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 June 30, 2010
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 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 £ 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 definition of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer £ Accelerated filer R
Non-accelerated filer £ (Do not check if a smaller reporting company) Smaller reporting company £
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. 6,934,511 shares of Common Stock as of August 5, 2010
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 | 26 | ||
Item 3. | Quantitative and Qualitative Disclosures About Market Risk | 43 | |
Item 4. | Controls and Procedures | 44 | |
Part II. Other Information | |||
Item 1. | Legal Proceedings | 45 | |
Item 1A. | Risk Factors | 45 | |
Item 2. | Unregistered Sales of Equity Securities and Use of Proceeds | 45 | |
Item 3. | Defaults upon Senior Securities | 45 | |
Item 4. | Removed and Reserved | 45 | |
Item 5. | Other Information | 45 | |
Item 6. | Exhibits | 45 | |
Signatures | 47 |
2
PART I. FINANCIAL INFORMATION
Item 1. FINANCIAL STATEMENTS
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Balance Sheets
(In Thousands, Except Share Data)
(Unaudited) | ||||||||
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
Assets: | ||||||||
Cash and due from banks | $ | 20,776 | $ | 18,365 | ||||
Interest-bearing deposits in banks | 50,448 | 24,845 | ||||||
Securities available for sale | 200,786 | 172,699 | ||||||
Loans held for sale | 62,442 | 45,010 | ||||||
Restricted securities, at cost | 6,225 | 6,225 | ||||||
Loans, net of allowance for loan losses of $10,075 in 2010 | ||||||||
and $9,185 in 2009 | 644,181 | 635,094 | ||||||
Premises and equipment, net | 23,264 | 23,506 | ||||||
Goodwill and identfied intangibles | 6,446 | 6,531 | ||||||
Other real estate owned, net of valuation allowance of | ||||||||
$873 in 2010 and $1,121 in 2009. | 8,257 | 6,511 | ||||||
Prepaid federal deposit insurance | 5,837 | 6,923 | ||||||
Accrued interest receivable and other assets | 32,690 | 30,665 | ||||||
Total assets | $ | 1,061,352 | $ | 976,374 | ||||
Liabilities and Shareholders' Equity: | ||||||||
Liabilities: | ||||||||
Deposits: | ||||||||
Non-interest bearing demand deposits | $ | 121,504 | $ | 106,459 | ||||
Savings and interest-bearing demand deposits | 411,249 | 397,720 | ||||||
Time deposits | 326,302 | 301,469 | ||||||
Total deposits | $ | 859,055 | $ | 805,648 | ||||
Securities sold under agreements to repurchase | 23,213 | 17,199 | ||||||
Short-term borrowings | 8,851 | 3,538 | ||||||
Long-term debt | 52,912 | 35,000 | ||||||
Subordinated notes | 5,155 | 5,155 | ||||||
Accrued interest and other liabilities | 6,874 | 6,475 | ||||||
Commitments and contingent liabilities | - | - | ||||||
Total liabilities | $ | 956,060 | $ | 873,015 | ||||
Shareholders' Equity: | ||||||||
Common stock, par value $2.50 share, authorized 20,000,000 shares | ||||||||
issued and outstanding at June 30, 2010 - 6,914,687 shares | ||||||||
issued and outstanding at December 31, 2009 - 6,909,293 shares | $ | 17,286 | $ | 17,273 | ||||
Capital surplus | 42,883 | 42,807 | ||||||
Retained earnings | 42,859 | 42,706 | ||||||
Accumulated other comprehensive (loss), net | (434 | ) | (2,474 | ) | ||||
Total Middleburg Financial Corporation shareholders'equity | $ | 102,594 | $ | 100,312 | ||||
Non-controlling interest in consolidated subsidiary | 2,698 | 3,047 | ||||||
Total shareholders' equity | $ | 105,292 | $ | 103,359 | ||||
Total liabilities and shareholders' equity | $ | 1,061,352 | $ | 976,374 |
See Accompanying Notes to Consolidated Financial Statements.
3
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Income
(In Thousands, Except Per Share Data)
Unaudited | Unaudited | |||||||||||||||
For the Six Months | For the Three Months | |||||||||||||||
Ended June 30, | Ended June 30, | |||||||||||||||
2010 | 2009 | 2010 | 2009 | |||||||||||||
Interest and Dividend Income | ||||||||||||||||
Interest and fees on loans | $ | 20,829 | $ | 25,820 | $ | 10,384 | $ | 12,870 | ||||||||
Interest on securities available for sale | ||||||||||||||||
Taxable | 2,028 | 2,463 | 1,090 | 1,202 | ||||||||||||
Exempt from federal income taxes | 1,293 | 1,474 | 600 | 746 | ||||||||||||
Dividends | 43 | 36 | 22 | 18 | ||||||||||||
Interest on federal funds sold and other | 63 | 58 | 28 | 24 | ||||||||||||
Total interest and dividend income | $ | 24,256 | $ | 29,851 | $ | 12,124 | $ | 14,860 | ||||||||
Interest Expense | ||||||||||||||||
Interest on deposits | $ | 6,251 | $ | 8,115 | $ | 3,077 | $ | 3,959 | ||||||||
Interest on securities sold under agreements to repurchase | 80 | 25 | 60 | 3 | ||||||||||||
Interest on short-term borrowings | 111 | 467 | 67 | 191 | ||||||||||||
Interest on long-term debt | 926 | 1,650 | 488 | 797 | ||||||||||||
Total interest expense | $ | 7,368 | $ | 10,257 | $ | 3,692 | $ | 4,950 | ||||||||
Net interest income | $ | 16,888 | $ | 19,594 | $ | 8,432 | $ | 9,910 | ||||||||
Provision for loan losses | 2,220 | 2,620 | 1,291 | 1,583 | ||||||||||||
Net interest income after provision | ||||||||||||||||
for loan losses | $ | 14,668 | $ | 16,974 | $ | 7,141 | $ | 8,327 | ||||||||
Other Income | ||||||||||||||||
Trust and investment advisory fee income | $ | 1,690 | $ | 1,589 | $ | 875 | $ | 792 | ||||||||
Service charges on deposit accounts | 909 | 945 | 468 | 490 | ||||||||||||
Net gains (losses) on securities available for sale | 469 | 1,070 | (37 | ) | 661 | |||||||||||
Total other-than-temporary impairment loss on securities | (300 | ) | (179 | ) | (98 | ) | - | |||||||||
Portion of loss recognized in other comprehensive income | (52 | ) | - | (1 | ) | - | ||||||||||
Net other-than-temporary impairment loss | (248 | ) | (179 | ) | (97 | ) | - | |||||||||
Commissions on investment sales | 311 | 257 | 167 | 172 | ||||||||||||
Bank owned life insurance | 255 | 257 | 130 | 130 | ||||||||||||
Gain on loans held for sale | 6,474 | 6,170 | 3,844 | 3,378 | ||||||||||||
Fees on loans held for sale | 834 | 527 | 476 | 292 | ||||||||||||
Other service charges, commissions and fees | 256 | 297 | 143 | 158 | ||||||||||||
Other operating income | 179 | 183 | 88 | 56 | ||||||||||||
Total other income | $ | 11,129 | $ | 11,116 | $ | 6,057 | $ | 6,129 | ||||||||
Other Expense | ||||||||||||||||
Salaries and employee benefits | $ | 14,381 | $ | 14,930 | $ | 7,457 | $ | 7,670 | ||||||||
Net occupancy expense of premises | 3,094 | 2,950 | 1,490 | 1,565 | ||||||||||||
Other taxes | 397 | 290 | 201 | 145 | ||||||||||||
Advertising | 428 | 365 | 248 | 216 | ||||||||||||
Computer operations | 668 | 661 | 340 | 360 | ||||||||||||
Other real estate owned | 505 | 1,460 | 295 | 649 | ||||||||||||
Audits and examinations | 277 | 310 | 162 | 108 | ||||||||||||
Legal fees | 306 | 299 | 167 | 176 | ||||||||||||
FDIC insurance | 1,153 | 1,057 | 352 | 777 | ||||||||||||
Other operating expenses | 3,000 | 2,529 | 1,554 | 1,353 | ||||||||||||
Total other expense | $ | 24,209 | $ | 24,851 | $ | 12,266 | $ | 13,019 | ||||||||
Income before income taxes | $ | 1,588 | $ | 3,239 | $ | 932 | $ | 1,437 | ||||||||
Income tax expense | 162 | 161 | 75 | 21 | ||||||||||||
Net income | $ | 1,426 | $ | 3,078 | $ | 857 | $ | 1,416 | ||||||||
Less: Net (income) / loss attributable to non-controlling interest | 112 | (1,281 | ) | (133 | ) | (603 | ) | |||||||||
Net income attributable to Middleburg Financial Corporation | $ | 1,538 | $ | 1,797 | $ | 724 | $ | 813 | ||||||||
Amortization of discount on preferred stock | - | 32 | - | 19 | ||||||||||||
Dividend on preferred stock | - | 464 | - | 278 | ||||||||||||
Net income available to common shareholders | $ | 1,538 | $ | 1,301 | $ | 724 | $ | 516 | ||||||||
Net income per common share, basic | $ | 0.22 | $ | 0.28 | $ | 0.10 | $ | 0.11 | ||||||||
Net income per common share, diluted | $ | 0.22 | $ | 0.28 | 0.10 | $ | 0.11 | |||||||||
Dividends per common share | $ | 0.20 | $ | 0.38 | 0.10 | $ | 0.19 | |||||||||
See Accompanying Notes to Consolidated Financial Statements |
4
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Changes in Shareholders’ Equity
For the Six Months Ended June 30, 2010 and 2009
(In Thousands, Except Share Data)
(Unaudited)
Middleburg Financial Corporation Shareholders | ||||||||||||||||||||||||
Accumulated | ||||||||||||||||||||||||
Other | ||||||||||||||||||||||||
Preferred | Common | Capital | Retained | Comprehensive | Comprehensive | Noncontrolling | ||||||||||||||||||
Stock | Stock | Surplus | Earnings | Income (Loss) | Income (Loss) | Interest | Total | |||||||||||||||||
Balances - December 31, 2008 | $ | - | $ | 11,336 | $ | 23,967 | $ | 43,555 | $ | (3,181 | ) | $ | 1,928 | $ | 77,605 | |||||||||
Comprehensive (loss): | ||||||||||||||||||||||||
Net income | 1,797 | $ | 1,797 | 1,281 | 3,078 | |||||||||||||||||||
Other comprehensive (loss) | ||||||||||||||||||||||||
net of tax: | ||||||||||||||||||||||||
Unrealized holding (losses) arising during the | ||||||||||||||||||||||||
period (net of tax $715) | (1,387 | ) | ||||||||||||||||||||||
Reclassification adjustment (net of tax $364) | (706 | ) | ||||||||||||||||||||||
Unrealized losses on securities for which an | ||||||||||||||||||||||||
other-than-temporary impairment loss has | ||||||||||||||||||||||||
been recognized in earnings, net of tax of $61 | 118 | |||||||||||||||||||||||
Other comprehensive loss (net of tax $1,018) | (1,975 | ) | $ | (1,975 | ) | (1,975 | ) | |||||||||||||||||
Total comprehensive income (loss) | $ | (178 | ) | |||||||||||||||||||||
Cash dividends: | ||||||||||||||||||||||||
Common stock | (1,765 | ) | (1,765 | ) | ||||||||||||||||||||
Preferred stock | (320 | ) | (320 | ) | ||||||||||||||||||||
Distributions to non-controlling interest | (176 | ) | (176 | ) | ||||||||||||||||||||
Equity compensation | 53 | 53 | ||||||||||||||||||||||
Issuance of preferred stock and related warrants | 21,571 | 429 | 22,000 | |||||||||||||||||||||
Amortization of preferred stock discount | 32 | (32 | ) | |||||||||||||||||||||
Issuance of common stock (458,928 shares) | 1,147 | 3,861 | 5,008 | |||||||||||||||||||||
Balances - June 30, 2009 | $ | 21,603 | $ | 12,483 | $ | 28,310 | $ | 43,235 | $ | (5,156 | ) | $ | 3,033 | $ | 103,508 | |||||||||
Balances - December 31, 2009 | $ | - | $ | 17,273 | $ | 42,807 | $ | 42,706 | $ | (2,474 | ) | $ | 3,047 | $ | 103,359 | |||||||||
Comprehensive income | ||||||||||||||||||||||||
Net income | 1,538 | $ | 1,538 | (112 | ) | 1,426 | ||||||||||||||||||
Other comprehensive income net of tax: | ||||||||||||||||||||||||
Unrealized holding gains arising during the | ||||||||||||||||||||||||
period (net of taxes of $1,108) | 2,152 | |||||||||||||||||||||||
Reclassification adjustment (net of taxes $159) | (310 | ) | ||||||||||||||||||||||
Unrealized losses on securities for which an | ||||||||||||||||||||||||
other-than-temporary impairment loss has | ||||||||||||||||||||||||
been recognized in earnings, net of tax of $18 | 34 | |||||||||||||||||||||||
Reclassification adjustment (net of taxes of $84) | 164 | |||||||||||||||||||||||
Total other comprehensive income | 2,040 | $ | 2,040 | 2,040 | ||||||||||||||||||||
Total comprehensive income | $ | 3,578 | ||||||||||||||||||||||
Cash dividends declared | (1,385 | ) | (1,385 | ) | ||||||||||||||||||||
Exercise of stock options (1,750 shares) | 4 | 14 | 18 | |||||||||||||||||||||
Vesting of restricted stock awards (3,650 shares) | 9 | (9 | ) | - | ||||||||||||||||||||
Distributions to non-controlling interest | (237 | ) | (237 | ) | ||||||||||||||||||||
Share-based compensation | - | 71 | 71 | |||||||||||||||||||||
Balances - June 30, 2010 | $ | - | $ | 17,286 | $ | 42,883 | $ | 42,859 | $ | (434 | ) | $ | 2,698 | $ | 105,292 |
See Accompanying Notes to Consolidated Financial Statements.
5
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDIARIES
Consolidated Statements of Cash Flows
(In Thousands)
Unaudited | ||||||||
For the Six Months Ended | ||||||||
June 30, | June 30, | |||||||
2010 | 2009 | |||||||
CASH FLOWS FROM OPERATING ACTIVITIES | ||||||||
Net income | $ | 1,538 | $ | 1,797 | ||||
Adjustments to reconcile net income to net cash used in operating activities: | ||||||||
Provision for loan losses | 2,220 | 2,620 | ||||||
Depreciation and amortization | 885 | 963 | ||||||
Equity in distributions in excess of undistributed earnings of affiliate | (159 | ) | (74 | ) | ||||
Net income (loss) attributable to non-controlling interest | (112 | ) | 1,281 | |||||
Valuation adjustment on other real estate owned | 244 | 1,035 | ||||||
Net (gain) loss on sale of other real estate owned | 165 | 82 | ||||||
Premium amortization and discount (accretion) on securities, net | 907 | 158 | ||||||
Net (gain) loss on securities available for sale | (469 | ) | (1,070 | ) | ||||
Other than temporary impairment loss | 248 | 179 | ||||||
Originations of loans held for sale | (337,650 | ) | (561,105 | ) | ||||
Proceeds from sales of loans held for sale | 326,692 | 533,230 | ||||||
Net (gain) loss on loans held for sale | (6,474 | ) | (6,170 | ) | ||||
Net (gain) loss on disposal of premises and equipment | (7 | ) | 1 | |||||
Earning on bank-owned life insurance | (255 | ) | (257 | ) | ||||
Share-based compensation | 71 | 53 | ||||||
Decrease in prepaid FDIC insurance | 1,086 | - | ||||||
(Increase) in other assets | (2,068 | ) | (1,285 | ) | ||||
Increase in other liabilities | 399 | 1,100 | ||||||
Net cash used in by operating activities | $ | (12,739 | ) | $ | (27,462 | ) | ||
CASH FLOWS FROM INVESTING ACTIVITIES | ||||||||
Proceeds from maturity, principal paydowns and | ||||||||
calls of securities available for sale | $ | 25,204 | $ | 13,872 | ||||
Proceeds from sale of securities available for sale | 37,345 | 59,188 | ||||||
Purchase of securities available for sale | (88,231 | ) | (56,362 | ) | ||||
Proceeds from sale of other real estate owned | 448 | 890 | ||||||
Net decrease (increase) in loans | (13,910 | ) | 15,007 | |||||
Purchases of bank-owned life insurance | (682 | ) | - | |||||
Purchase of premises and equipment | (463 | ) | (484 | ) | ||||
Net cash (used in) provided by investing activities | $ | (40,289 | ) | $ | 32,111 | |||
CASH FLOWS FROM FINANCING ACTIVITIES | ||||||||
Net increase in noninterest-bearing and interest-bearing demand deposits and savings accounts | $ | 38,909 | $ | 61,490 | ||||
Net increase in certificates of deposits | 14,498 | 3,861 | ||||||
Increase (decrease) in securities sold under agreements to repurchase | 6,014 | (3,173 | ) | |||||
Net increase (decrease) in short-term borrowings | 5,313 | (19,666 | ) | |||||
Proceeds from long-term debt | 17,912 | - | ||||||
Payments on long-term debt | - | (10,000 | ) | |||||
Distributions by subsidiary to non-controlling interest | (237 | ) | (176 | ) | ||||
Cash dividends paid | (1,385 | ) | (2,094 | ) | ||||
Exercise of stock options | 18 | - | ||||||
Issuance of common stock | - | 5,008 | ||||||
Issuance of preferred stock | - | 22,000 | ||||||
Net cash provided by financing activities | $ | 81,042 | $ | 57,250 | ||||
Increase (decrease) in cash and cash equivalents | $ | 28,014 | $ | 61,899 | ||||
CASH AND CASH EQUIVALENTS | ||||||||
Beginning | 43,210 | 35,380 | ||||||
Ending | $ | 71,224 | $ | 97,279 | ||||
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION | ||||||||
Cash payments for: | ||||||||
Interest | $ | 7,156 | $ | 10,597 | ||||
Income taxes | - | 852 | ||||||
SUPPLEMENTAL DISCLOSURES FOR NON-CASH | ||||||||
INVESTING AND FINANCING ACTIVITIES | ||||||||
Unrealized gain (loss) on securities available for sale | $ | 3,091 | $ | (2,993 | ) | |||
Transfer of loans to other real estate owned | 2,603 | 1,865 |
See Accompanying Notes to Consolidated Financial Statements.
6
MIDDLEBURG FINANCIAL CORPORATION AND SUBSIDAIRIES
Notes to Consolidated Financial Statements
For the Six Months Ended June 30, 2010 and 2009
(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 June 30, 2010 and December 31, 2009, the results of operations for the three and six months ended June 30, 2010 and 2009, and, changes in shareholders’ equity and cash flows for the six months ended June 30, 2010 and 2009, 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, 2009 (the “2009 Form 10-K”) of Middleburg Financial Corp oration (the “Company”). The results of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of the results to be expected for the full year. In preparing these financial statements, management has evaluated subsequent events and transactions for potential recognition or disclosure through the date these financial statements were issued. Management has concluded there were no material subsequent events to be disclosed at this time.
Note 2. Stock–Based Compensation Plan
As of June 30, 2010, the Company sponsored one stock-based compensation plan (the 2006 Equity Compensation Plan), which provides for the granting of stock options, stock appreciation rights, stock awards, performance share awards, incentive awards and stock units. The 2006 Equity Compensation Plan was approved by the Company’s shareholders at the Annual Meeting held on April 26, 2006 and has succeeded the Company’s 1997 Stock Incentive Plan. Under the plan, the Company may grant stock-based compensation to its directors, officers, employees and other persons the Company determines have contributed to the profits or growth of the Company. The Company may grant awards with respect to up to 255,000 shares of common stock under the 2006 Equity Compensation Plan.
The Company granted 24,440 shares of restricted stock on March 15, 2010. The restricted stock award is divided equally between service-based shares and performance-based shares. The service-based portion of the stock award has a vesting period of 25% of the shares granted one year after the date of grant, another 25% two years after the date of grant, and the remaining 50% on the third year after the date of grant. Service-based stock awards are entitled to voting and dividend rights on all shares granted as of the grant date. The performance-based stock awards vest at 100% on the third year after the date of grant if pre-established financial performance targets are met. If the performance targets are not met as of the end of the fiscal year preceding the third anniver sary date of the grant, the performance-based shares are forfeited. All unearned restricted stock grants are forfeited if the employee leaves the Company prior to vesting.
Additionally, 2,803 shares of service-based restricted stock were issued to certain executive officers on May 1, 2010. 1,430 of these shares vest on a graduated basis as discussed above. The remaining 1,373 shares will vest at 100% on May 1, 2011.
The Company recognized $71,000 for stock-based compensation expenses for the six months ended June 30, 2010.
7
The following table summarizes stock options awarded under the 2006 Equity Compensation Plan and remaining unexercised options under the 1997 Stock Incentive Plan at the end of the reporting period.
June 30, 2010 | |||||||||||
Weighted | |||||||||||
Average | Aggregate | ||||||||||
Exercise | Intrinsic | ||||||||||
Shares | Price | Value | |||||||||
Outstanding at beginning of year | 184,208 | $ | 19.34 | ||||||||
Granted | -- | -- | |||||||||
Exercised | (1,750 | ) | 10.63 | ||||||||
Forfeited | -- | -- | |||||||||
Outstanding at end of period | 182,458 | $ | 19.42 | $ | -- |
As of the end of the reporting period, 128,677 options were vested and exercisable representing 110,750 shares issued under the original 1997 plan and 17,927 vested options under the 2006 Plan. At June 30, 2010 the exercise price of these stock options was greater than the aggregate market price. The weighted average remaining contractual term for unexercised stock options at June 30, 2010 was 3.06 years. As of June 30, 2010 there was $90,000 of total unrecognized compensation expense related to stock option awards under the 2006 Equity Compensation Plan.
The following table summarizes restricted stock awarded under the 2006 Equity Compensation Plan at the end of the reportable period.
June 30, 2010 | |||||||||||
Weighted | |||||||||||
Average | Aggregate | ||||||||||
Grant-Date | Intrinsic | ||||||||||
Shares | Fair Value | Value | |||||||||
Outstanding at beginning of year | 23,830 | $ | 19.97 | ||||||||
Granted | 27,243 | 14.29 | |||||||||
Vested | (3,650 | ) | 26.30 | ||||||||
Forfeited | (3,197 | ) | 32.30 | ||||||||
Non-vested at end of period | 44,226 | $ | 15.06 | $ | 615,184 |
The weighted average remaining contractual term for non-vested restricted stock at June 30, 2010 was 2.04 years. As of June 30, 2010, there was $647,000 of total unrecognized compensation expense related to the non-vested restricted stock awards under the 2006 Equity Compensation Plan.
8
Note 3. Securities
Amortized costs and fair values of securities available for sale at June 30, 2010 are summarized as follows:
Gross | Gross | ||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | ||||||||||||||
cost | Gains | Losses | Value | ||||||||||||||
U.S. Treasury securities | $ | 3,024 | $ | 5 | $ | - | $ | 3,029 | |||||||||
U.S. government agency | |||||||||||||||||
securities | 1,130 | - | (9 | ) | 1,121 | ||||||||||||
Obligations of states and | |||||||||||||||||
political subdivision | 63,674 | 444 | (1,138 | ) | 62,980 | ||||||||||||
Mortgage-backed securities: | |||||||||||||||||
Agency | 113,671 | 1,856 | (44 | ) | 115,483 | ||||||||||||
Non-agency | 17,526 | 144 | (162 | ) | 17,508 | ||||||||||||
Corporate preferred stock | 39 | - | (2 | ) | 37 | ||||||||||||
Trust preferred securities | 2,379 | 3 | (1,754 | ) | 628 | ||||||||||||
Total | $ | 201,443 | $ | 2,452 | $ | (3,109 | ) | $ | 200,786 |
Amortized costs and fair values of securities available for sale at December 31, 2009 are summarized as follows:
Gross | Gross | ||||||||||||||||
Amortized | Unrealized | Unrealized | Fair | ||||||||||||||
cost | Gains | Losses | Value | ||||||||||||||
(In Thousands) | |||||||||||||||||
U.S. Treasury securities | $ | 3,084 | $ | 3 | $ | - | $ | 3,087 | |||||||||
Obligations of states and | |||||||||||||||||
political subdivision | 70,586 | 228 | (1,770 | ) | 69,044 | ||||||||||||
Mortgage-backed securities: | |||||||||||||||||
Agency | 89,933 | 949 | (642 | ) | 90,240 | ||||||||||||
Non-agency | 10,348 | 38 | (447 | ) | 9,939 | ||||||||||||
Corporate preferred stock | 39 | - | (5 | ) | 34 | ||||||||||||
Other Securities | 2,457 | 4 | (2,106 | ) | 355 | ||||||||||||
Total | $ | 176,447 | $ | 1,222 | $ | (4,970 | ) | $ | 172,699 |
The amortized cost and fair value of securities available for sale as of June 30, 2010, by contractual maturity are shown below. Maturities may differ from contractual maturities in corporate and mortgage-backed securities because the securities and mortgages underlying the securities may be called or repaid without any penalties. Therefore, these securities are not included in the maturity categories in the following maturity summary.
9
June 30, 2010 | ||||||||
Amortized | Fair | |||||||
Cost | Value | |||||||
(In Thousands) | ||||||||
Due in one year or less | $ | 3,619 | $ | 3,624 | ||||
Due after one year through five years | 8,967 | 8,863 | ||||||
Due after five years through ten years | 28,147 | 27,927 | ||||||
Due after ten years | 27,095 | 26,717 | ||||||
Mortgage-backed securities | 131,197 | 132,992 | ||||||
Corporate preferred | 39 | 36 | ||||||
Other | 2,379 | 627 | ||||||
Total | $ | 201,443 | $ | 200,786 | ||||
Proceeds from the sale of securities during the quarter ended June 30, 2010 were $21,228,000 and net losses of $37,000 were realized on those sales. Additionally, $97,000 in losses was recognized for impaired securities during the quarter. The tax benefit applicable to these net realized losses amounted to $45,600.
The carrying value of securities pledged to qualify for fiduciary powers, to secure public monies and for other purposes as required by law amounted to $79,161,000 at June 30, 2010.
At June 30, 2010, investments in an unrealized loss position that were temporarily impaired are as follows:
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair Value | (Losses) | Fair Value | (Losses) | Fair Value | (Losses) | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
U.S. government agency securities | $ | 1,122 | $ | (9 | ) | $ | -- | $ | -- | $ | 1,122 | $ | (9 | ) | ||||||||||
Obligations of states | ||||||||||||||||||||||||
and political subdivisions | 15,249 | (311 | ) | 20,430 | (827 | ) | 35,679 | (1,138 | ) | |||||||||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency | 9,323 | (44 | ) | -- | -- | 9,323 | (44 | ) | ||||||||||||||||
Non-agency | 9,476 | (162 | ) | -- | -- | 9,476 | (162 | ) | ||||||||||||||||
Other | 204 | (4 | ) | 357 | (1,752 | ) | 561 | (1,756 | ) | |||||||||||||||
Total temporarily | ||||||||||||||||||||||||
impaired securities | $ | 35,374 | $ | (530 | ) | $ | 20,787 | $ | (2,579 | ) | $ | 56,161 | $ | (3,109 | ) |
10
At December 31, 2009, investments in an unrealized loss position that were temporarily impaired are as follows:
Less Than 12 Months | 12 Months or More | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair Value | (Losses) | Fair Value | (Losses) | Fair Value | (Losses) | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Obligations of states | ||||||||||||||||||||||||
and political subdivisions | $ | 31,312 | $ | (639 | ) | $ | 20,143 | $ | (1,131 | ) | $ | 51,455 | $ | (1,770 | ) | |||||||||
Mortgage-backed securities: | ||||||||||||||||||||||||
Agency | 44,590 | (642 | ) | -- | -- | 44,590 | (642 | ) | ||||||||||||||||
Non-agency | 6,601 | (447 | ) | -- | -- | 6,601 | (447 | ) | ||||||||||||||||
Corporate preferred stock | -- | -- | 34 | (5 | ) | 34 | (5 | ) | ||||||||||||||||
Other | -- | -- | 252 | (2,106 | ) | 252 | (2,106 | ) | ||||||||||||||||
Total temporarily | ||||||||||||||||||||||||
impaired securities | $ | 82,503 | $ | (1,728 | ) | $ | 20,429 | $ | (3,242 | ) | $ | 102,932 | $ | (4,970 | ) |
Trust preferred securities were evaluated within the scope of EITF 99-20 (ASC 320 Investments – Debt and Equity Securities). The Company reviews current available information in estimating the future cash flows of these securities and determines whether there have been favorable or adverse changes in estimated cash flows from the cash flows previously projected. The Company considers the structure and term of the pool and the financial condition of the underlying issuers. Specifically, the evaluation incorporates factors such as interest rates and appropriate risk premiums, the timing and amount of interest and principal payments and the allocation of payments to the various note classes. Current estimates of cash flows are based on the most recent trustee reports, announcem ents of deferrals or defaults, expected future default rates and other relevant market information. The Company analyzed the cash flow characteristics of these securities.
In connection with the preparation of the financial statements included in this Form 10-Q, the Company identified three other than temporarily impaired securities within its portfolio and elected to recognize losses through the income statement. During the six months ended June 30, 2010, the Company recognized credit related impairment losses of $248,000 versus $179,000 for the six months ended June 30, 2009 related to these securities.
The following table provides further information on these three securities as of June 30, 2010 (in thousands):
Cumulative | Amount | ||||||||||
Current | Estimated | Other | of OTTI | Expected | |||||||
Tranche | Moody's | Par | Book | Fair | Comprehensive | Related to | Institutions | Default | Expected | Lag | |
Security | Level | Rating | Value | Value | Value | (Income) Loss | Credit Loss | Performing | Rate | Recovery | Years |
MM Community Funding | B | Ca | $1,000 | $482 | $56 | $426 | $518 | 10 | 1.20% | 15% | 1 |
MM Community Funding | B | Ca | $1,000 | $482 | $56 | 426 | 518 | 10 | 1.20% | 15% | 1 |
Trust Preferred XXII | D | C | $1,979 | -- | $12 | (12) | 284 | 71 | 0.75% | 15% | 2 |
$840 | $1,320 |
The Company also has the following investments in trust preferred securities not considered other than temporarily impaired as of June 30, 2010 (in thousands):
11
Cumulative | |||||||||||
Current | Estimated | Other | Expected | ||||||||
Tranche | Moody's | Par | Book | Fair | Comprehensive | Institutions | Deferrals/ | Default | Expected | Lag | |
Security | Level | Rating | Value | Value | Value | Loss | Performing | Defaults | Rate | Recovery | Years |
Trust Preferred IV | Mezzanine | Ca | $244 | $244 | $24 | $220 | 4 | 2.10% | 0.75% | 15% | 2 |
Trust Preferred V | Mezzanine | C | $688 | $692 | $69 | $623 | 2 | 3.60% | 0.75% | 15% | 2 |
MM Community Funding LTD | A | B1 | $208 | $208 | $151 | $57 | 10 | 20.74% | 1.20% | 15% | 1 |
At June 30, 2010, the Company concluded that no other adverse change in cash flows occurred during the quarter and did not consider any other securities other-than-temporarily impaired. Based on this analysis and because the Company does not intend to sell these securities and it is more likely than not the Company will not be required to sell these securities before recovery of amortized cost basis, which may be at maturity; and, for debt securities related to corporate securities, determined that there was no other adverse change in the cash flows as viewed by a market participant, the Company does not consider the investments in these assets to be other-than-temporarily impaired at June 30, 2010. However, there is a risk that this review could result in recognition of other-tha n-temporary impairment charges in the future.
Of the temporarily impaired securities, 53 are investment grade, five are speculative grade and one is non-rated. Obligations of states and political subdivisions make up the largest amount of temporarily impaired securities. The speculative grade securities are asset backed securities that are collateralized by trust preferred issuances of financial institutions. Market prices change daily and are affected by conditions beyond the control of the Company. Although the Company has the ability to hold these securities until the temporary loss is recovered, decisions by management may necessitate a sale before the loss is fully recovered. Investment decisions reflect the strategic asset/liability objectives of the Company. The investment portfolio is analyzed frequently by the Company 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:
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
(In Thousands) | ||||||||
Mortgage loans on real estate: | ||||||||
Construction | $ | 74,568 | $ | 72,934 | ||||
Secured by farmland | 2,996 | 2,491 | ||||||
Secured by 1-4 family residential | 323,438 | 312,723 | ||||||
Less: Mortgages held for resale | (62,442 | ) | (45,010 | ) | ||||
Total Secured by 1-4 family residential | 260,996 | 267,713 | ||||||
Other real estate loans | 262,479 | 240,729 | ||||||
Commercial loans | 37,970 | 43,367 | ||||||
Consumer loans | 15,090 | 16,907 | ||||||
All other loans | 157 | 138 | ||||||
Total loans | 654,256 | 644,279 | ||||||
Less: Allowance for loan losses | 10,075 | 9,185 | ||||||
Net loans | $ | 644,181 | $ | 635,094 | ||||
12
The Company had $62.4 million and $45.0 million in loans held for sale at June 30, 2010 and December 31, 2009, respectively.
The following table summarizes impaired loans:
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
(In Thousands) | ||||||||
Impaired loans for which, | ||||||||
A specific allowance has been provided | $ | 18,614 | $ | 12,282 | ||||
A specific allowance has not been provided | 7,803 | 10,441 | ||||||
Total impaired loans | $ | 26,417 | $ | 22,723 | ||||
Allowance provided for impaired loans, | ||||||||
included in the allowance for loan losses | $ | 1,878 | $ | 1,731 | ||||
Average balance of impaired loans | $ | 24,646 | $ | 22,740 | ||||
Interest income recognized | $ | 886 | $ | 1,225 |
There were $6.2 million and $908,000 in loans 90 days past due and still accruing interest on June 30, 2010 and December 31, 2009, respectively.
The total balance of restructured loans at June 30, 2010 was $3.7 million of which $1.6 million represented loans performing as agreed to the restructured terms and $300,000 represented loans less than 90 days delinquent. Approximately $2.0 million in restructured loan balances are included in the Company’s non-performing assets total as of June 30, 2010. This compares with $2.1 million in non-performing restructured loans at December 31, 2009, a decrease of $81,000 or 3.9%.
Note 5. Allowance for Loan Losses
The following is a summary of transactions in the allowance for loan losses:
June 30, | December 31, | |||||||
2010 | 2009 | |||||||
(In Thousands) | ||||||||
Balance at January 1 | $ | 9,185 | $ | 10,020 | ||||
Provision charged to operating expense | 2,220 | 4,551 | ||||||
Recoveries added to the allowance | 103 | 98 | ||||||
Loan losses charged to the allowance | (1,433 | ) | (5,484 | ) | ||||
Balance at the end of the period | $ | 10,075 | $ | 9,185 |
13
Note 6. Earnings Per Share
The following table shows the weighted average number of common 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.
Six months ended | ||||||||||||||||
June 30, 2010 | June 30, 2009 | |||||||||||||||
Per share | Per share | |||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||
Basic earnings per share | 6,910,524 | $ | 0.22 | 4,675,084 | $ | 0.28 | ||||||||||
Effect of dilutive securities: | ||||||||||||||||
stock options and grants | 14,153 | 5,882 | ||||||||||||||
Diluted earnings per share | 6,924,677 | $ | 0.22 | 4,680,966 | $ | 0.28 |
Three months ended | ||||||||||||||||
June 30, 2010 | June 30, 2009 | |||||||||||||||
Per share | Per share | |||||||||||||||
Shares | Amount | Shares | Amount | |||||||||||||
Basic earnings per share | 6,911,744 | $ | 0.10 | 4,813,673 | $ | 0.11 | ||||||||||
Effect of dilutive securities: | ||||||||||||||||
stock options and grants | 12,594 | 9,661 | ||||||||||||||
Diluted earnings per share | 6,924,338 | $ | 0.10 | 4,823,334 | $ | 0.11 |
The following table shows earnings available to common shareholders used in computing earnings per share.
For the Six Months | ||||||||
(In Thousands) | Ended June 30, | |||||||
2010 | 2009 | |||||||
Net income | $ | 1,426 | $ | 3,078 | ||||
Net (income) loss attributable to non-controlling interest | 112 | (1,281 | ) | |||||
Net income attributable to Middleburg Financial Corporation | $ | 1,538 | $ | 1,797 | ||||
Less: dividends to preferred shareholders | -- | 464 | ||||||
Less: amortization of discount on preferred stock | -- | 32 | ||||||
Net income available to common shareholders | $ | 1,538 | $ | 1,301 |
At June 30, 2010 and 2009, stock options, restricted grants and warrants representing 106,905 and 314,322 shares, respectively, were not included in the calculation of earnings per share because they would have been anti-dilutive.
14
Note 7. Segment Reporting
The Company operates in a decentralized fashion in three principal business activities: retail banking services; wealth management services; and mortgage banking services. Revenue from retail banking activities consists primarily of interest earned on loans and investment securities and service charges on deposit accounts.
Revenue from the wealth management activities is comprised of fees based upon the market value of the accounts under administration as well as commission on investment transactions. The wealth management services are conducted by the two subsidiaries of Middleburg Investment Group, Inc - Middleburg Trust Company and Middleburg Investment Advisors, Inc. and the investment services department of Middleburg Bank.
Revenue from the mortgage banking activities is comprised of interest earned on loans and fees received as a result of the mortgage origination process. The Company recognizes gains on the sale of loans as part of Other Income. The mortgage banking services are conducted by Southern Trust Mortgage, LLC.
Middleburg Bank and the Company have assets in custody with Middleburg Trust Company and accordingly pay Middleburg Trust Company a monthly fee. Middleburg Bank also pays interest to Middleburg Trust Company, Middleburg Investment Advisors and Southern Trust Mortgage on deposit accounts that each company has at Middleburg Bank. Southern Trust Mortgage has an outstanding line of credit and a participation agreement for which it pays interest to Middleburg Bank. Middleburg Bank provides office space and data processing services to Southern Trust Mortgage for which it receives rental and fee income. Middleburg Investment Advisors pays the Company a management fee each month for accounting and other services provided. Transactions related to these relationships a re eliminated to reach consolidated totals.
15
The following table presents segment information for the six months ended June 30, 2010 and 2009, respectively.
For the Six Months Ended | For the Six Months Ended | |||||||||||||||||||||||||||||
June 30, 2010 | June 30, 2009 | |||||||||||||||||||||||||||||
Retail | Wealth | Mortgage | Intercompany | Retail | Wealth | Mortgage | Intercompany | |||||||||||||||||||||||
Banking | Management | Banking | Eliminations | Consolidated | Banking | Management | Banking | Eliminations | Consolidated | |||||||||||||||||||||
(In Thousands) | ||||||||||||||||||||||||||||||
Revenues: | ||||||||||||||||||||||||||||||
Interest income | $ | 23,369 | $ | 4 | $ | 1,466 | $ | (583 | ) | $ | 24,256 | $ | 24,597 | $ | 4 | $ | 5,867 | $ | (617 | ) | $ | 29,851 | ||||||||
Trust and investment advisory | ||||||||||||||||||||||||||||||
fee income | - | 1,734 | - | (44 | ) | 1,690 | - | 1,882 | - | (36 | ) | 1,846 | ||||||||||||||||||
Other income | 1,680 | 311 | 7,453 | (5 | ) | 9,439 | 2,395 | - | 6,901 | (25 | ) | 9,271 | ||||||||||||||||||
Total operating income | 25,049 | 2,049 | 8,919 | (632 | ) | 35,385 | 26,992 | 1,886 | 12,768 | (678 | ) | 40,968 | ||||||||||||||||||
Expenses: | ||||||||||||||||||||||||||||||
Interest expense | 7,259 | - | 690 | (581 | ) | 7,368 | 9,794 | - | 1,080 | (617 | ) | 10,257 | ||||||||||||||||||
Salaries and employee benefits | 6,578 | 1,538 | 6,265 | - | 14,381 | 6,838 | 1,485 | 6,607 | - | 14,930 | ||||||||||||||||||||
Provision for loan losses | 2,002 | - | 218 | - | 2,220 | 2,517 | - | 103 | - | 2,620 | ||||||||||||||||||||
Other | 7,224 | 684 | 1,971 | (51 | ) | 9,828 | 7,222 | 768 | 1,993 | (61 | ) | 9,922 | ||||||||||||||||||
Total operating expenses | 23,063 | 2,222 | 9,144 | (632 | ) | 33,797 | 26,371 | 2,253 | 9,783 | (678 | ) | 37,729 | ||||||||||||||||||
Income before income taxes | ||||||||||||||||||||||||||||||
and non-controlling interest | 1,986 | (173 | ) | (225 | ) | - | 1,588 | 621 | (367 | ) | 2,985 | - | 3,239 | |||||||||||||||||
Income tax expense | 186 | (24 | ) | - | - | 162 | 263 | (102 | ) | - | - | 161 | ||||||||||||||||||
Net Income | 1,800 | (149 | ) | (225 | ) | - | 1,426 | 358 | (265 | ) | 2,985 | - | 3,078 | |||||||||||||||||
Non-controlling interest in | ||||||||||||||||||||||||||||||
(income)/loss of consolidated subsidiary | - | - | 112 | 112 | - | - | - | (1,281 | ) | (1,281 | ) | |||||||||||||||||||
Net income attributable to | ||||||||||||||||||||||||||||||
Middleburg Financial Corporation | $ | 1,800 | $ | (149 | ) | $ | (225 | ) | $ | 112 | $ | 1,538 | $ | 358 | $ | (265 | ) | $ | 2,985 | $ | (1,281 | ) | $ | 1,797 | ||||||
Total assets | $ | 1,043,703 | $ | 15,694 | $ | 72,652 | $ | (70,697 | ) | $ | 1,061,352 | $ | 1,039,951 | $ | 6,334 | $ | 87,829 | $ | (89,554 | ) | $ | 1,044,560 | ||||||||
Capital expenditures | $ | 430 | $ | 12 | $ | 21 | $ | 463 | $ | 460 | $ | 10 | $ | 14 | $ | 484 | ||||||||||||||
Goodwill and other intangibles | $ | - | $ | 4,579 | $ | 1,867 | $ | - | $ | 6,446 | $ | - | $ | 4,750 | $ | 1,867 | $ | - | $ | 6,617 |
16
The following table presents segment information for the three months ended June 30, 2010 and 2009, respectively.
For the Three Months Ended | For the Three Months Ended | ||||||||||||||||||||||||||||||
June 30, 2010 | June 30, 2009 | ||||||||||||||||||||||||||||||
Retail | Wealth | Mortgage | Intercompany | Retail | Wealth | Mortgage | Intercompany | ||||||||||||||||||||||||
Banking | Management | Banking | Eliminations | Consolidated | Banking | Management | Banking | Eliminations | Consolidated | ||||||||||||||||||||||
(In Thousands) | |||||||||||||||||||||||||||||||
Revenues: | |||||||||||||||||||||||||||||||
Interest income | $ | 11,782 | $ | 2 | $ | 691 | (351 | ) | $ | 12,124 | $ | 12,251 | $ | 2 | $ | 3,050 | $ | (443 | ) | $ | 14,860 | ||||||||||
Trust and investment advisory | |||||||||||||||||||||||||||||||
fee income | - | 895 | - | (20 | ) | 875 | - | 982 | - | (19 | ) | 963 | |||||||||||||||||||
Other income | 297 | 478 | 4,412 | (5 | ) | 5,182 | 1,471 | (55 | ) | 3,763 | (12 | ) | 5,167 | ||||||||||||||||||
Total operating income | 12,079 | 1,375 | 5,103 | (376 | ) | 18,181 | 13,722 | 929 | 6,813 | (474 | ) | 20,990 | |||||||||||||||||||
Expenses: | |||||||||||||||||||||||||||||||
Interest expense | 3,665 | - | 376 | (349 | ) | 3,692 | 4,760 | - | 633 | (443 | ) | 4,950 | |||||||||||||||||||
Salaries and employee benefits | 3,302 | 965 | 3,190 | - | 7,457 | 3,434 | 754 | 3,482 | - | 7,670 | |||||||||||||||||||||
Provision for loan losses | 1,053 | - | 238 | - | 1,291 | 1,502 | - | 81 | - | 1,583 | |||||||||||||||||||||
Other | 3,430 | 455 | 951 | (27 | ) | 4,809 | 3,842 | 358 | 1,181 | (31 | ) | 5,350 | |||||||||||||||||||
Total operating expenses | 11,450 | 1,420 | 4,755 | (376 | ) | 17,249 | 13,538 | 1,112 | 5,377 | (474 | ) | 19,553 | |||||||||||||||||||
Income before income taxes | |||||||||||||||||||||||||||||||
and non-controlling interest | 629 | (45 | ) | 348 | - | 932 | 184 | (183 | ) | 1,436 | - | 1,437 | |||||||||||||||||||
Income tax expense | 72 | 3 | - | - | 75 | 79 | (58 | ) | - | - | 21 | ||||||||||||||||||||
Net Income | 557 | (48 | ) | 348 | - | 857 | 105 | (125 | ) | 1,436 | - | 1,416 | |||||||||||||||||||
Non-controlling interest in | |||||||||||||||||||||||||||||||
(income)/loss of consolidated subsidiary | (133 | ) | (133 | ) | (603 | ) | (603 | ) | |||||||||||||||||||||||
Net income attributable to | |||||||||||||||||||||||||||||||
Middleburg Financial Corporation | $ | 557 | $ | (48 | ) | $ | 348 | $ | (133 | ) | $ | 724 | $ | 105 | $ | (125 | ) | $ | 1,436 | $ | (603 | ) | $ | 813 | |||||||
Total assets | $ | 1,043,703 | $ | 15,694 | $ | 72,652 | $ | (70,697 | ) | $ | 1,061,352 | $ | 1,039,951 | $ | 6,334 | $ | 87,829 | $ | (89,554 | ) | $ | 1,044,560 | |||||||||
Capital expenditures | $ | 327 | $ | 11 | $ | 16 | $ | 354 | $ | 460 | $ | 6 | $ | 10 | $ | 476 | |||||||||||||||
Goodwill and other intangibles | $ | - | $ | 4,579 | $ | 1,867 | $ | - | $ | 6,446 | $ | - | $ | 4,750 | $ | 1,867 | $ | - | $ | 6,617 |
17
Note 8. Defined Benefit Pension Plan
The table below reflects the components of the Net Periodic Benefit Cost related to the Company’s defined benefit pension plan.
Six months ended June 30, | ||||||||
2010 | 2009 | |||||||
(In Thousands) | ||||||||
Service cost | $ | -- | $ | 436 | ||||
Interest cost | 160 | 211 | ||||||
Expected return on plan assets | (194 | ) | (164 | ) | ||||
Amortization of net loss | -- | 64 | ||||||
Net periodic benefit cost (income) | $ | (34 | ) | $ | 547 |
Three months ended June 30, | ||||||||
2010 | 2009 | |||||||
(In Thousands) | ||||||||
Service cost | $ | -- | $ | 218 | ||||
Interest cost | 80 | 106 | ||||||
Expected return on plan assets | (97 | ) | (82 | ) | ||||
Amortization of net loss | -- | 32 | ||||||
Net periodic benefit cost (income) | $ | (17 | ) | $ | 274 |
18
The Company contributed $6,000 to its pension plan in January 2010. The defined benefit pension plan was suspended as of September 30, 2009 and the Company does not expect to make significant additional contributions to the plan.
Note 9. Capital Purchase Program and Stock Offerings
During 2009, the Company participated in the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 and issued 22,000 shares of preferred stock to the Treasury as well as a warrant (“the Warrant”) to purchase 208,202 shares of the Company’s common stock at an initial exercise price of $15.85 per share. As a result of the completion of the Company’s public stock offering in August 2009, the number of shares of common stock underlying the Warrant was reduced by one-half to 104,101. On December 23, 2009, the Company redeemed all of the shares of preferred stock issued to the Treasury, Pursuant to the purchase agreement with the Treasury, the Company may repurchase the W arrant now that it has fully redeemed its Preferred Stock. The price for the purchase of the Warrant is subject to negotiation and there can be no assurance that the Warrant will be repurchased. At this time, the Company has not repurchased the Warrant and the Warrant remains outstanding to the Treasury. The Company expects that the warrant will be sold by the U.S. Treasury at public auction.
Note 10. | Fair Value Measurements |
The Company adopted SFAS No. 157, Fair Value Measurements (ASC 820), on January 1, 2008 to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. ASC 820 clarifies that fair value of certain assets and liabilities is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants.
ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect the Company’s market assumptions. The three levels of the fair value hierarchy under ASC 820 based on these two types of inputs are as follows:
Level I: Quoted prices are available in active markets for identical assets or liabilities as of the reported date.
Level II: Pricing inputs are other than the quoted prices in active markets, which are either directly or indirectly observable as of the reported date. The nature of these assets and liabilities includes items for which quoted prices are available but traded less frequently and items that are fair-valued using other financial instruments, the parameters of which can be directly observed.
Level III: Assets and liabilities that have little to no pricing observability as of the reported date. These items do not have two-way markets and are measured using management’s best estimate of fair value, where the inputs into the determination of fair value require significant management judgment or estimation.
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:
19
Securities available for sale
Fair values for securities available for sale are determined by obtaining quoted prices on nationally recognized securities exchanges or matrix pricing, which is a mathematical technique widely used 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.
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of June 30, 2010.
Fair Value Measurements at June 30, 2010 Using | ||||||||||
Quoted Prices | Significant | |||||||||
in Active | Other | Significant | ||||||||
Balance as of | Markets for | Observable | Unobservable | |||||||
June 30, | Identical Assets | Inputs | Inputs | |||||||
Description | 2010 | (Level I) | (Level II) | (Level III) | ||||||
(in thousands) | ||||||||||
Assets: | ||||||||||
Securities available for Sale | $ 200,786 | $ -- | $ 197,641 | $ 3,145 |
The following table presents the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2009.
Fair Value Measurements at December 31, 2009 Using | ||||||||||
Quoted Prices | Significant | |||||||||
in Active | Other | Significant | ||||||||
Balance as of | Markets for | Observable | Unobservable | |||||||
December 31, | Identical Assets | Inputs | Inputs | |||||||
Description | 2009 | (Level I) | (Level II) | (Level III) | ||||||
(in thousands) | ||||||||||
Assets: | ||||||||||
Securities available for Sale | $ 172,699 | $ -- | $ 169,583 | $ 3,116 |
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The table below presents reconciliation and statements of income classification of gains and losses for all assets measured at fair value on a recurring basis using significant unobservable inputs (Level III) for the six months ended June 30, 2010:
Available for Sale Securities | ||||
(In Thousands) | ||||
Balance, December 31, 2009 | $ | 3,116 | ||
Total realized and unrealized gains (losses): | ||||
Included in earnings | -- | |||
Included in other comprehensive income | 38 | |||
Purchases, sales, issuances and settlements, net | (9 | ) | ||
Transfers in and (out) of Level III | -- | |||
Balance June 30, 2010 | $ | 3,145 |
Certain financial assets and certain financial liabilities are measured at fair value on a nonrecurring basis; that is, the instruments are not measured at fair value on a recurring basis but are subject to fair value adjustments in certain circumstances. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or impairment of individual assets.
The following describes the valuation techniques used by the Company to measure certain financial assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:
Loans held for sale
Loans held for sale are carried at the lower of cost or market value. These loans currently consist of one-to-four family residential loans originated for sale in the secondary market. Fair value is based on the price secondary markets are currently offering for similar loans using observable market data which is not materially different than cost due to the short duration between origination and sale (Level II). As such, the Company records any fair value adjustments on a nonrecurring basis. No nonrecurring fair value adjustments were recorded on loans held for sale during the six months ended June 30, 2010. Gains and losses on the sale of loans are recorded within income from mortgage banking on the consolidated statements of income.
Impaired Loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by a n independent, licensed appraiser outside of the Company using observable market data (Level II). However, if the collateral is a house or building in the
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process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level III. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’s financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level III). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period ended June 30, 2010.
Fair Value Measurements at June 30, 2010 Using | ||||||||||||
Quoted Prices | Significant | |||||||||||
in Active | Other | Significant | ||||||||||
Balance as of | Markets for | Observable | Unobservable | |||||||||
June 30, | Identical Assets | Inputs | Inputs | |||||||||
Description | 2010 | (Level 1) | (Level II) | (Level III) | ||||||||
(in thousands) | ||||||||||||
Assets: | �� | |||||||||||
Impaired loans | $ 16,736 | $ -- | $ 16,736 | $ -- | ||||||||
Mortgages held for sale | $ 62,442 | $ -- | $ 62,442 | $ -- |
The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period ended December 31, 2009.
Fair Value Measurements at December 31, 2009 Using | ||||||||||||
Quoted Prices | Significant | |||||||||||
in Active | Other | Significant | ||||||||||
Balance as of | Markets for | Observable | Unobservable | |||||||||
December 31, | Identical Assets | Inputs | Inputs | |||||||||
Description | 2009 | (Level 1) | (Level II) | (Level III) | ||||||||
(in thousands) | ||||||||||||
Assets: | ||||||||||||
Impaired loans | $ 10,551 | $ -- | $ 10,551 | $ -- | ||||||||
Mortgages held for sale | $ 45,010 | $ -- | $ 45,010 | $ -- |
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Other Real Estate Owned
The value of other real estate owned is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level II). Any fair value adjustments are recorded in the period incurred as loss on other real estate owned on the consolidated statements of income.
The following table summarizes the Company’s non-financial assets that were measured at fair value on a nonrecurring basis during the period ended June 30, 2010.
Fair Value Measurements at June 30, 2010 Using | ||||||||||
Quoted Prices | Significant | |||||||||
in Active | Other | Significant | ||||||||
Balance as of | Markets for | Observable | Unobservable | |||||||
June 30, | Identical Assets | Inputs | Inputs | |||||||
Description | 2010 | (Level I) | (Level II) | (Level III) | ||||||
(in thousands) | ||||||||||
Assets: | ||||||||||
Other real estate owned | $ 8,257 | $ -- | $ 8,257 | $ -- |
The following table summarizes the Company’s non-financial assets that were measured at fair value on a nonrecurring basis during the period ended December 31, 2009.
Fair Value Measurements at December 31, 2009 Using | ||||||||||
Quoted Prices | Significant | |||||||||
in Active | Other | Significant | ||||||||
Balance as of | Markets for | Observable | Unobservable | |||||||
December 31, | Identical Assets | Inputs | Inputs | |||||||
Description | 2009 | (Level I) | (Level II) | (Level III) | ||||||
(in thousands) | ||||||||||
Assets: | ||||||||||
Other real estate owned | $ 6,511 | $ -- | $ 6,511 | $ -- |
The fair value of a financial instrument is the current amount that would be exchanged between willing parties, other than in a forced liquidation. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument. Generally accepted accounting principles exclude cer tain financial instruments and all non-financial instruments from
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disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The estimated fair values, and related carrying amounts, of the Company's financial instruments are as follows:
June 30, 2010 | December 31, 2009 | |||||||||||||||
Carrying | Fair | Carrying | Fair | |||||||||||||
Amount | Value | Amount | Value | |||||||||||||
(In Thousands) | ||||||||||||||||
Financial assets: | ||||||||||||||||
Cash and cash equivalents | $ | 71,224 | $ | 71,224 | $ | 43,210 | $ | 43,210 | ||||||||
Securities | 200,786 | 200,786 | 172,699 | 172,699 | ||||||||||||
Loans - portfolio | 644,181 | 661,135 | 635,094 | 648,454 | ||||||||||||
Loans - held for sale | 62,442 | 62,442 | 45,010 | 45,010 | ||||||||||||
Accrued interest receivable | 3,743 | 3,743 | 3,842 | 3,842 | ||||||||||||
Financial liabilities: | ||||||||||||||||
Deposits | $ | 859,055 | $ | 849,707 | $ | 805,648 | $ | 812,080 | ||||||||
Securities sold under agreements | ||||||||||||||||
to repurchase | 23,213 | 23,213 | 17,199 | 17,199 | ||||||||||||
Short-term debt | 8,851 | 8,851 | 3,538 | 3,538 | ||||||||||||
Long-term debt | 52,912 | 53,271 | 35,000 | 35,078 | ||||||||||||
Trust preferred capital notes | 5,155 | 5,190 | 5,155 | 5,167 | ||||||||||||
Accrued interest payable | 1,557 | 1,557 | 1,495 | 1,495 |
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. As a result, the fair values of the Company's financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling ra te environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company's overall interest rate risk.
Note 11. Recent Accounting Pronouncements
In June 2009, the FASB issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140”, was adopted into Codification in December 2009 through the issuance of Accounting Standards Updated (“ASU”) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if
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any, in transferred financial assets. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In June 2009, the FASB issued new guidance relating to the variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 is effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In October 2009, the FASB issued Accounting Standards Update No. 2009-15 (ASU 2009-15), “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU 2010-04, Accounting for Various Topics – Technical Corrections to SEC Paragraphs. ASU 2010-04 makes technical corrections to existing SEC guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residential method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued Accounting Standards Update No. 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In February 2010, the FASB issued Accounting Standards Update No. 2010-08, “Technical Corrections to Various Topics.” ASU 2010-08 clarifies guidance on embedded derivatives and hedging. ASU 2010-08 is effective for interim and annual periods beginning after December 15, 2009. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In February 2010, the FASB issued Accounting Standards Update No. 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. ASU 2010-09 is effective immediately. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
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In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance will significantly expand the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending after December 15, 2010. Specific items regarding activity that occurred before the issuance of the ASU, such as the allowance rollforward and modification disclosures, will be required for periods beginning after December 15, 2010. The Company is currently assessing the impact that ASU 2010-20 w ill have on its consolidated financial statements.
Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion and analysis of the financial condition at June 30, 2010 and results of operations of the Company for the three months and the six months ended June 30, 2010 and 2009 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 2009 Form 10-K. 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, Middleburg Bank and Middleburg Investment Group, Inc and a majority owned subsidiary, Southern Trust Mortgage, LLC. Middleburg Bank is a community bank serving the Virginia counties of Loudoun, Fairfax and Fauquier with seven financial service centers and two limited service facilities. Middleburg Investment Group is a non-bank holding company that was formed in the fourth quarter of 2005. It has one wholly-owned subsidiary, Middleburg Trust Company which in turn wholly owns Middleburg Investment Advisors, Inc. Middleburg Trust Company is a trust company headquartered in Richmond, Virginia, and maintains offices in Williamsburg, Virginia and in several of Middleburg Bank’s facilities. Middleburg Investment Advisors is a registered investment advisor headquartered in Alexandria, Virginia serving clients in 24 states. Southern Trust Mortgage is a regional mortgage company headquartered in Virginia Beach, Virginia and maintains offices in Virginia, Maryland, Georgia, North Carolina and South Carolina.
The Company operates under a business model that makes all of its financial and wealth management services available to its clients at all of its financial service centers. Financial service centers are larger than most traditional retail banking branches in order to allow commercial, mortgage, retail and wealth management personnel and services to be readily available to serve clients. By working together in the financial service center and the market, the team at each financial service center becomes more effective in expanding relationships with current clients and new clients. The Company’s goal is to assist in the creation, preservation and ultimate transfer of the wealth of its clients.
The Company generates a significant amount of its income from the net interest income earned by Middleburg 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. Middleburg Bank’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
26
amount of additions to the allowance for loan losses. Middleburg Bank also generates income from fees on deposits and loans.
Middleburg Investment Group’s subsidiaries, Middleburg Trust Company and Middleburg Investment Advisors, 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 administration and, therefore, can be significantly affected by fluctuation in the values of securities caused by changes in the capital markets.
Southern Trust Mortgage generates fees from the origination and sale of mortgages loans. Southern Trust Mortgage also maintains a real estate construction portfolio and receives interest and fee income from these loans, which, net of interest expense, is included in net interest income.
Net income available to common shareholders for the six months ended June 30, 2010 increased to $1.5 million from $1.3 million for the six months ended June 30, 2009. Annualized return on total average assets for the six months ended June 30, 2010 was 0.3%, compared to 0.3% for the same period in 2009. Annualized return on total average equity of Middleburg Financial Corporation, which excludes the non-controlling interest in Southern Trust Mortgage, for the six months ended June 30, 2010 was 3.1%, compared to 3.7% for the same period in 2009. The 2009 results included preferred stock outstanding at June 30, 2009. The Company recognized losses in its loan portfolio resulting in net charge-offs against the reserves for loan losses of $1.3 million during the six months en ded June 30, 2010. As a result of the evaluation of the adequacy of the reserves for loan loss, subsequent to the recognition of net charge-offs, the Company increased its reserves for loan losses by $890,000, during the six months ended June 30, 2010.
Total interest income decreased $5.6 million or 19.0%, for the six months ended June 30, 2010, when compared to the same period in 2009. Interest and fees on loans decreased 19.3% for the six months ended June 30, 2010 to $20.8 million, compared to $25.8 million for the same period in 2009. Total interest expense was $7.4 million for the six months ended June 30, 2010, compared to $10.3 million for the six months ended June 30, 2009, a decrease of 28.2%. Interest expense on deposits for the six months ended June 30, 2010 decreased $1.9 million when compared to the same period in 2009 while interest bearing deposits increased $15.1 million or 14.13% during the six months ended June 30, 2010, compared to December 31, 2009. Total other income increased $13,000 to $11.1 million for th e six months ended June 30, 2010, when compared to the same period in 2009. Total other expense was $24.2 million for the six months ended June 30, 2010 compared to $24.9 million for the same period in 2009.
Net income available to common shareholders for the three months ended June 30, 2010 increased to $724,000 from $516,000 for the three months ended June 30, 2009. Net charge-offs against the reserves for loan losses were $1.1 million during the three months ended June 30, 2010. The Company increased its reserves for loan losses at Southern Trust Mortgage by $204,000 during the three months ended June 30, 2010. Total interest income decreased $2.7 million or 18.4%, for the three months ended June 30, 2010, when compared to the same period in 2009. Interest and fees on loans decreased 19.3% for the three months ended June 30, 2010 to $10.4 million, compared to $12.9 million for the same period in 2009. Total interest expense decreased $1.2 million or 25.4%, for the three months ended June 30, 2010, when compared to the same period in 2009. Other income decreased $72,000 to $6.1 million for the three months ended June 30, 2010, when compared to the same period in 2009. Total other expense was $12.3 million for the three months ended June 30, 2010 compared to $13.0 million for the same period in 2009.
On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act contains significant modifications to the current
27
bank regulatory structure and requires various federal agencies to adopt a broad range of new implementing rules and regulations. While not determinable at this time, the impact of the Dodd-Frank Act and the rules and regulations that will be promulgated thereunder could significantly affect our operations, increase our operating costs and divert management resources. Other than the potential impact of this legislation, the Company is not aware of any current recommendations by any regulatory authorities that, if 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 Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. The Company 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.
Middleburg Bank evaluates various loans individually for impairment as required by applicable accounting guidance. 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 with a group of loans that have similar characteristics.
For loans without individual measures of impairment, Middleburg Bank makes estimates of losses for groups of loans as required by applicable accounting standards. 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 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
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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 loans losses. This estimate of losses is compared to the allowance for loan losses of Middleburg 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. Middleburg Bank recognizes the inherent imprecision in es timates 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 $6.4 million in intangible assets and goodwill at June 30, 2010, a decrease of $85,000 since December 31, 2009. On April 1, 2002, the Company acquired Middleburg Investment Advisors, 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 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 $6.4 million in intangible assets and goodwill at June 30, 2010 was attributable to the Company’s investment in Middleburg Trust Company. With the consolidation of Southern Trust Mortgage, the Company recognized $1.9 million in goodwill as part of its equity investment.
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 acceleration in the amortization expense.
In addition, accounting standards require that goodwill be tested annually using a two-step process. The first step is to identify a potential impairment. The second step measures the amount of the impairment loss, if any. Processes and procedures have been identified for the two-step process.
When the Company completes its ongoing review of the recoverability of intangible assets and goodwill, factors that are considered important to determining whether 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. Any changes in the key management estimates or judgments could result in an impairment charge, and such a charge could have an adverse
29
effect on the Company’s financial condition and results of operations. The most recent review was performed as of December 31, 2009 and no impairment was indicated.
Tax-Equivalent Interest Income
Tax-equivalent interest income is gross interest income adjusted for the non-taxable interest income earned on loans, municipal securities and corporate securities, which are dividend-received deduction eligible. The effective tax rate of 34% is used in calculating tax equivalent income related to loans, municipal securities and corporate securities.
Other-Than-Temporary Impairment (OTTI)
Approximately $248,000 in losses related to other-than-temporary impairment on trust-preferred securities was recognized for the six months ended June 30, 2010. At June 30, 2010, the Company had $1.9 million in trust-preferred securities in its portfolio.
In accordance with applicable accounting guidance, we determine the other-than-temporary impairment for the trust preferred securities in the securities portfolio based on an evaluation of the underlying collateral. We developed cash flow projections based upon assumptions of default/deferral rates, recovery rates and prepayment rates for the collateral. The present value of the projected cash flows was calculated by discounting the projected cash flows using the effective yield at purchase in accordance with applicable accounting guidance. Finally, the present values of the projected cash flows were compared to the carrying values of the securities. If the present values were less than the carrying value, we determined th at the security had an other-than-temporary impairment equal to the difference between the present value and the carrying value of the bond.
The Company may need to recognize additional other-than-temporary impairments related to trust preferred securities during the remainder of 2010. We evaluate default assumptions and cash flow projections in relation to the credit performance of the collateral that underlies the trust preferred securities. Should additional deferrals/defaults occur on the collateral, projected cash flows from the collateral could be reduced which could result in additional other-than-temporary impairments in 2010.
Financial Condition
Assets, Liabilities and Shareholders’ Equity
Total assets for the Company increased to $1.1 billion at June 30, 2010, compared to $976.3 million at December 31, 2009, representing an increase of $85.0 million or 8.7%. Total average assets increased 1.8% from $1.02 billion for the three months ended June 30, 2009 to $1.04 billion for the same period in 2010. Total liabilities were $956.1 million at June 30, 2010, compared to $873.0 million at December 31, 2009. Total average liabilities increased $16.9 million or 1.8% to $932.9 million for the three months ended June 30, 2010, compared to the same period in 2009. Average shareholders’ equity increased 1.5% or $1.5 million over the same periods.
Loans
Total loans, including loans held for sale at June 30, 2010 increased $27.4 million to $716.7 million from the December 31, 2009 amount of $689.3 million. Loans held for sale increased to $62.4 million, or 8.7% of total loans at June 30, 2010, compared to $45.0 million, or 6.5% of total loans at December 31, 2009. Southern Trust Mortgage closed $337.7 million in loans for the six months ended
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June 30, 2010, compared to $533.2 million for the six months ended June 30, 2009. The Company experienced an increase in real estate construction loans, which were $74.6 million at June 30, 2010, compared to $72.9 million at December 31, 2009. Real estate mortgage loans of $523.5 million at June 30, 2010 increased from the December 31, 2009 amount of $508.4 million. Commercial, financial and agricultural loans, which are primarily loans to businesses, decreased to $41.0 million at June 30, 2010, compared to $45.8 at December 31, 2009. Southern Trust Mortgage has a $5.0 million line of credit and a $50.0 million participation agreement with Middleburg Bank. The line of credit and the participation amounts are eliminated in the consolidation process and are no t reflected in the Company’s consolidated financial statements. Net charge-offs were $1.3 million for the six months ended June 30, 2010. The provision for loan losses for the six months ended June 30, 2010 was $2.2 million compared to $2.6 million for the same period in 2009. The allowance for loan losses at June 30, 2010 was $10.1 million or 1.54% of total loans outstanding, excluding loans held for sale, compared to $9.2 million or 1.43% at December 31, 2009.
Securities
Securities, excluding Federal Reserve and Federal Home Loan Bank stock, increased to $200.1 million at June 30, 2010 compared to $172.7 million at December 31, 2009. During the six months ended June 30, 2010, the Company continued to maintain a higher cash liquidity position than in prior years by investing the proceeds of sales, maturities and principal payments of securities into interest bearing deposits at the Federal Reserve Bank. Accordingly, the yields on these investments were lower than the Company could attain in other less liquid investments. The average balance of federal funds sold was zero for the six months ended June 30, 2010, compared to $26.5 million for the six months ended June 30, 2009 while the average balance in interest-bearing bank balances incre ased to $46.1 million for the six months ended June 30, 2010 versus $17.3 million for the same period in 2009. The Company sold $37.5 million in securities, received proceeds of $25.2 million from maturities and principal payments, and purchased securities of $88.2 million during the six months ended June 30, 2010. Approximately $248,000 in losses related to other-than-temporary impairments on trust-preferred securities was recognized for the six months ended June 30, 2010. At June 30, 2010, the Company had $1.9 million in trust-preferred securities in its portfolio.
The Company will continue to maintain its securities portfolio as a source of liquidity and collateral. At June 30, 2010, the tax equivalent yield on the securities portfolio was 4.25%.
Premises and Equipment
Premises and equipment decreased $242,000 from $23.5 million at December 31, 2009 to $23.3 million at June 30, 2010. The decrease is the net of the change in accumulated depreciation and additions to premises and equipment during the period.
Goodwill and Other Identified Intangibles
Goodwill and other identified intangibles decreased $85,000 to $6.4 million at June 30, 2010 as the result of amortization of identified intangibles related to the acquisition of Middleburg Investment Advisors.
Other Real Estate Owned
Other real estate owned increased $1.8 million to $8.3 million at June 30, 2010 from $6.5 million at December 31, 2009. The increase is the net of real estate loans charged-off and subsequently added to other real estate owned, valuation adjustments and sales of other real estate owned properties during the
31
period. During the six months ended June 30, 2010, the Company received proceeds of $448,000 from the sale of other real estate owned properties and incurred a net loss of $165,000 on the sales.
Other Assets
Other assets increased $2.0 million to $32.7 million at June 30, 2010, when compared to December 31, 2009. The other assets section of the balance sheet includes Bank Owned Life Insurance (BOLI), in the amount of $15.3 million and deferred tax assets in the amount of $6.0 million at June 30, 2010.
Deposits
Deposits increased $53.4 million to $859.1 million at June 30, 2010 from $805.6 million at December 31, 2009. Average deposits for the six months ended June 30, 2010 increased 15.3% or $52.9 million compared to average deposits for the six months ended June 30, 2009. Average interest bearing demand deposits were $283.1 million for the six months ended June 30, 2010 compared to $236.0 million for the six months ended June 30, 2009. Average interest bearing deposits were $712.4 million for the six months ended June 30, 2010 compared to $661.3 million for the six months ended June 30, 2009.
The Company has an interest bearing product, known as Tredegar Institutional Select, that integrates the use of the cash within client accounts at Middleburg Trust Company for overnight funding at the Bank. The overall balance of this product was $41.4 million at June 30, 2010 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 product, savings and interest bearing demand deposits increased by $17.9 million from December 31, 2009 to June 30, 2010.
Time deposits increased $14.5 million from December 31, 2009 to $316.0 million at June 30, 2010. Time deposits include brokered certificates of deposit, which decreased $2.1 million to $61.9 million at June 30, 2010 from the December 31, 2009 amount of $64.0 million. The brokered certificates of deposit have maturities ranging from two months to five years. Securities sold under agreements to repurchase (“Repo Accounts”) increased $6.0 million from $17.2 million at December 31, 2009 to $23.2 million at June 30, 2010. The Repo Accounts include certain long-term commercial checking accounts with average balances that typically exceed $100,000 and the Tredegar Institutional Select account which includes accounts maintained by Middleburg Trust Company’s bu siness clients.
Short-term Borrowings and Long-term Debt
The Company had no FHLB overnight advances at June 30, 2010 and December 31, 2009, respectively. Southern Trust Mortgage has a line of credit with a regional bank that is primarily used to fund its loans held for sale. At June 30, 2010, this line had an outstanding balance of $8.9 million compared to $3.5 million at December 31, 2009. The line of credit is based on the London Inter-Bank Offered Rate (“LIBOR”). Southern Trust Mortgage also has a $5.0 million line of credit and a $50.0 million participation agreement with Middleburg Bank. The line of credit and the outstanding balance under the participation agreement are eliminated in the consolidation process and are not reflected in the consolidated financial statements of the Company. Long-term debt increased $17.9 million at June 30, 2010 from $35.0 million at December 31, 2009. The increase in long-term debt was used to fund loan originations and securities purchases.
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Other Liabilities
Other liabilities increased $399,000 to $6.9 million at June 30, 2010, when compared to December 31, 2009. The other liabilities section of the balance sheet includes escrows payable in the amount of $469,000 at June 30, 2010, compared to $141,000 at December 31, 2009.
Non-controlling Interest in Consolidated Subsidiary
The Company, through Middleburg Bank owns 57.1% of the issued and outstanding membership interest units in Southern Trust Mortgage. The remaining 42.9% of issued and outstanding membership interest units are owned by other partners. The ownership interest of these partners is represented in the financial statements as “Non-controlling Interest in Consolidated Subsidiary.” The non-controlling interest is reflected in total shareholders’ equity. Southern Trust Mortgage also has preferred stock of $1.0 million issued and outstanding at June 30, 2010. The Company, through Middleburg Bank owns 60.9% of the issued and outstanding preferred stock in Southern Trust Mortgage. The remaining 39.1% of issued and outstanding preferred stock is owned by other partners. The preferred stock held by these other partners is reflected in other liabilities.
Capital
Total shareholders’ equity, including non-controlling interest, was $105.3 million at June 30, 2010. This amount represents an increase of 1.9% from the December 31, 2009 amount of $103.4 million. Middleburg Financial Corporation’s shareholders’ equity, which excludes the non-controlling interest was $102.6 million at June 30, 2010, compared to $100.3 million at December 31, 2009. The book value of common shareholders was $14.84 per share at June 30, 2010 and $14.52 at December 31, 2009.
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 $16.9 million for the first six months of 2010 compared to $19.6 million for the same period in 2009, a decrease of 13.8%. Total interest income decreased 18.7% and total interest expense decreased 28.2% when comparing the six months ended June 30, 2010 to the six months ended June 30, 2009. The decrease in total interest income from 2009 to 2010 is primarily the result of lower market yields on loans and investments and higher average balances in lower yielding interest bearing deposits in other banks. Total inte rest expense was $7.4 million for the six months ended June 30, 2010 compared to $10.3 million for the same period in 2009. Average earning assets were $931.3 million for the six months ended June 30, 2010, compared to $941.6 million for the six months ended June 30, 2009.
Net interest income for the three months ended June 30, 2010 was $8.4 million, compared to $9.9 million for the same period in 2009. Total interest income for the three months ended June 30, 2010 was $12.1 million compared to $14.9 million for the three months ended June 30, 2009 representing a decrease of 18.4%. Total interest expense was $3.7 million for the three months ended June 30, 2010 compared to $5.0 million for the same period in 2009 representing a decrease of 25.4%. Average earning assets increased $8.6 million to $955.1 million for the three months ended June 30, 2010 from $946.5 million for the three months ended June 30, 2009. Average interest bearing liabilities increased $16.6
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million to $811.6 million for the three months ended June 30, 2010 when compared to the same period in 2009.
The following tables reflect an analysis of the Company’s net interest income using the daily average balances of the Company’s assets and liabilities for the periods indicated. Non-accrual loans are included in the loan balances.
Middleburg Financial Corporation | ||||||||||||||||||||||||
Average Balances, Income and Expenses, Yields and Rates | ||||||||||||||||||||||||
Six Months Ended June 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average | Income/ | Yield/ | Average | Income/ | Yield/ | |||||||||||||||||||
Balance | Expense | Rate (2) | Balance | Expense | Rate (2) | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Assets : | ||||||||||||||||||||||||
Securities: | ||||||||||||||||||||||||
Taxable | $ | 131,074 | $ | 2,070 | 3.18 | % | $ | 107,750 | $ | 2,499 | 4.68 | % | ||||||||||||
Tax-exempt (1) | 60,067 | 1,959 | 6.58 | % | 63,575 | 2,234 | 7.09 | % | ||||||||||||||||
Total securities | $ | 191,141 | $ | 4,029 | 4.25 | % | $ | 171,325 | $ | 4,733 | 5.57 | % | ||||||||||||
Loans | ||||||||||||||||||||||||
Taxable | $ | 694,025 | $ | 20,829 | 6.05 | % | $ | 726,395 | $ | 25,820 | 7.17 | % | ||||||||||||
Tax-exempt (1) | - | - | 0.00 | % | 2 | - | 0.00 | % | ||||||||||||||||
Total loans | $ | 694,025 | $ | 20,829 | 6.05 | % | $ | 726,397 | $ | 25,820 | 7.17 | % | ||||||||||||
Federal funds sold | - | - | 0.00 | % | 26,489 | 27 | 0.21 | % | ||||||||||||||||
Interest bearing deposits in | ||||||||||||||||||||||||
other financial institutions | 46,128 | 63 | 0.28 | % | 17,340 | 31 | 0.36 | % | ||||||||||||||||
Total earning assets | $ | 931,294 | $ | 24,921 | 5.40 | % | $ | 941,551 | $ | 30,611 | 6.56 | % | ||||||||||||
Less: allowances for credit losses | (9,532 | ) | (9,171 | ) | ||||||||||||||||||||
Total nonearning assets | 91,554 | 81,597 | ||||||||||||||||||||||
Total assets | $ | 1,013,316 | $ | 1,013,977 | ||||||||||||||||||||
Liabilities: | ||||||||||||||||||||||||
Interest-bearing deposits: | ||||||||||||||||||||||||
Checking | $ | 283,089 | $ | 1,180 | 0.84 | % | $ | 235,999 | $ | 1,592 | 1.36 | % | ||||||||||||
Regular savings | 73,802 | 372 | 1.02 | % | 53,478 | 360 | 1.36 | % | ||||||||||||||||
Money market savings | 51,321 | 222 | 0.87 | % | 37,542 | 214 | 1.15 | % | ||||||||||||||||
Time deposits: | ||||||||||||||||||||||||
$100,000 and over | 160,065 | 2,292 | 2.89 | % | 131,250 | 2,165 | 3.33 | % | ||||||||||||||||
Under $100,000 | 144,086 | 2,185 | 3.06 | % | 202,976 | 3,784 | 3.76 | % | ||||||||||||||||
Total interest-bearing deposits | $ | 712,363 | $ | 6,251 | 1.77 | % | $ | 661,245 | $ | 8,115 | 2.47 | % | ||||||||||||
Short-term borrowings | 5,428 | 111 | 4.12 | % | 31,133 | 467 | 3.02 | % | ||||||||||||||||
Securities sold under agreements | ||||||||||||||||||||||||
to repurchase | 23,319 | 80 | 0.70 | % | 21,822 | 25 | 0.23 | % | ||||||||||||||||
Long-term debt | 50,781 | 926 | 3.68 | % | 81,752 | 1,650 | 4.07 | % | ||||||||||||||||
Federal funds purchased | 23 | - | 0.00 | % | - | - | - | |||||||||||||||||
Total interest-bearing liabilities | $ | 791,914 | $ | 7,368 | 1.88 | % | $ | 795,952 | $ | 10,257 | 2.60 | % | ||||||||||||
Non-interest bearing liabilities | ||||||||||||||||||||||||
Demand deposits | 110,496 | 108,752 | ||||||||||||||||||||||
Other liabilities | 6,444 | 10,510 | ||||||||||||||||||||||
Total liabilities | $ | 908,854 | $ | 915,214 | ||||||||||||||||||||
Non-controlling interest | 2,698 | 2,583 | ||||||||||||||||||||||
Shareholders' equity | 101,764 | 96,180 | ||||||||||||||||||||||
Total liabilities and shareholders' | ||||||||||||||||||||||||
equity | $ | 1,013,316 | $ | 1,013,977 | ||||||||||||||||||||
Net interest income | $ | 17,553 | $ | 20,354 | ||||||||||||||||||||
Interest rate spread | 3.52 | % | 3.96 | % | ||||||||||||||||||||
Interest expense as a percent of | ||||||||||||||||||||||||
average earning assets | 1.60 | % | 2.20 | % | ||||||||||||||||||||
Net interest margin | 3.80 | % | 4.36 | % | ||||||||||||||||||||
(1) Income and yields are reported on tax equivalent basis assuming a federal tax rate of 34%. | ||||||||||||||||||||||||
(2) Income and yields include dividends on preferred bonds which are 70% excludable for tax purposes. | ||||||||||||||||||||||||
(2) All yields and rates have been annualized on a 365 day year. |
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Middleburg Financial Corporation | ||||||||||||||||||||||||
Average Balances, Income and Expenses, Yields and Rates | ||||||||||||||||||||||||
Three Months Ended June 30, | ||||||||||||||||||||||||
2010 | 2009 | |||||||||||||||||||||||
Average | Income/ | Yield/ | Average | Income/ | Yield/ | |||||||||||||||||||
Balance | Expense | Rate (2) | Balance | Expense | Rate (2) | |||||||||||||||||||
(Dollars in thousands) | ||||||||||||||||||||||||
Assets : | ||||||||||||||||||||||||
Securities: | ||||||||||||||||||||||||
Taxable | $ | 142,279 | $ | 1,112 | 3.13 | % | $ | 100,118 | $ | 1,221 | 4.89 | % | ||||||||||||
Tax-exempt (1) | 56,248 | 909 | 6.48 | % | 65,100 | 1,131 | 6.97 | % | ||||||||||||||||
Total securities | $ | 198,527 | $ | 2,021 | 4.08 | % | $ | 165,218 | $ | 2,352 | 5.71 | % | ||||||||||||
Loans | ||||||||||||||||||||||||
Taxable | $ | 709,042 | $ | 10,384 | 5.87 | % | $ | 727,690 | $ | 12,870 | 7.09 | % | ||||||||||||
Tax-exempt (1) | - | - | - | 1 | - | 0.00 | % | |||||||||||||||||
Total loans | $ | 709,042 | $ | 10,384 | 5.87 | % | $ | 727,691 | $ | 12,870 | 7.09 | % | ||||||||||||
Federal funds sold | - | - | - | 31,720 | 14 | 0.18 | % | |||||||||||||||||
Interest on money market investments | - | - | - | - | - | - | ||||||||||||||||||
Interest bearing deposits in | ||||||||||||||||||||||||
other financial institutions | 47,566 | 28 | 0.24 | % | 21,876 | 9 | 0.17 | % | ||||||||||||||||
Total earning assets | $ | 955,135 | $ | 12,433 | 5.22 | % | $ | 946,505 | $ | 15,245 | 6.46 | % | ||||||||||||
Less: allowances for credit losses | (9,956 | ) | (8,499 | ) | ||||||||||||||||||||
Total nonearning assets | 92,346 | 81,352 | ||||||||||||||||||||||
Total assets | $ | 1,037,525 | $ | 1,019,358 | ||||||||||||||||||||
Liabilities: | ||||||||||||||||||||||||
Interest-bearing deposits: | ||||||||||||||||||||||||
Checking | $ | 286,485 | $ | 579 | 0.81 | % | $ | 247,303 | $ | 783 | 1.27 | % | ||||||||||||
Regular savings | 77,173 | 188 | 0.98 | % | 54,980 | 176 | 1.28 | % | ||||||||||||||||
Money market savings | 51,683 | 107 | 0.83 | % | 39,190 | 103 | 1.05 | % | ||||||||||||||||
Time deposits: | ||||||||||||||||||||||||
$100,000 and over | 158,698 | 1,141 | 2.88 | % | 132,288 | 1,046 | 3.17 | % | ||||||||||||||||
Under $100,000 | 151,141 | 1,062 | 2.82 | % | 200,553 | 1,851 | 3.70 | % | ||||||||||||||||
Total interest-bearing deposits | $ | 725,180 | $ | 3,077 | 1.70 | % | $ | 674,314 | $ | 3,959 | 2.35 | % | ||||||||||||
Short-term borrowings | 6,030 | 67 | 4.46 | % | 21,003 | 191 | 3.65 | % | ||||||||||||||||
Securities sold under agreements | ||||||||||||||||||||||||
to repurchase | 24,977 | 60 | 0.98 | % | 20,559 | 3 | 0.06 | % | ||||||||||||||||
Long-term debt | 55,375 | 488 | 3.53 | % | 79,155 | 797 | 4.04 | % | ||||||||||||||||
Federal funds purchased | 35 | - | 0.00 | % | - | - | - | |||||||||||||||||
Total interest-bearing liabilities | $ | 811,597 | $ | 3,692 | 1.82 | % | $ | 795,031 | $ | 4,950 | 2.50 | % | ||||||||||||
Non-interest bearing liabilities | ||||||||||||||||||||||||
Demand deposits | 114,953 | 110,153 | ||||||||||||||||||||||
Other liabilities | 6,328 | 10,828 | ||||||||||||||||||||||
Total liabilities | $ | 932,878 | $ | 916,012 | ||||||||||||||||||||
Non-controlling interest | 2,671 | 2,851 | ||||||||||||||||||||||
Shareholders' equity | 101,976 | 100,495 | ||||||||||||||||||||||
Total liabilities and shareholders' | ||||||||||||||||||||||||
equity | $ | 1,037,525 | $ | 1,019,358 | ||||||||||||||||||||
Net interest income | $ | 8,741 | $ | 10,295 | ||||||||||||||||||||
Interest rate spread | 3.40 | % | 3.96 | % | ||||||||||||||||||||
Interest expense as a percent of | ||||||||||||||||||||||||
average earning assets | 1.55 | % | 2.10 | % | ||||||||||||||||||||
Net interest margin | 3.67 | % | 4.36 | % | ||||||||||||||||||||
(1) Income and yields are reported on tax equivalent basis assuming a federal tax rate of 34%. | ||||||||||||||||||||||||
(2) Income and yields include dividends on preferred bonds which are 70% excludable for tax purposes. | ||||||||||||||||||||||||
(2) All yields and rates have been annualized on a 365 day year. |
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Interest and fee income from loans decreased $5.0 million to $20.8 million for the six months ended June 30, 2010 compared to $25.8 million for the same period in 2009. The tax equivalent weighted average yield of loans decreased 112 basis points from 7.17% for the six months ended June 30, 2009 to 6.05% for the six months ended June 30, 2010.
For the three months ended June 30, 2010, interest income from loans was $10.4 million compared to $12.9 million for the three months ended June 30, 2009. The tax equivalent weighted average yield of loans decreased 122 basis points from 7.09% for the three months ended June 30, 2009 to 5.87% for the three months ended June 30, 2010.
Interest income from the securities portfolio and short-term investments decreased by $604,000 to $3.4 million for the six month period ended June 30, 2010 from $4.0 million for the six month period ended June 30, 2009. For the six months ended June 30, 2010, the Company sold $37.4 million of securities and purchased $88.2 million of securities as part of a restructuring of the securities portfolio. For the six months ended June 30, 2010, the tax equivalent yield on securities was 4.25% compared to 5.57% for the same period in 2009
For the three month period ended June 30, 2010, interest income from the securities portfolio decreased by $254,000 to $1.7 million compared to the same period in 2009. The tax equivalent yield on securities for the three months ended June 30, 2010 decreased 163 basis points to 4.08% compared to 5.71% for the three months ended June 30, 2009.
Interest expense on deposits decreased $1.8 million to $6.3 million for the six months ended June 30, 2010, compared to $8.1 million for the same period in 2009. The mix of demand and savings deposits versus time deposits changed slightly to 63.2% in demand and savings deposits, and 36.8% in time deposits at June 30, 2010. At December 31, 2009, the mix was 62.6% in savings and demand deposits, versus 37.4% in time deposits. For the six months ended June 30, 2010, average deposits increased $52.9 million to $822.9 million, compared to the same period in 2009.
Interest expense on deposits for the three months ended June 30, 2010, decreased $882,000 compared to the same period in 2009. For the three months ended June 30, 2010, average deposits increased $55.7 million to $840.1 million, compared to the same period in 2009.
Interest expense for securities sold under agreements to repurchase, which includes Tredegar Institutional Select, increased $56,000 from $25,000 for the six months ended June 30, 2009 to $81,000 for the six months ended June 30, 2010. 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 Federal funds purchased and short-term borrowings decreased $356,000 from $467,000 for the six months ended June 30, 2009 to $111,000 for the six months ended June 30, 2010. Interest expense related to long-term debt decreased $724,000 from $1.7 million for the six months ended June 30, 2009 to $926,000 for the six months ended June 30, 2010.
Interest expense for securities sold under agreements to repurchase increased to $61,000 for the three months ended June 30, 2010 from $3,000 for the three months ended June 30, 2009. Interest expense related to Federal funds purchased and short-term borrowings decreased $124,000 from $191,000 for the three months ended June 30, 2009 to $67,000 for the three months ended June 30, 2010. Interest expense related to long-term debt decreased $309,000 from $797,000 for the three months ended June 30, 2009 to $488,000 for the three months ended June 30, 2010.
The net interest margin, on a tax equivalent basis, was 3.80% for the six months ended June 30, 2010 compared to 4.36% for the same period in 2009. For the three months ended June 30, 2010, the net
36
interest margin, on a tax equivalent basis, was 3.67% compared to 4.36% for the same three-month period in 2009. The Company’s net interest margin is 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 in terest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit is 34.0% for all periods presented. 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.
Reconciliation of Net Interest Income to
Tax Equivalent Net Interest Income
For the Six months ended | ||||||||
June 30, | ||||||||
2010 | 2009 | |||||||
GAAP measures: | (in thousands) | |||||||
Interest Income – Loans | $ | 20,829 | $ | 25,820 | ||||
Interest Income - Investments & Other | 3,427 | 4,031 | ||||||
Interest Expense – Deposits | 6,251 | 8,115 | ||||||
Interest Expense - Other Borrowings | 1,117 | 2,142 | ||||||
Total Net Interest Income | $ | 16,888 | $ | 19,594 | ||||
NON-GAAP measures: | ||||||||
Tax Benefit Realized on Non-Taxable Interest Income - Municipal Securities | 665 | 760 | ||||||
Total Tax Benefit Realized on Non-Taxable Interest Income | $ | 665 | $ | 760 | ||||
Total Tax Equivalent Net Interest Income | $ | 17,553 | $ | 20,354 |
For the Three months ended | ||||||||
June 30, | ||||||||
2010 | 2009 | |||||||
GAAP measures: | (in thousands) | |||||||
Interest Income – Loans | $ | 10,384 | $ | 12,870 | ||||
Interest Income - Investments & Other | 1,740 | 1,990 | ||||||
Interest Expense – Deposits | 3,077 | 3,959 | ||||||
Interest Expense - Other Borrowings | 615 | 991 | ||||||
Total Net Interest Income | $ | 8,432 | $ | 9,910 | ||||
NON-GAAP measures: | ||||||||
Tax Benefit Realized on Non-Taxable Interest Income - Municipal Securities | 309 | 385 | ||||||
Total Tax Benefit Realized on Non-Taxable Interest Income | $ | 309 | $ | 385 | ||||
Total Tax Equivalent Net Interest Income | $ | 8,741 | $ | 10,295 |
The decrease in tax equivalent net interest margin was attributed to the decrease in average loan balances and a lower yield on both loans and investments from June 30, 2009 to June 30, 2010. The
37
Company’s total average earning assets decreased $10.3 million when comparing the six months ended June 30, 2010 to the six months ended June 30, 2009, while the yield on average earnings assets decreased by 116 basis points when comparing the same periods. Average balances in interest checking, regular savings and money market accounts increased by $81.2 million when comparing the six months ended June 30, 2010 to the same period in 2009. The weighted average cost of these accounts for the six months ended June 30, 2010 and 2009 was .87% and 1.32%, respectively. The average balance of certificates of deposits decreased $30.1 million when comparing the six months ended June 30, 2009 to the six months ended June 30, 2010. The weighted average cost of the Company 8217;s certificates of deposits decreased 62 basis points to 2.94% for the six months ended June 30, 2010.
When comparing the three months ended June 30, 2010 to the same period in 2009, the Company’s total average earning assets increased $8.6 million, while the yield on average earnings assets decreased by 124 basis points when comparing the same periods. Average balances in interest checking, regular savings and money market accounts increased by $73.9 million when comparing the three months ended June 30, 2010 to the same period in 2009. The weighted average cost of these accounts for the three months ended June 30, 2010 and 2009 was .84% and 1.24%, respectively. The average balance of certificates of deposits decreased $23.0 million when comparing the three months ended June 30, 2010 to the three months ended June 30, 2009. The weighted average cost of the Company ’s certificates of deposits decreased 64 basis points to 2.84% for the three months ended June 30, 2010 versus the three months ended June 30, 2009.
Other Income
Other income includes, among other items, fees generated by the retail banking and investment services departments of the Bank as well as by Middleburg Trust Company and Middleburg Investment Advisors. Other income also includes income from the Company’s 57.1% ownership interest in Southern Trust Mortgage, LLC. Other income increased 0.1% to $11.1 million for six months ended June 30, 2010 compared to the same period in 2009. Other income decreased 1.2% to $6.1 million for three months ended June 30, 2010 compared to the same period in 2009.
Commissions and fees from trust and investment advisory activities earned by Middleburg Trust Company (“MTC”) and Middleburg Investment Advisors (“MIA”) increased 6.4% to $1.7 million for the six month period ended June 30, 2010 compared to $1.6 million for the same period in 2009. Trust and investment advisory fees are based primarily upon the market value of the accounts under administration/management. Total consolidated assets under administration by MTC and MIA were at $1.2 billion at June 30, 2010, an increase of 4.5% relative to December 31, 2009 and an increase of 8.9% relative to June 30, 2009. The Bank holds a large portion of its investment portfolio in custody with MTC. MTC’s assets under administration were $821.1 million at June 30, 2010 and $771.5 million at December 31, 2009. MIA’s assets under administration were $312.6 million at June 30, 2010 and $313.5 million at December 31, 2009.
Commissions and fees from trust and investment advisory activities increased 10.5% to $875,000 for the three month period ended June 30, 2010 compared to $792,000 for the same period in 2009.
Service charges on deposits decreased 3.8% to $909,000 for the six months ended June 30, 2010, compared to $945,000 for the six months ended June 30, 2009. For the three months ended June 30, 2010, service charges on deposits decreased 4.5% to $468,000 compared to the same period in 2009.
The Company sold $37.3 million in securities and purchased $88.2 million in securities during the six months ended June 30, 2010. The Company realized a net gain of $469,000 on the sale of
38
securities in the six months ended June 30, 2010. The Company has identified three other-than-temporarily impaired securities in its portfolio and has elected to recognize decreases in the fair market value of the security through earnings. During the six months ended June 30, 2010, the Company recognized a loss of $248,000 related to the other-than-temporarily impaired securities. For the six months ended June 30, 2009, a loss of $179,000 was recognized as a result of the impaired securities.
Commissions on investment sales increased 21.0% to $311,000 for the six months ended June 30, 2010, compared to $257,000 for the six months ended June 30, 2009. For the three months ended June 30, 2010, commissions on investment sales decreased 2.9% to $167,000 compared to the three months ended June 30, 2009.
The revenues and expenses of Southern Trust Mortgage for the six and three months ended June 30, 2010 are reflected in the Company’s financial statements on a consolidated basis, with the proportionate share not owned by the Company reported as “Non-controlling Interest in Consolidated Subsidiary.” Gains and fees on loans held for sale of $7.3 million, which were generated by Southern Trust Mortgage during the six months ended June 30, 2010, are being reported as part of consolidated other income, compared to $6.7 million for the same period in 2009. Southern Trust Mortgage closed $337.7 million in loans during the six months ended June 30, 2010, compared to $561.1 for the same period in 2009.
Income earned from the Bank’s $15.3 million investment in Bank Owned Life Insurance (BOLI) contributed $255,000 and $130,000 to total other income for the six and three months ended June 30, 2010. The Company purchased $6.0 million of BOLI in the third quarter of 2004, $4.8 million in the fourth quarter of 2004, $485,000 in the second quarter of 2007, $453,000 in the fourth quarter of 2009, and $682,000 in the second quarter of 2010 to help subsidize increasing employee benefit costs and expenses related to the restructure of its supplemental retirement plans.
Other service charges, commissions and fees decreased 13.8% to $256,000 for the six months ended June 30, 2010, compared to $297,000 for the same period in 2009.
Other operating income decreased $4,000 to $179,000 for the six months ended June 30, 2010, compared to the same period in 2009. For the three months ended June 30, 2010, other operating income increased 57.1% to $88,000 compared to the three months ended June 30, 2009.
Other Expense
Total other expense includes employee-related costs, occupancy and equipment expense and other overhead. Total other expense decreased $642,000 from $24.9 million for the six months ended June 30, 2009 to $24.2 million for the six months ended June 30, 2010. When taken as a percentage of total average assets, other expense decreased to 2.4% of total average assets for the six months ended June 30, 2010 versus 2.5% for the same period in 2009. Total other expense decreased $753,000 from $13.0 million for the three months ended June 30, 2009 to $12.3 million for the three months ended June 30, 2010.
Salaries and employee benefits decreased $549,000 or 3.7% when comparing the six months ended June 30, 2010 to the six months ended June 30, 2009, primarily due to decreases in mortgage loan origination commissions and incentive pay accruals during the period. For the three months ended June 30, 2010, salaries and employee benefits decreased $213,000 to $7.5 million.
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Net occupancy expense increased by $144,000 or 4.9% from $3.0 million for the six months ended June 30, 2009 to $3.1 million for the six months ended June 30, 2010. For the three months ended June 30, 2010, net occupancy expense decreased $75,000 or 4.8% to $1.5 million from June 30, 2009. The year to date increase is the result of the Company’s growth as well as maintenance and improvements of the Company’s facilities. As growth efforts continue to progress, the Company anticipates higher levels of occupancy expense to be incurred.
Other tax expense increased 36.9% to $397,000 for the six months ended June 30, 2010 from $290,000 for the six months ended June 30, 2009. Other tax expense includes the state franchise tax paid by Middleburg Bank and Middleburg Trust Company in lieu of an income tax. The tax is based on each subsidiary’s equity capital at January 1st, net of adjustments, respectively. Total capital of Middleburg Bank increased 29.1% from January 1, 2009 to January 1, 2010, while total capital for Middleburg Trust Company increased 189.1% during the same period.
Advertising expense increased $63,000 to $428,000 for the six months ended June 30, 2010 compared to $365,000 for the six months ended June 30, 2009. For the three months ended June 30, 2010, advertising expense was $248,000, compared to $216,000 for the three months ended June 30, 2009.
Other real estate owned expense decreased $955,000 to $505,000 for the six months ended June 30, 2010 compared to $1.5 million for the six months ended June 30, 2009. For the three months ended June 30, 2010, other real estate owned expense decreased $354,000 to $295,000. The decrease was due to a decrease in legal expenses related to foreclosure, valuation adjustments and fewer losses on the sales of these assets.
FDIC insurance expense increased $96,000 to $1.2 million for the six months ended June 30, 2010 compared to $1.1 million for the six months ended June 30, 2009. For the three months ended June 30, 2010, FDIC insurance expense decreased $425,000 to $352,000. FDIC insurance premiums have increased due to the economic climate. The FDIC has levied a one time special assessment on banks so the reserves can be restored in the deposit insurance fund.
Other expenses increased 18.6% or $471,000 to $3.0 million for the six months ended June 30, 2010 from $2.5 million for the six months ended June 30, 2009.
Allowance for Loan Losses
The allowance for loan losses at June 30, 2010 was $10.1 million, or 1.5% of total portfolio loans, compared to $9.4 million, or 1.4% of total portfolio loans at June 30, 2009. The provision for loan losses was $2.2 million for the six months ended June 30, 2010, compared to $2.6 million for the six months ended June 30, 2009. For the three months ended June 30, 2010, the provision for loan losses was $1.3 million, compared to $1.6 million for the same period in 2009. For the six months ended June 30, 2010, net loan charge-offs totaled $1.3 million, compared to net loan charge-offs of $3.2 million for the same period in 2009. There were $6.2 million in loans past due 90 days or more at June 30, 2010, compared to zero at J une 30, 2009. Non-performing loans were $12.2 million at June 30, 2010, compared to $13.0 million at June 30, 2009. Management believes that the allowance for loan losses was adequate to cover credit losses inherent in the loan portfolio at June 30, 2010. 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.
Non performing assets increased from $16.0 million or 1.6% of total assets at December 31, 2009 to $26.7 million or 2.5% of total assets as of June 30, 2010. The increase in non performing assets during
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the six months ended June 30, 2010 was related to previously identified loans and was expected as we continue to work through the collection process for these loans. The increase was primarily due to an increase in delinquent loans over 90 days and an increase in non-accrual loans. Given the continued economic uncertainties, it is possible that we could experience further increases in non performing assets.
The total balance of restructured loans at June 30, 2010 was $3.7 million of which $1.6 million represented loans performing as agreed to the restructured terms and $300,000 represented loans less than 90 days delinquent. Approximately $2.0 million in restructured loan balances are included in the Company’s non-performing assets total as of June 30, 2010. This compares with $2.1 million in non-performing restructured loans at December 31, 2009, a decrease of $81,000 or 3.9%.
Capital Resources
Total shareholders’ equity at June 30, 2010 and December 31, 2009 was $102.6 million and $100.3 million, respectively. Total common shares outstanding at June 30, 2010 were 6,914,687.
At June 30, 2010, the Company’s tier 1 and total risk-based capital ratios were 13.4% and 14.6%, respectively, compared to 13.9% and 15.1% at December 31, 2009. The Company’s leverage ratio was 10.2% at June 30, 2010 compared to 10.4% at December 31, 2009. 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.
During the six months ended June 30, 2010, the Company increased its cash liquidity position by investing the proceeds of maturities and principal payments of securities into interest-bearing deposits as a precaution against the economic uncertainties and the resulting volatility that occurred in the securities markets. 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 $19.0 million, none of which were outstanding at June 30, 2010. At June 30, 2010 and December 31, 2009, the Company had $23.2 million and $17.2 million, respectively, of outstanding borrowings pursuant to repurchase agreements.
The Company has a credit line in at the Federal Home Loan Bank of Atlanta with an available borrowing capacity of $225.8 million. 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 six months of 2010. Southern Trust Mortgage has a $25.0 million revolving line of credit with a regional bank, which is primarily used to fund its loans held for sale. Middleburg Bank guarantees up to $10 million of borrowings on this line. At June 30, 2010, these lines had an outstanding balance of $8.9 million and are included in total short-term borrowings. Short-term and long-term advances averaged $5.4 million and $50.8 million, respectively, for the six months ended June 30, 2010.
At June 30, 2010, cash, interest bearing deposits with financial institutions, federal funds sold, short-term investments, loans held for sale and securities available for sale were 39.8% of total deposits.
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Off-Balance Sheet Arrangements and Contractual Obligations
Commitments to extend credit decreased $15.1 million to $69.5 million at June 30, 2010 compared to $84.6 million at December 31, 2009. 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 $1.9 million at June 30, 2010. This amount is a decrease from $2.0 million at December 31, 2009.
Contractual obligations increased $17.2 million to $87.3 million at June 30, 2010 compared to $70.1 million at December 31, 2009 excluding certificates of deposit and short-term borrowings. This change resulted primarily from additional long term debt of $17.9 million assumed during the six months ended June 30, 2010. Additional information on commitments to extend credit, standby letters of credit and contractual obligations is included in the Company’s 2009 Form 10-K.
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:
· | changes in general economic and business conditions in the Company’s market area; |
· | changes in banking and other laws and regulations applicable to the Company; |
· | maintaining asset qualities; |
· | risks inherent in making loans such as repayment risks and fluctuating collateral values; |
· | changing trends in customer profiles and behavior; |
· | maintaining cost controls and asset qualities as the Company opens or acquires new branches; |
· | changes in interest rates and interest rate policies; |
· | 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; |
· | the ability to continue to attract low cost core deposits to fund asset growth; |
· | 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; |
· | reliance on the Company’s management team, including its ability to attract and retain key personnel; |
· | demand, development and acceptance of new products and services; |
· | problems with technology utilized by the Company; |
· | maintaining capital levels adequate to support the Company’s growth; and |
· | other factors described in Item 1A, “Risk Factors,” included in our quarterly reports on Form 10-Q and the 2009 Form 10-K. |
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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 administration by Middleburg Trust Company 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 model prepared for June 30, 2010 did not include the assets and liabilities of Southern Trust Mortgage.
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 shift in rates over a 12-month period is assumed. The following reflects the Company’s net interest income sensitivity analysis as of June 30, 2010 and December 31, 2009.
Estimated Net Interest Income Sensitivity | ||
Rate Change | As of June 30, 2010 | As of December 31, 2009 |
+ 200 bp | (6.2%) | (11.5%) |
- 200 bp | (6.5%) | (10.0%) |
At June 30, 2010, 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 6.2% 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 decrease by 6.5% on
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average. While these numbers are subjective based upon the parameters used within the model, management believes the balance sheet is very balanced and is working to minimize risks to rising rates in the future.
Since December 31, 2009, the Company’s balance sheet has grown by $85.0 million. Increased deposits have provided the funding for the growth in the loan portfolio and liquid assets. The Company’s interest rate profile is symmetrical for the next 12 months. Based upon a June 30, 2010 simulation, the Company could expect an average negative impact to net interest income of $2.1 million 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 negative impact to net interest income of $2.2 million over the next 12 months. 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 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 Middleburg Bank, Middleburg Investment Group, Middleburg Investment Advisors and Middleburg Trust Comp any) 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
Our operations are subject to many risks that could adversely affect our future financial condition and performance and, therefore, the market value of our securities. The risk factors that are applicable to us are outlined in our Annual Report on Form 10-K for the year ended December 31, 2009. There have been no material changes in our risk factors from those disclosed in these reports.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.
Item 3. Defaults upon Senior Securities
None.
Item 4. Removed and Reserved
Item 5. Other Information
None
Item 6. Exhibits
3.1 | Bylaws of Middleburg Financial Corporation (restated in electronic format as of April 28, 2010) (incorporated by reference to Exhibit 3.1 of Form 8-K filed April 28, 2010). | |
10.1 | Employment Agreement, dated April 28, 2010, by and between Middleburg | |
Financial Corporation and Gary R. Shook (incorporated by reference to Exhibit | ||
10.1 of Form 8-K filed April 28, 2010). | ||
10.2 | Agreement, dated April 28, 2010, by and between Middleburg Financial | |
Corporation and Joseph L. Boling (incorporated by reference to Exhibit 10.2 of | ||
Form 8-K filed April 28, 2010). | ||
10.3 | Executive Retirement Plan, as amended and restated through April 28, 2010 | |
(incorporated by reference to Exhibit 10.3 of Form 8-K filed April 28, 2010). | ||
10.4 | Employment Agreement, dated May 7, 2010, by and between Middleburg | |
Financial Corporation and Raj Mehra (incorporated by reference to Exhibit 10.1 of Form 8-K filed May 13, 2010). | ||
10.5 | Employment Agreement, dated May 7, 2010, by and between Middleburg | |
Financial Corporation and Arch A. Moore, III (incorporated by reference to | ||
Exhibit 10.2 of Form 8-K filed May 13, 2010). |
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10.6 | Supplemental Benefit Plan, as amended and restated effective May 7, 2010 | |
(incorporated by reference to Exhibit 10.3 of Form 8-K filed May 13, 2010). | ||
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: August 9, 2010 | /s/ Gary R. Shook | |||
Gary R. Shook | ||||
President & Chief Executive Officer | ||||
Date: August 9, 2010 | /s/ Raj Mehra | |||
Raj Mehra | ||||
Executive Vice President | ||||
& Chief Financial Officer |
EXHIBIT INDEX
Exhibits
3.1 | Bylaws of Middleburg Financial Corporation (restated in electronic format as of April 28, 2010) (incorporated by reference to Exhibit 3.1 of Form 8-K filed April 28, 2010). | |
10.1 | Employment Agreement, dated April 28, 2010, by and between Middleburg | |
Financial Corporation and Gary R. Shook (incorporated by reference to Exhibit | ||
10.1 of Form 8-K filed April 28, 2010). | ||
10.2 | Agreement, dated April 28, 2010, by and between Middleburg Financial | |
Corporation and Joseph L. Boling (incorporated by reference to Exhibit 10.2 of | ||
Form 8-K filed April 28, 2010). | ||
10.3 | Executive Retirement Plan, as amended and restated through April 28, 2010 | |
(incorporated by reference to Exhibit 10.3 of Form 8-K filed April 28, 2010). | ||
10.4 | Employment Agreement, dated May 7, 2010, by and between Middleburg | |
Financial Corporation and Raj Mehra (incorporated by reference to Exhibit 10.1 of Form 8-K filed May 13, 2010). | ||
10.5 | Employment Agreement, dated May 7, 2010, by and between Middleburg | |
Financial Corporation and Arch A. Moore, III (incorporated by reference to | ||
Exhibit 10.2 of Form 8-K filed May 13, 2010). | ||
10.6 | Supplemental Benefit Plan, as amended and restated effective May 7, 2010 | |
(incorporated by reference to Exhibit 10.3 of Form 8-K filed May 13, 2010). | ||
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 |