Xenith Bankshares (XBKS) 10-Q 2014 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

Form 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2014

or

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

For the transition period from                    to                    

Commission file number: 000-53380

Xenith Bankshares, Inc.

(Exact name of registrant as specified in its charter)

Virginia	80-0229922
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)
One James Center 901 E. Cary Street, Suite 1700 Richmond, Virginia	23219
(Address of principal executive offices)	(Zip Code)

(804) 433-2200

(Registrant’s telephone number, including area code)

N/A

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

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

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

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

Large accelerated filer	¨	Accelerated filer	¨
Non-accelerated filer	¨  (Do not check if a smaller reporting company)	Smaller reporting company	x

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

The number of shares of Common Stock, par value $1.00 per share, outstanding at April 28, 2014 was 10,416,562.

TABLE OF CONTENTS

	Page
PART I - FINANCIAL INFORMATION
Item 1 Financial Statements		1
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		23
Item 3 Quantitative and Qualitative Disclosures About Market Risk		41
Item 4 Controls and Procedures		41
PART II - OTHER INFORMATION
Item 1 Legal Proceedings		42
Item 1A Risk Factors		42
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		42
Item 6 Exhibits		42
SIGNATURES

PART I—FINANCIAL INFORMATION

Item 1. Financial Statements

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

AS OF MARCH 31, 2014 AND DECEMBER 31, 2013

(in thousands, except share data)	(Unaudited) March 31, 2014			December 31, 2013
Assets
Cash and cash equivalents
Cash and due from banks	$	12,490		$	24,944
Federal funds sold		—			5,749
Total cash and cash equivalents		12,490			30,693
Securities available for sale, at fair value		58,651			69,185
Securities held to maturity, at cost (fair value - $9,247)		9,285			—
Loans held for sale		6,336			3,363
Loans held for investment, net of allowance for loan and lease losses, 2014 - $5,414; 2013 - $5,305		552,264			533,137
Premises and equipment, net		4,931			5,069
Other real estate owned, net		161			199
Goodwill and other intangible assets, net		15,533			15,624
Accrued interest receivable		2,749			2,403
Deferred tax asset		4,176			4,345
Bank owned life insurance		9,773			9,690
Other assets		7,195			6,188
Total assets	$	683,544		$	679,896
Liabilities and Shareholders’ Equity
Deposits
Demand and money market	$	349,707		$	359,455
Savings		5,037			4,785
Time		215,207			204,958
Total deposits		569,951			569,198
Accrued interest payable		226			215
Federal funds purchased and borrowed funds		21,423			20,000
Other liabilities		3,177			2,797
Total liabilities		594,777			592,210
Shareholders’ equity
Preferred stock, $1.00 par value, $1,000 liquidation value, 25,000,000 shares authorized as of March 31, 2014 and December 31, 2013; 8,381 shares issued and outstanding as of March 31, 2014 and December 31, 2013		8,381			8,381
Common stock, $1.00 par value, 100,000,000 shares authorized as of March 31, 2014 and December 31, 2013; 10,416,562 shares issued and outstanding as of March 31, 2014 and 10,437,630 shares issued and outstanding as of December 31, 2013		10,417			10,438
Additional paid-in capital		71,900			71,797
Accumulated deficit		(1,523	)		(1,758	)
Accumulated other comprehensive loss, net of tax		(408	)		(1,172	)
Total shareholders’ equity		88,767			87,686
Total liabilities and shareholders’ equity	$	683,544		$	679,896

See notes to consolidated financial statements.

1

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF OPERATIONS

FOR THE THREE MONTHS ENDED MARCH 31, 2014 AND 2013

(Unaudited)

(in thousands, except per share data)	March 31, 2014			March 31, 2013
Interest income
Interest and fees on loans	$	5,894		$	5,860
Interest on securities		371			250
Interest on federal funds sold and deposits in other banks		66			78
Total interest income		6,331			6,188
Interest expense
Interest on deposits		478			584
Interest on time certificates of $100,000 and over		289			263
Interest on federal funds purchased and borrowed funds		100			92
Total interest expense		867			939
Net interest income		5,464			5,249
Provision for loan and lease losses		227			411
Net interest income after provision for loan and lease losses		5,237			4,838
Noninterest income
Service charges on deposit accounts		134			94
Net (loss) gain on sale and write-down of other real estate owned and other collateral		(38	)		346
Gain on sales of securities		—			159
Increase in cash surrender value of bank owned life insurance		83			—
Other		141			61
Total noninterest income		320			660
Noninterest expense
Compensation and benefits		2,823			2,958
Occupancy		353			364
FDIC insurance		115			99
Bank franchise taxes		191			197
Technology		404			387
Communications		77			61
Insurance		72			74
Professional fees		417			253
Amortization of intangible assets		91			91
Guaranteed student loan servicing		156			—
Other		394			351
Total noninterest expense		5,093			4,835
Income before income tax		464			663
Income tax expense		209			245
Net income		255			418
Preferred stock dividend		(21	)		(21	)
Net income available to common shareholders	$	234		$	397
Earnings per common share (basic and diluted):	$	0.02		$	0.04

See notes to consolidated financial statements.

2

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE THREE MONTHS ENDED MARCH 31, 2014 AND 2013

(Unaudited)

(in thousands)	March 31, 2014			March 31, 2013
Net income	$	255		$	418
Other comprehensive (loss) income, before taxes:
Securities available for sale:
Unrealized gain (loss) arising during the year		1,696			(381	)
Reclassification adjustment for gains included in net income		—			(159	)
Unrealized gain (loss) on available-for-sale securities		1,696			(540	)
Securities held to maturity:
Unrealized loss transferred to held to maturity		(518	)		—
Amortization of unrealized loss transferred from available for sale		8			—
Unrealized loss on held-to-maturity securities		(510	)		—
Unrealized loss on derivative:
Unrealized loss arising during the year		(64	)		(1	)
Reclassification adjustment for losses included in net income		36			32
Unrealized (loss) gain on derivative		(28	)		31
Other comprehensive gain (loss), before taxes		1,158			(509	)
Income tax (expense) benefit related to other comprehensive income		(394	)		173
Comprehensive income	$	1,019		$	82

See notes to consolidated financial statements.

3

XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE THREE MONTHS ENDED MARCH 31, 2014 AND 2013

(Unaudited)

(in thousands)	March 31, 2014			March 31, 2013
Cash flows from operating activities
Net income	$	255		$	418
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Provision for loan and lease losses		227			411
Depreciation and amortization		263			304
Net amortization of securities		100			180
Accretion of acquisition accounting adjustments		(139	)		(502	)
Deferred tax (benefit) expense		(225	)		245
Gain on sales of securities		—			(159	)
Share-based compensation expense		328			164
Net loss (gain) on sale and write-down of other real estate owned and other collateral		38			(346	)
Increase in cash surrender value of bank owned life insurance		(83	)		—
Change in operating assets and liabilities:
Originations of loans held for sale		(12,057	)		(158,354	)
Proceeds from sales of loans held for sale		9,085			170,316
Accrued interest receivable		(346	)		92
Other assets		(924	)		(173	)
Accrued interest payable		11			(8	)
Other liabilities		372			868
Net cash (used in) provided by operating activities		(3,095	)		13,456
Cash flows from investing activities
Proceeds from sales, maturities and calls of securities		2,335			10,793
Purchases of securities		—			(7,081	)
Net (increase) decrease in loans held for investment		(19,196	)		7,071
Net proceeds from sale of other real estate owned and other collateral		—			346
Net purchase of premises and equipment		(33	)		(251	)
(Purchase) sale of FRB and FHLB stock		(124	)		26
Net cash (used in) provided by investing activities		(17,018	)		10,904
Cash flows from financing activities
Net (decrease) increase in demand and savings deposits		(9,496	)		7,994
Net increase in time deposits		10,249			7,573
Net increase in federal funds purchased and borrowed funds		1,423			—
Issuance of common stock		20			—
Repurchase of common stock		(265	)		—
Preferred stock dividend		(21	)		(21	)
Net cash provided by financing activities		1,910			15,546
Net (decrease) increase in cash and cash equivalents		(18,203	)		39,906
Cash and cash equivalents
Beginning of period		30,693			12,363
End of period	$	12,490		$	52,269
Supplementary disclosure of cash flow information
Cash payments for:
Interest	$	856		$	947
Income taxes	$	—		$	175

See notes to consolidated financial statements.

4

Xenith Bankshares, Inc. and Subsidiary

Notes to Unaudited Consolidated Financial Statements

March 31, 2014

Note 1. Organization

General

Xenith Bankshares, Inc. (“Xenith Bankshares” or the “company”) is the bank holding company for Xenith Bank (the “Bank”), a Virginia-based institution headquartered in Richmond, Virginia. As of March 31, 2014, the company, through the Bank, operates six full-service branches: one branch in Tysons Corner, Virginia, two branches in Richmond, Virginia, and three branches in Suffolk, Virginia.

Background

In December 2009, First Bankshares, Inc. (“First Bankshares”), the bank holding company for SuffolkFirst Bank, and Xenith Corporation completed the merger of Xenith Corporation with and into First Bankshares (the “merger”), with First Bankshares being the surviving entity in the merger. At the effective time of the merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank. Although the merger was structured as a merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity for legal purposes, Xenith Corporation was treated as the acquirer for accounting purposes.

Effective on July 29, 2011, the Bank completed the acquisition of select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office of Paragon Commercial Bank, a North Carolina banking corporation, and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the branch office (the “Paragon Transaction”).

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (the “FDIC”) acted as receiver of VBB. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Acquisition agreement, the Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The VBB Acquisition was completed without any shared-loss agreement with the FDIC.

On March 20, 2014, the company entered into a merger agreement with Colonial Virginia Bank (“CVB”), pursuant to which CVB will be merged with and into the Bank, with the Bank surviving the CVB merger as a wholly-owned subsidiary of the company. CVB operates two full-service branches in the Gloucester, Virginia area and one loan production office in Yorktown, Virginia, all within the company’s target markets. As of December 31, 2013, CVB reported total assets of $114.9 million, net loans of $71.4 million, total deposits of $99.5 million, and shareholders’ equity of $12.1 million. Under the terms of the merger agreement, each share of CVB common stock outstanding immediately prior to the effective time of the CVB merger will be converted into the right to receive 2.65 shares of Xenith Bankshares common stock without interest and less applicable amounts for taxes. There will be no cash transferred in the transaction, with the exception of the purchase of fractional shares.

On April 30, 2014, the Federal Reserve Bank of Richmond, acting on delegated authority from the Board of Governors of the Federal Reserve Bank, granted the federal bank regulatory approvals necessary for the merger. The completion of the CVB merger remains subject to certain conditions, including approval by the Bureau of Financial Institutions of the Virginia State Corporation Commission, approval by the shareholders of CVB, and other customary closing conditions.

Note 2. Basis of Presentation

The consolidated financial statements include the accounts of Xenith Bankshares and its wholly-owned subsidiary, Xenith Bank. All significant intercompany accounts have been eliminated.

In management’s opinion, the accompanying unaudited consolidated financial statements, which have been prepared in conformity with Generally Accepted Accounting Principles in the United States of America (“GAAP”) for interim period reporting, and reflect all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the financial positions at March 31, 2014 and December 31, 2013, the results of operations and comprehensive income for the three months ended March 31, 2014 and 2013, and the statements of cash flows for the three months ended March 31, 2014 and 2013. The results for the three months ended March 31, 2014 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2014. The unaudited consolidated financial statements and accompanying notes should be read in conjunction with the company’s consolidated financial statements and the accompanying notes to consolidated financial statements included in the company’s Annual Report on Form 10-K for the year ended December 31, 2013.

5

Certain amounts reported in prior periods’ financial statements have been reclassified to conform to the current presentation. Such reclassifications have no effect on previously reported total assets, liabilities, shareholders’ equity or net income.

All dollar amounts included in the tables in these notes are in thousands, except per share data, unless otherwise stated.

Note 3. Restrictions of Cash

To comply with regulations of the Board of Governors of the Federal Reserve System (the “Federal Reserve”), the Bank is required to maintain certain average cash reserve balances. The daily average cash reserve requirement based on the weeks closest to March 31, 2014 and December 31, 2013 was $5.7 million and $8.5 million, respectively.

Note 4. Securities

The following tables present the book value and fair value of securities as of the dates stated:

	March 31, 2014
	Book Value		Gross Unrealized					Fair Value
			Gains		(Losses)
Securities available for sale:
Mortgage-backed securities
- Fixed rate	$	43,828	$	456	$	(464	)	$	43,820
- Variable rate		4,804		98		(53	)		4,849
Municipals - fixed rate
- Tax exempt		1,630		—		(15	)		1,615
Collateralized mortgage obligations - fixed rate		8,488		70		(191	)		8,367
Total securities available for sale		58,750		624		(723	)		58,651
Securities held to maturity:
Municipals - fixed rate
- Taxable		9,285		33		(71	)		9,247
Total securities held to maturity		9,285		33		(71	)		9,247
Total securities	$	68,035	$	657	$	(794	)	$	67,898

	December 31, 2013
	Book Value		Gross Unrealized					Fair Value
			Gains		(Losses)
Mortgage-backed securities
- Fixed rate	$	45,693	$	368	$	(724	)	$	45,337
- Variable rate		4,903		77		(128	)		4,852
Municipals - fixed rate
- Taxable		9,810		—		(840	)		8,970
- Tax exempt		1,634		—		(61	)		1,573
Collateralized mortgage obligations - fixed rate		8,940		57		(544	)		8,453
Total securities available for sale	$	70,980	$	502	$	(2,297	)	$	69,185

As of March 31, 2014 and December 31, 2013, the company had securities with a fair value of $6.6 million and $6.3 million, respectively, pledged as collateral for public deposits.

6

The following table presents the book value and fair value of securities by contractual maturity as of the date stated:

	March 31, 2014
	Available for Sale				Held to Maturity
	Book Value		Fair Value		Book Value		Fair Value
Due within one year	$	—	$	—	$	—	$	—
Due after one year through five years		—		—		—		—
Due after five years through ten years		27,322		27,467		8,349		8,309
Due after ten years		31,428		31,184		936		938
Total securities	$	58,750	$	58,651	$	9,285	$	9,247

The following tables present fair values and the related unrealized losses in the company’s securities portfolio, with the information aggregated by investment category and by the length of time that individual securities have been in continuous unrealized loss positions, as of the dates stated. The number of loss securities in each category is also noted.

	March 31, 2014
	Number		Less than 12 months					More than 12 months				Total
			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses		Fair Value		Unrealized Losses
Securities available for sale:
Mortgage-backed securities
- Fixed rate		7	$	19,892	$	(464	)	$	—	$	—	$	19,892	$	(464	)
- Variable rate		2		3,211		(53	)		—		—		3,211		(53	)
Municipals - fixed rate
- Tax exempt		1		1,615		(15	)		—		—		1,615		(15	)
Collateralized mortgage obligations - fixed rate		2		4,174		(191	)		—		—		4,174		(191	)
Total securities available for sale		12		28,892		(723	)		—		—		28,892		(723	)
Securities held to maturity:
Municipals - fixed rate
- Taxable		3		5,486		(71	)		—		—		5,486		(71	)
Total securities held to maturity		3		5,486		(71	)		—		—		5,486		(71	)
Total securities		15	$	34,378	$	(794	)	$	—	$	—	$	34,378	$	(794	)

	December 31, 2013
	Number		Less than 12 months					More than 12 months					Total
			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses			Fair Value		Unrealized Losses
Mortgage-backed securities
- Fixed rate		10	$	26,610	$	(724	)	$	—	$	—		$	26,610	$	(724	)
- Variable rate		2		3,214		(128	)		—		—			3,214		(128	)
Municipals - fixed rate
- Taxable		5		8,069		(697	)		901		(143	)		8,970		(840	)
- Tax exempt		1		1,573		(61	)		—		—			1,573		(61	)
Collateralized mortgage obligations - fixed rate		3		6,361		(544	)		—		—			6,361		(544	)
Total securities		21	$	45,827	$	(2,154	)	$	901	$	(143	)	$	46,728	$	(2,297	)

All securities held as of March 31, 2014 were investment grade. The unrealized loss positions at March 31, 2014 were directly related to interest rate movements, and management believes there is minimal credit risk exposure in these investments. There is no intent to sell investments that were in an unrealized loss position at March 31, 2014, and it is more likely than not that the company will not be required to sell these investments before a recovery of unrealized losses. These investments were not considered to be other-than-temporarily impaired at March 31, 2014; therefore, no impairment has been recognized.

7

Note 5. Loans

The following table presents the company’s composition of loans, net of capitalized origination costs and unearned income, in dollar amounts and as a percentage of total loans held for investment as of the dates stated:

	March 31, 2014						December 31, 2013
	Amount			Percent of Total			Amount			Percent of Total
Commercial and industrial	$	245,936			44.10	%	$	246,324			45.75	%
Commercial real estate		191,790			34.39	%		172,711			32.08	%
Residential real estate		23,029			4.13	%		22,004			4.09	%
Consumer		3,414			0.61	%		3,191			0.59	%
Guaranteed student loans		93,142			16.70	%		94,028			17.46	%
Overdrafts		367			0.07	%		184			0.03	%
Loans held for investment	$	557,678			100.00	%	$	538,442			100.00	%
Allowance for loan and lease losses		(5,414	)					(5,305	)
Loans held for investment, net of allowance		552,264						533,137
Loans held for sale		6,336						3,363
Total loans	$	558,600					$	536,500

Loans held for investment, excluding guaranteed student loans, include unearned fees net of capitalized origination costs, of $249 thousand and $244 thousand, as of March 31, 2014 and December 31, 2013, respectively. As of March 31, 2014, $204.7 million of loans held for investment were pledged to the FHLB and the Federal Reserve Bank as collateral for borrowing capacity.

During the third quarter of 2013, the Bank began purchasing guaranteed student loans, which were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, these loans are substantially guaranteed by a guarantee agency and reinsured by the U.S. Department of Education. The purchased loans were also part of the Federal Rehabilitated Loan Program (“FRLP”), under which borrowers under defaulted loans have theone-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor, are brought current and sold to approved lenders.

As of March 31, 2014, the company had $93.1 million of guaranteed student loans recorded as loans held for investment on its consolidated balance sheet. This balance includes premium and acquisition costs of $2.5 million and $1.4 million, respectively, which are amortized into interest income on the effective interest method. The guaranteed student loans carry an approximate 98% federal government guaranty as to the payment of principal and accrued interest.

Loans Held for Sale

The Bank is a party to a sub-participation agreement with a commercial bank (the “participating bank”), whereby the participating bank and the Bank purchase participation interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators and the participating bank deliver the loans to the investors. Typically, the Bank, together with the participating bank, purchase up to an aggregate of a 99% participation interest with the originators retaining the remaining 1%. These loans are held for short periods, usually less than 30 days and more typically 10-20 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.

8

Loans Held for Investment

The following table presents the company’s loans held for investment by regulatory risk ratings classification and by loan type as of the dates stated. As defined by the Federal Reserve and adopted by the company, “special mention” loans are defined as having potential weaknesses that deserve management’s close attention; “substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any; and “doubtful” loans have all the weaknesses inherent in substandard loans, with the added characteristic that the weaknesses make collection in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Loans not categorized as special mention, substandard or doubtful are classified as “pass.” The company’s risk ratings, which are assigned to loans, are embedded within these categories.

	March 31, 2014
	Pass		Special Mention		Substandard		Doubtful		Total Loans
Commercial and industrial	$	240,296	$	1,032	$	4,608	$	—	$	245,936
Commercial real estate		186,312		2,080		3,398		—		191,790
Residential real estate		20,237		1,989		803		—		23,029
Consumer		3,106		—		308		—		3,414
Guaranteed student loans		93,142		—		—		—		93,142
Overdrafts		367		—		—		—		367
Total loans	$	543,460	$	5,101	$	9,117	$	—	$	557,678

	December 31, 2013
	Pass		Special Mention		Substandard		Doubtful		Total Loans
Commercial and industrial	$	238,655	$	1,990	$	5,679	$	—	$	246,324
Commercial real estate		166,398		2,366		3,947		—		172,711
Residential real estate		21,014		132		858		—		22,004
Consumer		2,849		—		342		—		3,191
Guaranteed student loans		94,028		—		—		—		94,028
Overdrafts		184		—		—		—		184
Total loans	$	523,128	$	4,488	$	10,826	$	—	$	538,442

Allowance for Loan and Lease Losses

The allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 450, “Contingencies,” and (2) a component for individual loan impairment recognized pursuant to FASB ASC Topic 310, “Receivables.” A loan is impaired when, based on current information and events, it is probable that all amounts due (principal and interest) according to the contractual terms of the loan agreement will not be collected.

The allowance for loan and lease losses is determined based on a periodic evaluation of the loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans that are originated by the company. In evaluating the loan portfolio, qualitative factors, such as general economic conditions, nationally and in the company’s target markets, are considered, as well as threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors and estimates may be subject to significant change. Increases to the allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in the consolidated statements of operations. Loans or portions of loans deemed to be uncollectible are charged against the allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to the allowance for loan and lease losses.

The company’s allowance for loan and lease losses related to guaranteed student loans is based on historical default rates for similar types of loans applied to the portion of carrying value in these loans that is not subject to federal guaranty.

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The following table presents the allowance for loan and lease loss activity, by loan category, for the dates stated:

	For the Three Months Ended March 31,
	2014			2013
Balance at beginning of period	$	5,305		$	4,875
Charge-offs:
Commercial and industrial		—			1
Commercial real estate		—			159
Residential real estate		35			—
Consumer		—			—
Guaranteed student loans		—			—
Overdrafts		1			1
Total charge-offs		36			161
Recoveries:
Commercial and industrial		1			—
Commercial real estate		—			—
Residential real estate		—			—
Consumer		—			—
Guaranteed student loans		—			—
Overdrafts		—			1
Total recoveries		1			1
Net charge-offs		35			160
Provision for loan and lease losses		227			411
Amount for unfunded commitments		(19	)		(27	)
Other (1)		(64	)		—
Balance at end of period	$	5,414		$	5,099

(1) Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

The following tables present the allowance for loan and lease losses, with the amount independently and collectively evaluated for impairment, and loan balances, by loan type, as of the dates stated:

	March 31, 2014
	Total Amount		Individually Evaluated for Impairment		Collectively Evaluated for Impairment
Allowance for loan losses applicable to:
Commercial and industrial	$	1,861	$	303	$	1,558
Commercial real estate		2,737		219		2,518
Residential real estate		407		218		189
Consumer		30		—		30
Guaranteed student loans		379		—		379
Total allowance for loan and lease losses	$	5,414	$	740	$	4,674
Loan balances applicable to:
Commercial and industrial	$	245,936	$	4,566	$	241,370
Commercial real estate		191,790		4,247		187,543
Residential real estate		23,029		1,656		21,373
Consumer		3,781		8		3,773
Guaranteed student loans		93,142		—		93,142
Total loans	$	557,678	$	10,477	$	547,201

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	December 31, 2013
	Total Amount		Individually Evaluated for Impairment		Collectively Evaluated for Impairment
Allowance for loan losses applicable to:
Commercial and industrial	$	2,148	$	292	$	1,856
Commercial real estate		2,756		298		2,458
Residential real estate		194		10		184
Consumer		12		—		12
Guaranteed student loans		195		—		195
Total allowance for loan and lease losses	$	5,305	$	600	$	4,705
Loan balances applicable to:
Commercial and industrial	$	246,324	$	5,526	$	240,798
Commercial real estate		172,711		4,875		167,836
Residential real estate		22,004		632		21,372
Consumer		3,375		8		3,367
Guaranteed student loans		94,028		—		94,028
Total loans	$	538,442	$	11,041	$	527,401

The following tables present the loans that were individually evaluated for impairment, by loan type, as of the dates stated. The tables present those loans with and without an allowance and various additional data, as of the dates stated:

	March 31, 2014
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	2,824	$	3,894	$	—	$	2,983	$	26
Commercial real estate		1,550		2,507		—		1,569		—
Residential real estate		302		332		—		311		2
Consumer		8		8		—		8		—
With an allowance recorded:
Commercial and industrial		1,742		1,820		303		1,758		14
Commercial real estate		2,697		2,941		219		2,696		38
Residential real estate		1,354		1,365		218		1,347		—
Consumer		—		—		—		—		—
Total loans individually evaluated for impairment	$	10,477	$	12,867	$	740	$	10,672	$	80

	December 31, 2013
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial and industrial	$	3,413	$	4,484	$	—	$	3,342	$	159
Commercial real estate		2,075		3,002		—		2,719		—
Residential real estate		444		474		—		447		8
Consumer		8		8		—		10		1
With an allowance recorded:
Commercial and industrial		2,113		2,194		292		2,220		50
Commercial real estate		2,800		3,085		298		2,934		197
Residential real estate		188		198		10		190		2
Consumer		—		—		—		—		—
Total loans individually evaluated for impairment	$	11,041	$	13,445	$	600	$	11,862	$	417

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Acquired loans pursuant to a business combination are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a straight-line basis or based on the underlying principal payments on the loan. Any change in credit quality subsequent to acquisition for these loans is reflected in the allowance for loan and lease losses.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that all contractually required principal and interest payments will not be collected are accounted for under FASB ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). A portion of the loans acquired in the VBB Acquisition were deemed by management to be credit-impaired loans qualifying for accounting under ASC 310-30.

In July 2011, the loans acquired in the Paragon Transaction and the VBB Acquisition were adjusted to estimated fair value by recording a discount of $1.8 million and $14.0 million, respectively. Of the $14.0 million discount recorded on the VBB Acquisition, $12.7 million related to $40.2 million of purchased credit-impaired loans. The remaining fair value adjustment on the purchased credit-impaired loans, as of March 31, 2014, was $2.9 million. The carrying value of purchased impaired loans, as of March 31, 2014, was approximately $9.3 million, which is net of any impairment charges recorded subsequent to acquisition.

For purchased credit-impaired loans, the excess of cash flows expected to be collected over the estimated fair value is referred to as the accretable yield and accreted into interest income over the remaining life of the loan, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference.

In applying ASC 310-30 to acquired loans, the company must periodically estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including default rates, the amount and timing of prepayments and the liquidation value and timing of underlying collateral, in addition to other factors. Decreases in expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the accretable yield remains unchanged. Increases in expected cash flows will result in an increase in the accretable yield, which is a reclassification from the nonaccretable difference. The increased accretable yield is recognized in income over the remaining period of expected cash flows from the loan.

If upon remeasurement in a future period, a loan for which an impairment charge has been taken is expected to have cash flows that exceed those previously determined, some portion of the impairment could be reversed. During the first quarter of 2014, the company recorded a benefit of $47 thousand due to the improvement of expected cash flows from a loan for which an impairment change was recorded in a prior period. Impairments and reversals of impairments are recorded in the provision for loan and lease losses in the consolidated statements of operations, and a component of the allowance for loan and lease losses in the consolidated balance sheet.

The following table presents the accretion activity related to acquired loans as of the dates stated:

	March 31, 2014			December 31, 2013
Balance at beginning of period	$	4,441		$	8,133
Accretion (1)		(139	)		(2,644	)
Disposals (2)		—			(1,048	)
Other (3)		64			—
Balance at end of period	$	4,366		$	4,441

(1) Accretion amounts are reported in interest income.

(2) Disposals represent the reduction of purchase accounting adjustments due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2013 amount, $85 thousand relates to loans reclassified as other real estate owned.

(3) Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

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The following tables present the age analysis of loans past due as of the dates stated:

	March 31, 2014
	30-89 days Past Due		90+ days Past Due		Total Past Due
Commercial and industrial	$	387	$	869	$	1,256
Commercial real estate		786		16		802
Residential real estate		432		1,248		1,680
Consumer		8		—		8
Guaranteed student loans		6,806		33,024		39,830
Total	$	8,419	$	35,157	$	43,576

	December 31, 2013
	30-89 days Past Due		90+ days Past Due		Total Past Due
Commercial and industrial	$	1,034	$	781	$	1,815
Commercial real estate		—		17		17
Residential real estate		228		385		613
Consumer		4		—		4
Guaranteed student loans		43,875		—		43,875
Total	$	45,141	$	1,183	$	46,324

The following table presents nonaccrual loans and other real estate owned (“OREO”) as of the dates stated. A loan is considered nonaccrual if it is 90 days or greater past due as to interest and principal or when collectability is in doubt, unless the estimated net realized value of collateral is sufficient to assure collection of principal balance and accrued interest. As of March 31, 2014, there were no loans past due 90 days or greater for which interest was accruing.

	March 31, 2014		December 31, 2013
Commercial and industrial	$	2,320	$	2,386
Commercial real estate		398		883
Residential real estate		1,577		553
Consumer		—		—
Total nonaccrual loans	$	4,295	$	3,822
Other real estate owned		161		199
Total nonperforming assets	$	4,456	$	4,021

In accordance with Accounting Standards Update (“ASU”) No. 2011-02, “Receivables: A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring,” the company assesses all restructurings for potential identification as troubled debt restructurings (“TDR”). A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. Modifications of terms for loans that are included as TDRs may involve either an increase or reduction of the interest rate, extension of the term of the loan, or deferral of principal payments, regardless of the period of the modification.

For loans classified as TDRs, the company further evaluates the loans as performing or nonperforming. If at the time of restructure the loan is on accrual status, it will be classified as performing and will continue to be classified as performing as long as the borrower continues making payments in accordance with the restructured terms. A modified loan will be classified as nonaccrual if the loan becomes 90 days delinquent. TDRs originally considered nonaccrual will be classified as nonperforming, but may be classified as performing TDRs if subsequent to restructure the loan experiences payment performance according to the restructured terms for a consecutive six-month period.

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The following table presents performing and nonperforming loans identified as TDRs, by loan type, as of the dates stated:

	March 31, 2014		December 31, 2013
Performing:
Commercial and industrial	$	490	$	1,030
Commercial real estate		907		908
Residential real estate		—		—
Consumer		—		—
Total performing TDRs	$	1,397	$	1,938
Nonperforming:
Commercial and industrial	$	1,909	$	1,940
Commercial real estate		16		17
Residential real estate		132		120
Consumer		—		—
Total nonperforming TDRs	$	2,057	$	2,077
Total TDRs	$	3,454	$	4,015

The following tables present loans classified as TDRs, including the type of modification, number of loans and loan type, as of the dates stated:

	March 31, 2014
	Number of Loans Modified		Rate Modification (1)		Term Extension and/or Other Concessions		Total
Commercial and industrial		7	$	1,137	$	1,262	$	2,399
Commercial real estate		3		907		16		923
Residential real estate		1		—		132		132
Consumer		—		—		—		—
Total TDRs		11	$	2,044	$	1,410	$	3,454

(1) Restructured loans that had a modification of the loan’s contractual interest rate may also have had an extension of the loan’s contractual maturity date.

	December 31, 2013
	Number of Loans Modified		Rate Modification (1)		Term Extension and/or Other Concessions		Total
Commercial and industrial		8	$	1,159	$	1,812	$	2,971
Commercial real estate		3		908		17		925
Residential real estate		1		—		119		119
Consumer		—		—		—		—
Total TDRs		12	$	2,067	$	1,948	$	4,015

(1) Restructured loans that had a modification of the loan’s contractual interest rate may also have had an extension of the loan’s contractual maturity date.

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Note 6. Goodwill and Other Intangible Assets

The following table presents goodwill and other intangible assets as of the dates stated:

	March 31, 2014			December 31, 2013
Amortizable core deposit intangibles:
Gross carrying value	$	3,710		$	3,710
Accumulated amortization		(1,166	)		(1,075	)
Net core deposit intangibles		2,544			2,635
Unamortizable goodwill		12,989			12,989
Total goodwill and other intangible assets, net	$	15,533		$	15,624

The following table presents the estimated future amortization expense for core deposit intangibles:

Year	Core Deposit Intangibles
2014	$	273
2015		365
2016		365
2017		365
2018		365
Thereafter		811
Total	$	2,544

Note 7. Deposits

The following table presents a summary of deposit accounts as of the dates stated:

	March 31, 2014		December 31, 2013
Noninterest-bearing demand deposits	$	114,708	$	116,083
Interest-bearing:
Demand and money market		234,999		243,372
Savings deposits		5,037		4,785
Time deposits of $100,000 or more		157,138		146,834
Other time deposits		58,069		58,124
Total deposits	$	569,951	$	569,198

Note 8. Derivatives

Cash Flow Hedges

The company’s objective in using interest rate derivatives is to manage its exposure to interest rate movements. The company is a party to three interest rate swap agreements. Pursuant to one of the agreements, the company pays fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreement without exchange of the underlying notional amount of $20 million. Pursuant to the other agreements, the company has minimized its exposure to interest rate movements by exchanging variable for fixed interest payments beginning at a specified future date without exchange of underlying notional amounts of $17.5 million. As of March 31, 2014, the company’s three interest rate swaps were designated as cash flow hedges, in accordance with FASB ASC Topic 815, “Derivatives and Hedging.”

The effective portion of changes in the fair value of derivatives designated as cash flow hedges is recorded in accumulated other comprehensive income (“AOCI”) and is subsequently reclassified into net income in the period that the hedged forecasted transaction affects earnings. The ineffective portion of the change in fair value of the derivatives is recognized directly in earnings. For the three-month period ended March 31, 2014, the ineffective portion was insignificant. The amount reported in AOCI as of March 31,

15

2014 was a loss of $6 thousand, net of a tax benefit of $3 thousand. As of March 31, 2014, an asset of $152 thousand was recorded in other assets and a liability of $179 thousand was recorded in other liabilities on the consolidated balance sheet related to these derivatives. Additionally, the company has minimum collateral requirements with its counterparty, and as of March 31, 2014, $250 thousand has been pledged as collateral under the agreements, as the valuation of one of the derivatives has surpassed the contractually specified minimum transfer amount of $250 thousand. If the company is not in compliance with the terms of the derivative agreements, it could be required to settle its obligations under the agreements at termination value.

Non-hedge Derivatives

Derivatives not designated as hedges are not speculative and result from a service the company provides to certain customers. The company executes interest rate derivatives with commercial banking customers to facilitate their respective risk management strategies. Those interest rate derivatives are simultaneously hedged by offsetting derivatives that the company executes with third parties, thus minimizing its net exposure from such transactions. These derivatives do not meet hedge accounting requirements; therefore, changes in the fair value of both the customer derivative and the offsetting derivative are recognized in earnings. As of March 31, 2014, $450 thousand was recorded in other assets and $429 thousand was recorded in other liabilities related to non-designated hedges. For the periods ended March 31, 2014 and 2013, $18 thousand and $3 thousand, respectively, was recorded in net income related to non-designated hedges. As of March 31, 2014, the company had $510 thousand pledged as collateral with respect to non-hedge derivatives.

Note 9. Bank Owned Life Insurance

The Bank invests in bank owned life insurance (“BOLI”), which is life insurance purchased by the Bank on a chosen group of employees. The Bank is the owner and primary beneficiary of the policies. BOLI is carried at the cash surrender value of the underlying policies. Earnings from the increase in cash surrender value of the policies are included in noninterest income on the statements of operations. The Bank has rights under the insurance contracts to redeem them for book value at any time.

Note 10. Income Taxes

Net deferred tax assets as of March 31, 2014 and December 31, 2013 were $4.2 million and $4.3 million, respectively. The following table presents the statutory tax rate reconciled to the company’s effective tax rate for the dates stated:

	March 31, 2014						December 31, 2013
	Tax			Rate			Tax			Rate
Income tax expense at statutory rate	$	158			34.00	%	$	1,037			34.00	%
Meals and entertainment		2			0.46	%		9			0.31	%
Share-based compensation		20			4.25	%		86			2.80	%
Transaction-related expenses		60			13.01	%		—			0.00	%
Tax exempt income		(30	)		-6.46	%		(67	)		-2.21	%
Other		(1	)		-0.25	%		—			0.00	%
Income tax expense reported	$	209			45.01	%	$	1,065			34.90	%

Note 11. Earnings per Common Share

The following table summarizes basic and diluted earnings per common share calculations for the periods stated:

	Three Months Ended March 31,
	2014			2013
Net income	$	255		$	418
Preferred stock dividend		(21	)		(21	)
Net income available to common shareholders	$	234		$	397
Weighted average shares outstanding, basic (1)		10,471			10,488
Dilutive shares		113			26
Weighted average shares outstanding, diluted		10,584			10,514
Earnings per common share, basic	$	0.02		$	0.04
Earnings per common share, diluted	$	0.02		$	0.04

(1) Includes vested restricted stock units.

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Note 12. Share Repurchase Program

In July 2013, the company’s board of directors authorized a share repurchase program permitting the company to repurchase in the open market or otherwise up to 210,000 shares, or approximately 2% of shares of the company’s then outstanding common stock. The authorization has no time limit. There is no guarantee as to the number of shares that will be repurchased by the company, and the company may discontinue the program at any time.

The company repurchased the following shares of common stock pursuant to the repurchase program for the period stated. The repurchases were made using available cash resources and occurred in the open market.

	Three Months Ended March 31, 2014
Shares of common stock repurchased		43,900
Price paid for common stock repurchased	$	265
Average price paid per common share	$	6.04

Note 13. Senior Non-Cumulative Perpetual Preferred Stock

On September 21, 2011, as part of the Small Business Lending Fund (“SBLF”) of the U.S. Department of Treasury (“U.S. Treasury”), the company issued and sold 8,381 shares of non-cumulative perpetual preferred stock to the Secretary of the U.S. Treasury (the “SBLF Preferred Stock”) for a purchase price of $8.4 million. The SBLF Preferred Stock investment qualifies as Tier 1 capital. The SBLF Preferred Stock is entitled to receive non-cumulative dividends, payable quarterly, on each January 1, April 1, July 1 and October 1. The dividend rate, as a percentage of the liquidation amount, can fluctuate on a quarterly basis based upon changes in the level of “Qualified Small Business Lending” (as defined in the SBLF Purchase Agreement) by the Bank with the lowest rate of 1%. For the three-month periods ended March 31, 2014 and 2013, the company’s dividend was $21 thousand, representing an effective dividend rate of 1% for both periods.

Note 14. Commitment and Contingencies

In the normal course of business, the Bank has commitments under credit agreements to lend to customers as long as there is no material violation of any condition established in the contracts. These commitments have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Additionally, the Bank issues letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

The following table presents unfunded commitments outstanding as of the dates stated:

	March 31, 2014		December 31, 2013
Commercial lines of credit	$	82,357	$	68,782
Commercial real estate		43,644		44,324
Residential real estate		6,753		7,183
Consumer		849		481
Letters of credit		6,624		6,796
Loans held for sale		11,664		5,637
Total commitments	$	151,891	$	133,203

In addition, the Bank has a commitment to invest in a limited partnership that operates as a small business investment company. As of March 31, 2014, the Bank had invested $450 thousand. An additional $550 thousand will be funded at the request of the general partner of the partnership.

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Note 15. Fair Value Measurements

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability.

FASB ASC Topic 820, “Fair Value Measurements and Disclosure” (“ASC 820”), establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs.

Under the guidance in ASC 820, the company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

Level 1	Quoted prices in active markets for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2	Significant observable inputs other than Level 1 prices, such as quoted prices for similar assets or liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets or liabilities.
Level 3	Valuations for assets and liabilities that are derived from other valuation methodologies, including option pricing models, discounted cash flow models and similar techniques, and not based on market exchange, dealer or broker-traded transactions. Level 3 valuations incorporate certain assumptions and projections in determining the fair value to such assets or liabilities.

The following is a description of valuation methodologies used for assets and liabilities recorded at fair value. The determination of where an asset or liability falls in the hierarchy requires significant judgment. The company evaluates its hierarchy disclosures each quarter, and, based on various factors, it is possible that an asset or liability may be classified differently from quarter to quarter. An adjustment to the pricing method used within either Level 1 or Level 2 inputs could generate a fair value measurement that effectively falls in a lower level in the hierarchy. The company expects changes in classifications between levels will be rare.

Securities available for sale:

Available-for-sale securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities and money market funds. Level 2 securities include U.S. Agency securities, mortgage-backed securities issued by government sponsored entities, collateralized mortgage obligations, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Other real estate owned:

Other real estate owned is measured at the asset’s fair value less costs for disposal. The company estimates fair value at the asset’s liquidation value less disposal costs using management’s assumptions, which are based on current market analysis or recent appraisals. Other real estate owned is classified as a nonrecurring Level 3 valuation.

Impaired loans:

Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. As of March 31, 2014, all of the impaired loans accounted for under ASC 310-30 were evaluated based on discounted cash flows or on the fair value of the collateral. Impaired loans where an allowance is established based on the fair value of collateral require classification in the fair value hierarchy. When the fair value of the collateral is based on an observable market price or a current appraised value, the company records the impaired loan as nonrecurring Level 2. When a current appraised value is not available, or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, or management evaluates fair value based on discounted cash flows, the company records the impaired loan as nonrecurring Level 3.

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Derivatives:

The fair values of interest rate swaps are determined using the market standard methodology of netting the discounted future fixed cash receipts (or payments) and the discounted expected variable cash payments (or receipts). The variable cash payments (or receipts) are based on an expectation of future interest rates (forward curves) derived from observable market interest rate curves. The company incorporates credit valuation adjustments to appropriately reflect both its own nonperformance risk and the respective counterparty’s nonperformance risk in the fair value measurements. In adjusting the fair value of its derivative contracts for the effect of nonperformance risk, the company has considered the impact of netting and any applicable credit enhancements, such as collateral postings, thresholds, mutual puts and guarantees.

Although the company has determined that the majority of the inputs used to value its derivatives fall within Level 2 of the value hierarchy, the credit valuation adjustments associated with its derivatives utilize Level 3 inputs, such as estimates of current credit spreads to evaluate the likelihood of default by itself and its counterparties. However, as of March 31, 2014 and 2013, the company has assessed the significance of the impact of the credit valuation adjustments on the overall valuation of its derivative positions and has determined that the credit valuation adjustments are not significant to the overall valuation of its derivatives. As a result, the company has determined that its derivative valuations in their entirety are classified in Level 2 of the fair value hierarchy.

In conjunction with the FASB’s fair value measurement guidance, the company has elected to measure the credit risk of its derivative financial instruments that are subject to master netting agreements on a net basis by counterparty portfolio.

Cash, cash equivalents and accrued interest:

The carrying value for cash and cash equivalents and accrued interest approximates fair value.

The methodology for measuring the fair value of other financial assets and financial liabilities that are not recorded at fair value on a recurring or nonrecurring basis are discussed below.

Securities held to maturity:

Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using matrix pricing, which is a mathematical technique used widely in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities’ relationship to other benchmark quoted securities. Level 1 securities include those traded on nationally recognized securities exchanges, U.S. Treasury securities and money market funds. Level 2 securities include U.S. Agency securities, mortgage-backed securities issued by government sponsored entities, collateralized mortgage obligations, municipal bonds and corporate debt securities. Securities classified as Level 3 include asset-backed securities in less liquid markets.

Performing loans:

For variable-rate loans that re-price frequently and with no significant changes in credit risk, fair values are based on carrying values. Fair values for all other loans are estimated using discounted cash flow analyses using interest rates currently being offered for loans with similar terms. The carrying value of loans held for sale approximates fair value.

Deposit liabilities:

The balance of demand, money market and savings deposits approximates the fair value payable on demand to the accountholder. The fair value of fixed-maturity time deposits is estimated using the rates currently offered for deposits of similar remaining maturities.

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 at the company’s current incremental borrowing rates for similar types of borrowing arrangements. The carrying amount of long-term borrowings, for which interest rates reset quarterly or less, approximate their fair value.

Other commitments:

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

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As noted, certain assets and liabilities are measured at fair value on a recurring and nonrecurring basis. The following tables present assets measured at fair value on a recurring and nonrecurring basis as of the dates stated:

				Fair Value Measurements as of March 31, 2014 Using
	March 31, 2014 Balance			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Securities available for sale:
Mortgage-backed securities
- Fixed rate	$	43,820		$	—	$	43,820		$	—
- Variable rate		4,849			—		4,849			—
Municipals		1,615			—		1,615			—
Collateralized mortgage obligations		8,367			—		8,367			—
Cash flow hedge - asset		152			—		152			—
Cash flow hedge - liability		(179	)		—		(179	)		—
Interest rate derivative - asset		450			—		450			—
Interest rate derivative - liability		(429	)		—		(429	)		—
Assets measured on a nonrecurring basis:
Impaired loans		10,477			—		—			10,477
Other real estate owned		161			—		—			161

				Fair Value Measurements as of December 31, 2013 Using
	December 31, 2013 Balance			Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)
Assets and liabilities measured on a recurring basis:
Securities available for sale:
Mortgage-backed securities
- Fixed rate	$	45,337		$	—	$	45,337		$	—
- Variable rate		4,852			—		4,852			—
Municipals
- Taxable		8,970			—		8,970			—
- Tax exempt		1,573			—		1,573			—
Collateralized mortgage obligations		8,453			—		8,453			—
Cash flow hedge - asset		192			—		192			—
Cash flow hedge - liability		(191	)		—		(191	)		—
Interest rate derivative - asset		135			—		135			—
Interest rate derivative - liability		(113	)		—		(113	)		—
Assets measured on a nonrecurring basis:
Impaired loans		11,041			—		—			11,041
Other real estate owned		199			—		—			199

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The following tables present the carrying amounts and approximate fair values of the company’s financial assets and liabilities as of the dates stated:

	March 31, 2014				Fair Value Measurements as of March 31, 2014 Using
	Carrying  Amount		Estimated  Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks	$	12,490	$	12,490	$	12,490	$	—	$	—
Securities available for sale		58,651		58,651		—		58,651		—
Securities held to maturity		9,285		9,247		—		9,247		—
Loans held for sale		6,336		6,336		—		6,336		—
Loans held for investment, net		552,264		558,127		—		—		558,127
Cash flow hedge		152		152		—		152		—
Interest rate derivative		450		450		—		450		—
Accrued interest receivable		2,749		2,749		—		2,749		—
Financial liabilities:
Cash flow hedge	$	179	$	179	$	—	$	179	$	—
Interest rate derivative		429		429		—		429		—
Federal funds purchased		1,423		1,423		—		1,423		—
Long-term borrowings		20,000		20,000		—		20,000		—
Deposits		569,951		569,370		—		569,370		—
Accrued interest payable		226		226		—		226		—

	December 31, 2013				Fair Value Measurements as of December 31, 2013 Using
	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Financial assets:
Cash and due from banks	$	24,944	$	24,944	$	24,944	$	—	$	—
Federal funds sold		5,749		5,749		—		5,749		—
Securities available for sale		69,185		69,185		—		69,185		—
Loans held for sale		3,363		3,363		—		3,363		—
Loans held for investment, net		533,137		534,232		—		—		534,232
Cash flow hedge		192		192		—		192		—
Interest rate derivative		135		135		—		135		—
Accrued interest receivable		2,403		2,403		—		2,403		—
Financial liabilities:
Cash flow hedge	$	191	$	191	$	—	$	191	$	—
Interest rate derivative		113		113		—		113		—
Long-term borrowings		20,000		20,000		—		20,000		—
Deposits		569,198		568,775		—		568,775		—
Accrued interest payable		215		215		—		215		—

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Fair value estimates are made at a specific point in time and are based on relevant market information, as well as information about the financial instruments or other assets. These estimates do not reflect any premium or discount that could result from offering for sale the company’s entire holdings of a particular financial instrument at one time. Fair value estimates are based on judgments regarding future expected loss experience, current economic conditions, risk characteristics of various financial instruments and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.

Fair value estimates are based on existing on and off-balance sheet financial instruments without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets that are not considered financial assets include deferred tax assets, premises and equipment, and OREO. In addition, the tax ramifications related to the realization of unrealized gains and losses can have a significant effect on fair value estimates and have not been considered in the estimates.

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

The following is management’s discussion and analysis of the company’s consolidated financial condition, changes in financial condition, results of operations, liquidity, cash flows and capital resources. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes in Part I, Item 1, “Financial Statements” in this Quarterly Report on Form 10-Q (“Form 10-Q”) and Part II, Item 8, “Financial Statements and Supplementary Data” in the company’s Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 Form 10-K”). The data presented as of March 31, 2014 and for the three-month periods ended March 31, 2014 and 2013 is derived from our unaudited interim financial statements and include, in the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the data for such period. The data presented as of December 31, 2013 is derived from our audited financial statements as of and for the year ended December 31, 2013, which is included in the 2013 Form 10-K.

All references to “Xenith Bankshares”, “our company”, “we”, “our” or “us” are to Xenith Bankshares, Inc. and its wholly-owned subsidiary, Xenith Bank, collectively. All references to “the Bank” are to Xenith Bank.

All dollar amounts included in the tables in this discussion and analysis are in thousands, except per share data. Columns and rows of amounts presented in tables may not total due to rounding.

BUSINESS OVERVIEW

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, which is a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail clients, which we refer to as our target customers. We are geographically focused on the Greater Washington, DC, Richmond, Virginia, and the Greater Hampton Roads, Virginia metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its six branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia, and three branches located in Suffolk, Virginia. We acquired the three branches located in Suffolk in the merger of Xenith Corporation with and into First Bankshares, Inc., the parent company of its wholly-owned subsidiary SuffolkFirst Bank. Prior to the merger, SuffolkFirst Bank opened the first branch in Suffolk, Virginia in 2003 under the name of SuffolkFirst Bank. All of the SuffolkFirst Bank branches now operate under the name Xenith Bank. As of March 31, 2014, we had total assets of $683.5 million, total loans, net of our allowance for loan and lease losses, of $558.6 million, total deposits of $570.0 million and shareholders’ equity of $88.8 million.

Our services and products consist primarily of taking deposits from, and making loans to, our target customers within our target markets. We provide a broad selection of commercial and retail banking products, including commercial and industrial loans, commercial and residential real estate loans, and select consumer loans. We also offer a wide range of checking, savings and treasury products, including remote deposit capture, automated clearing house transactions, debit cards, 24-hour ATM access, and Internet and mobile banking and bill pay service. We do not engage in any activities other than banking activities.

On March 20, 2014, we entered into a merger agreement with Colonial Virginia Bank (“CVB”), pursuant to which CVB will be merged with and into the Bank, with the Bank surviving the CVB merger as a wholly-owned subsidiary of the company. CVB operates two full-service branches in the Gloucester, Virginia area and one loan production office in Yorktown, Virginia, all within the company’s target markets. As of December 31, 2013, CVB reported total assets of $114.9 million, net loans of $71.4 million, total deposits of $99.5 million, and shareholders’ equity of $12.1 million. Under the terms of the merger agreement, each share of CVB common stock outstanding immediately prior to the effective time of the CVB merger will be converted into the right to receive 2.65 shares of Xenith Bankshares common stock without interest and less applicable amounts for taxes. There will be no cash transferred in the transaction, with the exception of the purchase of fractional shares.

On April 30, 2014, the Federal Reserve Bank of Richmond, acting on delegated authority from the Board of Governors of the Federal Reserve Bank, granted the federal bank regulatory approvals necessary for the merger. The completion of the CVB merger remains subject to certain conditions, including approval by the Bureau of Financial Institutions of the Virginia State Corporation Commission, approval by the shareholders of CVB, and other customary closing conditions.

In the third quarter of 2013, we began purchasing rehabilitated student loans, a significant portion of which are guaranteed by the federal government. These loans were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, the student loans are substantially guaranteed by a guarantee agency and reinsured by the U.S. Department of Education. The purchased loans were also part of the Federal Rehabilitated Loan Program (“FRLP”), under which borrowers on defaulted loans have the one-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor, are brought current and sold to approved lenders. We have an agreement with a third-party servicer of student loans that provides all day-to-day operational requirements for the servicing of these loans. As of March 31, 2014, guaranteed student loans were $93.1 million, which are classified as loans held for investment in our consolidated balance sheet. These loans carry a nearly 98% guaranty of principal and interest by a guarantee agency and are reinsured by the U.S. Department of Education.

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In the third quarter of 2013, the company announced a share repurchase program, under which we may repurchase in the open market or otherwise up to 210,000 shares of our outstanding common stock, or approximately 2% of outstanding shares at the time of the announcement. There is no guarantee as to the number of shares that will be repurchased by the company, and the program can be discontinued at any time. For the three months ended March 31, 2014, the company purchased 43,900 shares of its common stock at an average price of $6.04. For additional information regarding shares repurchased in the first quarter, see Part II, Item 2, “Unregistered Sales of Equity Securities and Use of Proceeds.”

The primary source of our revenue is net interest income, which represents the difference between interest income on interest-earning assets and interest expense on liabilities used to fund those assets. Interest-earning assets include loans, available-for-sale securities and federal funds sold. Interest-bearing liabilities include deposits and borrowings. Sources of noninterest income include service charges on deposit accounts, gains on the sale of securities and other assets, and other miscellaneous income. Deposits, Federal Home Loan Bank (“FHLB”) borrowed funds and federal funds purchased are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. Measures of our performance include net interest margin, return on average assets (“ROAA”), return on average equity (“ROAE”), and efficiency ratio. Such measures are common performance indicators in the banking industry.

The following table presents selected financial performance measures, for the dates stated:

	Three Months Ended March 31,
	2014			2013
Net interest margin (1)		3.42	%		3.83	%
Return on average assets (2)		0.15	%		0.29	%
Return on average common equity (3)		1.27	%		2.10	%
Efficiency ratio (4)		88	%		82	%

(1) Net interest margin is net interest income divided by average interest-earning assets. Average interest-earning assets are presented within the average balances, income and expenses, yields and rates table below.

(2) ROAA is net income divided by average total assets. Average total assets are presented within the average balances, income and expenses, yields and rates table below.

(3) ROAE is net income divided by average shareholders’ equity less average preferred stock. Average shareholders’ equity is presented within the average balances, income and expenses, yields and rates table below.

(4) Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

Merger of First Bankshares, Inc. and Xenith Corporation

First Bankshares, Inc. (“First Bankshares”) was incorporated in Virginia in 2008, and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002.

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares (the “merger”), with First Bankshares being the surviving entity in the merger. At the effective time of the merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. Following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank.

Acquisitions

Effective on July 29, 2011, the Bank acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office of Paragon Commercial Bank, a North Carolina banking corporation, and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the branch office (the “Paragon Transaction”).

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (“FDIC”) acted as receiver of VBB. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Acquisition agreement, the Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The VBB Acquisition was completed without any shared-loss agreement with the FDIC.

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Industry Conditions

The economy showed signs of improvement in 2013 and first quarter 2014, with a slight decline in unemployment, an improvement in consumer confidence, and some stabilization in housing markets. The national unemployment rate, seasonally adjusted and as published by the Bureau of Labor Statistics, for March 2014 was reported at 6.7%, remaining the same as December 2013. In the Fifth District of the Federal Reserve Bank (the “Fifth District”), which includes our target markets, the February 2014 unemployment rate was 5.7%, down from 6.2% at the end of 2013. More specifically, the unemployment rate in Virginia in February 2014 was 4.9%, based on data published by the Fifth District.

The Federal Open Market Committee (the “FOMC”) stated in an April 30, 2014 release that economic activity has been expanding at a moderate pace, and although labor market conditions have shown some improvement, the unemployment rate remains elevated. The FOMC stated business fixed investment declined, while the recovery in the housing sector remained slow, but household spending advanced.

The FOMC stated it will reduce the pace of its asset purchase program until the outlook for the labor market or inflation changes, with the future pace of the asset purchase program based on the efficacy and cost of the program. The FOMC stated it expects that a highly accommodative stance of monetary policy will remain appropriate for a considerable time. In determining how long to maintain the current 0 to ¼ percent target range for the federal funds rate, the FOMC stated it will assess progress (both realized and expected) toward its objectives of maximum employment and 2 percent inflation. The FOMC currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the FOMC views as normal in the longer run.

Low interest rates and intense competition, due to limited business investment, in addition to other factors, have put pressure on net interest margins of banks, including the Bank. Banks with which we compete are offering aggressive terms and may be loosening credit underwriting standards. We anticipate intense competition in our markets until the economy shows stronger signs of improvement.

Outlook

We believe we are well positioned to take advantage of competitive opportunities. We believe we will benefit from (1) our team of skilled bankers, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team. We intend to execute our business strategy by focusing on developing long-term relationships with our target customer base through a team of bankers with significant experience in our target markets.

Intense competition for quality loans in this low interest rate environment requires that we remain firm in applying our established credit underwriting practices, providing exceptional customer service, and offering competitive treasury services products, as well as cautiously stepping down rates on our deposits, and monitoring our expenses.

In our continuing evaluation of our business strategy, we believe properly priced acquisitions can complement our organic growth. We may seek to acquire other financial institutions or branches or assets of those institutions. Although our principal acquisition focus will be to expand our presence in our target markets, we may also expand into new markets or related banking lines of business and related services and products. We evaluate potential acquisitions to determine what is in the best interest of our company and long-term strategy. Our goal in making these decisions is to maximize shareholder value.

Critical Accounting Policies

Our accounting policies are fundamental to an understanding of our consolidated financial position and consolidated results of operations. We believe that our accounting and reporting policies are in accordance with generally accepted accounting principles in the United States of America and conform to general practices within the banking industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and the amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations.

We consider a policy critical if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate, and (2) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe that our most critical accounting policy relates to the allowance for loan and lease losses, which reflects our estimate of losses in the event of borrower default. An additional accounting policy that we deem critical using these criteria is our measurement of probable cash flows with respect to purchased credit-impaired loans accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). Yield and impairment for purchased credit-impaired loans is based on management’s estimate of future cash flows, which are re-estimated on a periodic basis. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, adjustments to our estimates would be made and additional provisions for loan and lease losses could be required, which could have a material adverse impact on our results of operations and financial condition. Further discussion of the estimates used in determining the allowance for loan and lease losses is

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contained in the discussion under “—Financial Condition—Allowance for Loan and Lease Losses” below and in measuring impairment for purchased credit-impaired loans is contained under “—Financial Condition—Allowance for Loan and Lease Losses—Acquired Loans” below.

Our critical accounting policies are discussed in detail in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies” and “Summary of Significant Accounting Policies” in the notes to the consolidated financial statements in our 2013 Form 10-K. Since December 31, 2013, there have been no changes in these policies that have had or could reasonably be expected to have a material effect on our results of operations or financial condition.

RESULTS OF OPERATIONS

Net Income

For the three months ended March 31, 2014, net income was $255 thousand compared to net income of $418 thousand for the three months ended March 31, 2013. Net income before income tax expense was $464 thousand for the three months ended March 31, 2014 compared to $663 thousand for the same period in 2013.

The following table presents our net income and earnings per common share information for the periods stated:

	Three Months Ended March 31,
	2014			2013
Net income	$	255		$	418
Preferred stock dividend		(21	)		(21	)
Net income available to common shareholders	$	234		$	397
Earnings per common share, basic and diluted	$	0.02		$	0.04

Net Interest Income

For the three months ended March 31, 2014, net interest income was $5.5 million compared to $5.2 million for the three months ended March 31, 2013. Higher net interest income in the 2014 period was primarily due to higher average balances of loans held for investment, including guaranteed student loans, partially offset by lower yields on loans held for investment and lower average balances of loans held for sale. Also contributing to higher net interest income was lower costs of deposits. Higher average balances of deposits were offset by lower costs of these deposits. Lower yields on loans held for investment were partially due to lower accretion on acquired loans in the 2014 period compared to the 2013 period, as further discussed below. As presented in the table below, our net interest margin for the three-month period ended March 31, 2014 was 3.42%, a 41 basis point decrease from 3.83% for the same period in 2013. Excluding the effect of purchase accounting adjustments, net interest margin declined 13 basis points for the period ended March 31, 2014 compared to the same period of 2013. Lower yields on guaranteed student loans affected net interest margin as these loans earn lower yields than our organic and acquired loans; however, we believe these loans, which carry a federal guarantee and reprice quarterly, offer attractive risk-adjusted returns.

Average interest-earning assets increased $90.8 million, primarily due to guaranteed student loans, while related interest income increased $147 thousand, for the three-month period ended March 31, 2014 compared to the same period in 2013. Average interest-bearing liabilities increased $74.0 million, primarily due to an increase in time deposits, while related interest expense decreased $72 thousand, for the three-month period ended March 31, 2014 compared to the same period in 2013. Yields on interest-earning assets decreased 55 basis points to 3.96%, and costs of interest-bearing liabilities decreased 20 basis points to 0.71%, when comparing the three-month period ended March 31, 2014 to the same period in 2013. Average interest-earning assets as a percentage of total assets were 93.5% for the three-month period ended March 31, 2014, a decline from 95.1% for the same period in 2013. The decrease in the percentage of interest-earning assets to total assets in the 2014 period was primarily due to our investment in bank owned life insurance (“BOLI”) in the second quarter of 2013.

Our loan portfolios acquired in the merger, the Paragon Transaction and VBB Acquisition were discounted to estimated fair value (for credit and interest rates) as of the acquisition dates. A portion of the discounts taken to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans or the period of expected cash flows from the loans. Amounts received in excess of the carrying value of loans accounted for on cost recovery are also accreted into interest income at the time of recovery. Loan discount accretion was $139 thousand for the three months ended March 31, 2014 compared to $502 thousand for the period ended March 31, 2013.

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The following table presents the effect of purchase accounting adjustments on our net interest margin for the periods stated:

	Three Months Ended March 31,
	2014			2013
Net interest margin		3.42	%		3.83	%
Purchase accounting adjustments impact (1)		0.09	%		0.37	%
Net interest margin excluding the impact of purchase accounting adjustments		3.33	%		3.46	%

(1) Purchase accounting adjustments include accretion of discounts on acquired loans.

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The following table provides an analysis of the effective yields and rates on average interest-earning assets and average interest-bearing liabilities as of and for the periods stated. The average balances and other statistical data used in this table were calculated using daily average balances. Tax-exempt income is reported on a taxable equivalent basis.

	Average Balances, Income and Expenses, Yields and Rates
	As of and For the Three Months Ended March 31,
																	2014 vs. 2013
	Average Balances (1)						Yield / Rate						Income / Expense (7)(8)				Increase			Change due to (2)
	2014			2013			2014			2013			2014		2013		(Decrease)			Rate			Volume
Assets
Interest-earning assets:
Federal funds sold	$	6,248		$	4,484			0.22	%		0.21	%	$	3	$	2	$	1		$	—		$	1
Interest-earning deposits		10,946			43,679			0.32	%		0.25	%		9		28		(19	)		6			(25	)
Investments		73,501			59,433			2.34	%		2.01	%		429		298		131			53			77
Loans held for sale		2,372			66,434			2.76	%		3.31	%		16		549		(533	)		(78	)		(455	)
Guaranteed student loans, gross		93,698			—			3.22	%		0.00	%		754		—		754			—			754
Loans held for investment, gross (3)		452,786			374,752			4.53	%		5.67	%		5,124		5,311		(187	)		(1,180	)		993
Total interest-earning assets		639,551			548,782			3.96	%		4.51	%		6,335		6,188		147			(1,199	)		1,345
Allowance for loan and lease losses		(5,388	)		(5,064	)
Noninterest-earning assets:
Cash and due from banks		10,330			4,656
Premises and fixed assets		5,009			5,412
Other assets		34,562			23,264
Total noninterest-earning assets		49,901			33,332
Total assets	$	684,064		$	577,050
Liabilities and Shareholders’ Equity
Interest-bearing liabilities:
Demand deposits	$	29,874		$	14,400			0.18	%		0.24	%	$	13	$	9	$	4		$	(3	)	$	7
Savings and money market deposits		217,336			242,152			0.51	%		0.62	%		279		374		(95	)		(59	)		(36	)
Time deposits		209,791			134,153			0.90	%		1.38	%		475		464		11			(195	)		206
Federal funds purchased and borrowed funds		28,354			20,673			1.41	%		1.77	%		100		92		8			(22	)		30
Total interest-bearing liabilities		485,355			411,378			0.71	%		0.91	%		867		939		(72	)		(279	)		207
Noninterest-bearing liabilities:
Noninterest-bearing demand deposits		106,451			75,312
Other liabilities		3,615			2,453
Total noninterest-bearing liabilities		110,066			77,765
Shareholders’ equity		88,643			87,907
Total liabilities and shareholders’ equity	$	684,064		$	577,050
Interest rate spread (4)								3.25	%		3.60	%
Net interest income (5)													$	5,468	$	5,249	$	219		$	(920	)	$	1,139
Net interest margin (6)								3.42	%		3.83	%

(1) Average balances are computed on a daily basis.

(2) Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.

(3) Nonaccrual loans have been included in the average balances. Guaranteed student loans are excluded.

(4) Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.

(5) Net interest income is interest income less interest expense.

(6) Net interest margin is net interest income divided by average interest-earning assets.

(7) Tax-exempt interest income is stated on a taxable equivalent basis.

(8) Interest income from loans held for investment in 2014 and 2013 includes $139 thousand and $502 thousand, respectively, in accretion related to acquired loans.

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Provision for Loan and Lease Losses

For three months ended March 31, 2014, our provision for loan and lease losses was $227 thousand compared to $411 thousand for the same period of 2013. Lower provision in the three-month period ended March 31, 2014 was primarily due to improved credit quality and loan mix.

Noninterest Income

For the three months ended March 31, 2014, noninterest income was $320 thousand compared to $660 thousand for the same period of 2013. Lower noninterest income in the 2014 period was primarily due to a gain of $361 thousand on the sale of collateral related to an impaired loan acquired in the VBB Acquisition and gains on sales of securities in 2013. In the three-month period ended March 31, 2014, we had higher noninterest income resulting from higher service charges and fees on deposit accounts, including fees from treasury management services, and earnings on BOLI compared to the same period in 2013.

Noninterest Expense

For the three-month period ended March 31, 2014, noninterest expense increased $258 thousand compared to the same period in 2013. Noninterest expense in the 2014 period included $205 thousand of expenses, primarily professional fees, related to the previously announced merger with CVB and $156 thousand of expenses for guaranteed student loan servicing.

Income Taxes

For the three-month periods ended March 31, 2014 and 2013, income tax expense was $209 thousand and $245 thousand, respectively. Income tax expense and our effective tax rate of 45% in the first quarter of 2014 reflects the nondeductibility of certain merger-related transaction costs, partially offset by the addition of BOLI, the earnings on which are tax exempt. Net deferred tax assets as of March 31, 2014 and December 31, 2013 were $4.2 million and $4.3 million, respectively.

FINANCIAL CONDITION

Securities

The following tables present information about our securities portfolio as of the dates stated. Weighted average life calculations and weighted average yields are based on the current level of contractual maturities and expected prepayments as of the dates stated. The decline in the fair value of our investment portfolio is primarily due to the recent rise in longer term interest rates. During the first quarter of 2014, we reclassified certain nonamortizing, fixed-rate securities to held to maturity.

	March 31, 2014
	Book Value		Fair Value		Weighted Average Life in Years		Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate	$	43,828	$	43,820		4.39		2.09	%
- Variable rate		4,804		4,849		10.84		1.90	%
Municipals - fixed rate
- Tax exempt (1)		1,630		1,615		7.87		2.95	%
Collateralized mortgage obligations - fixed rate		8,488		8,367		4.63		2.24	%
Total securities available for sale		58,750		58,651		5.06		2.12	%
Securities held to maturity:
Municipals - fixed rate
- Taxable		9,285		9,247		8.98		3.39	%
Total securities held to maturity		9,285		9,247		8.98		3.39	%
Total securities	$	68,035	$	67,898		5.59		2.29	%

(1) Yields on tax-exempt securities are calculated on a tax equivalent basis.

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	December 31, 2013
	Book Value		Fair Value		Weighted Average Life in Years		Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate	$	45,693	$	45,338		4.54		2.09	%
- Variable rate		4,903		4,852		4.20		1.68	%
Municipals - fixed rate
- Taxable		9,810		8,970		9.23		2.71	%
- Tax exempt (1)		1,634		1,573		8.12		2.95	%
Collateralized mortgage obligations - fixed rate		8,940		8,452		4.01		2.18	%
Total securities available for sale	$	70,980	$	69,185		5.16		2.17	%

(1) Yields on tax-exempt securities are calculated on a tax equivalent basis.

The following tables present a maturity analysis of our securities portfolio as of the dates stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the dates stated.

	March 31, 2014
	Within 1 Year		Weighted Average Yield		After 1 Year Through 5 Years		Weighted Average Yield		After 5 Years Through 10 Years		Weighted Average Yield			After 10 Years		Weighted Average Yield			Total		Weighted Average Yield
Securities available for sale:
Mortgage-backed securities
- Fixed rate	$	—		—	$	—		—	$	25,852		1.91	%	$	17,968		2.34	%	$	43,820		2.09	%
- Variable rate		—		—		—		—		—		—			4,849		1.90	%		4,849		1.90	%
Municipals - fixed rate
- Tax exempt (1)		—		—		—		—		1,615		2.95	%		—		—			1,615		2.95	%
Collateralized mortgage obligations - fixed rate		—		—		—		—		—		—			8,367		2.24	%		8,367		2.24	%
Total securities available for sale		—				—				27,467					31,184					58,651
Securities held to maturity:
Municipals - fixed rate
- Taxable		—		—		—		—		8,309		3.31	%		938		4.12	%		9,247		3.39	%
Total securities held to maturity		—				—				8,309					938					9,247
Total securities	$	—		—	$	—		—	$	35,776		2.28	%	$	32,122		2.07	%	$	67,898		2.29	%

(1) Yields on tax-exempt securities are calculated on a tax equivalent basis.

The following table presents the book value and fair value of securities for which the book value exceeded 10% of shareholders’ equity as of the date stated:

	March 31, 2014
	Book Value		Fair Value		Book Value as a Percentage of Shareholders’ Equity
Mortgage-backed securities
- Federal National Mortgage Association	$	38,292	$	38,430		43.1	%
- Federal Home Loan Mortgage Corporation		9,327		9,229		10.5	%

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Loans

The following table presents the company’s composition of loans, net of capitalized origination costs and unearned income, in dollar amounts and as a percentage of total loans as of the dates stated:

	March 31, 2014						December 31, 2013
	Amount			Percent of Total			Amount			Percent of Total
Commercial and industrial	$	245,936			44.10	%	$	246,324			45.75	%
Commercial real estate		191,790			34.39	%		172,711			32.08	%
Residential real estate		23,029			4.13	%		22,004			4.09	%
Consumer		3,414			0.61	%		3,191			0.59	%
Guaranteed student loans		93,142			16.70	%		94,028			17.46	%
Overdrafts		367			0.07	%		184			0.03	%
Loans held for investment	$	557,678			100.00	%	$	538,442			100.00	%
Allowance for loan and lease losses		(5,414	)					(5,305	)
Loans held for investment, net of allowance		552,264						533,137
Loans held for sale		6,336						3,363
Total loans	$	558,600					$	536,500

Loans held for sale

Loans held for sale represent our participation in a nationwide warehouse lending program with a commercial bank (the “participating bank”), whereby pursuant to the sub-participation agreement, the participating bank and the Bank purchase participation interests from unaffiliated mortgage originators that seek funding to facilitate the origination of single-family residential mortgage loans for sale in the secondary market. Typically, the Bank, together with the participating bank, purchases up to an aggregate of a 99% interest with the originators retaining the remaining 1% interest. These loans are held for short periods, usually less than 30 days and more typically 10-20 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.

Loans held for investment

The following tables provide the maturity analysis of our loans held for investment as of the dates stated based on whether loans are variable-rate or fixed-rate loans:

	March 31, 2014
			Variable Rate						Fixed Rate
	Within 1 year		1 to 5 years		After 5 years		Total variable > 1 year		1 to 5 years		After 5 years		Total fixed > 1 year		Total Maturities
Commercial and industrial (1)	$	101,702	$	86,790	$	12,461	$	99,251	$	33,927	$	8,728	$	42,655	$	243,608
Commercial real estate (2)		52,983		92,074		14,027		106,101		27,880		4,428		32,308		191,392
Residential real estate (3)		5,216		3,715		6,063		9,778		5,800		657		6,457		21,451
Consumer		2,579		—		255		255		578		1		579		3,413
Guaranteed student loans		35		993		92,114		93,107		—		—		—		93,142
Overdrafts		367		—		—		—		—		—		—		367
Total loans	$	162,882	$	183,572	$	124,920	$	308,492	$	68,185	$	13,814	$	81,999	$	553,373

(1) Excludes $1.5 million in nonaccrual fixed-rate loans and $872 thousand in nonaccrual variable-rate loans.

(2) Excludes $370 thousand in nonaccrual fixed-rate loans and $28 thousand in nonaccrual variable-rate loans.

(3) Excludes $132 thousand in nonaccrual fixed-rate loans and $1.4 million in nonaccrual variable-rate loans.

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	December 31, 2013
			Variable Rate						Fixed Rate
	Within 1 year		1 to 5 years		After 5 years		Total variable > 1 year		1 to 5 years		After 5 years		Total fixed > 1 year		Total Maturities
Commercial and industrial (1)	$	102,663	$	79,277	$	9,980	$	89,257	$	43,496	$	8,522	$	52,018	$	243,938
Commercial real estate (2)		57,749		78,167		8,489		86,656		23,029		4,394		27,423		171,828
Residential real estate (3)		6,994		3,615		5,006		8,621		5,355		481		5,836		21,451
Consumer		2,242		319		69		388		559		2		561		3,191
Guaranteed student loans		30		1,247		92,751		93,998		—		—		—		94,028
Overdrafts		185		—		—		—		—		—		—		185
Total loans	$	169,863	$	162,625	$	116,295	$	278,920	$	72,439	$	13,399	$	85,838	$	534,621

(1) Excludes $1.5 million in nonaccrual fixed-rate loans and $874 thousand in nonaccrual variable-rate loans.

(2) Excludes $384 thousand in nonaccrual fixed-rate loans and $499 thousand in nonaccrual variable-rate loans.

(3) Excludes $119 thousand in nonaccrual fixed-rate loans and $434 thousand in nonaccrual variable-rate loans.

A certain degree of risk is inherent in the extension of credit. Management has established loan and credit policies and guidelines designed to control both the types and amounts of risks we take and to minimize losses. Such policies and guidelines include loan underwriting parameters, loan-to-value parameters, credit monitoring guidelines, adherence to regulations, and other prudent credit practices.

Loans secured by real estate comprised 49.2% of our loan portfolio at March 31, 2014 and 47.9% at December 31, 2013. Commercial real estate (“CRE”) loans are secured by commercial properties. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt service coverage ratios as well. Residential real estate loans consist primarily of first and second lien loans, including home equity lines and credit loans, secured by residential real estate located primarily in our target markets, offered to select customers. These customers primarily include branch and private banking customers. Typically, our loan-to-value benchmark for these loans is below 80% at inception, with satisfactory debt-to-income ratios as well. The repayment of both residential and owner-occupied commercial real estate (“OORE”) loans depends primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary source of repayment. We classify OORE loans as commercial and industrial (“C&I”), as the primary source of repayment of the loan is generally dependent on the financial performance of the commercial enterprise occupying the property, with the real estate being a secondary source of repayment.

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to FASB ASC Topic 450, “Contingencies,” and (2) a component for individual loan impairment recognized pursuant to FASB ASC Topic 310, “Receivables.”

We determine the allowance for loan and lease losses based on a periodic evaluation of the loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans that we originate in our portfolio. We also consider qualitative factors, such as general economic conditions, nationally and in our target markets, as well as threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors are estimates and may be subject to significant change. Increases to our allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in our consolidated statements of operations. Loans deemed to be uncollectible, in full or in part, are charged against our allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to our allowance for loan and lease losses.

In assessing the adequacy of our allowance for loan and lease losses as of the end of a reporting period, we also evaluate our loan risk ratings. Each loan is assigned two “risk ratings” at origination. One risk rating is based on our assessment of our borrower’s financial capacity and the other is based on the type of collateral and estimated loan to value. Our assigned risk ratings generally determine the quantitative factors used in the calculation of our allowance for loan and lease losses. In addition to our assessment of risk ratings, we also consider internal observable data related to trends within the loan portfolio, such as concentrations, aging of the portfolio, changes to our policies and procedures, and external observable data such as industry and general economic trends.

In evaluating loans accounted for under ASC 310-30, we periodically estimate the amount and timing of cash flows expected to be collected. Upon re-estimation, any deterioration in the timing and/or amount of cash flows results in an impairment charge, which is reported as a provision for loan and lease losses in net income and a component of our allowance for loan and lease losses. A subsequent improvement in the expected timing or amount of future cash flows for those loans could result in the reduction of the allowance for loan and lease losses and an increase in our net income.

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In evaluating our acquired guaranteed student loans, our allowance for loan and lease losses is based on historical default rates for similar types of loans applied to the portion of carrying value in these loans that is not subject to federal guaranty.

Although we use various data and information sources to establish our allowance for loan and lease losses, future adjustments to our allowance for loan and lease losses may be necessary, if conditions, circumstances or events are substantially different from the assumptions used in making the assessments. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan and lease losses. Such agencies may require us to recognize additions or reductions to the allowance for loan and lease losses based on their judgments of information available to them at the time of their examination.

The following table presents the allowance for loan and losses by loan type and the percent of loans held for investment in each category to total loans as of the dates stated:

	March 31, 2014					December 31, 2013
	Amount		Percent of loans in each category to total loans held for investment			Amount		Percent of loans in each category to total loans held for investment
Balance at end of period applicable to:
Commercial and industrial	$	1,861		44.10	%	$	2,148		45.75	%
Commercial real estate		2,737		34.39	%		2,756		32.08	%
Residential real estate		407		4.13	%		194		4.09	%
Consumer		30		0.68	%		12		0.62	%
Guaranteed student loans		379		16.70	%		195		17.46	%
Total allowance for loan and lease losses	$	5,414		100.00	%	$	5,305		100.00	%

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The following tables present the activity in the allowance for loan and lease losses for the dates stated:

	For the Three Months Ended March 31,
	2014			2013
Balance at beginning of period	$	5,305		$	4,875
Charge-offs:
Commercial and industrial		—			1
Commercial real estate		—			159
Residential real estate		35			—
Consumer		—			—
Guaranteed student loans		—			—
Overdrafts		1			1
Total charge-offs		36			161
Recoveries:
Commercial and industrial		1			—
Commercial real estate		—			—
Residential real estate		—			—
Consumer		—			—
Guaranteed student loans		—			—
Overdrafts		—			1
Total recoveries		1			1
Net charge-offs		35			160
Provision for loan and lease losses		227			411
Amount for unfunded commitments		(19	)		(27	)
Other (1)		(64	)		—
Balance at end of period	$	5,414		$	5,099

(1) Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

Acquired Loans

Acquired loans are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a straight-line basis or based on the underlying principal payments on the loan. Any change in credit quality subsequent to acquisition for these loans is reflected in our allowance for loan and lease losses.

Pursuant to the merger with First Bankshares, the acquired loans were adjusted to estimated fair value with a discount of $7.6 million. The loans acquired in the Paragon Transaction and the VBB Acquisition were also adjusted to estimated fair value by recording a discount of $1.8 million and $14.0 million, respectively.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC 310-30. We concluded that a portion of the loans acquired in the VBB Acquisition are credit-impaired loans qualifying for accounting under ASC 310-30.

In applying ASC 310-30 to acquired loans, we must estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including estimated default rates and the amount and timing of prepayments, in addition to other factors. ASC 310-30 allows the purchaser to estimate cash flows on credit-impaired loans on a loan-by-loan basis or aggregate credit-impaired loans into one or more pools if the loans have common risk characteristics. We have estimated cash flows expected to be collected on a loan-by-loan basis.

The excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield. This amount is accreted into interest income over the period of expected cash flows from the loan, using the effective yield method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference.

If upon remeasurement in a future period, a loan for which an impairment charge has been taken is expected to have cash flows that exceed those previously determined, some portion of the impairment could be reversed. Our re-evaluation of expected cash flows

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in the first quarter of 2014 resulted in a benefit of $47 thousand due to the improvement of expected cash flows from a loan for which an impairment charge was recorded in a prior period. This benefit is recorded in the provision for loan and lease losses in the consolidated statement of operations and in our allowance for loan and lease losses in our consolidated balance sheet.

The following table presents our accretion activity as of the dates stated:

	March 31, 2014			December 31, 2013
Balance at beginning of period	$	4,441		$	8,133
Accretion (1)		(139	)		(2,644	)
Disposals (2)		—			(1,048	)
Other (3)		64			—
Balance at end of period	$	4,366		$	4,441

(1) Accretion amounts are reported in interest income.

(2) Disposals represent the reduction of purchase accounting adjustments due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2013 amount, $85 thousand relates to loans reclassified as other real estate owned.

(3) Represents the recovery of a credit-impaired loan’s prior period allowance through accretion income.

Nonperforming Assets

It is our policy to discontinue the accrual of interest income on nonperforming loans. We consider a loan as nonperforming when it is 90 days or greater past due as to interest and principal or when collectability is in doubt, unless the estimated net realized value of collateral is sufficient to assure collection of principal balance and accrued interest. As of March 31, 2014, and December 31, 2013, there were no loans 90 days or greater past due with respect to principal and interest for which interest was accruing.

As of March 31, 2014 and December 31, 2013, we had $161 thousand and $199 thousand, respectively, in OREO consisting primarily of residential properties and undeveloped land. OREO valuations are evaluated periodically, and any necessary reserve to carry the asset at its fair value is recorded as a charge to net income. In the three months ended March 31, 2014, we recorded a $38 thousand valuation allowance for two properties to reflect their net carrying values at estimated fair value.

The following table presents our nonperforming assets and various performance ratios for the periods and as of the dates stated:

	March 31, 2014			December 31, 2013
Nonaccrual loans	$	4,295		$	3,822
Other real estate owned		161			199
Total nonperforming assets	$	4,456		$	4,021
Nonperforming assets as a percentage of total loans held for investment		0.80	%		0.75	%
Nonperforming assets as a percentage of total assets		0.65	%		0.59	%
Net charge-offs as a percentage of average loans held for investment		0.01	%		0.22	%
Allowance for loan and lease losses as a percentage of total loans held for investment		0.97	%		0.99	%
Allowance for loan and lease losses to nonaccrual loans		126.06	%		138.78	%

Deposits

Deposits represent our primary source of funds and are comprised of demand deposits, savings deposits and time deposits. Deposits as of March 31, 2014 totaled $570.0 million compared to deposits of $569.2 million at December 31, 2013. Demand deposits, including money market accounts, as of March 31, 2014, decreased $9.7 million from balances at December 31, 2013, while time deposits increased $10.2 million. As of March 31, 2014 and December 31, 2013, $65.8 million and $71.3 million, respectively, of our deposits were in Insured Cash Sweep accounts and brokered time deposits, which we collectively refer to as brokered deposits.

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The following table presents average balances and rates paid, by deposit category, as of the dates stated:

	March 31, 2014					December 31, 2013
	Amount		Rate			Amount		Rate
Noninterest-bearing demand deposits	$	106,450		—		$	88,254		—
Interest-bearing deposits:
Demand and money market		242,224		0.48	%		251,110		0.54	%
Savings accounts		4,986		0.24	%		4,535		0.29	%
Time deposits $100,000 or greater		151,235		0.76	%		95,490		1.01	%
Time deposits less than $100,000		58,555		1.27	%		57,374		1.36	%
Total interest-bearing deposits		457,000		0.67	%		408,509		0.76	%
Total average deposits	$	563,450		0.54	%	$	496,763		0.63	%

The following table presents maturities of large denomination time deposits (equal to or greater than $100,000) as of March 31, 2014:

	Within 3 Months		3-6 Months		6-12 Months		Over 12 Months		Total		Percent of Total Deposits
Time deposits	$	28,513	$	30,919	$	54,047	$	43,659	$	157,138		27.57	%

Borrowings

The following table summarizes the period-end balance, highest month-end balance, average balance, and weighted average rate of short-term borrowings for each of the periods stated:

	March 31, 2014									December 31, 2013
	Period-End Balance		Highest Month-End Balance		Average Balance		Weighted Average Rate			Year-End Balance		Highest Month-End Balance		Average Balance		Weighted Average Rate
Federal funds purchased	$	1,423	$	6,367	$	1,499		0.58	%	$	—	$	—	$	247		0.58	%
Other borrowings		—		16,000		6,856		0.41	%		—		5,000		805		0.31	%
Total short-term borrowings	$	1,423	$	22,367	$	8,355		0.44	%	$	—	$	5,000	$	1,052		0.37	%

We have one secured long-term borrowing with the FHLB in the amount of $20 million, which matures on September 28, 2015. The borrowing is a nonamortizing term loan and bears interest at a rate of 20 basis points over LIBOR, which resets quarterly. The borrowing was a modification of a then-existing borrowing, and in connection with the modification, we paid a fee of $533 thousand that is being recognized as interest expense over the remaining term of the borrowing.

At the time we modified the FHLB borrowing, we entered into a derivative (interest rate swap) whereby we pay fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreement without the exchange of the underlying notional amount, which is $20 million. Our objective in using interest rate derivatives is to manage our exposure to interest rate movements. During the second quarter of 2013 and the first quarter of 2014, we entered into forward-starting swaps for notional amounts totaling $17.5 million, whereby upon the renewal of the FHLB borrowing for a specified period we pay fixed amounts and receive variable payments on a portion of the underlying notional amount of the borrowings. The derivatives are designated as cash flow hedges, whereby the effective portion of the hedges is recorded in accumulated other comprehensive (loss) income. The amount reported in accumulated other comprehensive (loss) income as of March 31, 2014, related to these derivatives was an unrealized loss of $6 thousand, net of a tax benefit of $3 thousand. As of March 31, 2014, the ineffective portion of the derivatives was insignificant.

We have agreements with the counterparty to our derivatives that contain a provision whereby, if we fail to maintain our status as a well/an adequate capitalized institution, we could be required to terminate or fully collateralize the derivative contracts. Additionally, if we default on any of our indebtedness, including default where repayment has not been accelerated by the lender, we could also be in default on our derivative obligations. We have minimum collateral requirements with our counterparty and, as of

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March 31, 2014, $250 thousand had been pledged as collateral under the agreements, as the valuation of one of the derivatives had surpassed the contractually specified minimum transfer amount of $250 thousand. If we are not in compliance with the terms of the derivative agreements, we could be required to settle obligations under the agreements at termination value. As of March 31, 2014, an asset of $152 thousand was recorded in other assets, and a hedge liability of $179 thousand was recorded in other liabilities on our consolidated balance sheet related to these derivatives.

For the three-month period ended March 31, 2014, our effective interest rate on the $20 million FHLB borrowing, including the effect of the modification fee and cash flow hedge, was 1.81%.

LIQUIDITY AND CAPITAL RESOURCES

In the three-month period ended March 31, 2014, cash and cash equivalents decreased $18.2 million compared to an increase of $39.9 million in the same period in 2013. Net cash used in operating activities was $3.1 million for the three-month period ended March 31, 2014 compared to net cash provided by operating activities of $13.5 million for the same period in 2013. Net cash used in operating activities in the 2014 period was primarily for the funding of loans held for sale in excess of the sale of these loans, whereas in the 2013 period, we funded fewer loans than we sold. Net cash used in investing activities was $17.0 million for the three-month period ended March 31, 2014 compared to net cash provided by investing activities of $10.9 million for the same period in 2013. Cash used in investing activities in the 2014 period reflected a net increase in loans held for investment of $19.2 million, partially offset by proceeds from securities. Net cash provided by investing activities in the three-month period ended March 31, 2013 reflected a net decrease in loans held for investment and proceeds from securities, partially offset by purchases of securities. Net cash provided by financing activities in the three-month period ended March 31, 2014 was $1.9 million compared to $15.5 million for the same period of 2013. Cash provided by financing activities in the 2014 period reflected a net increase in deposits and borrowings, while cash provided by financing activities in the 2013 period was primarily due to the increase in deposits. In the third quarter of 2013, we began our share repurchase program and used $265 thousand to repurchase shares of our common stock in the three-month period ended March 31, 2014.

Liquidity

Liquidity is the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate deposit withdrawals, payments of debt and operating expenses and increased loan demand, and to achieve stated objectives (including working capital requirements.) These events may occur daily or in other short-term intervals in the normal operation of business. Historical trends may help management predict the amount of cash required. In assessing liquidity, management gives consideration to various factors, including stability of deposits, maturity of time deposits, quality, volume and maturity of assets, sources and costs of borrowings, concentrations of business and industry, competition, and our overall financial condition and cash flows.

Our primary sources of liquidity are cash, due from banks, federal funds sold and securities in our available-for-sale securities portfolio. We have access to a credit line from our primary correspondent bank in the amount of $9.0 million. This line is for short-term liquidity needs, expires in February 2015, and is subject to the prevailing federal funds interest rate. At March 31, 2014, we had $1.4 million of federal funds purchased outstanding under this facility.

In addition, we have secured borrowing facilities with the FHLB and the Federal Reserve Bank (“FRB”). The total credit availability under the FHLB facility is equal to 30% of our total assets, which as of March 31, 2014 was $203.6 million, based on our December 31, 2013 balance sheet. Pledged collateral for this facility as of March 31, 2014 was $42.4 million. Under this facility, as of March 31, 2014, we had one nonamortizing term loan for $20 million borrowing outstanding. Credit availability under the FRB facility was $112.4 million as of March 31, 2014, which is also based on pledged collateral. Borrowings under the FRB facility bear the prevailing current rate for primary credit. There were no amounts outstanding under the FRB facility as of March 31, 2014.

We also have three additional uncommitted lines of credit by national banks to borrow federal funds up to $28.0 million in total on an unsecured basis. One line for $5.0 million expires on September 30, 2014. The remainder of the lines of credit can be cancelled at any time. As of March 31, 2014, no amounts were outstanding under these uncommitted lines of credit. Borrowings under these arrangements bear interest at the prevailing federal funds rate.

Capital Adequacy

Capital management in a regulated financial services industry must properly balance return on equity to shareholders, while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Our capital management strategies have been developed to maintain our “well-capitalized” position.

We are subject to various regulatory capital requirements administered by federal and other bank regulators. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on us. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. Capital amounts and reclassifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

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In July 2013, the Federal Reserve Board approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions. The rule implements in the United States the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act. Under the final rule, minimum requirements will increase for both the quantity and quality of capital held by banking organizations. The rule includes a new minimum ratio of common equity Tier 1 capital to risk-weighted assets of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets that will apply to all supervised financial institutions. The rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4% to 6% and includes a minimum leverage ratio of 4% for all banking organizations. The phase-in period for this rule is not scheduled to begin until January 2015.

The following table presents Tier 1 and total risk-based capital and risk-weighted assets for the Bank and Xenith Bankshares as of the dates stated:

	March 31, 2014				December 31, 2013
	Xenith Bank		Xenith Bankshares		Xenith Bank		Xenith Bankshares
Tier 1 capital	$	69,777	$	70,393	$	69,314	$	70,299
Total risk-based capital		75,545		76,161		74,955		75,940
Risk-weighted assets		546,463		546,622		526,841		526,752

The following table presents capital ratios and minimum capital ratios required by our regulators for the Bank and Xenith Bankshares as of the dates stated:

	March 31, 2014						December 31, 2013
	Xenith Bank			Xenith Bankshares			Xenith Bank			Xenith Bankshares			Regulatory Minimum			Well Capitalized
Tier 1 leverage ratio		10.50	%		10.60	%		10.37	%		10.52	%		4.00	%		> 5.00	%
Tier 1 risk-based capital ratio		12.77	%		12.88	%		13.16	%		13.35	%		4.00	%		> 6.00	%
Total risk-based capital ratio		13.82	%		13.93	%		14.23	%		14.42	%		8.00	%		> 10.00	%

Interest Rate Sensitivity

Financial institutions can be exposed to several market risks that may impact the value or future earnings capacity of an organization. Our primary market risk is interest rate risk. Interest rate risk is inherent in banking, because we derive a significant amount of our operating revenue from “purchasing” funds (customer deposits and borrowings) at various terms and rates. These funds are invested in interest-earning assets (e.g., loans and investments) at various terms and rates.

Interest rate risk is the exposure to fluctuations in our future earnings (earnings at risk) and value (market value at risk) resulting from changes in interest rates. This exposure results from differences between the amounts of interest-earning assets and interest-bearing liabilities that re-price within a specific time period as a result of scheduled maturities and prepayments and contractual interest rate changes.

The balance sheet may be asset or liability sensitive at a given time. We intend to manage the Bank’s asset or liability sensitivity to optimize earnings, to minimize interest rate risk to preserve capital within policy limits, while optimizing the return to our shareholders.

Management strives to control the Bank’s exposure to interest rate volatility, and we operate under an asset and liability management policy approved by our board of directors. In accordance with our policy, we emphasize the loan and deposit pricing characteristics that best meet our current view on the future direction of interest rates and use sophisticated analytical tools to support our asset and liability processes.

Gap Analysis

Gap analysis tools monitor the “gap” between interest-sensitive assets and interest-sensitive liabilities. The Bank uses a simulation model to forecast balance sheet and income statement behavior. By studying the effects on net interest income of rising, stable and falling interest rate scenarios, the Bank can position itself to mitigate risks associated with anticipated interest rate movements by understanding the dynamic nature of its balance sheet components. We evaluate our balance sheet components (securities, loan and deposit portfolios) to manage our interest rate risk position.

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A negative interest-sensitive gap results when interest-sensitive liabilities exceed interest-sensitive assets for a specific re-pricing “time horizon.” The gap is positive when interest-sensitive assets exceed interest-sensitive liabilities for a given time period. For a bank with a positive gap, rising interest rates would be expected to have a positive effect on net interest income, and falling rates would be expected to have a negative effect. The table below reflects the balances of interest-earning assets and interest-bearing liabilities at the earlier of their re-pricing or maturity dates. Variable-rate loans are reflected at the earliest re-pricing interval since they re-price according to their terms. Borrowed funds are reflected in the earliest contractual re-pricing interval. Interest-bearing liabilities, with no contractual maturity, such as interest-bearing transaction accounts and savings deposits, are reflected in expected re-pricing intervals. Time deposits and fixed-rate loans are reflected at their respective contractual maturity dates.

The following table, “Gap Report,” indicates that, on a cumulative basis through the next 12 months, our interest rate-sensitive assets exceed interest rate-sensitive liabilities, resulting in an asset-sensitive position as of March 31, 2014 of $240.4 million. This net asset-sensitive position was a result of $500.3 million in interest rate-sensitive assets being available for re-pricing during the next 12 months and $259.9 million in interest rate-sensitive liabilities being available for re-pricing during the same time period. Our gap position as of March 31, 2014 is considered by management to be favorable in an increasing interest rate environment.

	0-180 Days		181-360 days			1-3 Years			Over 3 Years		Totals
Assets:
Cash and cash due	$	2,201	$	—		$	—		$	—	$	12,490
Securities		7,513		5,109			15,227			40,188		67,936
Loans		476,149		8,865			19,531			53,416		564,014
Allowance for loan and lease losses		—		—			—			—		(5,414	)
Premises and equipment		—		—			—			—		4,931
Intangibles		—		—			—			—		15,533
OREO		—		—			—			—		161
Deferred tax asset		—		—			—			—		4,176
Bank owned life insurance		—		—			—			—		9,773
Other assets		476		—			—			4,282		9,944
Total assets	$	486,339	$	13,974		$	34,758		$	97,886	$	683,544
Liabilities and Equity:
Demand deposits	$	—	$	—		$	—		$	—	$	114,708
Interest-bearing deposits		129,996		128,496			182,462			14,291		455,243
Federal funds purchased		1,423		—			—			—		1,423
Borrowed funds		—		—			20,000			—		20,000
Other liabilities		—		—			—			—		3,403
Shareholders’ equity		—		—			—			—		88,767
Total liabilities and equity	$	131,419	$	128,496		$	202,462		$	14,291	$	683,544
Discrete gap:	$	354,920	$	(114,522	)	$	(167,704	)	$	83,595
Cumulative gap:	$	354,920	$	240,398		$	72,694		$	156,289

Commitments and Contingencies

In the normal course of business, we have commitments under credit agreements to lend to customers as long as there is no material violation of any condition established in the contracts. These commitments generally have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Additionally, we issue letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

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These commitments represent outstanding off-balance sheet commitments. The following table presents unfunded loan commitments outstanding as of the dates stated:

	March 31, 2014		December 31, 2013
Commercial lines of credit	$	82,357	$	68,782
Commercial real estate		43,644		44,324
Residential real estate		6,753		7,183
Consumer		849		481
Letters of credit		6,624		6,796
Loans held for sale		11,664		5,637
Total commitments	$	151,891	$	133,203

In addition, the Bank has a commitment to invest in a limited partnership that operates as a small business investment company. As of March 31, 2014, the Bank had invested $450 thousand. An additional $550 thousand will be funded at the request of the general partner of the partnership.

CAUTIONARY NOTICE ABOUT FORWARD-LOOKING STATEMENTS

Certain statements included in this Form 10-Q are “forward-looking statements.” All statements other than statements of historical facts contained in this Form 10-Q, including statements regarding our plans, objectives and goals, future events or results, our competitive strengths and business strategies, and the trends in our industry are forward-looking statements. The words “believe,” “will,” “may,” “could,” “estimate,” “project,” “predict,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “appear,” “future,” “likely,” “probably,” “suggest,” “goal,” “potential” and similar expressions, as they relate to our company, are intended to identify forward-looking statements.

Forward-looking statements made in this Form 10-Q reflect beliefs, assumptions, and expectations of future events or results, taking into account the information currently available to us. These beliefs, assumptions, and expectations may change as a result of many possible events, circumstances or factors, not all of which are currently known to us. If a change occurs, our business, financial condition, liquidity, results of operations and prospects may vary materially from those expressed in, or implied by, the forward-looking statements. Accordingly, you should not place undue reliance on these forward-looking statements. You should carefully consider these matters, along with the risks discussed under “Risk Factors” in our proxy statement/prospectus (Registration No. 333-195108) that we filed with the Securities and Exchange Commission (the “SEC”) on April 30, 2014 and the following factors, which are not intended to be exhaustive, that may cause actual results to vary materially from our forward-looking statements:

• general economic conditions nationally, regionally or in our target markets;

• the efforts of government agencies to stabilize the equity and debt markets;

• the adequacy of our allowance for loan and lease losses and the methodology for determining such allowance;

• adverse changes in our loan portfolio and credit risk-related losses and expenses;

• concentrations within our loan portfolio, including exposure to commercial real estate loans, and to our target markets;

• our dependence on our target markets in and around Virginia;

• reduced deposit flows and loan demand as well as increasing default rates;

• changes in interest rates, reducing our margins or the volumes or values of the loans we make and the deposits and investments we hold;

• our ability to generate sufficient taxable income to utilize our deferred tax assets, thus requiring a valuation allowance against this asset;

• business conditions in the financial services industry, including competitive pressures among financial services companies, new service and product offerings by competitors, and similar factors;

• the degree and nature of our competition, with the understanding that competitors may have greater financial resources and access to capital and may offer services that enable those competitors to compete more successfully than we can;

• the regulatory environment, including evolving banking industry standards, changes in legislation or regulation;

• our ability and willingness to pay dividends on our common stock in the future;

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• changes in accounting principles, policies and guidelines as well as estimates and assumptions used in the preparation of our financial statements;

• volatility of the market price of our common stock and capital markets generally;

• changes in our competitive strengths or business or strategies;

• the availability, terms and deployment of debt and equity capital;

• our dependence upon key personnel whose continued service is not guaranteed, and our ability to identify, hire and retain highly qualified personnel in the future;

• our ability to implement our business strategies successfully;

• the ability of the company and CVB to obtain required regulatory and shareholder approvals;

• our ability to complete the CVB merger as expected and within the expected timeframe;

• the possibility that one or more of the conditions to the completion of the CVB merger may not be satisfied;

• any event that could give rise to a termination of the CVB merger agreement;

• disruptions to customer and employee relationships and business operations caused by the CVB merger;

• our ability to achieve the cost savings and synergies contemplated by the CVB merger within the expected timeframe;

• our ability to maintain regulatory capital levels and adequate sources of funding and liquidity, which could be adversely affected by market conditions and changes in capital requirements made by regulators;

• negative publicity and the impact on our reputation;

• rapidly changing technology;

• war or terrorist activities causing deterioration in the economy;

• other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and

• the risks discussed in our public filings with the SEC.

As a result of these factors, among others, the future events or results that are the subject of our beliefs, assumptions and expectations expressed in, or implied by, our forward-looking statements in this Form 10-Q may not be achieved in any specified time frame, or at all, which could be material. Accordingly and as noted above, you should not place undue reliance on these forward-looking statements. All subsequent written and oral forward-looking statements attributable to us or the persons acting on our behalf are expressly qualified in their entirety by these cautionary statements. Except as required by applicable law or regulations, we do not undertake, and specifically disclaim any obligation, to update or revise any forward-looking statement.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Not applicable.

Item 4. Controls and Procedures

Management evaluated, with the participation of the company’s Chief Executive Officer and Chief Financial Officer, the effectiveness of the company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)), as of the end of the period covered by this Form 10-Q. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the company’s disclosure controls and procedures are effective as of the end of the period covered by this Form 10-Q to ensure that information required to be disclosed in the reports that the company files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

Management is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). No changes in the company’s internal control over financial reporting occurred during the fiscal quarter ended March 31, 2014 that have materially affected, or are reasonably likely to materially affect, the company’s internal control over financial reporting.

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We are not presently involved in any litigation, nor to our knowledge is any litigation threatened against us, that in management’s opinion would result in any material adverse effect on our financial position or results of operations or that is not expected to be covered by insurance.

Item 1A. Risk Factors

While we attempt to identify, manage and mitigate risks and uncertainties associated with our business to the extent practical under the circumstances, some level of risk and uncertainty will always be present. “Risk Factors” in the proxy statement/prospectus (Registration No. 333-195108) that we filed with the SEC on April 30, 2014 describes some of the risks and uncertainties associated with our business. These risks and uncertainties have the potential to materially affect our results of operations and our financial condition. We do not believe that there have been any material changes to the risk factors previously disclosed in the proxy statement/prospectus.

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

In July 2013, the company’s board of directors approved a share repurchase program, under which the company may repurchase in the open market or otherwise up to 210,000 shares of its outstanding common stock, or approximately 2% of its then outstanding shares. There is no guarantee as to the number of shares that will be repurchased by the company, and the program can be discontinued at any time.

The following table presents monthly stock repurchases during the first quarter of 2014. All purchases were made using available cash resources and occurred in the open market.

Period	Total Number of Shares Purchased		Average Price Paid per Share		Total Number of Shares Purchased as Part of Publicly Announced Program		Maximum Number of Shares that May Yet Be Purchased Under the Program
January 1, 2014 - January 31, 2014		14,900	$	6.07		14,900		144,670
February 1, 2014 - February 28, 2014		11,200	$	6.04		11,200		133,470
March 1, 2014 - March 31, 2014		17,800	$	6.02		17,800		115,670
Total		43,900	$	6.04		43,900

Item 6. Exhibits

Exhibit Index:

Exhibit Number	Description
2.1	Agreement of Merger, dated as of March 20, 2014, among Colonial Virginia Bank, Xenith Bankshares, Inc. and Xenith Bank (incorporated herein by reference to Exhibit 2.1 to Form 8-K filed on March 25, 2014 (File No. 000-53380)). (Schedules have been omitted pursuant to Item 601(b)(2) of Regulation S-K. Xenith Bankshares agrees to furnish supplementally to the Securities and Exchange Commission a copy of any omitted schedule upon request.)
10.1	Voting Agreement, dated as of March 20, 2014, among Xenith Bankshares, Inc. and the parties listed on Exhibit A to the Voting Agreement (incorporated herein by reference to Exhibit 10.1 to Form 8-K filed on March 25, 2014 (File No. 000-53380))
10.2	Form of Stock Unit Award Agreement
31.1	Certification of CEO pursuant to Rule 13a-14(a)
31.2	Certification of CFO pursuant to Rule 13a-14(a)
32.1	CEO Certification pursuant to 18 U.S.C. § 1350
32.2	CFO Certification pursuant to 18 U.S.C. § 1350
101.INS	XBRL Instance Document
101.SCH	XBRL Taxonomy Extension Schema Document
101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF	XBRL Taxonomy Extension Definition Linkbase Document
101.LAB	XBRL Taxonomy Extension Label Linkbase Document
101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

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

	XENITH BANKSHARES, INC.
Date: May 6, 2014	/S/    T. GAYLON LAYFIELD, III
	T. Gaylon Layfield, III President and Chief Executive Officer (Principal Executive Officer)
Date: May 6, 2014	/S/    THOMAS. W. OSGOOD
	Thomas W. Osgood
	Executive Vice President, Chief Financial Officer,
	Chief Administrative Officer and Treasurer
	(Principal Financial Officer)