same period of 2013.Total average interest-bearing liabilities decreased $12.5 million or 1.5% from $850.2 million for the nine months ended September 30, 2012 to $837.7 million for the same period of 2013.The decrease in net interest income was driven by the change in the mix and pricing of the balance sheet components including the impact of declining loan balances, increased short term investments and decreasing yields on the Company’s loan portfolio and was partially offset by the Company’s expansion of its investment portfolio funded by excess liquidity and higher rates earned on the aggregate investment portfolio.The impact of these changes was partially offset by decreases to the cost of all categories of interest-bearing liabilities.These shifts resulted in a decrease of 6 basis points in our net interest margin from 3.39% for the nine months ended September 30, 2012 to 3.33% for the same period of 2013.The percentage of average earning assets to total average assets decreased slightly to 93.0% for the nine months ended September 30, 2013, as compared to 93.6% for the same period of 2012.

Total interest income, on a fully tax equivalent basis, decreased $2.3 million from $34.3 million for the nine months ended September 30, 2012 to $32.0 million for the same period of 2013.This was driven by a decline in the yield on average earning assets from 4.58% for the nine months ended September 30, 2012 to 4.24% for the same period of 2013, and partially offset by a increase in average earning assets over the same period.The decreased yield on average earning assets was primarily the result of reduced yields on the loan portfolio, a significant decrease in average loan balances and a significant increase in average short term investments partially offset by higher average balances and yields on investment securities.

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Average total loan balances decreased $48.2 million from $720.4 million for the nine months ended September 30, 2012 to $672.2 million for the same period of 2013.The yield on loans decreased to 5.36% for the first nine months of 2013 compared to 5.58% for the same period of 2012.This resulted in a $3.2 million drop in interest income generated by our largest earning asset category from the prior year’s income level to $26.9 million for the nine months ended September 30, 2013 compared to $30.1 million for the same period of 2012.Interest income generated by the loan portfolio decreased due to weak loan demand in our markets as a result of the continuing challenging economic conditions, adjustments to our variable rate loans in the low interest rate environment, charge-offs, payment curtailments on outstanding loans and the sale of our credit card portfolio in September 2012.

Average investment security balances increased $26.1 million from $259.1 million for the nine months ended September 30, 2012 to $285.2 million for the same period of 2013. The yield on investment securities increased to 2.31% for the first nine months of 2013 compared to 2.13% for the same period of 2012.Average taxable investment securities increased $23.9 million from the first nine months of 2012 to the first nine months of 2013 and the yield on taxable investment securities increased from 1.89% for the nine months ended September 30, 2012 to 2.11% for the same period of 2013, an increase of 22 basis points.Average tax exempt investment securities increased $3.3 million from the first nine months of 2012 to the first nine months of 2013 and the yield on tax exempt investment securities decreased from 4.52% for the nine months ended September 30, 2012 to 3.98% for the same period of 2013, a drop of 54 basis points.

Average interest bearing deposits in other banks increased approximately $32.0 million from $18.4 million for the first nine months of 2012 to $50.4 million for the same period of 2013, while average federal funds sold decreased $63 thousand to $189 thousand during the first nine months of 2013 compared to $252 thousand for the same period of 2012.This increase in excess funds was due to the difficulty in the low rate environment of strategically deploying excess liquidity (including proceeds from the Private Placements and Rights Offering) including difficulty funding new loans to creditworthy borrowers and identifying investment securities with suitable rates of return.In total, our average excess funds increased $32.0 million from the first nine months of 2012 to the first nine months of 2013.

Average interest-bearing deposits increased $61 thousand from $718.6 million for the first nine months of 2012 to $718.7 million for the first nine months of 2013.Changes within the mix of these balances and the corresponding decrease in the rates paid on deposits were significant drivers for the reduction in interest expense in the first nine months of 2013 related to interest-bearing deposits and helped to partially offset the contemporaneous decrease in our interest income.Our overall cost of funds decreased approximately $2.1 million from the first nine months of 2012 to the same period of 2013, due to the prepayment of $107.5 million in higher rate long-term borrowings during August 2013, the maturity of a $10.0 million higher rate long-term borrowing during September 2013 and the total rate for average interest-bearing deposits decreasing from 0.94% for the nine months ended September 30, 2012 to 0.67% for the same period of 2013, a drop of 27 basis points.Retail deposits continued to shift from higher priced certificates of deposit to lower priced NOW and savings accounts.The largest increase from the first nine months of 2012 to the same period of 2013 was in our NOW accounts with an increase of $19.6 million in average balance and a corresponding rate decrease of 18 basis points from 0.56% to 0.38% from the first nine months of 2012 to the same period of 2013.Our savings deposits had an increase of $5.2 million in average balance and a corresponding rate decrease of 14 basis points from 0.30% to 0.16% for the same periods.Our average money market savings accounts had a decrease of $580 thousand and a corresponding rate decrease of 9 basis points from 0.51% to 0.42% for the same periods.Average large dollar certificates of deposit decreased $7.3 million from $132.5 million during the first nine months of 2012 to $125.2 million during the first nine months of 2013 and the rate dropped 38 basis points from 1.70% in the first nine months of 2012 to 1.32% for the same period of 2013.The average balance of other certificates of deposit declined $16.8 million from $147.6 million during the first nine months of 2012 to $130.8 million for the same period of 2013, with a simultaneous 38 basis point drop in rate from 1.58% in the first nine months of 2012 to 1.20% for the same period of 2013.Average short-term borrowings increased $6.9 million from $425 thousand during the first nine months of 2012 to $7.3 million for the same period of 2013, and the rate dropped 9 basis points from 0.31% in the first nine month of 2012 to 0.22% for the same period of 2013.The average balance of long-term borrowings decreased $19.5 million from $117.5 million during the first nine months of 2012 to $98.0 million for the same period of 2013, with a slight rate decrease of 2 basis points from 4.06% during the first nine months of 2012 to 4.04% for the same period of 2013.

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Table 1:Average Balance Sheet and Net Interest Margin Analysis

(dollars in thousands) 

	Three Months Ended September 30,
	2013						2012
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate (1)		Balance		Expense		Rate (1)
Assets:
Securities
Taxable, available for sale	$	241,757	$	1,296	2.13	%	$	253,626	$	1,140	1.79	%
Restricted securities		7,323		83	4.50	%		9,609		72	2.98	%
Tax exempt, available for sale (2)		29,312		305	4.13	%		3,001		34	4.51	%
Total securities		278,392		1,684	2.40	%		266,236		1,246	1.86	%
Interest bearing deposits in other banks		42,433		35	0.33	%		15,797		6	0.15	%
Federal funds sold		101		-	0.00	%		133		-	0.00	%
Loans, net of unearned income (3)		668,011		8,926	5.30	%		713,125		9,988	5.57	%
Total earning assets		988,937		10,645	4.27	%		995,291		11,240	4.49	%
Less allowance for loan losses		(17,935)						(22,938)
Total non-earning assets		102,747						90,782
Total assets	$	1,073,749					$	1,063,135
Liabilities & Shareholders' Equity:
Interest-bearing deposits
Checking	$	247,634	$	225	0.36	%	$	230,979	$	302	0.52	%
Savings		91,076		31	0.14	%		86,207		65	0.30	%
Money market savings		119,536		117	0.39	%		118,133		133	0.45	%
Large dollar certificates of deposit (4)		119,106		380	1.27	%		130,564		512	1.56	%
Other certificates of deposit		129,917		365	1.11	%		142,292		508	1.42	%
Total interest-bearing deposits		707,269		1,118	0.63	%		708,175		1,520	0.85	%
Federal funds purchased and     repurchase agreements		3,578		5	0.55	%		4,334		10	0.92	%
Short-term borrowings		21,637		12	0.22	%		886		1	0.45	%
Long-term borrowings		59,554		597	3.98	%		117,500		1,200	4.06	%
Trust preferred debt		10,310		89	3.42	%		10,310		91	3.51	%
Total interest-bearing liabilities		802,348		1,821	0.90	%		841,205		2,822	1.33	%
Noninterest-bearing liabilities
Demand deposits		130,984						117,041
Other liabilities		6,455						6,933
Total liabilities		939,787						965,179
Shareholders' equity		133,962						97,956
Total liabilities and shareholders' equity	$	1,073,749					$	1,063,135
Net interest income (2)			$	8,824					$	8,418
Interest rate spread (2)(5)					3.37	%					3.16	%
Interest expense as a percent of     average earning assets					0.73	%					1.13	%
Net interest margin (2)(6)					3.54	%					3.36	%

Notes:

(1)	Yields are annualized and based on average daily balances.
(2)	Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%, with a $93 adjustment for 2013 and a $11 adjustment in 2012.
(3)	Nonaccrual loans have been included in the computations of average loan balances.
(4)	Large dollar certificates of deposit are certificates issued in amounts of $100 or greater.
(5)	Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.
(6)	Net interest margin is the net interest income, calculated on a fully taxable basis, expressed as a percentage of average earning assets.

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 (dollars in thousands)

	Nine Months Ended September 30,
	2013						2012
	Average		Income/		Yield/		Average		Income/		Yield/
	Balance		Expense		Rate (1)		Balance		Expense		Rate (1)
Assets:
Securities
Taxable, available for sale	$	254,876	$	4,025	2.11	%	$	231,001	$	3,274	1.89	%
Restricted securities		8,493		252	3.97	%		9,645		228	3.16	%
Tax exempt, available for sale (2)		21,791		649	3.98	%		18,458		625	4.52	%
Total securities		285,160		4,926	2.31	%		259,104		4,127	2.13	%
Interest bearing deposits in other banks		50,443		100	0.27	%		18,386		32	0.23	%
Federal funds sold		189		-	0.00	%		252		-	0.00	%
Loans, net of unearned income (3)		672,184		26,934	5.36	%		720,362		30,091	5.58	%
Total earning assets		1,007,976		31,960	4.24	%		998,104		34,250	4.58	%
Less allowance for loan losses		(19,088)						(23,682)
Total non-earning assets		95,466						91,836
Total assets	$	1,084,354					$	1,066,258
Liabilities & Shareholders' Equity:
Interest-bearing deposits
Checking	$	246,156	$	695	0.38	%	$	226,551	$	943	0.56	%
Savings		90,051		111	0.16	%		84,888		190	0.30	%
Money market savings		126,440		401	0.42	%		127,020		482	0.51	%
Large dollar certificates of deposit (4)		125,219		1,238	1.32	%		132,538		1,685	1.70	%
Other certificates of deposit		130,809		1,173	1.20	%		147,617		1,741	1.58	%
Total interest-bearing deposits		718,675		3,618	0.67	%		718,614		5,041	0.94	%
Federal funds purchased and     repurchase agreements		3,435		15	0.58	%		3,325		23	0.92	%
Short-term borrowings		7,292		12	0.22	%		425		1	0.31	%
Long-term borrowings		97,973		2,958	4.04	%		117,500		3,575	4.06	%
Trust preferred debt		10,310		263	3.41	%		10,310		271	3.51	%
Total interest-bearing liabilities		837,685		6,866	1.10	%		850,174		8,911	1.40	%
Noninterest-bearing liabilities
Demand deposits		125,141						112,393
Other liabilities		6,966						6,684
Total liabilities		969,792						969,251
Shareholders' equity		114,562						97,007
Total liabilities and shareholders' equity	$	1,084,354					$	1,066,258
Net interest income (2)			$	25,094					$	25,339
Interest rate spread (2)(5)					3.14	%					3.18	%
Interest expense as a percent of     average earning assets					0.91	%					1.19	%
Net interest margin (2)(6)					3.33	%					3.39	%

Notes:

(1)	Yields are annualized and based on average daily balances.
(2)	Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%, with a $198 adjustment for 2013 and a $191 adjustment in 2012.
(3)	Nonaccrual loans have been included in the computations of average loan balances.
(4)	Large dollar certificates of deposit are certificates issued in amounts of $100 or greater.
(5)	Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.
(6)	Net interest margin is the net interest income, calculated on a fully taxable basis, expressed as a percentage of average earning assets.

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Noninterest Income

Noninterest income is comprised of all sources of income other than interest income on our earning assets. Significant revenue items include fees collected on certain deposit account transactions, debit and credit card fees, other general services, earnings from other investments we own in part or in full, gains or losses from investments, and gains or losses on sales of investments, loans, and fixed assets.

The following table depicts noninterest income for the three and nine months ended September 30, 2013 and 2012:

Table 2: Noninterest Income

	Three Months Ended September 30,
(dollars in thousands)	2013		2012
Service charges and fees on deposit accounts	$	847	$	815
Debit/credit card fees		391		463
Gain on sale of available for sale securities, net		-		135
Gain (loss) on sale of bank premises and equipment		223		(1)
Gain on sale of loans		-		197
Other operating income		334		275
Total noninterest income	$	1,795	$	1,884

	Nine Months Ended September 30,
(dollars in thousands)	2013		2012
Service charges and fees on deposit accounts	$	2,342	$	2,374
Debit/credit card fees		1,099		1,143
Gain on sale of available for sale securities, net		525		3,498
Gain (loss) on sale of bank premises and equipment		249		(1)
Gain on sale of loans		-		197
Other operating income		978		762
Total noninterest income	$	5,193	$	7,973

Noninterest income for the three months ended September 30, 2013 was $1.8 million, a decrease of $89 thousand or 4.7% over the noninterest income of $1.9 million for the same period of 2012. The decrease in this component was caused by the following events:

· Gain on the sale of loans was $197 thousand in the third quarter of 2012, generated by the sale of our credit card loan portfolio, while no such sales occurred during 2013;

· The Company did not sell any available for sale securities during the third quarter of 2013, and recognized net gains of $135 thousand on the sale of available for sale securities for the same period of 2012. During the first three quarters of 2012 the Company began to strategically adjust the composition of its investment portfolio by reducing its holdings of tax-exempt securities in an effort to increase the Company’s source of taxable income. To implement this strategy the Company sold tax-exempt securities issued by state and political subdivisions during the third quarter of 2012, many of which were in an unrealized gain position at the time of sale, and deployed the proceeds into taxable investment securities issued by state and political subdivisions as well as Agency mortgage-backed and Agency CMO securities. Many of these securities were in an unrealized gain position at the time of sale due to the low interest rate environment during the first nine months of 2012, which was principally due to economic conditions and monetary policies of the Federal Reserve to further reduce interest rates. The Company will continue to strategically evaluate opportunities to further adjust the composition of its investment portfolio through the balance of 2013;

· Debit/credit card fees were $391 thousand for the third quarter of 2013, a decrease of $72 thousand or 15.6% from $463 thousand for the third quarter of 2012, and were driven by a 13.1% decrease in debit card income;

· Gain (loss) on the sale of bank premises and equipment increased $224 thousand in the third quarter of 2013 as compared to the same period in 2012 due to the sale of our former Bowling Green branch office during the third quarter of 2013 which generated a gain of $224 thousand; and

· Other operating income was $334 thousand for the third quarter of 2013, an increase of $59 thousand or 21.5% over the $275 thousand for the third quarter of 2012, and was driven by a 19.5% increase in investment services income, a 61.8% increase in income from bank owned life insurance due to our additional $10.0 million investment in the second quarter of 2013, and partially offset by a 10.6% increase in write downs of our investments in community and housing development funds.

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Noninterest income for the nine months ended September 30, 2013 was $5.2 million, a decrease of $2.8 million or 34.9% over the noninterest income of $8.0 million for the same period of 2012. The decrease in this component was caused by the following events:

· Sales of available for sale securities generated net gains of $525 thousand in the first nine months of 2013, a decrease of $3.0 million or 85.0% from net gains of $3.5 million for the first nine months of 2012. During the first nine months of 2012 the Company began to strategically adjust the composition of its investment portfolio by reducing its holdings of tax-exempt securities in an effort to increase the Company’s source of taxable income. See the Company’s discussion of noninterest income for the three months ended September 30, 2013 as compared to the same period of 2012, for a discussion of adjustments during 2013 to the Company’s investment securities portfolio;

· Gain on the sale of loans was $197 thousand during the first nine months of 2012, generated by the sale of our credit card loan portfolio, while no such sales occurred during 2013;

· Gain (loss) on the sale of bank premises and equipment increased $250 thousand during the first nine months of 2013 as compared to the same period in 2012 due primarily to the sale of our former Bowling Green branch office during the third quarter of 2013 which generated a gain of $224 thousand; and

· Other operating income was $978 thousand for the first nine months of 2013, an increase of $216 thousand or 28.3% over the $762 thousand for the first nine months of 2012, and was driven by a 46.3% increase in investment services income, a 37.6% increase in income from bank owned life insurance due to our additional $10.0 million investment in the second quarter of 2013, and a 42.4% decrease in write downs of our investments in community and housing development funds.

Noninterest Expense

Noninterest expense includes all expenses with the exception of those paid for interest on borrowings and deposits. Significant expense items included in this component are salaries and employee benefits, occupancy and operating expenses.

The following table depicts noninterest expense for the three and nine months ended September 30, 2013 and 2012: 

Table 3: Noninterest Expense

	Three Months Ended September 30,
(dollars in thousands)	2013		2012
Salaries and employee benefits	$	4,418	$	3,910
Occupancy and equipment expenses		1,333		1,273
Telephone		293		242
FDIC expense		225		586
Consultant fees		268		229
Collection, repossession and other real estate owned		195		190
Marketing and advertising		132		145
Loss (gain) on sale of other real estate owned		668		(12)
Impairment losses on other real estate owned		437		769
Loss on extinguishment of debt		11,453		-
Other operating expenses		1,133		1,204
Total noninterest expenses	$	20,555	$	8,536

55

	Nine Months Ended September 30,
(dollars in thousands)	2013		2012
Salaries and employee benefits	$	12,713	$	11,624
Occupancy and equipment expenses		3,860		3,784
Telephone		858		818
FDIC expense		1,408		1,761
Consultant fees		697		615
Collection, repossession and other real estate owned		447		845
Marketing and advertising		612		566
Loss on sale of other real estate owned		823		105
Impairment losses on other real estate owned		580		1,676
Loss on extinguishment of debt		11,453		-
Other operating expenses		3,265		3,417
Total noninterest expenses	$	36,716	$	25,211

Noninterest expense for the three months ended September 30, 2013 was $20.6 million, an increase of approximately $12.0 million or 140.8% over the noninterest expense of $8.5 million for the same period of 2012. The increase in this component was caused by the following events:

· Loss on the extinguishment of debt was $11.5 million for the third quarter of 2013 and was incurred due to the prepayment of $107.5 million in long-term FHLB advances, while no such losses occurred in 2012. This prepayment penalty is the result of the Company successfully executing one of its previously disclosed strategic initiatives. The Company expects this transaction to improve the Company’s financial position by eliminating an estimated $4.5 million in annualized interest cost in future periods, thereby reducing the Company’s overall future cost of funds. The advances extinguished were fixed rate advances with a weighted average remaining maturity of 3.5 years and a current weighted average interest rate of 4.14%, and $94.0 million of the prepaid FHLB advances were callable quarterly by the FHLB;

· Salaries and employee benefits were $4.4 million for the third quarter of 2013, an increase of $508 thousand or 13.0% from $3.9 million for the same period of 2012. This increase was due to annual merit increases, lower deferred compensation on loan originations and an increase in group term insurance costs;

· Losses on the sale of other real estate owned were $668 thousand for the third quarter of 2013, an increase of $680 thousand from gains of $12 thousand for the same period of 2012 and are primarily due to the Company’s strategic initiative to remove risk from its balance sheet by expediting the resolution and disposition of OREO during the third quarter of 2013;

· FDIC insurance expense was $225 thousand for the third quarter of 2013, a decrease of $361 thousand or 61.6% from $586 thousand for the same period in 2012. This decrease was driven by lower base assessment rates due to the improvement in the Company’s subsidiary bank’s overall composite rating in connection with the termination of the Written Agreement in July 2013; and

· Impairment losses related to valuation adjustments on OREO were $437 thousand for the third quarter of 2013, a decrease of $332 thousand or 43.2% from losses of $769 thousand for the same period of 2012, as OREO balances have declined during 2013 and real estate prices in our markets have continued to stabilize in the third quarter of 2013.

Noninterest expense for the nine months ended September 30, 2013 was $36.7 million, an increase of $11.5 million or 45.6% over the noninterest expense of $25.2 million for the same period of 2012. The increase in this component was caused by the following events:

· Loss on the extinguishment of debt was $11.5 million for the first nine months of 2013 due to the factors mentioned in the quarterly analysis above, while no such losses occurred in 2012;

· Salaries and employee benefits were $12.7 million for the first nine months of 2013, an increase of $1.1 million or 9.4% from $11.6 million for the first nine months of 2012, and were due to the factors mentioned in the quarterly analysis above;

· Losses on the sale of other real estate owned were $823 thousand for the first nine months of 2013, an increase of $718 thousand from losses of $105 thousand for the same period of 2012, and were due to the factors mentioned in the quarterly analysis above;

56

· Impairment losses related to valuation adjustments on OREO were $580 thousand for the first nine months of 2013, a decrease of $1.1 million or 65.4% from losses of $1.7 million for the same period of 2012, as the Company aggressively addressed other real estate owned as part of its overall credit quality initiative during the first nine months of 2012, resulting in significant impairments on certain assets within the Company’s other real estate owned portfolio during the first nine months of 2012;

· Collection, repossession and other real estate owned expenses were $447 thousand for the first nine months of 2013, a decrease of $398 thousand or 47.1% from $845 thousand for the first nine months of 2012. This decrease was primarily due to the overall decrease in the carrying balance of OREO as well as the amount of nonperforming loans and classified assets; and

· FDIC insurance expense was $1.4 million for the first nine months of 2013, a decrease of $353 thousand or 20.0% from $1.8 million for the first nine months of 2012 and was due to the factors mentioned in the quarterly analysis above.

Income Taxes

The Company recorded an income tax benefit of $3.7 million for the three months ended September 30, 2013, compared to income tax expense of $269 thousand for the same period of 2012. The decrease in income tax expense from the third quarter of 2012 to the same period of 2013 was primarily the result of the Company’s pretax income decreasing by approximately $11.5 million due substantially to the $11.5 million prepayment penalty on the long-term FHLB advances prepaid during the third quarter of 2013 and an increase in the amount of tax-exempt income on investment securities during the third quarter of 2013 as the Company had rebalanced its securities portfolio during the quarter.

The Company recorded an income tax benefit of $3.3 million for the nine months ended September 30, 2013, compared to income tax expense of $604 thousand for the same period in 2012, reflecting a $3.9 million decrease in income tax expense. The decrease in income tax expense from the first nine months of 2012 to the same period of 2013 was primarily the result of the Company’s pretax income decreasing by approximately $11.3 million due to the factors mentioned in the quarterly analysis above.

Asset Quality

Provision and Allowance for Loan Losses

The allowance for loan losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio, and is based on periodic evaluations of the collectability and historical loss experience of loans. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio. Actual credit losses are deducted from the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent. Subsequent recoveries, if any, are credited to the allowance for loan losses.

The allowance for loan losses is comprised of a specific allowance for identified problem loans and a general allowance representing estimations done pursuant to either FASB ASC Topic 450 “Accounting for Contingencies”, or FASB ASC Topic 310 “Accounting by Creditors for Impairment of a Loan.” The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when deemed appropriate. The general component covers non-classified or performing loans and those loans classified as substandard, doubtful or loss that are not impaired. The general component is based on historical loss experience adjusted for qualitative factors, such as economic conditions, interest rates and unemployment rates. The Company uses a risk grading system for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans. Loans are graded on a scale from 1 to 9. Non-impaired real estate and commercial loans are assigned an allowance factor which increases with the severity of risk grading. A general description of the characteristics of the risk grades is as follows:

Pass Grades

· Risk Grade 1 loans have little or no risk and are generally secured by cash or cash equivalents;

· Risk Grade 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;

· Risk Grade 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;

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· Risk Grade 4 loans are satisfactory loans with borrowers not as strong as risk grade 3 loans but may exhibit a higher degree of financial risk based on the type of business supporting the loan; and

· Risk Grade 5 loans are loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay.

Special Mention

· Risk Grade 6 loans have increasing potential weaknesses beyond those at which the loan originally was granted and if not addressed could lead to inadequately protecting the Company’s credit position.

Classified Grades

· Risk Grade 7 loans are substandard loans and are inadequately protected by the current sound worth or paying capacity of the obligor or the collateral pledged. These have well defined weaknesses that jeopardize the liquidation of the debt with the distinct possibility the Company will sustain some loss if the deficiencies are not corrected;

· Risk Grade 8 loans are doubtful of collection and the possibility of loss is high but pending specific borrower plans for recovery, its classification as a loss is deferred until its more exact status is determined; and

· Risk Grade 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as a bank asset is not warranted.

The Company uses a past due grading system for consumer loans, including one to four family residential first and seconds and home equity lines. The past due status of a loan is based on the contractual due date of the most delinquent payment due. The past due grading of consumer loans is based on the following categories: current, 1-29 days past due, 30-59 days past due, 60-89 days past due and over 90 days past due. The consumer loans are segregated between performing and nonperforming loans. Performing loans are those that have made timely payments in accordance with the terms of the loan agreement and are not past due 90 days or more. Nonperforming loans are those that do not accrue interest or are greater than 90 days past due and accruing interest. Non-impaired consumer loans are assigned an allowance factor which increases with the severity of past due status. This component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio.

The Company's ALL Committee is responsible for assessing the overall appropriateness of the allowance for loan losses and monitoring the Company's allowance for loan losses methodology, particularly in the context of current economic conditions and a rapidly changing regulatory environment. The ALL Committee meets at least annually to review the Company's allowance for loan losses methodology.

The allocation methodology applied by the Company includes management’s ongoing review and grading of the loan portfolio into criticized loan categories (defined as specific loans warranting either specific allocation, or a classified status of substandard, doubtful or loss). The allocation methodology focuses on evaluation of several factors, including but not limited to: evaluation of facts and issues related to specific loans, management’s ongoing review and grading of the loan portfolio, consideration of historical loan loss experience using a rolling three year average and delinquency experience on each portfolio category, trends in past due and nonaccrual loans, the level of classified loans, the risk characteristics of the various classifications of loans, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the portfolio. In determining the allowance for loan losses, the Company considers its portfolio segments and loan classes to be the same.

Management believes that the level of the allowance for loan losses is appropriate in light of the credit quality and anticipated risk of loss in the loan portfolio. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses through increased provisions for loan losses or may require that certain loan balances be charged-off or downgraded into classified loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examinations.

58

The following table presents the Company’s loan loss experience for the periods indicated:

Table 4:Allowance for Loan Losses

	Nine Months Ended September 30,
(dollars in thousands)	2013			2012
Average loans outstanding*	$	672,184		$	720,362
Allowance for loan losses, January 1	$	20,338		$	24,102
Charge-offs:
Commercial, industrial and agricultural		(534)			(999)
Real estate - one to four family residential:
Closed end first and seconds		(1,137)			(1,265)
Home equity lines		(111)			(669)
Real estate - construction:
One to four family residential		(57)			(76)
Other construction, land development and other land		(1,154)			(1,618)
Real estate - non-farm, non-residential:
Owner occupied		(514)			(1,443)
Non-owner occupied		(1,912)			(1,507)
Consumer		(165)			(335)
Other		(98)			(70)
Total loans charged-off		(5,682)			(7,982)
Recoveries:
Commercial, industrial and agricultural		277			464
Real estate - one to four family residential:
Closed end first and seconds		67			14
Home equity lines		29			10
Real estate - construction:
One to four family residential		58			38
Other construction, land development and other land		68			1
Real estate - non-farm, non-residential:
Owner occupied		-			120
Non-owner occupied		55			409
Consumer		94			117
Other		40			27
Total recoveries		688			1,200
Net charge-offs		(4,994)			(6,782)
Provision for loan losses		1,550			4,783
Allowance for loan losses, September 30	$	16,894		$	22,103
Ratios:
Ratio of allowance for loan losses to total loans outstanding,    end of period		2.55	%		3.14	%
Ratio of annualized net charge-offs to average loans     outstanding during the period		0.99	%		1.26	%

*Net of unearned income and includes nonaccrual loans.

59

As a result of the challenges continuing to face the economy and the real estate and financial markets today, the Company made provisions for loan losses of $350 thousand and $1.6 million, respectively for the three and nine months ended September 30, 2013, as compared to $625 thousand and $4.8 million, respectively for the same periods of 2012. Net charge-offs for the three and nine months ended September 30, 2013 were $1.3 million and $5.0 million, respectively as compared to $1.4 million and $6.8 million, respectively for the same three and nine month periods of 2012. This represents, on an annualized basis, 0.77% and 0.99% of average loans outstanding for the three and nine months ending September 30, 2013 and 0.77% and 1.26% of average loans outstanding for the same periods of 2012. The contribution to the provision in the first nine months of 2013 and 2012 was made in response to sustained credit quality issues in our loan portfolio as well as current market conditions, both nationally and in our markets, all of which indicate that credit quality issues may continue to adversely impact our loan portfolio and our earnings in future periods.

Net charge-offs decreased $1.8 million, or 26.4%, from the nine months ended September 30, 2012 to the same period of 2013 due to improvements in some of the Company’s credit quality metrics, including continued decreases in the level of past due loans and nonperforming assets, and other factors, which are reflective of slowly improving economic conditions. However, net charge-offs remain elevated when compared to historical levels as the Company has aggressively focused on credit quality initiatives to improve its asset quality and resolve nonperforming assets.

The allowance for loan losses at September 30, 2013 was $16.9 million, compared with $20.3 million at December 31, 2012. This represented 2.55% of period end loans at September 30, 2013, compared with 2.97% of year end loans at December 31, 2012.

The following table shows the allocation of the allowance for loan losses at the dates indicated. Notwithstanding these allocations, the entire allowance for loan losses is available to absorb charge-offs in any category of loan. 

Table 5:Allocation of Allowance for Loan Losses

	At September 30,				At December 31,
	2013				2012
(dollars in thousands)	Allowance		Percent		Allowance		Percent
Commercial, industrial and agricultural	$	1,349	7.30	%	$	2,340	7.58	%
Real estate - one to four family residential:
Closed end first and seconds		3,062	33.91	%		2,876	34.91	%
Home equity lines		715	14.88	%		720	14.56	%
Real estate - multifamily residential		70	2.75	%		62	2.31	%
Real estate - construction:
One to four family residential		261	2.52	%		419	2.96	%
Other construction, land development and other land		2,020	3.30	%		3,897	5.04	%
Real estate - farmland		39	1.21	%		41	1.25	%
Real estate - non-farm, non-residential:
Owner occupied		5,695	19.44	%		5,092	17.50	%
Non-owner occupied		2,921	11.57	%		4,093	10.48	%
Consumer		215	2.67	%		215	2.94	%
Other		547	0.45	%		583	0.47	%
Total allowance for loan losses	$	16,894	100.00	%	$	20,338	100.00	%

(Percent is portfolio loans in category divided by total loans)Tabular presentations of commercial loans by credit quality indicator and consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at September 30, 2013 and December 31, 2012 can be found under Item 1. “Financial Statements,” under the heading “Note 3. Loan Portfolio.”

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Nonperforming Assets

The past due status of a loan is based on the contractual due date of the most delinquent payment due. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans greater than 90 days past due may remain on an accrual status if management determines it has adequate collateral to cover the principal and interest. If a loan or a portion of a loan is adversely classified, or is partially charged off, the loan is generally classified as nonaccrual. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the collectability of principal or interest on loans, it is management’s practice to place such loans on a nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due. As of September 30, 2013, management is not aware of any potential problem loans to place immediately on nonaccrual status.

When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, and the amortization of related deferred loan fees or costs is suspended. While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered. These policies are applied consistently across our loan portfolio.

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms of interest and principal.

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at the lower of cost or estimated fair market value of the property, less estimated disposal costs, if any. Cost includes loan principal and accrued interest. Any excess of cost over the estimated fair market value less costs to sell at the time of acquisition is charged to the allowance for loan losses. The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings. Development and improvement costs relating to property are capitalized. Net operating income or expenses of such properties are included in collection, repossession and other real estate owned expenses.

The following table presents information concerning nonperforming assets as of and for the nine months ended September 30, 2013 and the year ended December 31, 2012:

Table 6:Nonperforming Assets

	September 30,			December 31,
(dollars in thousands)	2013			2012
Nonaccrual loans*	$	6,352		$	11,874
Loans past due 90 days and accruing interest		-			-
Total nonperforming loans		6,352			11,874
Other real estate owned		1,203			4,747
Total nonperforming assets	$	7,555		$	16,621
Nonperforming assets to total loans and other real     estate owned		1.14	%		2.41	%
Allowance for loan losses to nonaccrual loans		265.95	%		171.29	%
Annualized net charge-offs to average loans for the period		0.99	%		1.32	%
Allowance for loan losses to period end loans		2.55	%		2.97	%

* Includes $2.6 million and $5.1 million in nonaccrual TDRs at September 30, 2013 and December 31, 2012, respectively.

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The following table presents the change in the OREO balance for the nine months ended September 30, 2013 and 2012:

Table 7:OREO Changes

	September 30,
(dollars in thousands)	2013		2012
Balance at the beginning of period, gross	$	5,558	$	8,729
Transfers from loans		1,675		4,708
Capitalized costs		-		-
Sales proceeds		(3,816)		(3,676)
Previously recognized impairment losses on disposition		(906)		(466)
(Loss) on disposition		(823)		(105)
Balance at the end of period, gross		1,688		9,190
Less valuation allowance		(485)		(2,613)
Balance at the end of period, net	$	1,203	$	6,577

The following table presents the change in the valuation allowance for OREO for the nine months ended September 30, 2013 and 2012:

Table 8:OREO Valuation Allowance Changes

	September 30,
(dollars in thousands)	2013		2012
Balance at the beginning of period	$	811	$	1,403
Valuation allowance		580		1,676
Charge-offs		(906)		(466)
Recoveries		-		-
Balance at the end of period	$	485	$	2,613

Nonperforming assets were $7.6 million or 1.14% of total loans and other real estate owned at September 30, 2013 compared to $16.6 million or 2.41% at December 31, 2012. Nonperforming assets increased from 2007 through 2010 as a result of the continued challenging economic conditions which has significantly increased unemployment, reduced profitability of local businesses, and reduced the ability of many of our customers to keep their loans current. Nonperforming assets began to trend downward during 2011, continued this trend throughout 2012 and decreased by $9.1 million during the first nine months of 2013. The sluggish economic recovery and continuing asset quality issues in the Company’s loan portfolio have prompted the Company to maintain the heightened level of the allowance for loan losses as compared to historical levels, which is 265.95% of nonaccrual loans at September 30, 2013, compared to 171.29% at December 31, 2012. Nonperforming loans decreased $5.5 million or 46.5% during the nine months ended September 30, 2013 to $6.4 million, with $758 thousand of this decline occurring in the third quarter of 2013.

Nonaccrual loans were $6.4 million at September 30, 2013, a decrease of $5.5 million or 46.5% from $11.9 million at December 31, 2012. Of the current $6.4 million in nonaccrual loans, $6.1 million or 95.5% is secured by real estate in our market area. Of these real estate secured loans, $4.5 million are residential real estate, $709 thousand are real estate construction, $457 thousand are farmland, and $450 thousand are commercial properties.

As of September 30, 2013 and December 31, 2012, there were no loans past due 90 days and still accruing interest.

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Other real estate owned, net of valuation allowance at September 30, 2013 was $1.2 million, a decrease of $3.5 million or 74.7% from $4.7 million at December 31, 2012. The balance at September 30, 2013 was comprised of 14 properties of which $947 thousand are residential real estate and $256 thousand are real estate construction properties. During the nine months ended September 30, 2013, new foreclosures included eighteen properties totaling $1.7 million transferred from loans. Sales of twenty other real estate owned properties for the nine months ended September 30, 2013 resulted in a net loss of $823 thousand. At September 30, 2013, there were six properties totaling $652 thousand under contract for sale. Subsequent to September 30, 2013, three of the properties under contract for sale at September 30, 2013 sold resulting in a net gain of approximately $46 thousand that will be recognized in the fourth quarter of 2013. The remaining properties are being actively marketed and the Company does not anticipate any material losses associated with these properties. The Company recorded losses of $580 thousand in its consolidated statement of operations for the nine months ended September 30, 2013, due to valuation adjustments on other real estate owned properties as compared to $1.7 million for the same period of 2012. Asset quality continues to be a top priority for the Company. The Company continues to allocate significant resources to the expedient disposition and collection of nonperforming and other lower quality assets, as demonstrated by the $5.4 million, or 81.7%, decrease in other real estate owned from September 30, 2012 to September 30, 2013. For more information on asset disposition strategies related to our 2013 Capital Initiative, see “2013 Capital Initiative and Strategic Initiatives” in this Item 2.

As discussed earlier in this Item 2, the Company measures impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are considered impaired loans. TDRs occur when we agree to modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions can be temporary and are made in an attempt to avoid foreclosure and with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated. These concessions could include, without limitation, rate reductions to below market rates, payment deferrals, forbearance, and, in some cases, forgiveness of principal or interest.

A tabular presentation of loans individually evaluated for impairment by class of loans at September 30, 2013 and December 31, 2012 can be found under Item 1. “Financial Statements,” under the heading “Note 3. Loan Portfolio.”

At September 30, 2013, the balance of impaired loans was $40.8 million, for which there were specific valuation allowances of $5.3 million. At December 31, 2012, the balance of impaired loans was $41.7 million, for which there were specific valuation allowances of $5.2 million. The average balance of impaired loans was $42.5 million for the nine months ended September 30, 2013, compared to $48.4 million for the year ended December 31, 2012. The Company’s impaired loans have declined when comparing the September 30, 2013 period to the December 31, 2012 period, but impaired loans remain elevated since 2008 as a result of the continued challenging economic conditions which have significantly increased unemployment, reduced profitability of local businesses, and reduced the ability of many of our customers to keep their loans current.

The following table presents the balances of TDRs at September 30, 2013 and December 31, 2012: 

Table 9:Troubled Debt Restructurings (TDRs)

	September 30,		December 31,
(dollars in thousands)	2013		2012
Performing TDRs	$	2,767	$	4,433
Nonaccrual TDRs*		2,630		5,089
Total TDRs	$	5,397	$	9,522

* Included in nonaccrual loans in Table 6:Nonperforming Assets.

At the time of a TDR, the loan is placed on nonaccrual status. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance (typically six months) in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

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Financial Condition

Summary

At September 30, 2013, the Company had total assets of $1.0 billion, a decrease of $42.5 million or 4.0% from $1.1 billion at December 31, 2012. The decrease in total assets was principally the result of decreases in cash and short-term investments, interest bearing deposits with banks, securities available for sale, restricted securities, loans, other real estate owned, deposits and borrowings, and partially offset by increases in deferred income taxes and total shareholders’ equity (primarily attributable to the closing of the private placements during the second quarter of 2013 and the closing of the rights offering during the third quarter of 2013) as detailed in the following schedule.

Table 10:Balance Sheet Changes

	September 30,		December 31,
(dollars in thousands)	2013		2012		Change $		Change %
Total assets	$	1,033,057	$	1,075,553	$	(42,496)	-4.0	%
Cash and short-term investments		13,655		16,762		(3,107)	-18.5	%
Interest bearing deposits with banks		5,205		29,837		(24,632)	-82.6	%
Securities available for sale, at fair value		269,456		276,913		(7,457)	-2.7	%
Restricted securities, at cost		6,150		9,251		(3,101)	-33.5	%
Total loans		662,625		684,668		(22,043)	-3.2	%
Deferred income taxes, net		18,814		10,687		8,127	76.0	%
Other real estate owned, net		1,203		4,747		(3,544)	-74.7	%
Total deposits		827,017		838,373		(11,356)	-1.4	%
Total borrowings		69,369		130,752		(61,383)	-46.9	%
Total shareholders' equity		130,633		99,711		30,922	31.0	%

Investment Securities

The investment portfolio plays a primary role in the management of the Company’s interest rate sensitivity. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements, such as those related to secure public deposits, balances with the Federal Reserve Bank and repurchase agreements. The investment portfolio entirely consists of securities available for sale, which may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors. These securities are carried at estimated fair value. Total investment securities were $269.5 million at September 30, 2013, reflecting a decrease of approximately $7.5 million or 2.7% from $276.9 million at December 31, 2012. The valuation allowance for the available for sale portfolio had an unrealized (loss), net of tax benefit, of ($7.5) million at September 30, 2013 compared with an unrealized gain, net of tax expense, of $1.9 million at December 31, 2012. These unrealized (losses) as of September 30, 2013 are principally due to current financial market conditions for these types of investments particularly changes in interest rates which rose between December 31, 2012 and September 30, 2013 causing bond prices to decline.

The decrease in the investment portfolio during the first nine months of 2013 was primarily the result of mark-to-market adjustments related to increases to the mid to long term interest rate curve, primarily late in the second quarter of 2013 and into the third quarter of 2013. Unrealized losses on investment securities were $11.3 million at September 30, 2013, compared to unrealized gains of $2.9 million at December 31, 2012. Management continues to restructure the composition of our securities portfolio to strategically deploy excess cash into investment securities as investment opportunities are available; due to relatively scarce suitable investment opportunities, a portion of our excess funding remains in lower yielding interest bearing deposits with banks. In the first nine months of 2013, management continued to allocate a greater portion of the investment portfolio to SBA Pool securities. The SBA Pool securities are modified mortgage pass-through securities that are assembled using the guaranteed portion of SBA loans and as such are unconditionally guaranteed as to principal and accrued interest by the U.S. government. Management continues to invest in these SBA Pool securities because they qualify under current risk-weighting regulations as 0% risk weighted assets, which more efficiently uses capital to produce a reasonable rate of return. Approximately 26.7% of the SBA Pool securities are adjustable rate products which will assist the Company with mitigating interest rate risk. In addition, for liquidity planning purposes, these securities provide an investment that may be pledged as collateral to secure public deposits, balances with the Federal Reserve Bank and repurchase agreements. During the first nine months of 2013, management purchased additional tax exempt investment securities issued by state and political subdivisions, as these securities offered a higher yield over a longer duration than other investment opportunities available in the period. As part of our overall asset/liability management strategy, we are targeting our investment portfolio to be approximately 20% of our total assets. As of September 30, 2013 and December 31, 2012, our investment portfolio was 26.1% and 25.8%, respectively, of total assets.

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Loans

The Company offers an array of lending and credit services to customers including mortgage, commercial and consumer loans. A substantial portion of the loan portfolio is represented by commercial and residential mortgage loans in our market area. The ability of our debtors to honor their contracts is dependent upon the real estate and general economic conditions in our market area. The loan portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. Total loans were $662.6 million at September 30, 2013, a decrease of approximately $22.0 million or 3.2% from $684.7 million at December 31, 2012. As previously mentioned our loan portfolio continues to decrease as a result of weak loan demand, additional charge-offs and payment curtailments on outstanding credits.

Deposits

The Company’s predominant source of funds is depository accounts. The Company’s deposit base, which is provided by individuals and businesses located within the communities served, is comprised of demand deposits, savings and money market accounts, and time deposits. The Company augments its deposit base through conservative use of brokered deposits, including through the Certificate of Deposit Account Registry Service program (“CDARS”). The Company’s balance sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios.

Total deposits were $827.0 million as of September 30, 2013, a decrease of $11.4 million or 1.4% from $838.4 million as of December 31, 2012. The following table sets forth the composition of the Company’s deposits at the dates indicated. 

Table 11:Deposits

	September 30,		December 31,
(dollars in thousands)	2013		2012		Change $		Change %
Noninterest-bearing deposits	$	136,835	$	116,717	$	20,118	17.2	%
Interest-bearing deposits:
Demand deposits	$	248,871	$	245,833	$	3,038	1.2	%
Money market deposits		112,616		128,438		(15,822)	-12.3	%
Savings deposits		90,471		86,868		3,603	4.1	%
Time deposits		238,224		260,517		(22,293)	-8.6	%
Total interest-bearing deposits	$	690,182	$	721,656	$	(31,474)	-4.4	%

During the first nine months of 2013, the Company continued to see a shift from interest-bearing retail time deposits to lower cost non-maturity interest-bearing and noninterest-bearing retail deposits as our consumers are willing to forego the higher yield on longer-term products in order to have more readily available access to their funds. The Company believes the increase in our noninterest-bearing and interest-bearing demand and savings deposits during the nine months ended September 30, 2013 is primarily the result of customers seeking the liquidity and safety of deposit accounts in light of the weak economic recovery in our markets and continuing economic uncertainty in general. At September 30, 2013 and December 31, 2012, the Company had $25.6 million and $28.6 million in broker certificates of deposits. The interest rates paid on these deposits are consistent, if not lower, than the market rates offered in our local area. Amounts included in these broker certificates of deposits also include deposits under the CDARS program.

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The Company has observed its customers, including counties and municipalities, maintaining significant liquid cash reserves in order to deleverage and prevent operating shortfalls. While the Company believes that it offers competitive interest rates on all deposit products, the continued weak loan demand, coupled with our ongoing deposit re-pricing strategy, have allowed for some deposit attrition particularly from depositors seeking higher yields at our competitors or from other investment vehicles.

Borrowings

The Company’s ability to borrow funds through non-deposit sources provides additional flexibility in meeting the liquidity needs of customers while enhancing its cost of funds structure. Total borrowings were $69.4 million at September 30, 2013, a decrease of $61.4 million or 46.9% from $130.8 million at December 31, 2012. The significant decrease in borrowings was driven by the prepayment of $107.5 million in long-term FHLB borrowings during August 2013 and the payment at maturity of a $10.0 million long-term FHLB borrowing during September 2013 and was partially offset by the addition of $55.3 million short-term FHLB borrowing during 2013.

Off-Balance Sheet Arrangements

As of September 30, 2013, there have been no material changes to the off-balance sheet arrangements disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Contractual Obligations

As of September 30, 2013, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Liquidity

Liquidity represents an institution’s ability to meet present and future financial obligations, including through the sale of existing assets or the acquisition of additional funds through short-term borrowings. Our liquidity is provided from cash and due from banks, interest bearing deposits with other banks, federal funds sold, repayments from loans, sales of loans, increases in deposits, lines of credit from the FHLB and three correspondent banks, sales of investments, interest and dividend payments received from investments and maturing investments. Our ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in our markets. Depending on our liquidity levels, our capital position, conditions in the capital markets and other factors, we may from time to time consider the issuance of debt, equity or other securities, or other possible capital market transactions, the proceeds of which could provide additional liquidity for operations.

On June 12, 2013, the Company closed on its previously discussed Private Placements that contributed gross proceeds of approximately $45.0 million to our liquidity. On July 5, 2013, the Company closed on its previously disclosed Rights Offering that contributed gross proceeds of approximately $5.0 million to our liquidity. The Company deployed a portion of these proceeds during the third quarter of 2013 to execute certain of the Company’s strategic initiatives including the prepayment of higher rate long-term FHLB advances and the accelerated resolution and disposition of adversely classified assets. The Company expects to continue deploying a portion of these proceeds to execute the remaining related business initiatives during the fourth quarter of 2013 and into 2014. For more information on our 2013 Capital Initiative, see “2013 Capital Initiative and Strategic Initiatives” in this Item 2.

As a result of our management of liquid assets and our ability to generate liquidity through liability funding, we believe that we maintain overall liquidity to satisfy our depositors’ requirements and to meet customers’ credit needs. We also take into account any liquidity needs generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit.

We monitor and plan our liquidity position for future periods. Liquidity strategies are implemented and monitored by our Asset/Liability Committee (“ALCO”). 

Cash, cash equivalents and federal funds sold totaled $18.9 million as of September 30, 2013 compared to $46.6 million as of December 31, 2012. At September 30, 2013, cash, cash equivalents, federal funds sold and unpledged securities available for sale were $226.0 million or 21.9% of total assets, compared to $217.7 million or 20.2% of total assets at December 31, 2012.

As disclosed in the Company’s consolidated statement of cash flows, net cash used in operating activities was $1.8 million, net cash provided by investing activities was $1.6 million and net cash used in financing activities was $27.5 million for the nine months ended September 30, 2013. Combined, this contributed to a $27.7 million decrease in cash and cash equivalents for the nine months ended September 30, 2013.

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The Company maintains access to short-term funding sources as well, including federal funds lines of credit with three correspondent banks up to $40.0 million and the ability to borrow from the FHLB up to $182.1 million. The Company has no reason to believe these arrangements will not be renewed at maturity. Additional loans and securities are available that can be pledged as collateral for future borrowings from the FHLB above the current lendable collateral value.

Certificates of deposit of $100,000 or more, maturing in one year or less, totaled $66.9 million at September 30, 2013. Certificates of deposit of $100,000 or more, maturing in more than one year, totaled $52.1 million at September 30, 2013.

As of September 30, 2013, and other than referenced in this Quarterly Report on Form 10-Q, the Company was not aware of any other known trends, events or uncertainties that have or are reasonably likely to have a material impact on our liquidity. As of September 30, 2013, the Company has no material commitments or long-term debt for capital expenditures.

Capital Resources

The assessment of capital adequacy depends on such factors as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The Company regularly reviews the adequacy of the Company’s capital. The Company maintains a capital structure that it believes will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks 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. Capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weighting, and other factors. 

Quantitative measures established by regulation to ensure capital adequacy require that the Bank maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2013, the Bank meets all capital adequacy requirements to which it is subject. 

As of September 30, 2013, the Bank was categorized as “well capitalized,” the highest level of capital adequacy. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios. The Company’s and the Bank’s actual capital amounts and ratios as of September 30, 2013 and December 31, 2012 are presented under Item 1. “Financial Statements,” under the heading “Note 13. Capital Requirements.” 

On February 17, 2011, the Parent and the Bank entered into a Written Agreement with the Reserve Bank and the Bureau. The Written Agreement was terminated on July 30, 2013. Under the terms of this Written Agreement, the Parent and the Bank were subject to additional limitations and regulatory restrictions and could not declare or pay dividends to its shareholders (including payments by the Parent on its trust preferred securities) and could not purchase or redeem shares of its stock without prior regulatory approval. Additional information about the Written Agreement can be found under Part I, Item 1. “Financial Statements,” under the heading “Note 14. Regulatory Agreements” and under “Executive Overview” of this Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

On September 5, 2013, the Parent and the Bank entered into a MOU with the Reserve Bank and the Bureau. Under the terms of this MOU, the Parent and the Bank are subject to additional limitations and regulatory restrictions and the Parent cannot declare or pay dividends to its shareholders (including payments by the Parent on its trust preferred securities) and cannot purchase or redeem shares of its stock without prior regulatory approval. Additional information about the MOU can be found under Part I, Item 1. “Financial Statements,” under the heading “Note 14. Regulatory Agreements” and under “Executive Overview” of this Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

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In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and for calculating risk-weighted assets, as modified by the U.S. federal bank regulators. For further information about these final rules, refer to Part I, Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” under the heading “Basel III Final Rules” in this Quarterly Report on Form 10-Q.

Cash Dividends

The Bank, as a Virginia banking corporation, may pay dividends only out of retained earnings. In addition, regulatory authorities may limit payment of dividends by any bank, when it is determined that such limitation is in the public interest and necessary to ensure financial soundness of the bank. Regulatory agencies place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. For the three and nine months ended September 30, 2013 and 2012, no cash dividends have been paid from the Bank to the Company.

For the three and nine months ended September 30, 2013 and 2012, the Company paid out no cash dividends to common shareholders. 

The Company’s Board of Directors determines whether to declare dividends and the amount of any dividends declared. Such determinations by the Board take into account the Company’s financial condition, results of operations and other relevant factors, including any relevant regulatory restrictions.

On August 15, 2013, the Company deferred its eleventh consecutive dividend on the Series A Preferred Stock. Deferral of dividends on the Series A Preferred Stock does not constitute an event of default. Dividends on the Series A Preferred Stock are, however, cumulative, and the Company has accumulated the dividends in accordance with the terms of the Series A Preferred Stock and U.S. GAAP and reflected the accumulated dividends as a portion of the effective dividend on Series A Preferred Stock on the consolidated statements of operations. As of September 30, 2013, the Company had accumulated $3.3 million for dividends on the Series A Preferred Stock. The Company has notified the holders that it is deferring the November 15, 2013 dividend on the Series A Preferred Stock. In addition, because dividends on the Series A Preferred Stock have not been paid for more than six quarters, the authorized number of directors on the Company’s Board of Directors has increased by two, and the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board of Directors at the next annual meeting (or a special meeting called for that purpose) and each annual meeting until all owed and unpaid dividends on the Series A Preferred Stock have been paid. To date the holders of the Series A Preferred Stock have not yet exercised this right.

On February 17, 2011, the Parent and the Bank entered into a Written Agreement with the Reserve Bank and the Bureau. The Written Agreement was terminated on July 30, 2013. Under the terms of this Written Agreement, the Parent and the Bank were subject to additional limitations and regulatory restrictions and could not declare or pay dividends to its shareholders (including payments by the Parent on its trust preferred securities) and could not purchase or redeem shares of its stock without prior regulatory approval. 

On September 5, 2013, the Parent and the Bank entered into a MOU with the Reserve Bank and the Bureau. Under the terms of this MOU, the Parent is subject to additional limitations and regulatory restrictions and cannot declare or pay dividends to its shareholders (including payments by the Parent on its trust preferred securities) and cannot purchase or redeem shares of its stock without prior regulatory approval. Additional information about the MOU can be found under Item 1. “Financial Statements,” under the heading “Note 14. Regulatory Agreements” and under “Executive Overview” of this Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations.”

Effects of Inflation

The effect of changing prices on financial institutions is typically different from other industries as the Company’s assets and liabilities are monetary in nature. The primary effect of inflation on the Company’s operations 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 significantly impacted by changes in the inflation rate, they do not necessarily change at the same time or in the same magnitude as the inflation rate.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes from the quantitative and qualitative disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

Item 4. Controls and Procedures

The Company’s management, including the Company’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2013 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

Management of the Company is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). There were no changes in the Company’s internal control over financial reporting during the Company’s third quarter ended September 30, 2013 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of operations, the Company and its subsidiaries may become a party to legal proceedings, or property of the Company or its subsidiaries may become subject to legal proceedings. As of September 30, 2013 and based on information currently available, there are no pending legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

Item 1A. Risk Factors

An investment in our common stock involves significant risks inherent to the Company’s business. Like other bank holding companies, we are subject to a number of risks, many of which are outside of our control. If any of the events or circumstances described in the following risk factors actually occur, our business, financial condition, results of operations and prospects could be harmed. These risks are not the only ones that we may face. Other risks of which we are not aware, including those which relate to the banking and financial services industry in general and us in particular, or those which we do not currently believe are material, may harm our future business, financial condition, results of operations and prospects.

Readers should consider carefully the following important risks, in addition to the risks set forth in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013 and our Annual Report for the year ended December 31, 2012, in conjunction with the other information in this Quarterly Report on Form 10-Q and the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012, including our consolidated financial statements and related notes, in evaluating us, our business and an investment in our securities. Other than as set forth below, there have been no material changes in the risk factors faced by the Company from those disclosed under Part II, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2013.

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The Company has a high concentration of loans secured by both residential and commercial real estate and a further downturn in either or both real estate markets, for any reason, may increase the Company’s credit losses, which would negatively affect its financial results.

The Company offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Most of the Company’s loans are secured by real estate (both residential and commercial) in its market area. At September 30, 2013, approximately 89.6% of the Company’s $662.6 million loan portfolio was secured by residential and commercial real estate. Changes in the real estate market, such as a greater deterioration in market value of collateral, or a greater decline in local employment rates or economic conditions, could adversely affect the Company’s customers’ ability to pay these loans, which in turn could impact the Company’s profitability. There has been a slowdown in the housing market across our geographical footprint, reflecting declining prices and excess inventories of houses to be sold. Repayment of our commercial loans is often dependent on the cash flow of the borrower, which may be unpredictable in the current economy. If the value of real estate serving as collateral for the loan portfolio materially declines, a significant portion of the loan portfolio could become under-collateralized. If the loans that are secured by real estate become troubled when real estate market conditions are declining or have declined, in the event of foreclosure the Company may not be able to realize the amount of collateral that was anticipated at the time of originating the loan. In that event, the Company may have to increase the provision for loan losses, which could have a material adverse effect on its operating results and financial condition.

We have a concentration of credit exposure in acquisition and development real estate loans.

At September 30, 2013, we had approximately $38.5 million in loans for the acquisition and development of real estate and for construction of improvements to real estate, representing approximately 5.8% of our total loans outstanding as of that date. These loans are to developers, builders and individuals. Project types financed include acquisition and development of residential subdivisions and commercial developments, builder lines for 1-4 family home construction and loans to individuals for primary and secondary residence construction. These types of loans are generally viewed as having more risk of default than residential real estate loans. Completion of development projects and sale of developed properties may be affected significantly by general economic conditions, and further downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because our loan portfolio contains acquisition and development loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our percentage of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.

The Company is not paying dividends on its common stock or Series B Preferred Stock and is deferring distributions on its Series A Preferred Stock, and is otherwise restricted from paying cash dividends on its common stock and Series B Preferred Stock. The failure to resume paying dividends and distributions may adversely affect the Company and has provided board appointment rights to the holders of our Series A Preferred Stock. 

The Company historically paid quarterly dividends before suspending dividend payments on its common stock in the first quarter of 2011. There is no assurance that the Company will resume paying cash common dividends. In addition and as previously disclosed, in the Memorandum of Understanding the Company has agreed to not declare or pay dividends of any kind without the prior written approval of the Reserve Bank and the Bureau. Even if the Company resumes paying common dividends, future payment of cash dividends on our common stock, if any, will be subject to the prior payment of all unpaid dividends and deferred distributions on the Company’s Series A Preferred Stock. All dividends are declared and paid at the discretion of our Board of Directors and are dependent upon our liquidity, financial condition, results of operations, capital requirements and such other factors as our Board of Directors may deem relevant.

Further, on November 15, 2013, the Company will defer its twelfth consecutive dividend on the Series A Preferred Stock originally issued to the Treasury. Deferral of dividends on the Series A Preferred Stock does not constitute an event of default. Dividends on the Series A Preferred Stock are, however, cumulative, and the Company has accumulated the dividends in accordance with the terms of the preferred stock and accounting principles generally accepted in the United States of America (“U.S. GAAP”) and reflected the accumulated dividends as a portion of the effective dividend on preferred stock on the consolidated statements of operations. As of November 15, 2013, the Company will have accumulated $3.6 million for dividends on the Series A Preferred Stock. Because dividends on the Series A Preferred Stock have not been paid for an aggregate of six quarterly dividend periods or more, whether or not consecutive, the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board at the next annual meeting (or at a special meeting called for that purpose) and at every subsequent annual meeting until all owed and unpaid dividends on the Series A Preferred Stock have been paid.

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In April 2012, the Treasury assigned an observer to attend the Company’s Board meetings, in part to determine whether and how to exercise this right, but the Treasury did not exercise this right to elect directors. On October 21, 2013, the Treasury sold all of the Series A Preferred Stock that it held to third parties through a private offering structured as a modified Dutch auction. Any holder of shares of Series A Preferred Stock has the board representation rights described in the preceding paragraph.

If the Series A Preferred Stock remains outstanding, we are at risk of an increase in the dividend rate on the Series A Preferred Stock and changes to our Board of Directors. 

If we are unable to redeem the Series A Preferred Stock prior to February 15, 2014, the dividend rate will increase substantially on that date from 5.0% per annum to 9.0% per annum. This increase in the annual dividend rate could have a material adverse effect on our liquidity, our net income available to common shareholders and our earnings per share.

Because dividends on the Series A Preferred Stock have not been paid for an aggregate of six quarterly dividend periods or more, the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board at the next annual meeting (or at a special meeting called for that purpose) and at every subsequent annual meeting until all owed and unpaid dividends on the Series A Preferred Stock have been paid. 

On October 21, 2013, the Treasury sold all of the Series A Preferred Stock that it held to third parties through a private offering structured as a modified Dutch auction. Any holder of shares of Series A Preferred Stock, including private equity funds, has the board representation rights described in the preceding paragraph. Although the Treasury did not exercise these rights when it held the Series A Preferred Stock, a private equity fund or other private purchaser of the Series A Preferred Stock may exercise this right and assume representation on the Board of Directors without the approval of existing Board members or our shareholders. The Board members would have voting rights and, as members of the Board, would have the ability to influence the management and control of the Company and its operations.

We have goodwill that may become impaired, and thus result in a charge against earnings. 

We are required by U.S. GAAP to test goodwill for impairment at least annually. Testing for impairment of goodwill involves the identification of reporting units and the estimation of fair values. The estimation of fair values involves a high degree of judgment and subjectivity in the assumptions used. As of September 30, 2013, we had $16.0 million of goodwill related to branch acquisitions in 2003 and 2008. To date, we have not recorded any impairment charges on our goodwill, however there is no guarantee that we may not be forced to recognize impairment charges in the future as operating and economic conditions change.

We are not paying dividends on our common stock or our Series B Preferred Stock. The failure to resume paying dividends on our common stock or to begin paying dividends on our Series B Preferred Stock may adversely affect the value of our common stock and our Series B Preferred Stock. 

We paid cash dividends on our common stock prior to 2011, when we suspended dividend payments. There is no assurance if or when we will be able to resume paying cash dividends on our common stock or Series B Preferred Stock.

Holders of Series B Preferred Stock are entitled to receive dividends if, as and when declared by the Company’s Board of Directors, in an identical form of consideration and at the same time, as those dividends or distributions that would have been payable on the number of whole shares of the Company’s common stock that such shares of Series B Preferred Stock would be convertible into upon satisfaction of the conversion conditions. Accordingly, since there is no assurance if or when we will be able to resume paying cash dividends on our common stock, there is also no assurance if or when we will be able to begin paying cash dividends on our Series B Preferred Stock.

In the Memorandum of Understanding EVBS agreed to not pay any dividends on its stock without the prior written consent of the Reserve Bank and the Bureau.

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Further, as of September 30, 2013, the Company had deferred ten quarterly interest payments and accumulated $887 thousand in interest on the junior subordinated debentures (the “Junior Subordinated Debentures”) relating to its trust preferred securities issued in September 2003. Until all accrued and unpaid interest on the Junior Subordinated Debentures is paid, the Company may not pay any dividends or distributions on, or redeem, purchase, acquire or make a liquidation payment with respect to, any of the Company’s capital stock, including its common stock and Series B Preferred Stock. Similarly, future payments of cash dividends on our common stock and Series B Preferred Stock, if any, will be subject to the prior payment of all unpaid dividends and deferred distributions on the Company’s Series A Preferred Stock. As of September 30, 2013, EVBS had accumulated $3.3 million for dividends on the Series A Preferred Stock.

In addition, all dividends are declared and paid at the discretion of our Board of Directors and are dependent upon our liquidity, financial condition, results of operations, regulatory capital requirements, and such other factors as our Board of Directors may deem relevant. The ability of our banking subsidiary, EVB, to pay dividends to us is also limited by obligations to maintain sufficient capital and by other general restrictions on dividends that are applicable to our banking subsidiary. If we do not satisfy these regulatory requirements, we are unable to pay dividends on our common stock.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 

In January 2001, the Company announced a stock repurchase program by which management was authorized to repurchase up to 300,000 shares of the Company’s common stock. This plan was amended in 2003 and the number of shares by which management is authorized to repurchase is up to 5% of the outstanding shares of the Company’s common stock on January 1 of each year. There is no stated expiration date for the program. During the three and nine months ended September 30, 2013, the Company did not repurchase any of its common stock.

In connection with the Written Agreement with the Reserve Bank and the Bureau, as previously described, the Company was subject to additional limitations and regulatory restrictions and could not purchase or redeem shares of its stock without prior regulatory approval. The Written Agreement was terminated on July 30, 2013.

In connection with the MOU with the Reserve Bank and the Bureau, as previously described, the Company is subject to additional limitations and regulatory restrictions and cannot purchase or redeem shares of its stock without prior regulatory approval.

Item 3. Defaults Upon Senior Securities 

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information 

None.

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Item 6. Exhibits

3.1	Amended and Restated Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective December 29, 2008 (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed March 10, 2009).
3.1.1	Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective January 6, 2009 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed January 13, 2009).
3.1.2	Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective June 10, 2013 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed June 14, 2013).
3.2	Bylaws of Eastern Virginia Bankshares, Inc., as amended June 4, 2013 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed June 14, 2013).
10.17	Memorandum of Understanding, dated September 5, 2013, by and among Eastern Virginia Bankshares, Inc., EVB, the Federal Reserve Bank of Richmond, and Virginia State Corporation Commission Bureau of Financial Institutions (incorporated by reference to Exhibit 10.17 to the Company’s Current Report on Form 8-K filed September 10, 2013).
31.1	Rule 13a-14(a) Certification of Chief Executive Officer.
31.2	Rule 13a-14(a) Certification of Chief Financial Officer.
32.1	Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2	Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.
101	The following materials from Eastern Virginia Bankshares, Inc. Quarterly Report on Form 10-Q for the quarter ended September 30, 2013, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Operations (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) (unaudited), (iv) Consolidated Statements of Shareholders’ Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited).

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SIGNATURES

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

Eastern Virginia Bankshares, Inc.

(Registrant)

Date:	November 14, 2013	/s/ Joe A. Shearin
		Joe A. Shearin
		President and Chief Executive Officer
		(Principal Executive Officer)
Date:	November 14, 2013	/s/ J. Adam Sothen
		J. Adam Sothen
		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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