UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
| x | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the fiscal year ended December 31, 2005
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 0-23565
EASTERN VIRGINIA BANKSHARES, INC.
(Exact name of registrant as specified in its charter)
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| VIRGINIA | | 54-1866052 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
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330 Hospital Road, Tappahannock, Virginia | | 22560 |
| (Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code (804) 443-8423
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, $2 Par Value
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x
The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2005 was approximately $95,533,034.
The number of shares of the registrant’s Common Stock outstanding as of March 2, 2006 was 4,909,875.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 2005 Annual Report to Shareholders are incorporated by reference into Part I and Part II, and portions of the 2006 definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held April 20, 2006 are incorporated by reference into Part III.
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EASTERN VIRGINIA BANKSHARES, INC.
FORM 10-K
For the Year Ended December 31, 2005
INDEX
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PART I
General
Eastern Virginia Bankshares, Inc. (the “Company” or “EVB”) is a bank holding company 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 three wholly owned subsidiaries, Southside Bank, Bank of Northumberland, Inc. and Hanover Bank (“the banks”). Bank of Northumberland, Inc. and Southside Bank were chartered as state banks under the laws of the Commonwealth of Virginia in 1910. Hanover Bank was chartered as a state bank in 2000.
The Company’s primary activity is retail banking. Through its bank subsidiaries the Company provides full service banking including commercial and consumer demand and time deposit accounts, real estate, commercial and consumer loans, Visa and MasterCard revolving credit accounts, drive-in banking services, automated teller machine transactions, internet banking and wire transfer services. With 22 branches at year end 2005, the banks serve diverse markets that primarily are in the counties of Caroline, Essex, Gloucester, Hanover, King and Queen, King William, Lancaster, Middlesex, Richmond, Northumberland, Southampton, Surry and Sussex, Virginia. Ancillary services provided by the banks to its customers include travelers’ checks, safe deposit box rentals and other customary bank services. The largest majority of the Company’s revenue comes from retail banking in the form of interest earned on loans and investment securities and fees related to deposit services.
The banks jointly own EVB Financial Services, Inc. (EVBFS), which owns other financial service businesses that the Company sets up. EVBFS in turn has 100% ownership of EVB Investments, Inc. and a 50% ownership interest in EVB Mortgage, Inc. The mortgage company operates with a partner in generating various real estate loans for sale in the mortgage loan markets and earns interest and fees from these loans while retaining no servicing rights. EVB Mortgage, Inc. was chartered in the first quarter of 2004 and began conducting business in the third quarter of 2004. For a fee, EVB Investments, Inc. provides securities, brokerage and investment advisory services. Investment advisory services offered through agreement by BI Investments, LLC, a registered advisory provider offered through Eastern Virginia Bankshares. It has a 5.15% ownership in Bankers Investment Group, LLC, which it uses as a brokerage firm for the investment services it provides. Southside Bank has a 75% ownership interest in EVB Title, LLC and a 2.33% interest in Virginia Bankers Insurance Center, LLC. EVB Title, LLC sells title insurance, while Virginia Bankers Insurance Center, LLC acts as a broker for insurance sales for its member banks. Bank of Northumberland has an ownership interest in Bankers Title, LLC, which provides title insurance services. EVB also owns 100% of Eastern Virginia Statutory Trust I that was setup for the sole purpose of Trust Preferred Debt issuance. The financial position and operating results of all of these subsidiaries are not significant in the aggregate to the Company as a whole and are not considered principal activities of the Company at this time.
Recent Developments
EVB started a re-engineering plan in late 2002 to gain “Best Practices” among its three bank subsidiaries. Prior to the re-engineering plan, each bank, and in some cases each branch, had different procedures for processing transactions at the bank level. Each bank also had its own separate Human Resources department, Accounting department, and Bond Portfolio management. The three banks were brought together to discuss each transaction that occurs in the branch to come up with the best procedure among them, which EVB refers to as “Best Practices”. The Company spent considerable time in 2003 and early 2004 completing these “Best Practices” and also consolidating the individual departments listed above. This was considered Phase I of the re-engineering plan in which the Company spent approximately $800 thousand in consulting fees. The compliance with the requirements of the Sarbanes-Oxley Act of 2002 (“SOX”) delayed Phase II of the re-engineering plan to the first quarter of 2005.
This phase represented the final consolidation of remaining back office functions such as Loan Operations, Branch Operations and Credit Review and the designing of consistent and unified procedures and policies. While the
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consolidation of the functions and most processes was completed in 2005, management continues to monitor all processes for refinements and efficiencies on a regular basis.
In November 2005, the Company announced plans to consolidate the three existing banks into a one-bank holding company. While consolidation of many back room services has already occurred, management determined that a consolidation could increase overall efficiencies, provide better services through a 22 branch system over a larger geographic region, improve customer service by having one process for most functions, and more effectively expand the franchise with one capital base as opposed to three. Utilizing the same consultant that has assisted in the work process consolidations, the Company is planning a more effective customer service oriented organization that can quickly respond to customers needs in a satisfactory manner. Planning began in November 2005 with the consolidation expected to become effective in the second quarter of 2006.
Available Information
The Company maintains an Internet website at www.evb.org, which contains information relating to it and its business. The Company makes available free of charge through its website its Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and any amendments to these documents as soon as reasonably practicable after it electronically files such material with, or furnishes it to, the Securities and Exchange Commission. Copies of the Company’s Audit Committee Charter, Nominating Committee Charter and Code of Conduct are available upon written request to the Company’s Corporate Secretary.
Employees
As of December 31, 2005, the Company and its subsidiary banks employed 296 full-time equivalent employees. EVB’s success is highly dependent on its ability to attract and retain qualified employees. Competition for employees is intense in the financial services industry. The Company believes it has been successful in its efforts to recruit qualified employees, but there is no assurance that it will continue to be successful in the future. None of the Company’s employees are subject to collective bargaining agreements. EVB believes relations with its employees are excellent.
Business Strategy
The Company’s business strategy is to grow both the existing franchise by taking advantage of opportunities in our current markets and to look at all possibilities to expand into other markets. Management investigates any potential opportunities to expand by acquisition or movement into other financial services products, which make the Company more profitable and will increase shareholder value.
Competition
EVB faces significant competition for loans and deposits based on the particular markets of operation, which can range from a small rural town to part of a large urban market. Competition for loans, the Company’s primary source of income, comes primarily from commercial banks and mortgage banking subsidiaries of both regional and community banks. Based on June 30, 2005 data published by the Federal Deposit Insurance Corporation, the most recent date for which such data is available, EVB held the largest deposit share among its competitors in Middlesex, Northumberland and Surry Counties. EVB also had a strong deposit share in Essex, King William, Southampton and Sussex Counties, and a rapidly growing deposit base in Gloucester and Hanover Counties. The Company’s primary competition is other community banks in Caroline, Essex, King William, Lancaster and Northampton Counties, while it competes with both community banks and large regional banks in Caroline, Gloucester, Hanover, Middlesex, Southampton, Surry and Sussex Counties.
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The Company’s deposit market share by county as of the latest available regulatory reports is:
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• Northumberland County | | 70.8 | % |
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• Surry County | | 69.0 | % |
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• Middlesex County | | 44.2 | % |
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• Essex County | | 38.2 | % |
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• Sussex County | | 27.8 | % |
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• Southampton County | | 24.2 | % |
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• King William County | | 23.3 | % |
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• Gloucester County | | 7.7 | % |
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• Caroline County | | 7.3 | % |
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• Hanover County | | 7.2 | % |
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• Lancaster County | | 2.7 | % |
Credit Policies
Most loans on EVB’s balance sheet are originated by one of the Company’s subsidiary banks – Southside Bank, Bank of Northumberland, Inc., or Hanover Bank. Any additional loans in the Company’s portfolio are from external participations purchased from other community banks or from loans purchased through EVB Mortgage, both of which must meet the same qualifications as those loans originated in the banks. For purposes of the discussion that follows, the banks will be collectively referred to as EVB.
The principal risk associated with each of the categories of loans in EVB’s portfolio is the creditworthiness of its borrowers. Within each category, such risk is increased or decreased, depending on certain factors. The risk associated with real estate mortgage loans, commercial loans and consumer loans varies based on employment levels, consumer confidence, fluctuations in the value of real estate and other conditions that affect the ability of borrowers to repay indebtedness. The risk associated with real estate construction loans varies based on the supply and demand for the type of real estate under construction. In an effort to manage these risks, EVB’s policy gives loan amount approval limits to individual loan officers based on their position and level of experience.
EVB has written policies and procedures to help manage credit risk. The Company utilizes a loan review process that includes formulation of portfolio management strategy, guidelines for underwriting standards and risk assessment, procedures for ongoing identification and management of credit deterioration, and regular independent third party portfolio reviews to establish loss exposure and to ascertain compliance with policies.
Each bank uses a Management Loan Committee, a Directors Loan Committee and, for larger loans, the Board of Directors to approve loans. The individual bank’s Chief Credit Officer is responsible for reporting to the Directors Loan Committee monthly on the activities of the Management Loan Committee and on the status of various delinquent and non-performing loans. The Directors Loan Committee also reviews lending policies proposed by management. EVB’s corporate Board of Directors establishes the total lending limit for the banks on a combined basis.
Loan Originations
Residential real estate loan originations come primarily from walk-in customers, real estate brokers and builders, and through referrals from EVB Mortgage. Loans generated and purchased from EVB Mortgage are referred to the banks for those loans that meet EVB’s underwriting guidelines. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of developers and continued business from current customers. An EVB loan officer as part of the application process reviews all loan applications. Information is obtained concerning the income, financial condition, and employment and credit history of the applicant. If commercial real estate is involved, information is also obtained concerning cash flow available for debt service. Depending on the type of loan involved, loan quality is analyzed based on EVB’s experience and credit underwriting guidelines as
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well as the guidelines used by an external loan review firm. Real estate collateral is appraised by independent appraisers who have been pre-approved by meeting the requirement of providing a current and valid license certification and based on the lender’s experience with these appraisers.
In the normal course of business, EVB makes various commitments and incurs certain contingent liabilities that are disclosed but not reflected in its annual financial statements including commitments to extend credit. At December 31, 2005, commitments to extend credit totaled $90.7 million. For more information, see Footnote 17 to the Consolidated Financial Statements included as part of this Form 10-K.
Construction Lending
EVB makes local construction and land acquisition and development loans. Residential houses under construction and the underlying land for which the loan was obtained secure construction loans. At December 31, 2005, construction, land acquisition and land development loans outstanding were $47.6 million, or 8.3% of total loans. These loans are concentrated in EVB’s local markets. The average life of a construction loan is less than one year. Because the interest rate charged on these loans usually floats with the market, they help EVB in managing its interest rate risk. Construction lending entails significant additional risks, compared with residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. Another risk involved in construction lending is attributable to the advancing of loan funds upon the security of the land or home under construction, where the value is estimated prior to the completion of construction. Thus, it is more difficult to evaluate accurately the total loan funds required to complete a project and related loan-to-value ratios. To mitigate the risks associated with construction lending, EVB generally limits loan amounts to 80% of appraised value in addition to analyzing the creditworthiness of its borrowers. The Company also obtains a first lien on the property as security for its construction loans and typically requires personal guarantees from the borrower’s principal owners.
Commercial Business Loans
Commercial business loans generally have a higher degree of risk than residential mortgage loans, as described below, but have higher yields. To manage these risks, EVB generally obtains appropriate collateral and personal guarantees from the borrower’s principal owners and monitors the financial condition of its business borrowers. Residential mortgage loans generally are made on the basis of the borrower’s ability to make repayment from employment and other income and are secured by real estate whose value tends to be readily ascertainable. In contrast, commercial business loans typically are made on the basis of the borrower’s ability to make repayment from cash flow from its business and are secured by business assets, such as commercial real estate, accounts receivable, equipment and inventory. As a result, the availability of funds for the repayment of commercial business loans is substantially dependent on the success of the business itself. Furthermore, the collateral for commercial business loans may depreciate over time and generally cannot be appraised with as much precision as residential real estate. EVB has a loan review and monitoring process to regularly assess the repayment ability of commercial borrowers. At December 31, 2005, commercial loans totaled $55.7 million, or 9.7% of the total loan portfolio.
Commercial Real Estate Lending
Various types of commercial real estate in EVB’s market area include commercial buildings and offices, recreational facilities, small shopping centers and churches, and other secure commercial real estate loans. At December 31, 2005, commercial real estate loans totaled $151.9 million, or 26.4% of EVB’s total loans. In its underwriting of commercial real estate, EVB may lend up to 80% of the secured property’s appraised value. Commercial real estate lending entails significant additional risk, compared with residential mortgage lending. Commercial real estate loans typically involve larger loan balances concentrated with single borrowers or groups of related borrowers. Additionally, the payment experience on loans secured by income producing properties is typically dependent on the successful operation of a business or a real estate project and thus may be subject, to a greater extent, to adverse conditions in the real estate market or in the economic environment. EVB’s commercial real estate loan underwriting criteria requires an examination of debt service coverage ratios, the borrower’s
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creditworthiness and prior credit history and reputation, and EVB typically requires personal guarantees or endorsements of the borrowers’ principal owners. In addition, EVB carefully evaluates the location of the security property.
One-to-Four-Family Residential Real Estate Lending
Residential one-to-four family mortgage loans comprise EVB’s total largest loan category. At December 31, 2005, this category of mortgage loans accounted for $263.2 million, or 45.8% of EVB’s total loan portfolio. Security for the majority of EVB’s residential lending is in the form of owner occupied one-to-four-family dwellings. Adjustable rate loans are $103.3 million of the residential real estate portfolio and are primarily 3 year Adjustable Rate Mortgages.
All residential mortgage loans originated by EVB contain a “due-on-sale” clause providing that the bank may declare the unpaid principal balance due and payable upon sale or transfer of the mortgaged premises. In connection with residential real estate loans, the banks require title insurance, hazard insurance and if required, flood insurance. The banks do not require escrows for real estate taxes and insurance.
Consumer Lending
EVB offers various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, automobile loans, boat loans, deposit account loans, installment and demand loans, credit cards, and home equity lines of credit and loans. At December 31, 2005, EVB had consumer loans, net of unearned interest, of $55.3 million or 9.6% of total loans. Such loans are generally made to customers with whom the Company has a pre-existing relationship. EVB currently originates all of its consumer loans in its geographic market area. Most of the consumer loans are issued based on a fixed rate.
Consumer loans may entail greater risk than residential mortgage loans, particularly in the case of consumer loans that are unsecured, such as lines of credit, or secured by rapidly depreciable assets such as automobiles. In such cases, any repossessed collateral for a defaulted consumer loan may not provide an adequate source of repayment of the outstanding loan balance as a result of the greater likelihood of damage, loss or depreciation. Due to the relatively small amounts involved, the remaining deficiency often does not warrant further substantial collection efforts against the borrower. In addition, consumer loan collections are dependent on the borrower’s continuing financial stability, and thus are more likely to be adversely affected by job loss, divorce, illness or personal bankruptcy. Furthermore, the application of various federal and state laws, including federal and state bankruptcy and insolvency laws, may limit the amount which can be recovered on such loans. Such loans may also give rise to claims and defenses by a consumer borrower against an assignee of collateral securing the loan such as EVB, and a borrower may be able to assert against such assignee claims and defenses that it has against the seller of the underlying collateral. Consumer loan delinquencies often increase over time as the loans age.
The underwriting standards employed by EVB to mitigate the risk for consumer loans include a determination of the applicant’s payment history on other debts and an assessment of ability to meet existing obligations and payments on the proposed loan. The stability of the applicant’s monthly income may be determined by verification of gross monthly income from primary employment, and additionally from any verifiable secondary income. Although creditworthiness of the applicant is of primary consideration, the underwriting process also includes an analysis of the value of the security in relation to the proposed loan amount.
Supervision and Regulation
The Company is subject to regulation under the Bank Holding Company Act of 1956 (BHCA) and the examination and reporting requirements of the Board of Governors of the Federal Reserve System. Under the BHCA, a bank holding company may not acquire ownership or control of more than 5% of the voting shares or substantially all of the assets of any bank or merge or consolidate with another bank holding company without the prior approval of the Federal Reserve Board. The BHCA generally limits the activities of a bank holding company and its
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subsidiaries to that of banking, managing or controlling banks, or any other activity that is determined to be so closely related to banking or to managing or controlling banks that an exception is allowed for those activities. The Company is also a registered bank holding company under the bank holding company laws of the Commonwealth of Virginia. Accordingly, the Company is also subject to regulation and supervision by the State Corporation Commission of Virginia.
As state-chartered banks, each of EVB’s three bank subsidiaries is subject to regulation, supervision and examination by the Virginia State Corporation Commission through its Bureau of Financial Institutions. All three subsidiary banks are members of the Federal Reserve System and subject to regulation, supervision and examination by the Federal Reserve Bank of Richmond. Federal and state laws also govern the activities in which the banks may engage regarding the investments that they may make and the aggregate amount of loans that may be granted to one borrower. The Company is subject to the reporting requirements of the Securities and Exchange Act of 1934, as amended, including the filing of quarterly, annual and other periodic reports with the Securities and Exchange Commission (the SEC).
There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the Federal Deposit Insurance Corporation (“FDIC”) insurance funds in the event that the depository institution is insolvent or in danger of becoming insolvent. For example, under the policy of the Federal Reserve Board with respect to bank holding company operations, a bank holding company is required to serve as a source of financial strength to its subsidiary depository institutions and to commit resources and to support such institutions in circumstances where it might not do so absent such policy. In addition, the “cross-guarantee” provisions of federal law require insured depository institutions under common control to reimburse the FDIC for any loss suffered or reasonably anticipated by either the Savings Association Insurance Fund or the Bank Insurance Fund as a result of the default of a commonly controlled insured depository institution in danger of default. The FDIC may decline to enforce the cross-guarantee provision if it determines that a waiver is in the best interests of the deposit insurance funds. The FDIC’s claim for reimbursement under the cross-guarantee provisions is superior to claims of shareholders of the insured depository institution or its holding company, but is subordinate to claims of depositors, secured creditors and nonaffiliated holders of subordinated debt of the commonly controlled insured depository institutions.
Federal law permits bank holding companies from any state to acquire banks and bank holding companies located in any other state, subject to certain conditions, including nationwide and state imposed concentration limits. Banks are also able to branch across state lines, provided certain conditions are met, including that applicable state laws expressly permit such interstate branching. Virginia has adopted legislation that permits branching across state lines, provided there is reciprocity with the state in which the out-of-state bank is located. After a bank has established branches in a state through an interstate merger transaction, the bank may establish and acquire additional branches at any location in the state where a bank headquartered in that state could have established or acquired branches under the applicable federal or state law.
Dividends
Earnings of the Company’s banking subsidiaries are impacted by general economic conditions, legislative changes, and management policies. The majority of the Company’s revenue from which dividends may be paid is dividends paid by the banks to the Company. Bank dividends are subject to regulatory requirements limiting dividends to current year earnings plus net retained earnings for the prior two years, unless otherwise approved by regulatory authorities. As of 2005 year-end, Southside Bank had $12.6 million, Bank of Northumberland $6.7 million, and Hanover Bank $1.4 million of retained income, free of restriction for payment of dividends. The Company maintains a policy that each of its banks is to maintain capital sufficient to be categorized as well-capitalized under banking regulations and to meet its desired lending limit requirements and to fund anticipated growth. Due to the Company having strong liquidity it was not necessary for the banks to pay a dividend in 2004 or 2005 although the Company paid dividends to shareholders of over $2.9 million in the aggregate each respective year.
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Capital
Banking regulatory agencies have issued risk-based and leverage capital guidelines applicable to banking organizations which they supervise. Under the risk-based capital guidelines of the federal regulatory agencies, the Company and the banks are required to maintain a minimum ratio of total capital to risk-weighted assets of at least 8% and a minimum Tier 1 capital to risk-weighted assets of at least 4%. At least half of total capital is required to be composed of common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles and other adjustments (Tier 1 capital). The remainder (Tier 2 capital) may consist of a limited amount of subordinated debt and other qualifying debt (including certain hybrid capital instruments), and a limited amount of the loan loss reserve.As of December 31, 2005, each of the three subsidiary banks was well capitalized under the regulatory guidelines of the FDIC. The Company’s capital is discussed in greater detail under the caption Capital Resources in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” below. In addition, actual capital ratios and regulatory ratios are compared and commented on in Note 19 to the Consolidated Financial Statements, which is included as part of this Form 10-K, under the caption Regulatory Matters. The Company is well capitalized in all measured categories.
The risk-based capital guidelines of the federal regulatory agencies explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agencies in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.
The Company and its subsidiary banks are also subject to certain other recent federal laws which directly impact operations of the Company:
USA Patriot Act
The USA Patriot Act became effective in October 2001 and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. Among other provisions, the USA Patriot Act permits financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government activities that may involve money laundering or terrorists’ activities. The USA Patriot Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Although it does create a reporting obligation, EVB has not experienced a material effect on products, services or other business activities since implementing the USA Patriot Act requirements.
The Federal Bureau of Investigation (“FBI”) has sent, and will send, our banking regulatory agencies lists of the names of persons suspected of terrorist activities. The banks have been requested, and will be requested, to search their records for any relationships or transactions with persons on those lists. If the Banks find any relationship or transactions, they must file a suspicious activity report and contact the FBI. The Office of Foreign Assets Control (“OFAC”), which is a division of the Department of the Treasury, is responsible for helping to ensure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress. Every two weeks, OFAC sends electronic lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the banks databases find a matching name on any account, or wire transfer that is on an OFAC list, the banks must freeze such accounts, file a suspicious activity report and notify the FBI.
Gramm-Leach-Bliley Act of 1999 (“GLBA”)
The GLBA implemented major changes to the statutory framework for providing banking and other financial services in the United States. The GLBA covers a broad range of issues, including the repeal of most of the restrictions on affiliations among depository institutions, securities firms and insurance companies. The Act
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repeals sections of 20 and 32 of the Glass-Stegall Act, thus permitting unrestricted affiliations between banks and securities firms. The Act also permits bank holding companies to elect to become financial holding companies. A financial holding company may engage in or acquire companies that engage in a broad range of financial services, including securities activities such as underwriting, dealing, brokerage, investment and merchant banking, insurance underwriting, sales and brokerage activities.
The Act provides that the states continue to have the authority to regulate insurance activities, but prohibits the states in most instances from preventing or significantly interfering with the ability of a bank, directly or through an affiliate, to engage in insurance sales, solicitations or cross-marketing activities. Although the states generally must regulate bank insurance activities in a nondiscriminatory manner, the states may continue to adopt and enforce rules that specifically regulate bank insurance activities in certain areas identified in the Act. The Act adopts a system of functional regulation under which the Federal Reserve Board is confirmed as the umbrella regulator for financial holding companies, but financial holding company affiliates are to be principally regulated by functional regulators such as the FDIC for state nonmember bank affiliates, the SEC for securities affiliates and state insurance regulators for insurance affiliates.
To become eligible for these activities, a bank holding company must qualify as a financial holding company. In order to become a financial holding company, the bank holding company and all of its affiliated depository institutions must be well-capitalized, well-managed, and have at least a satisfactory Community Reinvestment Act rating. In addition, the bank holding company must file with the Federal Reserve a declaration of its intention to become a financial holding company. While EVB satisfies these requirements, the Company has not found a sufficient business reason to elect to be treated as a financial holding company under the GLBA.
Bank Secrecy Act
The GLBA and the Bank Secrecy Act contain extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, at the inception of the customer relationship and annually thereafter, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The Act provides that, except for certain limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to its customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The Act also provides that the states may adopt customer privacy protections that are stricter than those contained in the Act. The Act also makes a criminal offense, except in limited circumstances, obtaining or attempting to obtain customer information of a financial nature by fraudulent or deceptive means.
Community Reinvestment Act
Southside Bank is subject to the requirements of the Community Reinvestment Act (“CRA”). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community credit needs are currently evaluated as part of the examination process pursuant to twelve assessment factors. These factors are considered in evaluating mergers, acquisitions and applications to open a branch or facility. At this time, the other banks are not subject to the requirements, but will be under the new one-bank organization.
Sarbanes-Oxley Act of 2002 (“SOX”)
The Sarbanes-Oxley Act of 2002, primarily provides for the improvement of corporate governance and reporting. A major part of SOX is Section 404, which requires certain companies to provide a report on their internal controls over financial reporting. This internal control report must (1) state the responsibility of management for establishing and maintaining an adequate internal control structure and procedures for financial reporting; and (2)
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contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting. This assessment of internal controls over financial reporting requires management to maintain evidential matter, including documentation, to support its assessment. Section 404 also requires an Attestation Report from the issuer’s registered public accounting firm. The Company believes it is fully complying with SOX. In the second year of implementation, 2005, the Company has continued to monitor its internal controls as a normal course of business and to maintain control as the Company goes through reorganizing and centralizing many of its reporting lines and backroom operations. See Item 9A below for more information.
An investment in the Company’s common stock involves significant risks inherent to the Company’s business. The risks and uncertainties that management believes affect or could affect the Company are described below. You should carefully read and consider these risks and uncertainties described below together with all of the other information included or incorporated by reference in this report, before you decide to invest in our common stock.
We may incur losses if we are unable to successfully manage interest rate risk.
Our profitability will depend in substantial part upon the spread between the interest rates earned on investments and loans and interest rates paid on deposits and other interest-bearing liabilities. These rates are normally in line with our competition with rises and falls based on the Asset Liability committee’s vision of the Company’s needs. However, the Company may pay above-market rates to attract deposits as we have done in some of our marketing promotions in the past. Changes in interest rates will affect our operating performance and financial condition in diverse ways including the pricing of securities, loans and deposits, and the volume of loan originations in our mortgage banking business. We attempt to minimize our exposure to interest rate risk, but we will be unable to eliminate it. Our net interest spread will depend on many factors that are partly or entirely outside our control, including competition, federal economic, monetary and fiscal policies, and economic conditions generally.
We may be adversely affected by economic conditions in our market area.
We operate in a mixed market environment with influences from both rural and urban areas. Because our lending is concentrated in these markets, we will be affected by the general economic conditions in the Eastern, Richmond and Tidewater areas of Virginia. Changes in the economy may influence the growth rate of our loans and deposits, the quality of the loan portfolio and loan and deposit pricing and the performance of our mortgage subsidiary. A significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic conditions and the demand for banking products and services generally, which could negatively affect our financial condition and performance.
Although we might not have significant credit exposure to all the businesses in our areas, the downturn in any of these businesses could have a negative impact on local economic conditions and real estate collateral values generally, which could negatively affect our profitability.
Our concentration in loans secured by real estate may increase our credit losses, which would negatively affect our financial results.
We offer a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Many of our loans are secured by real estate (both residential and commercial) in our market area. A major change in the real estate market, such as a deterioration in the value of this collateral, or in the local or national economy, could adversely affect our customers’ ability to pay these loans, which in turn could impact us. Risk of loan defaults and foreclosures are unavoidable in the banking
15
industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. We cannot fully eliminate credit risk, and as a result credit losses may occur in the future.
If our allowance for loan losses becomes inadequate, our results of operations may be adversely affected.
We maintain an allowance for loan losses that we believe is a reasonable estimate of known and inherent losses in our loan portfolio. Through a periodic review and consideration of the loan portfolio, management determines the amount of the allowance for loan losses by considering general market conditions, credit quality of the loan portfolio, the collateral supporting the loans and performance of our customers relative to their financial obligations with us. The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed our current estimates. Rapidly growing loan portfolios are, by their nature, unseasoned. As a result, estimating loan loss allowances is more difficult, and may be more susceptible to changes in estimates, and to losses exceeding estimates, than more seasoned portfolios.
Although we believe the allowance for loan losses is a reasonable estimate of known and inherent losses in our loan portfolio, we cannot fully predict such losses or that our loan loss allowance will be adequate in the future. Excessive loan losses could have a material impact on our financial performance. Consistent with our loan loss reserve methodology, we expect to make additions to our loan loss reserve levels as a result of our loan growth, which may affect our short-term earnings.
Federal and state regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further loan charge-offs, based on judgments different than those of our management. Any increase in the amount of our provision or loans charged-off as required by these regulatory agencies could have a negative effect on our operating results.
Our future success is dependent on our ability to compete effectively in the highly competitive banking industry.
We face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions for deposits, loans and other financial services in our market area. A number of these banks and other financial institutions are significantly larger than we are and have substantially greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations which may offer more favorable financing than we can. Many of our non-bank competitors are not subject to the same extensive regulations that govern us. As a result, these non-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
Our profitability may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.
The banking industry is subject to extensive regulation by state and federal banking authorities. Many of the banking regulations we are governed by are intended to protect depositors, the public or the insurance funds maintained by the Federal Deposit Insurance Corporation, not shareholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth and changes in regulations could adversely affect us. The burden imposed by these federal and state regulations may place banks in a competitive disadvantage compared to less regulated competitors. In addition, the cost of compliance with regulatory requirements could adversely affect our ability to operate profitably. See “Supervision and Regulation” for more information about applicable banking laws and regulations.
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We may not be able to successfully manage our growth, which may adversely affect our results of operations and financial condition.
During the last five years, we have experienced significant growth, and a key aspect of our business strategy is our continued growth and expansion. Our ability to continue to grow depends, in part, upon our ability to:
| | • | | open new branch offices or acquire existing branches or other financial institutions; |
| | • | | attract deposits to those locations; and |
| | • | | identify attractive loan and investment opportunities. |
We may not be able to successfully implement our growth strategy if we are unable to identify attractive markets, locations or opportunities to expand in the future. Our ability to manage our growth successfully also will depend on whether we can maintain capital levels adequate to support our growth, maintain cost controls and asset quality and successfully integrate any businesses we acquire into our organization.
As we continue to implement our growth strategy by opening new branches or acquiring branches or other banks, we expect to incur increased personnel, occupancy and other operating expenses. In the case of new branches, we must absorb those higher expenses while we begin to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding earning assets. Thus, our plans to branch aggressively could depress our earnings in the short run, even if we efficiently execute our branching strategy.
We rely heavily on our management team and the unexpected loss of any of those personnel could adversely affect our operations; we depend on our ability to attract and retain key personnel.
We are a customer-focused and relationship-driven organization. We expect our future growth to be driven in a large part by the relationships maintained with our customers by our Chairman, President and other Senior Officers. We have entered into employment agreements with five our executive officers. The existence of such agreements, however, does not necessarily assure that we will be able to continue to retain their services. The unexpected loss of any of our key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings. We do maintain Bank owned life insurance on key officers that would help cover some of the economic impact of a loss caused by death.
The implementation of our business strategy will also require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships as well as new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing customers if they were to leave their current employment. These agreements make the recruitment of these professionals more difficult. The market for these people is competitive, and we cannot assure you that we will be successful in attracting, hiring, motivating or retaining them.
We may identify a material weakness or a significant deficiency in our internal control over financial reporting that may adversely affect our ability to properly account for non-routine transactions.
As we have grown and expanded, we have acquired and added, and expect to continue to acquire and add, businesses and other activities that complement our core retail and commercial banking functions. Such acquisitions or additions frequently involve complex operational and financial reporting issues that can influence management’s internal control system. While we make every effort to thoroughly understand any new activity or acquired entity’s business processes, our planning for proper integration into our company can give no assurance that we will not encounter operational and financial reporting difficulties impacting our controls over the Company.
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If we need additional capital in the future to continue our growth, we may not be able to obtain it on terms that are favorable. This could negatively affect our performance and the value of our common stock.
Our business strategy calls for continued growth. We anticipate that we will be able to support this growth through the generation of additional deposits at new branch locations as well as investment opportunities. However, we may need to raise additional capital in the future to support our continued growth and to maintain our capital levels. Our ability to raise capital through the sale of additional securities will depend primarily upon our financial condition and the condition of financial markets at that time. We may not be able to obtain additional capital in the amounts or on terms satisfactory to us. Our growth may be constrained if we are unable to raise additional capital as needed.
We may in the future issue additional stock, any or all of which will dilute your percentage ownership and, possibly, the value of your shares.
Our board of directors generally has the authority to issue all or part of any authorized but unissued common shares without prior shareholder approval and without allowing the shareholders the right to purchase theirpro rata portion of such shares. This includes shares authorized to be issued under our stock option plans. The issuance of any new common shares will dilute your percentage ownership, and could dilute the value of your shares.
Because our mortgage banking revenue is sensitive to changes in economic conditions, decreased economic activity, a slowdown in the housing market or high interest rates may reduce our profits.
Maintaining a high level of fees from this operation depends primarily on our ability to continue to originate mortgage loans. Production levels are sensitive to changes in economic conditions and can suffer from decreased economic activity, a slowdown in the housing market or higher interest rates. Generally, any sustained period of decreased economic activity or higher interest rates could adversely affect our mortgage originations and, consequently, reduce our income from mortgage banking activities. As a result, these conditions may adversely affect our net income.
| Item 1B. | Unresolved Staff Comments |
None.
The Company’s principal executive offices are located at 330 Hospital Road, Tappahannock, Virginia 22560 where a 15,632 square foot corporate headquarters and operations center was opened in July 2003. The three subsidiary banks own 18 full service branch buildings including the land on which 17 of those buildings are located and two remote drive-in facilities. Four branch office buildings are leased at current market rates. Northumberland and Middlesex Counties each are the home to three of the branches. Gloucester County and King William County are home to two branch offices as is Essex County which also houses the Southside Bank loan administration center and the corporate/operations center. Hanover County houses four branch offices (three of which are leased) while Caroline County, Lancaster County, Southampton County, Surry County and Sussex County each have one full service branch office. Southampton County and Sussex County also have stand-alone drive-in/automated teller machine locations. All properties are in good condition. The land on which the Middlesex County office is located is under long-term lease.
Southside Bank opened its 14th branch along Rt. 17 at Glenns in Gloucester County in June 2005. This expanded on the original lease begun in November 2004 which allowed the Company to operate its training and accounts payable departments in parts of the building. The upper floor of the building is still used by the owner. As the Company looks at 2006, it is pursuing the relocation of the Airpark branch of Hanover Bank and anticipates
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opening in late 2006. The land for this location was purchased in mid 2004 and offers the Company a great site in a rapidly expanding market, Hanover County.
While the current locations are meeting the Company’s needs, and many may meet our needs into the future, the Company is a growing entity that is frequently reevaluating its locations and space needs. Continued growth may require expansions or relocations in the future.
EVB and its subsidiaries are not aware of any material pending or threatened litigation, unasserted claims and/or assessments. The only litigation in which EVB and its subsidiaries are involved consist of collection suits involving delinquent loan accounts in the normal course of business which management estimates will not have a material impact on the financial condition of the Company.
| Item 4. | Submission of Matters to a Vote of Security Holders |
No matters were submitted to a vote of security holders during the fourth quarter of 2005.
Executive Officers of the Registrant
Following are the persons who are currently executive officers of EVB, their ages as of December 31, 2005, their current titles and positions held during the last five years:
W. Rand Cook, 52, is the Chairman of the Board of Directors of EVB, serving since 2001, and has been a member of the Board since the Company’s inception in December 1997. He was a director of Hanover Bank from its inception in 2000 until 2002. He was a director of Southside Bank from 1996 to 2000. He is an attorney in Hanover County, VA.
F. L. Garrett, III, 66, has been Vice Chairman of the Board of Directors of EVB since the Company’s inception in December 1997. Mr. Garrett is also Chairman of the Board of Directors of Southside Bank of which he has been a member since 1982. He is a realtor in Essex County, VA
William E. Martin, Jr., 56, is Senior Vice President of EVB. Mr. Martin has served as the President and Chief Executive Officer of Hanover Bank since it began operations in 2000.
Lewis R. Reynolds, 55, is Senior Vice President of EVB. Mr. Reynolds has served as the President and Chief Executive Officer of Bank of Northumberland since 1991.
Joe A. Shearin, 49, is the President and Chief Executive Officer of EVB and its subsidiary Southside Bank. Mr. Shearin has served as President of Southside Bank since 2001 and as President and Chief Executive Officer of EVB since 2002. Prior to that time, he was Senior Vice President/City Executive of BB&T for three years.
Joseph H. James, 50, is Senior Vice President and Chief Operations Officer of EVB. Mr. James joined EVB in 2000 as Chief Operations Officer.
Ronald L. Blevins, 61, is Senior Vice President and Chief Financial Officer of EVB. Mr. Blevins joined EVB in 2000 as Chief Financial Officer.
J. Lloyd Railey, 55, is Senior Vice President and Risk Management Officer of EVB. He was Chief Financial Officer of Southside Bank from 2001 to 2002 when he was transferred to EVB. He was President of B&L Professional Services, Inc., providing banks with project management and other consultative services during 2000 and 2001.
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PART II
Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
The information titled “Common Stock Performance and Dividends” set forth on the last page of the 2005 Annual Report to Shareholders is incorporated herein by reference and is filed herewith as Exhibit 13.1.
Dividend Policy
The Company’s future dividend policy is subject to the discretion of the board of directors and will depend upon a number of factors, including future consolidated earnings, financial condition, liquidity and capital requirements of the Company and Hanover Bank, Bank of Northumberland, Inc. and Southside Bank, applicable governmental regulations and policies and other factors deemed relevant by the board of directors.
The Company’s ability to distribute cash dividends will depend primarily on the abilities of its subsidiary banks to pay dividends to the Company. As state member banks, the subsidiary banks are subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Furthermore, neither the Company nor any of the banks may declare or pay a cash dividend on any capital stock if it is insolvent or if the payment of the dividend would render it insolvent or unable to pay its obligations as they become due in the ordinary course of business. For additional information on these limitations, see “Supervision and Regulation - Dividends” in Item 1 above.
Purchases of Equity Securities
The repurchase and retirement of shares is part of a Board of Directors authorization in January 2001, to repurchase up to 300,000 shares of the Company’s common stock. That authorization was subsequently revised to a limit of not more than 60,000 shares per calendar quarter and again revised in November 2003 to a maximum of 5% of the outstanding shares per calendar year. A total of 133,383 shares have been repurchased under this Board authorized Plan that was publicly announced on January 31, 2001. The maximum number of shares that were available for repurchase under this Plan in 2005 was 245,250. The Company did not repurchase any of its securities during 2005.
| Item 6. | Selected Financial Data |
The information set forth on page 4 of the 2005 Annual Report to Shareholders is incorporated herein by reference and is filed herewith as Exhibit 13.2.
| Item 7. | Management’s Discussion and Analysis of Financial Condition and Results of Operations |
Management’s discussion and analysis is intended to assist the reader in evaluating and understanding the consolidated results of operations and financial condition of Eastern Virginia Bankshares, Inc. The following analysis provides information about the major components of the results of operations, financial condition, liquidity and capital resources of Eastern Virginia Bankshares and attempts to identify trends and material changes that occurred during the reporting periods. The discussion should be read in conjunction with Selected Financial Data (Item 6 above) and the Consolidated Financial Statements and Notes to Consolidated Financial Statements (Item 8 below).
Forward Looking Statements
Certain information contained in this discussion may include “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. These forward-looking statements are generally identified by phrases such as “the Company expects,” the Company believes” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to:
| | • | | Interest rate fluctuations |
| | • | | Risk inherent in making loans such as repayment risks and fluctuating collateral values |
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| | • | | Funding cost in an increasing competitive environment |
| | • | | Changes in banking and other laws and regulations applicable to the Company |
| | • | | Changes in general economic and business conditions |
| | • | | Competition within and from outside the banking industry |
| | • | | New products and services in the banking industry |
| | • | | Problems with technology utilized by the Company |
| | • | | Changing trends in customer profiles and behavior |
| | • | | Integration of newly acquired branches or businesses |
| | • | | The ability to successfully manage growth or the implementation of growth strategies |
| | • | | Other factors discussed in Item 1A, “Risk Factors”, above |
Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
CRITICAL ACCOUNTING POLICIES
General
The Company’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, we use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ substantially from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) SFAS No.5,Accounting for Contingencies, which requires that losses be accrued when they are probable of occurring and estimable and (ii) SFAS No.114,Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of the collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
The Company evaluates loans individually for impairment that are non-performing, such as nonaccrual loans, loans past due 90 days or more, restructured loans and other loans selected by management as required by SFAS No. 114. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of the impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5.
For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by SFAS No. 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical loss rates for each loan type, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans including: borrower or industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in risk selection; level of experience, ability and depth of lending staff; and national and economic conditions.
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The amounts of estimated losses for loans individually evaluated for impairment and groups of loans are added together for a total estimate of loan losses. The estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses is greater that the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether a reduction to the allowance would be necessary. While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments would be made in the relevant period and may be material to the Consolidated Financial Statements.
Executive Overview
While EVB increased net interest income by 3.6% for the year ended December 31, 2005, this was counteracted by increased noninterest expenses which lowered net income and earnings per share. The higher noninterest expense was the result of the Company’s backroom centralization project, the full expense impact of two new branches, and the initial impact of the planned one bank reorganization. The Company had net income of $6.73 million, or $1.37 per share on a basic and a diluted basis, down 7.1% from $7.24 million and $1.49 per share on basic and $1.48 per share on a diluted basis for 2004. Return on average assets (ROA) for 2005 was 0.93% compared to 1.05% in the prior year, and the return on average equity (ROE) was 11.05% for 2005 compared to 12.42% in 2004. Core earnings during the period from 2004 to 2005 continued to improve as net interest income increased by 3.6% and noninterest income excluding realized gains on securities increased 6.7% from the prior year. As stated this was largely offset by an 11.4% increase in noninterest expenses which reflects a slowing of the higher expense rate when compared to a 21.1% increase in noninterest expenses between 2003 and 2004.
As the Company went through the year 2005, it continued to feel the expense impact of the re-engineering project, SOX, the new branches, new training to raise the level of customer service and the initial impact of the one bank reorganization project. It benefited from both loan growth and better asset quality which should carry forward into 2006.
While most of the major costs associated with SOX hit in 2004, the costs to continue the procedures and maintain effective control of the Company are on going. A grid outlining the control responsibilities of all divisions has to be maintained and revised as the Company changes. The Company hired an outside consultant to perform SOX reviews and many internal audit functions. The external audit firm has more responsibilities to review the control environment of the Company and thus higher fees. In addition, the Company continues to conduct training for all government compliance requirements.
Late in 2004, Southside Bank opened the Central Garage branch in King William County near the crossroads of Route 360 and Route 30. In June 2005, Southside Bank opened a branch in Glenns, along the Route 17 corridor to Hampton Roads. While these branches have grown, their contribution in 2005 was mostly expenses. Management expects a higher contribution to expense coverage in 2006 through higher branch earnings. Customer service training was introduced late in the third quarter to make the whole company aware of the best practices in handling both external customer and internal bank employee calls for service or information. This training was presented to all the employees. This is an initial step to develop a sales culture within the Company, so the employees can better recognize and effectively meet the needs of our customers.
Finally, towards the end of the year, the Company announced plans to transform itself from a three-bank holding company to a one-bank holding company. This process will further streamline backroom processes by creating a unified process company-wide and minimize various reporting requirements from three banks to one. The costs associated with this began in the fourth quarter of 2005 and will most likely end in the second quarter of 2006.
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With all these non-income producing projects going on, the Company increased loan volume and the associated income very well. Even more important, the overall asset quality is at its highest level in the history of the Company. While the Federal Reserve continues increasing interest rates, future net interest income from loan rate growth could be squeezed by higher cost deposits, since the demand for funds from all financial sectors will drive up the cost of customer deposits.
Results of Operations
The table below lists the Company’s quarterly performance for the years ended December 31, 2005 and 2004.
SUMMARY OF FINANCIAL RESULTS BY QUARTER
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended |
| | | 2005 | | 2004 |
(dollars in thousands) | | Dec. 31 | | Sep. 30 | | June 30 | | Mar. 31 | | Dec. 31 | | Sep. 30 | | June 30 | | Mar. 31 |
Interest income | | $ | 11,660 | | $ | 10,979 | | $ | 10,511 | | $ | 10,079 | | $ | 9,862 | | $ | 10,042 | | $ | 9,881 | | $ | 9,959 |
Interest expense | | | 3,836 | | | 3,523 | | | 3,030 | | | 2,809 | | | 2,759 | | | 2,712 | | | 2,669 | | | 2,630 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | 7,824 | | | 7,456 | | | 7,481 | | | 7,270 | | | 7,103 | | | 7,330 | | | 7,212 | | | 7,329 |
Provision for loan losses | | | 64 | | | 282 | | | 198 | | | 8 | | | 322 | | | 340 | | | 277 | | | 340 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income after provision for loan losses | | | 7,760 | | | 7,174 | | | 7,283 | | | 7,262 | | | 6,781 | | | 6,990 | | | 6,935 | | | 6,989 |
Noninterest income | | | 1,139 | | | 1,313 | | | 1,132 | | | 1,143 | | | 1,156 | | | 1,118 | | | 1,223 | | | 1,087 |
Noninterest expense | | | 6,346 | | | 6,144 | | | 6,276 | | | 6,127 | | | 5,640 | | | 5,608 | | | 5,729 | | | 5,431 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Income before applicable income taxes | | | 2,553 | | | 2,343 | | | 2,139 | | | 2,278 | | | 2,297 | | | 2,500 | | | 2,429 | | | 2,645 |
Applicable income taxes | | | 734 | | | 656 | | | 590 | | | 607 | | | 640 | | | 648 | | | 610 | | | 733 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net Income | | $ | 1,819 | | $ | 1,687 | | $ | 1,549 | | $ | 1,671 | | $ | 1,657 | | $ | 1,852 | | $ | 1,819 | | $ | 1,912 |
| | | | | | | | | | | | | | | | | | | | | | | | |
Net income per share, basic and diluted | | $ | 0.37 | | $ | 0.34 | | $ | 0.32 | | $ | 0.34 | | $ | 0.34 | | $ | 0.38 | | $ | 0.37 | | $ | 0.39 |
Net Interest Income
Net interest income represents the Company’s gross profit margin and is defined as the difference between interest income and interest expense. For comparative purposes, income from tax-exempt securities is adjusted to a tax-equivalent basis using the federal statutory tax rate of 34%. Tax-exempt securities income is further adjusted by the Tax Equity Fiscal Responsibility Act (“TEFRA”) adjustment 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. This adjustment results in tax-exempt income and yields being presented on a basis comparable with income and yields from fully taxable earning assets. Net interest margin represents the Company’s net interest income divided by average earning assets. Changes in the volume and mix of earning assets and interest bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. The “Average Balances, Income and Expense, Yields and Rates” table presents average balances, related interest income and expense, and average yield/cost data for each of the past three years. The “Volume and Rate Analysis” table that follows reflects changes in interest income and interest expense resulting from changes in average volume and average rates.
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The following table shows interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid, for the periods indicated.
Average Balance, Income and Expense, Yields and Rates (1)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Twelve Months Ended December 31 | |
| | | 2005 | | | 2004 | | | 2003 | |
(dollars in thousands) | | Average
Balance | | | Income/
Expense | | Yield/
Rate | | | Average
Balance | | | Income/
Expense | | Yield/
Rate | | | Average
Balance | | | Income/
Expense | | Yield/
Rate | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Securities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable | | $ | 95,688 | | | $ | 4,477 | | 4.68 | % | | $ | 89,686 | | | $ | 4,460 | | 4.97 | % | | $ | 66,417 | | | $ | 3,430 | | 5.16 | % |
Tax exempt (1) | | | 37,456 | | | | 2,216 | | 5.92 | % | | | 46,596 | | | | 2,784 | | 5.97 | % | | | 49,089 | | | | 2,989 | | 6.09 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total securities | | | 133,144 | | | | 6,693 | | 5.03 | % | | | 136,282 | | | | 7,244 | | 5.32 | % | | | 115,506 | | | | 6,419 | | 5.56 | % |
Federal funds sold | | | 2,477 | | | | 76 | | 3.07 | % | | | 4,230 | | | | 53 | | 1.25 | % | | | 8,507 | | | | 95 | | 1.12 | % |
Loans (net of unearned income) (2) | | | 537,736 | | | | 37,137 | | 6.91 | % | | | 498,568 | | | | 33,298 | | 6.68 | % | | | 431,051 | | | | 30,604 | | 7.10 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total earning assets | | | 673,357 | | | | 43,906 | | 6.52 | % | | | 639,080 | | | | 40,595 | | 6.35 | % | | | 555,064 | | | | 37,118 | | 6.69 | % |
Less allowance for loan losses | | | (6,632 | ) | | | | | | | | | (6,788 | ) | | | | | | | | | (6,087 | ) | | | | | | |
Total non-earning assets | | | 59,427 | | | | | | | | | | 59,112 | | | | | | | | | | 38,307 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 726,152 | | | | | | | | | $ | 691,404 | | | | | | | | | $ | 587,284 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities & Shareholders’ Equity: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Checking | | $ | 78,953 | | | $ | 398 | | 0.50 | % | | $ | 79,094 | | | $ | 428 | | 0.54 | % | | $ | 61,177 | | | $ | 329 | | 0.54 | % |
Savings | | | 122,373 | | | | 1,312 | | 1.07 | % | | | 128,041 | | | | 1,296 | | 1.01 | % | | | 119,547 | | | | 1,458 | | 1.22 | % |
Money market savings | | | 51,451 | | | | 595 | | 1.16 | % | | | 57,103 | | | | 520 | | 0.91 | % | | | 45,696 | | | | 494 | | 1.08 | % |
Large dollar certificates of deposit (5) | | | 79,782 | | | | 2,813 | | 3.53 | % | | | 64,611 | | | | 2,123 | | 3.29 | % | | | 53,098 | | | | 1,882 | | 3.54 | % |
Other certificates of deposit | | | 179,198 | | | | 5,654 | | 3.16 | % | | | 179,748 | | | | 4,925 | | 2.74 | % | | | 161,063 | | | | 5,164 | | 3.21 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 511,757 | | | | 10,772 | | 2.10 | % | | | 508,597 | | | | 9,292 | | 1.83 | % | | | 440,581 | | | | 9,327 | | 2.12 | % |
Other borrowings | | | 54,543 | | | | 2,426 | | 4.45 | % | | | 34,679 | | | | 1,478 | | 4.26 | % | | | 25,784 | | | | 1,095 | | 4.25 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 566,300 | | | | 13,198 | | 2.33 | % | | | 543,276 | | | | 10,770 | | 1.98 | % | | | 466,365 | | | | 10,422 | | 2.23 | % |
Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | | 93,376 | | | | | | | | | | 83,841 | | | | | | | | | | 61,055 | | | | | | | |
Other liabilities | | | 5,603 | | | | | | | | | | 6,005 | | | | | | | | | | 5,224 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities | | | 665,279 | | | | | | | | | | 633,122 | | | | | | | | | | 532,644 | | | | | | | |
Shareholders’ equity | | | 60,873 | | | | | | | | | | 58,282 | | | | | | | | | | 54,640 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 726,152 | | | | | | | | | $ | 691,404 | | | | | | | | | $ | 587,284 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | | | | $ | 30,708 | | | | | | | | | $ | 29,825 | | | | | | | | | $ | 26,696 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate spread (3) | | | | | | | | | 4.19 | % | | | | | | | | | 4.37 | % | | | | | | | | | 4.45 | % |
Interest expense as a percent of average earning assets | | | | | | | | | 1.96 | % | | | | | | | | | 1.69 | % | | | | | | | | | 1.88 | % |
Net interest margin (4) | | | | | | | | | 4.56 | % | | | | | | | | | 4.67 | % | | | | | | | | | 4.81 | % |
Notes:
| (1) | Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%. |
| (2) | Nonaccrual loans have been included in the computations of average loan balances. |
| (3) | 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. |
| (4) | Net interest margin is the net interest income, calculated on a fully taxable basis assuming a federal income tax rate of 34%, expressed as a percentage of average earning assets. |
| (5) | Large dollar certificates of deposit are certificates issued in amounts of $100,000 or greater. |
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Tax-equivalent net interest income increased 3.0% in 2005 to $30.7 million from $29.8 million in 2004. Average earning asset growth of 5.4% produced $3.3 million of increased interest income, while interest-bearing liabilities grew 4.2% producing a $2.4 million increase in interest expense. The increase in net interest income resulted from a combination of higher volume and rates in earning assets, a volume increase in both large denomination certificates of deposit and long-term borrowings and higher rates on all interest-bearing liabilities except interest checking. The increased cost of deposits and borrowings seen in the rate column, more than offset the increase from rates in the earning assets. The Federal Reserve continued to raise rates throughout 2005 which caused customers to move out of lower yielding deposits and into higher yielding certificates of deposit or other investments outside of the bank. The Company did have an increase in demand deposits with most of this coming in personal and business checking. The slowing of deposit growth resulted in an increase in other borrowings and a liquidating of securities to help fuel the loan growth. The Company had a net interest margin of 4.56% for 2005, an eleven basis point decrease from 4.67% in 2004. Yield on earning assets increased 17 basis points to 6.52% in 2005 from 6.35% in 2004, while the cost of interest-bearing funds increased 35 basis points from 1.98% in 2004 to 2.33% in 2005. The higher increase in interest expense more than offset the increase in earning assets, resulting in an 11 basis point decrease in the net interest margin. In 2006, the Company expects the cost of deposits will further squeeze the net interest margin until rates stop rising.
Historically, the net interest margin pressure caused by an economic environment with a flat or inverted yield curve has proved extremely challenging for the banking industry. At June 30, 2004, just as the Federal Open Market Committee began raising the federal funds rate, which resulted in a matching increase in the Wall Street prime rate, the yield on a three month maturity treasury bond was 1.37% or 253 basis points below the 3.90% yield on a five year treasury and 332 basis points below the 4.69% yield on a 10 year treasury. By February 10, 2006 that yield had inverted to the point that a three month treasury was yielding 4.52%, while both the five year and ten year treasury were yielding the exact same 4.52%, the ten year treasury being below the level of 18 months ago. The yield curve change from a more than 250 basis point premium for a longer investment to a position where there is no premium for time risk is presenting funding and interest margin management pressures to the Company, as a flat or inverted yield curve significantly increases competition for deposits and their cost. While deposit cost is increasing, the lack of a similar movement in longer-term rates limits the yield increase on fixed rate loans. As a result, management considers the short-term risk of a further decrease in the net interest margin to be more likely than the potential of an increase in the margin.
Average earning asset growth of 5.4% resulted from increases in average loans outstanding of 7.9%, a decrease in federal funds sold of 41.4% and a slight decrease in average securities. Growth in average earning assets of $34.3 million was primarily funded by average deposit growth of $12.7 million and an increase in average borrowings of $19.9 million. In 2004, net interest income on a tax equivalent basis increased 11.7% to $29.8 million from $26.7 million in 2003. Average earning asset growth of 15.1% was the primary factor in the increase in net interest income and in producing a net interest margin of 4.67%, a 14 basis point decrease from 4.81% in 2003.
25
Volume and Rate Analysis (1)
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2005 vs. 2004 Increase (Decrease) Due to Changes in: | | | 2004 vs. 2003 Increase (Decrease) Due to Changes in: | |
(dollars in thousands) | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | |
Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable securities | | $ | 285 | | | $ | (268 | ) | | $ | 17 | | | $ | 1,160 | | | $ | (130 | ) | | $ | 1,030 | |
Tax exempt securities (2) | | | (545 | ) | | | (23 | ) | | | (568 | ) | | | (147 | ) | | | (58 | ) | | | (205 | ) |
Loans (net of unearned income) | | | 2,665 | | | | 1,174 | | | | 3,839 | | | | 4,582 | | | | (1,888 | ) | | | 2,694 | |
Federal funds sold | | | (29 | ) | | | 52 | | | | 23 | | | | (52 | ) | | | 10 | | | | (42 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total earning assets | | | 2,376 | | | | 935 | | | | 3,311 | | | | 5,543 | | | | (2,066 | ) | | | 3,477 | |
Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest checking | | | 2 | | | | (32 | ) | | | (30 | ) | | | 99 | | | | — | | | | 99 | |
Savings deposits | | | (59 | ) | | | 75 | | | | 16 | | | | 102 | | | | (264 | ) | | | (162 | ) |
Money market accounts | | | (57 | ) | | | 132 | | | | 75 | | | | 111 | | | | (85 | ) | | | 26 | |
Consumer certificates of deposit | | | (7 | ) | | | 736 | | | | 729 | | | | 321 | | | | (560 | ) | | | (239 | ) |
Large denomination certificates (3) | | | 526 | | | | 164 | | | | 690 | | | | 381 | | | | (140 | ) | | | 241 | |
Long-term borrowings | | | 880 | | | | 68 | | | | 948 | | | | 380 | | | | 3 | | | | 383 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 1,285 | | | | 1,143 | | | | 2,428 | | | | 1,394 | | | | (1,046 | ) | | | 348 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Change in net interest income | | $ | 1,091 | | | $ | (208 | ) | | $ | 883 | | | $ | 4,149 | | | $ | (1,020 | ) | | $ | 3,129 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Notes:
| (1) | Changes caused by the combination of rate and volume are allocated based on the percentage caused by each. |
| (2) | Income and yields are reported on a tax-equivalent basis, assuming a federal tax rate of 34%. |
| (3) | Large denomination certificates are those issued in amounts of $100 thousand or greater. |
Interest Sensitivity
EVB’s primary goals in interest rate risk management are to minimize negative fluctuations in net interest margin as a percentage of earning assets and to increase the dollar amount of net interest income at a growth rate consistent with the growth rate of total assets. These goals are accomplished by managing the interest sensitivity gap, which is the difference between interest sensitive assets and interest sensitive liabilities in a specific time interval. Interest sensitivity gap is managed by balancing the volume of floating rate liabilities with a similar volume of floating rate assets, by keeping the average maturity of fixed rate asset and liability contracts reasonably consistent and short, and by routinely adjusting pricing to market conditions on a regular basis.
The Company generally strives to maintain a position flexible enough to move to equality between rate-sensitive assets and rate-sensitive liabilities, which may be desirable when there are wide and frequent fluctuations in interest rates. Matching the amount of assets and liabilities maturing in the same time interval helps to hedge interest rate risk and to minimize the impact on net interest income in periods of rising or falling interest rates. When an unacceptable positive gap within a one-year time frame occurs, maturities can be extended by selling shorter-term investments and purchasing longer maturities. When an unacceptable negative gap occurs, variable rate loans can be increased and more investment in shorter-term investments can be made. Interest rate gaps are managed through investments, loan pricing and deposit pricing. The banking industry traditionally faces funding challenges in an environment such as that currently in place when the yield curve is flat to inverted. Managing the interest rate gap has become much more challenging in this current rising rate environment where many depositors have chosen to move funds out of savings and money market accounts and into higher rate, longer maturity certificates of deposit or the securities market. While this customer change in deposit preference unfavorably impacts the current interest margin, it creates an asset sensitive balance sheet, as more assets are subject to
26
short-term interest rate increases than the amount of liabilities subject to the same short-term increases. In the short term the Company is currently asset sensitive but will swing to a liability sensitive status as 2006 progresses and depending on when interest rates stop rising.
Noninterest Income
Noninterest income increased by $203 thousand or 4.5% from $4.5 million in 2004 to $4.7 million in 2005. Service charges on deposit accounts, the largest source of noninterest income, increased by $33 thousand or 1.1% from $2.95 million in 2004 to $2.99 million in 2005. Other operating income increased $227 thousand or 17.9% from $1.27 million in 2004 to $1.50 million in 2005. Other operating income includes a $217 thousand increase in other investment income, which reflects the increased revenue of the investment services business and from EVB Mortgage. The mortgage company is a joint venture entered into during the first quarter of 2004 with Southern Trust Mortgage. The increased income was related to loan volume generated in the final three quarters of 2005. Realized gain on sale of securities decreased $79 thousand to $224 thousand from $303 thousand in the prior year. Other items in this category are a loss of $58 thousand on disposal of fixed assets as the Company upgraded to a Voice Over Internet Protocol (VOIP) telephone system which uses our computer lines to transmit most of our telephone traffic.
Noninterest income increased $580 thousand or 14.7% from 2003 to 2004, attributable to a $554 thousand increase in service charges on deposits, a $50 thousand increase in other operating income, a $155 thousand decrease in gain on sale of other real estate and a $130 thousand increase in realized gain on sale of securities.
The following table shows the components of noninterest income for the periods indicated.
Noninterest Income:
| | | | | | | | | |
| | | Years Ended December 31 |
(dollars in thousands) | | 2005 | | 2004 | | 2003 |
Service charges on deposit accounts | | $ | 2,986 | | $ | 2,953 | | $ | 2,399 |
Gain on available for sale securities | | | 224 | | | 303 | | | 173 |
Gain on sale of other real estate | | | 22 | | | — | | | 155 |
Other operating income | | | 1,495 | | | 1,268 | | | 1,372 |
| | | | | | | | | |
| | $ | 4,727 | | $ | 4,524 | | $ | 4,099 |
| | | | | | | | | |
Noninterest Expense
Total noninterest expense increased $2.5 million or 11.4% during 2005 compared to an increase of $3.9 million or 21.1% during 2004. In total dollars, noninterest expense was $24.9 million in 2005 compared to $22.3 million in 2004. Salaries and benefits accounted for $1.4 million, or 53.6%, of the increase. On a year to year basis, it was a 10.7% increase to $14.1 million in 2005 compared to $12.7 million in 2004, slowing from the previous year’s increase. The increase in salaries and benefits was the result of additions to staff related to the opening of the new Central Garage office in late fourth quarter 2004 and the opening of the Glenns office in June 2005. These two locations added $229 thousand to personnel expense. Other personnel expenses included a $369 thousand or 39.2% increase in pension expense resulting from actuarial estimates related to market performance, the discount rate used and the prior year staff increases, a $126 thousand or 7.5% increase in payroll taxes and employee health insurance, and normal increases in salaries and other benefits. The total number of (FTE) officers and staff increased by 13 or 4.6% to 296 at year end 2005, compared to 283 at year end 2004. The increase was the result of staff for the new branch opened in June and minimal increases in customer contact areas.
Net occupancy and equipment expense increased $445 thousand or 13.6% to $3.7 million for 2005, from $3.3 million in 2004. The Central Garage branch and the Glenns branch contributed $255 thousand to this increase in
27
net occupancy and equipment expense. Other building and equipment expenses have increased as a result of the branch expansion over the last two years and the increases brought on by rising energy prices. The following expenses increased: utilities by $34 thousand; building repairs and maintenance by $37 thousand; rent by $48 thousand; and equipment service contracts by$33 thousand.
Other operating expenses increased $737 thousand or 11.7% to $7.1 million in 2005 from $6.3 million in 2004. Primary contributors to this expense growth were increases in: data processing $107 thousand; consultant fees $393 thousand; director fees $99 thousand; and audit and accounting fees $29 thousand. Data processing fees increased due to expansion of capacity and other upgrades. Consulting expense grew due to the Company incurring the last of the Standards of Excellence, Phase II program expense in the first half of the year and incurring some of the one bank consolidation expense in the last quarter of the year. More consulting expenses, relating to the one bank project, are expected to be incurred in the first half of 2006. The increase in director fees was primarily the result of more meetings for the one-bank project. Audit and accounting fees are up due to SOX compliance which created an additional fee from the outside auditor for their attestation on the control system and the engaging of another consulting firm to do internal work in maintaining compliance of SOX and other risk control audits. Miscellaneous lending and credit bureau expenses increased due to higher loan volume, while credit card expense increased due to bringing most of the function in-house.
Total noninterest expense increased $3.9 million or 21.1% from $18.5 million in 2003 to $22.3 million in 2004. Salaries and benefits accounted for $2.7 million of the increase, increasing 27.3% to $12.7 million in 2004 compared to $10.0 million in 2003. The increase in salaries and benefits was the result of additions to staff related to the opening of the new Gloucester Point office that opened in late first quarter 2003 and the acquisition of three new offices divested by BB&T/First Virginia Bank-Hampton Roads in the fourth quarter of 2003. EVB had a full year impact in 2004 for staff additions at these branches. In addition, several staff members were added to comply with internal control compliance related to SOX and to add additional infrastructure to position the Company for future growth. Other personnel expenses included a $341 thousand or 56.8% increase in pension expense related to adding the Hanover Bank subsidiary and the staff of the three branches acquired in September 2003 to the pension plan, a $204 thousand or 26.6% increase in payroll taxes and employee health insurance, and normal increases in salaries and other benefits. The total number of officers and staff increased by 39 or 16.0% to 283 at year end 2004, compared to 244 at year end 2003.
Net occupancy and equipment expense increased $614 thousand or 23.1% to $3.3 million for 2004, from $2.7 million in 2003. The primary contributor to the increase was related to a full year of expenses for the three branches purchased from the BB&T/First Virginia Bank-Hampton Roads divesture. They accounted for $402 thousand of the overall increase in net occupancy and equipment expense. Other operating expenses increased $611 thousand or 10.6% to $6.4 million in 2004 from $5.8 million in 2003. Primary contributors to this expense increase were $210 thousand of amortization of core deposit premium related to the acquisition of $66 million of deposits as part of the branch offices purchased from the BB&T/First Virginia Bank-Hampton Roads divesture, data processing fees of $160 thousand related to enterprise licensing fees associated with technology growth, and $82 thousand in telephone expense and $54 thousand in courier expense related to the four new branch offices opened and acquired in 2003. EVB spent approximately $300 thousand in consultant fees related to complying with the Sarbanes-Oxley Act of 2002 while budgeting only $100 thousand. The cost of complying with SOX was significant to the company and it is estimated that the reoccurring annual cost will be $100 thousand to maintain compliance.
28
The following table shows the components of noninterest expense for the periods indicated.
Noninterest Expense:
| | | | | | | | | |
| | | Years Ended December 31 |
(dollars in thousands) | | 2005 | | 2004 | | 2003 |
Salaries and employee benefits | | $ | 14,100 | | $ | 12,737 | | $ | 10,009 |
Occupancy and equipment | | | 3,717 | | | 3,272 | | | 2,658 |
Consultant fees | | | 1,165 | | | 772 | | | 804 |
Data processing | | | 754 | | | 647 | | | 487 |
Printing and supplies | | | 391 | | | 629 | | | 654 |
Telephone | | | 547 | | | 479 | | | 397 |
Directors’ fees | | | 441 | | | 342 | | | 468 |
Other operating expenses | | | 3,778 | | | 3,470 | | | 2,978 |
| | | | | | | | | |
Total noninterest expense | | $ | 24,893 | | $ | 22,348 | | $ | 18,455 |
| | | | | | | | | |
Income Taxes
Income tax expense in 2005 decreased $44 thousand to $2.59 million, compared to $2.63 million in 2004 and $2.55 million in 2003. Income tax expense corresponds to an effective rate of 27.8%, 26.7 % and 26.5 % for the three years ended December 31, 2005, 2004, and 2003, respectively. The 110 basis point increase in effective tax rate was primarily the result of decreased tax-exempt income.
Note 9 to the Consolidated Financial Statements provides a reconciliation between the amount of income tax expense computed using the federal statutory income tax rate and EVB’s actual income tax expense. Also included in Note 9 to the Consolidated Financial Statements is information regarding deferred taxes for 2005 and 2004. That Note (which is in Item 8 below) is incorporated by reference into this section of Management’s Discussion and Analysis.
Loan Portfolio
Loans, net of unearned income, increased to $574.1 million at December 31, 2005, up $61.5 million or 12.0% from $512.6 million at year-end 2004. The real estate loan portfolio increased by $54.6 million, the commercial, industrial and agricultural loans increased by $9.1 million, or 19.5%, while all other loans, primarily consumer loans, continued their downward trend with a decrease of $2.9 million. Real estate construction loans grew $23.9 million, or 101.1% while commercial real estate loans grew $20.3 million, or 15.4%. The loan growth was driven by the continued economic expansion in the business markets served by the Company. At year-end 2004, loans, net of unearned income, were $512.6 million, up $25.8 million or 5.3% from $486.8 million at year-end 2003. Loan growth in 2004 was primarily in the real estate portfolio which provided all of the increase of $37.3 million since the remainder of the portfolio had an $11.5 million decrease.
29
The following table shows the composition of the loan portfolio for the dates indicated.
| | | | | | | | | | | | | | | | | | | | |
| | | At December 31, | |
(dollars in thousands) | | 2005 | | | 2004 | | | 2003 | | | 2002 | | | 2001 | |
Commercial, industrial and agricultural loans | | $ | 55,732 | | | $ | 46,629 | | | $ | 55,547 | | | $ | 46,926 | | | $ | 43,809 | |
Residential real estate mortgage | | | 263,191 | | | | 252,895 | | | | 236,199 | | | | 198,303 | | | | 179,641 | |
Real estate construction | | | 47,620 | | | | 23,675 | | | | 20,199 | | | | 15,684 | | | | 10,708 | |
Commercial real estate | | | 151,897 | | | | 131,580 | | | | 114,426 | | | | 74,806 | | | | 49,239 | |
Consumer loans | | | 55,680 | | | | 58,801 | | | | 62,166 | | �� | | 66,787 | | | | 68,607 | |
All other loans | | | 321 | | | | 96 | | | | 86 | | | | 191 | | | | 650 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans | | | 574,441 | | | | 513,676 | | | | 488,623 | | | | 402,697 | | | | 352,654 | |
Less unearned income | | | (356 | ) | | | (1,126 | ) | | | (1,873 | ) | | | (3,563 | ) | | | (4,657 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total loans net of unearned discount | | | 574,085 | | | | 512,550 | | | | 486,750 | | | | 399,134 | | | | 347,997 | |
Less allowance for loan losses | | | (6,601 | ) | | | (6,676 | ) | | | (6,495 | ) | | | (5,748 | ) | | | (5,234 | ) |
| | | | | | | | | | | | | | | | | | | | |
Net loans | | $ | 567,484 | | | $ | 505,874 | | | $ | 480,255 | | | $ | 393,386 | | | $ | 342,763 | |
| | | | | | | | | | | | | | | | | | | | |
Remaining Maturities of Selected Loans
The following table presents loan categories that are particularly sensitive to rate changes:
Remaining Maturities of Selected Loans
Year Ended December 31, 2005
| | | | | | | | | | | | | | | | | | | | |
| | | | | Variable Rate | | Fixed Rate | | |
(in thousands) | | Within 1 year | | 1 to 5 years | | After 5 years | | Total | | 1 to 5 years | | After 5 years | | Total | | Total Maturities |
Commercial & Agricultural | | $ | 36,228 | | 4,801 | | — | | $ | 4,801 | | 13,030 | | 1,673 | | $ | 14,703 | | $ | 55,732 |
Real Estate Construction | | $ | 38,693 | | 7,508 | | — | | $ | 7,508 | | 439 | | 980 | | $ | 1,419 | | $ | 47,620 |
Approximately 80.6% of EVB’s loan portfolio at December 31, 2005 was comprised of loans secured by real estate. Residential real estate mortgages made up 45.8% of the loan portfolio at that date as compared to 49.3% at year-end 2004 and 48.5% at year-end 2003. Commercial real estate loans increased from 25.7% of the total loan portfolio at year-end 2004 to 26.5% at year-end 2005. Real estate construction loans accounted for 8.3% of total loans outstanding at year-end 2005 and 4.6% at year-end 2004.The Company’s losses on loans secured by real estate have historically been low, averaging $36 thousand in net charge offs per year over the last five years. Consumer loans are the fourth largest component of EVB’s loan portfolio in 2005, dropping from third in 2004. Consumer loans were 9.6% of the loan portfolio at year-end 2005, and 11.3% and 12.4% at year-end 2004 and 2003 respectively. This portfolio component consists primarily of installment loans. Net consumer loans for household, family and other personal expenditures totaled $55.3 million at 2005 year-end, down $2.4 million from $57.7 million at 2004 year-end. General economic conditions and intense competition including various rebate programs with low rates by the automotive industry continued the trend that started in 2002, decreasing consumer loans both in absolute amount and percentage of the total loan portfolio. Commercial and agricultural loans are designed specifically to meet the needs of small and medium size business customers. This category of loans increased $9.1 million in total loans outstanding at year-end 2005 compared to 2004, with the percentage to total loans increasing to 9.7% of the total loan portfolio from 9.1% at year-end 2004.
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Consistent with its focus on providing community-based financial services, EVB generally does not make loans outside of its principal market region. The Company does not engage in foreign lending activities; consequently the loan portfolio is not exposed to the sometimes volatile risk from foreign credits. EVB further maintains a policy not to originate or purchase loans classified by regulators as highly leveraged transactions or loans to foreign entities or individuals. The Company’s unfunded loan commitments, excluding credit card lines and letters of credit, at 2005 year-end totaled $82.3 million, up $21.7 million from $60.6 million at December 31, 2004. Unfunded loan commitments (excluding $15.6 million in home equity lines) are used in large part to meet seasonal funding needs which are generally higher from Spring through Fall than at year-end. Historically, EVB’s loan collateral has been primarily real estate because of the nature of our market region.
Asset Quality
The Company’s allowance for loan losses is an estimate of the amount needed to provide for potential losses in the loan portfolio. In determining adequacy of the allowance, management considers the Company’s historical loss experience, the size and composition of the loan portfolio, specific impaired loans, the overall level of nonaccrual loans, the value and adequacy of collateral and guarantors, experience and depth of lending staff, effects of credit concentrations and economic conditions. The allowance is increased by a provision for loan losses, which is charged to expense and reduced by charge offs, net of recoveries. Because the risk of loan loss includes general economic trends as well as conditions affecting individual borrowers, the allowance for loan losses can only be an estimate. EVB’s ratio of nonperforming assets in 2005 decreased to 0.44% down from 0.94% in 2004 and marking the lowest level this ratio has been at in the history of the Company. Actual nonperforming assets decreased to $2.5 million at year-end 2005, compared to $4.8 million at year-end 2004. Net charge offs for 2005 decreased $471 thousand or 42.9% to $627 thousand, compared to $1.1 million for the 2004 year.
Each of EVB’s subsidiary banks has a loan review function consisting of bank officers and board members. Additionally an independent credit review firm performs a review of loans for each of the banks, including a SFAS No.114 review for determining specific reserves. The Company utilizes a risk-based evaluation system based on loan type, collateral and payment history to determine the amount of the allowance for loan losses. Management believes the allowance for loan losses to be adequate based on this loan review process and analysis.
The Company’s improved asset quality in 2005 allowed EVB to lower its loan loss allowance ratio to 1.15% at year-end, compared to 1.30% at December 31, 2004 and 1.33% at year-end 2003, respectively. For the same dates, the loan loss allowance to nonaccrual loans ratio was 747%, 208% and 159%, indicating that the allowance was adequate with respect to nonaccrual loans. The allowance for loan losses is subject to regulatory examinations which may take into account such factors as methodology used to calculate the allowance and the size of the allowance in comparison to peer companies identified by regulatory agencies.
31
The following table shows loan charge-offs, loan recoveries, and loan loss provision for the periods indicated.
Allowance for Loan Losses
| | | | | | | | | | | | | | | | | | | | |
| | | Years Ended December 31 | |
(Dollars in thousands) | | 2005 | | | 2004 | | | 2003 | | | 2002 | | | 2001 | |
Average loans outstanding, net of unearned income | | $ | 537,736 | | | $ | 498,568 | | | $ | 431,051 | | | $ | 379,527 | | | $ | 319,165 | |
Allowance for loan losses, January 1 | | | 6,676 | | | | 6,495 | | | | 5,748 | | | | 5,234 | | | | 4,408 | |
Loans charged off: | | | | | | | | | | | | | | | | | | | | |
Commercial and agricultural | | | 156 | | | | 135 | | | | 130 | | | | 97 | | | | 548 | |
Real estate | | | 67 | | | | 56 | | | | 46 | | | | 43 | | | | 38 | |
Consumer | | | 895 | | | | 1,318 | | | | 1,154 | | | | 1,154 | | | | 1,069 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans charged off | | | 1,118 | | | | 1,509 | | | | 1,330 | | | | 1,294 | | | | 1,655 | |
Recoveries: | | | | | | | | | | | | | | | | | | | | |
Commercial and agricultural | | | 66 | | | | 48 | | | | 56 | | | | 10 | | | | 1 | |
Real estate | | | 36 | | | | 9 | | | | 4 | | | | 1 | | | | 18 | |
Consumer | | | 389 | | | | 354 | | | | 380 | | | | 282 | | | | 279 | |
| | | | | | | | | | | | | | | | | | | | |
Total recoveries | | | 491 | | | | 411 | | | | 440 | | | | 293 | | | | 298 | |
| | | | | | | | | | | | | | | | | | | | |
Net loans charged off | | | 627 | | | | 1,098 | | | | 890 | | | | 1,001 | | | | 1,357 | |
Provision for loan losses | | | 552 | | | | 1,279 | | | | 1,637 | | | | 1,515 | | | | 2,183 | |
| | | | | | | | | | | | | | | | | | | | |
Allowance for loan losses, December 31 | | $ | 6,601 | | | $ | 6,676 | | | $ | 6,495 | | | $ | 5,748 | | | $ | 5,234 | |
| | | | | | | | | | | | | | | | | | | | |
Ratios: | | | | | | | | | | | | | | | | | | | | |
Ratio of allowance for loan losses to total loans outstanding, end of year | | | 1.15 | % | | | 1.30 | % | | | 1.33 | % | | | 1.44 | % | | | 1.50 | % |
Ratio of net charge-offs to average loans outstanding during the year | | | 0.12 | % | | | 0.22 | % | | | 0.21 | % | | | 0.26 | % | | | 0.43 | % |
The following table shows the allocation of allowance for loan losses at the dates indicated.
Allocation of Allowance for Loan Losses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | At December 31, | |
| | | 2005 | | | 2004 | | | 2003 | | | 2002 | | | 2001 | |
| | | Allowance | | Percent | | | Allowance | | Percent | | | Allowance | | Percent | | | Allowance | | Percent | | | Allowance | | Percent | |
Commercial and agricultural | | $ | 1,893 | | 9.71 | % | | $ | 1,299 | | 9.08 | % | | $ | 1,365 | | 11.41 | % | | $ | 1,270 | | 11.76 | % | | $ | 1,407 | | 12.59 | % |
Residential real estate | | | 763 | | 45.85 | % | | | 1,002 | | 49.22 | % | | | 1,375 | | 48.53 | % | | | 1,206 | | 49.68 | % | | | 1,369 | | 51.61 | % |
Real estate construction | | | 492 | | 8.30 | % | | | 206 | | 4.61 | % | | | 246 | | 4.15 | % | | | 157 | | 3.93 | % | | | 108 | | 3.08 | % |
Commercial real estate | | | 2,037 | | 26.46 | % | | | 2,664 | | 25.62 | % | | | 1,455 | | 23.51 | % | | | 873 | | 18.74 | % | | | 537 | | 14.15 | % |
Consumer | | | 1,258 | | 9.64 | % | | | 1,349 | | 11.45 | % | | | 1,808 | | 12.39 | % | | | 1,982 | | 15.84 | % | | | 1,602 | | 18.38 | % |
Other loans | | | — | | 0.04 | % | | | — | | 0.02 | % | | | — | | 0.01 | % | | | 1 | | 0.05 | % | | | 3 | | 0.19 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total allowance for balance sheet loans | | | 6,443 | | 100.00 | % | | | 6,520 | | 100.00 | % | | | 6,249 | | 100.00 | % | | | 5,489 | | 100.00 | % | | | 5,026 | | 100.00 | % |
Unallocated | | | 158 | | | | | | 156 | | | | | | 246 | | | | | | 259 | | | | | | 208 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total allowance for loan losses | | $ | 6,601 | | | | | $ | 6,676 | | | | | $ | 6,495 | | | | | $ | 5,748 | | | | | $ | 5,234 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Percent is loans in category divided by total loans)
32
Nonperforming Assets
Total nonperforming assets, consisting of nonaccrual loans, loans past due 90 days or more, and other real estate owned, decreased $2.3 million or 47.4% to $2.5 million at year-end 2005, while total loans outstanding increased $61.5 million or 12.0% to $574.1 million for the same period, thus decreasing the ratio of nonperforming assets at year end to 0.44% of total loans and other real estate owned, compared to 0.94% at year end 2004. The Company had one loan of $1.5 million to a single borrower that went into nonaccrual status during the third quarter of 2004 and was paid in full in the second quarter of 2005.
Nonperforming loans at year-end 2005 consisted of $2.2 million of loans secured by real estate in the Company’s market area, $54 thousand of commercial and agricultural loans and $262 thousand of consumer loans. Based on estimated fair values of the related collateral, management considers the nonperforming real estate loans recoverable, with any individual deficiency well covered by the allowance for loan losses. The total amount of unsecured nonaccrual loans was $54 thousand. Loans are placed on nonaccrual status at the time when the collection of principal and interest are considered to be doubtful. No interest is accrued on loans placed in a nonaccrual status, and any unpaid interest previously accrued on such loans is reversed when a loan is placed in nonaccrual status. If interest on nonaccrual loans had been accrued, such income would have approximated $37 thousand and $121 thousand for the years 2005 and 2004, respectively.
The following table shows nonperforming assets at the dates indicated.
Nonperforming Assets
| | | | | | | | | | | | | | | | | | | | |
| | | At December 31, | |
(dollars in thousands) | | 2005 | | | 2004 | | | 2003 | | | 2002 | | | 2001 | |
Nonaccrual loans | | $ | 884 | | | $ | 3,217 | | | $ | 4,093 | | | $ | 3,240 | | | $ | 4,651 | |
Restructured loans | | | — | | | | — | | | | — | | | | — | | | | — | |
Loans past due 90 days and accruing interest | | | 1,655 | | | | 1,614 | | | | 19 | | | | 28 | | | | 9 | |
| | | | | | | | | | | | | | | | | | | | |
Total nonperforming loans | | | 2,539 | | | | 4,831 | | | | 4,112 | | | | 3,268 | | | | 4,660 | |
Other real estate owned | | | — | | | | — | | | | — | | | | 155 | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Total nonperforming assets | | $ | 2,539 | | | $ | 4,831 | | | $ | 4,112 | | | $ | 3,423 | | | $ | 4,660 | |
| | | | | | | | | | | | | | | | | | | | |
Nonperforming assets to total loans and other real estate owned | | | 0.44 | % | | | 0.94 | % | | | 0.84 | % | | | 0.86 | % | | | 1.34 | % |
Allowance for loan losses to nonaccrual loans | | | 746.72 | % | | | 207.52 | % | | | 158.69 | % | | | 177.41 | % | | | 112.52 | % |
Net charge-offs to average loans for the year | | | 0.12 | % | | | 0.22 | % | | | 0.21 | % | | | 0.26 | % | | | 0.43 | % |
Allowance for loan losses to year end loans | | | 1.15 | % | | | 1.30 | % | | | 1.33 | % | | | 1.44 | % | | | 1.50 | % |
Foregone interest income on nonaccrual loans | | $ | 37 | | | $ | 121 | | | $ | 131 | | | $ | 114 | | | $ | 193 | |
Net charge offs in 2005 decreased to $627 thousand from $1.1 million in 2004. The year 2005 net charge offs included $506 thousand of consumer loans, $90 thousand of commercial loans and $31 thousand of real estate loans. Although trends for credit quality factors continued to be stable, it is likely that EVB will continue provisions for loan losses in 2006. The primary factor for additional provision is growth in the loan portfolio and the level of net charge offs and nonperforming loans.
33
At December 31, 2005, the Company’s subsidiary banks reported $14.3 million in impaired loans. Loans are viewed as impaired based upon individual evaluations of discounted expected cash flows or collateral valuations. These loans are subject to constant management attention, and their status is reviewed on a regular basis.
Securities
Securities available for sale include those securities that may be sold in response to changes in market interest rates, changes in the security’s prepayment risk, increases in loan demand, general liquidity needs, and other similar factors, and are carried at estimated fair market value.
At December 31, 2005, the securities portfolio, at fair market value, was $135.4 million, a 1.3% increase from $133.7 million at 2004 year-end. At December 31, 2004, the securities portfolio was $133.7 million, a 5.5% decrease from $141.4 million at 2003 year-end. The effect of valuing the available for sale portfolio at market, net of income taxes, is reflected as a line in the Shareholders’ Equity section of the Balance Sheet as accumulated other comprehensive income of negative $1.8 million at December 31, 2005 and positive $597 thousand at 2004 year-end.
EVB follows a policy of not engaging in activities considered to be derivative in nature such as options, futures, swaps or forward commitments. The Company considers derivatives to be speculative in nature and contrary to EVB’s historical philosophy. EVB does not hold or issue financial instruments for trading purposes.
The following table presents the book value and fair value of securities at the dates indicated.
Investment Securities and Securities Available for Sale
| | | | | | | | | | | | | | | | | | |
| | | December 31, 2005 | | December 31, 2004 | | December 31, 2003 |
(dollars in thousands) | | Amortized
Cost | | Fair Value | | Amortized
Cost | | Fair Value | | Amortized
Cost | | Fair Value |
Available for sale: | | | | | | | | | | | | | | | | | | |
U S Treasury and Agencies | | $ | 29,849 | | $ | 29,301 | | $ | 33,434 | | $ | 33,316 | | $ | 40,499 | | $ | 40,547 |
Mortgage-backed securities | | | 36,010 | | | 35,222 | | | 28,017 | | | 27,988 | | | 14,051 | | | 14,265 |
States and political subdivisions | | | 35,373 | | | 35,795 | | | 42,345 | | | 43,858 | | | 51,568 | | | 53,817 |
Corporate, CMO and other securities | | | 31,959 | | | 30,183 | | | 25,620 | | | 25,159 | | | 28,938 | | | 29,670 |
Restricted securities | | | 4,919 | | | 4,919 | | | 3,372 | | | 3,372 | | | 3,128 | | | 3,128 |
| | | | | | | | | | | | | | | | | | |
Total securities | | $ | 138,110 | | $ | 135,420 | | $ | 132,788 | | $ | 133,693 | | $ | 138,184 | | $ | 141,427 |
| | | | | | | | | | | | | | | | | | |
The following table presents the maturity schedule of securities at their amortized cost at the date indicated.
Maturity Distribution and Yields of Securities
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2005 | |
| | | Due in 1 year or less | | | Due after 1 through 5 years | | | Due after 5 through
10 years | | | Due after 10 years and
equity securities | | | Total | |
(Dollars in thousands) | | Amount | | Yield | | | Amount | | Yield | | | Amount | | Yield | | | Amount | | Yield | | | Amount | | Yield | |
U.S. Treasury and agencies | | $ | 2,750 | | 4.15 | % | | $ | 10,868 | | 4.33 | % | | $ | 11,248 | | 4.24 | % | | $ | 4,983 | | 5.09 | % | | $ | 29,849 | | 4.41 | % |
Mortgage-backed securities | | | 335 | | 4.25 | % | | | 29,647 | | 4.40 | % | | | 5,671 | | 4.98 | % | | | 358 | | 4.01 | % | | | 36,011 | | 4.48 | % |
States and political subdivisions | | | 1,085 | | 6.85 | % | | | 13,683 | | 6.15 | % | | | 15,852 | | 5.80 | % | | | 4,753 | | 5.96 | % | | | 35,373 | | 5.99 | % |
Corporate, CMO and other securities | | | 4,125 | | 6.40 | % | | | 16,753 | | 4.88 | % | | | 5,109 | | 6.28 | % | | | 10,890 | | 4.63 | % | | | 36,877 | | 5.17 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total securities | | $ | 8,295 | | 5.63 | % | | $ | 70,951 | | 4.84 | % | | $ | 37,880 | | 5.28 | % | | $ | 20,984 | | 5.03 | % | | $ | 138,110 | | 5.04 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Yields on tax- exempt securities have been calculated on a tax equivalent basis.
See Note 3 to the Consolidated Financial Statements (see Item 8 below) for an analysis of gross unrealized gains and losses in the securities portfolio.
34
Deposits
The Company has historically focused on increasing core deposits to reduce the need for other borrowings to fund growth in earning assets. Core deposits provide a low cost and stable source of funding for the Company’s asset growth. Interest rates paid on deposits are carefully managed to provide an attractive market rate while at the same time not adversely affecting the net interest margin. Borrowing through the Federal Home Loan Bank of Atlanta is utilized for funding when the cost of borrowed funds falls below the cost of new interest-bearing deposits.
EVB’s $38.5 million, or 6.5%, deposit growth in 2005 was less than its loan growth requiring the Company to spend more for deposits and borrow from the FHLB to fund loan growth. Total deposits at December 31, 2005 of $628.3 million compared to $589.9 million at 2004 year-end. Noninterest-bearing deposits increased $12.9 million or 14.8% to $99.7 million at 2005 year-end compared to $86.8 million at December 31, 2004. During the same period, interest-bearing deposits increased 5.1% to $528.6 million at 2005 year-end, compared to $503.0 million at December 31, 2004. While these figures represent the balances at December 31, 2005 or 2004, it is more meaningful to review average deposits for the year which reflect how much the Company is really funding over the year. For 2005, average total deposits of $605.1 million reflected a 2.1% increase over the 2004 average of $592.4 million. Average deposits for 2005 decreased in all categories except large certificates of deposit and noninterest bearing demand deposits, while the demand increase helps the overall cost of funds, the increase in the most expensive funding category tightened the interest margin. Management anticipates that this tightening will continue as long as the Federal Reserve continues to raise rates.
Total deposits at 2004 year-end of $589.9 million reflected an increase of $8.7 million or 1.5% compared to $581.1 million at 2003 year-end. The meager increase in deposit growth in 2004 was the result of management not raising deposit rates quickly as the loans repriced at higher rates. Average deposits for 2004 were $592.4 million, an increase of 18.1% or $90.8 million compared to 2003 average deposits of $501.6 million. All categories of deposits experienced an increase in average deposits for 2004.
The following table presents average deposits balances and rates for the periods indicated:
Average Deposits and Rates Paid
| | | | | | | | | | | | | | | | | | |
| | | Years Ended December 31 | |
| | | 2005 | | | 2004 | | | 2003 | |
(dollars in thousands) | | Amount | | Rate | | | Amount | | Rate | | | Amount | | Rate | |
Noninterest bearing demand deposits | | $ | 93,376 | | | | | $ | 83,841 | | | | | $ | 61,055 | | | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | | | |
NOW accounts | | | 78,953 | | 0.50 | % | | | 79,094 | | 0.54 | % | | | 61,177 | | 0.54 | % |
Money market accounts | | | 51,451 | | 1.16 | % | | | 57,103 | | 0.91 | % | | | 45,696 | | 1.08 | % |
Regular savings accounts | | | 122,373 | | 1.07 | % | | | 128,041 | | 1.01 | % | | | 119,547 | | 1.22 | % |
Large denomination certificates (1) | | | 79,782 | | 3.53 | % | | | 64,611 | | 3.29 | % | | | 53,098 | | 3.54 | % |
Other certificates of deposit | | | 179,198 | | 3.15 | % | | | 179,748 | | 2.88 | % | | | 161,063 | | 3.21 | % |
| | | | | | | | | | | | | | | | | | |
Total interest-bearing | | | 511,757 | | 2.10 | % | | | 508,597 | | 1.83 | % | | | 440,581 | | 2.12 | % |
| | | | | | | | | | | | | | | | | | |
Total average deposits | | $ | 605,133 | | | | | $ | 592,438 | | | | | $ | 501,636 | | | |
| | | | | | | | | | | | | | | | | | |
| (1) | Certificates issued in amounts of $100,000 or greater |
35
The following table presents the maturity schedule of large denomination certificates at the dates indicated:
Maturities of Large Denomination Certificates of Deposit (1)
| | | | | | | | | | | | | | | | | | |
(dollars in thousands) | | Within
3 Months | | 3-12
Months | | 1-3
Years | | Over 3
Years | | Total | | Percent
of Total
Deposits | |
At December 31, 2005 | | $ | 5,519 | | $ | 35,800 | | $ | 30,325 | | $ | 19,356 | | $ | 91,000 | | 14.48 | % |
At December 31, 2004 | | $ | 9,997 | | $ | 19,153 | | $ | 22,745 | | $ | 12,623 | | $ | 64,518 | | 10.94 | % |
At December 31, 2003 | | $ | 4,430 | | $ | 19,912 | | $ | 19,945 | | $ | 16,140 | | $ | 60,427 | | 10.40 | % |
| (1) | Certificates issued in amounts of $100,000 or greater |
Capital Resources
Capital resources are managed to maintain a capital structure that provides the Company the ability to support asset growth, absorb potential losses and expand EVB’s franchise when appropriate. Capital represents original investment by shareholders along with retained earnings and provides financial resources over which management can exercise greater control as compared to deposits and borrowed funds.
Regulatory authorities have adopted guidelines to establish minimum capital standards. Specifically, the guidelines classify assets and balance sheet items into four risk-weighted categories. The minimum regulatory total capital to risk-weighted assets is 8.0%, of which at least 4.0% must be Tier 1 capital, defined as common equity and retained earnings, plus trust preferred debt up to 25% of Tier 1 capital, less goodwill and intangibles. At December 31, 2005, EVB had a total capital ratio of 13.23% and a Tier 1 ratio of 12.04%, both far in excess of regulatory guidelines and the amount needed to support each subsidiary’s banking business.
Capital is carefully managed as the financial opportunities of a high capital base are weighed against the impact of the return on equity ratio. In January 2001, the Company announced a stock repurchase program intended to reduce high capital levels and to increase return on equity to shareholders. The Company repurchased no shares in 2005, 9,345 shares in 2004, 12,500 shares in 2003, 61,264 shares in 2002, and 50,274 shares in 2001.
36
The following table provides an analysis of the Company’s capital as of December 31, 2005, 2004, and 2003. Note 19 in the Consolidated Financial Statements (see Item 8 below) presents an analysis of the capital position of each of the subsidiary banks as of year-end 2005, 2004 and 2003:
Analysis of Capital
| | | | | | | | | | | | |
| | | At December 31, | |
(dollars in thousands) | | 2005 | | | 2004 | | | 2003 | |
Tier 1 capital: | | | | | | | | | | | | |
Common stock | | $ | 9,812 | | | $ | 9,763 | | | $ | 9,734 | |
Surplus | | | — | | | | — | | | | — | |
Retained earnings | | | 53,838 | | | | 49,403 | | | | 44,682 | |
| | | | | | | | | | | | |
Total equity | | | 63,650 | | | | 59,166 | | | | 54,416 | |
Trust preferred debt | | | 10,000 | | | | 10,000 | | | | 10,000 | |
Less goodwill and intangibles | | | (7,056 | ) | | | (7,335 | ) | | | (7,614 | ) |
| | | | | | | | | | | | |
Total Tier 1 capital | | | 66,594 | | | | 61,831 | | | | 56,802 | |
| | | |
Tier 2 capital: | | | | | | | | | | | | |
Allowance for loan losses | | | 6,601 | | | | 6,134 | | | | 5,729 | |
| | | | | | | | | | | | |
Total risk-based capital | | | 73,195 | | | | 67,965 | | | | 62,531 | |
Risk-weighted assets | | | 553,167 | | | | 490,196 | | | | 457,566 | |
| | | |
Capital ratios: | | | | | | | | | | | | |
Tier 1 risk based capital | | | 12.04 | % | | | 12.61 | % | | | 12.41 | % |
Total risk based capital | | | 13.23 | % | | | 13.86 | % | | | 13.67 | % |
Tier 1 capital to average total assets | | | 8.87 | % | | | 8.90 | % | | | 8.54 | % |
Off -Balance Sheet Arrangements
At December 31, 2005, the Company had $90.7 million of off-balance sheet credit exposure in the form of $88.8 million of commitments to grant loans and unfunded commitments under lines of credit and $1.9 million of standby letters of credit. Guaranteed credit card balances were purchased in 2005 and added to the Company’s credit card balances. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are usually uncollateralized and do not always contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments if deemed necessary.
37
Liquidity
Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, deposits with other banks, federal funds sold, investments and loans maturing or repricing within one year. EVB’s management of liquid assets provides a liquidity level which management believes is sufficient to satisfy its depositors’ requirements and to meet its customers’ credit needs. At December 31, 2005, $209.4 million or 31.1% of total earning assets were due to mature or reprice within the next year.
EVB also maintains additional sources of liquidity through a variety of borrowing arrangements. Federal funds borrowing arrangements with major regional banks combined with lines of credit with the Federal Home Loan Bank totaled $164.0 million at December 31, 2005. At year-end 2005, the Company had $51.9 million of FHLB borrowings outstanding. During 2005, the Company borrowed $30.5 million in new FHLB borrowings and paid down principle of $1.4 on preexisting FHLB borrowings.
The following table presents the Company’s contractual obligations and scheduled payment amounts due at various intervals over the next five years and beyond.
| | | | | | | | | | | | | | | |
As of 12/31/2005 | | Payments Due by Period |
| | | Total | | Less than 1
year | | 1-3 years | | 3-5 years | | Over 5 years |
Long-term debt | | | 62,238 | | $ | 1,429 | | $ | 2,858 | | $ | 17,141 | | $ | 40,810 |
Capital lease obligations | | | — | | | — | | | — | | | — | | | — |
Operating leases | | | 1,282 | | | 228 | | | 393 | | | 281 | | | 380 |
Purchase obligations | | | — | | | — | | | — | | | — | | | — |
Other long-term liabilities | | | — | | | — | | | — | | | — | | | — |
| | | | | | | | | | | | | | | |
Total | | $ | 63,520 | | $ | 1,657 | | $ | 3,251 | | $ | 17,422 | | $ | 41,190 |
| | | | | | | | | | | | | | | |
Inflation
In financial institutions, unlike most manufacturing companies, virtually all of the assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on a bank’s performance than the effects of general levels of inflation. Interest rate movement is not necessarily tied to movements in the same direction or with the same magnitude as the prices of goods and services, since such prices are affected by inflation to a larger extent than interest rates.
Accounting Rule Changes
Refer to Note 1 of the audited financial statements, in Item 8 below, for Recent Accounting Pronouncements.
| Item 7A. | Quantitative and Qualitative Disclosures About Market Risk |
Market risk is the risk of loss arising from adverse changes in the fair value of financial instruments due to changes in interest rates, exchange rates and equity prices. EVB’s market risk is composed primarily of interest rate risk. The Company’s Management is responsible for reviewing the interest rate sensitivity position of EVB’s subsidiary banks and establishing policies to monitor and limit exposure to interest rate risk. The Board of Directors reviews guidelines established by Management. It is EVB’s policy not to engage in activities considered to be derivative in nature such as futures, option contracts, swaps, caps, floors, collars or forward commitments. EVB considers derivatives as speculative which is contrary to the Company’s historical or prospective philosophy. EVB does not hold or issue financial instruments for trading purposes. It does hold in its loan and security portfolio investments that adjust or float according to changes in the “prime” lending rate which is not considered speculative, but necessary for good asset/liability management.
38
Asset/Liability Risk Management: The primary goals of asset/liability risk management are to maximize net interest income and the net value of EVB’s future cash flows within the interest rate limits set by the Company’s Asset/Liability Committee (ALCO).
Interest Rate Risk Measurement:Interest rate risk is monitored through the use of three complementary measures: static gap analysis, earnings simulation modeling and net present value estimation. While each of the interest rate risk measurements has limitations, taken together they represent a reasonably comprehensive view of the magnitude of interest rate risk in the Company, the distribution of risk along the yield curve, the level of risk through time, and the amount of exposure to changes in certain interest rate relationships.
Static Gap:Gap analysis measures the amount of repricing risk embedded in the balance sheet at a point in time. It does so by comparing the differences in the repricing characteristics of assets and liabilities. A gap is defined as the difference between the principal amount of assets and liabilities, adjusted for off-balance sheet instruments, which reprice within a specific time period. The cumulative one-year gap at year-end was (+1.35%) which is within the policy limit for the one-year gap of plus 15% to minus 15% of total earning assets at a combined Company level.
Core deposits and loans with noncontractual maturities are included in the gap repricing distributions based upon historical patterns determined by statistical analysis, based upon industry accepted assumptions including the most recent core deposit defaults set forth by the FFIEC (Federal Financial Institutions Examination Council). The gap repricing distributions include principal cash flows from residential mortgage loans and mortgage-backed securities in the time frames in which they are expected to be received. Mortgage prepayments are estimated by applying industry median projections of prepayment speeds to portfolio segments based on coupon range and loan age.
Earnings Simulation:The earnings simulation model forecasts one-year net income under a variety of scenarios that incorporate changes in the absolute level of interest rates, changes in the shape of the yield curve and changes in interest rate relationships. Management evaluates the effects on income of alternative interest rate scenarios against earnings in a stable interest rate environment. This type of analysis is also most useful in determining the short-run earnings exposures to changes in customer behavior involving loan payments and deposit additions and withdrawals.
The most recent earnings simulation model projects net income would decrease approximately -8.55% of stable rate net income if rates were to fall immediately by 200 basis points. It projects an increase of approximately 0.96% if rates rise by 200 basis points. Management believes this reflects a liability sensitive interest risk for the one-year horizon.
This dynamic simulation model includes assumptions about how the balance sheet is likely to evolve through time, in different interest rate environments. Loan and deposit growth rate assumptions are derived from historical analysis and management’s outlook, as are the assumptions used to project yields and rates for new loans and deposits. All maturities, calls and prepayments in the securities portfolio are assumed to be reinvested in like instruments. Mortgage loan prepayment assumptions are developed from industry median estimates of prepayment speeds for portfolios with similar coupon ranges and seasoning. Noncontractual deposit growth rates and pricing are assumed to follow historical patterns. The sensitivities of key assumptions are analyzed at least annually and reviewed by management.
Net Present Value:The Net Present Value (“NPV”) of the balance sheet, at a point in time, is defined as the discounted present value of asset cash flows minus the discounted value of liability cash flows. Interest rate risk analysis using NPV involves changing the interest rates used in determining the cash flows and in discounting the cash flows. The resulting percentage change in NPV is an indication of the longer term repricing risk and options embedded in the balance sheet.
39
At year-end, a 200 basis point immediate increase in rates is estimated to decrease NPV by –23.61%. Additionally, NPV is estimated to increase by 9.51% if rates fall immediately by 200 basis points. Analysis of the average quarterly change in the Treasury yield curve over the past ten years indicates that a parallel curve shift of 200 basis points or more is an event that has less than a 0.1% chance of occurrence.
As with gap analysis and earnings simulation modeling, assumptions about the timing and variability of balance sheet cash flows are critical in NPV analysis. Particularly important are the assumptions driving mortgage prepayments and the assumptions about expected attrition of the core deposit portfolios. These assumptions are applied consistently across the different rate risk measures.
Summary information about interest rate risk measures is presented below:
| | | | | | |
| | | December 31, | |
| | | 2005 | | | 2004 | |
Static 1-Year Cumulative Gap | | 1.35 | % | | -4.25 | % |
1-year net income simulation projection: | | | | | | |
-200 basis point shock vs. stable rate | | -8.55 | % | | 4.15 | % |
+200 basis point shock vs. stable rate | | 0.96 | % | | -13.21 | % |
Static net present value change: | | | | | | |
-200 basis point shock vs. stable rate | | 9.51 | % | | 15.77 | % |
+200 basis point shock vs. stable rate | | -23.61 | % | | -26.05 | % |
The earnings simulation model indicates that if all prepayments, calls and maturities of the securities portfolios expected over the next year were to remain uninvested, then the current liability sensitive position would be lessened. Management projects interest rates to increase 50 basis points in the first quarter of 2006, remaining stable through the remainder of the year with rates declining in 2007.
| Item 8. | Financial Statements and Supplementary Data |
The following financial statements are filed as a part of this report following item 15:
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosures |
None.
| Item 9A. | Controls and Procedures |
Disclosure Controls and Procedures
The Company maintains disclosure controls and procedures that are designed to provide assurance that the information required to be disclosed by the Company in the reports that it files or submits under the Securities
40
Exchange Act of 1934 is recorded, processed, summarized and reported within the time periods required by the Securities and Exchange Commission. An evaluation of the effectiveness of the design and operations of the Company’s disclosure controls and procedures at the end of the period covered by this report was carried out under the supervision and with the participation of management, including the Company’s Chief Executive Officer and Chief Financial Officer. Based on such evaluation, such officers concluded that the Company’s disclosure controls and procedures were effective as of the end of such period.
Management’s Report on Internal Control Over Financial Reporting
The management of Eastern Virginia Bankshares, Inc. (the “Company”) is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Securities Exchange Act of 1934). The Company’s internal control over financial reporting is a process designed under the supervision of the Company’s Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of the Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
As of December 31, 2005, management has assessed the effectiveness of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control – Integrated Framework” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on the assessment, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2005, based on those criteria.
Yount, Hyde and Barbour, P.C., the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005. The report, which states an unqualified opinion on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2005, is incorporated by reference in Item 8 above, under the heading “Report of Independent Registered Public Accounting Firm.”
No changes were made in the Company’s internal control over financial reporting during the quarter ended December 31, 2005 that has materially affected, or that is reasonably likely to materially affect, the Company’s internal control over financial reporting.
| Item 9B. | Other Information |
None.
PART III
| Item 10. | Directors and Executive Officers of the Registrant |
The response to this Item is incorporated by reference to the information under the caption “Election of Directors” and “Section 16(a) Beneficial Ownership Reporting Compliance” in EVB’s Proxy Statement for the 2006 annual meeting of shareholders and to the information under the caption “Executive Officers of the Registrant” following Item 4 above.
Audit Committee Chairman Leslie E. Taylor, CPA fulfills the applicable standard as an independent audit committee financial expert.
The Board of Directors has approved a Code of Ethics for all directors, officers and staff of the Company and its subsidiaries. The Code of Ethics is designed to promote honest and ethical conduct, proper disclosure of financial information in the Company’s periodic reports, and compliance with applicable laws, rules, and regulations by the Company’s senior officers who have financial responsibilities. The Code of Ethics is available on the Company’s web page at www.evb.org.
41
| Item 11. | Executive Compensation |
The response to this Item is incorporated by reference to the information under the caption “Executive Compensation”, “Stock Options”, “Employee Benefit Plans”, “Compensation Committee”, “Interlocks and Insider Participation”, “Employment Contracts and Termination and Change in Control Arrangements” and “Director Compensation” in EVB’s Proxy Statement for the 2006 annual meeting of shareholders.
| Item 12. | Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters |
The response to this Item is incorporated by reference to the information under the caption “Security Ownership of Management”, “Security Ownership of Certain Beneficial Owners” and “Equity Compensation Plans” in EVB’s Proxy Statement for the 2006 annual meeting of shareholders.
| Item 13. | Certain Relationships and Related Transactions |
The response to this Item is incorporated by reference to the information under the caption “Transactions with Management” in EVB’s Proxy Statement for the 2006 annual meeting of shareholders.
| Item 14. | Principal Accounting Fees and Services |
The response to this Item is incorporated by reference to the information under the caption “Fees of Independent Registered Public Accounting Firm” and “Pre-Approved Services” in EVB’s Proxy Statement for the 2006 annual meeting of shareholders.
PART IV
| Item 15. | Exhibits, Financial Statement Schedules |
(a)(1) The response to this portion of Item 15 is included in Item 8 above.
(a)(2) The response to this portion of Item 15 is included in Item 8 above.
(a)(3) Exhibits
The following exhibits are filed as part of this Form 10-K and this list includes the Exhibit Index.
| | |
Exhibit Number | | |
| 3.1 | | Articles of Incorporation of Eastern Virginia Bankshares, Inc., attached as Exhibit 3.1 to the Company’s Annual Report on Form 10-K for the year ended December 31, 1997, incorporated herein by reference. |
| |
| 3.2 | | Bylaws of Eastern Virginia Bankshares, Inc., as amended June 17, 2004, attached as Exhibit 3.2 to the Company’s Quarterly Report on Form 10-Q for the period ended June 30, 2004, incorporated herein by reference. |
| |
| 10.1 | | Eastern Virginia Bankshares, Inc. 2003 Stock Incentive Plan, included in the Company’s 2003 Proxy Statement, as filed with the Commission on March 24, 2003, incorporated by reference. * |
| |
| 10.2 | | Employment Agreement dated as of January 6, 2003, between Eastern Virginia Bankshares, Inc. and Joe A. Shearin, attached as Exhibit 10.2 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, incorporated herein by reference. * |
| |
| 10.3 | | Employment Agreement dated as of January 6, 2003, between Eastern Virginia Bankshares, Inc. and Ronald L. Blevins, attached as Exhibit 10.3 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, incorporated herein by reference. * |
| |
| 10.4 | | Employment Agreement dated as of January 6, 2003, between Eastern Virginia Bankshares, Inc. and Joseph H. James, attached as Exhibit 10.4 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2002, incorporated herein by reference. * |
42
| | |
| 10.5 | | Employment Agreement dated as of March 25, 2004, between Hanover Bank and William E. Martin Jr, attached as Exhibit 10.5 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, incorporated herein by reference. * |
| |
| 10.6 | | Employment Agreement dated as of August 11, 2004, between Bank of Northumberland, Inc. and Lewis R. Reynolds, attached as Exhibit 10.6 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2004, incorporated herein by reference. * |
| |
| 13.1 | | Excerpt from the 2005 Annual Report to Shareholders with respect to Market for the Company’s Common Stock. |
| |
| 13.2 | | Excerpt from the 2005 Annual Report to Shareholders with respect to Selected Financial Data. |
| |
| 14.1 | | Code of Conduct and Business Ethics, attached as Exhibit 14 to the Company’s Annual Report on Form 10-K for the year ended December 31, 2003, incorporated herein by reference. |
| |
| 21.1 | | Subsidiaries of Eastern Virginia Bankshares, Inc. |
| |
| 23.1 | | Consent of Yount, Hyde & Barbour, P.C. |
| |
| 31.1 | | Rule 13a-14(a) Certification of Chief Executive Officer |
| |
| 31.2 | | Rule 13a-14(a) Certification of Chief Financial Officer |
| |
| 32.1 | | Section 906 Certification of Chief Executive Officer |
| |
| 32.2 | | Section 906 Certification of Chief Financial Officer |
| * | Management contract or compensatory plan or arrangement. |
| (b) | Exhibits – See exhibit index included in Item 15(a)(3) above. |
| (c) | Financial Statement Schedules – See Item 15(a)(2) above. |
(All exhibits not incorporated herein by reference are attached as exhibits to the Company’s Annual Report on Form 10-K for the year ended December 31, 2005, as filed with the Securities and Exchange Commission.)
43
To the Board of Directors
Eastern Virginia Bankshares, Inc.
Tappahannock, Virginia
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated balance sheets of Eastern Virginia Bankshares, Inc. and subsidiaries as of December 31, 2005 and 2004, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the years in the three-year period ended December 31, 2005. We also have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting appearing under Item 9A, that Eastern Virginia Bankshares, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control— Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Eastern Virginia Bankshares, Inc. and subsidiaries’ management is responsible for these financial statements, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on these financial statements, an opinion on management’s assessment, and an opinion on the effectiveness of Eastern Virginia Bankshares, Inc. and subsidiaries’ internal control over financial reporting based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audit of financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company;
48
(2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Eastern Virginia Bankshares, Inc. and subsidiaries as of December 31, 2005 and 2004, and the results of operations and cash flows for each of the years in the three-year period ended December 31, 2005 in conformity with accounting principles generally accepted in the United States of America. Also in our opinion, management’s assessment that Eastern Virginia Bankshares, Inc. and subsidiaries maintained effective internal control over financial reporting as of December 31, 2005, is fairly stated, in all material respects, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Furthermore, in our opinion, Eastern Virginia Bankshares, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2005, based on criteria established inInternal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO).
|
|
 |
| Winchester, Virginia |
| February 7, 2006 |
49
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2005 and 2004
| | | | | | | |
| | | (dollars in thousands) |
| | | 2005 | | | 2004 |
Assets | | | | | | | |
Cash and due from banks | | $ | 21,516 | | | $ | 17,714 |
Federal funds sold | | | — | | | | 83 |
Securities available for sale, at fair value | | | 135,420 | | | | 133,693 |
Loans, net of allowance for loan losses of $6,601 in 2005 and $6,676 in 2004 | | | 567,484 | | | | 505,874 |
Deferred income taxes | | | 2,820 | | | | 1,411 |
Bank premises and equipment, net | | | 15,147 | | | | 15,613 |
Accrued interest receivable | | | 3,583 | | | | 2,991 |
Goodwill | | | 5,725 | | | | 5,725 |
Other assets | | | 12,231 | | | | 13,223 |
| | | | | | | |
Total assets | | $ | 763,926 | | | $ | 696,327 |
| | | | | | | |
Liabilities and Shareholders’ Equity | | | | | | | |
Liabilities | | | | | | | |
Noninterest-bearing demand accounts | | $ | 99,718 | | | $ | 86,848 |
Interest bearing deposits | | | 528,625 | | | | 503,030 |
| | | | | | | |
Total deposits | | | 628,343 | | | | 589,878 |
Federal funds purchased | | | 6,822 | | | | 8,400 |
Federal Home Loan Bank Advances | | | 51,928 | | | | 22,857 |
Trust preferred debt | | | 10,310 | | | | 10,310 |
Accrued interest payable | | | 1,264 | | | | 839 |
Other liabilities | | | 3,385 | | | | 4,280 |
Commitments and contingent liabilities | | | — | | | | — |
| | | | | | | |
Total liabilities | | | 702,052 | | | | 636,564 |
| | | | | | | |
Shareholders’ Equity | | | | | | | |
Common stock of $2 par value per share; authorized 50,000,000 shares; issued and outstanding, 4,905,701 in 2005 and 4,881,544 in 2004 | | | 9,812 | | | | 9,763 |
Retained earnings | | | 53,838 | | | | 49,403 |
Accumulated other comprehensive income, net | | | (1,776 | ) | | | 597 |
| | | | | | | |
Total shareholders’ equity | | | 61,874 | | | | 59,763 |
| | | | | | | |
Total liabilities and shareholders’ equity | | $ | 763,926 | | | $ | 696,327 |
| | | | | | | |
See Notes to Consolidated Financial Statements.
50
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31, 2005, 2004 and 2003
| | | | | | | | | |
| | | (dollars in thousands, except per share data) |
| | | 2005 | | 2004 | | 2003 |
Interest and Dividend Income | | | | | | | | | |
Loans and fees on loans | | | 37,137 | | $ | 33,298 | | $ | 30,604 |
Interest on investments: | | | | | | | | | |
Taxable interest income | | | 4,295 | | | 4,313 | | | 3,325 |
Tax exempt interest income | | | 1,539 | | | 1,933 | | | 2,076 |
Dividends | | | 182 | | | 147 | | | 105 |
Interest on Federal funds sold | | | 76 | | | 53 | | | 95 |
| | | | | | | | | |
Total interest and dividend income | | | 43,229 | | | 39,744 | | | 36,205 |
| | | | | | | | | |
Interest Expense | | | | | | | | | |
Deposits | | | 10,772 | | | 9,291 | | | 9,326 |
Federal funds purchased | | | 109 | | | 14 | | | 17 |
Interest on FHLB advances | | | 1,666 | | | 1,026 | | | 960 |
Interest on Trust preferred debt | | | 651 | | | 439 | | | 118 |
| | | | | | | | | |
Total interest expense | | | 13,198 | | | 10,770 | | | 10,421 |
| | | | | | | | | |
Net interest income | | | 30,031 | | | 28,974 | | | 25,784 |
Provision for Loan Losses | | | 552 | | | 1,279 | | | 1,637 |
| | | | | | | | | |
Net interest income after provision for loan losses | | | 29,479 | | | 27,695 | | | 24,147 |
Noninterest Income | | | | | | | | | |
Service charges on deposit accounts | | | 2,986 | | | 2,953 | | | 2,399 |
Gain on sale of available for sale securities | | | 224 | | | 303 | | | 173 |
Gain on sale of other real estate owned | | | 22 | | | — | | | 155 |
Other operating income | | | 1,495 | | | 1,268 | | | 1,217 |
| | | | | | | | | |
Total noninterest income | | | 4,727 | | | 4,524 | | | 3,944 |
| | | | | | | | | |
Noninterest Expenses | | | | | | | | | |
Salaries and benefits | | | 14,100 | | | 12,737 | | | 10,009 |
Occupancy and equipment expense | | | 3,717 | | | 3,272 | | | 2,658 |
Printing and supplies | | | 391 | | | 629 | | | 654 |
Telephone | | | 547 | | | 479 | | | 397 |
Directors’ fees | | | 441 | | | 342 | | | 468 |
Data processing | | | 754 | | | 647 | | | 487 |
Consultant fees | | | 1,165 | | | 772 | | | 804 |
Other operating expenses | | | 3,778 | | | 3,470 | | | 2,978 |
| | | | | | | | | |
Total noninterest expense | | | 24,893 | | | 22,348 | | | 18,455 |
| | | | | | | | | |
Income before income taxes | | | 9,313 | | | 9,871 | | | 9,636 |
Income Tax Expense | | | 2,587 | | | 2,631 | | | 2,553 |
| | | | | | | | | |
Net income | | $ | 6,726 | | $ | 7,240 | | $ | 7,083 |
| | | | | | | | | |
Earnings Per Share, basic | | $ | 1.37 | | $ | 1.49 | | $ | 1.46 |
| | | | | | | | | |
Diluted earnings per share | | $ | 1.37 | | $ | 1.48 | | $ | 1.46 |
| | | | | | | | | |
Dividends Per Share | | $ | 0.60 | | $ | 0.60 | | $ | 0.57 |
| | | | | | | | | |
See Notes to Consolidated Financial Statements.
51
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2005, 2004 and 2003
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2005 | | | 2004 | | | 2003 | |
Cash Flows from Operating Activities | | | | | | | | | | | | |
Net income | | $ | 6,726 | | | $ | 7,240 | | | $ | 7,083 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
Loss from equity investment in partnership | | | 16 | | | | — | | | | — | |
Depreciation and amortization | | | 2,090 | | | | 2,055 | | | | 1,577 | |
Deferred tax provision (benefit) | | | (186 | ) | | | 86 | | | | 139 | |
Provision for loan losses | | | 552 | | | | 1,279 | | | | 1,637 | |
(Gain) loss realized on fixed assets | | | 57 | | | | (1 | ) | | | (13 | ) |
(Gain) realized on available for sale securities | | | (224 | ) | | | (303 | ) | | | (173 | ) |
(Gain) realized on Other Real Estate | | | (22 | ) | | | — | | | | — | |
Accretion and amortization on securities, net | | | 896 | | | | 926 | | | | 410 | |
Changes in assets and liabilities: | | | | | | | | | | | | |
(Increase) decrease in accrued interest receivable | | | (593 | ) | | | 326 | | | | (390 | ) |
(Increase) decrease in other assets and goodwill | | | 976 | | | | (890 | ) | | | (7,840 | ) |
Increase (decrease) in accrued interest payable | | | 425 | | | | (25 | ) | | | 39 | |
Increase (decrease) in other liabilities | | | (894 | ) | | | (37 | ) | | | 1,372 | |
| | | | | | | | | | | | |
Net cash provided by operating activities | | | 9,819 | | | | 10,656 | | | | 3,841 | |
| | | | | | | | | | | | |
Cash Flows from Investing Activities | | | | | | | | | | | | |
Proceeds from sales of securities available for sale | | | 11,067 | | | | 23,984 | | | | 12,601 | |
Maturities and principal repayments of securities available for sale | | | 19,112 | | | | 42,174 | | | | 45,153 | |
Purchases of securities available for sale | | | (36,172 | ) | | | (61,780 | ) | | | (98,115 | ) |
Proceeds from sale of other real estate | | | 321 | | | | — | | | | 155 | |
Net (increase) in loans | | | (62,462 | ) | | | (26,898 | ) | | | (60,170 | ) |
Purchases of bank premises and equipment | | | (1,889 | ) | | | (3,212 | ) | | | (4,691 | ) |
Acquisition of branches, net of cash acquired | | | — | | | | — | | | | 26,090 | |
Proceeds from sale of bank premises and equipment | | | 207 | | | | — | | | | 209 | |
| | | | | | | | | | | | |
Net cash (used in) investing activities | | | (69,816 | ) | | | (25,732 | ) | | | (78,768 | ) |
| | | | | | | | | | | | |
52
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2005, 2004 and 2003
(continued)
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2005 | | | 2004 | | | 2003 | |
Cash Flows from Financing Activities | | | | | | | | | | | | |
Net increase in demand deposit accounts, interest-bearing demand deposits and savings accounts | | | (3,140 | ) | | | 4,575 | | | | 35,889 | |
Net increase in certificates of deposit | | | 41,605 | | | | 4,154 | | | | 10,107 | |
Proceeds from Federal Home Loan Bank advances | | | 30,500 | | | | — | | | | 10,000 | |
Repayments of Federal Home Loan Bank advances | | | (1,429 | ) | | | (1,429 | ) | | | (714 | ) |
Proceeds from issuance of trust preferred debt | | | | | | | — | | | | 10,000 | |
Increase (decrease) in federal funds purchased | | | (1,578 | ) | | | 8,400 | | | | — | |
Repurchases and retirement of stock | | | — | | | | (191 | ) | | | (239 | ) |
Issuance of common stock under dividend reinvestment plan | | | 387 | | | | 405 | | | | 359 | |
Stock-based compensation | | | 181 | | | | 85 | | | | 50 | |
Director stock grant | | | 125 | | | | 131 | | | | 151 | |
Dividends paid | | | (2,935 | ) | | | (2,920 | ) | | | (2,768 | ) |
| | | | | | | | | | | | |
Net cash provided by financing activities | | | 63,716 | | | | 13,210 | | | | 62,835 | |
| | | | | | | | | | | | |
Cash and Cash Equivalents | | | | | | | | | | | | |
Beginning of year | | | 17,797 | | | | 19,663 | | | | 31,755 | |
Net increase (decrease) in cash and cash equivalents | | | 3,719 | | | | (1,866 | ) | | | (12,092 | ) |
| | | | | | | | | | | | |
End of year | | $ | 21,516 | | | $ | 17,797 | | | $ | 19,663 | |
| | | | | | | | | | | | |
Supplemental Disclosures of Cash Flow Information | | | | | | | — | | | | | |
Cash payments for Interest | | $ | 12,774 | | | $ | 10,795 | | | $ | 10,382 | |
| | | | | | | | | | | | |
Cash payments for Income taxes | | $ | 1,680 | | | $ | 2,967 | | | $ | 2,521 | |
| | | | | | | | | | | | |
Supplemental Disclosures of Noncash Investing and Financing Activities | | | | | | | | | | | | |
Transfers from loans to foreclosed real estate | | $ | 300 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | |
Unrealized gain (loss) on securities available for sale | | $ | (2,373 | ) | | $ | (2,337 | ) | | $ | (732 | ) |
| | | | | | | | | | | | |
Details of acquisition of branches: | | | | | | | | | | | | |
Fair value of assets acquired | | $ | — | | | $ | — | | | $ | 31,946 | |
Fair value of liabilities assumed | | | — | | | | — | | | | (66,052 | ) |
Purchase price in excess of net assets acquired | | | — | | | | — | | | | 7,099 | |
| | | | | | | | | | | | |
Cash received | | | — | | | | — | | | | (27,007 | ) |
Less cash acquired | | | — | | | | — | | | | 917 | |
| | | | | | | | | | | | |
Net cash received for acquisition | | $ | — | | | $ | — | | | $ | (26,090 | ) |
| | | | | | | | | | | | |
See Notes to Consolidated Financial Statements.
53
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statement of Changes in Shareholders’ Equity
For the Years Ended December 31, 2005, 2004 and 2003
(dollars in thousands)
| | | | | | | | | | | | | | | | | | | | |
| | | Common
Stock | | | Retained
Earnings | | | Accumulated
Other
Comprehensive
Income | | | Comprehensive
Income | | | Total | |
Balance, December 31, 2002 | | $ | 9,717 | | | $ | 40,063 | | | $ | 2,623 | | | | | | | | 52,403 | |
Net income - 2003 | | | — | | | | 7,083 | | | | — | | | $ | 7,083 | | | | 7,083 | |
Other comprehensive income: | | | | | | | | | | | | | | | | | | | | |
Unrealized holding gains arising during period, (net of tax, $190) | | | — | | | | — | | | | — | | | | (369 | ) | | | — | |
Reclassification adjustment, (net of tax, $59) | | | — | | | | — | | | | — | | | | (114 | ) | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Other comprehensive income (net of tax, $249) | | | — | | | | — | | | | (483 | ) | | | (483 | ) | | | (483 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | | — | | | | — | | | $ | 6,600 | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Cash dividends declared | | | — | | | | (2,768 | ) | | | — | | | | | | | | (2,768 | ) |
Stock-based compensation | | | — | | | | 50 | | | | — | | | | | | | | 50 | |
Director stock grant | | | 12 | | | | 139 | | | | — | | | | | | | | 151 | |
Issuance of common stock under dividend reinvestment plan, net of repurchases | | | 30 | | | | 329 | | | | — | | | | | | | | 359 | |
Shares purchased and retired | | | (25 | ) | | | (214 | ) | | | — | | | | | | | | (239 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2003 | | $ | 9,734 | | | $ | 44,682 | | | $ | 2,140 | | | | | | | $ | 56,556 | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | |
Net income - 2004 | | | — | | | | 7,240 | | | | — | | | $ | 7,240 | | | | 7,240 | |
Other comprehensive income: | | | | | | | | | | | | | | | | | | | | |
Unrealized holding gains arising during period, (net of tax, ($898)) | | | — | | | | — | | | | — | | | | (1,743 | ) | | | — | |
Reclassification adjustment, (net of tax, $103) | | | — | | | | — | | | | — | | | | 200 | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Other comprehensive income (net of tax, $795) | | | — | | | | — | | | | (1,543 | ) | | | (1,543 | ) | | | (1,543 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | | — | | | | — | | | $ | 5,697 | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Cash dividends declared | | | — | | | | (2,920 | ) | | | — | | | | | | | | (2,920 | ) |
Stock-based compensation | | | — | | | | 85 | | | | — | | | | | | | | 85 | |
Director stock grant | | | 13 | | | | 118 | | | | — | | | | | | | | 131 | |
Issuance of common stock under dividend reinvestment plan, net of repurchases | | | 35 | | | | 370 | | | | — | | | | | | | | 405 | |
Shares purchased and retired | | | (19 | ) | | | (172 | ) | | | — | | | | | | | | (191 | ) |
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2004 | | $ | 9,763 | | | $ | 49,403 | | | $ | 597 | | | | | | | $ | 59,763 | |
| | | | | | | | | | | | | | | | | | | | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | |
Net income - 2005 | | | — | | | | 6,726 | | | | — | | | $ | 6,726 | | | | 6,726 | |
Other comprehensive income: | | | | | | | | | | | | | | | | | | | | |
Unrealized holding gains arising during period, (net of tax, ($1,298)) | | | — | | | | — | | | | — | | | | (2,521 | ) | | | — | |
Reclassification adjustment, (net of tax, $76) | | | — | | | | — | | | | — | | | | 148 | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Other comprehensive income (net of tax, ($1,222)) | | | — | | | | — | | | | (2,373 | ) | | | (2,373 | ) | | | (2,373 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | | — | | | | — | | | $ | 4,353 | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Cash dividends declared | | | — | | | | (2,935 | ) | | | — | | | | | | | | (2,935 | ) |
Stock-based compensation | | | — | | | | 181 | | | | — | | | | | | | | 181 | |
Director stock grant | | | 12 | | | | 113 | | | | — | | | | | | | | 125 | |
Issuance of common stock under dividend reinvestment plan, net of repurchases | | | 37 | | | | 350 | | | | — | | | | | | | | 387 | |
| | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2005 | | $ | 9,812 | | | $ | 53,838 | | | $ | (1,776 | ) | | | | | | $ | 61,874 | |
| | | | | | | | | | | | | | | | | | | | |
See Notes to Consolidated Financial Statements.
54
Notes to Consolidated Financial Statements
| Note 1. | Summary of Significant Accounting Policies |
The accounting and reporting policies of Eastern Virginia Bankshares, Inc. and subsidiaries (the “Company”) conform to accounting principles generally accepted in the United States of America and general practices within the banking industry. The following is a description of the more significant of those policies:
Business
Eastern Virginia Bankshares, Inc. (the “Company” or “EVB”) is a bank holding company 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 three wholly owned subsidiaries, Southside Bank, Bank of Northumberland, Inc. and Hanover Bank. Bank of Northumberland, Inc. and Southside Bank were chartered as state banks under the laws of the Commonwealth of Virginia in 1910. Hanover Bank was chartered as a state bank in 2000.
The Company’s primary activity is retail banking. Through its bank subsidiaries the Company provides full service banking including commercial and consumer demand and time deposit accounts, real estate, commercial and consumer loans, Visa and MasterCard revolving credit accounts, drive-in banking services, automated teller machine transactions, internet banking and wire transfer services. With 22 branches at 2005 year end, the banks serve diverse markets that primarily are in the counties of Caroline, Essex, Gloucester, Hanover, King and Queen, King William, Middlesex, Richmond, Northumberland, Southampton, Surry and Sussex. Ancillary services provided by the banks include travelers’ checks, safe deposit box rentals, collections and other customary bank services to its customers. The largest majority of the Company’s revenue comes from retail banking in the form of interest earned on loans and investment securities and fees related to deposit services. The Company also owns EVB Statutory Trust I, a limited purpose entity that was created in 2003 for the purpose of issuing the EVB’s trust preferred debt.
The banks jointly own EVB Financial Services, Inc., which in turn has 100% ownership of EVB Investments, Inc. and a 50% ownership interest in EVB Mortgage, Inc. EVB Investments Inc. has a 5.15% ownership in Bankers Investment Group, LLC, which it uses as a brokerage firm for the investment services it provides. Southside Bank has a 75% ownership interest in EVB Title, LLC and a 2.33% interest in Virginia Bankers Insurance Center, LLC. EVB Title, LLC sells title insurance, while Virginia Bankers Insurance Center, LLC acts as a broker for insurance sales for its member banks. Bank of Northumberland has an ownership interest in Bankers Title, LLC, which provides title insurance services. EVB Mortgage, Inc. was chartered in the first quarter of 2004 and began conducting business in the third quarter of 2004. EVB also owns 100% of Eastern Virginia Statutory Trust I that was setup for the sole purpose of Trust Preferred Debt issuance. 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.
Principles of Consolidation
The consolidated financial statements include the accounts of Eastern Virginia Bankshares, Inc. and all subsidiaries. All material intercompany balances and transactions have been eliminated in consolidation. FASB interpretation No. 46 (R) requires that the Company no longer eliminate through consolidation the $310 thousand which represents the equity investment in EVB Statutory Trust I. The subordinated debt of the trust is reflected as a liability of the Company.
55
Notes to Consolidated Financial Statements
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities 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, the valuation of foreclosed real estate and deferred taxes.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash and balances due from banks and federal funds sold, which all mature within ninety days.
Securities
Securities, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The Company does not have any securities classified as “held to maturity” or “trading.”
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Declines in the fair value of securities below their cost that are deemed to be other than temporary are reflected in earnings as realized losses. In estimating other than temporary impairment losses, management considers (1) the length of time and extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Loans
The Company grants mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans in the Company’s market area. The ability of the Company’s debtors to honor their contracts is dependent upon the real estate and general economic conditions in the Company’s market area.
Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances adjusted for charge- offs, the allowance for loan losses, and any deferred fees or costs on originated loans. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized as an adjustment of the related loan yield using the interest method.
The accrual of interest on loans, except credit cards and residential mortgage loans is automatically discontinued at the time the loan is 90 days delinquent. Credit card loans and other personal loans are typically charged off before reaching 180 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Loans that are deemed to be impaired (i.e. probable that the Company will be unable to collect all amounts due according to the terms of the loan agreement) are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or, as a
56
Notes to Consolidated Financial Statements
practical matter, at the loan’s observable market value or fair value of the collateral if the loan is collateral dependent. A valuation reserve is established to record the difference between the stated loan amount and the present value or market value of the impaired loan. Impaired loans may be valued on a loan-by-loan basis (i.e. loans with risk characteristics unique to an individual borrower) or an aggregate basis (i.e. loans with similar risk characteristics). The Company’s policy for recognition of interest income on impaired loans is the same as its interest income recognition policy for non-impaired loans. The Company discontinues the accrual of interest at the earlier of the date when the collectibility of such interest becomes doubtful or the impaired loan becomes 90 days past due in payment of either interest or principal.
All interest accrued but not collected for loans that are placed on nonaccrual or charged-off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought within 90 days of being current and future payments are reasonably assured.
Allowance for Loan Losses
The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance considered adequate to absorb potential losses in the portfolio. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on an evaluation of the portfolio, current economic conditions, historical loss experience, the value and adequacy of collateral, and other risk factors. Recovery of the carrying value of loans is dependent to some extent on future economic, operating and other conditions that may be beyond the Company’s control. Unanticipated future adverse changes in such conditions could result in material adjustments to the allowance for loan losses.
The allowance consists of specific, general and unallocated components. The specific component generally relates to loans that are classified as either doubtful, substandard or special mention. The general component covers non-classified loans and is based on historical loss experience adjusted for qualitative factors. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated 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 portfolio.
A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due, according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of collateral if the loan is
57
Notes to Consolidated Financial Statements
collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, the Company does not separately identify the individual consumer and residential loans for impairment disclosures.
Other Real Estate
Real estate acquired through, or in lieu of, foreclosure is held for sale and is initially recorded at the lower of the loan balance or fair value at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of the carrying amount or fair value less cost to sell. Revenues and expenses from operations and changes in the valuation are included in other operating expenses.
Bank Premises and Equipment
Bank premises and equipment are stated at cost, less accumulated depreciation. Land is carried at cost with no depreciation. Depreciation is charged to expense over the estimated useful lives of the assets, ranging from three to thirty years, and is computed using the straight-line or declining-balance method for financial reporting purposes. Depreciation for tax purposes is computed based upon accelerated methods. The costs of major renewals or improvements are capitalized while the costs of ordinary maintenance and repairs are charged to expense as incurred.
Income Taxes
Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
Stock Compensation Plan
At December 31, 2005, the Company had one stock-based compensation plan, which is described more fully in Note 12. The Company accounts for this plan under the recognition and measurement principles of FASB Statement No. 123 “Accounting for Stock-Based Compensation.” Stock-based compensation costs included in salaries and benefit expense totaled $181 thousand for the year 2005, $85 thousand for the year 2004 and $50 thousand for the year 2003.
Earnings Per Share
Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options, and are determined using the treasury method. Earnings per share calculations are presented in Note 11.
Comprehensive Income
Accounting principles generally accepted in the United States of America require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income.
58
Notes to Consolidated Financial Statements
Pension Plan
The Company has a defined benefit pension plan covering employees meeting certain age and service requirements. The Company computes the net periodic pension cost of the plan in accordance with FASB No. 87, “Employers’ Accounting for Pensions.” See Note 10.
Advertising
The Company practices the policy of charging advertising costs to expense as incurred. Advertising expense totaled $239 thousand, $282 thousand, and $248 thousand for the three years ended December 31, 2005, 2004 and 2003, respectively.
Intangible Assets
Core deposit intangibles are included in other assets and are being amortized on a straight-line basis over the period of expected benefit, which is 7 years. Core deposit intangible, net of amortization amounted to $1.3 million and $1.6 million at December 31, 2005 and 2004 respectively.
Goodwill
In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 141, Business Combinations and SFAS No. 142, Goodwill and Other Intangible Assets. SFAS No. 141 requires that the purchase method of accounting be used for all business combinations. Additionally, it further clarifies the criteria for the initial recognition and measurement of intangible assets separate from goodwill. SFAS No. 142 also prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives. Instead these assets are subject to at least an annual impairment review, and more frequently if certain impairment indicators are in evidence.
Goodwill totaled $5.7 million at both December 31, 2005 and 2004. The goodwill is not amortized, but instead tested for impairment at least annually. Based on the testing, there were no impairment charges in 2005 or 2004.
Reclassifications
Certain reclassifications have been made to prior period balances to conform to the current year presentation.
Recent Accounting Pronouncements
In November 2005, FASB Staff Position (FSP) 115-1 “The Meaning of Other-Than-Temporary Impairment and Its Application to Certain Investments” was issued. The FSP addresses the determination as to when an investment is considered impaired, whether that impairment is other than temporary, and the measurement of an impairment loss. This FSP also includes accounting considerations subsequent to the recognition of an other-than-temporary impairment and requires certain disclosures about unrealized losses that have not been recognized as other-than-temporary impairments. The guidance in this FSP amends FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities” and APB Opinion No. 18, “The Equity Method of Accounting for Investments in Common Stock”. The FSP applies to investments in debt and equity securities and cost-method investments. The application guidance within the FSP includes items to consider in determining whether an investment is impaired, in evaluating if an impairment is other than temporary and recognizing impairment losses equal to the difference between the investment’s cost and its fair value when an impairment is determined. The FSP is required for all reporting
59
Notes to Consolidated Financial Statements
periods beginning after December 15, 2005. Earlier application is permitted. The Company does not anticipate the amendment will have a material effect on its financial statements.
In May 2005, the Financial Accounting Standards Board (“FASB”) issued Statement No. 154, (“SFAS No. 154”) “Accounting Changes and Error Corrections - A Replacement of APB Opinion No. 20 and FASB Statement No. 3.” The new standard changes the requirements for the accounting for and reporting of a change in accounting principle. Among other changes, SFAS No. 154 requires that a voluntary change in accounting principle be applied retrospectively with all prior period financial statements presented on the new accounting principle, unless it is impracticable to do so. SFAS No. 154 also provides that (1) a change in method of depreciating or amortizing a long-lived nonfinancial asset be accounted for as a change in estimate (prospectively) that was effected by a change in accounting principle, and (2) correction of errors in previously issued financial statements should be termed a “restatement. “ The new standard is effective for accounting changes and corrections of errors made in fiscal years beginning after December 15, 2005. The Company does not anticipate this revision will have a material effect on its financial statements.
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement No. 123 (Revised 2004) (SFAS No. 123R) “Share-Based Payment”, which requires that the compensation cost relating to share-based payment transactions be recognized in financial statements. SFAS No. 123R replaces SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” Share-based compensation arrangements include share options, restricted share plans, performance-based awards, share appreciation rights and employee share purchase plans. SFAS No. 123R requires all share-based payments to employees to be valued using a fair value method on the date of grant and expensed based on that fair value over the applicable vesting period. SFAS No. 123R also amends SFAS No. 95 “Statement of Cash Flows” requiring the benefits of tax deductions in excess of recognized compensation cost be reported as financing instead of operating cash flows. The Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 107 (“SAB 107”), which expresses the SEC’s views regarding the interaction between SFAS No. 123R and certain SEC rules and regulations. Additionally, SAB No. 107 provides guidance related to share-based payment transactions for public companies. The Company will be required to apply SFAS No. 123R as of the annual reporting period that begins after September 15, 2005. FASB No. 123 has no impact on the Company because the Company has expensed stock options since its first grant of options in 2002.
In December 2003, the Accounting Standards Executive Committee of the American Institute of Certified Public Accountants issued Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”). SOP 03-3 addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt securities (loans) acquired in a transfer if those differences are attributable, at least in part, to credit quality. It includes loans purchased by the Company or acquired in business combinations. SOP 03-3 does not apply to loans originated by the Company. The Company adopted the provisions of SOP 03-3 effective January 1, 2005. The initial implementation had no material effect on the Company’s financial statements.
60
Notes to Consolidated Financial Statements
| Note 2. | Cash and Due From Banks |
To comply with Federal Reserve Regulations, the Company’s subsidiary banks are required to maintain certain average reserve balances. For the final weekly reporting period in the years ended December 31, 2005 and 2004, the aggregate amounts of daily average required balances were approximately $4.1 million and $5.6 million.
The amortized cost and fair value of securities, with gross unrealized gains and losses, follows:
| | | | | | | | | | | | |
| | | December 31, 2005 |
(dollars in thousands) | | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Available for Sale: | | | | | | | | | | | | |
Obligations of U.S. Government agencies | | $ | 29,849 | | $ | 1 | | $ | 549 | | $ | 29,301 |
Mortgage-backed securities | | | 36,010 | | | 23 | | | 811 | | | 35,222 |
State and political subdivisions | | | 35,373 | | | 584 | | | 162 | | | 35,795 |
Corporate, CMO and other securities | | | 31,959 | | | 36 | | | 1,812 | | | 30,183 |
Restricted securities | | | 4,919 | | | — | | | — | | | 4,919 |
| | | | | | | | | | | | |
Total | | $ | 138,110 | | $ | 644 | | $ | 3,334 | | $ | 135,420 |
| | | | | | | | | | | | |
| | | December 31, 2004 |
(dollars in thousands) | | Amortized Cost | | Gross Unrealized Gains | | Gross Unrealized Losses | | Estimated Fair Value |
Available for Sale: | | | | | | | | | | | | |
Obligations of U.S. Government agencies | | $ | 33,434 | | $ | 76 | | $ | 194 | | $ | 33,316 |
Mortgage-backed securities | | | 28,017 | | | 116 | | | 145 | | | 27,988 |
State and political subdivisions | | | 42,345 | | | 1,596 | | | 83 | | | 43,858 |
Corporate, CMO and other securities | | | 25,620 | | | 326 | | | 787 | | | 25,159 |
Restricted securities | | | 3,372 | | | — | | | — | | | 3,372 |
| | | | | | | | | | | | |
Total | | $ | 132,788 | | $ | 2,114 | | $ | 1,209 | | $ | 133,693 |
| | | | | | | | | | | | |
The following is a comparison of amortized cost and estimated fair values of the Company’s securities by contractual maturity at December 31, 2005. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalty.
| | | | | | |
(dollars in thousands) | | Amortized
Cost | | Estimated
Fair Value |
Due in one year or less | | $ | 8,295 | | $ | 8,254 |
Due after one year through five years | | | 70,951 | | | 69,945 |
Due after five years through ten years | | | 37,880 | | | 37,366 |
Due after ten years | | | 16,065 | | | 14,936 |
Restricted securities | | | 4,919 | | | 4,919 |
| | | | | | |
Total | | $ | 138,110 | | $ | 135,420 |
| | | | | | |
61
Notes to Consolidated Financial Statements
At December 31, 2005, investments in an unrealized loss position that are temporarily impaired are:
| | | | | | | | | | | | | | | | | | |
| | | December 31, 2005 |
| | | Less than 12 months | | 12 months or more | | Total |
(dollars in thousands) | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss |
Description of Securities | | | | | | | | | | | | | | | | | | |
U. S. Treasury and federal agencies | | $ | 17,448 | | $ | 255 | | $ | 10,601 | | $ | 294 | | $ | 28,049 | | $ | 549 |
Mortgage-backed securities | | | 23,925 | | | 520 | | | 9,986 | | | 291 | | | 33,911 | | | 811 |
States and political subdivisions | | | 7,566 | | | 53 | | | 3,120 | | | 109 | | | 10,686 | | | 162 |
All other securities including CMO’s | | | 16,218 | | | 460 | | | 7,229 | | | 1,352 | | | 23,447 | | | 1,812 |
| | | | | | | | | | | | | | | | | | |
| | $ | 65,157 | | $ | 1,288 | | $ | 30,936 | | $ | 2,046 | | $ | 96,093 | | $ | 3,334 |
| | | | | | | | | | | | | | | | | | |
Bonds with unrealized loss positions of less than 12 months duration at 2005 year-end included 21 federal agencies, 27 mortgage-backed securities, 8 corporate bonds, 19 municipal bonds, 6 CMO’s and 1 federal agency preferred stock. Securities with losses of one year or greater duration included 10 federal agencies, 20 mortgage-backed securities, 9 municipal bonds and 2 federal agency preferred stocks. The unrealized loss positions at December 31, 2005 were primarily related to interest rate movements. Holdings of GMAC and Ford Motor Credit contained unrealized loss positions because these securities have been downgraded by Moodys and Standard & Poors rating agencies to levels below investment grade. As of year-end, the Company held $3.55 million in GMAC bonds and $250 thousand in Ford Motor Credit Corp bonds. These holdings are monitored regularly by EVB’s Chief Financial Officer and reported to the bank boards on a monthly basis. Given the attractive yield and the belief that the risk of default is remote, management has not recommended sale of the holdings.
At December 31, 2004, investments in an unrealized loss position that were temporarily impaired were:
| | | | | | | | | | | | | | | | | | |
| | | Less than 12 months | | 12 months or more | | Total |
(dollars in thousands) | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss |
Description of Securities | | | | | | | | | | | | | | | | | | |
U. S. Treasury and federal agencies | | $ | 15,221 | | $ | 158 | | $ | 1,464 | | $ | 36 | | $ | 16,685 | | $ | 194 |
Mortgage-backed securities | | | 21,595 | | | 233 | | | 1,097 | | | 22 | | | 22,692 | | | 255 |
States and political subdivisions | | | 2,259 | | | 22 | | | 2,324 | | | 61 | | | 4,583 | | | 83 |
All other securities including CMO’s | | | 10,696 | | | 451 | | | 1,245 | | | 226 | | | 11,941 | | | 677 |
| | | | | | | | | | | | | | | | | | |
| | $ | 49,771 | | $ | 864 | | $ | 6,130 | | $ | 345 | | $ | 55,901 | | $ | 1,209 |
| | | | | | | | | | | | | | | | | | |
For the years ended December 31, 2005, 2004 and 2003, proceeds from sales of securities available for sale amounted to $11.0 million, $24.0 million, and $12.6 million, respectively. Gross realized gains amounted to $224 thousand, $303 thousand, and $173 thousand in 2005, 2004 and 2003 respectively. The book value of securities pledged to secure public deposits and other purposes amounted to $22.1 million and $16.8 million at December 31, 2005 and 2004, respectively.
62
Notes to Consolidated Financial Statements
The following is a comparison of loans by type that were outstanding at December 31, 2005 and 2004.
| | | | | | | | |
(in thousands) | | 2005 | | | 2004 | |
Real estate - construction | | $ | 47,620 | | | $ | 23,675 | |
Real estate - mortgage | | | 263,191 | | | | 252,895 | |
Commercial real estate | | | 151,897 | | | | 131,580 | |
Commercial, industrial and agricultural loans | | | 55,732 | | | | 46,629 | |
Loans to individuals for household, family and other consumer expenditures | | | 55,680 | | | | 58,801 | |
All other loans | | | 321 | | | | 96 | |
| | | | | | | | |
Total gross loans | | | 574,441 | | | | 513,676 | |
Less unearned income | | | (356 | ) | | | (1,126 | ) |
Less allowance for loan losses | | | (6,601 | ) | | | (6,676 | ) |
| | | | | | | | |
Total net loans | | $ | 567,484 | | | $ | 505,874 | |
| | | | | | | | |
Within the loan portfolio, the Company has a concentration of loans in special categories. Marina loans represent 1.7%, boat loans 1.2%, church loans 1.2% and golf course loans 1.1% of the total loan portfolio. The concentration in recreational businesses is representative of the market that the Company serves. Church loans have historically been excellent loans usually secured by property.
| Note 5. | Allowance for Loan Losses |
The following is a summary of the activity in the allowance for loan losses:
| | | | | | | | | | | | |
| | | December 31 | |
| | | 2005 | | | 2004 | | | 2003 | |
| | | (in thousands) | |
Balance at the beginning of year | | $ | 6,676 | | | $ | 6,495 | | | $ | 5,748 | |
Provision charged against income | | | 552 | | | | 1,279 | | | | 1,637 | |
Recoveries of loans charged off | | | 491 | | | | 411 | | | | 440 | |
Loans charged off | | | (1,118 | ) | | | (1,509 | ) | | | (1,330 | ) |
| | | | | | | | | | | | |
Balance at end of year | | $ | 6,601 | | | $ | 6,676 | | | $ | 6,495 | |
| | | | | | | | | | | | |
The following is a summary of information pertaining to impaired loans:
| | | | | | | | | |
| | | December 31 |
| | | 2005 | | 2004 | | 2003 |
| | | (in thousands) |
Impaired loans for which an allowance has been provided | | $ | 14,293 | | $ | 19,657 | | $ | 822 |
| | | | | | | | | |
Allowance related to impaired loans | | $ | 1,849 | | $ | 2,383 | | $ | 124 |
| | | | | | | | | |
Average balance of impaired loans | | $ | 17,175 | | $ | 5,068 | | $ | 690 |
| | | | | | | | | |
Interest income recognized and collected on impaired loans | | $ | 1,028 | | $ | 1,046 | | $ | 40 |
| | | | | | | | | |
63
Notes to Consolidated Financial Statements
No additional funds are committed to be advanced in connection with impaired loans.
Nonaccrual loans excluded from impaired loan disclosure under FASB 114 amounted to $772 thousand, and $850 thousand at December 31, 2005 and 2004. If interest on these loans had been accrued such income would have approximated $35 thousand and $32 thousand, respectively. Loans past due and still accruing interest amounted to $1.69 million, $1.61 million and $19 thousand at December 31, 2005, 2004 and 2003, respectively.
| Note 6. | Related Party Transactions |
Loans to directors and officers totaled $14.9 million and $13.3 million at December 31, 2005 and 2004, respectively. New advances to directors and officers totaled $4.8 million and repayments totaled $8.9 million in the year ended December 31, 2005.
| Note 7. | Bank Premises and Equipment |
A summary of the cost and accumulated depreciation of bank premises and equipment follows:
| | | | |
| | | 2005 | | 2004 |
| | | (in thousands) |
Land and improvements | | 3,869 | | 2,972 |
Buildings and leasehold improvements | | 12,675 | | 11,512 |
Furniture, fixtures and equipment | | 10,073 | | 10,719 |
Construction in progress | | 512 | | 2,428 |
| | | | |
| | 27,129 | | 27,631 |
Less accumulated depreciation | | 11,982 | | 12,018 |
| | | | |
Net balance | | 15,147 | | 15,613 |
| | | | |
For 2005, depreciation and amortization of premises and equipment was $2.1 million. Depreciation and amortization expense amounted to $2.1 million and $1.6 million for 2004 and 2003, respectively.
The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $91.0 million and $64.5 million at December 31, 2005 and 2004, respectively.
| | | |
| | | (in thousands) |
2006 | | $ | 133,973 |
2007 | | | 73,573 |
2008 | | | 26,789 |
2009 | | | 18,474 |
2010 | | | 29,916 |
Thereafter | | | 12 |
| | | |
Total | | $ | 282,737 |
| | | |
At December 31, 2005, the scheduled maturities of certificates of deposit were as follows:
At December 31, 2005 and 2004, overdraft demand deposits reclassified to loans totaled $253 thousand and $232 thousand, respectively.
64
Notes to Consolidated Financial Statements
Net deferred tax assets consist of the following components as of December 31, 2005 and 2004.
| | | | | | |
| | | 2005 | | 2004 |
| | | (in thousands) |
Deferred tax assets: | | | | | | |
Allowance for loan losses | | $ | 2,139 | | $ | 2,079 |
Interest on nonaccrual loans | | | 12 | | | 41 |
Organizational costs | | | — | | | 10 |
Net unrealized loss on available for sale securities | | | 915 | | | — |
Depreciation and amortization | | | 8 | | | — |
| | | | | | |
| | | 3,074 | | | 2,130 |
Deferred tax liabilities: | | | | | | |
Net unrealized gain on available for sale securities | | | — | | | 308 |
Depreciation and amortization | | | — | | | 246 |
FHLB dividend | | | 8 | | | 8 |
Pension liability | | | 4 | | | — |
Goodwill and other intangible assets | | | 196 | | | 112 |
Other | | | 46 | | | 45 |
| | | | | | |
| | | 254 | | | 719 |
| | | | | | |
Net deferred tax assets | | $ | 2,820 | | $ | 1,411 |
| | | | | | |
Income tax expense charged to operations for the years ended December 31, 2005, 2004 and 2003, consists of the following:
| | | | | | | | | | |
| | | 2005 | | | 2004 | | 2003 |
| | | (in thousands) |
Currently payable | | $ | 2,773 | | | $ | 2,545 | | $ | 2,414 |
Deferred tax provision | | | (186 | ) | | | 86 | | | 139 |
| | | | | | | | | | |
| | $ | 2,587 | | | $ | 2,631 | | $ | 2,553 |
| | | | | | | | | | |
The income tax provision differs from the amount of income tax determined by applying the U.S.
Federal income tax rate to pretax income for the years ended December 31, 2005, 2004 and 2003, due to the following:
| | | | | | | | | | | | |
| | | 2005 | | | 2004 | | | 2003 | |
| | | (in thousands) | |
Expected tax expense at statutory rate (34%) | | | | | | | | | | | | |
Increase (decrease) in taxes resulting from: | | $ | 3,167 | | | $ | 3,356 | | | $ | 3,276 | |
Tax exempt interest | | | (597 | ) | | | (618 | ) | | | (655 | ) |
Other | | | 17 | | | | (107 | ) | | | (68 | ) |
| | | | | | | | | | | | |
| | $ | 2,587 | | | $ | 2,631 | | | $ | 2,553 | |
| | | | | | | | | | | | |
65
Notes to Consolidated Financial Statements
| Note 10. | Employee Benefit Plans |
Pension Plan
The Company has a defined benefit pension plan covering substantially all of the employees. Benefits are based on years of service and the employee’s compensation during the last five years of employment. The Company’s funding policy is to contribute annually the maximum amount that can be deducted for federal income tax purposes. Contributions are intended to provide not only for benefits attributable to service to date but also for those expected to be earned in the future.
Information about the plan follows:
| | | | | | | | | | | | |
| | | 2005 | | | 2004 | | | 2003 | |
| | | (in thousands) | |
Change in Benefit Obligation | | | | | | | | | | | | |
Benefit obligation, beginning | | $ | 9,869 | | | $ | 8,189 | | | $ | 6,237 | |
Service cost | | | 1,094 | | | | 792 | | | | 428 | |
Interest cost | | | 589 | | | | 529 | | | | 433 | |
Plan amendment | | | — | | | | — | | | | 137 | |
Actuarial loss | | | 1,234 | | | | 1,473 | | | | 1,063 | |
Benefits paid | | | (292 | ) | | | (1,114 | ) | | | (109 | ) |
| | | | | | | | | | | | |
Benefit obligation, ending | | $ | 12,494 | | | $ | 9,869 | | | $ | 8,189 | |
| | | | | | | | | | | | |
Change in Plan Assets | | | | | | | | | | | | |
Fair value of plan assets, beginning | | $ | 6,595 | | | $ | 6,018 | | | $ | 4,435 | |
Actual return on plan assets | | | 995 | | | | 782 | | | | 1,069 | |
Employer contributions | | | 1,311 | | | | 909 | | | | 623 | |
Benefits paid | | | (292 | ) | | | (1,114 | ) | | | (109 | ) |
| | | | | | | | | | | | |
Fair value of plan assets, ending | | $ | 8,609 | | | $ | 6,595 | | | $ | 6,018 | |
| | | | | | | | | | | | |
Funded status | | $ | (3,885 | ) | | $ | (3,274 | ) | | $ | (2,171 | ) |
Unrecognized net actuarial loss | | | 3,721 | | | | 3,084 | | | | 1,978 | |
Unrecognized net obligation at transition | | | 10 | | | | 14 | | | | 18 | |
Unrecognized prior service cost | | | 188 | | | | 210 | | | | 231 | |
| | | | | | | | | | | | |
Prepaid benefit cost included in other assets | | $ | 34 | | | $ | 34 | | | $ | 56 | |
| | | | | | | | | | | | |
Accumulated Benefit Obligation | | $ | 7,129 | | | $ | 5,772 | | | $ | 5,179 | |
Components of Net Periodic Benefit Cost | | | | | | | | | | | | |
Service cost | | $ | 1,094 | | | $ | 792 | | | $ | 428 | |
Interest cost | | | 589 | | | | 529 | | | | 433 | |
Expected return on plan assets | | | (514 | ) | | | (480 | ) | | | (370 | ) |
Amortization of prior service cost | | | 22 | | | | 22 | | | | 14 | |
Amortization of net obligation at transition | | | 4 | | | | 4 | | | | 4 | |
Recognized net actuarial loss | | | 116 | | | | 64 | | | | 58 | |
| | | | | | | | | | | | |
Net periodic benefit cost | | $ | 1,311 | | | $ | 931 | | | $ | 567 | |
| | | | | | | | | | | | |
66
Notes to Consolidated Financial Statements
| | | | | | | | | |
| | | 2005 | | | 2004 | | | 2003 | |
| | | (in thousands) | |
Weighted-Average Assumptions for Benefit Obligation as of September 30 | | | | | | | | | |
Discount rate | | 5.75 | % | | 6.00 | % | | 6.50 | % |
Long-term rate of return | | 8.50 | % | | 8.50 | % | | 8.50 | % |
Rate of compensation increase | | 5.00 | % | | 5.00 | % | | 5.00 | % |
Weighted-Average Assumptions for Net Periodic Benefit Cost as of September 30 | | | | | | | | | |
Discount rate | | 6.00 | % | | 6.50 | % | | 7.00 | % |
Long-term rate of return | | 8.50 | % | | 8.50 | % | | 9.00 | % |
Rate of compensation increase | | 5.00 | % | | 5.00 | % | | 5.00 | % |
Long Term Rate of Return
In consultation with their investment advisors and actuary, the plan sponsor selects the expected long-term rate of return on assets assumption. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of inflation), for the major asset classes held or anticipated to be held by the trust, and for the trust itself. Undue weight is not given to recent experience, that may not continue over the measurement period, with significance placed on current forecasts of future long-term economic conditions. The discount rate used to calculate funding requirements and benefit expense was decreased effective October 1, 2004 from 6.50% to 6.00%, resulting in an increase in plan expense for 2005.
Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Solely for this purpose, the plan is assumed to continue in force and not terminate during the period during which the assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated with periodic cost). The Company’s estimate of contributions to the plan for 2006 is $1.6 million.
The pension plan’s weighted average asset allocations at December 31, 2005 and 2004, by asset category are as follows:
| | | | | | |
| | | Plan Assets | |
| | | 2005 | | | 2004 | |
Asset Category: | | | | | | |
Mutual funds - fixed income | | 19 | % | | 20 | % |
Mutual funds - equity | | 81 | % | | 80 | % |
| | | | | | |
Total | | 100 | % | | 100 | % |
| | | | | | |
The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return, with a targeted asset allocation of 25% fixed income and 75% equities. The Investment Manager selects investment fund managers with demonstrated experience and expertise, and funds with demonstrated historical performance, for the implementation of the Plan’s investment strategy. The Investment Manager will consider both
67
Notes to Consolidated Financial Statements
actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.
It is the responsibility of the Trustee to administer the investments of the Trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the Trust.
Estimated Future Benefit Payments
The following benefit payments reflecting the appropriate expected future service are expected to be paid:
| | | |
| | | Pension
Benefits |
| | | (in thousands) |
10/1/2005 - 9/30/2006 | | $ | 115 |
10/1/2006 - 9/30/2007 | | | 183 |
10/1/2007 - 9/30/2008 | | | 194 |
10/1/2008 - 9/30/2009 | | | 198 |
10/1/2009 - 9/30/2010 | | | 280 |
10/1/2010 - 9/30/2015 | | | 2,772 |
401(k) Plan
The Company has a 401(k) defined contribution plan applicable to all eligible employees. Contributions to the Plan are made in accordance with proposals set forth and approved by the Board of Directors. Employees may elect to contribute to the Plan an amount not to exceed 20% of their salary. The Company has elected to contribute amounts not to exceed 50% of the first 6% of the employee’s contribution. Contributions to this Plan by the Company of $208 thousand, $186 thousand and $114 thousand were included in expenses for the years ended December 31, 2005, 2004, and 2003, respectively.
68
Notes to Consolidated Financial Statements
| Note 11. | Earnings Per Share |
The following shows the weighted average number of shares used in computing the earnings per share and the effect on weighted average number of shares of diluted potential common stock. Potential diluted common stock had no effect on income available to common shareholders. 89,862 shares were excluded from the 2005 calculations and 30,150 shares were excluded from the 2004 and 2003 calculations because their effects were anti-dilutive.
| | | | | | | | | | | | | | | | |
| | | Years Ended December 31 |
| | | 2005 | | 2004 | | | 2003 |
| | | Shares | | Per Share
Amount | | Shares | | Per Share
Amount | | | Shares | | Per Share
Amount |
Basic earnings per share | | 4,893,259 | | $ | 1.37 | | 4,873,271 | | $ | 1.49 | | | 4,858,087 | | $ | 1.46 |
Effect of dilutive securities, stock options | | 9,143 | | | — | | 10,288 | | | (0.01 | ) | | 10,161 | | | — |
| | | | | | | | | | | | | | | | |
Diluted earnings per share | | 4,902,402 | | $ | 1.37 | | 4,883,559 | | $ | 1.48 | | | 4,868,248 | | $ | 1.46 |
| | | | | | | | | | | | | | | | |
| Note 12. | Stock Compensation Plan |
On September 21, 2000, the Company adopted the Eastern Virginia Bankshares, Inc. 2000 Stock Option Plan to provide a means for selected key employees and directors of the Company and its subsidiaries to increase their personal financial interest in the Company, thereby stimulating their efforts and strengthening their desire to remain with the Company. Under the Plan, up to 400,000 shares of Company common stock may be granted. No options may be granted under the Plan after September 21, 2010. On April 17, 2003, the shareholders approved the 2003 Stock Incentive Plan, amending and restating the 2000 Plan while still authorizing the issuance of up to 400,000 shares of common stock.
The fair value of each grant is estimated at the grant date using the Black-Scholes option-pricing model with the following weighted-average assumptions for grants in 2005, 2004 and 2003:
| | | | | | | | | |
| | | 2005 | | | 2004 | | | 2003 | |
Dividend rate: | | 2.76 | % | | 2.78 | % | | 2.81 | % |
Price Volatility: | | 23.61 | % | | 24.99 | % | | 23.07 | % |
Risk-free interest rate: | | 4.13 | % | | 4.95 | % | | 4.69 | % |
Expected life: | | 10 Years | | | 10 Years | | | 10 Years | |
69
Notes to Consolidated Financial Statements
The following table presents the status of the plans at December 31, 2005, 2004 and 2003, and changes during the years then ended:
| | | | | | | | | | | | | | | | | |
| | | Shares | | 2005 | | Shares | | | 2004 | | Shares | | | 2003 |
| | | | Weighted
Average
Exercise
Price | | | Weighted
Average
Exercise
Price | | | Weighted
Average
Exercise
Price |
Outstanding at beginning of year | | 100,095 | | $ | 21.55 | | 58,095 | | | $ | 22.88 | | 30,555 | | | $ | 16.10 |
Granted | | 59,712 | | | 20.57 | | 44,575 | | | | 19.92 | | 31,500 | | | | 28.60 |
Exercised | | — | | | — | | — | | | | — | | — | | | | — |
Forfeited | | — | | | — | | (2,575 | ) | | | 23.25 | | (3,960 | ) | | | 16.10 |
| | | | | | | | | | | | | | | | | |
Outstanding at December 31: | | 159,807 | | $ | 21.18 | | 100,095 | | | $ | 21.55 | | 58,095 | | | $ | 22.88 |
| | | | | | | | | | | | | | | | | |
Weighted average fair value of options granted during the year | | | | $ | 5.31 | | | | | $ | 5.78 | | | | | $ | 11.58 |
| | | | | | | | | | | | | | | | | |
No shares were exercisable at December 31, 2005, December 31, 2004 and December 31, 2003. The status of the options outstanding at December 31, 2005 is as follows:
| | | | | |
| Options Outstanding |
Range of
Exercise
Prices | | Number
Outstanding | | Weighted
Average
Remaining
Term |
| $ | 16.10 | | 25,770 | | 6.3 years |
| | 28.60 | | 30,150 | | 7.7 years |
| | 19.92 | | 44,175 | | 8.5 years |
| | 20.57 | | 59,712 | | 9.5 years |
| | | | | |
| | Total | | 159,807 | | 8.4 years |
| | | | | |
| Note 13. | Commitments and Contingent Liabilities |
Southside Bank has entered into a long-term land lease for its Hartfield branch. The lease was entered into on May 9, 1988 for an original term of fifteen years and renewed for an additional term of ten years in 2003. The Bank has an option to renew for an additional term of ten years and three additional terms of five years each and, thereafter, for five additional terms of five years each.
Hanover Bank rents its principal location in Mechanicsville from a related party under an operating lease. The lease was entered into on May 1, 2000 and provides for an original term of five years with two renewal options of five years each.
Hanover Bank leases a banking facility in Ashland, Virginia under an operating lease. The lease was entered into on April 26, 2001 for an original term of three years and was renewed in January 2004 for an additional term of four years.
Hanover Bank leases a banking facility in the Ashland-Hanover Office Building under an operating lease. The lease was entered into on July 1, 2001 and provides for an original term of five years with two renewal options of five years each.
70
Notes to Consolidated Financial Statements
Hanover Bank leases office space at Hanover Green Drive in Mechanicsville, Virginia under an operating lease. The lease was entered into on May 27, 2004 and provides for a term of five years expiring May 31, 2009 with three renewal options of five years each.
Southside Bank leases office space at the Glenns intersection of Routes 17 and 33 in Gloucester County, Virginia under an operating lease. The lease was entered into on June 30, 2004 and provides for a term of 10 years with three renewal options of five years each.
Total rent expense was $250 thousand, $202 thousand and $151 thousand for 2005, 2004, and 2003, respectively, and was included in occupancy expense.
The following is a schedule by year of future minimum lease requirements required under the long-term non-cancelable lease agreements:
| | |
(in thousands) | | |
2006 | | 228 |
2007 | | 196 |
2008 | | 197 |
2009 | | 163 |
2010 | | 118 |
2011 | | 106 |
2012 | | 109 |
2013 | | 109 |
2014 | | 56 |
2015 | | — |
| | |
| | 1,282 |
| | |
In the normal course of business there are outstanding various commitments and contingent liabilities, which are not reflected in the accompanying financial statements. Management does not anticipate any material losses as a result of these transactions.
See Note 17 with respect to financial instruments with off-balance-sheet risk.
| Note 14. | Restrictions on Transfers to Parent |
Transfers of funds from banking subsidiaries to the Parent Company in the form of loans, advances and cash dividends, are restricted by federal and state regulatory authorities. As of December 31, 2005, retained net income, which was free of restriction, amounted to $20.7 million.
Federal Home Loan Bank Advances and Available Lines of Credit
At December 31, 2005 the Company’s Federal Home Loan Bank (FHLB) debt consisted of advances of $51.9 million, $10 million of which is continuously callable but has not been called, $25.5 million callable in 2007, and $10.0 million callable in 2010. There are two advances totaling $6.4 million at December 31, 2005 which are payable semi-annually over a seven-year period beginning in 2003. Advances mature through 2015. At December 31, 2005, the interest rates ranged from 3.10% to 5.92% with a weighted average interest rate of 4.04%. Advances on the line
71
Notes to Consolidated Financial Statements
are secured by a blanket lien on qualified 1 to 4 family residential real estate loans. Immediate available credit amounted to $122.2 million.
Aggregate annual maturities of FHLB advances (based on final maturity dates) are as follows:
| | |
(in thousands) | | |
2006 | | 1,429 |
2007 | | 1,429 |
2008 | | 1,429 |
2009 | | 1,429 |
2010 | | 15,712 |
2012 | | 10,000 |
2015 | | 20,500 |
| | |
Total | | 51,928 |
| | |
The Company has unused lines of credit totaling $17.6 million with nonaffiliated banks as of December 31, 2005.
Trust Preferred Securities
On September 5, 2003, EVB Statutory Trust I (the Trust), a wholly-owned subsidiary of the Company, was formed for the purpose of issuing redeemable capital securities. On September 17, 2003, $10 million of trust preferred securities were issued through a pooled underwriting totaling approximately $650 million. The Trust issued $310 thousand in common equity to the Company. The securities have a LIBOR indexed floating rate of interest. The interest rate at December 31, 2005 was 7.45%. The securities have a mandatory redemption date of September 17, 2033, and are subject to varying call provisions beginning September 17, 2008. The principal asset of the Trust is $10.310 million of the Company’s junior subordinated debt securities with the same maturity and interest rate structures as the capital securities.
The trust preferred securities may be included in Tier I capital for regulatory capital adequacy purposes as long as their amount does not exceed 25% of Tier I capital, including total trust preferred securities. The portion of the trust preferred securities not considered as Tier I capital, if any, may be included in Tier 2 capital. The total amount ($10 million) of trust preferred securities issued by the Trust can be included in the Company’s Tier I capital.
The obligations of the Company with respect to the issuance of the capital securities constituted a full and unconditional guarantee by the Company of the Trust’s obligations with respect to the capital
securities.
Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related capital securities.
| Note 16. | Dividend Reinvestment Plan |
The Company has in effect a Dividend Reinvestment Plan, which provides an automatic conversion of dividends into common stock for enrolled shareholders. It is based on the stock’s fair market value on each dividend record date, and allows for voluntary contributions to purchase stock up to $5 thousand per shareholder per calendar quarter.
72
Notes to Consolidated Financial Statements
| Note 17. | Financial Instruments with Off-Balance-Sheet Risk |
The Company, through its banking subsidiaries, is party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet. The contract or notional amounts of those instruments reflect the extent of involvement the Company has in particular classes of financial instruments.
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance-sheet instruments.
At December 31, 2005 and 2004, the following financial instruments were outstanding whose contract amounts represent credit risk:
| | | | | | |
| | | Contract Amounts |
| | | 2005 | | 2004 |
| | | (in thousands) |
Commitments to grant loans and unfunded commitments under lines of credit | | $ | 88,833 | | $ | 65,278 |
Standby letters of credit | | | 1,879 | | | 2,343 |
Private label credit card guarantees | | | — | | | 46 |
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are usually uncollateralized and do not always contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments if deemed necessary.
The Company maintains cash accounts in other commercial banks. The amount on deposit with correspondent institutions at December 31, 2005 exceeded the insurance limits of the Federal Deposit Insurance Corporation by $10.2 million.
73
Notes to Consolidated Financial Statements
| Note 18. | Fair Value of Financial Instruments and Interest Rate Risk |
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the fair discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. SFAS No.107 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The following methods and assumptions were used to estimate the fair value of each class of financial instruments for which it is practicable to estimate that value.
Cash and Short-Term Investments
For those short-term instruments, the carrying amount is a reasonable estimate of fair value.
Securities
For securities 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 market prices for similar securities.
Loans
For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. The fair values for other loans were estimated using discounted cash flow analyses, using interest rates currently being offered.
Deposit Liabilities
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 Company’s current incremental borrowing rates for similar types of borrowing arrangements.
Long-Term Debt
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
The carrying amounts of accrued interest approximate fair value.
74
Notes to Consolidated Financial Statements
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.
At December 31, 2005 and 2004, the fair value of loan commitments and standby letters of credit are immaterial.
The estimated fair values and related carrying amounts of the Company’s financial instruments are as follows:
| | | | | | | | |
| | | December 31, 2005 | | December 31, 2004 |
| | | Carrying
Amount | | Estimated
Fair Value | | Carrying
Amount | | Estimated
Fair Value |
| | | (in thousands) | | (in thousands) |
Financial assets: | | | | | | | | |
Cash and short-term investments | | 21,516 | | 21,516 | | 17,797 | | 17,797 |
Securities - available for sale | | 135,420 | | 135,420 | | 133,693 | | 133,693 |
Loans, net | | 567,484 | | 564,397 | | 505,874 | | 511,890 |
Accrued interest receivable | | 2,820 | | 2,820 | | 2,991 | | 2,991 |
| | | | |
Financial liabilities: | | | | | | | | |
Noninterest-bearing deposits | | 99,718 | | 99,718 | | 86,848 | | 86,848 |
Interest-bearing deposits | | 528,625 | | 527,111 | | 503,030 | | 504,700 |
Short-term borrowings | | 6,822 | | 6,822 | | 8,400 | | 8,400 |
Federal Home Loan Bank advances | | 51,928 | | 51,167 | | 22,857 | | 23,500 |
Trust prefered debt | | 10,310 | | 10,310 | | 10,310 | | 10,310 |
Accrued interest payable | | 1,264 | | 1,264 | | 839 | | 839 |
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its 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. Management 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. Management 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.
75
Notes to Consolidated Financial Statements
| Note 19. | Regulatory Matters |
The Company (on a consolidated basis) and the subsidiary banks 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 subsidiary banks’ financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the subsidiary banks 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, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and subsidiary banks to maintain minimum amounts and ratios (set forth in the table that follows) 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 December 31, 2005 and 2004, that the Company and subsidiary banks meet all capital adequacy requirements to which they are subject.
As of December 31, 2005, based on regulatory guidelines, the Company believes that the subsidiary banks are well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, the institutions must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since that notification that management believes have changed the institutions’ category.
The Company’s and the Banks’ actual capital amounts and ratios are presented in the following table.
76
Notes to Consolidated Financial Statements
| | | | | | | | | | | | | | | | | | |
| | | Actual | | | Minimum Capital
Requirement | | | Minimum To Be Well
Capitalized Under
Prompt Corrective
Action Provision | |
| | | Amount | | Ratio | | | Amount | | Ratio | | | Amount | | Ratio | |
| | | (dollars in thousands) | |
As of December 31, 2005 | | | | |
Total capital to risk weighted assets Consolidated | | $ | 73,195 | | 13.23 | % | | $ | 44,253 | | 8.00 | % | | | NA | | NA | |
SSB | | | 35,940 | | 12.22 | % | | | 23,527 | | 8.00 | % | | $ | 29,409 | | 10.00 | % |
BNI | | | 21,252 | | 14.21 | % | | | 11,968 | | 8.00 | % | | | 14,960 | | 10.00 | % |
HB | | | 11,768 | | 10.84 | % | | | 8,687 | | 8.00 | % | | | 10,859 | | 10.00 | % |
Tier 1 capital to risk weighted assets Consolidated | | $ | 66,594 | | 12.04 | % | | $ | 22,127 | | 4.00 | % | | | NA | | NA | |
SSB | | | 31,777 | | 10.81 | % | | | 11,764 | | 4.00 | % | | $ | 17,645 | | 6.00 | % |
BNI | | | 18,377 | | 12.28 | % | | | 5,984 | | 4.00 | % | | | 8,976 | | 6.00 | % |
HB | | | 10,602 | | 9.76 | % | | | 4,344 | | 4.00 | % | | | 6,515 | | 6.00 | % |
Tier 1 capital to average adjusted assets Consolidated | | $ | 66,594 | | 8.87 | % | | $ | 30,047 | | 4.00 | % | | | NA | | NA | |
SSB | | | 31,777 | | 7.73 | % | | | 16,437 | | 4.00 | % | | $ | 20,546 | | 5.00 | % |
BNI | | | 18,377 | | 8.36 | % | | | 8,794 | | 4.00 | % | | | 10,992 | | 5.00 | % |
HB | | | 10,602 | | 8.40 | % | | | 5,051 | | 4.00 | % | | | 6,314 | | 5.00 | % |
As of December 31, 2004 | | | | |
Total capital to risk weighted assets Consolidated | | $ | 67,965 | | 13.86 | % | | $ | 39,216 | | 8.00 | % | | | NA | | NA | |
SSB | | | 31,639 | | 11.80 | % | | | 21,451 | | 8.00 | % | | $ | 26,815 | | 10.00 | % |
BNI | | | 19,650 | | 14.97 | % | | | 10,502 | | 8.00 | % | | | 13,127 | | 10.00 | % |
HB | | | 11,053 | | 12.50 | % | | | 7,074 | | 8.00 | % | | | 8,842 | | 10.00 | % |
Tier 1 capital to risk weighted assets Consolidated | | $ | 61,831 | | 12.61 | % | | $ | 19,608 | | 4.00 | % | | | NA | | NA | |
SSB | | | 25,416 | | 9.48 | % | | | 10,726 | | 4.00 | % | | $ | 16,088 | | 6.00 | % |
BNI | | | 14,001 | | 10.67 | % | | | 5,251 | | 4.00 | % | | | 7,876 | | 6.00 | % |
HB | | | 7,748 | | 8.76 | % | | | 3,537 | | 4.00 | % | | | 5,305 | | 6.00 | % |
Tier 1 capital to average adjusted assets Consolidated | | $ | 61,831 | | 8.90 | % | | $ | 27,783 | | 4.00 | % | | | NA | | NA | |
SSB | | | 25,416 | | 6.65 | % | | | 15,286 | | 4.00 | % | | $ | 19,108 | | 5.00 | % |
BNI | | | 14,001 | | 6.84 | % | | | 8,187 | | 4.00 | % | | | 10,234 | | 5.00 | % |
HB | | | 7,748 | | 7.01 | % | | | 4,420 | | 4.00 | % | | | 5,525 | | 5.00 | % |
77
Notes to Consolidated Financial Statements
| Note 20. | Condensed Financial Information - Parent Company Only |
EASTERN VIRGINIA BANKSHARES, INC.
(Parent Corporation Only)
Balance Sheets
December 31, 2005 and 2004
| | | | | | | |
| | | (dollars in thousands) |
| | | 2005 | | | 2004 |
Assets | | | | | | | |
Cash on deposit with subsidiary banks | | $ | 2,223 | | | $ | 3,543 |
Subordinated debt in subsidiaries | | | 2,000 | | | | 9,200 |
Investment in subsidiaries | | | 66,346 | | | | 55,407 |
Other investments | | | 118 | | | | 118 |
Deferred income taxes | | | 93 | | | | 20 |
Premises and equipment, net | | | 919 | | | | 938 |
Other assets | | | 908 | | | | 1,360 |
| | | | | | | |
Total assets | | $ | 72,607 | | | $ | 70,586 |
| | | | | | | |
Liabilities | | | | | | | |
Trust preferred debt | | $ | 10,310 | | | $ | 10,310 |
Deferred income taxes | | | — | | | | — |
Other liabilities | | | 423 | | | | 513 |
| | | | | | | |
| | | 10,733 | | | | 10,823 |
| | | | | | | |
Shareholders’ Equity | | | | | | | |
Common stock | | | 9,812 | | | | 9,763 |
Retained earnings | | | 53,838 | | | | 49,403 |
Accumulated other comprehensive income, net | | | (1,776 | ) | | | 597 |
| | | | | | | |
Total shareholders’ equity | | | 61,874 | | | | 59,763 |
| | | | | | | |
Total liabilities and shareholders’ equity | | $ | 72,607 | | | $ | 70,586 |
| | | | | | | |
78
Notes to Consolidated Financial Statements
EASTERN VIRGINIA BANKSHARES, INC.
(Parent Corporation Only)
Statements of Income
For the Years Ended December 31, 2005, 2004 and 2003
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2005 | | | 2004 | | | 2003 | |
Income: | | | | | | | | | | | | |
Dividends from subsidiaries | | | — | | | $ | — | | | $ | 3,200 | |
Dividends | | | 2 | | | | 1 | | | | 3 | |
Interest from subsidiaries | | | 5 | | | | 14 | | | | 22 | |
Interest from subordinated debt | | | 233 | | | | 644 | | | | 644 | |
Management fee, corporate services and operations services | | | 6,873 | | | | 5,533 | | | | 2,760 | |
Loss on disposal of fixed assets | | | (44 | ) | | | — | | | | — | |
Miscellaneous income | | | 4 | | | | 5 | | | | 20 | |
| | | | | | | | | | | | |
| | | 7,073 | | | | 6,197 | | | | 6,649 | |
| | | | | | | | | | | | |
Expenses: | | | | | | | | | | | | |
Interest on trust preferred debt | | | 651 | | | | 439 | | | | 118 | |
Salaries and benefits | | | 4,382 | | | | 2,950 | | | | 1,981 | |
Occupancy and equipment expense | | | 1,099 | | | | 1,017 | | | | 811 | |
Data processing | | | 643 | | | | 493 | | | | 357 | |
Consultant fees | | | 994 | | | | 690 | | | | 724 | |
Postage | | | 273 | | | | 253 | | | | 229 | |
Printing and supplies | | | 125 | | | | 189 | | | | 192 | |
Directors fees | | | 219 | | | | 160 | | | | 224 | |
Miscellaneous | | | 609 | | | | 497 | | | | 323 | |
| | | | | | | | | | | | |
| | | 8,995 | | | | 6,688 | | | | 4,959 | |
| | | | | | | | | | | | |
Net income (loss) before undistributed earnings of subsidiaries | | | (1,922 | ) | | | (491 | ) | | | 1,690 | |
Undistributed earnings of subsidiaries | | | 8,113 | | | | 7,631 | | | | 4,919 | |
Income tax benefit | | | (535 | ) | | | (100 | ) | | | (474 | ) |
| | | | | | | | | | | | |
Net income | | $ | 6,726 | | | $ | 7,240 | | | $ | 7,083 | |
| | | | | | | | | | | | |
79
EASTERN VIRGINIA BANKSHARES, INC.
(Parent Corporation Only)
Statements of Cash Flows
For the Years Ended December 31, 2005, 2004 and 2003
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2005 | | | 2004 | | | 2003 | |
Cash Flows from Operating Activities | | | | | | | | | | | | |
Net income | | $ | 6,726 | | | $ | 7,240 | | | $ | 7,083 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
Undistributed earnings of subsidiaries | | | (8,113 | ) | | | (7,631 | ) | | | (4,919 | ) |
Depreciation and amortization | | | 574 | | | | 677 | | | | 572 | |
Deferred income taxes | | | (74 | ) | | | (102 | ) | | | 13 | |
(Gain) loss on sale/disposal of fixed assets | | | 44 | | | | — | | | | (13 | ) |
Decrease (increase) in other assets | | | 551 | | | | (534 | ) | | | 425 | |
Increase (decrease) in other liabilities | | | (89 | ) | | | (45 | ) | | | 362 | |
| | | | | | | | | | | | |
Net cash provided by (used in) operating activities | | | (381 | ) | | | (395 | ) | | | 3,523 | |
| | | | | | | | | | | | |
Cash Flows from Investing Activities | | | | | | | | | | | | |
Proceeds from disposal of fixed assets | | | — | | | | — | | | | 209 | |
Purchases of premises and equipment | | | (697 | ) | | | (335 | ) | | | (742 | ) |
| | | | | | | | | | | | |
Net cash (used in) investing activities | | | (697 | ) | | | (335 | ) | | | (533 | ) |
| | | | | | | | | | | | |
Cash Flows from Financing Activities | | | | | | | | | | | | |
Capital transferred to subsidiaries | | | (5,200 | ) | | | — | | | | (10,500 | ) |
Subordinated debt to subsidiary banks | | | 7,200 | | | | — | | | | — | |
Proceeds from issuance of trust preferred debt | | | — | | | | — | | | | 10,000 | |
Dividends paid | | | (2,935 | ) | | | (2,920 | ) | | | (2,768 | ) |
Exercise of stock options | | | — | | | | — | | | | — | |
Stock-based compensation | | | 181 | | | | 85 | | | | 50 | |
Director stock grant | | | 125 | | | | 131 | | | | 151 | |
Issuance of common stock under dividend reinvestment plan, net of repurchases | | | 387 | | | | 405 | | | | 359 | |
Repurchases and retirement of stock | | | — | | | | (191 | ) | | | (239 | ) |
| | | | | | | | | | | | |
Net cash (used in) financing activities | | | (242 | ) | | | (2,490 | ) | | | (2,947 | ) |
| | | | | | | | | | | | |
Increase (decrease) in cash and cash equivalents | | | (1,320 | ) | | | (3,220 | ) | | | 43 | |
Cash and Cash Equivalents, beginning of year | | | 3,543 | | | | 6,763 | | | | 6,720 | |
| | | | | | | | | | | | |
Cash and Cash Equivalents, end of year | | $ | 2,223 | | | $ | 3,543 | | | $ | 6,763 | |
| | | | | | | | | | | | |
80
Signatures
Pursuant to the requirements of Section 13 or 15 (d) 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. | | | | |
| | | | |
By | | /s/ Ronald L. Blevins | | | | Date: | | March 2, 2006 |
| | Ronald L. Blevins Senior Vice President and Chief Financial Officer | | | | | | |
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities indicated on March 11, 2006.
| | |
Signature | | Title |
| |
/s/ W. Rand Cook W. Rand Cook | | Chairman of the Board of Directors |
| |
/s/ F. L. Garrett, III F. L. Garrett, III | | Vice Chairman of the Board of Directors |
| |
/s/ Joe A. Shearin Joe A. Shearin | | President and Chief Executive Officer and Director (Principal Executive Officer) |
| |
/s/ Ira C. Harris Ira C. Harris | | Director |
| |
/s/ F. Warren Haynie, Jr. F. Warren Haynie, Jr. | | Director |
| |
/s/ William L. Lewis William L. Lewis | | Director |
| |
/s/ Charles R. Revere Charles R. Revere | | Director |
| |
/s/ Howard R. Straughan Howard R. Straughan | | Director |
| |
/s/ Leslie E. Taylor Leslie E. Taylor | | Director |
| |
/s/ Jay T. Thompson Jay T. Thompson | | Director |
| |
/s/ Ronald L. Blevins Ronald L. Blevins | | Chief Financial Officer (Principal Financial and Accounting Officer) |
