UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
[X] Quarterly Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the quarterly period ended March 31, 2006
or
[ ] Transition Report Pursuant to Section 13 or 15(d)
of the Securities Exchange Act of 1934
For the transition period from ____________ to _____________
Commission File Number: 0-24159
MIDDLEBURG FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)
Virginia (State or other jurisdiction of incorporation or organization) | 54-1696103 (I.R.S. Employer Identification No.) |
111 West Washington Street Middleburg, Virginia (Address of principal executive offices) | 20117 (Zip Code) |
(703) 777-6327
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes R No £
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer £
Accelerated filer R
Non-accelerated filer £
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No R
Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date. 3,809,053 shares of Common Stock as of May 5, 2006
MIDDLEBURG FINANCIAL CORPORATION
INDEX
Part I. Financial Information
Page No.
Item 1.
Financial Statements
Consolidated Balance Sheets
3
Consolidated Statements of Income
4
Consolidated Statements of Changes in Shareholders’ Equity
5
Consolidated Statements of Cash Flows
6
Notes to Consolidated Financial Statements
7
Item 2.
Management’s Discussion and Analysis of Financial
Condition and Results of Operations
14
Item 3.
Quantitative and Qualitative Disclosures About Market Risk
24
Item 4. Controls and Procedures
26
Part II. Other Information
Item 1.
Legal Proceedings
27
Item 1A.
Risk Factors
27
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
27
Item 3.
Defaults upon Senior Securities
27
Item 4.
Submission of Matters to a Vote of Security Holders
27
Item 5.
Other Information
27
Item 6.
Exhibits
27
Signatures
28
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands, Except Share Data)
(Unaudited) | ||||
March 31, | December 31, | |||
2006 | 2005 | |||
Assets: | ||||
Cash and due from banks | $ 13,813 | $ 15,465 | ||
Interest-bearing deposits in banks | 288 | 160 | ||
Securities (fair value: March 31, 2006, | ||||
$149,985, December 31, 2005, $149,616) | 149,967 | 149,591 | ||
Loans, net of allowance for loan losses of $5,370 in 2006 | ||||
and $5,143 in 2005 | 543,399 | 520,511 | ||
Premises and equipment, net | 18,638 | 18,656 | ||
Accrued interest receivable and other assets | 35,912 | 35,528 | ||
| ||||
Total assets | $ 762,017 | $ 739,911 | ||
Liabilities and Shareholders' Equity: | ||||
Liabilities: | ||||
Deposits: | ||||
Non-interest bearing demand deposits | $ 121,809 | $ 128,641 | ||
Savings and interest bearing demand deposits | 287,881 | 273,570 | ||
Time deposits | 136,138 | 149,221 | ||
Total deposits | $ 545,828 | $ 551,432 | ||
Federal funds purchased | 275 | -- | ||
Securities sold under agreements to repurchase | 34,902 | 34,317 | ||
Federal Home Loan Bank advances | 51,000 | 24,100 | ||
Long-term debt | 55,000 | 57,500 | ||
Trust preferred capital notes | 15,465 | 15,465 | ||
Accrued interest payable and other liabilities | 5,014 | 3,621 | ||
Total liabilities | $ 707,484 | $ 686,435 | ||
Shareholders' Equity: | ||||
Common stock, par value $2.50 per | ||||
share, authorized 20,000,000 shares; | ||||
issued and outstanding at March 31, 2006 - 3,809,053 | ||||
issued and outstanding at December 31, 2005 - 3,806,053 | $ 9,523 | $ 9,515 | ||
Capital surplus | 5,459 | 5,431 | ||
Retained earnings | 40,605 | 39,281 | ||
Accumulated other comprehensive loss, net | (1,054) | (751) | ||
Total shareholders' equity | $ 54,533 | $ 53,476 | ||
Total liabilities and shareholders' equity | $ 762,017 | $ 739,911 |
See Accompanying Notes to Consolidated Financial Statements.
3
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
(Unaudited) | ||||
For the Three Months | ||||
Ended March 31, | ||||
2006 | 2005 | |||
Interest and Dividend Income | ||||
Interest and fees on loans | $ 8,866 | $ 5,784 | ||
Interest on investment securities: | ||||
Taxable | 1 | 1 | ||
Nontaxable | 22 | 35 | ||
Interest on securities available for sale: | ||||
Taxable | 1,329 | 1,432 | ||
Nontaxable | 350 | 365 | ||
Dividends | 75 | 71 | ||
Interest on deposits in banks and federal funds sold | 10 | 4 | ||
Total interest and dividend income | $ 10,653 | $ 7,692 | ||
Interest Expense | ||||
Interest on deposits | $ 2,525 | $ 938 | ||
Interest on securities sold under agreements to repurchase | 323 | 169 | ||
Interest on short-term debt | 343 | 184 | ||
Interest on long-term debt | 851 | 778 | ||
Total interest expense | $ 4,042 | $ 2,069 | ||
Net interest income | $ 6,611 | $ 5,623 | ||
Provision for loan losses | 250 | 472 | ||
Net interest income after provision | ||||
for loan losses | $ 6,361 | $ 5,151 | ||
Other Income | ||||
Service charges on deposit accounts | $ 436 | $ 390 | ||
Trust and investment advisory fee income | 1,071 | 943 | ||
Commissions on investment sales | 193 | 205 | ||
Equity in earnings of affiliate | 103 | 194 | ||
Other service charges, commissions and fees | 160 | 110 | ||
Bank-owned life insurance | 104 | 112 | ||
Other operating income | 24 | 22 | ||
Total other income | $ 2,091 | $ 1,976 | ||
Other Expense | ||||
Salaries and employees’ benefits | $ 3,477 | $ 3,159 | ||
Net occupancy and equipment expense | 741 | 702 | ||
Other taxes | 125 | 117 | ||
Computer operations | 233 | 206 | ||
Other operating expenses | 970 | 936 | ||
Total other expense | $ 5,546 | $ 5,120 | ||
Income before income taxes | $ 2,906 | $ 2,007 | ||
Income taxes | 858 | 598 | ||
Net income | $ 2,048 | $ 1,409 | ||
Net income per share, basic | $ 0.54 | $ 0.37 | ||
Net income per share, diluted | $ 0.52 | $ 0.36 | ||
Dividends per share | $ 0.19 | $ 0.19 |
See Accompanying Notes to Consolidated Financial Statements.
4
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
For the Three Months Ended March 31, 2006 and 2005
(In Thousands, Except Share Data)
(Unaudited)
Accumulated | ||||||||||||
Other | ||||||||||||
Common | Capital | Retained | Comprehensive | Comprehensive | ||||||||
Stock | Surplus | Earnings | Income (Loss) | Income | Total | |||||||
Balances - December 31, 2004 | $ 9,523 | $ 5,684 | $ 34,997 | $ 1,358 | $ 51,562 | |||||||
Comprehensive Income | ||||||||||||
Net income | 1,409 | $ 1,409 | 1,409 | |||||||||
Other comprehensive loss net of tax: | ||||||||||||
Unrealized holding losses arising during the | ||||||||||||
period (net of tax, $659) | (1,277) | |||||||||||
Change in fair value of derivatives for interest | ||||||||||||
rate swap (net of tax, $59) | 109 | |||||||||||
Other comprehensive loss (net of tax, $600) | (1,168) | $ (1,168) | (1,168) | |||||||||
Total comprehensive income | $ 241 | |||||||||||
Cash dividends declared | (722) | (722) | ||||||||||
Repurchase of common stock (11,000 shares) | (27) | (380) | (407) | |||||||||
Issuance of common stock (150 shares) | - | 2 | 2 | |||||||||
Balances – March 31, 2005 | $ 9,496 | $ 5,306 | $ 35,684 | $ 190 | $ 50,676 | |||||||
Balances - December 31, 2005 | $ 9,515 | $ 5,431 | $ 39,281 | $ (751) | $ 53,476 | |||||||
Comprehensive Income | ||||||||||||
Net income | 2,048 | $ 2,048 | 2,048 | |||||||||
Other comprehensive loss net of tax: | ||||||||||||
Unrealized holding losses arising during the | ||||||||||||
period (net of tax, $153) | (298) | |||||||||||
Change in fair value of derivatives for interest | ||||||||||||
rate swap (net of tax, $3) | (5) | |||||||||||
Other comprehensive loss (net of tax, $156) | (303) | $ (303) | (303) | |||||||||
Total comprehensive income | $ 1,745 | |||||||||||
Cash dividends declared | (724) | (724) | ||||||||||
Issuance of common stock (3,000 shares) | 8 | 28 | 36 | |||||||||
Balances – March 31, 2006 | $ 9,523 | $ 5,459 | $ 40,605 | $ (1,054) | $ 54,533 |
See Accompanying Notes to Consolidated Financial Statements.
5
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
(Unaudited)
For the Three Months Ended | |||
March 31, | March 31, | ||
2006 | 2005 | ||
CASH FLOWS FROM OPERATING ACTIVITIES | |||
Net income | $ 2,048 | $ 1,409 | |
Adjustments to reconcile net income to net cash provided by operating activities: | |||
Provision for loan losses | 250 | 472 | |
Depreciation and amortization | 430 | 388 | |
(Equity in undistributed earnings) and distributions in excess of earnings of affiliate | 46 | (55) | |
Premium amortization and discount (accretion) on securities, net | 12 | (2) | |
Originations of loans held for sale | -- | (50,791) | |
Proceeds from sales of loans held for sale | -- | 60,473 | |
(Increase) in other assets | (437) | (5) | |
Increase in other liabilities | 1,392 | 716 | |
Net cash provided by operating activities | $ 3,741 | $ 12,605 | |
CASH FLOWS FROM INVESTING ACTIVITIES | |||
Proceeds from maturity, principal paydowns and calls on investment securities | $ -- | $ 222 | |
Proceeds from maturity, principal paydowns and calls of securities available for sale | 3,215 | 6,832 | |
Proceeds from sale of securities available for sale | 2,487 | 2,220 | |
Purchase of securities available for sale | (6,540) | (6,525) | |
Net (increase) in loans | (23,138) | (47,333) | |
Purchases of premises and equipment | (258) | (1,147) | |
Net cash (used in) investing activities | $ (24,234) | $ (45,731) | |
CASH FLOWS FROM FINANCING ACTIVITIES | |||
Net increase in non-interest bearing and interest bearing demand deposits and savings accounts | $ 7,479 | $ 10,569 | |
Net increase (decrease) in certificates of deposits | (13,083) | 14,751 | |
Net increase in federal funds purchased | 275 | -- | |
Proceeds from Federal Home Loan Bank advances | 82,175 | 66,890 | |
Payment on Federal Home Loan Bank advances | (55,275) | (42,250) | |
Payment on long-term debt | (2,500) | -- | |
Cash dividends paid | (723) | (724) | |
Issuance of common stock | 36 | 2 | |
Repurchase of common stock | -- | (407) | |
Increase (decrease) in securities sold under agreements to repurchase | 585 | (15,588) | |
Net cash provided by financing activities | $ 18,969 | $ 33,243 | |
(Decrease) increase in cash and cash equivalents | $ (1,524) | $ 117 | |
CASH AND CASH EQUIVALENTS | |||
Beginning | 15,625 | 15,007 | |
Ending | $ 14,101 | $ 15,124 | |
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | |||
Cash payments for: | |||
Interest | $ 3,826 | $ 1,779 | |
Income taxes | 35 | 611 | |
SUPPLEMENTAL DISCLOSURES FOR NON-CASH | |||
INVESTING AND FINANCING ACTIVITIES | |||
Unrealized (loss) on securities available for sale | (450) | (1,936) | |
Change in fair value of interest rate swap | (8) | 168 |
See Accompanying Notes to Consolidated Financial Statements.
6
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDAIRIES
Notes to Consolidated Financial Statements
For the Three Months Ended March 31, 2006 and 2005
(Unaudited)
Note 1.
General
In the opinion of management, the accompanying unaudited financial statements contain all adjustments (consisting of only normal recurring accruals) necessary to present fairly the financial position at March 31, 2006 and the results of operations, changes in shareholders’ equity and cash flows for the three months ended March 31, 2006 and 2005, in accordance with accounting principles generally accepted in the United States of America. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Annual Report on Form 10-K for the year ended December 31, 2005 (the “2005 Form 10-K”) of Middleburg Financial Corporation (the “Company”). The results of operations for the three month periods ended March 31, 2006 and 2005 are not necessarily indicative of the results to be expected for the full year.
Note 2.
Stock –Based Employee Compensation Plan
As of March 31, 2006, the Company sponsored one stock option plan (the 1997 Stock Option Plan), which provides for the granting of both incentive and nonqualified stock options. Under the plan, the Company may grant options to its officers and employees for up to 380,000 shares of common stock. The exercise price of each option equals the market price of the Company’s stock on the date of grant. The options vest over the three years following the date of grant. All options expire ten years from the grant date. The Company did not grant any options during the three months ended March 31, 2006.
(Subsequent to March 31, 2006, the Company’s shareholders approved the 2006 Equity Compensation Plan, which will succeed the 1997 Stock Option Plan. The Company has not made any grants or awards under the new plan.)
In December 2004, the Financial Accounting Standards Board (“FASB”) issued Statement of Financial Accounting Standards (“SFAS”) No. 123R,Share-Based Payment. SFAS No. 123R requires companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options, based on the fair value of those awards at the date of the grant and eliminates the choice to account for stock options under Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees. The Company adopted SFAS No. 123R effective January 1, 2006 using the modified prospective method and, as such, results for prior periods have not been restated. As of March 31, 2006, there was $21,000 in unrecognized compensation expense. Prior to January 1, 2006, no stock-based employee compensation cost was reflected in net income, as all options granted under the Company’s plan had an exercise price equal to the market value of the underlying common stock on the date of grant.
The following table illustrates the effect on net income and earnings per share for the period indicated if the Company had applied the fair value recognition provisions of SFAS No. 123,Accounting for Stock-Based Compensation, prior to January 1, 2006.
7
Three Months Ended | ||
March 31, 2005 | ||
(In Thousands, except per share data) | ||
Net income, as reported | $ 1,409 | |
Deduct: Total stock-based employee | ||
compensation expense determined under | ||
fair value based method for all awards | (22) | |
Pro forma net income | $ 1,387 | |
Earnings per share: | ||
Basic - as reported | $ 0.37 | |
Basic - pro forma | 0.36 | |
Diluted - as reported | 0.36 | |
Diluted - pro forma | 0.35 |
Note 3.
Securities
Amortized costs and fair values of securities being held to maturity at March 31, 2006 are summarized as follows:
|
| Gross |
| Gross |
|
| ||
Amortized | Unrealized | Unrealized | Market | |||||
Cost |
| Gains |
| (Losses) |
| Value | ||
(In Thousands) | ||||||||
Obligations of states and | ||||||||
political subdivisions | $ 1,699 | $ 18 | $ - | $ 1,717 | ||||
Mortgage backed securities | 34 | - | - | 34 | ||||
$ 1,733 | $ 18 | $ - | $ 1,751 |
8
Amortized costs and fair values of securities available for sale at March 31, 2006 are summarized as follows:
|
| Gross |
| Gross |
|
| |
Amortized | Unrealized | Unrealized | Market | ||||
Cost |
| Gains |
| (Losses) |
| Value | |
(In Thousands) | |||||||
U.S. Treasury securities | |||||||
and obligations of U.S. | |||||||
government corporations | |||||||
and agencies | $ 9,439 | $ - | $ (174) | $ 9,265 | |||
Corporate preferred stock | 2,090 | - | (6) | 2,084 | |||
Obligations of states and | |||||||
political subdivisions | 30,804 | 969 | (46) | 31,727 | |||
Mortgage backed securities | 87,858 | 93 | (3,006) | 84,945 | |||
Restricted Stock | 6,798 | - | - | 6,798 | |||
Other | 13,041 | 376 | (2) | 13,415 | |||
$ 150,030 | $ 1,438 | $ (3,234) | $ 148,234 |
At March 31, 2006, investments in an unrealized loss position that were temporarily impaired are as follows:
Less Than 12 Months | 12 Months or More | |||||||
Unrealized | Unrealized | |||||||
Fair Value | (Losses) | Fair Value | (Losses) | |||||
(In thousands) | ||||||||
U.S. Treasury securities | ||||||||
and obligations of U.S. | ||||||||
government corporations | ||||||||
and agencies | $ 1,340 | $ (9) | $ 7,900 | $ (165) | ||||
Obligations of states | ||||||||
and political subdivisions | 2,920 | (18) | 610 | (28) | ||||
Mortgage-backed | ||||||||
securities | 36,238 | (908) | 43,852 | (2,098) | ||||
Corporate preferred | - - | - - | 2,085 | (6) | ||||
Other | 98 | (2) | - - | - - | ||||
Total temporarily | ||||||||
impaired securities | $ 40,596 | $ (937) | $ 54,447 | $ (2,297) |
The unrealized losses in the portfolio as of March 31, 2006 are considered temporary and are a result of the current interest rate environment and not increased credit risk. Of the temporarily impaired securities, 89 are investment grade and one is non-rated. The federal agency mortgage-backed securities have the largest temporary impairment but are issued by government sponsored enterprises (Federal National Mortgage Association and Federal Home Loan Mortgage Corporation). The non-rated security is a corporate trust preferred security that has a par value at maturity of $90,000. Market prices change daily and are affected by conditions beyond the control of the Company. Although the Company has the ability and intent to hold these securities until the temporary loss is recovered, decisions by management
9
may necessitate the sale before the loss is fully recovered. Investment decisions reflect the strategic asset/liability objectives of the Company. The investment portfolio is analyzed frequently and managed to provide an overall positive impact to the Company’s income statement and balance sheet.
Note 4.
Loan Portfolio
The consolidated loan portfolio was composed of the following:
March 31, |
| December 31, | |
2006 | 2005 | ||
(In Thousands) | |||
Commercial, financial and agricultural | $ 27,519 | $ 28,388 | |
Real estate construction | 96,873 | 88,312 | |
Real estate mortgage | 405,846 | 390,970 | |
Consumer installment | 17,699 | 17,128 | |
Total loans | 547,937 | 524,798 | |
Add: Deferred loan costs | 832 | 856 | |
Less: Allowance for loan losses | 5,370 | 5,143 | |
Net loans | $ 543,399 | $ 520,511 |
The Company had $11,000 in non-performing assets at March 31, 2006.
Note 5.
Allowance for Loan Losses
The following is a summary of transactions in the allowance for loan losses:
March 31, |
| December 31, | |
2006 |
| 2005 | |
(In Thousands) | |||
Balance at January 1 | $ 5,143 | $ 3,418 | |
Provision charged to operating expense | 250 | 1,744 | |
Recoveries added to the allowance | 24 | 60 | |
Loan losses charged to the allowance | (47) | (79) | |
Balance at the end of the period | $ 5,370 | $ 5,143 |
Note 6.
Earnings Per Share
The following table shows the weighted average number of shares used in computing earnings per share and the effect on the weighted average number of shares of potential dilutive common stock. Potential dilutive common stock has no effect on income available to common shareholders.
10
Three Months Ended | |||||||||
March 31, 2006 | March 31, 2005 | ||||||||
Per Share | Per Share | ||||||||
Shares | Amount | Shares | Amount | ||||||
Basic EPS | 3,807,786 | $ 0.54 | 3,802,732 | $ 0.37 | |||||
Effect of dilutive | |||||||||
securities: stock options | 97,179 | 109,158 | |||||||
Diluted EPS | 3,904,965 | $ 0.52 | 3,911,890 | $ 0.36 |
Note 7.
Segment Reporting
The Company operates in a decentralized fashion in two principal business activities: banking services and trust and investment advisory services. Revenue from banking activities consists primarily of interest earned on loans and investment securities, service charges on deposit accounts, and income recognized from the 41.8% investment of Middleburg Bank (the “Bank”) in Southern Trust Mortgage, LLC (“STM”).
Middleburg Investment Group, Inc. (“MIG”), the non-bank subsidiary of the Company, generates revenues from trust and investment advisory activities through its two subsidiaries, Middleburg Trust Company (“MTC”) and Middleburg Investment Advisors, Inc. (“MIA”). Trust and investment advisory revenue is comprised of fees based upon the market value of the accounts under administration.
The banking segment has assets in custody with MTC and accordingly pays MTC a monthly fee. The banking segment also pays interest to both MTC and MIA on deposit accounts that each company has at the Bank. MIA pays the Company a management fee each month for accounting and other services provided. Transactions related to these relationships are eliminated to reach consolidated totals.
11
The following table presents segment information for the three months ended March 31, 2006 and 2005, respectively.
For the Three Months Ended | For the Three Months Ended | ||||||||||||||
March 31, 2006 | March 31, 2005 | ||||||||||||||
Trust and | Trust and | ||||||||||||||
Investment | Intercompany | Investment | Intercompany | ||||||||||||
Banking | Advisory | Eliminations | Consolidated | Banking | Advisory | Eliminations | Consolidated | ||||||||
(In Thousands) | |||||||||||||||
Revenues: | |||||||||||||||
Interest income | $ 10,645 | $ 16 | $ (8) | $ 10,653 | $ 7,686 | $ 11 | $ (5) | $ 7,692 | |||||||
Trust and investment advisory | |||||||||||||||
fee income | - | 1,096 | (25) | 1,071 | - | 970 | (27) | 943 | |||||||
Other income | 1,029 | 1 | (10) | 1,020 | 1,043 | - | (10) | 1,033 | |||||||
Total operating income | 11,674 | 1,113 | (43) | 12,744 | 8,729 | 981 | (42) | 9,668 | |||||||
Expenses: | �� | ||||||||||||||
Interest expense | 4,050 | - | (8) | 4,042 | 2,074 | - | (5) | 2,069 | |||||||
Salaries and employee benefits | 2,914 | 563 | - | 3,477 | 2,672 | 487 | - | 3,159 | |||||||
Provision for loan losses | 250 | - | - | 250 | 472 | - | - | 472 | |||||||
Other | 1,788 | 316 | (35) | 2,069 | 1,710 | 288 | (37) | 1,961 | |||||||
Total operating expenses | 9,002 | 879 | (43) | 9,838 | 6,928 | 775 | (42) | 7,661 | |||||||
Income before income taxes | 2,672 | 234 | - | 2,906 | 1,801 | 206 | - | 2,007 | |||||||
Provision for income taxes | 760 | 98 | - | 858 | 507 | 91 | - | 598 | |||||||
Net income | $ 1,912 | $ 136 | $ - | $ 2,048 | $ 1,294 | $ 115 | $ - | $ 1,409 | |||||||
Total assets | $ 755,636 | $ 7,774 | $ (1,393) | $ 762,017 | $ 640,044 | $ 7,610 | $ (7,935) | $ 639,719 | |||||||
Capital expenditures | $ 243 | $ 15 | $ - | $ 258 | $ 1,147 | $ - | $ - | $ 1,147 |
12
Note 8.
Defined Benefit Pension Plan
The table below reflects the components of the Net Periodic Benefit Cost.
Three Months Ended March 31, | |||
2006 | 2005 | ||
(In Thousands) | |||
Service cost | $ 169 | $ 148 | |
Interest cost | 60 | 54 | |
Expected return on plan assets | (92) | (77) | |
Amortization of net obligation | |||
at transition | (1) | (1) | |
Net actuarial loss | 6 | 10 | |
Net periodic benefit cost | $ 142 | $ 134 |
The Company previously disclosed in the 2005 Form 10-K that it expected to contribute $428,000 to its pension plan in 2006. As of March 31, 2006, no contributions have been made. The Company plans to make all required contributions for 2006.
Note 9.
Recent Accounting Pronouncements
In March 2006, FASB issued SFAS No. 156,Accounting for Servicing of Financial Assets – an amendment of SFAS No. 140. SFAS no. 156 amends SAFS No. 140 with respect to separately recognized servicing assets and liabilities. SFAS No. 156 requires an entity to recognize a servicing asset or liability each time it undertakes an obligation to service a financial asset by entering into a servicing contract and requires all servicing assets and liabilities to be initially measured at fair value, if practicable. SFAS No. 156 also permits entities to subsequently measure servicing assets and liabilities using an amortization method or fair value measurement method. Under the amortization method, servicing assets and liabilities are amortized in proportion to and over the estimated period of the servicing. Under the fair value measurement method, servicing assets are measured at fair value at each reporting date and changes in fair value are reported in net income for the period the change occurs.
Adoption of SFAS No. 156 is required as of the beginning of fiscal years beginning subsequent to September 15, 2006. Earlier adoption is permitted as of the beginning of an entities fiscal year, provided the entity had not yet issued financial statements, including interim financial statements.
The Company does not expect the adoption of SFAS No. 156 at the beginning of 2007 to have a material impact.
13
Item 2.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition and results of operations of the Company for the three months ended March 31, 2006 should be read in conjunction with the Company’s Consolidated Financial Statements and the accompanying Notes to Consolidated Financial Statements included in this report and in the 2005 Form 10K. It should also be read in conjunction with the “Caution About Forward Looking Statements” section at the end of this discussion.
Overview
The Company is headquartered in Middleburg, Virginia and conducts its primary operations through two wholly owned subsidiaries, the Bank and MIG. The Bank is a community bank serving the Virginia counties of Loudoun, Fairfax and Fauquier with seven full service facilities and one limited service facility. MIG is a non-bank holding company with two wholly owned subsidiaries, MTC and MIA. MTC is a trust company headquartered in Richmond, Virginia. MIA is a registered investment advisor headquartered in Alexandria, Virginia serving clients in 24 states.
Net income for the three months ended March 31, 2006 increased to $2.0 million from $1.4 million for the three months ended March 31, 2005. Annualized returns on average assets and equity for the three months ended March 31, 2006 were 1.1% and 15.2%, respectively, compared to 0.9% and 11.1% for the same period in 2005. The Company’s continued focus on loan growth resulted in an increase in interest income. Interest and fees on loans increased 53.3% for the three months ended March 31, 2006 to $8.9 million, compared to $5.8 million for the same period in 2005. Core operations have been impacted by increased funding costs. Total interest expense was $4.0 million for the three months ended March 31, 2006, compared to $2.1 million for the three months ended March 31, 2005. Trust and investment advisory fees increased 13.6% for the three months ended March 31, 2006 compared to the three months ended March 31, 2005. Total other expense was $5.5 million for the three months ended March 31, 2006 compared to $5.1 million for the same period in 2005.
The Company generates a significant amount of its income from the net interest income earned by the Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. The Company’s cost of money is a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses.
The Company has adopted a business model whereby all of its financial resources will be available at a single branch, known as a financial service center location. The financial service centers are larger than most traditional retail branches in order to allow commercial, mortgage, retail and wealth management personnel and services to be readily available to serve clients. The Company owns a one acre parcel in Sterling, Virginia and has plans to construct a financial service center in 2007. The Company’s anticipated expansion may negatively impact earnings.
MIG’s subsidiaries, MTC and MIA, generate fee income by providing investment management and trust services to its clients. Investment management and trust fees are generally based upon the value of assets under management and, therefore, can be significantly affected by fluctuation in the values of securities caused by changes in the capital markets.
With the creation of MIG, the Company has expanded the integration of MTC, MIA and the Bank’s investment services department into a more focused wealth management program for all of the Company’s clients. The Company intends to make each of its wealth management services available
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within all of its financial service centers. Also, through the affiliation with STM, the Bank may continue to increase its loan portfolio by purchasing high credit quality, low loan to value first deeds of trusts on residential property. The Bank plans to continue its focus on low cost deposit growth with advertising campaigns. Management has developed a growth strategy that includes expansion into Sterling, Virginia (Loudoun County) in 2007. Other new markets under consideration include Herndon and Chantilly (Fairfax County). Management will look for key lenders in those markets to join the Company’s team to develop relationships and generate earning assets prior to the opening of a financial service center.
The Company is not aware of any current recommendations by any regulatory authorities that, if they were implemented, would have a material effect on the registrant’s liquidity, capital resources or results of operations.
Critical Accounting Policies
General
The financial condition and results of operations presented in the Consolidated Financial Statements, the accompanying Notes to Consolidated Financial Statements and this section are, to a large degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.
Presented below is discussion of those accounting policies that management believes are the most important (“Critical Accounting Policies”) to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require management’s most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.
Allowance for Loan Losses
The Bank monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. The Bank maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance the methodology is maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.
The Bank evaluates various loans individually for impairment as required by SFAS No. 114,Accounting by Creditors for Impairment of a Loan, and SFAS No. 118,Accounting by Creditors for Impairment of a Loan – Income Recognition and Disclosures. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5,Accounting for Contingencies, with a group of loans that have similar characteristics.
For loans without individual measures of impairment, the Bank makes estimates of losses for groups of loans as required by SFAS No. 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses
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for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.
The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loan losses. This estimate of losses is compared to the allowance for loan losses of the Bank as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. The Bank recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements.
Intangibles and Goodwill
The Company had approximately $5.8 million in intangible assets and goodwill at March 31, 2006, a decrease of $84,000 since December 31, 2005. On April 1, 2002, the Company acquired MIA, a registered investment advisor, for $6.0 million. Approximately $5.9 million of the purchase price was allocated to intangible assets and goodwill. In connection with this investment, a purchase price valuation (using SFAS No. 141,Business Combinations,and SFAS No. 142,Goodwill and Other Intangible Assets,as a guideline) was completed to determine the appropriate allocation to identified intangibles. The valuation concluded that approximately 42% of the purchase price was related to the acquisition of customer relationships with an amortizable life of 15 years. Another 19% of the purchase price was allocated to a non-compete agreement with an amortizable life of seven years. The remainder of the purchase price has been allocated to goodwill. Approximately $1.0 million of the $5.8 million in intangible assets and goodwill at March 31, 2006 was attributable to the Company’s investment in MTC.
The purchase price allocation process requires management estimates and judgment as to expectations for the life span of various customer relationships as well as the value that key members of management add to the success of the Company. For example, customer attrition rates were determined based upon assumptions that the past five years may predict the future. If the actual attrition rates, among other assumptions, differed from the estimates and judgments used in the purchase price allocation, the amounts recorded in the Consolidated Financial Statements could result in a possible impairment of the intangible assets and goodwill or require an acceleration in the amortization expense.
In addition, SFAS No. 142 requires that goodwill be tested annually using a two-step process. The first step is to identify a potential impairment. Factors that are considered important to determining whether an impairment might exist include loss of customers acquired or significant withdrawals of the assets currently under management and/or early retirement or termination of key members of management. The second step measures the amount of the impairment loss, if any. On February 16, 2006, Davenport & Company, LLC, an unaffiliated third party, issued an opinion that stated the amount of goodwill carried on the Company’s balance sheet at December 31, 2005 was not impaired. Any changes in the key management estimates or judgments could result in an impairment charge, and such a charge could have an adverse effect on the Company’s financial condition and results of operations.
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Financial Condition
Assets
Total assets for the Company increased to $762.0 million at March 31, 2006, compared to $739.9 million at December 31, 2005, representing an increase of $22.1 million or 3.0%. Total average assets increased 22.1% from $614.7 million for the three months ended March 31, 2005 to $750.3 million for the same period in 2006. Average shareholders’ equity increased 6.2% or $3.2 million over the same periods.
Loans
Total loans at March 31, 2006 were $547.9 million, an increase of $23.1 million from the December 31, 2005 amount of $524.8 million. The Company continues to see increases in real estate construction loans which were $96.9 million at March 31, 2006 or 17.7% of total loans. The growth in real estate mortgage loans was largely in the category of non-farm, non-residential loans, which increased $14.2 million from the December 31, 2005 amount of $177.2 million. Additional lenders, a solid local economy, the relationship with STM and referrals arising from the success of the business model have contributed to the loan growth experienced. At March 31, 2006, the Company’s newest financial service center in Warrenton had outstanding loans of $44.9 million. Net charge-offs were $23,000 for the three months ended March 31, 2006. The provision for loan losses for the three months ended March 31, 2006 was $250,000 compared to $472,000 for the same period in 2005. The allowance for loan losses was $5.4 million or 0.98% of total loans outstanding at March 31, 2006.
Investments
The investment portfolio increased to $150.0 million at March 31, 2006 compared to $149.6 million at December 31, 2005. The Company plans to maintain the investment portfolio at an amount comparable to the December 31, 2005 amount. At March 31, 2006, the tax equivalent yield on the investment portfolio was 5.33%.
Premises and Equipment
Premises and equipment decreased $18,000 from $18.7 million at December 31, 2005 to $18.6 million at March 31, 2006.
Other Assets
The other assets section of the balance sheet includes Bank Owned Life Insurance (BOLI), in the amount of $11.7 million, and the Bank’s investment in STM, in the amount of $9.8 million, at March 31, 2006. Goodwill and identified intangibles of $5.8 million related to the acquisitions of MTC and MIA are included in other assets as of March 31, 2006. The Bank’s ownership interest in STM changed on January 1, 2006 with the withdrawal of one of the partners in STM. The Bank’s new ownership interest is 41.8% as of March 31, 2006 compared to 40.0% as of December 31, 2005.
Deposits
Although deposits decreased $5.6 million to $545.8 million at March 31, 2006 from $551.4 million at December 31, 2005, average deposits for the quarter ended March 31, 2006 increased 3.0% or $16.1 million compared to average deposits for the quarter ended December 31, 2005. Average non-interest bearing demand deposits were $129.2 million for the three months ended March 31, 2006 compared to $128.5 million for the three months ended December 31, 2005.
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During 2005, the Company developed three high yield deposit products, a savings account, a business money market account and an interest bearing checking account. The new products had a combined balance of $116.4 million at March 31, 2006 compared to $93.0 million at December 31, 2005. The Company has an interest bearing product, known as Tredegar Institutional Select, that integrates the use of the cash within client accounts at MTC for overnight funding at the Bank. The overall balance of this product was $25.3 million at March 31, 2006 and is reflected in both the savings and interest bearing demand deposits and the “securities sold under agreements to repurchase” amounts on the balance sheet. Excluding the Tredegar Institutional Select, savings and interest bearing demand deposits grew by $12.5 million from December 31, 2005 to March 31, 2006.
Time deposits decreased $13.1 million from December 31, 2005 to $136.1 million at March 31, 2006. Time deposits include brokered certificates of deposit of $13.9 million with maturities ranging from two to four years. Securities sold under agreements to repurchase (“Repo Accounts”) increased $585,000 from $34.3 million at December 31, 2005 to $34.9 million at March 31, 2006. The Repo Accounts include certain long-term commercial checking accounts with average balances that typically exceed $100,000 and all Tredegar Institutional Select accounts maintained by business clients.
Borrowings
Cash flow from the investment portfolio and additional Federal Home Loan Bank (“FHLB”) borrowings funded the Company’s asset growth experienced during the three months ended March 31, 2006. FHLB overnight advances were $51.0 million at March 31, 2006 compared to $24.1 million at December 31, 2005. FHLB long-term advances decreased to $55.0 million at March 31, 2006 from $57.5 million at December 31, 2005. Federal funds purchased, which represent an additional overnight funding source, were $275,000 at March 31, 2006.
Capital
Shareholders’ equity was $54.5 million at March 31, 2006. This amount represents an increase of 2.0% from the December 31, 2005 amount of $53.5 million. The book value per common share was $14.32 at March 31, 2006 and $14.05 at December 31, 2005.
Results of Operations
Net Interest Income
Net interest income is the Company’s primary source of earnings and represents the difference between interest and fees earned on earning assets and the interest expense paid on deposits and other interest bearing liabilities. Net interest income totaled $6.6 million for the first three months of 2006 compared to $5.6 million for the same period in 2005, an increase of 17.6%. Interest income increased 38.5% and interest expense increased 95.4% when comparing the three months ended March 31, 2006 to March 31, 2005. Average earning assets increased $129.1 million from $552.7 million for the three months ended March 31, 2005 to $681.8 million for the three months ended March 31, 2006.
Interest income from loans increased $3.1 million to $8.9 million for the three months ended March 31, 2006 compared to $5.8 million for the same period in 2005. The increase in loan interest income results from the amount of loan growth experienced since March 31, 2005. The weighted average yield of loans increased 57 basis points from 6.2% for the three months ended March 31, 2005 to 6.8% for the three months ended March 31, 2006. The net increase to the portfolio of $22.9 million during the first three months of 2006 and the recent increases in the prime lending rate helped mitigate the impact of record low interest rates on fixed rate loan products to the Company. Approximately $115.2 million, or 21.0%, of total loans at March 31, 2006 are tied to the Wall Street Journal prime interest rate.
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Under SFAS No. 91,Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loans, loan fees are recognized over the life of the related loan as an adjustment of yield. Since December 31, 2005, the recognition of $85,000 in loan fees has been deferred. The deferral of such fees decreased the yield on the loan portfolio by approximately six basis points for the three month period ended March 31, 2006. As a result, for the same three month period, the income recognition change negatively affected the net interest margin by approximately five basis points. Loan origination costs are recorded as a deferred expense and are recognized over the life of the loan. Deferred loan origination costs for the three months ended March 31, 2005 were $72,000.
Interest income from the investment portfolio decreased by $121,000 to $1.8 million for the three month period ended March 31, 2006 from $1.9 million for the three month period ended March 31, 2005. This is the result of the Company’s strategy of decreasing the size of the investment portfolio by using the cash received from principal pay-downs, maturities and calls of securities to fund loan growth instead of reinvesting in securities. The tax equivalent yield on securities for the three months ended March 31, 2006 increased 39 basis points compared to the March 31, 2005 yield of 4.94%. The increase in yield helped to offset the impact of the decrease in the size of the portfolio. For 2006, management plans to maintain the balance in the investment portfolio at or near current levels through reinvestment in securities.
Average deposits increased $123.8 million from $427.6 million for the three months ended March 31, 2005 to $551.4 million for the three months ended March 31, 2006. Total interest expense on deposits increased $1.6 million for the three months ended March 31, 2006, compared to the same period in 2005. Competition and the rising rate environment continued to exert upward pressures on the cost of deposits, thus resulting in increased levels of interest expense. The mix of low cost deposits versus time deposits changed slightly to approximately 75% in low cost deposits, versus 25% in higher cost time deposits at March 31, 2006. At March 31, 2005, the mix had been 71% in low cost deposits, versus 29% in higher cost time deposits.
Interest expense for securities sold under agreements to repurchase, which includes Tredegar Institutional Select, increased $154,000 from the three months ended March 31, 2005 to $323,000 for the three months ended March 31, 2006. Tredegar Institutional Select earns interest at a rate equal to approximately 90% of the Federal Home Loan Bank of Atlanta’s overnight rate. Interest expense related to borrowed funds increased nearly $232,000 from $962,000 for the three months ended March 31, 2005 to $1.2 million for the three months ended March 31, 2006.
The net interest margin, on a tax equivalent basis, was 4.05% for the three months ended March 31, 2006 compared to 4.29% for the same period in 2005. The Company’s net interest margin is a not a measurement under accounting principles generally accepted in the United States, but it is a common measure used by the financial service industry to determine how profitably earning assets are funded. The net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is non taxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for 2006 and 2005 is 34% and 35%, respectively. The reconciliation of tax equivalent net interest income, which is not a measurement under accounting principles generally accepted in the United States, to net interest income is reflected in the table below. The decline in tax equivalent net interest margin was attributed to both the lower yields earned on loans due to the flattening of the yield curve and the steady rise in shorter term interest rates on deposits and borrowed money to fund the earning asset growth. The Company’s total average earning assets increased $129.1 million from the three months ended March 31, 2005 to the three months ended March 31, 2006. Tax equivalent interest income increased $2.9 million to $10.8 million for the three months ended March 31, 2006 from $7.9 million for the same period in 2005.
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Reconciliation of Net Interest Income to
Tax Equivalent Net Interest Income
For the Quarter Ended | ||||
March 31, | ||||
(in thousands) | 2006 | 2005 | ||
GAAP measures: | ||||
Interest Income – Loans | $ 8,866 | $ 5,784 | ||
Interest Income - Investments & Other | 1,787 | 1,908 | ||
Interest Expense – Deposits | 2,525 | 938 | ||
Interest Expense - Other Borrowings | 1,517 | 1,131 | ||
Total Net Interest Income | $ 6,611 | $ 5,623 | ||
Plus: | ||||
NON-GAAP measures: | ||||
Tax Benefit Realized on Non- Taxable Interest Income - Loans | $ 1 | $ 2 | ||
Tax Benefit Realized on Non- Taxable Interest Income - Municipal Securities | 191 | 216 | ||
Tax Benefit Realized on Non- Taxable Interest Income - Corporate Securities | - | 1 | ||
Total Tax Benefit Realized on Non- Taxable Interest Income | $ 192 | $ 219 | ||
Total Tax Equivalent Net Interest Income | $ 6,803 | $ 5,842 |
Non-interest Income
Non-interest income increased 5.8% to $2.1 million for the first three months of 2006 compared to $2.0 million for the same period in 2005.
Commissions and fees from trust and investment advisory activities increased 13.6% or $128,000 to $1.1 million for the three month period ended March 31, 2006 compared to $943,000 for the same period in 2005. Consolidated investment advisory fees provided by MIA totaled $558,000 and $518,000 for the three months ended March 31, 2006 and 2005, respectively. At March 31, 2006, assets under management at MIA had increased $21.3 million from $569.3 million at March 31, 2005 to $590.6 million. Consolidated fiduciary fees for services, provided by MTC, increased 20.7% to $513,000 for the three months ended March 31, 2006 from $425,000 for the three months ended March 31, 2005. At March 31, 2006, MTC managed $620.8 million in assets, including intercompany assets of $122.8 million, an increase of 7.9% or $45.7 million from assets under administration of nearly $575.1 million, including intercompany assets of $147.0 million, at March 31, 2005. Fiduciary fees are based upon the market value of the accounts under administration.
Service charges on deposits increased 11.8% to $436,000 for the three months ended March 31, 2006, compared to $390,000 for the same period in 2005. In particular, ATM and Visa check card fees increased approximately $21,000 for the three months ended March 31, 2006 when compared to the same period in 2005. Other service charges, commissions and fees, which include certain loan fees and other retail banking fees, increased $50,000 or 45.5% to $160,000 for the three months ended March 31, 2006 when compared to the same period in 2005. Safe deposit box rent, which is included in other service charges, increased $33,000 for the three months ended March 31, 2006 compared to the same period in 2005. The increase is the result of additional boxes available for rent and an increase in rental fee amounts.
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Commissions on investment sales decreased 5.9% to $193,000 for the three months ended March 31, 2006, compared to $205,000 for the three months ended March 31, 2005. The Company currently has three financial consultants who are available to each of the Company’s facilities, compared to four financial consultants in 2005.
Equity in earnings from affiliate, which reflects the 41.8% ownership interest in STM, comprised 4.9% of total non-interest income for the three months ended March 31, 2006 compared to 9.8% for the three months ended March 31, 2005. STM closed $213.8 million in loans the first three months of 2006 with 61.0% of its production attributable to purchase money financings. For the same period in 2005, STM closed $198.8 million in loans with 61.1% of its production attributable to purchase money financings. Although STM added lending officers during 2005 to increase its production efforts, narrowed margins continue to negatively impact its earnings.
In addition to equity earnings from STM, the Bank also receives rental and data processing fees and interest on the outstanding balance of loan participations with STM. These amounts are included in other operating income. For the three month periods ending March 31, 2006 and 2005, the rental and data processing income earned from STM was $8,000 and $9,000, respectively.
Income earned from the Bank’s $11.7 million investment in Bank Owned Life Insurance (BOLI) contributed $104,000 to total other income for the three months ended March 31, 2006. The Company purchased $6.0 million of BOLI in the third quarter of 2004 and $4.8 million in the fourth quarter of 2004 to help subsidize increasing employee benefit costs and expenses related to the restructure of its supplemental retirement plans.
Non-interest Expense
Total non-interest expense includes employee-related costs, occupancy and equipment expense and other overhead. Total non-interest expense increased 8.3% or $426,000 from $5.1 million for the three months ended March 31, 2005 to $5.5 million for the three months ended March 31, 2006. However, when taken as a percentage of total average assets for the quarter ended March 31, 2006, the quarter’s non-interest expense was 0.74% of total average assets, a decrease from 0.83% for the same period in 2005. The decrease in net interest margin from March 31, 2005 to March 31, 2006 has also negatively impacted the Company’s efficiency.
Salaries and employee benefits increased 10.1% when comparing the three months ended March 31, 2006 to the three months ended March 31, 2005. Additions to staff to support business development, retail branching and the formation of a wealth management team have contributed to the increase in salaries and employee benefits. Several experienced commercial lenders were hired to support business development efforts in both the Reston and Warrenton areas.
Net occupancy expense increased by $39,000 or 5.6% from $702,000 for the three months ended March 31, 2005 to $741,000 for the three months ended March 31, 2006. As growth efforts continue to progress, the Company anticipates higher levels of occupancy expense to be incurred.
Computer operations expense increased from $206,000 for the three months ended March 31, 2005 to $233,000 for the three months ended March 31, 2006. The increase is related to both additional software licensing for the set up of the new non-bank holding company, MIG, and the costs associated with and increased cost of computer related maintenance contracts.
Other tax expense increased 6.8% to $125,000 for the three months ended March 31, 2006 from $117,000 for the three months ended March 31, 2005. The increase was mainly the result of the Bank’s franchise tax, which is paid to the state in lieu of an income tax and is based on the Bank’s equity capital.
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Other expense increased 3.6% or $34,000 to $970,000 for the three months ended March 31, 2006 from $936,000 for the three months ended March 31, 2005. The increase resulted from small increases in various expense categories, including advertising, office supplies, courier services and entertainment, due to the Company’s growth.
Allowance for Loan Losses
The allowance for loan losses at March 31, 2006 was $5.4 million compared to $3.9 million at March 31, 2005. The allowance for loan losses was 0.98% of total loans outstanding at March 31, 2006 and March 31, 2005. The provision for loan losses was $250,000 for the three months ended March 31, 2006. The provision was $472,000 for the three months ended March 31, 2005. For the three months ended March 31, 2006, net loan charge-offs totaled $23,000, compared to $8,000 for the same period in 2005. Total loans past due 90 days or more at March 31, 2006 were approximately $5,000. Non-performing loans were $11,000 at March 31, 2006 compared to $89,000 at March 31, 2005. Management believes that the allowance for loan losses was adequate to cover credit losses inherent in the loan portfolio at March 31, 2006. Loans classified as loss, doubtful, substandard or special mention are adequately reserved for and are not expected to have a material impact beyond what has been reserved.
Capital Resources
Shareholders’ equity at March 31, 2006 and December 31, 2005 was $54.5 million and $53.5 million, respectively. Total common shares outstanding at March 31, 2006 were 3,809,053.
At March 31, 2006, the Company’s tier 1 and total risk-based capital ratios were 10.8% and 11.7%, respectively, compared to 11.1% and 12.0% at December 31, 2005. The Company’s leverage ratio was 8.8% at March 31, 2006 compared to 8.7% at December 31, 2005. The Company’s capital structure places it above the well capitalized regulatory guidelines, which affords the Company the opportunity to take advantage of business opportunities while ensuring that it has the resources to protect against risk inherent in its business.
Liquidity
Liquidity represents an institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquid assets include cash, interest-bearing deposits with banks, federal funds sold, short-term investments, securities classified as available for sale and loans and securities maturing within one year. As a result of the Company’s management of liquid assets and the ability to generate liquidity through liability funding, management believes that the Company maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.
The Company has relied on wholesale funding and issued trust preferred securities to support its growth in the past. The Company will continue to evaluate funding alternatives as necessary to support future growth.
The Company also maintains additional sources of liquidity through a variety of borrowing arrangements. The Company maintains federal funds lines with large regional and money-center banking institutions. These available lines totaled approximately $8 million, of which $275,000 were outstanding at March 31, 2006. Federal funds purchased during the first three months of 2006 averaged $942,000 compared to an average of $816,000 during the same period in 2005. At March 31, 2006 and December 31, 2005, the Company had $34.9 million and $34.3 million, respectively, of outstanding borrowings pursuant to repurchase agreements, with maturities of one day.
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The Company has a credit line in the amount of $219.7 million at the Federal Home Loan Bank of Atlanta. This line may be utilized for short and/or long-term borrowing. The Company utilized the credit line for both overnight and long-term funding throughout the first three months of 2006. Overnight and long-term advances averaged $28.2 million and $55.1 million, respectively, for the three months ended March 31, 2006.
At March 31, 2006, cash, interest-bearing deposits with financial institutions, federal funds sold, short-term investments, loans held for sale and securities available for sale were 28.5% of total deposits.
Off-Balance Sheet Arrangements and Contractual Obligations
Commitments to extend credit decreased $2.3 million to $91.3 million at March 31, 2006 compared to $93.6 million at December 31, 2005. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent expected future cash flows. Standby letters of credit were $3.0 million at March 31, 2006. This amount is a decrease from $3.7 million at December 31, 2005.
Contractual obligations decreased $2.7 million to $80.0 million at March 31, 2006 compared to $82.7 million at December 31, 2005. This change results from maturities on certain long-term debt obligations and decreases in operating lease obligations.
The Company enters into interest rate swaps to lock in the interest cash outflows on its floating-rate debt. On December 8, 2004, the Company borrowed a $15 million variable rate advance from the FHLB. On that same date, the Company also entered into an interest rate swap with SunTrust Bank. The total notional amount of the swap is $15 million. This cash flow hedge effectively changes the variable-rate interest on the FHLB advance to a fixed-rate of interest. Under the terms of the swap (which expires in December 2006), the Company pays SunTrust Bank a fixed interest rate of 3.35%. SunTrust Bank pays the Company a variable rate of interest indexed to the three month LIBOR, plus 0.02%. The interest receivable from SunTrust Bank reprices quarterly. Changes in the fair value of the interest rate swap designated as a hedging instrument of the variability of cash flows associated with the long-term debt are reported in other comprehensive income. This amount is subsequently reclassified into interest expense as a yield adjustment in the same period in which the related interest on floating-rate debt obligation affects earnings. Because there are no differences between the critical terms of the interest rate swap and the hedged debt obligation, the Company has determined no ineffectiveness in the hedging relationship.
Caution About Forward Looking Statements
Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import.
Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:
·
the ability to continue to attract low cost core deposits to fund asset growth;
·
the successful management of interest rate risk;
·
competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
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·
the ability to successfully manage the Company’s growth or implement its growth strategies if it is unable to identify attractive markets, locations or opportunities to expand in the future;
·
maintaining cost controls and asset qualities as the Company opens or acquires new branches;
·
maintaining capital levels adequate to support the Company’s growth;
·
changes in general economic and business conditions in the Company’s market area;
·
changes in interest rates and interest rate policies;
·
reliance on the Company’s management team, including its ability to attract and retain key personnel;
·
risks inherent in making loans such as repayment risks and fluctuating collateral values;
·
demand, development and acceptance of new products and services;
·
problems with technology utilized by the Company;
·
changing trends in customer profiles and behavior; and
·
changes in banking and other laws and regulations applicable to the Company.
Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.
Item 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market risk is the risk of loss in a financial instrument arising from adverse changes in market rates or prices such as interest rates, foreign currency exchange rates, commodity prices and equity prices. The Company’s primary market risk exposure is interest rate risk, though it should be noted that the assets under management by MTC are affected by equity price risk. The ongoing monitoring and management of this risk is an important component of the Company’s asset/liability management process, which is governed by policies established by its Board of Directors that are reviewed and approved annually. The Board of Directors delegates responsibility for carrying out asset/liability management policies to the Asset/Liability Committee (“ALCO”) of the Bank. In this capacity, ALCO develops guidelines and strategies that govern the Company’s asset/liability management related activities, based upon estimated market risk sensitivity, policy limits and overall market interest rate levels and trends.
Interest rate risk represents the sensitivity of earnings to changes in market interest rates. As interest rates change, the interest income and expense streams associated with the Company’s financial instruments also change, affecting net interest income, the primary component of the Company’s earnings. ALCO uses the results of a detailed and dynamic simulation model to quantify the estimated exposure of net interest income to sustained interest rate changes. While ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon, it also employs additional tools to monitor potential longer-term interest rate risk.
The simulation model captures the impact of changing interest rates on the interest income received and interest expense paid on all assets and liabilities reflected on the Company’s balance sheet. The simulation model is prepared and updated four times during each year. This sensitivity analysis is compared to ALCO policy limits, which specify a maximum tolerance level for net interest income exposure over a one-year horizon, assuming no balance sheet growth, given a 200 basis point (bp) upward shift and a 200 basis point downward shift in interest rates. A parallel and pro rata shift in rates over a 12-month period is assumed. The following reflects the range of the Company’s net interest income sensitivity analysis during the three months ended March 31, 2006 and the year ended December 31, 2005.
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For the Three Months Ended March 31, 2006
Rate Change
Estimated Net Interest Income Sensitivity
High
Low
Average
+ 200 bp
(1.83%)
(1.83%)
(1.83%)
- 200 bp
2.91%
2.91%
2.91%
For the Year Ended December 31,2005
Rate Change
Estimated Net Interest Income Sensitivity
High
Low
Average
+ 200 bp
(3.14%)
(1.66%)
(2.45%)
- 200 bp
1.72%
(0.24%)
0.57%
At March 31, 2006, the Company’s interest rate risk model indicated that, in a rising rate environment of 200 basis points over a 12 month period, net interest income could decrease by 1.83% on average. For the same time period the interest rate risk model indicated that in a declining rate environment of 200 basis points over a 12 month period net interest income could increase by 2.91% on average. While these numbers are subjective based upon the parameters used within the model, management believes the balance sheet is very balanced with little risk to rising rates in the future.
Since December 31, 2005, the Company’s balance sheet has grown by $22.1 million. Increased borrowings from the Federal Home Loan Bank have provided the funding for the growth in the loan portfolio. The Company’s interest rate profile is liability sensitive bias for the next 12 months. The profile then shifts toward intermediate and long term asset sensitivity over a “one to two year” and “beyond two year” time frame, respectively. Based upon a March 31, 2006 simulation, the Company could expect an average negative impact to net interest income of $492,000 over the next 12 months if rates rise 200 basis points. If rates were to decline 200 basis points, the Company could expect an average positive impact to net interest income of $782,000 over the next 12 months.
The Company maintains an interest rate risk management strategy that uses derivative instruments to minimize significant, unanticipated earnings fluctuations caused by interest rate volatility. The Company’s specific goal is to lower (where possible) the cost of its borrowed funds.
The preceding sensitivity analysis does not represent a forecast and should not be relied upon as being indicative of expected operating results. These hypothetical estimates are based upon numerous assumptions, including the nature and timing of interest rate levels such as yield curve shape, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment or replacement of asset and liability cashflows. While assumptions are developed based upon current economic and local market conditions, the Company cannot make any assurances about the predictive nature of these assumptions, including how customer preferences or competitor influences might change.
Also, as market conditions vary from those assumed in the sensitivity analysis, actual results will also differ due to factors such as prepayment and refinancing levels likely deviating from those assumed, the varying impact of interest rate change, caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other internal and external variables. Furthermore, the sensitivity
25
analysis does not reflect actions that ALCO might take in response to, or in anticipation of, changes in interest rates.
Item 4. CONTROLS AND PROCEDURES
As of the end of the period covered by this report, the Company carried out an evaluation, under the supervision and with the participation of the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company’s disclosure controls and procedures pursuant to Rule 13a-15 under the Securities Exchange Act of 1934, as amended. Based upon that evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures are effective in timely alerting them to material information relating to the Company (including its consolidated subsidiaries) required to be included in the Company’s periodic filings with the Securities and Exchange Commission.
The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
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PART II. OTHER INFORMATION
Item 1. Legal Proceedings
There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.
Item 1A. Risk Factors
As of May 10, 2006, there were no material changes to the risk factors previously disclosed in the 2005 Form 10K.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None
Item 3. Defaults upon Senior Securities
None
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits
31.1
Rule 13a-14(a) Certification of Chief Executive Officer
31.2
Rule 13a-14(a) Certification of Chief Financial Officer
32.1
Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
MIDDLEBURG FINANCIAL CORPORATION
(Registrant)
Date: May 10, 2006
/s/ Joseph L. Boling
Joseph L. Boling
Chairman of the Board & CEO
Date: May 10, 2006
/s/ Kathleen J. Chappell
Kathleen J. Chappell
Senior Vice President & CFO
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EXHIBIT INDEX
Exhibits
31.1
Rule 13a-14(a) Certification of Chief Executive Officer
31.2
Rule 13a-14(a) Certification of Chief Financial Officer
32.1
Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. § 1350