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, 2008
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)
| | |
| VIRGINIA | | 54-1866052 |
(State or other jurisdiction of incorporation or organization) | | (I.R.S. Employer Identification No.) |
| |
330 Hospital Road, Tappahannock, Virginia | | 22560 |
| (Address of principal executive offices) | | (Zip Code) |
Registrant’s telephone number, including area code (804) 443-8423
Securities registered pursuant to Section 12(b) of the Act:
| | |
Title of each class | | Name of each exchange on which registered |
Common Stock, $2 Par Value | | The Nasdaq Stock Market, LLC |
Securities registered pursuant to Section 12(g) of the Act: None
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, a non-accelerated filer or a smaller reporting company. See definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
| | | | | | |
| Large accelerated filer ¨ | | Accelerated filer x | | Non-accelerated filer ¨ | | Smaller reporting company ¨ |
| | | | (Do not check if a smaller reporting company) | | |
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, 2008 was approximately $89.9 million.
The number of shares of the registrant’s Common Stock outstanding as of February 28, 2009 was 5,911,129.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the 2008 Annual Report to Shareholders are incorporated by reference into Part I and Part II, and portions of the 2009 definitive Proxy Statement to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held May 21, 2009 are incorporated by reference into Part III.
EASTERN VIRGINIA BANKSHARES, INC.
FORM 10-K
For the Year Ended December 31, 2008
INDEX
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PART I
General
Eastern Virginia Bankshares, Inc. (“the Company”, “our Company”, “we”, “our” or us”) is a bank holding company headquartered in Tappahannock, Virginia (45 miles northeast of Richmond, Virginia). Through our wholly-owned bank subsidiary, EVB, we operate 25 full service branches in eastern Virginia. EVB is a community bank targeting small to medium-sized businesses and consumers in our traditional coastal plain markets and the emerging suburbs outside of the Richmond and Greater Tidewater areas.
Our mission is to maximize shareholder value while providing superior financial products and services in each of the communities we serve and empowering employees to always do the right thing with a level of integrity that lives up to the trust our customers place in us.
We provide a broad range of personal and commercial banking services including commercial, consumer and real estate loans. We complement our lending operations with an array of retail and commercial deposit products and fee-based services. Our services are delivered locally by well-trained and experienced bankers, whom we empower to make decisions at the local level, so they can provide timely lending decisions and respond promptly to customer inquiries. We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.
Until April 2006, we operated as an affiliation of three separate community banks. Two of the banks, Bank of Northumberland, Inc. and Southside Bank, were established in 1910. Seeking to accelerate our growth in a higher growth adjacent market, we started a de novo bank, Hanover Bank, in 2000. From the beginning of 2003 through April 2006 we put into practice our Standards of Excellence program which standardized operations in all departments through out the bank. Some of the support functions were consolidated to benefit from the efficiency of one process rather than three and in April 2006, we completed the final phase of the Standards of Excellence program when our three subsidiary banks merged and the surviving bank was rebranded as EVB. Over the last two years we have seen many benefits from the consolidation. Our goal has been to expand our footprint in eastern and central Virginia and to accomplish that we have expanded and improved our branch network. Late in 2007, we opened a new branch in New Kent County, Virginia at a temporary location which established the bank in a new growth market. The permanent location opened in late 2008. In January 2008, we relocated our Village branch to a prominent Hanover County location, called the Windmill, which gives us a highly visible location on Route 360. In March 2008, we purchased two branches from Millennium Bank placing us in two new Virginia markets: Henrico County and Colonial Heights. This transaction grew our bank by adding $93 million in deposits and $49 million in loans. We plan to continue these strategies of building new branches in growing markets and purchasing other locations as the opportunities arise.
EVB Financial Services, Inc., a wholly owned subsidiary of EVB, has 100% ownership of EVB Investments, Inc. and a 50% ownership interest in EVB Mortgage, LLC. The mortgage company operates with a partner in generating various real estate loans for sale in the mortgage loan markets, earning interest and fees from these loans prior to sale while retaining no servicing rights after the sale. For a fee, EVB Investments Inc. provides securities, brokerage and investment advisory services through its sales force and its minority ownership in Infinex Financial Group which purchased Bankers Investment Group, LLC. Infinex provides our investment company with a brokerage firm through which it sells investment services. The bank also 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 selling insurance products for its member banks. Through these investments, we are able to augment our fee income by providing financial products and services that are complementary to traditional banking products. These investments give us and our customer’s access to experienced professionals while we avoid making large investments to develop these capabilities internally.
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Recent Developments
On January 9, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 (“EESA”), (the Company) entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which the Company sold (i) 24,000 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $2.00 per share, having a liquidation preference of $1,000 per share (the “Preferred Stock”) and (ii) a warrant to purchase 373,832 shares of the Company’s common stock, par value $2.00 per share, at an initial exercise price of $9.63 per share, subject to certain anti-dilution and other adjustments, for an aggregate purchase price of $24,000,000 in cash. While we are a well capitalized bank, these funds are part of our Tier I capital and increase our capital ratios. We expect that the funds will be used to fund loan growth and other asset expansion.
Available Information
We maintain Internet websites atwww.bankevb.com for our bank and atwww.evb.org for our corporation. Among other items, the bank site offers our customers information about our products and locations and is the site to access online banking. Our corporate site offers information, free of charge, on the corporation including our 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 we electronically file such material with, or furnish it to, the Securities and Exchange Commission. If not on the website, please make written requests to our Corporate Secretary to receive copies of our Audit Committee Charter, Nominating Committee Charter and Code of Conduct or other information that may be available.
Employees
As of December 31, 2008, we employed 317 full-time equivalent employees. Our success is highly dependent on our ability to attract and retain qualified employees in a financial services environment where competition for employees is intense. We emphasize training for our employees, so they can provide excellent service to our customers. We believe we have been successful in our efforts to recruit qualified employees, but there is no assurance that we will continue to be successful in the future. None of our employees are subject to collective bargaining agreements. We believe relations with our employees are excellent.
Executive Officers of the Registrant
Following are the persons who are currently executive officers of EVB, their ages as of December 31, 2008, their current titles and positions held during the last five years:
Joe A. Shearin, 52, joined our Company in 2001 as the president and chief executive officer of Southside Bank until 2006 when he became president and chief executive officer of EVB. Mr. Shearin became the president and chief executive officer of our Company in 2002.
Joseph H. James, 53, has been executive vice president of EVB and chief operations officer of our Company since April 2006 and became senior executive vice president and chief operating officer of the EVB in January 2009. Mr. James joined us in 2000 as vice president and operations manager. From April 2002 until November 2002, Mr. James was our vice president and chief operations officer. From November 2002 through April 2006, Mr. James was our senior vice president and chief operations officer.
Ronald L. Blevins, 64, has been our chief financial officer since 2000. He served as our senior vice president from December 2000 until April 2006. In April 2006, he was named an executive vice president of EVB.
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James S. Thomas, 54, joined Southside Bank in 2003 as senior vice president and retail banking manager. In 2005, he became executive vice president and chief operating officer of Southside Bank and served in that position through April 2006. In April 2006, Mr. Thomas became executive vice president – retail banking of EVB. In June 2007, he became executive vice president and Chief Credit Officer of EVB. Prior to joining Southside Bank, Mr. Thomas was vice president of South Trust from 2002 to 2003. Mr. Thomas was also senior vice president and senior credit officer of Bank of Richmond from 2001 to 2002.
The Board of Directors has approved a Code of Ethics for all directors, officers and staff of our Company and its subsidiaries. The Code of Ethics is designed to promote honest and ethical conduct, proper disclosure of financial information in our periodic reports, and compliance with applicable laws, rules, and regulations by our senior officers who have financial responsibilities. The Code of Ethics is available on our web page at www.bankevb.com.
Market Areas and Growth Strategy
We currently conduct business through 25 branches. Our markets are located east of U.S. Route 250 and extend from northeast of Richmond to the Chesapeake Bay in central Virginia and across the James River from Colonial Heights to southeastern Virginia. We divide our market area into four regions: Northern Neck, Middle Peninsula, Capital (suburbs of Richmond) and Southern.
Our Northern Neck and Middle Peninsula regions are in the eastern coastal plain of Virginia, often referred to as River Country. According to the Virginia Economic Development Partnership, the region’s industries have traditionally been associated with abundant natural resources that include five rivers and the Chesapeake Bay. The diversified economy includes seafood harvesting, light manufacturing, agriculture, leisure marine services and service sectors dedicated to many upscale retirement communities.
Our Capital region is currently comprised of Hanover, Henrico, King William and Caroline counties and Colonial Heights which are emerging suburbs of Richmond. Hanover County is approximately 10 miles from downtown Richmond and 86 miles south of Washington, DC. Hanover County is the largest county by area in the Richmond metropolitan area. The county provides residents and businesses the geographic advantages of a growing metropolitan area coupled with substantial acreage for expansion in a suburban setting. The addition of a branch in the adjacent county of Henrico which is closer to Richmond and has similar economic potential is in keeping with our strategic plan.
Our Southern region is comprised of New Kent, Surry, Sussex, and Southampton counties. New Kent is a fast growing county south of Richmond and north of Williamsburg which places us in the growth zone of U.S. highway 64 that runs from Richmond to the Virginia Beach area of the Virginia Tidewater region. The other three counties are approximately 50 miles southeast of Richmond along or just off the state route 460 corridor and are adjacent to the Greater Tidewater area. The port of Hampton Roads is approximately 50 miles to the east of our Southern region. The region’s close proximity to major military, naval and research centers and transportation infrastructure make this an attractive location for contractors, service and manufacturing companies. Our addition of a branch in Colonial Heights gives us a link between the U.S. 64 and the 460 access routes and positions us to take advantage of new growth occurring at Fort Lee which is nearby.
Business Strategy
As a result of our nearly 100 years of experience serving the Northern Neck and Middle Peninsula regions, we have a stable, loyal customer base and a high deposit market share in these regions. Due to the lower projected population growth of these markets, we expanded in Hanover, Henrico, Gloucester, New Kent and King William Counties and the city of Colonial Heights to target the even higher growth in these existing and emerging suburban markets. The deposit market share we have accumulated in our Northern Neck, Middle Peninsula and Southern regions has helped fund our loan growth in the emerging suburban areas in the Central region. While 2008 and 2007 were challenging years for deposit growth, our purchase of two branches in early 2008 brought in deposits which aided our loan growth. We anticipate that we will gain market share in each of our regions, as our branches mature and we take advantage of opportunities for branch acquisitions and de novo growth.
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We believe that economic growth and bank consolidation have created a growing number of businesses and consumers in need of the broad range of products and services and high level of service that we provide. While we work through the economic challenges of 2008, our long-term business plan is to capitalize on the growth opportunity in our markets by further developing our branch network in our existing markets and augmenting our market area by expanding to the counties near the urban markets of Richmond and Greater Tidewater. We intend not only to build upon existing relationships, but also to create new relationships and expand into new markets by de novo branch expansion, branch acquisitions or potential whole bank acquisitions that meet our strategic and financial criteria.
Competition
We face significant competition for loans and deposits. The sources of competition vary based on the particular market of operation, which can range from a small rural town to part of an urban market. Competition for loans, our primary source of income, comes primarily from commercial banks and mortgage banking subsidiaries of both regional and community banks. Based on June 30, 2008 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, Essex, Northumberland and Surry Counties. EVB also had a strong deposit share in King William, Southampton and Sussex Counties, and a rapidly growing deposit base in Gloucester and Hanover Counties. Our primary competition is other community banks in Essex, King William, Lancaster and Northumberland Counties, while we compete with both community banks and large regional banks in Caroline, Gloucester, Hanover, Henrico, Middlesex, Southampton, Surry and Sussex Counties and the city of Colonial Heights.
Credit Policies
The principal risk associated with each of the categories of loans in our portfolio is the creditworthiness of our borrowers. Within each category, such risk is increased or decreased, depending on various factors. The risks associated with real estate mortgage loans, commercial loans and consumer loans vary 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, we have loan amount approval limits for individual loan officers based on their position and level of experience.
We have written policies and procedures to help manage credit risk. We use a loan review process that includes a 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 monitor compliance with policies. The third party reviews are done by a consulting firm that is comprised of experienced commercial lenders who understand the laws, regulations and critical areas of portfolio management. They provide management with an unbiased opinion of our credits and actions needed to strengthen them or protect the company.
Our loan approval process includes our management loan committee, directors loan committee and, for larger loans, the board of directors. Our 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. Our board of directors establishes our total lending limit policy which is less than the legal lending limit.
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Loan Originations
Residential real estate loan originations come primarily from walk-in customers, real estate brokers and builders, and through referrals from EVB Mortgage, LLC. Adjustable rate loans and other loans that cannot be sold in the secondary mortgage market, but that meet our underwriting guidelines, are referred to us by EVB Mortgage, LLC. Commercial real estate loan originations are obtained through broker referrals, direct solicitation of prospects and continued business from current customers. We may also purchase or sell loan participations with other community banks in Virginia.
Our loan officers, as part of the application process, review and underwrite all loan applications. Information is obtained concerning the repayment ability and stability, credit history and collateral of the applicant. Loan quality is analyzed based on our experience and credit underwriting guidelines as well as the guidelines used by an independent third party loan review firm based on the type of loan. 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 bank’s experience with these appraisers.
In the normal course of business, we make various commitments and incur certain contingent liabilities that are disclosed but not reflected in our annual financial statements including commitments to extend credit. At December 31, 2008, commitments to extend credit totaled $117.2 million for loans, $8.1 million for credit cards and $6.3 million related to letters of credit.
Construction Lending
We make local construction and land acquisition and development loans. Residential houses and commercial real estate under construction and the underlying land secure construction loans. At December 31, 2008, construction, land acquisition and land development loans outstanding were $102.8 million, or 12.6% of total loans. These loans are concentrated in our local markets. The average life of a construction loan is generally less than one year. Because the interest rate charged on these loans usually floats with the market, the rates charged assist us in managing our interest rate risk. Construction lending entails significant additional risks, compared to residential mortgage lending. Construction loans often involve larger loan balances concentrated with single borrowers or groups of related borrowers. In addition, the value of the building under construction is only estimable when the loan funds are disbursed. 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, we generally limit loan amounts to 80% of appraised value in addition to analyzing the creditworthiness of our borrowers. We also obtain a first lien on the property as security for its construction loans and typically require personal guarantees from the borrower’s principal owners.
Commercial Business Loans
Commercial business loans generally have a higher degree of risk than loans secured by real property but have higher yields. To manage these risks, we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of our 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 is heavily impacted by the economic environment and may depreciate over time and generally cannot be appraised with as much precision as residential real estate. We have a loan review and monitoring process to regularly assess the repayment ability of commercial borrowers. At December 31, 2008, commercial loans totaled $69.0 million, or 8.4% of the total loan portfolio.
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Commercial Real Estate Lending
Various types of commercial real estate in our market area include commercial buildings and offices, recreational facilities, small shopping centers and churches, and other secured commercial real estate loans. At December 31, 2008, commercial real estate loans totaled $221.8 million, or 27.1% of our total loans. We 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. Our commercial real estate loan underwriting criteria requires an examination of debt service coverage ratios, the borrower’s creditworthiness and prior credit history and reputation, and we typically require personal guarantees or endorsements of the borrowers’ principal owners. In addition, we carefully evaluate the location of the security property.
One-to-Four-Family Residential Real Estate Lending
Residential one-to-four family mortgage loans comprise our total largest loan category. At December 31, 2008, this category of mortgage loans accounted for $372.1 million, or 45.4% of our total loan portfolio. Security for the majority of our residential lending is in the form of owner occupied one-to-four-family dwellings. Adjustable rate loans are $175.7 million of the residential real estate portfolio and are primarily 3-year adjustable rate mortgages.
All residential mortgage loans originated by us contain a “due-on-sale” clause providing that we may declare the unpaid principal balance due and payable upon sale or transfer of the mortgaged premises. In connection with residential real estate loans, we require title insurance, hazard insurance and if required, flood insurance. We do not require escrows for real estate taxes and insurance.
Consumer Lending
We offer 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, 2008, we had consumer loans, net of unearned interest, of $47.2 million or 5.8% of total loans. Such loans are generally made to customers with whom we have a pre-existing relationship. We currently originate all of our consumer loans in our geographic market area. Most of the consumer loans are made at fixed rates.
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 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 that 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, 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 we employ 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 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.
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Supervision and Regulation
We are subject to the periodic reporting requirements of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which include, but are not limited to, the filing of annual, quarterly and other reports with the Securities and Exchange Commission. As an Exchange Act reporting company, we are directly affected by the Sarbanes-Oxley Act, which seeks to improve corporate governance and reporting procedures by requiring expanded disclosure of our corporate operations and internal controls. We are already complying with SEC and other rules and regulations implemented pursuant to the Sarbanes-Oxley Act and intend to comply with any applicable rules and regulations implemented in the future. Although we have incurred, and expect to continue to incur, additional expense in complying with the provisions of the Sarbanes-Oxley Act and the resulting regulations, our management does not expect such compliance to have a material impact on our financial condition or results of operations in the future.
We are a bank holding company within the meaning of the Bank Holding Company Act of 1956, and are registered as such with, and subject to the supervision of, the Board of Governors of the Federal Reserve System and the Federal Reserve Bank of Richmond. A bank holding company is prohibited from engaging in or acquiring direct or indirect ownership or control of more than 5% of the voting shares of any company engaged in non-banking activities. Subject to notice to the Federal Reserve or the Federal Reserve’s prior approval, a bank holding company may, however, engage in or acquire an interest in a company that engages in activities that the Federal Reserve has determined by regulation or order are so closely related to banking as to be a proper incident to banking. In making these determinations, the Federal Reserve considers whether the performance of such activities by a bank holding company would offer advantages to the public that outweigh possible adverse effects. A bank holding company must seek the prior approval of the Federal Reserve before it acquires all or substantially all of the assets of any bank, and before it acquires ownership or control of the voting shares of any bank if, after giving effect to the acquisition, the bank holding company would own or control more than 5% of the voting shares of such bank. Federal Reserve approval is also required for the merger or consolidation of bank holding companies.
We file periodic reports with the Federal Reserve and must provide any additional information that the Federal Reserve may require. The Federal Reserve also has the authority to examine us and our nonbanking affiliates, as well as any arrangements between us and EVB, with the cost of any such examinations to be borne by us.
Banking subsidiaries of bank holding companies are subject to certain restrictions imposed by federal law in dealings with their holding companies and other affiliates. Subject to certain restrictions set forth in the Federal Reserve Act and Federal Reserve regulations promulgated thereunder, a bank can loan or extend credit to an affiliate, purchase or invest in the securities of an affiliate, purchase assets from an affiliate or issue a guarantee, acceptance or letter of credit on behalf of an affiliate, as long as the aggregate amount of such transactions of the bank and its subsidiaries with its affiliates does not exceed 10% of the capital stock and surplus of the bank on a per affiliate basis or 20% of the capital stock and surplus of the bank on an aggregate affiliate basis. In addition, such transactions must be on terms and conditions that are consistent with safe and sound banking practices. In particular, a bank and its subsidiaries generally may not purchase from an affiliate a low-quality asset, as defined in the Federal Reserve Act and Federal Reserve regulations promulgated thereunder. These restrictions also prevent the bank holding company and its other affiliates from borrowing from the bank unless the loans are secured by marketable collateral of designated amounts. Additionally, the bank holding company and the bank are prohibited from engaging in certain tie-in arrangements in connection with any extension of credit, sale or lease of property or furnishing of services, other than in connection with a traditional banking product such as a loan, discount, deposit or trust service.
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As a Virginia-chartered, federally-insured bank, and Federal Reserve member, EVB is subject to regulation, supervision and regular examination by the Bureau of Financial Institutions of the Virginia State Corporation Commission and the Federal Reserve as its appropriate federal bank regulator. Moreover, EVB’s deposits are insured by the Deposit Insurance Fund, as administered by the FDIC, to the maximum amount permitted by law. Congress has enacted legislation authorizing the increase in deposit insurance coverage limits to $250,000 effective October 3, 2008 through December 31, 2009. On January 1, 2010, the standard coverage limit will return to $100,000 for all deposit categories except IRAs and certain retirement accounts, which will continue to be insured up to $250,000 per owner. In addition, EVB is participating in the FDIC’s “Transaction Account Guarantee Program.” Under this program, through December 31, 2009, all EVB non-interest bearing checking accounts, IOLTAs, and NOW accounts (paying interest of 0.50% or less) are fully guaranteed by the FDIC for the entire amount in the account. This coverage is in addition to and separate from the coverage available under the FDIC’s general deposit insurance rules.
EVB pays insurance premiums on deposits in accordance with a deposit premium assessment system recently revised by the FDIC in accordance with the Federal Deposit Insurance Reform Act of 2005 (“FDIRA”), which required that the FDIC revise its current risk-based deposit premium system by November 2006. The revised rules impose deposit insurance premium assessments based upon perceived risks to the Deposit Insurance Fund, by evaluating an institution’s CAMELS (Capital, Assets, Management, Earnings, Liquidity and Sensitivity to market risk) ratios and other financial ratios and then determining insurance premiums based upon the likelihood an institution could be downgraded to a CAMELS 3 or worse in the succeeding year. As a result, institutions deemed to pose less risk would pay lower premiums than those institutions deemed to pose more risk, which would pay more. Although EVB is not considered a high risk institution by these standards, the changes in coverage and premium assessments described above have resulted in a substantial increase in our deposit premium assessments; we have estimated that our 2009 assessment will be approximately $1.2 million, compared to an assessment of $545 thousand (before an $80 thousand credit carryover from prior years) in 2008.
The regulations of the Bureau of Financial Institutions, FDIC and Federal Reserve govern most aspects of our business, including deposit reserve requirements, investments, loans, certain check clearing activities, issuance of securities, branching, payment of dividends and numerous other matters. As a consequence of the extensive regulation of commercial banking activities in the United States, our business is particularly susceptible to changes in legislation and regulations, which may have the effect of increasing the cost of doing business, limiting permissible activities or increasing competition. The likelihood and timing of any legislation or regulatory modifications and the impact they might have on us or EVB cannot be determined at this time.
Change of Control.
Federal Reserve approval would be required prior to any acquisition of control of us. “Control” is conclusively presumed to exist if a person or company acquires, directly or indirectly, more than 25% of any class of voting stock of a company, controls in any manner the election of a majority of directors or the power to exercise directly or indirectly a controlling influence over management or policies of a company. Under Federal Reserve regulations, control is also presumed to exist, subject to rebuttal, if a person acquires more than 10% of any class of voting stock and no other person will own, control or hold the power to vote a greater percentage of that class of voting shares immediately after the transaction. Under the Bank Holding Company Act, a corporate acquirer of control of a company must register with the Board of Governors of the Federal Reserve System and be subject to the activities limitations of the Bank Holding Company Act. Non-controlling acquirers of more than 10% but less than 25% of a company’s voting securities also may be required to enter into certain passivity commitments, to ensure they lack an ability to control the company.
Governmental Policies and Legislation
Banking is a business that depends primarily on interest rate differentials. In general, the difference between the interest rates paid by the bank on its deposits and its other borrowings and the interest rates received by the bank on loans extended to its customers and securities held in its portfolio comprise the major portion of our earnings. These rates are highly sensitive to many factors that are beyond our control. Accordingly, our growth and earnings are subject to the influence of domestic and foreign economic conditions, including inflation, recession and unemployment.
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The commercial banking business is affected not only by general economic conditions, but is also influenced by the monetary and fiscal policies of the federal government and the policies of its regulatory agencies, particularly the Federal Reserve. The Federal Reserve implements national monetary policies (with objectives such as curbing inflation and combating recession) by its open-market operations in U.S. Government securities, by adjusting the required level of reserves for financial institutions subject to its reserve requirements and by varying the discount rates applicable to borrowings by depository institutions. The actions of the Federal Reserve in these areas influence the growth of bank loans, investments and deposits, and also affect interest rates charged on loans and paid on deposits. The nature and impact of any future changes in monetary policies cannot be predicted.
From time to time, legislation is enacted that has the effect of increasing the cost of doing business, limiting or expanding permissible activities or affecting the competitive balance between banks and other financial institutions. Proposals to change the laws and regulations governing the operations and taxation of bank holding companies, banks and other financial institutions are frequently made in Congress and in the Virginia Legislature and are brought before various bank regulatory agencies. The likelihood of any major changes and the impact such changes might have are impossible to predict.
Dividends
We are organized under the Virginia Stock Corporation Act, which prohibits the payment of a dividend if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.
We are a legal entity separate and distinct from our subsidiaries. Our ability to distribute cash dividends will depend primarily on the ability of EVB to pay dividends to us, and EVB is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member bank, EVB is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Under Virginia law, a bank may not declare a dividend in excess of its undivided profits. Additionally, EVB may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by it in any calendar year exceeds the total of its retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the Federal Reserve.
The Federal Reserve and the state have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the state and the Federal Reserve have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice. Under the Federal Reserve’s regulations, EVB may not declare or pay any dividend in excess of its net income for the current year plus any retained net income from the prior two calendar years. EVB may also not declare or pay a dividend without the approval of its board and two-thirds of its shareholders if the dividend would exceed its undivided profits, as reported to the Federal Reserve.
In addition, we are subject to certain regulatory requirements to maintain capital to satisfy certain required regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. Banking regulators have indicated that a bank holding company should generally pay dividends only if its net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition.
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Capital Requirements
The Federal Reserve and the FDIC have adopted risk-based capital adequacy guidelines for bank holding companies and banks. These capital adequacy regulations are based upon a risk-based capital determination, and a bank holding company’s capital adequacy is determined in light of the risk, both on- and off-balance sheet, contained in the company’s assets. Different categories of assets are assigned risk weightings and are counted at a percentage of their book value.
The regulations divide capital between Tier 1 capital (“core capital”) and Tier 2 capital. For a bank holding company, Tier 1 capital consists primarily of common stock, related surplus, non-cumulative perpetual preferred stock and minority interests in consolidated subsidiaries. Restricted core capital elements, including qualifying trust preferred securities, qualifying cumulative perpetual preferred stock and certain minority interests, may be treated as Tier 1 capital in an amount up to 25% of total Tier 1 capital. The excess, if any, of such securities may be included in Tier 2 capital. Goodwill and certain other intangibles are excluded from Tier 1 capital. Tier 2 capital consists of an amount equal to the allowance for loan and lease losses up to a maximum of 1.25% of risk weighted assets, limited other types of preferred stock not included in Tier 1 capital, hybrid capital instruments and term subordinated debt. Investments in and loans to unconsolidated banking and finance subsidiaries that constitute capital of those subsidiaries are excluded from capital. The sum of Tier 1 and Tier 2 capital constitutes qualifying total capital. The guidelines generally require banks to maintain a total qualifying capital to weighted risk assets level of 8% (the “total capital ratio”). Of the total 8%, at least 4% of the total qualifying capital to weighted risk assets (the “Tier 1 capital ratio”) must be Tier 1 capital.
The Federal Reserve and the FDIC have adopted leverage requirements that apply in addition to the risk-based capital requirements. Banks and bank holding companies are required to maintain a minimum leverage ratio of Tier 1 capital to average total consolidated assets (the “leverage capital ratio”) of at least 3.0% for the most highly-rated, financially sound banks and bank holding companies and a minimum leverage capital ratio of at least 4.0% for all other banks. The FDIC and the Federal Reserve define Tier 1 capital for banks in the same manner for both the leverage capital ratio and the total capital ratio. However, the Federal Reserve defines Tier 1 capital for bank holding companies in a slightly different manner. An institution may be required to maintain Tier 1 capital of at least 4% or 5%, or possibly higher, depending upon the activities, risks, rate of growth, and other factors deemed material by regulatory authorities. As of December 31, 2008, we and our subsidiary bank EVB both met all applicable capital requirements imposed by regulation.
Federal Deposit Insurance Act and Prompt Corrective Action Requirements
As an insured depository institution, EVB is required to comply with the capital requirements promulgated under the Federal Deposit Insurance Act and the Federal Reserve’s prompt corrective action regulations thereunder, which set forth five capital categories, each with specific regulatory consequences. Under these regulations, the categories are:
| | • | | Well Capitalized — The institution exceeds the required minimum level for each relevant capital measure. A well capitalized institution is one (i) having a total capital ratio of 10% or greater, (ii) having a Tier 1 capital ratio of 6% or greater, (iii) having a leverage capital ratio of 5% or greater and (iv) that is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure. |
| | • | | Adequately Capitalized — The institution meets the required minimum level for each relevant capital measure. No capital distribution may be made that would result in the institution becoming undercapitalized. An adequately capitalized institution is one (i) having a total capital ratio of 8% or greater, (ii) having a Tier 1 capital ratio of 4% or greater and (iii) having a leverage capital ratio of 4% or greater or a leverage capital ratio of 3% or greater if the institution is rated composite 1 under the CAMELS rating system. |
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| | • | | Undercapitalized — The institution fails to meet the required minimum level for any relevant capital measure. An undercapitalized institution is one (i) having a total capital ratio of less than 8% or (ii) having a Tier 1 capital ratio of less than 4% or (iii) having a leverage capital ratio of less than 4%, or if the institution is rated a composite 1 under the CAMEL rating system, a leverage capital ratio of less than 3%. |
| | • | | Significantly Undercapitalized — The institution is significantly below the required minimum level for any relevant capital measure. A significantly undercapitalized institution is one (i) having a total capital ratio of less than 6% or (ii) having a Tier 1 capital ratio of less than 3% or (iii) having a leverage capital ratio of less than 3%. |
| | • | | Critically Undercapitalized — The institution fails to meet a critical capital level set by the appropriate federal banking agency. A critically undercapitalized institution is one having a ratio of tangible equity to total assets that is equal to or less than 2%. |
If the appropriate federal banking regulator determines, after notice and an opportunity for hearing, that a bank is in an unsafe or unsound condition, the regulator is authorized to reclassify the bank to the next lower capital category (other than critically undercapitalized) and require the submission of a plan to correct the unsafe or unsound condition.
If a bank is not well capitalized, it cannot accept brokered deposits without prior FDIC approval and, if approval is granted, cannot offer an effective yield in excess of 75 basis points on interest paid on deposits of comparable size and maturity in such institution’s normal market area for deposits accepted from within its normal market area, or national rate paid on deposits of comparable size and maturity for deposits accepted outside the bank’s normal market area. Moreover, if a bank becomes less than adequately capitalized, it must adopt a capital restoration plan acceptable to the appropriate federal regulator that is subject to a limited performance guarantee by the bank. A bank also would become subject to increased regulatory oversight and is increasingly restricted in the scope of its permissible activities. Each company having control over an undercapitalized institution also must provide a limited guarantee that the institution will comply with its capital restoration plan.
Except under limited circumstances consistent with an accepted capital restoration plan, an undercapitalized institution may not grow. An undercapitalized institution may not acquire another institution, establish additional branch offices or engage in any new line of business unless determined by the appropriate Federal banking agency to be consistent with an accepted capital restoration plan, or unless the FDIC determines that the proposed action will further the purpose of prompt corrective action. The appropriate federal banking agency may take any action authorized for a significantly undercapitalized institution if an undercapitalized institution fails to submit an acceptable capital restoration plan or fails in any material respect to implement a plan accepted by the agency. A critically undercapitalized institution is subject to having a receiver or conservator appointed to manage its affairs and for loss of its charter to conduct banking activities.
An insured depository institution may not pay a management fee to a bank holding company controlling that institution or any other person having control of the institution if, after making the payment, the institution, would be undercapitalized. In addition, an institution cannot make a capital distribution, such as a dividend or other distribution that is in substance a distribution of capital to the owners of the institution if following such a distribution the institution would be undercapitalized. Thus, if payment of such a management fee or the making of such would cause the bank to become undercapitalized, it could not pay a management fee or dividend to us.
As of December 31, 2008, both we and EVB were considered “well capitalized.”
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Gramm-Leach-Bliley Act of 1999
The Gramm-Leach-Bliley Act of 1999 implemented major changes to the statutory framework for providing banking and other financial services in the United States. The Gramm-Leach-Bliley Act, among other things, eliminated many of the restrictions on affiliations among banks and securities firms, insurance firms and other financial service providers. A bank holding company that qualifies as a financial holding company will be permitted to engage in activities that are financial in nature or incidental or complimentary to financial activities. The activities that the Gramm-Leach-Bliley Act expressly lists as financial in nature include insurance underwriting, sales and brokerage activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.
To become eligible for these expanded activities, a bank holding company must qualify as a financial holding company. To qualify as a financial holding company, each insured depository institution controlled by the bank holding company must be well-capitalized, well-managed and have at least a satisfactory rating under the Community Reinvestment Act (discussed below). In addition, a bank holding company must file with the Federal Reserve a declaration of its intention to become a financial holding company. While we satisfy these requirements, we do not contemplate seeking to become a financial holding company unless we identify significant specific benefits from doing so.
The Gramm-Leach-Bliley Act has not had a material adverse impact on our operations. To the extent that it allows banks, securities firms and insurance firms to affiliate, the financial services industry may experience further consolidation.
Privacy and Fair Credit Reporting
Financial institutions, such as our subsidiary bank EVB, are required to disclose their privacy policies to customers and consumers and require that such customers or consumers be given a choice (through an opt-out notice) to forbid the sharing of nonpublic personal information about them with nonaffiliated third persons. EVB has a written privacy policy that is delivered to each of its customers when customer relationships begin and annually thereafter. In accordance with the privacy policy, EVB will protect the security of information about its customers, educate its employees about the importance of protecting customer privacy, and allow its customers to remove their names from the solicitation lists they use and share with others. EVB requires business partners with whom it shares such information to have adequate security safeguards and to abide by the re-disclosure and reuse provisions of applicable law. EVB has programs to fulfill the expressed requests of customers and consumers to opt out of information sharing subject to applicable law. In addition to adopting federal requirements regarding privacy, individual states are authorized to enact more stringent laws relating to the use of customer information. To date, Virginia has not done so, but is authorized to consider proposals that would impose additional requirements or restrictions on EVB. If the federal or state regulators establish further guidelines for addressing customer privacy issues, EVB may need to amend its privacy policies and adapt its internal procedures.
Community Reinvestment Act
EVB is subject to the requirements of the 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 three performance tests. These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility.
USA PATRIOT Act
The USA PATRIOT Act became effective on October 26, 2001 and provides, in part, for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering by enhancing anti-money laundering and financial transparency laws, as well as enhanced
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information collection tools and enforcement mechanics for the U.S. government, including: (i) requiring standards for verifying customer identification at account opening; (ii) rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (iii) reports by nonfinancial trades and businesses filed with the Treasury Department’s Financial Crimes Enforcement Network for currency transactions exceeding $10,000; (iv) filing suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations; and (v) requiring enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.
Under the USA PATRIOT Act, the Federal Bureau of Investigation (“FBI”) has sent, and will send, our banking regulatory agencies lists of the names of persons suspected of involvement in terrorist activities. The bank has been requested, and will be requested, to search its records for any relationships or transactions with persons on those lists. If the bank finds any relationships or transactions, it 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 insure 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. OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze the account and block any transactions from the account, file a suspicious activity report and notify the FBI. The bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.
The federal financial institution regulators also have promulgated rules and regulations implementing the USA PATRIOT Act, which (i) prohibit U.S. correspondent accounts with foreign banks that have no physical presence in any jurisdiction, (ii) require financial institutions to maintain certain records for correspondent accounts of foreign banks, (iii) require financial institutions to produce certain records relating to anti-money laundering compliance upon the request of the appropriate federal banking agency, (iv) require due diligence with respect to private banking and correspondent banking accounts, (v) facilitate information sharing between government and financial institutions, (vi) require verification of customer identification, and (vii) require financial institutions to have in place an anti-money laundering program.
Consumer Laws and Regulations
The bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. While the list set forth herein is not exhaustive, these laws and regulations include the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate Settlement Procedures Act, the Service Members’ Civil Relief Act, and implementing regulations promulgated thereunder. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions transact business with customers. The bank must comply with the applicable provisions of these consumer protection laws and regulations as part of its ongoing customer relations.
An investment in our common stock involves risks. You should carefully consider the risks described below in conjunction with the other information in this Form 10-K, including our consolidated financial statements and related notes, before investing in our common stock. If any of the following risks or other risks that have not been identified
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or that we may believe are immaterial or unlikely to actually occur, were to occur, then our business, financial condition and results of operations could be harmed. This could cause the price of our stock to decline, and you may lose part or all of your investment. This Form 10-K contains forward-looking statements that involve risks and uncertainties, including statements about our future plans, objectives, intentions and expectations. Past results are not a reliable indicator of future results, and historical trends should not be used to anticipate results or trends in future periods. Many factors, including those described below, could cause actual results to differ materially from those discussed in forward-looking statements.
Difficult market conditions have adversely affected our industry.
Dramatic declines in the housing market over the past year, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of real estate related loans and resulted in significant write-downs of asset values by financial institutions. These write-downs, initially of asset-backed securities but spreading to other securities and loans, have caused many financial institutions to seek additional capital, to reduce or eliminate dividends, to merge with larger and stronger institutions and, in some cases, to fail. Reflecting concern about the stability of the financial markets generally and the strength of counterparties, many lenders and institutional investors have reduced or ceased providing funding to borrowers, including to other financial institutions. This market turmoil and tightening of credit have led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. The resulting economic pressure on consumers and lack of confidence in the financial markets has adversely affected our business, financial condition and results of operations. Market developments may affect consumer confidence levels and may cause adverse changes in payment patterns, causing increases in delinquencies and default rates, which may impact our charge-offs and provision for credit losses. A worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the financial institutions industry.
Current levels of market volatility are unprecedented.
The capital and credit markets have been experiencing volatility and disruption for more than 12 months. Recently, the volatility and disruption has reached unprecedented levels. In some cases, the markets have produced downward pressure on stock prices and credit availability for certain issuers without regard to those issuers’ underlying financial strength. If current levels of market disruption and volatility continue or worsen, there can be no assurance that we will not experience an adverse effect, which may be material, on our ability to access capital and on our business, financial condition and results of operations.
The soundness of other financial institutions could adversely affect us.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. To prepare us for these possibilities, we monitor the financial soundness of companies we deal with. However, there is no assurance that any such losses would not materially and adversely affect our results of operations.
There can be no assurance that recently enacted legislation will stabilize the U.S. financial system.
On October 3, 2008, President Bush signed into law the Emergency Economic Stabilization Act of 2008 (the “EESA”). The legislation was the result of a proposal by Treasury Secretary Henry Paulson to the U.S. Congress in response to the financial crises affecting the banking system and financial markets and threats to investment banks
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and other financial institutions. Pursuant to the EESA, the U.S. Treasury will have the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets. On October 14, 2008, the U.S. Department of Treasury announced a program under the EESA pursuant to which it would make senior preferred stock investments in participating financial institutions (the “TARP Capital Purchase Program”). On October 14, 2008, the Federal Deposit Insurance Corporation announced the development of a guarantee program under the systemic risk exception to the Federal Deposit Act (“FDA”) pursuant to which the FDIC would offer a guarantee of certain financial institution indebtedness in exchange for an insurance premium to be paid to the FDIC by issuing financial institutions (the “FDIC Temporary Liquidity Guarantee Program”). Most recently, on February 17, 2009, President Obama signed into law the American Recovery and Reinvestment Act of 2009 (the “ARRA”), which contains a wide array of provisions aimed at stimulating the U.S. economy.
There can be no assurance, however, as to the actual impact that the EESA, ARRA and their implementing regulations, the FDIC programs, or any other governmental program will have on the financial markets. The failure of the EESA, ARRA, the FDIC, or the U.S. government to stabilize the financial markets and a continuation or worsening of current financial market conditions could materially and adversely affect our business, financial condition, results of operations, access to credit or the trading price of our common stock.
The impact on us of recently enacted legislation, in particular the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009 and their implementing regulations, and actions by the FDIC, cannot be predicted at this time.
The programs established or to be established under the EESA, ARRA and Troubled Asset Relief Program may have adverse effects upon us. We may face increased regulation of our industry. Compliance with such regulation may increase our costs and limit our ability to pursue business opportunities. Also, participation in specific programs may subject us to additional restrictions. For example, participation in the TARP Capital Purchase Program will limit (without the consent of the Department of Treasury) our ability to increase our dividend or to repurchase our common stock for so long as any securities issued under such program remain outstanding. It will also subject us to additional executive compensation restrictions. Similarly, programs established by the FDIC under the systemic risk exception of the FDA, whether we participate or not, may have an adverse effect on us. Participation in the FDIC Temporary Liquidity Guarantee Program likely will require the payment of additional insurance premiums to the FDIC. We may be required to pay significantly higher Federal Deposit Insurance Corporation premiums even if we do not participate in the FDIC Temporary Liquidity Guarantee Program because market developments have significantly depleted the insurance fund of the FDIC and reduced the ratio of reserves to insured deposits. The affects of participating or not participating in any such programs and the extent of our participation in such programs cannot reliably be determined at this time.
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 the interest rates paid on deposits and other interest-bearing liabilities. These rates are normally in line with general market rates and rise and fall based on the asset liability committee’s view of our needs. However, we 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 are unable to completely eliminate this risk. 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. Our net interest income will be adversely affected if market interest rates change so that the interest we pay on deposits and borrowings increases faster than the interest we earn on loans and investments.
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We are experiencing strong competition from other banks and financial institutions for deposits. We may offer more competitive rates to our customers or find alternative funding sources to fund the growth in our loan portfolio. In 2008 and 2007, deposit growth was not sufficient to fund our loan growth. In 2007, we were able to utilize the $23.5 million from our stock offering in late 2006 to fund loan growth early in the year. In addition, as we did in 2006, we used Federal Home Loan Bank advances and principal and interest payments on available-for-sale securities to make up the difference. In 2008, we borrowed from the FHLB early in the year but were able to fund a large part of our loan growth from the deposits we acquired from our purchase of 2 branches.
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 president and chief executive officer and other senior officers. We have entered into employment agreements with six of 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 an 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.
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. Consequently, a decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are geographically diverse.
In addition to the financial strength and cash flow characteristics of the borrower in each case, we often secure loans with real estate collateral. At December 31, 2008, approximately 85.0% of our loans have real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected.
Risk of loan defaults and foreclosures are unavoidable in the banking industry, and we try to limit our exposure to this risk by monitoring our extensions of credit carefully. While the subprime loan problems of the financial industry did not have a direct impact on us in 2007 and early 2008, the economic implosion caused by the economic melt down in the last half of 2008 has increased the risk in our earning asset portfolios. The economy for the near-term is expected to be unsettled with the potential for more downturns. Since we cannot fully eliminate credit risk and impact of the current economy, credit losses may occur in the future.
We have a concentration of credit exposure in acquisition and development (“ADC”) real estate loans.
At December 31, 2008, we had approximately $102.8 million in loans for the acquisition and development of real estate and for construction of improvements to real estate, representing approximately 12.6% of our total loans outstanding as of that date. These loans are to developers, builders and individuals. Project types financed include acquisition and development of residential subdivisions and commercial developments, builder lines for 1-4 family
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home construction and loans to individuals for primary and secondary residence construction. These types of loans are generally viewed as having more risk of default than residential real estate loans. Completion of development projects and sale of developed properties may be affected significantly by general economic conditions, and further downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because our loan portfolio contains acquisition and development loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in our percentage of non-performing loans. An increase in non-performing loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on our financial condition and results of operations.
Our ADC loans have grown 4.0% since December 31, 2007. The banking regulators are giving ADC lending greater scrutiny, and may require banks with higher levels of ADC loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital levels as a result of ADC lending growth and exposures.
In 2008, the company increased its allowance for loan losses by $2.7 million or 33.6% to match potential losses in our loan portfolio. Of this amount, a little over $1.0 million was allocated to the ADC type loans. We will continue to monitor our situation and make adjustments as warranted.
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 operation is concentrated in the Eastern, Richmond and Tidewater areas of Virginia, we will be affected by the general economic conditions in these markets. Changes in the local economy may influence the growth rate of our loans and deposits, the quality of the loan portfolio, and loan and deposit pricing. 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 small to medium-sized business target market may have fewer financial resources to weather a downturn in the economy.
We target our commercial development and marketing strategy primarily to serve the banking and financial services needs of small and medium-sized businesses. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected.
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. While we believe we compete effectively with these other financial institutions in our primary markets, we may face a competitive disadvantage as a result of our smaller size,
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smaller asset base, lack of geographic diversification and inability to spread our marketing costs across a broader market. If we have to raise interest rates paid on deposits or lower interest rates charged on loans to compete effectively, our net interest margin and income could be negatively affected. Failure to compete effectively to attract new, or to retain existing, clients may reduce or limit our margins and our market share and may adversely affect our results of operations, financial condition and growth.
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 probable 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 probable 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.
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 for branch expansion could decrease our earnings in the short run, even if we efficiently execute our branching strategy.
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We could sustain losses if our asset quality declines.
Our earnings are significantly affected by our ability to properly originate, underwrite and service loans. We could sustain losses if we incorrectly assess the creditworthiness of our borrowers or fail to detect or respond to deterioration in asset quality in a timely manner. Problems with asset quality could cause our interest income and net interest margin to decrease and our provisions for loan losses to increase, which could adversely affect our results of operations and financial condition.
We may face risks with respect to de novo banking opportunities and future acquisitions.
As a strategy, we have sought to increase the size of our franchise by pursuing business development opportunities, and we have grown rapidly since we were formed. As part of that strategy, we have grown primarily through opening new branches. We also acquired three branches in 2003, and purchased two branches in the first quarter of 2008. We may acquire other branches or financial institutions in the future, if a desirable opportunity presents itself. Growth through new branches or acquisitions involves a number of risks, including:
| | • | | the time and costs associated with identifying and evaluating where we should open a new branch and who may be a favorable acquisition or merger partner; |
| | • | | the estimates and judgments used to evaluate credit, operations, management and market risks with respect to any growth opportunity may not be accurate; |
| | • | | the time and costs of evaluating new markets, hiring experienced local management and opening new offices, and the time lags between these activities and the generation of sufficient assets and deposits to support the costs of the expansion; |
| | • | | entry into new markets where we lack experience; |
| | • | | our ability to finance an acquisition and possible ownership and economic dilution to our shareholders; |
| | • | | the diversion of our management’s attention to the negotiation of a transaction, and the integration of the operations and personnel of the combining businesses; |
| | • | | the introduction of new products and services into our business; |
| | • | | the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations; and |
| | • | | the loss of key employees and clients. |
We may incur substantial costs to expand, and we can give no assurance such expansion will result in the levels of profits we seek. There can be no assurance that integration efforts for any new branches or future mergers or acquisitions will be successful. Also, we may issue equity securities, including common stock and securities convertible into shares of our common stock, in connection with future acquisitions, which could cause ownership and economic dilution to our shareholders. There is no assurance that, following any future merger or acquisition, our integration efforts will be successful or we, after giving effect to the acquisition, will achieve profits comparable to or better than our historical experience.
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 fund maintained by the Federal Deposit Insurance Corporation rather than our 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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The Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the Securities and Exchange Commission and NASDAQ that are applicable to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices, including the cost of completing our audit and maintaining our internal controls. As a result, we may experience greater compliance costs.
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 internal control over financial reporting.
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.
Liquidity needs could adversely affect our results of operations and financial condition.
We rely on dividends from our bank as our primary source of funds. The primary sources of funds of our bank are client deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to clients on alternative investments and general economic conditions. Accordingly, we may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include Federal Home Loan Bank advances, sales of securities and loans, and federal funds lines of credit from correspondent banks, as well as out-of-market time deposits. While we believe that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if we continue to grow and experience increasing loan demand. We may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.
Our recent results may not be indicative of our future results.
We may not be able to sustain our historical rate of growth or may not even be able to grow our business at all. In addition, our recent and rapid growth may distort some of our historical financial ratios and statistics. In the future, we may be subject to various factors that may influence our performance such as the interest rate environment which can have drastic swings that impact our revenue stream and cost of funds, the state of the real estate market and the valuations associated with property that is collateral on loans, or the ability to find suitable expansion opportunities. Other factors, such as economic conditions, regulatory and legislative considerations and competition, may also impede or prohibit our ability to expand our market presence. If we experience a significant decrease in our historical rate of growth, our results of operations and financial condition may be adversely affected due to a high percentage of our operating costs being fixed expenses.
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We depend on the accuracy and completeness of information about clients and counterparties.
In deciding whether to extend credit or enter into other transactions with clients and counterparties, we may rely on information furnished to us by or on behalf of clients and counterparties, including financial statements and other financial information. We also rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, we assume that a customer’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of the customer. Our financial condition and results of operations could be negatively impacted to the extent we rely on financial statements that do not comply with GAAP or are materially misleading.
| Item 1B. | Unresolved Staff Comments |
None.
Our 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. We merged our three subsidiary banks into one bank in April 2006. At the end of 2008, EVB owned 25 full service branch buildings including the land on which 19 of those buildings are located and two remote drive-in facilities. Six branch office buildings are leased at current market rates. The counties of Gloucester, Northumberland and Middlesex are each the home to three of our branches. Essex and King William County are home to two branch offices. In addition, Essex County houses the EVB loan administration center and the corporate/operations center. Hanover County houses four branch offices (two of which are leased) while Caroline, Henrico, Lancaster, New Kent, Southampton, Surry, Sussex Counties and Colonial Heights 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 Hartfield office is located is under long-term lease.
In March 2008 we purchased two branches with leased facilities. One is in Henrico County and the other is in Colonial Heights. In New Kent County, our temporary office moved into a permanent, owned location in September of 2008. Also in 2008, we purchased a 5.5 acre parcel of unimproved land on Walnut Grove Road in Hanover County in anticipation of future growth needs.
While the existing locations are meeting our needs, and many may meet our needs into the future, we are a growing entity and are frequently reevaluating our locations and space needs. Our strategy of continued growth through purchases, relocations or de novo branching may require expansions or relocations in the future.
We and our subsidiaries are not aware of any material pending or threatened litigation, unasserted claims and/or assessments. The only litigation in which we and our subsidiaries are involved consists of collection suits involving delinquent loan accounts in the normal course of business and deposit disputes which management estimates will not have a material impact on our financial condition.
| Item 4. | Submission of Matters to a Vote of Security Holders |
On December 29, 2008, the Company held a special meeting of shareholders to vote on an amendment and restatement of our Articles of Incorporation. At this meeting, the shareholders approved the following proposal by the margins indicated:
To act on a proposed amendment and restatement of our Articles of Incorporation to authorize the issuance of up to 10,000,000 shares of preferred stock;
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| | | | |
For | | 3,429,716 shares | | |
Against | | 464,269 shares | | |
Abstained | | 46,977 shares | | |
Broker non-votes | | 0 shares | | |
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 2008 Annual Report to Shareholders is incorporated herein by reference and is filed herewith as Exhibit 13.1.
Dividend Policy
We have historically paid cash dividends on a quarterly basis. However, we cannot assure you that we will continue to pay cash dividends on any particular schedule or that we will not reduce the amount of dividends we pay in the future. Our future dividend policy is subject to the discretion of the board of directors and will depend upon a number of factors deemed relevant by our board, including but not limited to the future consolidated earnings, financial condition, liquidity, capital requirements for us and EVB, applicable governmental regulations and policies.
As a result of our issuance of preferred stock to the Treasury on January 9, 2009, some new requirements will be in effect. The Preferred Stock is in a superior ownership position compared to common stock. Dividends must be paid to the preferred stock holder before they can be paid to the common stock holder. In addition, prior to January 9, 2012, unless the Company has redeemed the Preferred Stock or the Treasury has transferred the Preferred Stock to a third party, the consent of the Treasury will be required for the Company to increase its common stock dividend or repurchase its common stock or other equity or capital securities, other than in certain circumstances specified in the Purchase Agreement. If the dividends on the Preferred Stock have not been paid for an aggregate of six (6) quarterly dividend periods or more, whether or not consecutive, the Company’s authorized number of directors will be automatically increased by two (2) and the holders of the Preferred Stock will have the right to elect those directors at the Company’s next annual meeting or at a special meeting called for that purpose; these two directors will be elected annually and will serve until all accrued and unpaid dividends for all past dividend periods have been declared and paid in full.
We are organized under the Virginia Stock Corporation Act, which prohibits the payment of a dividend if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.
We are a legal entity separate and distinct from our subsidiaries. Our ability to distribute cash dividends will depend primarily on the ability of EVB to pay dividends to us, and EVB is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member bank, EVB is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. The Federal Reserve and the state of Virginia have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the state of Virginia and the Federal Reserve have indicated that paying dividends that deplete a bank’s capital base to an inadequate level would be an unsound and unsafe banking practice. Under Virginia law, a bank may not declare a dividend in excess of its undivided profits.
Under the Federal Reserve’s regulations, EVB may not declare or pay any dividend if the total amount of all dividends, including the proposed dividend, is in excess of its net income for the current year plus any retained net income from the prior two calendar years, unless the dividend is approved by the Federal Reserve. In addition, EVB may not declare or pay a dividend without the approval of its board and two-thirds of its shareholders if the dividend would exceed its undivided profits, as reported to the Federal Reserve.
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In addition, we are subject to certain regulatory requirements to maintain capital at or above regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. The Federal Reserve has indicated that a bank holding company should generally pay dividends only if its net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition.
For additional information on these limitations, see “Supervision and Regulation – Governmental Policies and Legislation – Dividends” on page 11 of this Form 10-K.
Purchases of Equity Securities None in fourth quarter
| Item 6. | Selected Financial Data |
The information set forth on the page following the “To Our Shareholders” letter in the 2008 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 Operation |
Management’s discussion and analysis is intended to assist the reader in evaluating and understanding the consolidated results of operations and our financial condition. 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. We caution you to be aware of the speculative nature of “forward-looking statements.” These statements are not guarantees of performance or results. Statements that are not historical in nature, including statements that include the words “may,” “anticipate,” “estimate,” “could,” “should,” “would,” “will,” “plan,” “predict,” “project,” “potential,” “expect,” “believe,” “intend,” “continue,” “assume” and similar expressions, are intended to identify forward-looking statements. Although these statements reflect our good faith belief based on current expectations, estimates and projections about (among other things) the industry and the markets in which we operate, they are not guarantees of future performance. Whether actual results will conform to our expectations and predictions is subject to a number of known and unknown risks and uncertainties, including the risks and uncertainties discussed in this form 10-K, including the following:
| | • | | the strength of the economy in our target market area, as well as general economic, market, or business conditions; |
| | • | | changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries, decline in real estate values in our markets, or in the repayment ability of individual borrowers or issuers; |
| | • | | The impact of government intervention in the banking business; |
| | • | | changes in the interest rates affecting our deposits and our loans; |
| | • | | the loss of any of our key employees; |
| | • | | changes in our competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and our ability to compete effectively against other financial institutions in our banking markets; |
| | • | | an insufficient allowance for loan losses as a result of inaccurate assumptions; |
| | • | | our ability to manage growth; |
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| | • | | our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth; |
| | • | | our ability to assess and manage our asset quality; |
| | • | | changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services; |
| | • | | our ability to maintain internal control over financial reporting; |
| | • | | our ability to raise capital as needed by our business; |
| | • | | our reliance on secondary sources, such as Federal Home Loan Bank advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet our liquidity needs; |
| | • | | changes in laws, regulations and the policies of federal or state regulators and agencies; and |
| | • | | other circumstances, many of which are beyond our control. |
Consequently, all of the forward-looking statements made in this filing are qualified by these cautionary statements and there can be no assurance that the actual results anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us or our business or operations. You should refer to risks detailed under the “Risk Factors” section included in this Form 10-K and in our periodic and current reports filed with the Securities and Exchange Commission for specific factors that could cause our actual results to be significantly different from those expressed or implied by our forward-looking statements.
Critical Accounting Policies
General
Our 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) Statement of Financial Accounting Standards (SFAS) No.5,Accounting for Contingencies, which requires that losses be accrued when their occurrence is probable 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.
We evaluate non-performing loans individually for impairment, 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, we make 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
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historical loss rates for each loan type, the predominant collateral type for the group and the terms of the loan. The resulting estimates 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 local economic conditions.
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 our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be considered. 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.
Goodwill
Goodwill is evaluated annually to see if there is any impairment associated with its value. Refer to Footnote 1, item goodwill on page 65.
Executive Overview
The year 2008 was not a normal year in the banking industry. It showed the falling domino impact of loan instruments that are used to collateralize investment instruments and then sold to various institutions. Although we did not deal in subprime loans as a matter of direct business, we still were impacted. The year began with the financial industry, not just banks, continuing to deal with the subprime loan fallout. The Federal Reserve continued to lower rates through out the year which put a squeeze on interest margins, the largest contributor to our net income, as variable rate loans and investments re-priced quickly while fixed rate deposits and borrowings re-priced over a longer period of time. Finally in late summer the impact of the decreased value of asset backed securities, the high rate of defaulted mortgages and a liquidity crunch blended to cause massive write downs of securities, the takeover by the U. S. Government of its mortgage agencies FNMA and FHLMC and the buy out or failure of many institutions. This brought in the U. S. Treasury to assist the Federal Reserve and other government supervisory agencies in stabilizing the economy. As we enter 2009, we are operating under a quasi government controlled financial industry that is working hard to right itself.
Eastern Virginia Bankshares was not immune to these impacts. We had to take an impairment charge to write down some securities, primarily preferred stock of FNMA and FHLMC. When the Treasury Secretary acted to place the FNMA and FHLMC Government Sponsored Entities (“GSE’s”) into conservatorship, banks holding the securities were negatively impacted. Only a few months prior to the Treasury action, banking regulators had encouraged banks to incorporate these securities in the mix of their portfolio holdings to assist in meeting capital needs of these GSE’s. The result was that all financial institutions that held investments in the GSE’s were forced to take impairment charges that negatively impacted earnings. In addition, we have an increased volume of loans in nonaccrual status and subject to foreclosure risks. However, we have maintained a conservative strategy; risks within our markets are diversified; we are still earning net income and most important we are well capitalized with enough liquidity to meet most turns in the economic markets.
Our balance sheet, the primary driver of income, grew in 2008. Total assets are up $124.7 million from $926.7 at the end of 2007 to $1.05 billion at the end of 2008. Gross loans, our primary earning asset, are up $110.4 million and deposits are up $141.6 million while fed funds purchased are down at year end by $13.5 million. FHLB borrowing increased $7.6 million from a transaction early in the first quarter of 2008. As a result of this growth, if we were in a normal economic market, we start 2009 with the potential to produce a good earnings flow. With the
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economic turmoil, the potential might not come to fruition. Our 2008 growth was not just from branch purchases. While our branch purchases provided $49 and $93 million in loans and deposits, respectively, we still had significant growth from our existing markets. Loans increased an additional $61.4 million. The additional $48.6 million in deposits includes the addition of some low rate of brokered deposits. However, the deposit mix started changing with increases in interest checking and money market accounts. In addition, there was little run off from the acquired branches. The limitations on the earnings potential will be similar to those we faced in 2008. We begin the year with an economy still sliding and a hope that it will bottom out sooner than later. We anticipate weakened loan payment flows due to continued unemployment increases, creating a nervous public that is still looking for stability in the markets.
Net income for the year ended December 2008 was $3.1 million or a 64.9% decrease from $8.8 million for the year ended December 2007. This was the result of a number of factors. Our income on earning assets increased as loans and securities income were up while fed funds and dividend income were down. Dividends were impacted by lower payments from the FHLB of Atlanta, including the fourth quarter dividend being deferred to 2009. The infusion of deposits from our purchase of two Millennium bank branches helped fuel our funding needs for much of the second and third quarters, but our loan growth put us in a borrowing position by the end of the year. Rate changes through out the year were the primary cause of the declining interest income. The yield on earning assets dropped 63 basis points for the year while the yield on interest bearing liabilities was down only 32 basis points. This 31 point gap represents the rate change delay banks have in a declining rate environment.
While the rate gap is the major factor in 2008’s interest income weakening it is not the only factor in earnings decline. The provision for loan losses increased from $1.2 million in 2007 to $4.0 in 2008, taking an additional $2.8 million out of earnings for 2008. In addition, the competition for deposits has become extremely aggressive. This is pointed out in the trend of our net interest margin. In 2003, our net interest margin was 4.45% while in 2008 it was 3.57%. The rate has declined every year except 2006 when it was up 10 basis points. Management, in an effort to minimize this trend, looks at funding alternatives outside the traditional deposit sources and makes purchases of borrowed funds or brokered deposits when the spreads are significantly better than the normal deposit market.
Noninterest income was $3.0 million for 2008, a decrease of $3.1 million compared to $6.1 million in 2007. The decline was influenced by a number of unusual items that skew the year to year comparison. Our core noninterest income for 2008 was $6.5 million, an increase of 7.1%, compared to 2007. The unusual items that impacted 2008 noninterest income creating a net loss of $3.6 million were a $4.9 million other than temporary impairment, partially offset by a $1.3 million pension curtailment gain. The securities loss resulted primarily from the impairment charge taken on the FNMA and FHLMC preferred stock when the Federal Government took control of the agencies and eliminated the dividend. The economy is still in turmoil, but with the infusion of government money into the economy, we anticipate that it will eventually reverse these negative trends. This should occur as the funds move out to businesses that can then hire employees and start producing goods again and as the consumers move back into the work force and begin to feel more comfortable with spending. Our current view of the economy does not permit us to provide an estimate of when the turn-around is likely to occur.
Noninterest expense rose for the year due to infrastructure changes in the telecommunications system, higher FDIC insurance premiums due to a revised pricing structure but primarily from the acquisition of two new branches in the middle of March 2008. The purchase, as mentioned, helped fund our loan growth during the year, but did add noninterest expense. Our analysis of the performance of the acquired branches indicated that the acquisition was accretive to 2008. With strong expense controls and a freeze on merit increases in 2009, we expect noninterest expense increases in 2009 to only be related to non-controllable items such as FDIC insurance, postage, telecommunications and legal expenses related to loan defaults.
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Management’s announced strategy of growing net income annually by 10% is primarily dependent on growth of our existing markets and positioning the Company to grow in new markets. This strategy is emphasized by the progression over the last six years but in an economy that we are facing now, an economy never seen by most bankers in their careers, that goal takes a secondary position to our focus to help and work with our customers and our communities. Until the economy reverses direction, growth will probably be limited. However, while we do not plan any new branch openings in 2009, we are open to opportunities that may present themselves. If these opportunities arise, we will evaluate them and will act to enhance shareholder value. In light of the current economic conditions, our primary goal in 2009 is to maintain the stability of our company and assist our customers and communities.
Results of Operations
The table below lists our quarterly performance for the years ended December 31, 2008 and 2007.
SUMMARY OF FINANCIAL RESULTS BY QUARTER
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended |
| | | 2008 | | 2007 |
(dollars in thousands) | | Dec. 31 | | | Sep. 30 | | | June 30 | | Mar. 31 | | Dec. 31 | | Sep. 30 | | June 30 | | Mar. 31 |
Interest income | | $ | 14,415 | | | $ | 15,177 | | | $ | 15,031 | | $ | 14,763 | | $ | 15,090 | | $ | 14,822 | | $ | 14,374 | | $ | 13,915 |
Interest expense | | | 6,642 | | | | 6,816 | | | | 6,792 | | | 6,558 | | | 6,615 | | | 6,439 | | | 6,107 | | | 5,801 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | 7,773 | | | | 8,361 | | | | 8,239 | | | 8,205 | | | 8,475 | | | 8,383 | | | 8,267 | | | 8,114 |
Provision for loan losses | | | 1,225 | | | | 1,050 | | | | 1,300 | | | 450 | | | 611 | | | 325 | | | 150 | | | 153 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income after provision for loan losses | | | 6,548 | | | | 7,311 | | | | 6,939 | | | 7,755 | | | 7,864 | | | 8,058 | | | 8,117 | | | 7,961 |
Noninterest income | | | 1,418 | | | | (3,039 | ) | | | 1,934 | | | 2,657 | | | 1,642 | | | 1,643 | | | 1,477 | | | 1,349 |
Noninterest expense | | | 7,305 | | | | 6,986 | | | | 7,059 | | | 6,595 | | | 6,791 | | | 6,431 | | | 6,374 | | | 6,278 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Income before applicable income taxes | | | 661 | | | | (2,714 | ) | | | 1,814 | | | 3,817 | | | 2,715 | | | 3,270 | | | 3,220 | | | 3,032 |
Applicable income taxes | | | (1,553 | ) | | | 355 | | | | 560 | | | 1,145 | | | 649 | | | 1,005 | | | 905 | | | 924 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Net Income | | $ | 2,214 | | | $ | (3,069 | ) | | $ | 1,254 | | $ | 2,672 | | $ | 2,066 | | $ | 2,265 | | $ | 2,315 | | $ | 2,108 |
| | | | | | | | | | | | | | | | | | | | | | | | | | |
Net income per share, basic and diluted | | $ | 0.38 | | | $ | (0.52 | ) | | $ | 0.21 | | $ | 0.45 | | $ | 0.35 | | $ | 0.38 | | $ | 0.38 | | $ | 0.35 |
Net Interest Income
The primary source of income for our company is net interest income which represents our 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 35%. Tax-exempt securities income is further adjusted by the Tax Equity and 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. By making these adjustments, tax-exempt income and their yields are presented on a comparable basis with income and yields from fully taxable earning assets. Net interest margin is a ratio based on the formula of net interest income divided by average earning assets that represents the profits left over after paying for deposits and borrowed funds. 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. Below, the “Average Balances, Income and Expense, Yields and Rates” table presents average balances, interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid, for each of the past three years.
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Average Balances, Income and Expense, Yields and Rates (1)
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Year Ended December 31 | |
| | | 2008 | | | 2007 | | | 2006 | |
(dollars in thousands) | | Average
Balance | | | Income/
Expense | | Yield/
Rate | | | Average
Balance | | | Income/
Expense | | Yield/
Rate | | | Average
Balance | | | Income/
Expense | | Yield/
Rate | |
Assets: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Securities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable | | $ | 114,507 | | | $ | 6,273 | | 5.48 | % | | $ | 104,116 | | | $ | 5,522 | | 5.30 | % | | $ | 95,315 | | | $ | 4,809 | | 5.05 | % |
Tax exempt (1) | | | 40,482 | | | | 2,388 | | 5.90 | % | | | 34,325 | | | | 2,038 | | 5.94 | % | | | 34,120 | | | | 2,023 | | 5.93 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total securities | | | 154,989 | | | | 8,661 | | 5.59 | % | | | 138,441 | | | | 7,560 | | 5.46 | % | | | 129,435 | | | | 6,832 | | 5.28 | % |
Federal funds sold | | | 4,416 | | | | 84 | | 1.90 | % | | | 12,382 | | | | 638 | | 5.15 | % | | | 5,994 | | | | 299 | | 4.99 | % |
Loans (net of unearned income) (2) | | | 773,838 | | | | 51,371 | | 6.64 | % | | | 681,456 | | | | 50,626 | | 7.43 | % | | | 614,330 | | | | 44,503 | | 7.24 | % |
Total earning assets | | | 933,243 | | | | 60,116 | | 6.44 | % | | | 832,279 | | | | 58,824 | | 7.07 | % | | | 749,759 | | | | 51,634 | | 6.89 | % |
Less allowance for loan losses | | | (9,489 | ) | | | | | | | | | (7,296 | ) | | | | | | | | | (5,815 | ) | | | | | | |
Total non-earning assets | | | 72,659 | | | | | | | | | | 58,920 | | | | | | | | | | 55,165 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total assets | | $ | 996,413 | | | | | | | | | $ | 883,903 | | | | | | | | | $ | 799,109 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Liabilities & Shareholders’ Equity: | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest bearing deposits | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Checking | | $ | 144,558 | | | $ | 2,925 | | 2.02 | % | | $ | 105,494 | | | $ | 1,864 | | 1.77 | % | | $ | 80,962 | | | $ | 432 | | 0.53 | % |
Savings | | | 74,667 | | | | 671 | | 0.90 | % | | | 81,843 | | | | 950 | | 1.16 | % | | | 99,509 | | | | 1,239 | | 1.25 | % |
Money market savings | | | 52,321 | | | | 1,256 | | 2.40 | % | | | 40,817 | | | | 983 | | 2.41 | % | | | 45,006 | | | | 936 | | 2.08 | % |
Large dollar certificates of deposit (3) | | | 143,115 | | | | 6,376 | | 4.46 | % | | | 120,735 | | | | 5,799 | | 4.80 | % | | | 103,789 | | | | 4,505 | | 4.34 | % |
Other certificates of deposit | | | 242,184 | | | | 9,109 | | 3.76 | % | | | 212,967 | | | | 9,525 | | 4.47 | % | | | 204,440 | | | | 8,018 | | 3.92 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing deposits | | | 656,845 | | | | 20,337 | | 3.10 | % | | | 561,856 | | | | 19,121 | | 3.40 | % | | | 533,706 | | | | 15,130 | | 2.83 | % |
Federal Funds Purchased | | | 3,817 | | | | 91 | | 2.38 | % | | | 1,353 | | | | 73 | | 5.40 | % | | | 1,799 | | | | 88 | | 4.89 | % |
Other borrowings | | | 144,529 | | | | 6,381 | | 4.42 | % | | | 121,378 | | | | 5,768 | | 4.75 | % | | | 92,656 | | | | 4,226 | | 4.56 | % |
Total interest-bearing liabilities | | | 805,191 | | | | 26,809 | | 3.33 | % | | | 684,587 | | | | 24,962 | | 3.65 | % | | | 628,161 | | | | 19,444 | | 3.10 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Noninterest-bearing liabilities | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Demand deposits | | | 96,874 | | | | | | | | | | 98,282 | | | | | | | | | | 99,213 | | | | | | | |
Other liabilities | | | 7,770 | | | | | | | | | | 11,375 | | | | | | | | | | 6,564 | | | | | | | |
Total liabilities | | | 909,835 | | | | | | | | | | 794,244 | | | | | | | | | | 733,938 | | | | | | | |
Shareholders’ equity | | | 86,578 | | | | | | | | | | 89,659 | | | | | | | | | | 65,171 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 996,413 | | | | | | | | | $ | 883,903 | | | | | | | | | $ | 799,109 | | | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Net interest income | | | | | | $ | 33,307 | | | | | | | | | $ | 33,862 | | | | | | | | | $ | 32,190 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Interest rate spread (4) | | | | | | | | | 3.11 | % | | | | | | | | | 3.42 | % | | | | | | | | | 3.79 | % |
Interest expense as a percent of average earning assets | | | | | | | | | 2.87 | % | | | | | | | | | 3.00 | % | | | | | | | | | 2.59 | % |
Net interest margin (5) | | | | | | | | | 3.57 | % | | | | | | | | | 4.07 | % | | | | | | | | | 4.29 | % |
Notes:
| (1) | Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 35%. |
| (2) | Nonaccrual loans have been included in the computations of average loan balances. |
| (3) | Large dollar certificates of deposit are certificates issued in amounts of $100,000 or greater. |
| (4) | 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. |
| (5) | Net interest margin is the net interest income, calculated on a fully taxable basis assuming a federal income tax rate of 35%, expressed as a percentage of average earning assets. |
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Tax-equivalent net interest income decreased 1.6% to $33.3 million in 2008 from $33.9 million in 2007. Average earning assets grew 12.1%, or $101.0 million, while interest-bearing liabilities grew 17.6%, or $120.6 million. Despite growth on both sides of the balance sheet, the 2008 yield on earning assets was 6.44% a decline of 63 basis points compared to a cost of 3.33% on interest bearing liabilities which was down 32 basis points. In spite of the growth, the earnings on the loan portfolio were unable to hold pace with the rapid interest decreases throughout 2008 and the spread declined 31 basis points. This displays the re-pricing gap that existed most of the year as the Federal Reserve’s rapid price cuts to fight economic problems created a disparity by re-pricing variable rate loans right away while not impacting fixed rate liabilities until their maturity. All categories of earning assets grew except Federal Funds sold. Average securities were up $16.5 million with a $10.4 million increase in taxable securities and a $6.2 million increase in tax exempt securities. Taxable securities income went up contributing $750 thousand more to interest income, while tax exempt income was up $350 thousand. This increase of $1.1 million more than offset the decline of $554 thousand in federal funds sold earnings. The yield on the largest earning asset category, loans, was down 79 basis points at 6.64% compared to 7.43% in 2007.
Total average deposits grew $93.6 million, or 14.2%, with increases in all categories except demand deposits and savings which continued their decline as consumers continued to move to interest-bearing checking and money market savings. For 2008, interest-bearing checking was again our fastest grower with a $39.1 million increase and a 25 basis point increase in interest cost at 2.02% for 2008. This category is comprised mostly of our Reward checking product with its above market interest rate and demonstrates customers’ interest in better returns on their deposit funds. Interest-bearing checking is 22% of our total average interest-bearing deposits. Consumer certificates comprising 36.9% of our average interest-bearing deposit base grew $29.2 million. Balance changes were influenced by a higher level of brokered deposits. The cost of both certificate categories decreased: from 4.80% to 4.46% for large CD’s and from 4.47% to 3.76% for consumer certificates. Despite the lower rates, the dollar amount of interest on large CD’s went up $577 thousand while consumer CD’s went down $416 thousand. While rates went down, large CD’s grew $22.4 million dollars from $120.7 million in 2007 to $143.1 million in 2008. This rate decline is the result of market rate decreases. Average noninterest bearing demand deposits decreased $1.4 million compared to 2007.
In 2007, average earning asset growth of 11.0% resulted from an increase in average loans outstanding of 10.9%; average federal funds sold increased 106.6% and average securities increased 7.0%. Growth in average earning assets of $82.5 million was primarily funded by average deposit growth of $28.2 million and an increase in average borrowings of $28.3 million. In 2007, net interest income on a tax equivalent basis increased 5.2% to $33.9 million from $32.2 million in 2006. Average earning asset growth of 11.0% produced $7.2 million of increased interest income, while interest-bearing liabilities grew 9.0% producing a $5.5 million increase in interest expense. While the interest income increased, the total funding cost grew faster, resulting in a net interest margin of 4.07%, down from 4.29% in 2006.
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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Volume and Rate Analysis (1)
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | 2008 vs. 2007
Increase (Decrease)
Due to Changes in: | | | 2007 vs. 2006
Increase (Decrease)
Due to Changes in: | |
(dollars in thousands) | | Volume | | | Rate | | | Total | | | Volume | | | Rate | | | Total | |
Earning Assets: | | | | | | | | | | | | | | | | | | | | | | | | |
Taxable securities | | $ | 559 | | | $ | 192 | | | $ | 751 | | | $ | 468 | | | $ | 246 | | | $ | 714 | |
Tax exempt securities (2) | | | 364 | | | | (14 | ) | | | 350 | | | | 12 | | | | 3 | | | | 15 | |
Loans (net of unearned income) | | | 5,150 | | | | (5,704 | ) | | | (554 | ) | | | 4,931 | | | | 1,192 | | | | 6,123 | |
Federal funds sold | | | 1,019 | | | | (274 | ) | | | 745 | | | | 329 | | | | 10 | | | | 339 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total earning assets | | | 7,092 | | | | (5,800 | ) | | | 1,292 | | | | 5,740 | | | | 1,451 | | | | 7,191 | |
Interest-Bearing Liabilities: | | | | | | | | | | | | | | | | | | | | | | | | |
Interest checking | | | 770 | | | | 291 | | | | 1,061 | | | | 159 | | | | 1,273 | | | | 1,432 | |
Savings deposits | | | (80 | ) | | | (199 | ) | | | (279 | ) | | | (204 | ) | | | (85 | ) | | | (289 | ) |
Money market accounts | | | 277 | | | | (4 | ) | | | 273 | | | | (93 | ) | | | 140 | | | | 47 | |
Consumer certificates of deposit | | | 2,200 | | | | (1,623 | ) | | | 577 | | | | 1,237 | | | | 270 | | | | 1,507 | |
Large denomination certificates (3) | | | 16 | | | | (432 | ) | | | (416 | ) | | | 294 | | | | 1,000 | | | | 1,294 | |
Long-term borrowings | | | 1,138 | | | | (507 | ) | | | 631 | | | | 1,663 | | | | (136 | ) | | | 1,527 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total interest-bearing liabilities | | | 4,321 | | | | (2,474 | ) | | | 1,847 | | | | 3,056 | | | | 2,462 | | | | 5,518 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Change in net interest income | | $ | 2,771 | | | $ | (3,326 | ) | | $ | (555 | ) | | $ | 2,684 | | | $ | (1,011 | ) | | $ | 1,673 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
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 35%. |
| (3) | Large denomination certificates are those issued in amounts of $100 thousand or greater. |
Interest Sensitivity
Our 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 fixed rate average maturity of asset and liability contracts reasonably consistent and short, and by routinely adjusting pricing to market conditions on a regular basis.
We generally strive 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. Interest rate gaps are managed through investments, loan pricing and deposit pricing. 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.
Managing the interest rate gap in an environment where rates have fallen so quickly presents management with different challenges. Depositors are uncertain about where to put their money, especially with the probability of a continuation of the current economic recession. We anticipate more funds coming to us as customers look for safer
32
investments but that will take time. Currently, we have almost a third of our loan portfolio repricing almost instantly with each rate cut. However, our deposits, especially certificates, do not reprice until they mature which results in a short term narrowing of earnings. We saw clear evidence of this in late 2008 when our daily interest income decreased over $1,000 per day with each 25 basis point change. In a 90 day horizon the balance sheet is asset sensitive, but we are slightly liability sensitive in a one year time frame. This means we have a large number of deposits repricing later in the next year and will have to look for lower cost funding in the short term to support asset growth.
Noninterest Income
Noninterest income for 2008 was $3.0 million, a decrease of $3.1 million or 51.4% compared to 2007. This decline was primarily the result of a number of non-core financial events during the year. Without these items, recurring noninterest income for 2008 was $6.5 million compared to $6.1 million in 2007. Service charges on deposit accounts, the largest source of noninterest income, increased by $320 thousand or 8.7% from $3.7 million in 2007 to $4.0 million in 2008. Debit card and ATM fee income increased $291 thousand or 34.5% from $844 thousand in 2007 to $1.1 million in 2008. Service charge fees were strong until the fourth quarter when the economy appears to have forced consumers to look more closely at expenses, especially fees for overdrawing their accounts. Debit and ATM activity fees were driven by higher volume as consumers moved to electronic transactions rather than checks. Other operating income was impacted by decreases of $154 thousand in investment services income and $81 thousand in EVB Mortgage, Inc. income and increases of $18 thousand in bank owned life insurance (“BOLI”) income and $15 thousand in wire transfer fees. LLC investments and fixed asset sales increased $274 thousand primarily from a one time benefit from the exchange of our ownership in Bankers Investment for a similar interest in Infinex. Realized gains on sale of securities increased $30 thousand from $14 thousand to $44 thousand in 2008. Our non-core items included an $4.9 million impairment on securities (see securities discussion, page 40) partially offset by a $1.3 million actuarial gain from our pension plan restructuring and a $229 thousand other than temporary impairment of an OREO asset.
In 2007, noninterest income increased $945 thousand or 18.3% from 2006 to 2007, attributable to a $437 thousand increase in service charges on deposits, a $335 thousand increase in debit card and ATM fee income and an $83 thousand increase in investment services income. Other operating income increased from $1.4 million in 2006 to $1.6 million in 2007, the result of increases in mortgage business income and increases in other income categories. There were no gains or losses on sale of other real estate in 2007 or 2006 while realized gain on sale of securities decreased $22 thousand from 2006.
The following table shows the components of noninterest income for the periods indicated.
Noninterest Income:
| | | | | | | | | | |
| | | Years Ended December 31 |
(dollars in thousands) | | 2008 | | | 2007 | | 2006 |
Service Charges of deposit accounts | | $ | 3,991 | | | $ | 3,671 | | $ | 3,234 |
Card transaction fees | | | 1,135 | | | | 844 | | | 509 |
Other Operating Income | | | 1,405 | | | | 1,581 | | | 1,386 |
Gain on available for sale securities | | | 44 | | | | 14 | | | 36 |
| | | | | | | | | | |
Core Noninterest Income | | $ | 6,575 | | | $ | 6,110 | | $ | 5,165 |
Impairment - Securities | | | (4,933 | ) | | | — | | | — |
Actuarial Gain Pension Curtailment | | | 1,328 | | | | — | | | — |
| | | | | | | | | | |
Noninterest Income | | $ | 2,970 | | | $ | 6,110 | | $ | 5,165 |
| | | | | | | | | | |
33
Noninterest Expense
Total noninterest expense for 2008 increased $2.1 million or 8.0% compared to an increase of $55 thousand or 0.2% for 2007. Noninterest expense was $27.9 million in 2008 compared to $25.9 million in 2007. Total personnel expenses increased $229 thousand, or 1.6%, from $14.5 million in 2007 to $14.8 million in 2008, highlighted by decreases in pension expense of $974 thousand and bonus expense of $563 thousand as the company paid no management bonuses for 2008. Fulltime equivalent staff count was up at year end 2008 to 317 compared to 305 at December 31, 2007, as the Company absorbed the staffing from the new branches.
Net occupancy and equipment expense increased $456 thousand or 10.6% to $4.7 million for 2008, from $4.3 million in 2007. Over half of the increase, $226 thousand was from taking on the expenses of our purchased branches. With no major projects planned in 2009, many of the expense categories should stabilize.
With the purchase of the branches in 2008 and the decline in the economy, other noninterest expenses increased, $1.4 million or 19.7% to $8.4 million compared to $7.0 million in 2007. Telephone expense was up $383 thousand due to infrastructure enhancements and the addition of new locations. FDIC expense rose $365 thousand as the impact of the increased FDIC rate structure was implemented. FDIC expense will have a greater increase in 2009. Marketing and advertising expense increased $118 thousand with much of that related to the opening of the new branches. Loan expenses were up $190 thousand, primarily from increases of $67 thousand in collection expense, $63 thousand in OREO expense on foreclosed properties and $31 thousand in home equity line (“HELOC”) closing expenses. Legal expenses were up $108 thousand; audit fees were up $29 thousand and director fees were down $50 thousand. Legal fees were from two sources an increase in assistance with loan situations and the fees associated with TARP filings. We changed our approach to marketing from the traditional mass media to more local involvement. These changes reflect the tightened economy and the increased effort to collect our outstanding payments on loans. HELOC costs increased as we focused on growth in that loan category. In addition, employee mileage reimbursement increased $72 thousand, or 48%, as a result of the higher cost of gasoline. With the economy in recession and the need to assist our communities, management plans to hold tight reins on these expenses in 2009.
For 2007, total noninterest expense increased $55 thousand or 0.2% compared to an increase of $926 thousand, or 3.7% in 2006. Noninterest expense was $25.8 million in 2007 compared to $25.9 million in 2006. Total personnel expense decreased $120 thousand, or 0.8%, from $14.7 million in 2006 to $14.5 million in 2007.
Net occupancy and equipment expense increased $376 thousand or 9.6% to $4.3 million for 2007, compared to $3.9 million in 2006. This increase was associated with the full year depreciation on our Kings Charter branch and the relocation of two branches that increased the rent.
Other noninterest expenses decreased $201 thousand or 2.8% to $7.0 million in 2007 from $7.2 million in 2006. This decrease resulted from decreases in consulting fees of $139 thousand, data processing of $180 thousand and marketing and advertising expense of $115 thousand.
The following table shows the components of noninterest expense for the periods indicated.
Noninterest Expense:
| | | | | | | | | |
| | | Years Ended December 31 |
(dollars in thousands) | | 2008 | | 2007 | | 2006 |
Salaries and employee benefits | | $ | 14,776 | | $ | 14,547 | | $ | 14,667 |
Occupancy and equipment | | | 4,738 | | | 4,282 | | | 3,906 |
Consultant Fees | | | 653 | | | 629 | | | 768 |
Data processing | | | 270 | | | 261 | | | 441 |
Telephone | | | 996 | | | 613 | | | 571 |
Marketing and advertising | | | 874 | | | 756 | | | 871 |
Other operating expenses | | | 5,638 | | | 4,786 | | | 4,595 |
| | | | | | | | | |
Total Noninterest Expense | | $ | 27,945 | | $ | 25,874 | | $ | 25,819 |
| | | | | | | | | |
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Income Taxes
Income tax expense in 2008 decreased $3.0 million to $506 thousand, compared to $ 3.5 million in 2007 and $3.0 million in 2006. In 2008, increased tax exempt income and the decrease in net income were the primary reasons for the tax expense reduction. Income tax expense corresponds to an effective rate of 14.2%, 28.5% and 29.0% for the three years ended December 31, 2008, 2007 and 2006, respectively.
Note 9 in the Consolidated Financial Statements provides a reconciliation between the amount of income tax expense computed using the federal statutory income tax rate and our actual income tax expense. Also included in Note 9 to the Consolidated Financial Statements is information regarding deferred taxes for 2008 and 2007. That Note is incorporated by reference into this section of Management’s Discussion and Analysis.
Loan Portfolio
Loans, net of unearned income, increased to $819.3 million at December 31, 2008, an increase of $110.4 million, or 15.6%, from $708.8 million at year-end 2007. The real estate loan portfolio continued to drive growth in 2008, increasing $102.0 million, or 17.2%, with the commercial, industrial and agricultural loan portfolio increasing by $8.2 million, or 13.6%, and consumer loans declining by $4.9 million, or 9.4%. Consumer loan balances continue a declining trend with 2007 being an anomaly with a slight gain. The gains in loan balances are attributable to two factors: one the purchase of two branches and the other continued steady growth in our markets, especially in our Gloucester and Richmond areas. The acquisition of branches included $48.9 million in loans, primarily real estate secured while our existing markets brought in another $65 million. Real estate construction loans grew $4.0 million, or 4.0%, while commercial real estate loans grew $43.8 million, or 24.6%. This growth continued through the fourth quarter but at a slower pace as the economic downturn accelerated. At year-end 2007, loans, net of unearned income, were $708.8 million, up $58.3 million or 9.0% from $650.5 million at year-end 2006. Loan growth for all periods reported was primarily driven by increases in the real estate portfolio. In the fourth quarter of 2008, the Company performed a loan scrub of all loan categories which resulted in some movement from category to category. The changes put us in position to more effectively report our loan categories based on Federal Reserve definitions.
The following table shows the composition of the loan portfolio at the dates indicated.
| | | | | | | | | | | | | | | | | | | | |
| | | At December 31 | |
(dollars in thousands) | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
Commercial, industrial and agricultural loans | | $ | 69,024 | | | $ | 60,778 | | | $ | 59,859 | | | $ | 55,732 | | | $ | 46,629 | |
Residential real estate mortgage | | | 372,067 | | | | 317,767 | | | | 288,114 | | | | 263,191 | | | | 252,895 | |
Real estate construction | | | 102,837 | | | | 98,877 | | | | 85,910 | | | | 47,620 | | | | 23,675 | |
Commercial real estate | | | 221,769 | | | | 178,011 | | | | 164,948 | | | | 151,897 | | | | 131,580 | |
Consumer loans | | | 47,226 | | | | 52,170 | | | | 51,446 | | | | 55,680 | | | | 58,800 | |
All other loans | | | 6,354 | | | | 1,243 | | | | 305 | | | | 321 | | | | 96 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans | | | 819,277 | | | | 708,846 | | | | 650,582 | | | | 574,441 | | | | 513,675 | |
Less unearned income | | | (11 | ) | | | (29 | ) | | | (90 | ) | | | (356 | ) | | | (1,126 | ) |
| | | | | | | | | | | | | | | | | | | | |
Total loans net of unearned discount | | | 819,266 | | | | 708,817 | | | | 650,492 | | | | 574,085 | | | | 512,549 | |
Less allowance for loan losses | | | (10,542 | ) | | | (7,888 | ) | | | (7,051 | ) | | | (6,601 | ) | | | (6,675 | ) |
| | | | | | | | | | | | | | | | | | | | |
Net loans | | $ | 808,724 | | | $ | 700,929 | | | $ | 643,441 | | | $ | 567,484 | | | $ | 505,874 | |
| | | | | | | | | | | | | | | | | | | | |
The following table presents loan categories that are particularly sensitive to rate changes:
Remaining Maturities of Selected Loans
| | | | | | | | | | | | | | | | | | | | |
| | | | | Variable Rate | | Fixed Rate | | |
Year Ended December 31, 2008 (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 | | $ | 47,738 | | 4,212 | | — | | $ | 4,212 | | 15,291 | | 1,783 | | $ | 17,074 | | $ | 69,024 |
Real Estate Construction | | $ | 94,651 | | 4,651 | | — | | $ | 4,651 | | 2,654 | | 881 | | $ | 3,535 | | $ | 102,837 |
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Loans secured by real estate comprised approximately 85.0% of our loan portfolio at December 31, 2008. Within this category, residential real estate mortgages made up 45.4% of the loan portfolio at year end 2008, 44.8% at December 31, 2007 and 44.3% at year-end 2006. While the percentage to total loan portfolio are similar each year, in 2008 residential real estate mortgages grew $54.3 million, or 17.1%. This was the largest growth in any single loan category for the year and was supplemented by purchases from our mortgage company and our branch acquisition. As a percentage of the portfolio, commercial real estate loans increased from 25.1% of the total loan portfolio at year-end 2007 to 27.1% at year-end 2008. Real estate construction loans grew 4.0% over 2007 balances and accounted for 12.6% of total loans outstanding at year-end 2008 compared to 13.9% at year-end 2007 and 13.2% at year-end 2006.Our losses on loans secured by real estate have historically been low, averaging $141 thousand in net charge offs per year over the last ten years. In the shaky real estate market where valuations are dropping, management takes these changed risks into consideration in assessing our loan to value exposure.
Consumer loans are again the fifth largest component of our loan portfolio in 2008 comprising 5.8% of the portfolio at year-end 2008 compared to 7.4% at year-end 2007 and 7.9% at year-end 2006. This portfolio’s primary component consists of installment loans. Net consumer loans for household, family and other personal expenditures totaled $47.2 million at 2008 year-end, a decrease of $4.9 million from $52.1 million at 2007 year-end. Much of the decrease was the result of our reclassification during the loan review. Consumer lifestyle changes have resulted in increasing emphasis on fast and easy one-step loans which has created intense competition for consumer borrowing dollars. This change, combined with the automotive industry’s various rebate programs with low rates at the dealer location, continues a trend that started in 2002 of 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 $8.2 million, or 13.6% to $69.0 million at December 31, 2008 compared to $60.8 million at December 31, 2007. However, due to the continued growth of real estate loans, it comprises only 8.4% of the total portfolio at year-end 2008 compared to 8.6% at year-end 2007 and 9.2% at year-end 2006. The growth in real estate construction and commercial, industrial and agricultural loans emphasize our clear commitment to support small to medium sized businesses.
Consistent with our focus on providing community-based financial services, we generally do not make loans outside of our principal market region. We do not engage in foreign lending activities; consequently the loan portfolio is not exposed to the sometimes volatile risk from foreign credits. We further maintain a policy not to originate or purchase loans classified by regulators as highly leveraged transactions or loans to foreign entities or individuals. Our unfunded loan commitments, excluding credit card lines and letters of credit, at year-end 2008 totaled $117.2 million, compared to $105.6 million at year-end 2007. Unfunded loan commitments (excluding $47.2 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, our loan collateral has been primarily real estate because of the nature of our market region. However, as we expand into newer markets, to us, we are encountering other collateral options which in lieu of real estate, are booked based on strong credit guidelines and controls to monitor the status of the collateral.
Asset Quality
Our allowance for loan losses is an estimate of the amount needed to provide for inherent losses in the loan portfolio. In determining adequacy of the allowance, we consider our 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. Our ratio of nonperforming assets to total loans and other real estate owned at year-end 2008 increased to 2.04% compared to 0.40% at December 31, 2007 and up
36
from 0.45% at December 31, 2006. The rapid increase in this measure points out the sudden decline in the lending environment as the economy deteriorates and unemployment measures worsen. As a result, nonperforming assets rose $13.8 million, or 476% to $16.7 million at year-end 2008, compared to $2.9 million at year end 2007. Net charge offs for 2008 increased $1.5 million or 363.8% to $1.9 million, compared to $401 thousand for the year 2007.
We have a loan review committee consisting of bank officers and board members. Additionally an independent credit review firm performs a review of loans, including a SFAS No.114 review for determining specific reserves. We utilize 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. In the current lending environment with the economic markets stressed and our borrowers struggling, management took aggressive action raising the provision for loan loss to just over $4.0 million and expects to continue building the reserve in 2009 as the risk assessments dictate. In 2008, at year-end, EVB had a ratio of allowance for loan losses to total loans outstanding of 1.29% compared to 1.11% at year-end 2007 and to 1.08% at December 31, 2006, respectively. For the same dates, the loan loss allowance to nonaccrual loans ratio was 78%, 544% and 504%, indicating that the allowance was adequate with respect to nonaccrual loans. The adequacy of the allowance for loan losses is subject to regulatory examinations which may review such factors as the method used to calculate the allowance and the size of the allowance in comparison to peer companies identified by regulatory agencies.
We will continue to increase our loan loss reserve in 2009 if the portfolio risks dictate. We will work with each customer through these tough economic times wherever it is feasible. In addition, we will review all the new initiatives that the U.S. government implements that may offer relief to our borrowers.
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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) | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
Average loans outstanding, net of unearned income | | $ | 773,838 | | | $ | 681,456 | | | $ | 614,330 | | | $ | 537,736 | | | $ | 498,568 | |
Allowance for loan losses, January 1 | | | 7,888 | | | | 7,051 | | | | 6,601 | | | | 6,676 | | | | 6,495 | |
Loans charged off: | | | | | | | | | | | | | | | | | | | | |
Commercial and agricultural | | | 441 | | | | 37 | | | | 37 | | | | 156 | | | | 135 | |
Real estate | | | 1,092 | | | | 98 | | | | 42 | | | | 67 | | | | 56 | |
Consumer | | | 880 | | | | 726 | | | | 691 | | | | 895 | | | | 1,318 | |
| | | | | | | | | | | | | | | | | | | | |
Total loans charged off | | | 2,413 | | | | 861 | | | | 770 | | | | 1,118 | | | | 1,509 | |
Recoveries: | | | | | | | | | | | | | | | | | | | | |
Commercial and agricultural | | | 170 | | | | 63 | | | | 23 | | | | 66 | | | | 48 | |
Real estate | | | 30 | | | | 27 | | | | 23 | | | | 36 | | | | 9 | |
Consumer | | | 354 | | | | 370 | | | | 449 | | | | 389 | | | | 354 | |
| | | | | | | | | | | | | | | | | | | | |
Total recoveries | | | 554 | | | | 460 | | | | 495 | | | | 491 | | | | 411 | |
| | | | | | | | | | | | | | | | | | | | |
Net loans charged off | | | 1,859 | | | | 401 | | | | 275 | | | | 627 | | | | 1,098 | |
Reserve on acquired loans | | | 488 | | | | — | | | | — | | | | — | | | | — | |
Provision for loan losses | | | 4,025 | | | | 1,238 | | | | 725 | | | | 552 | | | | 1,279 | |
| | | | | | | | | | | | | | | | | | | | |
Allowance for loan losses, December 31 | | $ | 10,542 | | | $ | 7,888 | | | $ | 7,051 | | | $ | 6,601 | | | $ | 6,676 | |
| | | | | | | | | | | | | | | | | | | | |
Ratios: | | | | | | | | | | | | | | | | | | | | |
Ratio of allowance for loan losses to total loans outstanding, end of year | | | 1.29 | % | | | 1.11 | % | | | 1.08 | % | | | 1.15 | % | | | 1.30 | % |
Ratio of net charge-offs to average loans outstanding during the year | | | 0.24 | % | | | 0.06 | % | | | 0.04 | % | | | 0.12 | % | | | 0.22 | % |
The following table shows the allocation of allowance for loan losses at the dates indicated.
Allocation of Allowance for Loan Losses
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | At December 31 | |
| | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
| | | Allowance | | Percent | | | Allowance | | Percent | | | Allowance | | Percent | | | Allowance | | Percent | | | Allowance | | Percent | |
Commercial and agricultural | | | 1,454 | | 8.4 | % | | $ | 1,235 | | 8.57 | % | | $ | 1,061 | | 9.20 | % | | $ | 1,893 | | 9.08 | % | | $ | 1,299 | | 9.08 | % |
Real estate mortgage | | | 2,309 | | 45.4 | % | | | 1,145 | | 44.83 | % | | | 1,144 | | 44.29 | % | | | 763 | | 49.22 | % | | | 1,002 | | 49.22 | % |
Real estate construction | | | 2,624 | | 12.6 | % | | | 1,606 | | 13.95 | % | | | 1,066 | | 13.21 | % | | | 492 | | 4.61 | % | | | 206 | | 4.61 | % |
Commercial real estate | | | 3,021 | | 27.1 | % | | | 2,569 | | 25.11 | % | | | 2,630 | | 25.35 | % | | | 2,037 | | 25.62 | % | | | 2,664 | | 25.62 | % |
Consumer | | | 969 | | 5.8 | % | | | 981 | | 7.36 | % | | | 949 | | 7.91 | % | | | 1,258 | | 11.45 | % | | | 1,349 | | 11.45 | % |
Other loans and overdrafts | | | 84 | | 0.8 | % | | | 55 | | 0.18 | % | | | 54 | | 0.04 | % | | | — | | 0.02 | % | | | — | | 0.02 | % |
Total allowance for balance sheet loans | | | 10,461 | | 100.0 | % | | | 7,591 | | 100.00 | % | | | 6,904 | | 100.00 | % | | | 6,443 | | 100.00 | % | | | 6,520 | | 100.00 | % |
Unallocated | | | 81 | | | | | | 297 | | | | | | 147 | | | | | | 158 | | | | | | 156 | | | |
Total allowance for loan losses | | $ | 10,542 | | | | | $ | 7,888 | | | | | $ | 7,051 | | | | | $ | 6,601 | | | | | $ | 6,676 | | | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Percent is loans in category divided by total loans)
Nonperforming Assets
Total nonperforming assets, consisting of nonaccrual loans, loans past due 90 days or more, and other real estate owned, increased $13.9 million or 484% to $16.7 million at year-end 2008, while total loans outstanding, net of unearned discount, increased $110.4 million or 15.6% to $819.3 million for the same period. The ratio of nonperforming assets to total loans and other real estate at year-end 2008 was 2.04% compared to 0.40% at year-end 2007.
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Nonperforming loans at year-end 2008 were $16.2 million which included $13.6 million in nonaccrual loans with $13.0 million of the nonaccrual loans secured by real estate in our market area, $248 thousand of commercial and agricultural loans and $337 thousand of consumer loans. Based on estimated fair values of the related collateral, we consider the nonperforming real estate loans recoverable, with any individual deficiency covered by the allowance for loan losses. The total amount of non real estate secured nonaccrual loans was $585 thousand. Loans are placed on nonaccrual status at the time when the collection of principal and interest are considered to be doubtful. The accrual of interest on loans, except credit cards, consumer loans 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. 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 $571 thousand and $72 thousand for the years 2008 and 2007, respectively.
The balance of the nonperforming assets at year-end 2008 is the other real estate (“OREO”) owned in the amount of $560 thousand compared to $1.1 million in 2007. OREO consists of two properties, one for $460 thousand and the other for $100 thousand. The $460 thousand OREO property was sold at a small gain subsequent to year end 2008.
The following table shows nonperforming assets at the dates indicated.
Nonperforming Assets
| | | | | | | | | | | | | | | | | | | | |
| | | At December 31, | |
(dollars in thousands) | | 2008 | | | 2007 | | | 2006 | | | 2005 | | | 2004 | |
Nonaccrual loans | | $ | 13,574 | | | $ | 1,449 | | | $ | 1,400 | | | $ | 884 | | | $ | 3,217 | |
Restructured loans | | | — | | | | — | | | | — | | | | — | | | | — | |
Loans past due 90 days and accruing interest | | | 2,590 | | | | 358 | | | | 1,504 | | | | 1,655 | | | | 1,614 | |
| | | | | | | | | | | | | | | | | | | | |
Total nonperforming loans | | | 16,164 | | | | 1,807 | | | | 2,904 | | | | 2,539 | | | | 4,831 | |
Other real estate owned | | | 560 | | | | 1,056 | | | | — | | | | — | | | | — | |
| | | | | | | | | | | | | | | | | | | | |
Total nonperforming assets | | $ | 16,724 | | | $ | 2,863 | | | $ | 2,904 | | | $ | 2,539 | | | $ | 4,831 | |
| | | | | | | | | | | | | | | | | | | | |
Nonperforming assets to total loans and other real estate owned | | | 2.04 | % | | | 0.40 | % | | | 0.45 | % | | | 0.44 | % | | | 0.94 | % |
Allowance for loan losses to nonaccrual loans | | | 77.66 | % | | | 544.37 | % | | | 503.52 | % | | | 746.72 | % | | | 207.52 | % |
Net charge-offs to average loans for the year | | | 0.24 | % | | | 0.06 | % | | | 0.04 | % | | | 0.12 | % | | | 0.22 | % |
Allowance for loan losses to year end loans | | | 1.29 | % | | | 1.11 | % | | | 1.08 | % | | | 1.15 | % | | | 1.30 | % |
Foregone interest income on nonaccrual loans | | $ | 571 | | | $ | 72 | | | $ | 45 | | | $ | 37 | | | $ | 121 | |
Net charge offs in 2008 increased to $1.9 million from $401 thousand in 2007. The 2008 net charge offs included $526 thousand of consumer loans, $271 thousand of commercial loans and $1.1 million of real estate loans. These are major increases which have been brought on by the economic down turn. The year 2009 will probably be similar as the economic forecasts do not show a turn around until the end of the year or possibly in 2010. As stated earlier, reserves will continue to be increased as needed. While loans are charged off, there is some potential to recover portions in the future.
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At December 31, 2008, we reported $15.0 million in impaired loans, an increase of $10.6 million from $4.4 million at December 31, 2007. Of this $15.0 million in impaired loans, $8.3 million was included in nonperforming loans. The average balance of impaired loans for the twelve months ended December 31, 2008 was $8.6 million. 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. An independent third party review of this portfolio is made annually and presented to the Board of Directors as an unbiased presentation of our risks and the condition of the portfolio.
At December 31, 2008 the securities portfolio, at fair market value, was $161.9 million, a 0.6% increase from $160.9 million at 2007 year-end which was a 26.5% increase from $127.2 million at 2006 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 (loss) as a loss of $11.8 million at December 31, 2007 and a loss of $2.9 million at 2007 year-end.
We follow a policy of not engaging in activities considered to be derivative in nature such as options, futures, swaps or forward commitments. We consider derivatives to be speculative in nature and contrary to our historical philosophy. We do 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.
| | | | | | | | | | | | | | | | | | |
| | | December 31, 2008 | | December 31, 2007 | | December 31, 2006 |
(dollars in thousands) | | Amortized
Cost | | Fair
Value | | Amortized
Cost | | Fair
Value | | Amortized
Cost | | Fair
Value |
Available for Sale: | | | | | | | | | | | | | | | | | | |
Obligations of U.S. Government agencies | | $ | 33,149 | | $ | 33,619 | | $ | 43,284 | | $ | 43,515 | | $ | 31,596 | | $ | 31,132 |
Mortgage-backed and CMO securities | | | 68,351 | | | 69,152 | | | 39,439 | | | 39,069 | | | 41,691 | | | 40,678 |
State and political subdivisions | | | 39,376 | | | 39,241 | | | 41,137 | | | 41,211 | | | 32,429 | | | 30,937 |
Pooled trust preferred securities | | | 14,575 | | | 3,267 | | | 18,207 | | | 16,385 | | | 5,500 | | | 5,500 |
FNMA and FHLMC preferred stock | | | 94 | | | 94 | | | 4,708 | | | 3,885 | | | 2,734 | | | 2,614 |
Corporate securities | | | 15,302 | | | 7,272 | | | 10,156 | | | 8,378 | | | 10,164 | | | 9,520 |
Restricted securities | | | 9,234 | | | 9,234 | | | 8,422 | | | 8,422 | | | 6,787 | | | 6,787 |
| | | | | | | | | | | | | | | | | | |
Total | | $ | 180,081 | | $ | 161,879 | | $ | 165,353 | | $ | 160,865 | | $ | 130,901 | | $ | 127,168 |
| | | | | | | | | | | | | | | | | | |
Additional information regarding each of the pooled trust preferred securities as of December 31, 2008 follows:
| | | | | | | | | | | | | | | | | | | | | |
| Cost | | Fair Value | | Percent of
Underlying
Collateral
Performing | | | Percent of
Underlying
Collateral
in Deferral | | | Percent of
Underlying
Collateral
in Default | | | Additional
Default
Protection
Before Yield
Suffers | | | Discounted
Present
Value
Cash Flow
Coverage | | | Current
Fitch
Rating |
| $ | 2,951,740 | | $ | 711,665 | | 94.57 | % | | 2.55 | % | | 2.88 | % | | 20.6 | % | | 98.40 | % | | BBB |
| | 2,486,593 | | | 377,962 | | 94.88 | % | | 3.41 | % | | 1.71 | % | | 17.1 | % | | 100.10 | % | | BBB |
| | 2,474,103 | | | 336,973 | | 89.17 | % | | 7.98 | % | | 2.85 | % | | 13.4 | % | | 100.10 | % | | BBB |
| | 2,032,494 | | | 280,275 | | 91.35 | % | | 5.23 | % | | 3.42 | % | | 18.2 | % | | 101.60 | % | | BBB |
| | 3,720,114 | | | 827,063 | | 96.17 | % | | 3.83 | % | | none | | | 16.9 | % | | 106.90 | % | | BBB |
| | 910,353 | | | 733,342 | | 96.17 | % | | 3.83 | % | | none | | | 49.9 | % | | 107.70 | % | | AAA |
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The following table presents the maturity and yields of securities at their amortized cost at the date indicated.
Maturity Distribution and Yields of Securities
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2008 | |
| | | 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 | | $ | 24,000 | | 0.80 | % | | $ | 5,002 | | 5.03 | % | | $ | 4,147 | | 6.08 | % | | | — | | 0.00 | % | | $ | 33,149 | | 2.10 | % |
Mortgage-backed securities | | | 1,821 | | 3.78 | % | | | 19,405 | | 4.54 | % | | | 26,501 | | 4.98 | % | | $ | 2,693 | | 5.92 | % | | | 50,420 | | 4.82 | % |
States and political subdivisions (1) | | | 3,539 | | 6.30 | % | | | 15,062 | | 5.98 | % | | | 8,627 | | 6.21 | % | | | 12,149 | | 6.34 | % | | | 39,377 | | 6.17 | % |
Corporate, CMO and other securities | | | — | | 0.00 | % | | | 24,573 | | 5.08 | % | | | 11,108 | | 6.39 | % | | | 12,222 | | 5.27 | % | | | 47,903 | | 5.43 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
Total securities | | $ | 29,360 | | 1.65 | % | | $ | 64,042 | | 5.12 | % | | $ | 50,383 | | 5.59 | % | | $ | 27,064 | | 5.81 | % | | $ | 170,849 | | 4.77 | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| (1) | Yields on tax- exempt securities have been calculated on a tax equivalent basis at 5.90% for 2008. |
See Note 3 to the Consolidated Financial Statements.
Deposits
We have 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 our 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 (FHLB) is utilized for funding when the cost of borrowed funds falls below the cost of new interest-bearing deposits. We also utilize purchased deposits from a couple of sources when the rates are below our market rates. At year end 2008, our total deposit balance was $813.5 million an increase of $141.6 million from $671.9 million at year end 2007. This growth included $93 million acquired in our branch purchase, while the remainder is from market growth and an increase in brokered deposits. Our loan growth in 2008 continued at a rapid rate that drove a demand for funding which our normal markets could not handle that quickly since rates were dropping throughout the year. Management decided to increase the level of brokered deposits on a short-term basis. At year end 2008, there were $55.0 million in brokered deposits. This included about $20 million that mature in early January 2009 but were prefunded in December. Noninterest-bearing deposits decreased by $5.7 million or 6.0% to $90.1 million at 2008 year-end compared to $95.8 million at December 31, 2007.
A more representative review of the year long funding picture is the average deposits for the year, which reflect how much we are really funding over the year. For 2008, average total deposits of $753.7 million represented a 14.2% increase over the 2007 average of $660.1 million. Average deposits for 2008 grew in all categories except demand and savings deposits. Noninterest bearing average deposits declined $1.4 million to $96.9 million for 2008, a decline that has been going on since a high in 2005. Savings decreased $7.2 million, or 7.8%, compared to 2007 when this same category declined 17.7%. In looking at these two categories, it is important to note that the trend in our lowest cost deposit categories is down which forces the bank to pay more for deposits. Money market accounts grew 28.2% to $52.3 million while the rate was down 1 basis point. In 2008, large dollar and regular certificates of deposit increased $22.4 million, or 18.5%, and $29.2 million, or 13.7%, respectively, continuing a trend seen since 2006. Interest bearing checking accounts (NOW) increased $39.1 million, or 37.0%, in 2008 compared to an increase of $24.5 million in 2007. This increase is attributed to our Reward Checking product, whose balances have continually grown since its introduction in late 2006. This product pays an above market interest rate if customers achieve some basic requirements that encourage the customer to utilize electronic transactions which are less costly to the bank.
NOW accounts, at an average balance of $144.6 million are our second largest deposit category after consumer certificates of deposit and total $242.2 million. The actual annual yield on NOW account has risen from 1.77% in 2007 to 2.02% in 2008. While this is a high rate for what used to be considered “cheap” money, it is well below 4.46% and 3.76% for large and consumer certificates, respectively. Attracting deposits to our bank has been a
41
challenge over the last three years. The high interest rate environment in the market three years ago, then the rapid decline in rates in 2008, coupled with the plummeting economy have made customers and potential customers fearful of what will happen to their money. Management’s challenge in 2009 is to manage the net interest margin in a recessionary economy by anticipating, reacting to and adjusting to each new change in the markets.
Total deposits at 2007 year-end of $671.9 million were an increase of $17.9 million, or 2.7%, compared to $654.0 million at 2006 year-end. The deposit growth in 2007 was the result of increases in certificates of deposit and NOW deposits. All other deposit categories declined in 2007. Average deposits for 2007 were $660.1 million, an increase of 4.3%, or $27.2 million, compared to 2006 average deposits of $632.9 million.
The following table presents average deposit balances and rates for the periods indicated:
Average Deposits and Rates Paid
| | | | | | | | | | | | | | | | | | |
| | | Years Ended December 31 | |
| | | 2008 | | | 2007 | | | 2006 | |
(dollars in thousands) | | Amount | | Rate | | | Amount | | Rate | | | Amount | | Rate | |
Noninterest bearing demand deposits | | $ | 96,874 | | | | | $ | 98,282 | | | | | $ | 99,213 | | | |
Interest-bearing deposits: | | | | | | | | | | | | | | | | | | |
Checking (NOW accounts) | | | 144,558 | | 2.02 | % | | | 105,494 | | 1.77 | % | | | 80,962 | | 0.53 | % |
Money market accounts | | | 52,321 | | 2.40 | % | | | 40,817 | | 2.41 | % | | | 45,006 | | 2.08 | % |
Regular savings accounts | | | 74,667 | | 0.90 | % | | | 81,843 | | 1.16 | % | | | 99,509 | | 1.25 | % |
Large denomination certificates (1) (2) | | | 143,115 | | 4.46 | % | | | 120,735 | | 4.80 | % | | | 103,789 | | 4.34 | % |
Other certificates of deposit (2) | | | 242,184 | | 3.76 | % | | | 212,967 | | 4.47 | % | | | 204,440 | | 3.92 | % |
| | | | | | | | | | | | | | | | | | |
Total interest-bearing | | | 656,845 | | 3.10 | % | | | 561,856 | | 3.40 | % | | | 533,706 | | 2.83 | % |
| | | | | | | | | | | | | | | | | | |
Total average deposits | | $ | 753,719 | | | | | $ | 660,138 | | | | | $ | 632,919 | | | |
| | | | | | | | | | | | | | | | | | |
| (1) | Certificates issued in amounts of $100,000 or greater |
| (2) | Includes some brokered deposits |
The following table presents the maturity schedule of large denomination certificates at the dates indicated:
Maturities of Large Denomination Certificates of Deposit (1) (2)
| | | | | | | | | | | | | | | | | | |
(dollars in thousands) | | Within
3 Months | | 3-6
Months | | 6-12
Months | | Over 12
Months | | Total | | Percent
of Total
Deposits | |
At December 31, 2008 | | $ | 33,188 | | $ | 22,220 | | $ | 95,733 | | $ | 29,281 | | $ | 180,422 | | 26.85 | % |
| (1) | Certificates issued in amounts of $100,000 or greater |
| (2) | Includes some brokered deposits |
Capital Resources
Capital resources are managed to maintain a capital structure that provides us the ability to support asset growth, absorb potential losses and expand our franchise when appropriate. Capital represents original investment by shareholders plus retained earnings and provides financial resources over which we 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, 2008, we had a total risk based capital ratio of 11.56% and a Tier 1 leverage ratio of 8.62%, both in excess of regulatory guidelines and the amount needed to support our banking business.
42
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, we announced a stock repurchase program intended to reduce high capital levels and to increase return on equity to shareholders. This plan was amended in 2003 and the number of shares that can be repurchased is 5% of the outstanding shares on January 1 of each year. We repurchased 70,545 shares in 2008, 179,350 shares in 2007 and no shares in 2006. Details of the number of shares available and purchases by month can be seen in our 10-Q filings with the SEC. Theere were no shares repurchased in the third and fourth quarters of 2008.
In December 2006, we completed an offering of our common stock. We sold 1.15 million shares and received over $23.5 million (net proceeds) in new capital. These funds gave us flexibility in 2007 which allowed us to fund assets purchases early in 2007 with out borrowing and gave us flexibility in a tight deposit milieu.
Subsequent to year end, the January 9, 2009 issuance of preferred stock to the U. S. Treasury added $24 million to capital. The preferred stock will pay cumulative dividends at a fixed rate of 5% per annum for the first five years, and thereafter, at a rate of 9% per annum. There are no material commitments at this time but management estimates that all our capital ratios will increase by about 3.0%.
The following table provides an analysis of our capital as of December 31, 2008, 2007 and 2006. Note 19 in the Consolidated Financial Statements presents an analysis of the capital position of both our Company and EVB as of year-end 2008, 2007 and 2006:
Analysis of Capital
| | | | | | | | | | | | |
| | | At December 31, | |
(dollars in thousands) | | 2008 | | | 2007 | | | 2006 | |
Tier 1 capital: | | | | | | | | | | | | |
Common stock | | $ | 11,798 | | | $ | 11,865 | | | $ | 12,166 | |
Surplus | | | 18,456 | | | | 18,812 | | | | 21,276 | |
Retained earnings | | | 62,804 | | | | 63,616 | | | | 58,731 | |
| | | | | | | | | | | | |
Total equity | | | 93,058 | | | | 94,293 | | | | 92,173 | |
Trust preferred debt | | | 10,000 | | | | 10,000 | | | | 10,000 | |
Less goodwill and intangibles | | | (16,472 | ) | | | (6,496 | ) | | | (6,776 | ) |
| | | | | | | | | | | | |
Total Tier 1 capital | | | 86,586 | | | | 97,797 | | | | 95,397 | |
Tier 2 capital: | | | | | | | | | | | | |
Allowance for loan losses | | | 10,301 | | | | 7,888 | | | | 7,051 | |
Deductions for other investments (1) | | | 1,658 | | | | 1,260 | | | | 1,448 | |
| | | | | | | | | | | | |
Total risk-based capital | | | 95,229 | | | | 104,425 | | | | 101,000 | |
Risk-weighted assets | | | 823,862 | | | | 707,850 | | | | 634,287 | |
Capital ratios: | | | | | | | | | | | | |
Tier 1 risk based capital | | | 10.51 | % | | | 13.82 | % | | | 15.04 | % |
Total risk based capital | | | 11.56 | % | | | 14.75 | % | | | 15.92 | % |
Tier 1 capital to average total assets | | | 8.62 | % | | | 10.80 | % | | | 11.57 | % |
| (1) | Regulatory authorities require a deduction from capital for the value of other LLC’s in which we have an ownership interest. |
43
Off -Balance Sheet Arrangements
At December 31, 2008, we had $131.7 million of off-balance sheet credit exposure in the form of $125.4 million of commitments to grant loans and unfunded commitments under lines of credit and $6.3 million of standby letters of credit. 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 us, is based on our 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 we are committed.
Standby letters of credit are conditional commitments issued by us 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 a loan to our customers. We generally hold collateral supporting those commitments if deemed necessary.
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. Our management of liquid assets provides a liquidity level that we believe is sufficient to satisfy our depositors’ requirements and to meet our customers’ credit needs. At December 31, 2008, $366.4 million or 37.6% of total earning assets were due to mature or reprice within the next year.
We also maintain additional sources of liquidity through a variety of borrowing arrangements. Federal funds borrowing arrangements with major regional banks combined with immediately available lines of credit with the Federal Home Loan Bank totaled $26.6 million at December 31, 2008. At year-end 2008, we had $134.6 million of FHLB borrowings outstanding. During 2008, we executed new borrowings of $9.0 million and had paydowns of $1.5 million in FHLB borrowings.
The following table presents our contractual obligations and scheduled payment amounts due at various intervals over the next five years and beyond.
As of 12/31/2008
| | | | | | | | | | | | | | | |
| | | Payments Due by Period |
| | | Total | | Less than
1 year | | 1-3 years | | 3-5 years | | Over 5 years |
| | | (dollars in thousands) |
Long-term debt | | $ | 144,643 | | $ | 11,429 | | $ | 15,714 | | $ | — | | $ | 117,500 |
Capital lease obligations | | | — | | | — | | | — | | | — | | | — |
Operating leases | | | 1,882 | | | 446 | | | 799 | | | 553 | | | 84 |
Purchase obligations | | | — | | | — | | | — | | | — | | | — |
Other long-term liabilities | | | — | | | — | | | — | | | — | | | — |
| | | | | | | | | | | | | | | |
Total | | $ | 146,525 | | $ | 11,875 | | $ | 16,513 | | $ | 553 | | $ | 117,584 |
| | | | | | | | | | | | | | | |
44
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 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. Our market risk is composed primarily of interest rate risk. We are responsible for reviewing the interest rate sensitivity position of EVB and establishing policies to monitor and limit exposure to interest rate risk. The Board of Directors reviews guidelines established by Management. It is our policy not to engage in activities considered to be derivative in nature such as futures, option contracts, swaps, caps, floors, collars or forward commitments. We consider derivatives as speculative which is contrary to our historical or prospective philosophy. We do not hold or issue financial instruments for trading purposes. We do hold in our loan and securities portfolios investments that adjust or float according to changes in index rates which is not considered speculative, but necessary for good asset/liability management.
Asset/Liability Risk Management: The primary goals of asset/liability risk management are to maximize net interest income and the net value of our future cash flows within the interest rate limits set by our 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 our interest rate risk, 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 a negative 10.91% 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.
45
The most recent earnings simulation model projects net income would decrease approximately 12.06% of stable rate or base net income if rates were to fall immediately by 200 basis points. It projects a decrease of approximately 1.57% if rates rise by 200 basis points. Management believes this reflects an asset sensitive interest risk for the one-year horizon although an alternative calculation indicates an asset sensitive position in a 90 day horizon and a slightly liability sensitive position in a 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.
At year-end, a 200 basis point immediate increase in rates is estimated to decrease NPV by 15.68%. Additionally, NPV is estimated to decrease by 11.49% 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:
| | | | | | |
| | | 2008 | | | 2007 | |
Static 1 - Year Cumulative Gap | | -10.91 | % | | 0.44 | % |
1 - Year net income simulation projection: | | | | | | |
- 200 basis point shock vs. stable rate | | -12.06 | % | | -21.50 | % |
+ 200 basis point shock vs. stable rate | | 1.21 | % | | 2.12 | % |
Static net present value change: | | | | | | |
- 200 basis point shock vs. stable rate | | -11.49 | % | | 0.31 | % |
+ 200 basis point shock vs. stable rate | | -15.68 | % | | -13.08 | % |
| Item 8. | Financial Statements and Supplementary Data |
The following financial statements are filed as a part of this report following item 15:
| | • | | Report of Independent Registered Public Accounting Firm |
46
| | • | | Consolidated Balance Sheets as of December 31, 2008 and 2007 |
| | • | | Consolidated Statements of Income for the three years ended December 31, 2008 |
| | • | | Consolidated Statements of Changes in Shareholders’ Equity for the three years ended December 31, 2008 |
| | • | | Consolidated Statements of Cash Flows for the three years ended December 31, 2008 |
| | • | | Notes to Consolidated Financial Statements |
| Item 9. | Changes in and Disagreements with Accountants on Accounting and Financial Disclosure |
None.
| Item 9A. | Controls and Procedures |
Disclosure Controls and Procedures
We maintain disclosure controls and procedures that are designed to provide assurance that the information required to be disclosed in the reports that we file or submit under the Securities 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 our 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 our 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). Our internal control over financial reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our Company’s financial statements for external purposes in accordance with accounting principles generally accepted in the United States of America.
As of December 31, 2008, management has assessed the effectiveness of our 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 we maintained effective internal control over financial reporting as of December 31, 2008, based on those criteria.
Yount, Hyde and Barbour, P.C., the independent registered public accounting firm that audited our consolidated financial statements, included in this Annual Report on Form 10-K, has issued an attestation report on the effectiveness of our internal control over financial reporting as of December 31, 2008. The report, which states an unqualified opinion on the effectiveness of our internal control over financial reporting as of December 31, 2008, is incorporated by reference in Item 8 above, under the heading “Report of Independent Registered Public Accounting Firm.”
No changes were made in our internal control over financial reporting during the quarter ended December 31, 2008 that have materially affected, or that are reasonably likely to materially affect, our internal control over financial reporting.
47
| Item 9B. | Other Information |
None.
PART III
| Item 10. | Directors, Executive Officers and Corporate Governance |
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 2009 annual meeting of shareholders, and for executive officers is listed below:
| Item 11. | Executive Compensation |
The response to this Item is incorporated by reference to the information under the captions “Executive Compensation” and “Director Compensation” in EVB’s Proxy Statement for the 2009 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 captions “Ownership of Stock” and “Executive Compensation” in our Proxy Statement for the 2009 annual meeting of shareholders.
| Item 13. | Certain Relationships and Related Transactions, and Director Independence |
The response to this Item is incorporated by reference to the information under the captions “Corporate Governance and the Board of Directors, including the statement on independence of directors” and “Transactions with Management” in our Proxy Statement for the 2009 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 2009 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 | | Amended and restated Articles of Incorporation of Eastern Virginia Bankshares, Inc., as amended and restated on December 29, 2008. |
| |
| 3.2 | | Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., attached as Exhibit 3.1 to the Company’s current report on form 8-K filed January 13, 2009, incorporated herein by reference. |
| |
| 3.3 | | Bylaws of Eastern Virginia Bankshares, Inc., as amended February 21, 2008, attached as Exhibit 3.1 to the Company’s current Report on Form 8- K filed February 27, 2008, incorporated herein by reference. |
48
| | |
| 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 herein by reference. * |
| |
| 10.2 | | Eastern Virginia Bankshares, Inc. 2007 Equity Compensation Plan, included in the Company’s 2007 Proxy Statement, as filed with the Commission on March 21, 2007, incorporated herein by reference. * |
| |
| 10.3 | | Employment Agreement dated as of January 1, 2008, between Eastern Virginia Bankshares, Inc. and Joe A. Shearin. * |
| |
| 10.4 | | Employment Agreement dated as of March 4, 2008, between Eastern Virginia Bankshares, Inc. and Ronald L. Blevins. * |
| |
| 10.5 | | Employment Agreement dated as of March 4, 2008 between Eastern Virginia Bankshares, Inc. and Joseph H. James. * |
| |
| 10.6 | | Employment Agreement dated as of June 10, 2008, between Eastern Virginia Bankshares, Inc. and James S. Thomas. * |
| |
| 10.7 | | Purchase and Assumption Agreement between EVB and Millennium Bank, N.A., attached as Exhibit 99.2 to the Company’s Current Report on Form 8-K, filed December 3, 2007, incorporated herein by reference. |
| |
| 13.1 | | Excerpt from the 2008 Annual Report to Shareholders with respect to Market for the Company’s Common Stock. |
| |
| 13.2 | | Excerpt from the 2008 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, 2008, as filed with the Securities and Exchange Commission.)
49
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 10, 2009 |
| | Ronald L. Blevins | | | | | | |
| | 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 4, 2009.
| | |
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) |
50
EXHIBIT INDEX
| | |
Exhibit Number | | |
| |
| 3.1 | | Amended and restated Articles of Incorporation of Eastern Virginia Bankshares, Inc., as amended and restated on December 29, 2008. |
| |
| 3.2 | | Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., attached as Exhibit 3.1 to the Company’s current report on form 8-K filed January 13, 2009, incorporated herein by reference. |
| |
| 3.3 | | Bylaws of Eastern Virginia Bankshares, Inc., as amended February 21, 2008, attached as Exhibit 3.1 to the Company’s current Report on Form 8- K filed, February 27, 2008, 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 herein by reference. * |
| |
| 10.2 | | Eastern Virginia Bankshares, Inc. 2007 Equity Compensation Plan, included in the Company’s 2007 Proxy Statement, as filed with the Commission on March 21, 2007, incorporated herein by reference. * |
| |
| 10.3 | | Employment Agreement dated as of January 1, 2008, between Eastern Virginia Bankshares, Inc. and Joe A. Shearin. * |
| |
| 10.4 | | Employment Agreement dated as of March 4, 2008, between Eastern Virginia Bankshares, Inc. and Ronald L. Blevins. * |
| |
| 10.5 | | Employment Agreement dated as of March 4, 2008 between Eastern Virginia Bankshares, Inc. and Joseph H. James.* |
| |
| 10.6 | | Employment Agreement dated as of June 10, 2008, between Eastern Virginia Bankshares, Inc. and James S. Thomas.* |
| |
| 10.7 | | Purchase and Assumption Agreement between EVB and Millennium Bank, N.A., attached as Exhibit 99.2 to the Company’s Current Report on Form 8-K, filed December 3, 2007, incorporated herein by reference. |
| |
| 13.1 | | Excerpt from the 2008 Annual Report to Shareholders with respect to Market for the Company’s Common Stock. |
| |
| 13.2 | | Excerpt from the 2008 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 |
51
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
Eastern Virginia Bankshares, Inc.
Tappahannock, Virginia
We have audited the accompanying consolidated balance sheets of Eastern Virginia Bankshares, Inc. and subsidiaries as of December 31, 2008 and 2007, and the related consolidated statements of income, changes in shareholders’ equity, and cash flows for the years ended December 31, 2008, 2007 and 2006. These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on these financial statements 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 audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
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, 2008 and 2007, and the results of their operations and their cash flows for the years ended December 31, 2008, 2007 and 2006, in conformity with U.S. generally accepted accounting principles.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Eastern Virginia Bankshares, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission, and our report dated March 3, 2009 expressed an unqualified opinion on the effectiveness of Eastern Virginia Bankshares, Inc. and subsidiaries’ internal control over financial reporting.
|
 |
| Winchester, Virginia |
| March 3, 2009 |
52
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
To the Shareholders and Board of Directors
Eastern Virginia Bankshares, Inc.
Tappahannock, Virginia
We have audited Eastern Virginia Bankshares, Inc. and subsidiaries’ internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Eastern Virginia Bankshares, Inc. and subsidiaries’ management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanyingManagement’s Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the corporation’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A corporation’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 corporation’s internal control over financial reporting includes those policies and procedures that(a) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the corporation;(b) 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 corporation are being made only in accordance with authorizations of management and directors of the corporation; and(c) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the corporation’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, Eastern Virginia Bankshares, Inc. and subsidiaries maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established inInternal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.
We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets and the related consolidated statements of income, changes in shareholders’ equity and cash flows of Eastern Virginia Bankshares, Inc. and subsidiaries and our report dated March 3, 2009 expressed an unqualified opinion.
|
|
| Winchester, Virginia |
| March 3, 2009 |
53
PART I - FINANCIAL INFORMATION
| Item 1. | Financial Statements |
EASTERN VIRGINIA BANKSHARES, INC. and SUBSIDIARIES
Consolidated Balance Sheets
December 31, 2008 and 2007
| | | | | | | | |
| | | (dollars in thousands) | |
| | | 2008 | | | 2007 | |
Assets: | | | | | | | | |
Cash and due from banks | | $ | 13,214 | | | $ | 18,017 | |
Federal funds sold | | | — | | | | 367 | |
Securities available for sale, at fair value | | | 161,879 | | | | 160,865 | |
Loans, net of unearned income | | | 819,266 | | | | 708,817 | |
Allowance for loan losses | | | (10,542 | ) | | | (7,888 | ) |
| | | | | | | | |
Total loans, net | | | 808,724 | | | | 700,929 | |
| | | | | | | | |
Deferred income taxes | | | 12,930 | | | | 4,584 | |
Bank premises and equipment, net | | | 20,806 | | | | 18,261 | |
Accrued interest receivable | | | 4,050 | | | | 4,124 | |
Other real estate | | | 560 | | | | 1,056 | |
Goodwill | | | 15,970 | | | | 5,725 | |
Other assets | | | 13,230 | | | | 12,783 | |
| | | | | | | | |
Total assets | | $ | 1,051,363 | | | $ | 926,711 | |
| | | | | | | | |
Liabilities and Shareholders’ Equity: | | | | | | | | |
Liabilities | | | | | | | | |
Noninterest-bearing demand accounts | | $ | 90,091 | | | $ | 95,823 | |
Interest-bearing deposits | | | 723,442 | | | | 576,077 | |
| | | | | | | | |
Total deposits | | | 813,533 | | | | 671,900 | |
| | | | | | | | |
Federal funds purchased | | | 3,593 | | | | 17,099 | |
Federal Home Loan Bank (FHLB) advances | | | 134,643 | | | | 127,071 | |
Trust preferred debt | | | 10,310 | | | | 10,310 | |
Accrued interest payable | | | 2,512 | | | | 3,539 | |
Other liabilities | | | 8,743 | | | | 6,023 | |
| | | | | | | | |
Total liabilities | | | 973,334 | | | | 835,942 | |
| | | | | | | | |
Shareholders’ Equity | | | | | | | | |
Preferred stock, $2 par value, 50,000,000 shares authorized none issue | | | — | | | | — | |
Common stock, $2 par value per share, authorized 50,000,000 shares, issued and outstanding 5,912,553 (including 13,500 nonvested shares), and 5,947,443 (including 15,000 nonvested shares), respectively | | | 11,798 | | | | 11,865 | |
Surplus | | | 18,456 | | | | 18,811 | |
Retained earnings | | | 62,804 | | | | 63,616 | |
Accumulated other comprehensive (loss), net | | | (15,029 | ) | | | (3,523 | ) |
| | | | | | | | |
Total shareholders’ equity | | | 78,029 | | | | 90,769 | |
| | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 1,051,363 | | | $ | 926,711 | |
| | | | | | | | |
See Notes to Consolidated Financial Statements.
54
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Income
For the Years Ended December 31, 2008, 2007 and 2006
| | | | | | | | | | |
| | | (dollars in thousands, except per share data) |
| | | 2008 | | | 2007 | | 2006 |
Interest and Dividend Income | | | | | | | | | | |
Loans and fees on loans | | $ | 51,371 | | | $ | 50,626 | | $ | 44,503 |
Interest on investments: | | | | | | | | | | |
Taxable interest income | | | 5,918 | | | | 5,065 | | | 4,417 |
Tax exempt interest income | | | 1,658 | | | | 1,415 | | | 1,405 |
Dividends | | | 355 | | | | 457 | | | 392 |
Interest on federal funds sold | | | 84 | | | | 638 | | | 299 |
| | | | | | | | | | |
Total interest and dividend income | | | 59,386 | | | | 58,201 | | | 51,016 |
| | | | | | | | | | |
Interest Expense | | | | | | | | | | |
Deposits | | | 20,337 | | | | 19,121 | | | 15,130 |
Federal funds purchased | | | 90 | | | | 73 | | | 88 |
Interest on FHLB advances | | | 5,754 | | | | 4,919 | | | 3,415 |
Interest on trust preferred debt | | | 628 | | | | 849 | | | 811 |
| | | | | | | | | | |
Total interest expense | | | 26,809 | | | | 24,962 | | | 19,444 |
| | | | | | | | | | |
Net interest income | | | 32,577 | | | | 33,239 | | | 31,572 |
Provision for Loan Losses | | | 4,025 | | | | 1,238 | | | 725 |
| | | | | | | | | | |
Net interest income after provision for loan losses | | | 28,552 | | | | 32,001 | | | 30,847 |
| | | | | | | | | | |
Noninterest Income: | | | | | | | | | | |
Service charges on deposit accounts | | | 3,991 | | | | 3,671 | | | 3,234 |
Debit/credit card fees | | | 1,135 | | | | 844 | | | 509 |
Other operating income | | | 1,405 | | | | 1,581 | | | 1,386 |
Gain on sale of available for sale securities, net | | | 44 | | | | 14 | | | 36 |
Impairment on securities available for sale | | | (4,933 | ) | | | — | | | — |
Actuarial gain on pension curltailment | | | 1,328 | | | | — | | | — |
| | | | | | | | | | |
Total noninterest income | | | 2,970 | | | | 6,110 | | | 5,165 |
| | | | | | | | | | |
Noninterest Expenses: | | | | | | | | | | |
Salaries and benefits | | | 14,776 | | | | 14,547 | | | 14,667 |
Occupancy and equipment expense | | | 4,738 | | | | 4,282 | | | 3,906 |
Telephone | | | 996 | | | | 613 | | | 571 |
Consultant fees | | | 653 | | | | 629 | | | 768 |
Marketing and advertising | | | 874 | | | | 756 | | | 871 |
Other operating expenses | | | 5,908 | | | | 5,047 | | | 5,036 |
| | | | | | | | | | |
Total noninterest expense | | | 27,945 | | | | 25,874 | | | 25,819 |
| | | | | | | | | | |
Income before income taxes | | | 3,577 | | | | 12,237 | | | 10,193 |
Income Tax Expense | | | 506 | | | | 3,483 | | | 2,956 |
| | | | | | | | | | |
Net income | | $ | 3,071 | | | $ | 8,754 | | $ | 7,237 |
| | | | | | | | | | |
Net income per common share: | | | | | | | | | | |
Basic | | $ | 0.52 | | | $ | 1.45 | | $ | 1.45 |
| | | | | | | | | | |
Diluted | | $ | 0.52 | | | $ | 1.45 | | $ | 1.45 |
| | | | | | | | | | |
Dividends Per Share | | $ | 0.64 | | | $ | 0.64 | | $ | 0.63 |
| | | | | | | | | | |
See Notes to Consolidated Financial Statements.
55
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2008, 2007 and 2006
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2008 | | | 2007 | | | 2006 | |
Cash Flows from Operating Activities | | | | | | | | | | | | |
Net income | | $ | 3,071 | | | $ | 8,754 | | | $ | 7,237 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
(Gain) loss from equity investment in partnership | | | (130 | ) | | | 16 | | | | 16 | |
Depreciation and amortization, net | | | 2,215 | | | | 1,984 | | | | 1,917 | |
Deferred tax provision (benefit) | | | (2,096 | ) | | | (439 | ) | | | (1,323 | ) |
Provision for loan losses | | | 4,025 | | | | 1,238 | | | | 725 | |
Gain realized on sale of fixed assets | | | (129 | ) | | | (12 | ) | | | (26 | ) |
(Gain) realized on available for sale securities, net | | | (44 | ) | | | (14 | ) | | | (36 | ) |
Actuarial Gain- Pension Curtailment | | | (1,328 | ) | | | — | | | | — | |
Impairment on securities | | | 4,933 | | | | — | | | | — | |
Impairment on OREO | | | 229 | | | | — | | | | — | |
Accretion and amortization on securities, net | | | 20 | | | | 59 | | | | 265 | |
Stock based compensation | | | 277 | | | | 250 | | | | 210 | |
Changes in assets and liabilities: | | | | | | | | | | | | |
(Increase) decrease in accrued interest receivable | | | 247 | | | | 8 | | | | (549 | ) |
(Increase) decrease in other assets | | | (1,913 | ) | | | 386 | | | | (899 | ) |
Increase (decrease) in accrued interest payable | | | (1,234 | ) | | | 1,261 | | | | 1,014 | |
Increase in other liabilities | | | 85 | | | | 1,449 | | | | 1,237 | |
| | | | | | | | | | | | |
Net cash provided by operating activities | | | 8,228 | | | | 14,940 | | | | 9,788 | |
| | | | | | | | | | | | |
Cash Flows from Investing Activities | | | | | | | | | | | | |
Proceeds from sales of securities available for sale | | | 5,624 | | | | 4,070 | | | | 4,746 | |
Maturities and principal repayments of securities available for sale | | | 83,178 | | | | 11,632 | | | | 12,977 | |
Purchases of securities available for sale | | | (107,627 | ) | | | (50,271 | ) | | | (10,742 | ) |
Purchase of restricted stock, net | | | (812 | ) | | | — | | | | — | |
Proceeds from sale of other real estate | | | 950 | | | | — | | | | — | |
Acquisition of branches | | | 33,995 | | | | — | | | | — | |
Improvement to other real estate | | | (123 | ) | | | — | | | | — | |
Net (increase) in loans | | | (63,483 | ) | | | (59,782 | ) | | | (76,681 | ) |
Purchases of bank premises and equipment | | | (4,658 | ) | | | (3,338 | ) | | | (3,676 | ) |
Proceeds from sale of bank premises and equipment | | | 209 | | | | 12 | | | | 26 | |
| | | | | | | | | | | | |
Net cash (used in) investing activities | | | (52,747 | ) | | | (97,677 | ) | | | (73,350 | ) |
| | | | | | | | | | | | |
56
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Cash Flows
For the Years Ended December 31, 2008, 2007 and 2006
(continued)
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2008 | | | 2007 | | | 2006 | |
Cash Flows from Financing Activities | | | | | | | | | | | | |
Net increase (decrease) in demand deposit accounts, interest-bearing demand deposits and savings accounts | | | 16,488 | | | | 16,594 | | | | (25,657 | ) |
Net increase in certificates of deposit | | | 33,272 | | | | 1,327 | | | | 51,293 | |
Proceeds from Federal Home Loan Bank advances | | | 18,000 | | | | 85,000 | | | | 40,000 | |
Repayments of Federal Home Loan Bank advances | | | (10,428 | ) | | | (48,429 | ) | | | (1,429 | ) |
Increase (decrease) in federal funds purchased | | | (13,506 | ) | | | 17,099 | | | | (6,822 | ) |
Repurchases and retirement of stock | | | (1,237 | ) | | | (3,610 | ) | | | — | |
Exercise of stock options | | | — | | | | 38 | | | | 13 | |
Issuance of common stock under dividend reinvestment plan | | | 434 | | | | 413 | | | | 394 | |
Issuance of common stock under stock offering | | | — | | | | — | | | | 23,576 | |
Director stock grant | | | 104 | | | | 143 | | | | 191 | |
Dividends paid | | | (3,778 | ) | | | (3,869 | ) | | | (3,098 | ) |
| | | | | | | | | | | | |
Net cash provided by financing activities | | | 39,349 | | | | 64,706 | | | | 78,461 | |
| | | | | | | | | | | | |
Cash and Cash Equivalents | | | | | | | | | | | | |
Beginning of year | | | 18,384 | | | | 36,415 | | | | 21,516 | |
Net increase (decrease) in cash and cash equivalents | | | (5,170 | ) | | | (18,031 | ) | | | 14,899 | |
| | | | | | | | | | | | |
End of year | | $ | 13,214 | | | $ | 18,384 | | | $ | 36,415 | |
| | | | | | | | | | | | |
Supplemental Disclosures of Cash Flow Information | | | | | | | | | | | | |
Cash payments for interest | | $ | 27,836 | | | $ | 23,701 | | | $ | 18,431 | |
| | | | | | | | | | | | |
Cash payments for income taxes | | $ | 2,370 | | | $ | 4,009 | | | $ | 2,956 | |
| | | | | | | | | | | | |
Supplemental Disclosures of Noncash Investing and Financing Activities | | | | | | | | | | | | |
Transfers from loans to foreclosed real estate | | $ | 559 | | | $ | 1,056 | | | $ | — | |
| | | | | | | | | | | | |
Unrealized (loss) on securities available for sale | | $ | (13,714 | ) | | $ | (754 | ) | | $ | (1,044 | ) |
| | | | | | | | | | | | |
Minimum pension liability and change in measurement date adjustment | | $ | (4,147 | ) | | $ | 1,949 | | | $ | (2,881 | ) |
| | | | | | | | | | | | |
Details of acquisition of branches: | | | | | | | | | | | | |
Fair value of assets acquired | | $ | 49,171 | | | $ | — | | | $ | — | |
Fair value of liabilities assumed | | | 93,706 | | | | — | | | | — | |
Purchase price in excess of net assets acquired | | | 10,265 | | | | — | | | | — | |
| | | | | | | | | | | | |
Cash received | | | 34,270 | | | | — | | | | — | |
Less cash acquired | | | (275 | ) | | | — | | | | — | |
| | | | | | | | | | | | |
Net cash received for acquisition | | $ | 33,995 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | |
57
EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
For the Years Ended December 31, 2008, 2007 and 2006
(dollars in thousands)
| | | | | | | | | | | | | | | | | | | | | | | | |
| | | Common
Stock | | | Surplus | | | Retained
Earnings | | | Accumulated
Other
Comprehensive
Income (Loss) | | | Comprehensive
Income (loss) | | | Total | |
Balance, December 31, 2005 | | $ | 9,812 | | | $ | — | | | $ | 53,838 | | | $ | (1,776 | ) | | | | | | $ | 61,874 | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Net income - 2006 | | | — | | | | — | | | | 7,237 | | | | — | | | $ | 7,237 | | | | 7,237 | |
Other comprehensive loss: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized securities losses arising during period, (net of tax, $343) | | | — | | | | — | | | | — | | | | — | | | | (665 | ) | | | — | |
Reclassification adjustment, (net of tax, $12) | | | — | | | | — | | | | — | | | | — | | | | (24 | ) | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Other comprehensive loss | | | — | | | | — | | | | — | | | | (689 | ) | | | (689 | ) | | | (689 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | | — | | | | — | | | | — | | | $ | 6,548 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Adjustment to initially apply FASB Statement | | | — | | | | — | | | | | | | | (1,901 | ) | | | | | | | (1,901 | ) |
No. 158, net of tax ($980) | | | — | | | | — | | | | — | | | | — | | | | | | | | — | |
Cash dividends declared | | | — | | | | — | | | | (3,098 | ) | | | — | | | | | | | | (3,098 | ) |
Stock-based compensation | | | — | | | | — | | | | 210 | | | | — | | | | | | | | 210 | |
Director stock grant | | | 17 | | | | — | | | | 174 | | | | — | | | | | | | | 191 | |
Stock options exercised | | | 1 | | | | — | | | | 12 | | | | — | | | | | | | | 13 | |
Issuance of common stock under offering, net | | | 2,300 | | | | 21,276 | | | | — | | | | — | | | | | | | | 23,576 | |
Issuance of common stock under dividend | | | | | | | | | | | | | | | | | | | | | | | — | |
reinvestment plan | | | 36 | | | | — | | | | 358 | | | | — | | | | | | | | 394 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2006 | | $ | 12,166 | | | $ | 21,276 | | | $ | 58,731 | | | $ | (4,366 | ) | | | | | | $ | 87,807 | |
Comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Net income - 2007 | | | — | | | | | | | | 8,754 | | | | — | | | $ | 8,754 | | | | 8,754 | |
Other comprehensive income: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized securities losses arising during period, (net of tax, $296) | | | — | | | | | | | | — | | | | — | | | | (444 | ) | | | — | |
Reclassification adjustment, (net of tax, $5) | | | — | | | | | | | | — | | | | — | | | | (9 | ) | | | — | |
Change in unfunded pension liability | | | | | | | | | | | | | | | | | | | | | | | | |
(net of tax ($653)) | | | — | | | | | | | | — | | | | — | | | | 1,296 | | | | — | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Other comprehensive income | | | | | | | | | | | | | | | 843 | | | | 843 | | | | 843 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive income | | | — | | | | | | | | — | | | | — | | | $ | 9,597 | | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Cash dividends declared | | | — | | | | | | | | (3,869 | ) | | | — | | | | | | | | (3,869 | ) |
Stock-based compensation | | | — | | | | 250 | | | | — | | | | — | | | | | | | | 250 | |
Director stock grant | | | 13 | | | | 130 | | | | — | | | | — | | | | | | | | 143 | |
Stock options exercised | | | 5 | | | | 33 | | | | — | | | | | | | | | | | | 38 | |
Shares purchased and retired | | | (359 | ) | | | (3,251 | ) | | | — | | | | — | | | | | | | | (3,610 | ) |
Issuance of common stock under dividend reinvestment plan | | | 40 | | | | 373 | | | | — | | | | — | | | | | | | | 413 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2007 | | $ | 11,865 | | | $ | 18,811 | | | $ | 63,616 | | | $ | (3,523 | ) | | | | | | $ | 90,769 | |
Comprehensive (loss): | | | | | | | | | | | | | | | | | | | | | | | | |
Net income - 2008 | | | — | | | | | | | | 3,071 | | | | — | | | $ | 3,071 | | | | 3,071 | |
Other comprehensive loss: | | | | | | | | | | | | | | | | | | | | | | | | |
Unrealized securities losses arising during period, (net of tax, ($4,785 million)) | | | — | | | | | | | | — | | | | — | | | | (8,885 | ) | | | | |
Reclassification adjustment, (net of tax, $15) | | | — | | | | | | | | — | | | | — | | | | (29 | ) | | | | |
Change in unfunded pension liability | | | | | | | | | | | | | | | | | | | — | | | | | |
(net of tax ($653)) | | | — | | | | | | | | — | | | | — | | | | (2,592 | ) | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Other comprehensive loss | | | — | | | | | | | | — | | | | (11,506 | ) | | | (11,506 | ) | | | (11,506 | ) |
| | | | | | | | | | | | | | | | | | | | | | | | |
Total comprehensive loss | | | | | | | | | | | | | | | | | | $ | (8,435 | ) | | | | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Cash dividends declared | | | — | | | | | | | | (3,778 | ) | | | — | | | | | | | | (3,778 | ) |
Stock-based compensation | | | — | | | | 277 | | | | — | | | | — | | | | | | | | 277 | |
Director stock grant | | | 13 | | | | 91 | | | | — | | | | — | | | | | | | | 104 | |
Pension plan date change | | | — | | | | | | | | (105 | ) | | | | | | | | | | | (105 | ) |
Shares purchased and retired | | | (141 | ) | | | (1,096 | ) | | | | | | | | | | | | | | | (1,237 | ) |
Restricted common stock vested | | | 3 | | | | (3 | ) | | | | | | | | | | | | | | | — | |
Issuance of common stock under dividend reinvestment plan | | | 58 | | | | 376 | | | | — | | | | — | | | | | | | | 434 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
Balance, December 31, 2008 | | $ | 11,798 | | | $ | 18,456 | | | $ | 62,804 | | | $ | (15,029 | ) | | | | | | $ | 78,029 | |
| | | | | | | | | | | | | | | | | | | | | | | | |
See Notes to Consolidated Financial Statements.
58
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”, “our Company”, “we” “us” or “our”) 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. is a bank holding company headquartered in Tappahannock, Virginia that was organized and chartered under the laws of the Commonwealth of Virginia on September 5, 1997 and commenced operations on December 29, 1997. We conduct our primary operations through our wholly-owned bank subsidiary, EVB. Two of our predecessor banks, Bank of Northumberland, Inc. and Southside Bank, were established in 1910. Seeking to accelerate our growth in a higher growth adjacent market, we started a de novo bank, Hanover Bank, in 2000. The three predecessor banks were merged and the surviving bank re-branded as EVB in April 2006.
Our primary activity is retail banking. Through our bank subsidiary, we provide full service banking including commercial and consumer demand and time deposit accounts, real estate, commercial and consumer loans, Visa revolving credit accounts, drive-in banking services, automated teller machine transactions, internet banking and wire transfer services. With 25 branches at 2008 year end, our bank serves diverse markets that primarily are in the counties of Caroline, Essex, Gloucester, Hanover, Henrico, King and Queen, King William, Lancaster, Middlesex, New Kent, Richmond, Northumberland, Southampton, Surry, Sussex and the City of Colonial Heights. Ancillary services provided by our bank include travelers’ checks, safe deposit box rentals, collections and other customary bank services to its customers. The majority of our 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 our trust preferred debt.
Our bank owns 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 770 share interest in Infinex, which it uses as a brokerage firm for the investment services it provides. The bank also 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. EVB Mortgage, Inc. was chartered in the first quarter of 2004 and began conducting business in the third quarter of 2004. The financial position and operating results of all of these subsidiaries are not significant to us as a whole and are not considered principal activities of our 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 we no longer eliminate through consolidation the $310 thousand that represents the equity investment in EVB Statutory Trust I. The subordinated debt of the trust is reflected as a liability of our Company.
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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 and deferred taxes.
Cash and Cash Equivalents
For purposes of the consolidated statements of cash flows, cash and cash equivalents include cash, 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. We do 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, we consider (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) our intent and ability to retain our 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
We grant mortgage, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans in our market area. The ability of our debtors to honor their contracts is dependent upon the real estate and general economic conditions in our market area. Loans that we have 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 for loans with a maturity greater than one year at origination.
The accrual of interest on loans, except credit cards, consumer loans 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.
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 current and future payments are reasonably assured.
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Notes to Consolidated Financial Statements
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. Our 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 our 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 or substandard. 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 we 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. We determine 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 collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment. Accordingly, we do 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 less cost to sell are periodically performed by our 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.
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Notes to Consolidated Financial Statements
Bank Premises and Equipment
Bank premises and equipment are stated at cost, less accumulated depreciation. Land is carried at cost. Depreciation and amortization are computed using the straight-line or declining-balance method for financial reporting purposes and are charged to expense over the estimated useful lives of the assets, ranging from three to thirty years. 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 basis of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statements of income.
Stock Compensation Plan
At December 31, 2008, we had two stock-based compensation plans, which are described more fully in Note 12. We account for these plans under the recognition and measurement principles of FASB Statement No. 123R “Share–Based Payment.” Stock-based compensation costs included in salaries and benefits expense totaled $277 thousand for the year 2008, $250 thousand for the year 2007 and $210 thousand for the year 2006.
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 to outstanding stock options and restricted stock awards, 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, and pension liability adjustments 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.
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Notes to Consolidated Financial Statements
Pension Plan
We have a defined benefit pension plan covering employees meeting certain age and service requirements. We compute the net periodic pension cost of the plan in accordance with FASB No. 158, “Employers’ Accounting for Defined Benefit Pensions and Other Post Retirement Plans.” See Note 10.
Advertising
We practice the policy of charging advertising costs to expense as incurred. Advertising expense totaled $559 thousand, $459 thousand, and $621 thousand for the three years ended December 31, 2008, 2007 and 2006, 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 28.5 months to seven years. Core deposit intangibles, net of amortization amounted to $503 thousand and $770 thousand at December 31, 2008 and 2007 respectively. Core deposit intangibles are included in other assets on our Consolidated Financial Statements.
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 prior to January 1, 2009. 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 amounted to $16.0 million and $5.7 million at December 31, 2008 and 2007, respectively. Goodwill is not amortized, but instead tested for impairment at least annually. Based on the testing, there were no impairment charges in 2008, 2007 or 2006.
Reclassifications
Certain reclassifications have been made to prior period balances to conform to the current year presentation.
Recent Accounting Pronouncements
In September 2006, the Financial Accounting Standards Board (FASB) reached a consensus on Emerging Issues Task Force (“EITF”) Issue 06-4, “Accounting for Deferred Compensation and Postretirement Benefit Aspects of Endorsement Split-Dollar Life Insurance Arrangements,” (“EITF Issue 06-4”). In March 2007, the FASB reached a consensus on EITF Issue 06-10, “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements,” (“EITF Issue 06-10”). Both of these standards require a company to recognize an obligation over an employee’s service period based upon the substantive agreement with the employee such as the promise to maintain a life insurance policy or provide a death benefit postretirement. The Company adopted the provisions of these standards effective January 1, 2008. The adoption of these standards was not material to the consolidated financial statements.
63
Notes to Consolidated Financial Statements
In September 2006, the FASB issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather, provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. This Statement is effective for financial statements issued for fiscal years beginning after November 15, 2007 and interim periods within those years. The FASB has approved a one-year deferral for the implementation of the Statement for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis.The Company adopted SFAS 157 effective January 1, 2008. The adoption of SFAS 157 was not material to the consolidated financial statements.
In February 2007, the FASB issued Statement of Financial Accounting Standards No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (SFAS 159). This Statement permits entities to choose to measure many financial instruments and certain other items at fair value. The objective of this Statement is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The fair value option established by this Statement permits all entities to choose to measure eligible items at fair value at specified election dates. A business entity shall report unrealized gains and losses on items for which the fair value option has been elected in earnings at each subsequent reporting date. The fair value option may be applied instrument by instrument and is irrevocable. SFAS 159 is effective as of the beginning of an entity’s first fiscal year that begins after November 15, 2007, with early adoption available in certain circumstances. The Company adopted SFAS 159 effective January 1, 2008. The Company decided not to report any existing financial assets or liabilities at fair value that are not already reported, thus the adoption of this statement did not have a material impact on the consolidated financial statements.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)). The Statement will significantly change the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes principles for how an acquirer recognizes and measures the identifiable assets acquired, liabilities assumed, and any noncontrolling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisition dates on or after the beginning of an entity’s first year that begins after December 15, 2008. The Company does not expect the implementation of SFAS 141(R) to have a material impact on its consolidated financial statements, at this time.
In December 2007, the FASB issued Statement of Financial Accounting Standards No. 160, “Noncontrolling Interests in Consolidated Financial Statements an Amendment of ARB No. 51” (SFAS 160). The Statement will significantly change the financial accounting and reporting of noncontrolling (or minority) interests in consolidated financial statements. SFAS 160 is effective as of the beginning of an entity’s first fiscal year that begins after December 15, 2008, with early adoption prohibited. The Company does not expect the implementation of SFAS 160 to have a material impact on its consolidated financial statements, at this time.
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Notes to Consolidated Financial Statements
In November 2007, the Securities and Exchange Commission (SEC) issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (SAB 109). SAB 109 expresses the current view of the staff that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SEC registrants are expected to apply the views in Question 1 of SAB 109 on a prospective basis to derivative loan commitments issued or modified in fiscal quarters beginning after December 15, 2007. Implementation of SAB 109 did not have a material impact on our consolidated financial statements.
In December 2007, the SEC issued Staff Accounting Bulletin No. 110, “Use of a Simplified Method in Developing Expected Term of Share Options” (SAB 110). SAB 110 expresses the current view of the staff that it will accept a company’s election to use the simplified method discussed in SAB 107 for estimating the expected term of “plain vanilla” share options regardless of whether the company has sufficient information to make more refined estimates. The staff noted that it understands that detailed information about employee exercise patterns may not be widely available by December 31, 2007. Accordingly, the staff will continue to accept, under certain circumstances, the use of the simplified method beyond December 31, 2007. Implementation of SAB 110 did not have a material impact on its consolidated financial statements.
In March 2008, the FASB issued SFAS No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of SFAS No. 133,” (“SFAS No. 161”). SFAS No. 161 requires that an entity provide enhanced disclosures related to derivative and hedging activities. SFAS No. 161 is effective for the Company on January 1, 2009.
In April 2008, the FASB issued FASB Staff Position (FSP) No. 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP No. 142-3”). FSP No. 142-3 amends the factors an entity should consider in developing renewal or extension assumptions used in determining the useful life of recognized intangible assets under FASB SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS No. 142”). The intent of FSP No. 142-3 is to improve the consistency between the useful life of a recognized intangible asset under SFAS No. 142 and the period of expected cash flows used to measure the fair value of the assets under SFAS No. 141(R). FSP No. 142-3 is effective for the Company on January 1, 2009, and applies prospectively to intangible assets that are acquired individually or with a group of other assets in business combinations and asset acquisitions. The adoption of FSP No. 142-3 is not expected to have a material impact on the Company’s consolidated financial statements.
In May 2008, the FASB issued SFAS No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” (“SFAS No. 162”). SFAS No. 162 identifies the sources of accounting principles and the framework for selecting the principles to be used in the preparation of financial statements of nongovernmental entities that are presented in conformity with generally accepted accounting principles. SFAS No. 162 is effective 60 days following the SEC’s approval of the Public Company Accounting Oversight Board amendments to AU Section 411, “The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles.” Management does not expect the adoption of the provision of SFAS No. 162 to have any impact on our consolidated financial statements.
65
Notes to Consolidated Financial Statements
In September 2008, the FASB issued FSP FAS 133-1 and FIN 45-4, “Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161,” (“FSP 133-1 and FIN 45-4”). FSP 133-1 and FIN 45-4 require a seller of credit derivatives to disclose information about its credit derivatives and hybrid instruments that have embedded credit derivatives to enable users of financial statements to assess their potential effect on its financial position, financial performance and cash flows. The disclosures required by FSP 133-1 and FIN 45-4 were effective for the Company on December 31, 2008 did not expected to have a material impact on our consolidated financial statements.
In October 2008, the FASB issued FSP FAS 157-3, “Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active,” (“FSP 157-3”). FSP 157-3 clarifies the application of SFAS No. 157 in determining the fair value of a financial asset during periods of inactive markets. FSP 157-3 was effective as of September 30, 2008 and did not have material impact on the Company’s consolidated financial statements.
In December 2008, the FASB issued FSP No. FAS 140-4 and FIN 46(R)-8, “Disclosures by Public Entities (Enterprises) about Transfers of Financial Assets and Interests in Variable Interest Entities.” FSP No. FAS 140-4 and FIN 46(R)-8 requires enhanced disclosures about transfers of financial assets and interests in variable interest entities. The FSP is effective for interim and annual periods ending after December 15, 2008. Since the FSP requires only additional disclosures concerning transfers of financial assets and interest in variable interest entities, adoption of the FSP will not affect the Company’s financial condition, results of operations or cash flows.
In January 2009, the FASB reached a consensus on EITF Issue 99-20-1. This FSP amends the impairment guidance in EITF Issue No. 99-20, “Recognition of Interest Income and Impairment on Purchased Beneficial Interests and Beneficial Interests That Continue to Be Held by a Transferor in Securitized Financial Assets,” to achieve more consistent determination of whether an other-than-temporary impairment has occurred. The FSP also retains and emphasizes the objective of an other-than-temporary impairment assessment and the related disclosure requirements in FASB Statement No. 115, “Accounting for Certain Investments in Debt and Equity Securities,” and other related guidance. The FSP is effective for interim and annual reporting periods ending after December 15, 2008 and shall be applied prospectively. The FSP was effective as of December 31, 2008 and did not have a material impact on the consolidated financial statements.
Note 2. Cash and Due From Banks
To comply with Federal Reserve Regulations, our subsidiary bank is required to maintain certain average reserve balances. For the final weekly reporting period in the years ended December 31, 2008 and 2007, the daily average required balances were approximately $75 thousand for both periods.
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Notes to Consolidated Financial Statements
Note 3. Securities
The amortized cost and fair value of securities, with gross unrealized gains and losses, follows:
| | | | | | | | | | | | |
| | | December 31, 2008 |
(dollars in thousands) | | Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Estimated
Fair Value |
Available for Sale: | | | | | | | | | | | | |
Obligations of U.S. Government agencies | | $ | 33,149 | | $ | 540 | | $ | 70 | | $ | 33,619 |
Mortgage-backed and CMO securities | | | 68,351 | | | 1,307 | | | 506 | | | 69,152 |
State and political subdivisions | | | 39,376 | | | 753 | | | 888 | | | 39,241 |
Pooled trust preferred securities | | | 19,075 | | | — | | | 15,493 | | | 3,582 |
FNMA and FHLMC preferred stock | | | 94 | | | — | | | — | | | 94 |
Corporate securities | | | 10,802 | | | — | | | 3,845 | | | 6,957 |
Restricted securities | | | 9,234 | | | — | | | — | | | 9,234 |
| | | | | | | | | | | | |
Total | | $ | 180,081 | | $ | 2,600 | | $ | 20,802 | | $ | 161,879 |
| | | | | | | | | | | | |
| |
| | | December 31, 2007 |
(dollars in thousands) | | Amortized
Cost | | Gross
Unrealized
Gains | | Gross
Unrealized
Losses | | Estimated
Fair Value |
Available for Sale: | | | | | | | | | | | | |
Obligations of U.S. Government agencies | | $ | 43,284 | | $ | 285 | | $ | 54 | | $ | 43,515 |
Mortgage-backed and CMO securities | | | 39,439 | | | 121 | | | 491 | | | 39,069 |
State and political subdivisions | | | 41,137 | | | 384 | | | 310 | | | 41,211 |
Pooled trust preferred securities | | | 18,207 | | | — | | | 1,822 | | | 16,385 |
FNMA and FHLMC preferred stock | | | 4,708 | | | 57 | | | 880 | | | 3,885 |
Corporate securities | | | 10,156 | | | 13 | | | 1,791 | | | 8,378 |
Restricted securities | | | 8,422 | | | — | | | — | | | 8,422 |
| | | | | | | | | | | | |
Total | | $ | 165,353 | | $ | 860 | | $ | 5,348 | | $ | 160,865 |
| | | | | | | | | | | | |
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Notes to Consolidated Financial Statements
The following is a comparison of amortized cost and estimated fair values of our securities by contractual maturity at December 31, 2008. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.
| | | | | | |
(dollars in thousands) | | Amortized
Cost | | Estimated
Fair Value |
Due in one year or less | | $ | 29,360 | | $ | 29,397 |
Due after one year through five years | | | 64,041 | | | 57,592 |
Due after five years through ten years | | | 50,382 | | | 48,262 |
Due after ten years | | | 27,064 | | | 17,394 |
Restricted securities | | | 9,234 | | | 9,234 |
| | | | | | |
Total | | $ | 180,081 | | $ | 161,879 |
| | | | | | |
At December 31, 2008, investments in an unrealized loss position that are temporarily impaired are:
| | | | | | | | | | | | | | | | | | |
| | | December 31, 2008 |
| | | Less than 12 months | | 12 months or more | | Total |
(dollars in thousands) Description of Securities | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss |
Obligations of U. S. Government agencies | | $ | 20,000 | | $ | — | | $ | 930 | | $ | 70 | | $ | 20,930 | | $ | 70 |
Mortgage-backed and CMO securities | | | 8,325 | | | 87 | | | 5,054 | | | 419 | | | 13,379 | | | 506 |
States and political subdivisions | | | 14,643 | | | 888 | | | — | | | — | | | 14,643 | | | 888 |
Pooled trust preferred securities | | | 736 | | | 197 | | | 2,846 | | | 15,296 | | | 3,582 | | | 15,493 |
Corporate securities | | | 2,960 | | | 536 | | | 3,997 | | | 3,309 | | | 6,957 | | | 3,845 |
| | | | | | | | | | | | | | | | | | |
| | $ | 46,664 | | $ | 1,708 | | $ | 12,827 | | $ | 19,094 | | $ | 59,491 | | $ | 20,802 |
| | | | | | | | | | | | | | | | | | |
We recognized other than temporary impairment charges as reflected on our income statement during 2008 of $4.6 million on our investments in the preferred stock of Federal Home Loan Mortgage Co (“FHLMC”) and Federal National Mortgage Association (“FNMA”). These mortgage agencies were taken over by the government resulting in severe stress in the financial industry, creating decreased capital adequacy in many financial institutions and were a significant cause of the need for a government bailout. Revocation of dividends resulted in the value of these securities falling more than 95% and requiring the other than temporary impairment.
Bonds with unrealized loss positions of less than 12 months duration at 2008 year-end included 8 federal agency mortgage backed issues, 2 corporate bonds, 33 municipal bonds, 1 corporate trust-preferred issue and 3 collateralized mortgage obligations (“CMO”). Securities with losses of one year or greater duration included 1 federal agency, 4 federal agency mortgage-backed securities, 9 corporate bonds, 6 corporate trust preferred securities, and 1 CMO. The unrealized loss positions
68
Notes to Consolidated Financial Statements
at December 31, 2008 were primarily related to widened market spreads or lack of an orderly market for corporate securities. Holdings of GMAC contained unrealized loss positions totaling $1.4 million. These securities have been downgraded by Moodys and Standard & Poors rating agencies to levels below investment grade. As of year-end, the Company held $3.0 million in GMAC bonds. Early in the year, we recognized an other than temporary impairment charge of $300 thousand on one of our GMAC holdings. These holdings are monitored regularly by the Company’s Chief Financial Officer and reported to the EVB Board on a monthly basis. Given the attractive yield and the belief that the risk of default is remote, we have not recommended sale of the holdings. GMAC has recently received approval to switch to a bank charter and has been approved to participate in the Treasury’s TARP Capital Purchase Program.
The 7 trust-preferred issues with losses include 6 pooled trust securities secured by debt of banks and insurance companies, primarily banks, and 1 similar issue consisting solely of bank borrowings. One of these pooled trust preferred issues is the senior A tranche rated AAA while the other 6 issues are the D “mezzanine” tranche rated BBB by Fitch at time of issue. None of the pooled trust securities have been downgraded by the rating agency. Additional information concerning the trust preferred holdings is presented in the Securities section of our Form 10-K for the year ended December 31, 2008.
At December 31, 2007, investments in an unrealized loss position that were temporarily impaired were:
| | | | | | | | | | | | | | | | | | |
| | | December 31, 2007 |
| | | Less than 12 months | | 12 months or more | | Total |
(dollars in thousands) Description of Securities | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss | | Fair
Value | | Unrealized
Loss |
Obligations of U. S. Government agencies | | $ | 14,275 | | $ | 22 | | $ | 5,873 | | $ | 32 | | $ | 20,148 | | $ | 54 |
Mortgage-backed and CMO securities | | | 2,303 | | | 29 | | | 27,924 | | | 462 | | | 30,227 | | | 491 |
States and political subdivisions | | | 5,650 | | | 51 | | | 5,026 | | | 259 | | | 10,676 | | | 310 |
Pooled trust preferred securities | | | 16,385 | | | 1,822 | | | — | | | — | | | 16,385 | | | 1,822 |
FNMA and FHLMC preferred stock | | | 671 | | | 329 | | | 1,180 | | | 551 | | | 1,851 | | | 880 |
Corporate securities | | | 299 | | | 2 | | | 6,565 | | | 1,789 | | | 6,864 | | | 1,791 |
| | | | | | | | | | | | | | | | | | |
| | $ | 39,583 | | $ | 2,255 | | $ | 46,568 | | $ | 3,093 | | $ | 86,151 | | $ | 5,348 |
| | | | | | | | | | | | | | | | | | |
For the years ended December 31, 2008, 2007 and 2006, proceeds from sales of securities available for sale amounted to $5.6 million, $4.1 million, and $4.7 million, respectively. Net realized gains amounted to $44 thousand, $14 thousand, and $36 thousand in 2008, 2007 and 2006, respectively. The book value of securities pledged to secure public deposits and for other purposes amounted to $15.3 million and $17.3 million at December 31, 2008 and 2007, respectively.
69
Notes to Consolidated Financial Statements
Note 4. Loans
The following is a comparison of loans by type that were outstanding at December 31, 2008 and 2007.
| | | | | | | | |
| | | 2008 | | | 2007 | |
| | | (in thousands) | |
Real estate - construction | | $ | 102,837 | | | $ | 98,877 | |
Real estate - mortgage | | | 372,067 | | | | 317,767 | |
Commercial real estate | | | 221,769 | | | | 178,011 | |
Commercial, industrial and agricultural loans | | | 69,024 | | | | 60,778 | |
Loans to individuals for household, family and other consumer expenditures | | | 47,226 | | | | 52,170 | |
All other loans | | | 6,354 | | | | 1,243 | |
| | | | | | | | |
Total gross loans | | | 819,277 | | | | 708,846 | |
Less unearned income | | | (11 | ) | | | (29 | ) |
Less allowance for loan losses | | | (10,542 | ) | | | (7,888 | ) |
| | | | | | | | |
Total net loans | | $ | 808,724 | | | $ | 700,929 | |
| | | | | | | | |
We have a concentration in acquisition and development loans for the acquisition and development of real estate and improvements to real estate, representing approximately 12.6% of our total loans outstanding at December 31, 2008. In addition to the percent of total loans, we look at the percent of capital in determining the concentration definition.
Note 5. Allowance for Loan Losses
The following is a summary of the activity in the allowance for loan losses:
| | | | | | | | | | | | |
| | | December 31, | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands) | |
Balance at beginning of year | | $ | 7,888 | | | $ | 7,051 | | | $ | 6,601 | |
Reserve on acquired loans | | | 488 | | | | — | | | | — | |
Provision charged against income | | | 4,025 | | | | 1,238 | | | | 725 | |
Recoveries of loans charged off | | | 554 | | | | 460 | | | | 495 | |
Loans charged off | | | (2,413 | ) | | | (861 | ) | | | (770 | ) |
| | | | | | | | | | | | |
Balance at end of year | | $ | 10,542 | | | $ | 7,888 | | | $ | 7,051 | |
| | | | | | | | | | | | |
70
Notes to Consolidated Financial Statements
The following is a summary of information pertaining to impaired loans:
| | | | | | | | | |
| | | December 31 |
| | | 2008 | | 2007 | | 2006 |
| | | (in thousands) |
Nonaccrual loans for which no valuation allowance has been provided | | $ | 9,264 | | $ | 1,442 | | $ | 103 |
| | | | | | | | | |
Impaired loans with a valuation allowance | | $ | 14,977 | | $ | 4,365 | | $ | 3,653 |
| | | | | | | | | |
Allowance related to impaired loans | | $ | 2,881 | | $ | 1,054 | | $ | 601 |
| | | | | | | | | |
Average balance of impaired loans | | $ | 8,564 | | $ | 3,810 | | $ | 11,927 |
| | | | | | | | | |
Interest income recognized and collected on impaired loans | | $ | 583 | | $ | 270 | | $ | 266 |
| | | | | | | | | |
No additional funds are committed to be advanced in connection with impaired loans. If interest on nonaccrual loans had been accrued such income would have approximated $570 thousand and $72 thousand, for the years ended December 31, 2008 and 2007, respectively. Loans past due 90 days or greater and still accruing interest amounted to $2.5 million, $358 thousand and $1.5 million at December 31, 2008, 2007 and 2006, respectively.
Note 6. Related Party Transactions
Loans to directors and executive officers totaled $11.3 million and $6.6 million at December 31, 2008 and 2007, respectively. New advances to directors and officers totaled $9.5 million and repayments totaled $4.8 million in the year ended December 31, 2008. Deposits of directors and executive officers totaled $3.2 million and $4.2 million at December 31, 2008 and 2007, respectively.
Note 7. Bank Premises and Equipment
A summary of the cost and accumulated depreciation of bank premises and equipment follows:
| | | | | | |
| | | December 31, |
| | | 2008 | | 2007 |
| | | (in thousands) |
Land and improvements | | | 4,480 | | $ | 4,208 |
Buildings and leasehold improvements | | | 18,344 | | | 15,492 |
Furniture, fixtures and equipment | | | 14,431 | | | 12,777 |
Construction in progress | | | 1,354 | | | 1,608 |
| | | | | | |
| | | 38,609 | | | 34,085 |
Less accumulated depreciation | | | 17,803 | | | 15,824 |
| | | | | | |
Net balance | | $ | 20,806 | | $ | 18,261 |
| | | | | | |
For 2008, depreciation and amortization of premises and equipment was $2.2 million. Depreciation and amortization expense amounted to $2.0 million for 2007 and $1.9 million for 2006.
Total rent expense was $441 thousand, $285 thousand and $278 thousand for 2008, 2007, and 2006, respectively, and was included in occupancy expense.
71
Notes to Consolidated Financial Statements
The following is a schedule by year of future minimum lease requirements required under the long-term non-cancelable lease agreements:
| | | |
| | | (in thousands) |
2009 | | $ | 446 |
2010 | | | 429 |
2011 | | | 370 |
2012 | | | 291 |
2013 | | | 262 |
2014 | | | 84 |
| | | |
Total | | $ | 1,882 |
| | | |
Note 8. Deposits
The aggregate amount of certificates of deposit with a minimum denomination of $100,000 was $180.4 million and $121.6 million at December 31, 2008 and 2007, respectively.
At December 31, 2008, the scheduled maturities of certificates of deposit were as follows:
| | | |
| | | (in thousands) |
2009 | | $ | 348,433 |
2010 | | | 48,770 |
2011 | | | 15,442 |
2012 | | | 10,299 |
2013 | | | 10,835 |
| | | |
Total | | $ | 433,779 |
| | | |
At December 31, 2008 and 2007, overdraft demand deposits reclassified to loans totaled $341 thousand and $359 thousand, respectively.
Note 9. Income Taxes
The Company files income tax returns in the U.S. federal jurisdiction and the state of Virginia. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2005.
The Company adopted the provisions of FIN 48, “Accounting for Uncertainty in Income Taxes,” on January 1, 2007 with no impact on the financial statements.
72
Notes to Consolidated Financial Statements
Net deferred tax assets consist of the following components as of December 31, 2008 and 2007.
| | | | | | |
| | | 2008 | | 2007 |
| | | (in thousands) |
Deferred tax assets: | | | | | | |
Allowance for loan losses | | $ | 3,690 | | $ | 2,761 |
Impairment on securities | | | 1,726 | | | — |
Interest on nonaccrual loans | | | 200 | | | 25 |
Accrued benefit cost | | | 1,778 | | | 326 |
Net unrealized loss on available for sale securities | | | 6,369 | | | 1,571 |
Depreciation and amortization | | | — | | | 280 |
Home equity line closing cost | | | 90 | | | 45 |
| | | | | | |
| | | 13,853 | | | 5,008 |
| | | | | | |
Deferred tax liabilities: | | | | | | |
FHLB dividend | | | 8 | | | 8 |
Depreciation and amortization | | | 18 | | | — |
Goodwill and other intangible assets | | | 790 | | | 369 |
Other | | | 107 | | | 47 |
| | | | | | |
| | | 923 | | | 424 |
| | | | | | |
Net deferred tax assets | | $ | 12,930 | | $ | 4,584 |
| | | | | | |
Income tax expense charged to operations for the years ended December 31, 2008, 2007 and 2006, consists of the following:
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands) | |
Currently payable | | $ | 2,602 | | | $ | 3,922 | | | $ | 4,279 | |
Deferred tax benefit | | | (2,096 | ) | | | (439 | ) | | | (1,323 | ) |
| | | | | | | | | | | | |
| | $ | 506 | | | $ | 3,483 | | | $ | 2,956 | |
| | | | | | | | | | | | |
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, 2008, 2007 and 2006, due to the following.
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands) | |
Expected tax expense at statutory rate (34%) | | $ | 1,216 | | | $ | 3,400 | | | $ | 3,400 | |
Expected tax expense at statutory rate (35%) | | | — | | | | 783 | | | | 68 | |
Increase (decrease) in taxes resulting from: | | | | | | | | | | | | |
Tax exempt interest | | | (705 | ) | | | (573 | ) | | | (550 | ) |
Other | | | (5 | ) | | | (127 | ) | | | 38 | |
| | | | | | | | | | | | |
| | $ | 506 | | | $ | 3,483 | | | $ | 2,956 | |
| | | | | | | | | | | | |
73
Notes to Consolidated Financial Statements
Note 10. Employee Benefit Plans
Pension Plan
We have historically had a defined benefit pension plan covering substantially all of our employees. Benefits are based on years of service and the employee’s compensation during the last five years of employment. Our funding policy has been 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. The Plan was amended January 28, 2008 to freeze the Plan with no additional contributions for a majority of Participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the defined benefit plan which continues without revision for those participants.
Information about the plan follows:
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands) | |
Change in Benefit Obligation | | | | | | | | | | | | |
Obligations at beginning of year | | $ | 13,994 | | | $ | 13,136 | | | $ | 12,494 | |
Service cost | | | 1,146 | | | | 1,491 | | | | 1,400 | |
Interest cost | | | 961 | | | | 784 | | | | 715 | |
Actuarial (gain) | | | (909 | ) | | | (1,188 | ) | | | (801 | ) |
Decrease in obligation due to cutailment | | | (2,147 | ) | | | — | | | | — | |
Benefits paid | | | (217 | ) | | | (229 | ) | | | (672 | ) |
| | | | | | | | | | | | |
Benefit obligation, end of year | | $ | 12,828 | | | $ | 13,994 | | | $ | 13,136 | |
| | | | | | | | | | | | |
Change in Plan Assets | | | | | | | | | | | | |
Fair value of plan assets, beginning | | $ | 13,062 | | | $ | 10,256 | | | $ | 8,609 | |
Actual return on plan assets | | | (4,411 | ) | | | 1,410 | | | | 701 | |
Employer contributions | | | 642 | | | | 1,625 | | | | 1,618 | |
Benefits paid | | | (217 | ) | | | (229 | ) | | | (672 | ) |
| | | | | | | | | | | | |
Fair value of plan assets, end of year | | $ | 9,076 | | | $ | 13,062 | | | $ | 10,256 | |
| | | | | | | | | | | | |
Funded Status at the End of the Year | | $ | (3,751 | ) | | $ | (932 | ) | | $ | (2,881 | ) |
| | | | | | | | | | | | |
Amounts Recognized in the Balance Sheet | | | | | | | | | | | | |
Other liabilities, accrued pension | | $ | (3,751 | ) | | $ | (932 | ) | | $ | (2,881 | ) |
Amounts Recognized in Accumulated Other Comprehensive (Income)/Loss | | | | | | | | | | | | |
Net loss | | $ | 4,802 | | | $ | 785 | | | $ | 2,709 | |
Prior service cost | | | 117 | | | | 144 | | | | 166 | |
Deferred income tax benefit | | | (1,722 | ) | | | (327 | ) | | | (980 | ) |
Net obligation at transition | | | — | | | | 3 | | | | 6 | |
| | | | | | | | | | | | |
Amount recognized | | $ | 3,197 | | | $ | 605 | | | $ | 1,901 | |
| | | | | | | | | | | | |
74
Notes to Consolidated Financial Statements
| | | | | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
| | | (in thousands) | |
Components of Net Periodic Benefit Cost | | | | | | | | | | | | |
Service cost | | $ | 916 | | | $ | 1,491 | | | $ | 1,400 | |
Interest cost | | | 769 | | | | 784 | | | | 715 | |
Expected return on plan assets | | | (1,068 | ) | | | (755 | ) | | | (653 | ) |
Amortization of prior service cost | | | 22 | | | | 22 | | | | 22 | |
Amortization of net obligation at transition | | | 3 | | | | 4 | | | | 4 | |
Recognized net gain due to curtailment | | | (1,328 | ) | | | | | | | | |
Recognized net actuarial loss | | | — | | | | 79 | | | | 130 | |
| | | | | | | | | | | | |
Net periodic benefit cost | | $ | (686 | ) | | $ | 1,625 | | | $ | 1,618 | |
| | | | | | | | | | | | |
Other Changes in Plan Assets and Benefit Obligations Recognized in Other Comprehensive (Income) Loss | | | | | | | | | | | | |
Net (gain) loss | | $ | 4,018 | | | $ | (1,923 | ) | | $ | 2,709 | |
Prior service cost | | | — | | | | — | | | | 166 | |
Amortization of prior service cost | | | (27 | ) | | | (22 | ) | | | — | |
Amortization of net obligation at transition | | | (3 | ) | | | (4 | ) | | | — | |
Net obligation at transition | | | — | | | | — | | | | 6 | |
| | | | | | | | | | | | |
Total recognized in Other Comprehensive (Income) Loss | | $ | 3,988 | | | $ | (1,949 | ) | | $ | 2,881 | |
| | | | | | | | | | | | |
Adjustment to Retained Earnings due to Change in Measurement Date | | | | | | | | | | | | |
Service cost | | $ | 229 | | | $ | — | | | $ | — | |
Interest cost | | | 192 | | | | — | | | | — | |
Expected return on plan assets | | | (266 | ) | | | — | | | | — | |
Amortization of prior service cost | | | 5 | | | | — | | | | — | |
Deferred income tax | | | (55 | ) | | | — | | | | — | |
| | | | | | | | | | | | |
Net periodic benefit cost | | $ | 105 | | | $ | — | | | $ | — | |
| | | | | | | | | | | | |
75
Notes to Consolidated Financial Statements
| | | | | | | | | | |
| | | 2008 | | 2007 | | | 2006 |
| | | (in thousands) |
| | | | | | | | | | |
Total Recognized in Net Periodic Benefit Cost and Other Comprehensive Income | | $ | 3,302 | | $ | (324 | ) | | $ | 4,499 |
| | | | | | | | | | |
Weighted-Average Assumptions for Benefit Obligation. End of Year
| | | | | | | | | |
Discount rate | | 6.00 | % | | 6.25 | % | | 6.00 | % |
Rate of compensation increase | | 4.00 | % | | 5.00 | % | | 5.00 | % |
Weighted-Average Assumptions for Net Periodic Benefit Cost
| | | | | | | | | |
Discount rate | | 6.25 | % | | 6.00 | % | | 5.75 | % |
Expected return on plan assets | | 8.50 | % | | 8.50 | % | | 8.50 | % |
Rate of compensation increase | | 4.00 | % | | 5.00 | % | | 5.00 | % |
Long Term Rate of Return
In consultation with their investment advisors and actuary, our 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 increased from 6.00% in 2007 to 6.25% in 2008.
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). Our estimate of contributions to the plan for 2009 is $941 thousand.
The pension plan’s weighted average asset allocations at December 31, 2008 and 2007, by asset category are as follows:
| | | | | | |
| | | Plan Assets | |
| | | 2008 | | | 2007 | |
Asset Category: | | | | | | |
Cash and equivalents | | 4 | % | | 4 | % |
Mutual funds - fixed income | | 18 | % | | 22 | % |
Mutual funds - equity | | 78 | % | | 74 | % |
| | | | | | |
Total | | 100 | % | | 100 | % |
| | | | | | |
76
Notes to Consolidated Financial Statements
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 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 our 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. There is no Company common stock included in the Plan assets.
Estimated Future Benefit Payments
The following benefit payments reflecting the appropriate expected future service are expected to be paid:
| | | |
| | | Pension
Benefits |
| | | (in thousands) |
1/1/2009 - 12/31/2009 | | $ | 256 |
1/1/2010 - 12/31/2010 | | | 282 |
1/1/2011 - 12/31/2011 | | | 409 |
1/1/2012 - 12/31/2012 | | | 454 |
1/1/2013 - 12/31/2013 | | | 572 |
1/1/2014 - 12/31/2018 | | | 4,336 |
401(k) Plan
We have 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. In 2008, the Company had elected to contribute amounts not to exceed 50% of the first 6% of the employee’s contribution for employees grandfathered in the defined benefit pension plan. For those employees whose pension benefits were frozen as of January 1, 2008, our contribution is 75% of the first 6% of the employee’s contribution plus an additional contribution at year-end equal to 3% of the employee’s salary. Contributions to this Plan by the Company of $642 thousand, $253 thousand and $222 thousand were included in expenses for the years ended December 31, 2008, 2007, and 2006, respectively. We estimate that our contribution to the Plan in 2009 will increase to approximately $650 thousand. There is no Company common stock included in the 401 (k) Plan assets.
77
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. There were 304,112 shares excluded from the 2008 calculations, 237,137 shares from the 2007 calculations and 188,987 shares from the 2006 calculations because their effects were anti-dilutive.
| | | | | | | | | | | | | | | |
| | | Years Ended December 31, |
| | | 2008 | | 2007 | | 2006 |
| | | Shares | | Per Share
Amount | | Shares | | Per Share
Amount | | Shares | | Per Share
Amount |
Basic earnings per share | | 5,888,655 | | $ | 0.52 | | 6,034,741 | | $ | 1.45 | | 4,985,078 | | $ | 1.45 |
Effect of dilutive securities, | | | | | | | | | | | | | | | |
Stock options | | 919 | | | — | | 5,069 | | | — | | 6,542 | | | — |
Nonvested shares | | — | | | — | | 539 | | | — | | — | | | — |
| | | | | | | | | | | | | | | |
| | 919 | | | — | | 5,608 | | | — | | 6,542 | | | — |
| | | | | | | | | | | | | | | |
Diluted earnings per share | | 5,889,574 | | $ | 0.52 | | 6,039,810 | | $ | 1.45 | | 4,991,620 | | $ | 1.45 |
| | | | | | | | | | | | | | | |
Note 12. Stock Compensation Plan
On September 21, 2000, we 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 our Company, thereby stimulating their efforts and strengthening their desire to remain with us. Under the Plan, options to purchase 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. There are 35,443 shares still available under that Plan. On April 19, 2007, the shareholders approved the 2007 Equity Compensation Plan under which options or restricted stock for up to 400,000 shares of common stock may be granted. There are 400,000 shares still available under that Plan.
In December 2004, the FASB issued SFAS No. 123R, “Share-Based Payment”. SFAS 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options, based on the fair value of those awards at the date of grant. We had already adopted SFAS No. 123 in 2002 and began recognizing compensation expense for stock option grants in that year.
SFAS 123R also requires that new awards to employees eligible for retirement prior to the award becoming fully vested be recognized as compensation cost over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. Our stock options granted to eligible participants prior to the adoption of SFAS 123R that had an accelerated vesting feature associated with employee retirement are being recognized, as required, as compensation cost over the vesting period except in the instance of the participant’s actual retirement.
78
Notes to Consolidated Financial Statements
For the years ended December 31, 2008, 2007 and 2006, stock option compensation expense of $248 thousand, $250 thousand and $210 thousand were included in salary and benefit expense and are identified as part of stock compensation expense in both the Statements of Consolidated Cash Flows and the Consolidated Statements of Changes in Shareholders’ Equity. No tax benefits were recognized in 2008, 2007 and 2006 on the qualified stock options.
Stock option compensation expense is the estimated fair value of options granted amortized on a straight-line basis over the requisite service period for each stock grant award. The weighted average estimated fair value of stock options granted in the years ended December 31, 2008, 2007 and 2006 was $3.62, $5.95 and $5.40, respectively. Fair value is estimated using the Black-Scholes option-pricing model with the assumptions indicated below:
| | | | | | | | | |
| | | 2008 | | | 2007 | | | 2006 | |
Dividend rate: | | 2.82 | % | | 2.82 | % | | 2.97 | % |
Price Volatility: | | 33.25 | % | | 32.89 | % | | 22.94 | % |
Risk-free interest rate: | | 3.56 | % | | 4.56 | % | | 4.65 | % |
Expected life: | | 7 Years | | | 7 Years | | | 10 Years | |
The dividend rate is calculated as the average quarterly dividend yield on our stock for the past seven years by dividing the quarterly dividend by the average daily closing price of the stock for the period. Volatility is a measure of the standard deviation of the daily closing stock price plus dividend yield for the same period. The risk-free interest rate is the 7 year Treasury strip rate on the date of the grant. The expected life of options granted in 2008 was calculated using the simplified method whereby the vesting period and contractual period are averaged.
Stock option plan activity for the year ended December 31, 2008 is summarized below:
| | | | | | | | | | | |
| | | Shares | | | 2008 | | Weighted
Average
Remaining
Contractual
Life (in years) | | Intrinsic
Value of
Unexercised
In-the Money
Options
(in thousands) |
| | | | Weighted
Average
Exercise
Price | | |
Outstanding at beginning of year | | 259,762 | | | $ | 21.19 | | | | | |
Granted | | 49,000 | | | | 12.36 | | | | | |
Exercised | | — | | | | — | | | | | |
Forfeited | | (4,450 | ) | | | 22.02 | | | | | |
| | | | | | | | | | | |
Outstanding at December 31, 2008 | | 304,312 | | | | 20.87 | | 7.1 | | $ | — |
| | | | | | | | | | | |
Options exercisable at December 31, 2008 | | 92,725 | | | | 21.68 | | 4.8 | | $ | — |
| | | | | | | | | | | |
As of December 31, 2008, there was $489 thousand of unrecognized compensation expense related to stock options that will be recognized over the remaining requisite service period. There were no stock options exercised in 2008. Cash proceeds from options exercised in 2007 was $38 thousand. The intrinsic value of stock options exercised in 2007 was $14 thousand. There were no tax benefits realized from the exercise of stock options during 2008 or 2007.
79
Notes to Consolidated Financial Statements
The table below summarizes information concerning stock options outstanding at December 31, 2008.
| | | | | | | | | | |
| Options Outstanding | | Options Exercisable |
Exercise
Price | | Number
Outstanding | | Weighted
Average
Remaining
Term | | Exercise
Price | | Number
Exercisable |
| $ | 16.10 | | 22,625 | | 3.25 years | | $ | 16.10 | | 22,625 |
| | 28.60 | | 28,825 | | 4.875 years | | | 28.60 | | 28,825 |
| | 19.92 | | 41,275 | | 5.50 years | | | 19.92 | | 41,275 |
| | 20.57 | | 54,962 | | 6.50 years | | | — | | — |
| | 21.16 | | 59,125 | | 7.75 years | | | — | | — |
| | 19.25 | | 48,500 | | 8.75 years | | | — | | — |
| | 12.36 | | 49,000 | | 9.75 years | | | — | | — |
| | | | | | | | | | |
| | | 304,312 | | 7.09 years | | $ | 21.68 | | 92,725 |
| | | | | | | | | | |
A summary of the status of our nonvested shares as of December 31, 2008, and changes during the year ended December 31, 2008 is presented below:
| | | | | | |
| | | Shares | | | Weighted-Average
Grant-Date Fair
Value |
Nonvested as of January 1, 2008 | | 15,000 | | | $ | 17.25 |
Granted | | — | | | | — |
Vested | | (1,500 | ) | | | 17.25 |
Forfeited | | — | | | | — |
| | | | | | |
Nonvested as of December 31, 2008 | | 13,500 | | | $ | 17.25 |
| | | | | | |
As of December 31, 2008, there was $65 thousand of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under our restricted stock plan. That cost is expected to be recognized over a remaining weighted-average period of four years. The total fair value of shares vested during 2008 was $14 thousand.
As of December 31, 2008, there was $65 thousand of unrecognized compensation cost related to the time-vested awards. Half of the 2007 restricted share award is performance based and will vest on June 30, 2010 if, and only if, 2009 financial achievements of the Company meet very aggressive targets. Given the aggressive targets for the performance based award, compensation expense will be recognized only if the awards vest. Compensation is accounted for using the fair market value of our common stock on the date the restricted shares were awarded, which was $17.25 per share.
80
Notes to Consolidated Financial Statements
Note 13 Branch Acquisitions
On March 14, 2008, we purchased two branches from Millennium Bank, N. A. The purchase price of $8.5 million represented a 9.25% premium on the deposits assumed at the date of consummation.
The acquisition included the assumption of certain deposit accounts and purchase of selected loans and fixed assets as follows:
| | | |
Assets purchased (at fair value): | | | |
Cash | | $ | 275 |
Loans | | | 48,896 |
Furniture, fixtures and equipment | | | 102 |
Other assets | | | 173 |
Goodwill | | | 10,245 |
Core deposit intangibles | | | 20 |
| | | |
Total assets acquired | | $ | 59,711 |
| | | |
Liabilities acquired (at fair value): | | | |
Deposit accounts | | $ | 93,499 |
Other liabilities | | | 207 |
| | | |
Total liabilities assumed | | $ | 93,706 |
| | | |
Net liabilities assumed | | $ | 33,995 |
| | | |
Of the acquired intangible assets, $20 thousand was assigned to core deposit intangibles to be amortized over a period of 28.5 months. The unamortized balance of accumulated core deposit intangibles, including previous branch acquisitions, was $503 thousand and $770 thousand at December 31, 2008 and 2007, respectively. The estimated aggregate amortization expense for core deposit intangibles for the next 21 months is $24 thousand per month.
In addition, $1.6 million was assigned as a discount on the certificates of deposit assumed, while $438 thousand was assigned as a premium on the loans purchased. Weighted average lives for the certificates of deposit and loans receivable were 1.05 years and 7.0 years, respectively. The unamortized balance of the CD discount was $389 thousand and $0 at December 31, 2008 and 2007, respectively. The unamortized balance of the loan premium was $391 thousand and $0 at December 31, 2008 and 2007, respectively. The estimated aggregate CD discount on a monthly basis through March 2009 is $130 thousand per month. The estimated aggregate loan premium amortization on a monthly basis for the remaining 76 month amortization period is $5 thousand.
Note 14. Commitments and Contingent Liabilities
In the normal course of business there are outstanding various commitments and contingent liabilities, which are not reflected in the accompanying financial statements. We do not anticipate any material losses as a result of these transactions.
See Note 18 with respect to financial instruments with off-balance-sheet risk.
Note 15. 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, 2008, retained net income, which was free of restriction, amounted to $9.1 million.
81
Notes to Consolidated Financial Statements
Note 16. Borrowings
Federal Home Loan Bank Advances and Available Lines of Credit
At December 31, 2008, our Federal Home Loan Bank (FHLB) debt consisted of advances of $134.6 million, $122.5 million of which is callable - $85 million in 2009, $28.5 million in 2010 and $9 million in 2011. There are two advances totaling $2.1 million at December 31, 2008 which are payable semi-annually over a seven-year period beginning in 2003. Advances mature through 2015. There is a $10 million advance maturing in January 2009 with a rate which floats at 3 month LIBOR that is used to match fund certain investments also floating at 3 month LIBOR with a 170 basis point spread. At December 31, 2008, the interest rates ranged from 2.44% to 5.92% with a weighted average interest rate of 4.35%. Advances on the line are secured by a blanket lien on qualified 1 to 4 family residential real estate loans. Immediate available credit amounted to$1.6 million with existing collateral pledged and to $123 million subject to the pledge of additional collateral.
Aggregate annual maturities of FHLB advances (based on final maturity dates) are as follows:
| | | |
2009 | | $ | 11,429 |
2010 | | | 5,714 |
2011 | | | 10,000 |
2012 | | | — |
2013 | | | — |
Thereafter | | | 107,500 |
| | | |
Total | | $ | 134,643 |
| | | |
We have unused lines of credit totaling $37.5 million with nonaffiliated banks as of December 31, 2008.
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, 2008 was 4.82%. 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 $10.31 million of our 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 our Tier I capital.
Our obligations 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, we 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.
82
Notes to Consolidated Financial Statements
Note 17. Dividend Reinvestment Plan
We have 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 the three trading days prior to each dividend record date, and allows for voluntary contributions to purchase stock up to $5 thousand per shareholder per calendar quarter.
Note 18. Financial Instruments with Off-Balance-Sheet Risk
We are party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments include commitments to extend credit and standby letters of credit. To varying degrees those instruments involve 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 we have in particular classes of financial instruments.
Our exposure to credit loss is represented by the contractual amount of these commitments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance-sheet instruments.
At December 31, 2008 and 2007, the following financial instruments were outstanding whose contract amounts represent credit risk:
| | | | | | |
| | | Contract Amounts |
| | | 2008 | | 2007 |
| | | (in thousands) |
Commitments to grant loans and unfunded commitments under lines of credit | | $ | 125,366 | | $ | 112,209 |
Standby letters of credit | | | 6,338 | | | 6,291 |
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 us, 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 we are committed.
Standby letters of credit are conditional commitments issued by our bank 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. We generally hold collateral supporting those commitments if deemed necessary.
83
Notes to Consolidated Financial Statements
We maintain cash accounts in other commercial banks. The amount on deposit with correspondent institutions at December 31, 2008 exceeded the insurance limits of the Federal Deposit Insurance Corporation by $5.9 million.
Note 19. SFAS No. 157, Fair Value Measurements
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 our Company.
We adopted SFAS No. 157, “Fair Value Measurements” (SFAS 157), on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. SFAS 157 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
In February of 2008, the FASB issued Staff Position No. 157-2 (FSP 157-2) which delayed the effective date of SFAS 157 for certain nonfinancial assets and nonfinancial liabilities except for those items that are recognized or disclosed at fair value in the financial statements on a recurring basis. FSP 157-2 defers the effective date of SFAS 157 for such nonfinancial assets and nonfinancial liabilities to fiscal years beginning after November 15, 2008, and interim periods within those fiscal years. Thus, we has only partially applied SFAS 157. Those items affected by FSP 157-2 include other real estate owned (OREO), goodwill and core deposit intangibles.
In October of 2008, the FASB issued Staff Position No. 157-3 (FSP 157-3) to clarify the application of SFAS 157 in a market that is not active and to provide key considerations in determining the fair value of a financial asset when the market for that financial asset is not active. FSP 157-3 was effective upon issuance, including prior periods for which financials statements were not issued.
SFAS 157 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions. The three levels of the fair value hierarchy under SFAS 157 based on these two types of inputs are as follows:
| | • | | Level 1 – inputs to the valuation methodology are quoted prices (unadjusted) for identical assets or liabilities in active markets. |
| | • | | Level 2 – inputs to the valuation methodology include quoted prices for similar assets and liabilities in active markets, and inputs that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the financial instrument. |
| | • | | Level 3 – inputs to the valuation methodology are unobservable and significant to the fair value measurement. |
84
Notes to Consolidated Financial Statements
Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:
Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2).
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2008. Securities identified in Note 3 as restricted securities including stock in the Federal Home Loan Bank of Atlanta (“FHLB”) and the Federal Reserve Bank (“FRB”) are excluded from the table below since there is no ability to sell these securities except when the FHLB or FRB require redemption based on either our borrowings at the FHLB, or in the case of the FRB changes in certain portions of our capital.
| | | | | | | | | | | | |
| | | | | Fair Value Measurements at December 31, 2008 Using |
Description | | Balance as of
December 31,
2008 | | Quoted Prices
in Active
Markets for
Identical
Assets
(Level 1) | | Significant
Other
Observable
Inputs
(Level 2) | | Significant
Unobservable
Inputes
(Level 3) |
Assets: | | | | | | | | | | | | |
Available-for-sale securities | | $ | 152,645 | | $ | — | | $ | 152,645 | | $ | — |
Certain financial assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following describes the valuation techniques used to measure certain financial assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed external appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
85
Notes to Consolidated Financial Statements
The following table summarizes our financial assets that were measured at fair value on a nonrecurring basis during the period.
| | | | | | | | | | | | |
| | | | | Fair Value Measurements at December 31, 2008 Using |
Description | | Balance as of
December 31,
2008 | | Quoted Prices in
Active Markets
for Identical
Assets
(Level 1) | | Significant
Other
Observable
Inputs
(Level 2) | | Significant
Unobservable
Inputes
(Level 3) |
Assets: | | | | | | | | | | | | |
Impaired loans | | $ | 12,096 | | $ | — | | $ | 7,538 | | $ | 4,558 |
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 prices for similar securities. All securities prices are provided by independent third party vendors.
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 current incremental borrowing rates for similar types of borrowing arrangements.
Long-Term Debt
The fair values of our long-term borrowings are estimated using discounted cash flow analyses based on our current incremental borrowing rates for similar types of borrowing arrangements.
86
Notes to Consolidated Financial Statements
Accrued Interest
The carrying amounts of accrued interest approximate fair value.
Off-Balance-Sheet Financial Instruments
The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present 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, 2008 and 2007, the fair value of loan commitments and standby letters of credit are immaterial to fair value.
The estimated fair values and related carrying amounts of our financial instruments are as follows:
| | | | | | | | | | | | |
| | | December 31, 2008 | | December 31, 2007 |
| | | Carrying
Amount | | Estimated
Fair Value | | Carrying
Amount | | Estimated
Fair Value |
| | | (in thousands) | | (in thousands) |
Financial assets: | | | | | | | | | | | | |
Cash and short-term investments | | $ | 13,214 | | $ | 13,214 | | $ | 18,384 | | $ | 18,384 |
Securities - available for sale | | | 161,879 | | | 161,879 | | | 160,865 | | | 160,865 |
Loans, net | | | 808,724 | | | 835,595 | | | 700,929 | | | 730,252 |
Accrued interest receivable | | | 4,050 | | | 4,050 | | | 4,124 | | | 4,124 |
Financial liabilities: | | | | | | | | | | | | |
Noninterest-bearing deposits | | $ | 90,091 | | $ | 90,091 | | $ | 95,823 | | $ | 95,823 |
Interest-bearing deposits | | | 723,442 | | | 713,498 | | | 576,077 | | | 577,219 |
Short-term borrowings | | | 3,593 | | | 3,593 | | | 17,099 | | | 17,099 |
Federal Home Loan Bank advances | | | 134,643 | | | 139,400 | | | 127,071 | | | 123,722 |
Trust preferred debt | | | 10,310 | | | 10,868 | | | 10,310 | | | 11,234 |
Accrued interest payable | | | 2,512 | | | 2,512 | | | 3,539 | | | 3,539 |
We assume interest rate risk (the risk that general interest rate levels will change) as a result of our normal operations. As a result, the fair values of our financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to us. We attempt 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. We monitor rates and maturities of assets and liabilities and attempt to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate our overall interest rate risk.
87
Notes to Consolidated Financial Statements
Note 20. Regulatory Matters
The Company (on a consolidated basis) and EVB are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our and EVB’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we and EVB must meet specific capital guidelines that involve quantitative measures of our 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 us and EVB 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). We believe, as of December 31, 2008 and 2007, that we and EVB meet all capital adequacy requirements to which we are subject.
As of December 31, 2008, based on regulatory guidelines, we believe that EVB is well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, EVB 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 bank’s category.
Our Company’s and the bank’s actual capital amounts and ratios are presented in the following table.
88
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, 2008 | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | | | | | | | | | | | | | | | | | |
Consolidated | | $ | 95,229 | | 11.56 | % | | $ | 65,909 | | 8.00 | % | | | NA | | NA | |
EVB | | | 91,688 | | 11.16 | % | | | 65,750 | | 8.00 | % | | $ | 82,187 | | 10.00 | % |
Tier 1 capital to risk weighted assets | | | | | | | | | | | | | | | | | | |
Consolidated | | $ | 86,586 | | 10.51 | % | | $ | 32,954 | | 4.00 | % | | | NA | | NA | |
EVB | | | 71,953 | | 8.75 | % | | | 32,875 | | 4.00 | % | | $ | 49,312 | | 6.00 | % |
Tier 1 capital to average adjusted assets | | | | | | | | | | | | | | | | | | |
Consolidated | | $ | 86,586 | | 8.62 | % | | $ | 32,954 | | 4.00 | % | | | NA | | NA | |
EVB | | | 71,953 | | 7.17 | % | | | 40,144 | | 4.00 | % | | $ | 50,181 | | 5.00 | % |
As of December 31, 2007 | | | | | | | | | | | | | | | | | | |
Total capital to risk weighted assets | | | | | | | | | | | | | | | | | | |
Consolidated | | $ | 104,425 | | 14.75 | % | | $ | 56,680 | | 8.00 | % | | | NA | | NA | |
EVB | | | 76,391 | | 10.79 | % | | | 56,618 | | 8.00 | % | | $ | 70,772 | | 10.00 | % |
Tier 1 capital to risk weighted assets | | | | | | | | | | | | | | | | | | |
Consolidated | | $ | 97,797 | | 13.82 | % | | $ | 28,340 | | 4.00 | % | | | NA | | NA | |
EVB | | | 68,086 | | 9.62 | % | | | 28,309 | | 4.00 | % | | $ | 42,463 | | 6.00 | % |
Tier 1 capital to average adjusted assets | | | | | | | | | | | | | | | | | | |
Consolidated | | $ | 97,797 | | 10.80 | % | | $ | 36,210 | | 4.00 | % | | | NA | | NA | |
EVB | | | 68,086 | | 7.53 | % | | | 36,181 | | 4.00 | % | | $ | 45,226 | | 5.00 | % |
Note 21. Subsequent Event
On January 13, 2009, we filed an 8-K with the SEC reporting that we had signed a definitive agreement with the U. S. Department of the Treasury under the Economic Stabilization Act of 2008. The Company entered into a Letter Agreement and Securities Purchase Agreement under which it sold 24,000 shares of its Fixed Rate Cumulative Perpetual Preferred Stock, Series A to the Treasury for an aggregate purchase price of $24 million. The filing also reported that the Company had issued a warrant to the Treasury to purchase 373,832 shares of the Company’s common stock at an initial exercise price of $9.63 per share
89
Notes to Consolidated Financial Statements
Note 22. Condensed Financial Information - Parent Company Only
EASTERN VIRGINIA BANKSHARES, INC.
(Parent Corporation Only)
Balance Sheets
December 31, 2008 and 2007
| | | | | | | | |
| | | (dollars in thousands) | |
| | | 2008 | | | 2007 | |
Assets: | | | | | | | | |
Cash on deposit with subsidiary banks | | $ | 682 | | | $ | 27,291 | |
Subordinated debt in subsidiaries | | | 13,000 | | | | 2,000 | |
Investment in subsidiaries | | | 75,428 | | | | 71,975 | |
Deferred income taxes | | | 1,278 | | | | 326 | |
Other assets | | | 1,777 | | | | 452 | |
| | | | | | | | |
Total assets | | $ | 92,165 | | | $ | 102,044 | |
| | | | | | | | |
Liabilities: | | | | | | | | |
Trust preferred debt | | $ | 10,310 | | | $ | 10,310 | |
Accrued benefit cost | | | 3,751 | | | | 932 | |
Other liabilities | | | 75 | | | | 33 | |
| | | | | | | | |
| | | 14,136 | | | | 11,275 | |
| | | | | | | | |
Shareholders’ Equity: | | | | | | | | |
Common stock | | | 11,798 | | | | 11,865 | |
Surplus | | | 18,456 | | | | 18,811 | |
Retained earnings | | | 62,804 | | | | 63,616 | |
Accumulated other comprehensive loss | | | (15,029 | ) | | | (3,523 | ) |
| | | | | | | | |
Total shareholders’ equity | | | 78,029 | | | | 90,769 | |
| | | | | | | | |
Total liabilities and shareholders’ equity | | $ | 92,165 | | | $ | 102,044 | |
| | | | | | | | |
90
Notes to Consolidated Financial Statements
EASTERN VIRGINIA BANKSHARES, INC.
(Parent Corporation Only)
Statements of Income
For the Years Ended December 31, 2008, 2007 and 2006
| | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2008 | | 2007 | | | 2006 | |
Income: | | | | | | | | | | | |
Dividends from subsidiaries | | $ | — | | $ | 4,000 | | | $ | 6,000 | |
Interest from subsidiaries | | | 279 | | | 669 | | | | 54 | |
Interest from subordinated debt | | | 432 | | | 140 | | | | 140 | |
Actuarial gain - pension curtailment | | | 1,328 | | | — | | | | — | |
Miscellaneous income | | | — | | | — | | | | 1 | |
| | | | | | | | | | | |
| | | 2,039 | | | 4,809 | | | | 6,195 | |
| | | | | | | | | | | |
Expenses: | | | | | | | | | | | |
Interest on trust preferred debt | | | 628 | | | 849 | | | | 811 | |
Directors fees | | | 60 | | | 45 | | | | 77 | |
Miscellaneous | | | 286 | | | 206 | | | | 178 | |
| | | | | | | | | | | |
| | | 974 | | | 1,100 | | | | 1,066 | |
| | | | | | | | | | | |
Net income before undistributed earnings of subsidiaries | | | 1,065 | | | 3,709 | | | | 5,129 | |
Undistributed earnings of subsidiaries | | | 2,368 | | | 4,958 | | | | 1,812 | |
Income tax expense ( benefit) | | | 362 | | | (87 | ) | | | (296 | ) |
| | | | | | | | | | | |
Net income | | $ | 3,071 | | $ | 8,754 | | | $ | 7,237 | |
| | | | | | | | | | | |
91
Notes to Consolidated Financial Statements
EASTERN VIRGINIA BANKSHARES, INC.
(Parent Corporation Only)
Statements of Cash Flows
For the Years Ended December 31, 2008, 2007 and 2006
| | | | | | | | | | | | |
| | | (dollars in thousands) | |
| | | 2008 | | | 2007 | | | 2006 | |
Cash Flows from Operating Activities | | | | | | | | | | | | |
Net income | | $ | 3,071 | | | $ | 8,754 | | | $ | 7,237 | |
Adjustments to reconcile net income to cash provided by operating activities: | | | | | | | | | | | | |
Undistributed earnings of subsidiaries | | | (2,368 | ) | | | (4,958 | ) | | | (1,812 | ) |
Deferred income taxes | | | — | | | | — | | | | 94 | |
Stock-based compensation | | | 277 | | | | 250 | | | | 210 | |
Decrease (increase) in other assets | | | (13,695 | ) | | | 396 | | | | (49 | ) |
Increase (decrease) in other liabilities | | | 1,583 | | | | (64 | ) | | | (327 | ) |
| | | | | | | | | | | | |
Net cash provided by (used in) operating activities | | | (11,132 | ) | | | 4,378 | | | | 5,353 | |
| | | | | | | | | | | | |
Cash Flows from Investing Activities | | | | | | | | | | | | |
Proceeds from disposal of fixed assets | | | — | | | | — | | | | 1,264 | |
Purchases of premises and equipment | | | — | | | | — | | | | (118 | ) |
Subordinated debt to subsidiary banks | | | (11,000 | ) | | | — | | | | — | |
| | | | | | | | | | | | |
Net cash provided by (used in) investing activities | | | (11,000 | ) | | | — | | | | 1,146 | |
| | | | | | | | | | | | |
Cash Flows from Financing Activities | | | | | | | | | | | | |
Dividends paid | | | (3,778 | ) | | | (3,869 | ) | | | (3,098 | ) |
Exercise of stock options | | | — | | | | 38 | | | | 13 | |
Director stock grant | | | 104 | | | | 143 | | | | 191 | |
Issuance of common stock under stock offering | | | — | | | | — | | | | 23,576 | |
Issuance of common stock under dividend reinvestment plan, net of repurchases | | | 434 | | | | 413 | | | | 394 | |
Repurchases and retirement of stock | | | (1,237 | ) | | | (3,610 | ) | | | — | |
| | | | | | | | | | | | |
Net cash provided by (used in) financing activities | | | (4,477 | ) | | | (6,885 | ) | | | 21,076 | |
| | | | | | | | | | | | |
Increase (decrease) in cash and cash equivalents | | | (26,609 | ) | | | (2,507 | ) | | | 27,575 | |
Cash and Cash Equivalents, beginning of year | | | 27,291 | | | | 29,798 | | | | 2,223 | |
| | | | | | | | | | | | |
Cash and Cash Equivalents, end of year | | $ | 682 | | | $ | 27,291 | | | $ | 29,798 | |
| | | | | | | | | | | | |
92
