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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

(Mark One)

x Annual report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For fiscal year ended December 31, 2010

 

¨ Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from                      to                     

Commission file number 000-50729

 

 

CNB BANCORP, INC.

(Exact name of registrant as specified in its charter)

 

Virginia   54-2059214

(State or Other Jurisdiction of

Incorporation or Organization)

 

(I.R.S. Employer

Identification No.)

11407 Windsor Blvd., Windsor, VA   23487
(Address of Principal Executive Offices)   (Zip Code)

(757) 242-4422

Registrant’s Telephone Number

Securities registered under Section 12(b) of the Exchange Act: None.

Securities registered under Section 12(g) of the Exchange Act: Common Stock, $0.01 par.

 

 

Indicate by check mark if the registrant is a well-known seasoned issued, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T 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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

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

 

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

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

The aggregate market value of the voting and non-voting common equity held by non-affiliates (shareholders each holding less than 5% of an outstanding class of stock, excluding directors and executive officers) of the Company on June 30, 2010 was $2,564,917. This calculation is based upon an estimate of the fair market value of the Company’s common stock at $2.19 per share, which was the price of the last trade of which management is aware prior to this date.

Indicate the number of shares outstanding of each of the registrant’s classes of common stock, as of the latest practicable date: As of March 16, 2011, 1,500,427 shares of the registrant’s common stock, $.01 par value, were issued and outstanding.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the definitive Proxy Statement dated April 29, 2011 to be delivered to shareholders in connection with the Annual Meeting of Shareholders to be held on June 9, 2011, are incorporated by reference into Part III.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

          Page  
PART I         3   

Item 1.

   Business      3   

Item 1A.

   Risk Factors      12   

Item 1B.

   Unresolved Staff Comments      14   

Item 2.

   Properties      15   

Item 3.

   Legal Proceedings      15   

Item 4.

   Removed and Reserved      15   
PART II         15   

Item 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities      15   

Item 6.

   Selected Financial Data      15   

Item 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations      16   

Item 7A.

   Quantitative and Qualitative Disclosures About Market Risk      25   

Item 8.

   Financial Statements and Supplementary Data      26   

Item 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      52   

Item 9A.

   Controls and Procedures      52   

Item 9B.

   Other Information      53   
PART III         53   

Item 10.

   Directors, Executive Officers and Corporate Governance      53   

Item 11.

   Executive Compensation      53   

Item 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      53   

Item 13.

   Certain Relationships and Related Transactions, and Director Independence      53   

Item 14.

   Principal Accounting Fees and Services      53   
PART IV         54   

Item 15.

   Exhibits, Financial Statement Schedules      54   
SIGNATURES      

 

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PART I

 

ITEM 1. BUSINESS

Special Cautionary Notice Regarding Forward-Looking Statements

This Report contains statements that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and the Securities Exchange Act of 1934. Various matters discussed in this document and in documents incorporated by reference herein, including matters discussed under the caption “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements for purposes of the Securities Act and the Securities Exchange Act. These statements are based on many assumptions and estimates and are not guarantees of future performance and may involve known and unknown risks, uncertainties and other factors which may cause the actual results, performance or achievements of CNB Bancorp, Inc. (the “Company” or “CNB”) to be materially different from future results, performance or achievements expressed or implied by such forward-looking statements. The words “expect,” “anticipate,” “intend,” “plan,” “believe,” “seek,” “estimate,” and similar expressions are intended to identify such forward-looking statements. The Company’s actual results may differ materially from the results anticipated in these forward-looking statements due to a variety of factors, including, without limitation:

 

   

The effects of future economic conditions;

 

   

Governmental monetary and fiscal policies, as well as legislative and regulatory changes;

 

   

The risks of changes in interest rates on the level and composition of deposits, loan demand, and the values of loan collateral, securities and interest-rate protection agreements, as well as interest-rate risks;

 

   

The effects of competition from other financial institutions and financial service providers operating in the Company’s market area and elsewhere, including institutions operating locally, regionally, nationally and internationally, together with such competitors offering banking products and services by mail, telephone, and computer and the Internet; and

 

   

The failure of assumptions underlying the establishment of reserves for possible loan losses and estimations of values of collateral and various financial assets and liabilities.

All written or oral forward-looking statements attributable to the Company are expressly qualified in their entirety by these cautionary statements.

CNB Bancorp, Inc.

CNB was incorporated as a Virginia corporation on November 12, 2001, to serve as a bank holding company that holds all of the outstanding capital stock of Citizens National Bank (the “Bank”), a nationally chartered bank located in Windsor, Virginia. Other than its investment in the Bank, the Company has no other material asset, nor does it conduct any other business activity.

During its organization, the Company’s operations, pre-opening expenses and capital costs from April 23, 2001 through the opening of the Bank were funded by and conducted through CNB Bancorp, LLC (the “LLC”), a limited liability company formed by the Company’s organizing directors. The Company closed its public offering on December 31, 2002. The offering raised $5.4 million, net of offering expenses. Upon opening the Bank, the Company and the Bank used part of the offering proceeds to reimburse the LLC for operational and pre-opening expenses related to the Company and the Bank and the LLC was subsequently dissolved. The amount of the pre-opening expenses paid by the LLC was $439,000. The proceeds of the offering net of offering expenses and pre-opening expenses totaled $4.97 million.

In September, 2006, the Company completed a 3-for-2 stock split, followed by an offering of 650,000 shares of its common stock in a rights offering and a public offering. The offering raised $4.0 million, net of offering expenses. The Company used the net proceeds from the offering to increase equity and subsequently the Bank’s legal lending limit. The funds have also been used for general corporate purposes, including any future growth and expansion. Also during 2006, CNB Bancorp, Inc. common stock began trading on the OTC Bulletin Board with the symbol CNBV.

We chose our holding company structure because we believe it provides flexibility that would not otherwise be available to us. Subject to Federal Reserve debt guidelines, through a holding company structure, we can assist the Bank in maintaining its required capital ratios by borrowing money and contributing the proceeds to the Bank as primary capital. Additionally, under provisions of the Gramm-Leach-Bliley Act, a holding company may engage in activities that are financial in nature or incidental or complementary to a financial activity including some insurance transactions, real estate development activities and merchant banking activities, which a bank may not engage in. Although we do not presently intend to engage in these types of activities, we will be able to do so with a proper notice or filing to the Federal Reserve if we believe that there is a need for these services in our market area and that these activities could be profitable.

 

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Citizens National Bank

Citizens National Bank received its final approval to become a national bank from the Office of the Comptroller of Currency (OCC) and began operations in April, 2003.

Market Area and Competition. Our primary service area consists of the 15-mile radius surrounding our main office location in the Town of Windsor, Virginia. This area includes all of the County of Isle of Wight, the Cities of Franklin and Suffolk, and portions of Southampton, Surry and Sussex Counties.

As of December 31, 2010, our primary service area was serviced by 14 financial institutions with 40 banking offices, and there was only one other bank operating in the Town of Windsor. Almost all of the financial institutions operating within our primary service area are large national, regional or super-regional banks. With the exception of one local bank, Farmers Bank, none of these financial institutions are headquartered in our primary service area.

The majority of our competitors have substantially greater resources and lending limits than Citizens National Bank has and provide other services, such as extensive and established branch networks and trust services, which we do not expect to provide in the near future. As a result of these competitive factors, Citizens National Bank may have to pay higher interest rates to attract depositors or extend credit with lower interest rates to attract borrowers.

Lending Policy. The Bank continues to aggressively seek creditworthy borrowers within its primary service area. As of December 31, 2010, the Bank’s loan portfolio was comprised of the following:

 

Loan Classification

   Percentage of
Total Loans
 

Real estate-related loans

     84.2

Commercial loans

     7.7

Consumer loans

     8.1

Loan Approval and Review. The Bank’s loan approval policies provide for various levels of officer lending authority. When the total amount of loans to a single borrower exceeds an individual officer’s lending authority, an officer with a higher lending limit or the Bank’s director loan committee determines whether to approve the loan request. As part of its lending policy, the Bank does not make loans to its directors or executive officers unless a majority of its disinterested board members approves the loan and the terms of the loan are no more favorable than would be available to any other borrower similarly situated.

Lending Limits. The Bank’s lending activities are subject to a variety of lending limits imposed by federal law. Differing limits apply based on the type of loan and the nature of the borrower, including the borrower’s relationship to the Bank. In general, however, the Bank is able to loan any one borrower a maximum principal amount equal to either:

 

   

15% of the Bank’s capital and surplus; or

 

   

25% of its capital and surplus if the excess over 15% is within federal guidelines, which provides an exception to the 15% limit for debt secured by readily marketable collateral, as defined by OCC regulations.

The Bank complies with the statutory lending limits, as described above. The Bank’s legal lending limits will increase or decrease as the Bank’s capital increases or decreases as a result of, among other reasons, its earnings or losses. The Bank may sell loan participations to other financial institutions to meet the needs of customers requiring loans above these limits.

Real Estate Loans. The Bank makes and holds real estate-related loans, consisting primarily of mortgage loans, home equity lines of credit and non-farm, non-residential loans secured by real estate (typically owner-occupied commercial buildings). The Bank is involved in both the originating and servicing of its first and second mortgage loans, and generally requires an aggregated loan-to-value ratio of no more than 85%. For construction loans, the Bank requires a first lien position on the land associated with the project with terms not exceeding one year. Loan disbursements on construction loans require on-site inspections to assure the project is on budget and that the loan proceeds are not being diverted to another project. The loan-to-value ratios for construction loans are typically 90% of the as-built appraised value or 100% of project cost. The Bank also offers home equity lines of credit, which equaled approximately 3.3% of the Bank’s total loans, as of December 31, 2010, and have interest rate terms that are variable rather than fixed.

 

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As of December 31, 2010, approximately 29.8% of the Bank’s real estate-related loans had interest rate terms that were variable or carried a term of 12 months or less. Additionally, the terms of the Bank’s real estate loans generally do not exceed five years. Loans for construction can present a high degree of risk to the lender and depend upon, among other things, the builder’s ability to sell the home to a buyer, the buyer’s ability to obtain permanent financing and the construction project’s ability to produce income in the interim.

Commercial Loans. The Bank’s commercial lending is directed principally toward small to medium-size businesses whose demands for funds fall within the legal lending limits of the Bank. The Bank’s commercial loans are made to individual, partnership or corporate borrowers, and are obtained for a variety of business purposes. Of the Bank’s commercial loans as of December 31, 2010, approximately 67.1% were adjustable-rate loans or mature within one year and 32.9% had maturities extending beyond 12 months but less than 60 months. Risks associated with these loans can be significant and include, but are not limited to, fraud, bankruptcy, continued prolonged economic downturn, deteriorated or non-existing collateral and changes in interest rates.

Consumer Loans. The Bank makes consumer loans, consisting primarily of installment loans to individuals for personal, family and household purposes, including loans for automobiles, home improvements and investments. Almost all of the Bank’s consumer loans are fixed rate loans with maturities ranging from 3 to 5 years. Risks associated with consumer loans include, but are not limited to, fraud, deteriorated or non-existing collateral, general economic downturn and customer financial problems.

Investments. In addition to its loan operations, the Bank makes other investments primarily in obligations of the United States or obligations guaranteed as to principal and interest by the United States and other taxable securities such as corporate bonds and state and municipal bonds. The Bank also may invest in certificates of deposits in other financial institutions. The amount invested in such time deposits, as viewed on an institution by institution basis, generally would not exceed $250,000; therefore, being fully insured by the FDIC. No investment held by the Bank exceeds any applicable limitation imposed by law or regulation. Our asset and liability management committee reviews the investment portfolio on an ongoing basis to ascertain investment profitability and to verify compliance with the Bank’s investment policies.

Deposits. The Bank’s core deposits include checking accounts, money market accounts, a variety of certificates of deposit and IRA accounts. The Bank’s primary sources of deposits are residents of, and businesses and their employees located in Isle of Wight County. The Bank has obtained its deposits primarily through personal solicitation by its officers and directors and advertisements published in the local media. We plan to continue generating deposits by offering competitively priced deposit services, including demand deposits, regular savings accounts, money market deposits, certificates of deposit, retirement accounts and other legally permitted deposit or fund transfer services.

Other Banking Services. In addition to its lending and deposit products and services, the Bank offers internet banking, commercial cash management, bill pay, commercial deposit capture, mortgage brokering, debit cards, travelers’ checks, notary public services, wire services, safe deposit box rental, ATM services, On-Call telephone banking, and other traditional bank services to its customers.

Asset and Liability Management. The Bank has established an asset and liability management committee to manage its assets and liabilities. The goal of this committee is to maintain an optimum and stable net interest margin, a profitable after-tax return on assets and return on equity and adequate liquidity. The committee conducts these management functions within the framework of written loan and investment policies that the Bank has adopted. The committee also attempts to maintain a balanced position between rate sensitive assets and rate sensitive liabilities. Specifically, the committee charts the Bank’s assets and liabilities on a matrix by maturity and interest adjustment period and attempts to manage any gaps in maturity ranges.

Employees. As of December 31, 2010, the Bank had a total of 16 full time equivalent employees. CNB does not have any employees who are not also employees of Citizens National Bank.

Reports to Security Holders. The public may read and copy any materials the Company has filed with the Securities Exchange Commission (the “SEC”) at the Public Reference Room at 450 Fifth Street, N.W., Washington D.C., 20549. Information on the operation of the SEC Public Reference Room may by obtained by calling 1-800-SEC-0330. The SEC also maintains an Internet site, www.sec.gov, which contains reports, proxy and information statements, and other information free of charge regarding the Company’s filings. The Bank’s website, www.cnbva.com, contains a link directly to Company SEC filings.

 

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Supervision and Regulation

Both the Company and the Bank are subject to extensive state and federal banking laws and-regulations that impose restrictions on and provide general regulatory oversight of their operations. These laws and regulations-are generally intended to protect depositors and not shareholders. Legislation and regulations authorized by legislation influence, among other things:

 

   

how, when, and where we may expand geographically;

 

   

into what product or service market we may enter;

 

   

how we must manage our assets;

 

   

and under what circumstances money may or must flow between the parent bank holding company and the subsidiary bank.

Set forth below is an explanation of the major pieces of legislation affecting our industry and how that legislation affects our actions. The following summary is qualified by reference to the statutory and regulatory provisions discussed. Changes in applicable laws or regulations may have a material effect on our business and prospects, and legislative changes and the policies of various regulatory authorities may significantly affect our operations. We cannot predict the effect that fiscal or monetary policies, or new federal or state legislation may have on our business and earnings in the future.

The Company

The Company owns all of the capital stock of the Bank; therefore, it is a bank holding company under the Bank Holding Company Act of 1956. As a result, the Company is primarily subject to the supervision, examination, and reporting requirements of the Bank Holding Company Act and the regulations of the Federal Reserve. As a bank holding company registered under the Virginia Banking Act, the Virginia Bureau of Financial Institutions, a division of the Virginia State Corporation Commission, also regulates and monitors all significant aspects of the Company’s operations.

Acquisitions of Banks. The Bank Holding Company Act requires every bank holding company to obtain the Federal Reserve’s prior approval before:

 

   

acquiring direct or indirect ownership or control of any voting shares of any bank if, after the acquisition, the bank holding company will directly or indirectly own or control more than 5% of the bank’s voting shares;

 

   

acquiring all or substantially all of the assets of any bank; or

 

   

merging or consolidating with any other bank holding company.

Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly, or substantially lessen competition, or otherwise function as a restraint of trade, unless the anticompetitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy, which is discussed below.

Under the Bank Holding Company Act, if adequately capitalized and adequately managed, the Company or any other bank holding company located in Virginia may purchase a bank located outside of Virginia. Conversely, an adequately capitalized and adequately managed bank holding company located outside of Virginia may purchase a bank located inside Virginia. In each case, however, restrictions, including the laws of other states, may be placed on the acquisition of a bank that has only been in existence for a limited amount of time or will result in specified concentrations of deposits.

Change in Bank Control. Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or company acquires 10% or more, but less than 25%, of any class of voting securities and either:

 

   

the bank holding company has registered securities under Section 12 of the Securities Exchange Act of 1934; or

 

   

no other person owns a greater percentage of that class of voting securities immediately after the transaction.

Our common stock is registered under the Securities Exchange Act of 1934. The regulations provide a procedure for challenging the rebuttable presumption of control.

Permitted Activities. The Bank Holding Company Act has generally prohibited a bank holding company from engaging in activities other than banking or managing or controlling banks or other permissible subsidiaries and from acquiring or retaining direct or indirect control of any company engaged in any activities other than those determined by the Federal Reserve to be

 

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closely related to banking as to be a proper incident thereto. Provisions of the Gramm-Leach-Bliley Act have expanded the permissible activities of a bank holding company that qualifies as a financial holding company. Under the regulations implementing the Gramm-Leach-Bliley Act, a financial holding company may engage in additional activities that are financial in nature or incidental or complementary to financial activity. Those activities include, among other activities, certain insurance and securities activities.

To qualify to become a financial holding company, the Bank and any other depository institution subsidiary of the Company must be well capitalized and well managed and must have a Community Reinvestment Act rating of at least “satisfactory.” Additionally, the Company must file an election with the Federal Reserve to become a financial holding company and must provide the Federal Reserve-with 30 days’ written notice prior to engaging in a permitted financial activity. While the Company meets the qualification standards applicable to financial holding companies, the Company has not elected to become a financial holding company at this time.

Support of Subsidiary Institution. Under Federal Reserve policy, the Company is expected to act as a source of financial strength for the Bank and to commit resources to support the Bank. This support may be required at times when, without this Federal Reserve policy, the Company might not be inclined to provide it. In addition, any capital loans made by the Company to the Bank will be repaid only after the Bank’s deposits and various other obligations are repaid in full. In the unlikely event of the Company’s bankruptcy, any commitment by it to a federal bank regulatory agency to maintain the capital of the Bank will be assumed by the bankruptcy trustee and entitled to a priority of payment.

The Bank

Since the Bank is chartered as a national bank, it is primarily subject to the supervision, examination, and reporting requirements of the National Bank Act and the regulations of the Office of the Comptroller of the Currency. The Office of the Comptroller of the Currency regularly examines the Bank’s operations and has the authority to approve or disapprove mergers, the establishment of branches and similar corporate actions. The Office of the Comptroller of the Currency also has the power to prevent the continuance or development of unsafe or unsound banking practices or other violations of law. Because the Bank’s deposits are insured by the FDIC to the maximum extent provided by law, it is also subject to certain FDIC regulations. The Bank is also subject to numerous state and federal statutes and regulations that affect its business, activities, and operations.

Branching. National banks are required by the National Bank Act to adhere to branch office banking laws applicable to state banks in the states in which their main office is located. Under current Virginia law, the Bank may open branch offices throughout Virginia with the prior approval of the Office of the Comptroller of the Currency. In addition, with prior regulatory approval, the Bank will generally be able to acquire banking operations in Virginia. Furthermore, federal legislation has been passed which permits interstate branching. These laws permit out-of-state acquisitions by bank holding companies, interstate branching by banks if allowed by state law, and interstate merging by banks.

Prompt Corrective Action. The Federal Deposit Insurance Corporation Improvement Act of 1991 established a system of prompt corrective action to resolve the problems of undercapitalized financial institutions. Under this system, the federal banking regulators have established five capital categories (well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized) in which all institutions are placed. The federal banking agencies have specified by regulation the relevant capital level for each category.

Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The other capital categories are well capitalized, adequately capitalized, and undercapitalized. As of December 31, 2010, the Bank qualified for the well-capitalized category.

A “well-capitalized” bank is one that significantly exceeds all of its capital requirements, which include maintaining a total risk-based capital ratio of at least 10%, a tier 1 risk-based capital ratio of at least 6%, and a tier 1 leverage ratio of at least 5%. Generally, a classification as well capitalized will place a bank outside of the regulatory zone for purposes of prompt corrective action. However, a well-capitalized bank may be reclassified as “adequately capitalized” based on criteria other than capital, if the federal regulator determines that a bank is in an unsafe or unsound condition, or is engaged in unsafe or unsound practices and has not corrected the deficiency.

FDIC Insurance Assessments. The Bank’s deposits are insured up to applicable limits by the Deposit Insurance Fund (DIF) of the FDIC, an independent agency of the United States government. The FDIC amended its risk-based assessment system

 

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in 2007 to implement authority granted by the Federal Deposit Insurance Reform Act of 2005 (FDIRA). Under the revised system, insured institutions are assigned to one of four risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. An institution’s assessment rate depends upon the category to which it is assigned. Unlike the other categories, Risk Category I, which contains the least risky depository institutions, contains further risk differentiation based on the FDIC’s analysis of financial ratios, examination component ratings and other information. Assessment rates are determined by the FDIC and, for calendar year 2008, assessments ranged from five to 43 basis points of each institution’s deposit assessment base. Due to losses incurred by the DIF in 2008 from failed institutions, and anticipated future losses, the FDIC adopted an across the board seven basis point increase in the assessment range for the first quarter of 2009. The FDIC made further refinements to its risk-based assessment that became effective April 1, 2009, and effectively made the range seven to 77.5 basis points. The FDIC may adjust rates uniformly from one quarter to the next, except that no single adjustment can exceed three basis points.

Under an interim rule adopted on February 27, 2009, the FDIC imposed an emergency special assessment of 20 basis points as of June 30, 2009. In November 2009, the FDIC adopted a final rule requiring insured depository institutions to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009, and for all of 2010, 2011 and 2012, on December 31, 2009, along with each institution’s risk-based deposit insurance assessment for the third quarter of 2009. The prepayment was based on an institution’s assessment rate and assessment base for the third quarter of 2009, assuming a five percent annual growth in deposits each year. While the FDIC plan would maintain current assessment rates through 2010, effective January 1, 2011, the rates would increase by three basis points across the board. The FDIC has elected to forgo this increase under a new DIF restoration plan adopted in October 2010 as discussed below. On December 30, 2009, the Company prepaid $214,000 of FDIC assessments.

In October 2010, the FDIC adopted a new DIF restoration plan to ensure that the fund reserve ratio reaches 1.35 percent by September 30, 2020, as required by the Dodd-Frank Act, which Act is described in more detail below. Under the new restoration plan, the FDIC will forego the uniform three-basis point increase in initial assessment rates scheduled to take place on January 1, 2011 and maintain the current schedule of assessment rates for all depository institutions. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.

In November 2010, the FDIC issued a final rule to implement provisions of the Dodd-Frank Act that provide for temporary unlimited coverage for noninterest-bearing transaction accounts beginning January 1, 2011 and continuing through December 2012. For purposes of this extension, the definition of noninterest-bearing transaction accounts excludes negotiable order of withdraw consumer checking accounts (NOW accounts) and Interest on Lawyer Trust Accounts (IOLTAs). The extended program is not optional and will no longer be funded by separate premiums.

In February 2011, the FDIC approved a final rule that changes the assessment base from domestic deposits to average consolidated total assets minus average tangible equity (defined as Tier 1 capital); adopts a new large-bank pricing assessment scheme; and sets a target size for the DIF. The changes will go into effect beginning with the second quarter of 2011 and will be payable at the end of September 2011. The rule, as mandated by the Dodd-Frank Act, finalizes a target size for the DIF at 2 percent of insured deposits. It also implements a lower assessment rate schedule when the fund reaches 1.15 percent and, in lieu of dividends, provides for a lower rate schedule when the reserve ration reaches 2 percent and 2.5 percent.

Community Reinvestment Act. The Community Reinvestment Act requires that, in connection with examinations of financial institutions within their respective jurisdictions, the federal bank regulators shall evaluate the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. These facts are also considered in evaluating mergers, acquisitions and applications to open a branch or facility. Failure to adequately meet these criteria could impose additional requirements and limitations on the Bank. Additionally, the Bank must publicly disclose the terms of various Community Reinvestment Act-related agreements.

Allowance for Loan and Lease Losses. The Allowance for Loan and Lease Losses (the “ALLL”) represents one of the most significant estimates in the Bank’s financial statements and regulatory reports. Because of its significance, the Bank has developed a system by which it develops, maintains, and documents a comprehensive, systematic, and consistently applied process for determining the amounts of the ALLL and the provision for loan and lease losses. The Interagency Policy Statement on the Allowance for Loan and Lease Losses, issued on December 13, 2006, encourages all banks to ensure controls are in place to consistently determine the ALLL in accordance with GAAP, the bank’s stated policies and procedures, management’s best judgment, and relevant supervisory guidance. Consistent with supervisory guidance, the Bank maintains a prudent and conservative, but not excessive, ALLL, that is at a level that is appropriate to cover estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the remainder of the loan and lease portfolio. The Bank’s estimate of credit losses reflects consideration of all significant factors that affect the collectibility of the portfolio as of the evaluation date. See “Management’s Discussion and Analysis – Critical Accounting Policies.”

 

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Commercial Real Estate Lending. The Bank’s lending operations may be subject to enhanced scrutiny by federal banking regulators based on its concentration of commercial real estate loans. On December 6, 2006, the federal banking regulators issued final guidance to remind financial institutions of the risk posed by commercial real estate (“CRE”) lending concentrations. CRE loans generally include land development, construction loans, loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance prescribes the following guidelines for its examiners to help identify institutions that are potentially exposed to significant CRE risk and may warrant greater supervisory scrutiny:

 

   

total reported loans for construction, land development and other land represent 100% or more of the institutions total capital, or

 

   

total commercial real estate loans represent 300% or more of the institution’s total capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more.

Other Regulations. Interest and other charges collected or contracted for by the Bank are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations are subject to federal laws applicable to credit transactions, such as the:

 

   

Truth-In-Lending Act, governing disclosures of credit terms to consumer borrowers;

 

   

Home Mortgage Disclosure Act of 1975, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;

 

   

Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed, or other prohibited factors in extending credit;

 

   

Fair Credit Reporting Act of 1978, as amended by the Fair and Accurate Credit Transactions Act, governing the use and provision of information to credit reporting agencies, certain identity theft protections, and certain credit and other disclosures;

 

   

Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies;

 

   

Soldiers’ and Sailors’ Civil Relief Act of 1940, as amended, governing the repayment terms of, and property rights underlying, secured obligations of persons currently on active duty with the United States military;

 

   

Talent Amendment in the 2007 Defense Authorization Act, establishing a 36% annual percentage rate ceiling, which includes a variety of charges including late fees, for certain types of consumer loans to military service members and their dependents; and

 

   

rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

The Bank’s deposit operations are subject to federal laws applicable to depository accounts, such as the following:

 

   

Right to Financial Privacy Act, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records;

 

   

Truth-In-Savings Act, requiring certain disclosures for consumer deposit accounts;

 

   

Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve Board to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of automated teller machines and other electronic banking services; and rules and regulations of the various federal agencies charged with the responsibility of implementing these federal laws.

The Dodd-Frank Act. On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the Dodd-Frank Act) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including provisions that, among other things, will:

 

   

Centralize significant aspects of consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws for institutions with more than $10 billion of assets and, to a lesser extent, smaller institutions. As a smaller institution, most consumer protection aspects of the Dodd-Frank Act will continue to be applied to the Company by the Federal Reserve and to the Bank by the FDIC.

 

   

Restrict the preemption of state law by federal law and disallow subsidiaries and affiliates of national banks from availing themselves of such preemption.

 

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Apply the same leverage and risk-based capital requirements that apply to insured depository institutions to most bank holding companies.

 

   

Require bank holding companies and banks to be both well capitalized and well managed in order to acquire banks located outside their home state.

 

   

Change the assessment base for federal deposit insurance from the amount of insured deposits to consolidated assets less tangible capital, eliminate the ceiling on the size of the DIF and increase the floor of the size of the DIF.

 

   

Impose comprehensive regulation of the over-the-counter derivatives market, which would include certain provisions that would effectively prohibit insured depository institutions from conducting certain derivatives businesses in the institution itself.

 

   

Require large, publicly traded bank holding companies to create a risk committee responsible for the oversight of enterprise risk management.

 

   

Require loan originators to retain 5 percent of any loan sold or securitized, unless it is a “qualified residential mortgage”, which must still be defined by the regulators. FHA, VA and Rural Housing Service loans are specifically exempted from the risk retention requirements.

 

   

Implement corporate governance revisions, including with regard to executive compensation and proxy access by shareholders that apply to all public companies not just financial institutions.

 

   

Make permanent the $250,000 limit for federal deposit insurance and increase the cash limit of Securities Investor Protection Corporation protection from $100,000 to $250,000 and provide unlimited federal deposit insurance until December 31, 2012 for non-interest bearing demand transaction accounts at all insured depository institutions

 

   

Repeal the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts.

 

   

Amend the Electronic Fund Transfer Act (EFTA) to, among other things, give the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer.

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, making it difficult to anticipate the overall financial impact on the Company, its Bank subsidiary, its customers or the financial industry more generally.

Capital Adequacy

The Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve, in the case of the Company, and the Office of the Comptroller of the Currency, in the case of the Bank. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. Because the Company’s consolidated total assets are less than $500 million, under the Federal Reserve’s capital guidelines, our capital adequacy is measured on a bank-only basis, as opposed to a consolidated basis. The Bank is also subject to risk-based and leverage capital requirements adopted by the Office of the Comptroller of the Currency, which are substantially similar to those adopted by the Federal Reserve for bank holding companies.

The risk-based capital standards are designed to make regulatory capital requirements more sensitive to differences in risk profiles among banks and bank holding companies, to account for off-balance-sheet exposure, and to minimize disincentives for holding liquid assets. Assets and off-balance-sheet items, such as letters of credit and unfunded loan commitments, are assigned to broad risk categories, each with appropriate risk weights. The resulting capital ratios represent capital as a percentage of total risk-weighted assets and off-balance-sheet items.

The minimum guideline for the ratio of total capital to risk-weighted assets is 8%. Total capital consists of two components, Tier 1 Capital and Tier 2 Capital. Tier 1 Capital generally consists of common stock, minority interests in the equity accounts of consolidated deposit institution subsidiaries, noncumulative perpetual preferred stock in consolidated non-depository subsidiaries, and a limited amount of qualifying cumulative perpetual preferred stock, less goodwill and other specified intangible assets. Tier 1 Capital must equal at least 4% of risk-weighted assets. Tier 2 Capital generally consists of subordinated debt, other preferred stock, and a limited amount of loan loss reserves. The total amount of Tier 2 Capital is limited to 100% of Tier 1 Capital. At December 31, 2010, our consolidated ratio of total capital to risk-weighted assets was 19.8% and our consolidated ratio of Tier 1 Capital to risk-weighted assets was 18.6%.

 

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In addition, the Federal Reserve has established minimum leverage ratio guidelines for bank holding companies. These guidelines provide for a minimum ratio of Tier 1 Capital to average assets, less goodwill and other specified intangible assets, of 3% for bank holding companies that meet specified criteria, including having the highest regulatory rating and implementing the Federal Reserve’s risk-based capital measure for market risk. All other bank holding companies generally are required to maintain a leverage ratio of at least 4%. At December 31, 2010, our consolidated leverage ratio was 13.6%. The guidelines also provide that bank holding companies experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without reliance on intangible assets. The Federal Reserve considers the leverage ratio and other indicators of capital strength in evaluating proposals for expansion or new activities.

Failure to meet capital guidelines could subject a bank or bank holding company to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits, and certain other restrictions on its business. As described above, significant additional restrictions can be imposed on FDIC-insured depository institutions that fail to meet applicable capital requirements.

Payment of Dividends

The Company is a legal entity separate and distinct from the Bank. The principal sources of the Company’s cash flow, including cash flow to pay dividends to its shareholders, are dividends that the Bank pays its sole shareholder, the Company. Statutory and regulatory limitations apply to the Bank’s payment of dividends to the Company as well as to the Company’s payment of dividends to its shareholders.

The Bank is required by federal law to obtain prior approval of the Office of the Comptroller of the Currency for payments of dividends if the total of all dividends declared by the Bank’s board of directors in any year will exceed (1) the total of the Bank’s net profits for that year, plus (2) the Bank’s retained net profits of the preceding two years, less any required transfers to surplus. The payment of dividends by the Company and the Bank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. At December 31, 2010, the Bank could not pay cash dividends without prior regulatory approval.

If, in the opinion of the Office of the Comptroller of the Currency, the Bank were engaged in or about to engage in an unsafe or unsound practice, the Office of the Comptroller of the Currency could require, after notice and a hearing, that the Bank stop or refrain from engaging in the practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the Federal Deposit Insurance Corporation Improvement Act of 1991, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized. Moreover, the federal agencies have issued policy statements that provide that bank holding companies and insured banks should generally only pay dividends out of current operating earnings.

Restrictions on Transactions with Affiliates

The Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

 

   

a bank’s loans or extensions of credit to affiliates;

 

   

a bank’s investment in affiliates;

 

   

assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve Board;

 

   

loans or extensions of credit to third parties collateralized by the securities or obligations of affiliates; and

 

   

a bank’s guarantee, acceptance, or letter of credit issued on behalf of an affiliate.

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid the taking of low-quality assets.

The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibit an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

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The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders, and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

Proposed Legislation and Regulatory Action

The Dodd-Frank Act is discussed above. Additional new regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations, and competitive relationships of financial institutions operating and doing business in the United States. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which our business may be affected by any new regulation or statute.

Effect of Governmental Monetary Policies

Our earnings are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve Bank’s monetary policies have had, and are likely to continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve affect the levels of bank loans, investments and deposits through its control over the issuance of United States government securities, its regulation of the discount rate applicable to member banks and its influence over reserve requirements to which member banks are subject. Neither the Company nor the Bank can predict the nature or impact of future changes in monetary and fiscal policies.

 

ITEM 1A. RISK FACTORS

An investment in our common stock involves risks. If any of the following risks or other risks, which have not been identified or which we may believe are immaterial or unlikely, actually occur, our business, financial condition and results of operations could be harmed. In such a case, the trading price of our common stock could decline, and you may lose all or part of your investment. The risks discussed below also include forward-looking statements, and our actual results may differ substantially from those discussed in these forward-looking statements. The Risk Factors are not required for smaller reporting companies, however we believe this information is useful to our shareholders in the current economic environment.

We could suffer additional loan losses from declines in credit quality.

We could sustain additional losses if borrowers, guarantors, and related parties fail to perform in accordance with the terms of their loans. We have adopted underwriting and credit monitoring procedures and policies, including the establishment and review of the allowance for credit losses that we believe are appropriate to minimize this risk by assessing the likelihood of nonperformance, tracking loan performance and diversifying our credit portfolio. These policies and procedures, however, may not prevent unexpected losses that could materially adversely affect our results of operations.

If the value of real estate in our core market were to continue to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on our business, financial condition, and results of operations.

In addition to considering the financial strength and cash flow characteristics of borrowers, we often secure loans with real estate collateral. At December 31, 2010, approximately 84.2% of our loans had real estate as a primary or secondary component of collateral. The real estate collateral in each case provides an alternate source of repayment in the event of default by the borrower and may deteriorate in value during the time the credit is extended. In a market with reduced real estate values, our earnings and capital could be adversely affected if we are required to liquidate the collateral securing a loan to satisfy the debt. Consequently, a further decline in local economic conditions may have a greater effect on our earnings and capital than on the earnings and capital of larger financial institutions whose real estate loan portfolios are more geographically diverse.

Our allowance for loan losses may not be adequate to cover actual loan losses, which may require us to take a charge to our earnings and adversely impact our financial condition and results of operations.

We maintain an allowance for estimated loan losses that we believe is adequate for absorbing probable losses in our loan portfolio. Management determines the provision for loan losses based upon an analysis of general market conditions, credit quality of our loan portfolio, and performance of our customers relative to their financial obligations to us. We employ an outside vendor specializing in credit risk management to evaluate our loan portfolio for risk grading, which can result in changes in our allowance for estimated loan losses. The amount of future losses is susceptible to changes in economic, operating, and other conditions, including changes in interest rates, which may be beyond our control. These future losses

 

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may exceed the allowance for estimated loan losses. Although management believes that the allowance for estimated loan losses is adequate to absorb any probable losses on existing loans that may become uncollectible, there can be no assurance that the allowance will prove sufficient to cover actual loan losses in the future. Significant increases to the provision for loan losses may be necessary if material adverse changes in general economic conditions occur or the performance of our loan portfolio deteriorates. Additionally, federal banking regulators, as an integral part of their supervisory function, periodically review the allowance for estimated loan losses. If these regulatory agencies require us to increase the allowance for estimated loan losses, it would have a negative effect on our results of operations and financial condition.

As a community bank, losses on a few large loans or lending relationships can cause significant volatility in earnings.

Due to our limited size, individual loan values can be large relative to our earnings for a particular period. If a few relatively large loan relationships become non-performing in a period and we are required to increase our loan loss reserves, or to write off principal or interest relative to such loans, the operating results for that period could be significantly adversely affected. The effect on results of operations for any given period from a change in the performance of a relatively small number of loan relationships may be disproportionately larger than the impact of such loans on the quality of our overall loan portfolio.

Continued negative developments in the financial industry and the domestic credit markets may adversely affect our operations and results.

Negative developments starting in 2007 and 2008, which continued through 2009 and into 2010, in the global credit and derivative markets have resulted in uncertainty in the financial markets in general. As a result of this “credit crunch,” commercial as well as consumer loan portfolio performances have deteriorated at many institutions and the competition for deposits and quality loans has increased significantly. Global securities markets and bank holding company stock prices in particular, have been negatively affected, as has the ability of banks and bank holding companies to raise capital or borrow in the debt markets. If these negative trends continue, our business operations and financial results may be negatively affected.

The FDIC Deposit Insurance assessments that we are required to pay may materially increase in the future, which would have an adverse effect on our earnings.

The FDIC insures deposits at FDIC insured financial institutions, including the Bank. The FDIC charges insured financial institutions premiums to maintain the DIF at a certain level. Economic conditions since 2008 have increased the rate of bank failures and expectations for further bank failures, requiring the FDIC to make payments for insured deposits from the DIF and prepare for future payments from the DIF.

During 2009, the FDIC imposed a special deposit insurance assessment on all institutions which it regulates, including the Bank. This special assessment was imposed due to the need to replenish the DIF, as a result of increased bank failures and expected future bank failures. In addition, the FDIC required regulated institutions to prepay their fourth quarter 2009, and full year 2010, 2011 and 2012 assessments in December 2009. Any similar, additional measures taken by the FDIC to maintain or replenish the DIF may have an adverse effect on our financial condition and results of operations.

On February 7, 2011, the FDIC adopted final rules to implement changes required by the Dodd-Frank Act with respect to the FDIC assessment rules that become effective April 1, 2011. A depository institution’s deposit insurance assessment is now calculated based on the institution’s total assets less tangible equity, rather than the previous base of total deposits. The Company expects that these changes will not increase the Company’s FDIC insurance assessments for comparable asset and deposit levels. However, if the Bank’s asset size increases or the FDIC takes other actions to replenish the DIF, the Bank’s FDIC insurance premiums could increase. During the year ended December 31, 2010, we paid $59,000 in deposit insurance assessments.

Competition from other financial institutions may adversely affect our profitability.

The banking business is highly competitive, and we experience strong competition from many other financial institutions. We compete with commercial banks, credit unions, savings and loan associations, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market funds, and other financial institutions, which operate in our primary market areas and elsewhere.

We compete with these institutions both in attracting deposits and in making loans. In addition, we have to attract our customer base from other existing financial institutions and from new residents. Many of our competitors are well established and much larger financial institutions. While we believe we can and do successfully compete with these other financial institutions in our markets, we may face a competitive disadvantage as a result of our smaller size and lack of geographic diversification. Although we compete by concentrating our marketing efforts in our primary market area with local advertisements, personal contacts, and greater flexibility in working with local customers, we can give no assurance that this strategy will be successful.

 

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We are subject to extensive regulation that could limit or restrict our activities and impose financial requirements or limitations on the conduct of our business, which limitations or restrictions could adversely affect our profitability.

As a bank holding company, we are primarily regulated by the Board of Governors of the Federal Reserve System. Our subsidiary bank is primarily regulated by the FDIC and the OCC. Our compliance with Federal Reserve Board, FDIC, and OCC regulations is costly and may limit our growth and restrict certain of our activities, including payment of dividends, mergers and acquisitions, investments, loans and interest rates charged, interest rates paid on deposits and locations of offices. We are also subject to the capital requirements of our regulators.

The laws and regulations applicable to the banking industry could change at any time, and we cannot predict the effects of these changes on our business and profitability. Because government regulation greatly affects the business and financial results of all commercial banks and bank holding companies, our cost of compliance could adversely affect our ability to operate profitably.

The Sarbanes-Oxley Act of 2002, the related rules and regulations promulgated by the SEC that currently apply to us and the related exchange rules and regulations, have increased the scope, complexity and cost of corporate governance, reporting, and disclosure practices. Additional legislation or regulations, or amendments to current legislation or regulations, related to corporate governance, reporting, and disclosure may cause us to experience greater compliance costs.

The Dodd-Frank Act could increase our regulatory compliance burden and associated costs, place restrictions on certain current and future products and services, and limit our future capital raising strategies.

A wide range of regulatory initiatives directed at the financial services industry have been proposed in recent months. One of those initiatives, the Dodd-Frank Act, was signed into law on July 21, 2010. The Dodd-Frank Act represents a sweeping overhaul of the financial services industry within the United States and mandates significant changes in the financial regulatory landscape that will impact all financial institutions, including the Company. The Dodd-Frank Act will likely increase our regulatory compliance burden and may have a material adverse effect on us, by increasing the costs associated with our regulatory examinations and compliance measures. The federal regulatory agencies, and particularly bank regulatory agencies, are given significant discretion in drafting the Dodd-Frank Act’s implementing rules and regulations and, consequently, many of the details and much of the impact of the Dodd-Frank Act will depend on the final implementing rules and regulations. Accordingly, it remains too early to fully assess the impact of the Dodd-Frank Act and subsequent regulatory rulemaking processes on our business, financial condition or results of operations.

Although the Consumer Financial Protection Bureau has jurisdiction over banks with $10 billion or greater in assets, rules, regulations and policies issued by the Bureau may also apply to the Company or its subsidiary by virtue of the adoption of such policies and best practices by the Federal Reserve and OCC. The costs and limitations related to this additional regulatory agency and the limitations and restrictions that will be placed upon the Company with respect to its consumer product and service offerings have yet to be determined. However, these costs, limitations and restrictions may produce significant, material effects on our business, financial condition and results of operations

We are subject to liquidity risk in our operations.

Liquidity risk is the possibility of being unable, at a reasonable cost and within acceptable risk tolerances, to pay obligations as they come due, to capitalize on growth opportunities as they arise, or to pay regular dividends because of an inability to liquidate assets or obtain adequate funding on a timely basis. Liquidity is required to fund various obligations, including credit obligations to borrowers, mortgage originations, withdrawals by depositors, repayment of debt, dividends to shareholders, operating expenses, and capital expenditures. Liquidity is derived primarily from retail deposit growth and retention, principal and interest payments on loans and investment securities, net cash provided from operations, and access to other funding sources. Our access to funding sources in amounts adequate to finance our activities could be impaired by factors that affect us specifically or the financial services industry in general. Factors that could detrimentally affect our access to liquidity sources include a decrease in the level of our business activity due to a market downturn or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a severe disruption in the financial markets or negative views and expectations about the prospects for the financial services industry as a whole, given the recent turmoil faced by banking organizations in the domestic and worldwide credit markets.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

None.

 

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ITEM 2. PROPERTIES

The Company began its banking operations at 11407 Windsor Blvd., Windsor, Virginia, in March, 2004, which facility is owned by the Company and has approximately 7,000 square feet of finished office space with additional square footage available for expansion.

 

ITEM 3. LEGAL PROCEEDINGS

None.

 

ITEM 4. REMOVED AND RESERVED

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

In December 2002, the Company completed its initial public offering of its common stock. This offering was registered under the Securities Act of 1933, and raised $5.4 million in net proceeds through the sale of 561,137 shares of common stock (equivalent to 841,706 shares adjusted for 3-for-2 stock split in September, 2006). Out of the net proceeds of the offering, $5.25 million was used to capitalize the Bank in exchange for 100% of its outstanding common stock as required by the Bank’s primary regulator. No unregistered securities of the Company were sold or issued during the period covered by this Report.

During the fourth quarter of 2006, the Company completed a rights offering and a public offering, selling 650,000 shares of its common stock. The offering was registered under the Securities act of 1933 and raised $4 million in net proceeds. The Company has and will continue to use the net proceeds from the offering to increase equity and subsequently the Bank’s legal lending limit and for general corporate purposes, including any potential future growth and expansion.

The Company’s common stock is traded on the Over-the-Counter Bulletin Board under the symbol CNBV. To the Company’s knowledge, the last price at which our stock was sold was $1.54 per share on March 4, 2011. As of December 31, 2010, we had approximately 921 shareholders of record. The Company’s high and low stock price over the past eight quarters is shown in the following table.

 

     2010      2009  
     High      Low      High      Low  

First Quarter

   $ 1.75       $ 1.60       $ 2.50       $ 1.40   

Second Quarter

     2.22         1.93         2.80         2.40   

Third Quarter

     2.24         1.77         5.25         2.40   

Fourth Quarter

     1.77         1.73         5.25         1.75   

To date, the Company has not paid cash dividends on its common stock. The Company’s board of directors currently intends to retain earnings to support future operations and therefore do not anticipate paying cash dividends in the foreseeable future. All of the Company’s outstanding shares of common stock are entitled to share equally in dividends from funds legally available when, and if, declared by the board of directors.

The Company did not repurchase any common stock during 2010 or 2009.

The information contained on pages 11 through 13 of the 2011 Proxy Statement under the caption, “Security Ownership of Certain Beneficial Owners and Management,” is incorporated herein by reference and outlines our securities authorized for issuance under equity compensation plans as of December 31, 2010.

 

ITEM 6. SELECTED FINANCIAL DATA

The Selected Financial Data is not required by smaller reporting companies.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company. This discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to Consolidated Financial Statements.

Overview

The Company is headquartered in Windsor, Virginia and conducts its primary operations through its wholly owned subsidiary, Citizens National Bank. The Bank is a community bank serving the Town of Windsor, County of Isle of Wight, the Cities of Franklin and Suffolk, and portions of Southampton, Surry and Sussex Counties with one full service branch.

Like most financial institutions, our profitability depends largely upon net interest income, which is the difference between the interest received on earning assets, such as loans and investment securities, and the interest paid on interest-bearing liabilities, principally deposits and borrowings. Our results of operations are also affected by our provision for loan losses; non-interest expenses, such as salaries, employee benefits, and occupancy expenses; and non-interest income, such as mortgage loan fees and service charges on deposit accounts.

Economic conditions, competition and federal monetary and fiscal policies also affect financial institutions. The year 2010 continued to be a challenging year in margin management as we worked to balance asset repricing that occurs sooner than deposit repricing in a lower interest rate environment. In a normal slow rate decline as seen in many business cycles in the past, this process would be relatively straight forward, but in the worldwide economic downturn that surfaced in 2007 and has remained prevalent, we remain more challenged. While community banks like us for the most part have not been involved in subprime lending, we are exposed to a broad market reaction to the financial services industry which has lowered stock prices and negatively affected certain of the larger institutions that took part in sub-prime loans or utilized hedge funds relying on these loans. The economic environment that has been created has and may continue to influence the ability of some of our customers to repay their loans. The fast downward movement of interest rates may also influence our investment portfolio. The drop in rates may cause bonds to be called faster than normal, prompting close management attention to maintain the yield on the portfolio. Until rates stabilize, we will operate in an environment that will likely negatively influence our earnings in the short term.

As of December 31, 2010, the Company’s total assets were $49.3 million, consisting primarily of securities of $8.0 million, loans, net of allowance for loan losses, of $35.2 million and premises and equipment of $1.4 million. Comparatively, at December 31, 2009, total assets were $47.5 million, which consisted primarily of securities of $7.6 million, loans, net of allowance for loan losses, of $36.1 million and premises and equipment of $1.4 million. At December 31, 2010, total deposits were $42.5 million compared to total deposits at December 31, 2009 of $40.8 million. Interest bearing deposits at December 31, 2010 and 2009 were $39.8 million and $38.4 million, respectively. For the year ended December 31, 2010, the Company had net operating income before the provision for loan losses of $186,000 compared to $54,000 for the year ended December 31, 2009. Net income in 2010 of $95,000 increased from a net loss position of $1.1 million in 2009, which was due primarily to increased loan loss provisions and FDIC insurance premiums.

Critical Accounting Policies

The financial condition and results of operations presented in the consolidated financial statements, accompanying notes to the consolidated financial statements and management’s discussion and analysis 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 a discussion of those accounting policies that management believes are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. These 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 in the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are 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.

 

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The Company evaluates various loans individually for impairments. 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.

For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon 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 and leases, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; peer group comparison; results of examinations and evaluations of the overall portfolio by senior management, external auditors, and regulatory examiners; and national and local economic conditions.

The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is adequate. The establishment of allowance factors is a continuing exercise and may change from period to period, resulting in an increase or decrease in the amount of provision or allowance based upon the same volume or classification of loans. 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.

Accounting for Income Taxes

Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences and operating loss and tax credit carryforwards and deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

The Company has recorded a 100% deferred tax valuation allowance related to various temporary differences, principally consisting of the provision for loan losses and its net operating loss carryforwards. Since the Company has only been in operation since April 29, 2003 and did not show a profit during 2003, 2004, 2005, or 2009, it is management’s opinion that it is prudent at this time to only recognize the deferred tax asset to the extent that income tax benefits are realized.

Results of Operations

Net Income (Loss)

It is normal for new banks to experience operating losses in their formative years through start up and operating expenses. The Company began experiencing sustainable operating income during 2006 and continued to post earnings in 2007 and 2008. However, the economic downturn that we are experiencing produced results which did and may continue to impact our earnings potential. For the year ended December 31, 2010, the Company’s net income was $95,000; $0.06 earnings per basic and diluted share. We were profitable in the first and second quarters of 2009, but our annualized earnings were negatively impacted by increased FDIC deposit insurance premiums, significantly higher provisions for loan losses, the impact of nonaccrual interest lost, and increased personnel costs, resulting in a net loss of $1.1 million for the year ended December 31, 2009. This represents a net loss per basic and diluted share of ($0.76). Return on average assets (ROA) measures how effectively the Company employs its assets to produce net income. For the year ended December 31, 2010, ROA was 0.20% compared to (2.45%) for the year ended December 31, 2009. Return on average equity (ROE), another measure of earnings performance, indicates the amount of net income earned in relation to the total equity capital invested. ROE for the year ended December 31, 2010 was 1.40% compared with (15.10%) for the year ended December 31, 2009. Average equity to average assets was 14.13% and 16.22% for the years ended December 31, 2010 and 2009, respectively. During 2010, the Company reserved $91,000, a decrease of $1.1 million or 92.4% from the $1.2 million reserved during 2009. Net income from operations before the provision for loan losses was $186,000 for 2010 compared to $54,000 for 2009, an increase of 244.4%.

 

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TABLE 1: Average Balances, Interest Income and Expense, Yields and Rates

The following table shows the average balance sheet for the year ended December 31, 2010 and 2009. In addition, the amount of interest earned on earning assets, with related yields and interest on interest bearing liabilities, together with rates, is shown.

 

      2010     2009  

(Dollars in thousands)

   AVERAGE
BALANCE
    INTEREST
INCOME/
EXPENSE
     YIELD/
RATE
    AVERAGE
BALANCE
    INTEREST
INCOME/
EXPENSE
     YIELD/
RATE
 

Assets:

              

Securities, taxable

   $ 8,068      $ 277         3.43   $ 6,812      $ 293         4.32

Loans

     35,908        2,538         7.07     36,893        2,686         7.28

Federal funds sold

     2,159        3         0.14     995        2         0.20
                                                  

Total earnings assets

     46,135      $ 2,818         6.11     44,700      $ 2,981         6.67

Less: Allowance for loan losses

     (643          (715     

Total non-earning assets

     2,699             2,563        
                          

Total Assets

   $ 48,191           $ 46,548        
                          

Liabilities and shareholders’ equity:

              

Interest bearing deposits:

              

Checking

   $ 1,056      $ 5         0.47   $ 911      $ 4         0.44

Money market savings

     906        7         0.77     1,198        15         1.25

Regular savings

     1,429        4         0.28     1,260        3         0.24

Time Deposits:

              

$100,000 and over

     15,397        404         2.62     13,125        462         3.52

Under $100,000

     19,477        492         2.53     19,416        649         3.34
                                                  

Total interest bearing deposits

     38,265        912         2.38     35,910        1,133         3.16

Federal funds purchased

     —          —           N/A        57        1         1.75
                                                  

Total interest bearing liabilities:

     38,265      $ 912         2.38     35,967      $ 1,134         3.15

Non-interest bearing liabilities:

              

Demand deposits

     2,931             2,877        

Other liabilities

     188             150        
                          

Total liabilities

     41,384             38,994        

Shareholders’ equity

     6,807             7,554        
                          

Total Liabilities and Shareholders’ equity

   $ 48,191           $ 46,548        
                          

Net interest income

     $ 1,906           $ 1,847      
                          

Interest rate spread

          3.73          3.52
                          

Interest expense to average earning assets

          1.98          2.54
                          

Net interest margin

          4.13          4.13
                          

 

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The following table describes the impact on the interest income resulting from changes in average balances and average rates for the periods indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

TABLE 2: Rate and Volume Analysis

 

      Years ended December 31,  
      2010 compared to 2009     2009 compared to 2008  
      Change Due To:     Change Due To:  

(Dollars in thousands)

   Increase
(Decrease)
    Rate     Volume     Increase
(Decrease)
    Rate     Volume  

Interest income:

            

Securities

   $ (16   $ (163   $ 147      $ (36   $ (78   $ 42   

Loans

     (148     (77     (71     (99     (336     237   

Federal funds sold

     1        (0     1        (10     (31     21   
                                                

Total interest income

     (163     (240     77        (145     (445     300   
                                                

Interest expense:

            

Interest bearing deposits:

            

Checking

     1        0        1        (5     (4     (1

Money market savings

     (8     (5     (3     (2     95        (97

Regular savings

     1        1        0        (3     (3     (0

Time Deposits:

            

$100,000 and over

     (58     (181     123        (12     73        (85

Under $100,000

     (157     (159     2        (159     (169     10   

Federal funds purchased

     (1     —          (1     (4     (100     96   
                                                

Total interest bearing liabilities

     (222     (344     122        (185     (108     (77
                                                

Net interest income

   $ 59      $ 104      $ (45   $ 40      $ (337   $ 377   
                                                

Net Interest Income

Net interest income, CNB’s primary source of consolidated earnings, is the amount by which interest generated from earning assets exceeds the expense of funding those assets. Changes in volume and mix of interest earning assets and interest bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. Other factors affecting net interest income included paying higher interest rates to attract depositors and extending credit with lower interest rates to attract borrowers. For the year ended December 31, 2010, interest income and interest expense were $2.8 million and $912,000, respectively. For the year ended December 31, 2009, interest income was $3.0 million and interest expense was $1.1 million. Net interest income remained largely stable for 2010 at $1.9 million, increasing $59,000 or 3.2%, compared to $1.8 million for 2009.

Non-Interest Income

Non-interest income has been and will continue to be an important factor for increasing profitability. Management recognizes this importance and continues to review and consider areas where non-interest income can be increased. Non-interest income for the year ended December 31, 2010 was $242,000, compared to $224,000 for the year ended December 31, 2009. The Company’s main sources of non-interest income for the year ended December 31, 2010 were $69,000 from non-sufficient fund/overdraft accounts, $8,000 from shares owned in a local title insurance agency, and $37,000 from debit card and ATM activity. Also during 2010, the Company realized gains of $99,000 on the disposition of securities. The primary sources of non-interest income for the year ended December 31, 2009 were $74,000 from non-sufficient fund/overdraft accounts, $11,000 from fixed rate mortgage brokerage fees, $12,000 from shares owned in a local title insurance agency, and $27,000 from debit card and ATM activity, and realized gains of $67,000 on disposition of securities.

 

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TABLE 3: Non-Interest Income

 

     Year Ended December 31,  

(Dollars in thousands)

   2010      2009  

Service charges on deposit accounts

   $ 10       $ 12   

Other fees and commissions

     83         89   

Realized gain on sale of securities

     99         67   

Other operating income

     50         56   
                 

Total non-interest income

   $ 242       $ 224   
                 

Non-Interest Expense

Improving operating efficiency is as important to management as enhancing non-interest income. For the year ended December 31, 2010, major components of other operating expenses were ATM expense – $50,000, insurance – $27,000, FDIC assessments – $59,000, regulatory assessments – $29,000, and franchise taxes – $48,000. The same major components for the year ended December 31, 2009 were $45,000, $22,000, $73,000, $28,000, and $56,000, respectively. Comparatively, non-interest expense decreased 2.7% in 2010 from 2009.

TABLE 4: Non-Interest Expense

 

     Year Ended December 31,  

(Dollars in thousands)

   2010      2009  

Personnel

   $ 1,071       $ 1,138   

Occupancy and equipment

     127         123   

Professional fees

     215         218   

Advertising

     12         20   

Computer services

     109         90   

Other operating expenses

     428         428   
                 

Total non-interest expense

   $ 1,962       $ 2,017   
                 

Summary of Loan Loss Experience

The allowance for loan losses is an estimate of the amount that will be adequate to provide for potential losses in the Bank’s loan portfolio. Management’s methodology in evaluating the adequacy of the allowance for loan losses considers potential specific losses, as well as the volume, growth, composition, and loss history of the loan portfolio. General economic trends as well as any conditions affecting individual borrowers may also affect the level of loan losses. The allowance is periodically examined by bank regulators for adequacy. Examiners take into account factors such as the methodology used to calculate the allowance and the size of allowance in comparison to peer financial institutions.

The Bank’s Loan Committee and Board of Directors review problem loans monthly, including their effect on the allowance for loan losses. In management’s opinion, the allowance for loan losses is adequate to absorb the current estimated risk of loss in the loan portfolio. The Company’s management continually evaluates the adequacy of the allowance for loan losses, and changes in the provision are based on the analyzed inherent risk of the loan portfolio. The allowance is increased by the provision for loan losses and reduced by loans charged off, net of recoveries. The following table summarizes loans charged off, recoveries of loans previously charged off and additions to the reserve that have been charged to operating expense for the periods indicated. We have no lease financing or foreign loans.

TABLE 5: Allowance for Loan Losses

 

     Year Ended December 31,  

(Dollars in thousands)

   2010     2009  

Allowance, beginning of period

   $ 686      $ 493   

Provision for loan losses

     91        1,194   

Loans charged off

     (157     (1,002

Recoveries of loans previously charged off

     —          1   
                

Allowance, end of period

   $ 620      $ 686   
                

 

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The allocation of the allowance at December 31, 2010 and 2009 and the ratio of related outstanding loan balances to total loans are as follows:

TABLE 6: Allocation of Allowance for Loan Losses

 

     2010     2009  

(Dollars in thousands)

   Allowance for
Loan Losses
     Percent of Loans
in Category to
Total Loans
    Allowance for
Loan Losses
     Percent of Loans
in Category to
Total Loans
 

Commercial and industrial

   $ 109         8.05   $ 115         9.39

Real estate commercial

     311         39.75        268         34.55   

Real estate consumer

     123         44.13        161         44.78   

Consumer installment

     77         8.07        137         11.28   

Unallocated

     —           N/A        5         N/A   
                                  

Balance, December 31

   $ 620         100.00   $ 686         100.00
                                  

Financial Condition

Summary

A financial institution’s primary sources of revenue are generated by its earning assets, while its major expenses are produced by the funding of those assets with interest-bearing liabilities. Effective management of these sources and uses of funds is essential in attaining profitability while maintaining an acceptable level of risk. At December 31, 2010, the Company had $49.3 million in total assets. Interest-earning assets were $47.3 million and interest-bearing liabilities were $39.8 million.

At December 31, 2009, the Company had $47.5 million in total assets. Interest-earning assets and interest-bearing liabilities were $45.6 million and $38.4 million, respectively.

Loan Portfolio

CNB’s loan portfolio is its largest and most profitable component of earning assets, totaling 75.8% of interest-earning assets at December 31, 2010 and 80.7% at December 31, 2009. The Company, through the Bank, engages in a wide range of lending activities, which include one-to-four family and multi-family residential mortgage loans, commercial real estate loans, construction loans, land acquisition and development loans, consumer loans, and commercial business loans. CNB continues to emphasize loan portfolio growth and diversification as a means of increasing earnings while minimizing credit risk.

TABLE 7: Loan Portfolio

 

      December 31,  

(Dollars in thousands)

   2010      2009  

Commercial and industrial

   $ 2,663       $ 3,154   

Real estate construction

     3,759         4,431   

Real estate mortgage:

     

Residential (1-4 family)

     10,869         10,871   

Home equity lines

     1,179         1,151   

Non-farm, non-residential (1)

     14,240         12,696   

Agricultural

     222         297   

Consumer installment

     2,889         4,143   
                 

Total loans

   $ 35,821       $ 36,743   
                 

 

(1) This category generally consists of commercial and industrial loans where real estate constitutes a source of collateral.

Non-farm, non-residential loans are typically owner-occupied commercial buildings. At December 31, 2010, non-farm, non-residential loans were 39.8% of the total portfolio, compared to 34.6% at December 31, 2009. Commercial, industrial and agricultural loan portfolio consists of secured and unsecured loans to small businesses, comprising 8.1% and 9.4% of the total portfolio at December 31, 2010 and 2009, respectively.

CNB’s unfunded loan commitments totaled $2.9 million at December 31, 2009 and $2.7 million at December 31, 2009.

The following table reflects the maturity distribution of selected loan categories at December 31, 2010.

 

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TABLE 8: Remaining Maturities of Selected Loan Categories

 

(Dollars in thousands)

   Commercial and
Industrial,
Agricultural
     Real Estate -
Construction
 

Variable Rate:

     

Within 1 year

   $ 10       $ 353   

Fixed Rate:

     

Within 1 year

     1,777         2,592   

1 to 5 years

     1,098         814   

After 5 years

     —           —     
                 

Total Maturities

   $ 2,885       $ 3,759   
                 

Loans are placed on non-accrual status when collection of principal and interest is doubtful, generally when a loan becomes 90 days past due. There are three negative implications for earnings when a loan is placed on non-accrual status. First, all interest accrued but unpaid at the date that the loan is placed on non-accrual status is either deducted from interest income or written off as a loss. Second, accruals of interest are discontinued until it becomes certain that both principal and interest can be repaid. Finally, there may be actual losses that may require that additional provision for loan losses be charged against earnings. For real estate loans, upon foreclosure, the balance of the loan is transferred to “Other Real Estate Owned” (OREO) and carried at the lower of the outstanding loan balance or the fair market value of the property less costs to sell based on current appraisals and other current market trends. If a write down of the OREO property is necessary at the time of foreclosure, the amount is charged-off against the allowance for loan losses. A review of the recorded property value is performed in conjunction with normal loan reviews, and if market conditions indicate that the recorded value exceeds the fair market value less costs to sell, additional write downs of the property value are charged directly to operations.

Nonperforming assets consist of non-accrual loans, loans restructured due to debtors’ financial difficulties, loans past due 90 days or more as to interest or principal and still accruing, and other real estate owned, which is real estate acquired through foreclosure and repossession. Non-accrual loans are those loans on which recognition of interest income has been discontinued. Restructured loans generally allow for an extension of the original repayment period or a reduction or deferral of interest or principal because of deterioration in the financial position of the borrower. Loans, whether secured or unsecured, are generally placed on non-accrual status when principal and/or interest is 90 days or more past due, or sooner if it is known or expected that the collection of all principal and/or interest is unlikely. Any loan past due 90 days or more, if not classified as non-accrual based on a determination of collectibility, is classified as a past-due loan. Other real estate owned is initially recorded at the lower of cost or estimated market value less costs to sell at the date of acquisition. A provision for estimated losses is recorded when a subsequent decline in value occurs.

At December 31, 2010, the Company had nonperforming assets of twelve loans on non-accrual totaling $1.8 million. Of these twelve loans, nine loans totaling $1.8 million were classified as impaired. Two loans, which were also non-accrual and impaired, totaling $437,000 were classified as doubtful for regulatory purposes, There were no loans delinquent 90 days or more and still accruing and no loans classified for regulatory purposes as loss. The Company had other real estate owned in the amount of $270,000. The Company had nonperforming assets of seven loans on non-accrual totaling $920,000 at December 31, 2009. Five loans totaling $919,000 classified as non-accrual were also classified as impaired. Four loans, two of which were also non-accrual and impaired, totaling $525,000 were also classified for regulatory purposes as doubtful. There were no loans delinquent 90 days or more and still accruing interest or classified for regulatory purposes as loss or other real estate owned. We have no loans in our portfolio to borrowers in foreign countries.

Loan concentrations exist when large amounts of money are loaned to multiple borrowers who would be similarly impacted by economic or other conditions. The loan portfolio is concentrated in various commercial, real estate and consumer loans to individuals and entities located in our primary service area. Accordingly, the ultimate collectibility of the loans is largely dependent upon economic conditions of our primary service area. Other than our geographic concentrations due to our physical location and the loan type concentrations as shown in the above table, we have no other concentrations of loans that exceed 10% of our total loan portfolio as of December 31, 2010.

We have no other interest-bearing assets that would be required to be disclosed as nonperforming assets if they were loans.

 

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Securities Portfolio

The investment portfolio plays a primary role in the management of interest rate sensitivity of the Company and generates substantial interest income. In addition, the portfolio serves as a source of liquidity. Table 9 presents information pertaining to the composition of the securities portfolio. CNB manages its investment portfolio consistent with established policies that include guidelines for maturity distribution, rate sensitivity, and liquidity needs. The investment portfolio consists of securities available for sale, which may be sold in response to established policies. These securities are carried at estimated fair value, which was $7.8 million at December 31, 2010.

TABLE 9: Securities Available for Sale, Maturity Distribution and Average Yields

 

(Dollars in thousands)

   Amortized
Cost
     Fair
Value
     Weighted
Average
Yield
 

U.S. government agencies and corporations:

        

Maturing within 1 to 5 years

   $ 500       $ 496         2.25

Maturing within 5 to 10 years

     3,036         2,964         2.06   

Maturing after 10 years

     3,199         3,252         3.90   
                          

Total U.S. government agencies and corporations

     6,735         6,712         3.23   

State and municipals:

        

Maturing within 5 to 10 years

     530         533         5.25   

Maturing after 10 years

     538         509         4.20   
                          

Total state and municipals

     1,068         1,042         4.73   
                          

Total securities

   $ 7,803       $ 7,754         3.43
                          

Deposits

Deposits are an important funding source and the primary supplier of CNB’s growth. The Company’s strategy has been to increase its core deposits at the same time that it controls its cost of funds. CNB’s deposit base is comprised of demand deposits, savings and money market accounts, time deposits and individual retirement accounts. These deposits are provided by individuals and businesses located within the communities served.

Table 10 presents the average deposit balances and average rates paid for the periods ended December 31, 2010 and 2009. Table 11 details maturities of certificates of deposit with balances of $100,000 or more at December 31, 2010.

TABLE 10: Average Deposits and Rates Paid

 

      December 31,  
      2010     2009  

(In thousands)

   Amount      Rate     Amount      Rate  

Non-interest bearing deposits

   $ 2,931         $ 2,877      
                      

Interest bearing accounts:

          

Interest checking

     1,056         0.47     911         0.44

Regular savings

     1,429         0.28        1,260         0.24   

Money market accounts

     906         0.77        1,198         1.25   

Time deposits:

          

$100,000 and greater

     15,397         2.62        13,125         3.52   

Under $100,000

     19,477         2.53        19,416         3.34   
                                  

Total interest bearing deposits

     38,265         2.38     35,910         3.16
                                  

Total

   $ 41,196         $ 38,787      
                      

 

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TABLE 11: Maturities of Certificates of Deposits with Balances of $100,000 or More

 

(Dollars in thousands)

   Within
Three
Months
     Three to
Six
Months
     Six to
Twelve
Months
     Over
One
Year
     Total      Percent
of Total
Deposits
 

At December 31, 2010

   $ 3,101       $ 1,732       $ 3,268       $ 8,532       $ 16,633         39.10

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 as well as loans and securities maturing within one year. As a result of CNB’s management of liquid assets and the ability to generate liquidity through liability funding, management believes CNB maintains overall liquidity sufficient to satisfy its depositors’ requirements and meet its customers’ credit needs.

Although maintaining and increasing deposits will serve as the primary source of liquidity, CNB maintains additional sources of liquidity through a federal funds line with Community Bankers Bank. At December 31, 2010, cash, federal funds sold, securities available for sale, and loans maturing within one year were 56.3% of total deposits and liabilities.

The Company’s primary component of market risk is interest rate volatility. Fluctuations in interest rates will impact both the level of interest income and interest expense and the market value of the Company’s interest earning assets and interest bearing liabilities. The primary technique for managing interest rate risk exposure is management of the interest sensitivity gap. The interest sensitivity gap is defined as the difference between the amount of interest earning assets anticipated to mature or re-price within a specific time period and the amount of interest bearing liabilities anticipated to mature or re-price within that same time period. During a period of rising interest rates, a “positive gap” implies that net interest income would be positively affected because the yield of the Company’s interest earning assets is likely to rise more quickly than the cost of its interest bearing liabilities. In a period of falling interest rates, the opposite effect on net income is likely to occur. Table 12 sets forth the amounts of interest earning assets and interest bearing liabilities outstanding at December 31, 2010.

TABLE 12: Interest Rate Sensitivity

 

(Dollars in thousands)

   0 - 3
Months
    3 - 12
Months
    1 - 5
Years
    Over 5
Years
    Total  

Interest Earning Assets

          

Securities

   $ —        $ 496      $ —        $ 7,258      $ 7,754   

Loans

     5,661        6,572        23,587        1        35,821   

Federal funds sold

     3,454        —          —          —          3,454   
                                        

Total

   $ 9,115      $ 7,068      $ 23,587      $ 7,259      $ 47,029   

Cumulative totals

   $ 9,115      $ 16,183      $ 39,770      $ 47,029     

Interest Bearing Liabilities

          

Interest checking (1)

   $ 1,098      $ —        $ —        $ —        $ 1,098   

Savings (1)

     1,328        —          —          —          1,328   

Money Market (1)

     891        —          —          —          891   

Time Deposits

     5,487        12,507        18,460        —          36,454   
                                        

Total

   $ 8,804      $ 12,507      $ 18,460      $ —        $ 39,771   

Cumulative totals

   $ 8,804      $ 21,311      $ 39,771      $ 39,771     
                                        

Interest sensitivity gap

   $ 311      $ (5,439   $ 5,127      $ 7,259      $ 7,258   

Cumulative interest sensitivity gap

   $ 311      $ (5,128   $ (1   $ 7,258     

Cumulative interest sensitivity gap to total interest earning assets

     0.66     -10.90     0.00     15.43  

 

(1) Non-maturity, interest sensitive, deposits are classified as repriceable within 0-3 months, under the assumption that rates are subject to change weekly, at the discretion of management.

 

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Capital Resources

The assessment of capital adequacy depends on a number of factors such as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. Management reviews the adequacy of capital on an ongoing basis and seeks to maintain a structure that will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

At December 31, 2010, consolidated shareholders’ equity was $6.7 million or 13.5% of total assets. At December 31, 2009, consolidated shareholder’s equity was $6.5 million or 13.7% of total assets. The Company’s common stock had a tangible book value of $4.44 per share at December 31, 2010 and $4.34 per share at December 31, 2009.

TABLE 13: Capital Analysis

 

      December 31,  

(In thousands)

   2010     2009  

Tier 1 Capital:

    

Common stock

   $ 15      $ 15   

Capital surplus

     9,567        9,567   

Retained earnings (deficit)

     (2,872     (2,967
                

Total Tier 1 capital

     6,710        6,615   

Tier 2 Capital:

    

Allowance for loan losses

     453        462   
                

Total risk-based capital

   $ 7,163      $ 7,077   
                

Risk weighted assets

   $ 36,112      $ 36,744   

CAPITAL RATIOS:

    

Tier 1 risk-based capital ratio

     18.58     18.00

Total risk-based capital ratio

     19.84     19.26

Tier 1 capital to average total assets

     13.63     13.70

Off-Balance Sheet Arrangements

We are a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of our customers. These financial instruments consist of commitments to extend credit and standby letters of credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Standby letters of credit are written conditional commitments issued by a bank to guarantee the performance of a customer to a third party. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. A commitment involves, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets. Our exposure to credit loss in the event of non-performance by the other party to the instrument is represented by the contractual notional amount of the instrument.

Because certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We use the same credit policies in making commitments to extend credit as we do for on-balance-sheet instruments. Collateral held for commitments to extend credit varies but may include accounts receivable, inventory, property, plant, equipment, and income-producing commercial properties.

Our off-balance-sheet financial instruments whose contract amounts represented credit risk as of December 31, 2010 were unfulfilled loan commitments of $2.9 million. The Company had no standby letters of credit as of December 31, 2010.

No losses are anticipated as a result of the foregoing commitments and we do not feel that they are reasonably likely to have a material effect on our consolidated financial condition.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The Quantitative and Qualitative Disclosures about Market Risk is not required by smaller reporting companies.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements are included in this Item 8:

 

   

Consolidated Financial Statements:

 

  1. Consolidated Balance Sheets dated as of December 31, 2010 and 2009.

 

  2. Consolidated Statements of Operations for years ended December 31, 2010 and 2009.

 

  3. Consolidated Statements of Changes in Shareholders’ Equity for years ended December 31, 2010 and 2009.

 

  4. Consolidated Statements of Cash Flows for years ended December 31, 2010 and 2009.

 

  5. Notes to Consolidated Financial Statements.

 

   

Report of Independent Registered Public Accounting Firm

 

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CNB BANCORP, INC.

CONSOLIDATED BALANCE SHEETS

      December 31,  

(In thousands, except share and per share data)

   2010     2009  

Assets

    

Cash and due from banks

   $ 597      $ 634   

Federal funds sold

     3,454        1,197   

Securities available for sale, at fair value

     7,754        7,414   

Restricted securities, at cost

     246        199   

Loans, net of allowance for loan losses of $620 and $686 on December 31, 2010 and 2009

     35,201        36,057   

Premises and equipment, net

     1,370        1,420   

Foreclosed real estate

     270        —     

Other assets

     454        596   
                

Total assets

   $ 49,346      $ 47,517   
                

Liabilities and Shareholders’ Equity

    

Liabilities

    

Non-interest bearing deposits

   $ 2,766      $ 2,461   

Interest bearing deposits

     39,771        38,359   
                

Total deposits

     42,537        40,820   

Accrued interest payable

     87        96   

Other liabilities

     61        91   
                

Total liabilities

     42,685        41,007   
                

Shareholders’ Equity

    

Common stock, $.01 par, 10,000,000 shares authorized, 1,500,427 shares issued and outstanding at December 31, 2010 and 2009

     15        15   

Additional paid-in capital

     9,567        9,567   

Retained earnings (deficit)

     (2,872     (2,967

Accumulated other comprehensive (loss)

     (49     (105
                

Total shareholders’ equity

     6,661        6,510   
                

Total liabilities and shareholders’ equity

   $ 49,346      $ 47,517   
                

See Notes to Consolidated Financial Statements.

 

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CNB BANCORP, INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

      For the Years Ended
December 31,
 

(In thousands, except share and per share data)

   2010      2009  

Interest and Dividend Income

     

Loans, including fees

   $ 2,538       $ 2,686   

Investment securities, taxable

     277         293   

Federal funds sold

     3         2   
                 

Total Interest and Dividend Income

     2,818         2,981   
                 

Interest Expense

     

Deposits

     912         1,133   

Other borrowings

     —           1   
                 

Total Interest Expense

     912         1,134   
                 

Net Interest Income

     1,906         1,847   

Provision for Loan Losses

     91         1,194   
                 

Net Interest Income after Provision for Loan Losses

     1,815         653   
                 

Non-Interest Income

     

Service charges on deposit accounts

     10         12   

Other fees and commissions

     83         89   

Net realized gains on disposition of securities

     99         67   

Income from investment in title company

     8         12   

Other income

     42         44   
                 

Total Non-Interest Income

     242         224   
                 

Non-Interest Expense

     

Personnel

     1,071         1,138   

Occupancy and equipment

     127         123   

Professional fees

     215         218   

Advertising

     12         20   

Computer services

     109         90   

Other

     428         428   
                 

Total Non-Interest Expense

     1,962         2,017   
                 

Net Income (Loss)

   $ 95       $ (1,140
                 

Earnings (loss) per share, basic and diluted

   $ 0.06       $ (0.76
                 

Weighted average shares outstanding, basic and diluted

     1,500,427         1,500,427   
                 

See Notes to Consolidated Financial Statements.

 

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CNB BANCORP, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

For the Years Ended December 31, 2010 and 2009

 

(Dollars in thousands)

   Shares of
Common
Stock
     Common
Stock
     Additional
Paid-in
Capital
     Retained
Earnings
(Deficit)
    Accumulated
Other
Comprehensive
Income
(Loss)
    Comprehensive
Income

(Loss)
    Total  
                 
                 
                 
                 
                 

Balance - December 31, 2009

     1,500,427       $ 15       $ 9,567       $ (2,967   $ (105     $ 6,510   

Comprehensive income:

                 

Net income

     —           —           —           95        —        $ 95        95   

Other comprehensive income:

                 

Unrealized gain on securities available for sale

     —           —           —           —          —          155        —     

Reclassification adjustment

     —           —           —           —          —          (99     —     
                       

Total other comprehensive income

     —           —           —           —          56      $ 56        56   
                       

Total comprehensive income

     —           —           —           —          —        $ 151        —     
                                                           

Balance - December 31, 2010

     1,500,427       $ 15       $ 9,567       $ (2,872   $ (49     $ 6,661   
                                                     

Balance - December 31, 2008

     1,500,427       $ 15       $ 9,567       $ (1,827   $ 47        $ 7,802   

Comprehensive loss:

                 

Net loss

     —           —           —           (1,140     —        $ (1,140     (1,140

Other comprehensive loss:

                 

Unrealized loss on securities available for sale

     —           —           —           —          —          (85     —     

Reclassification adjustment

     —           —           —           —          —          (67     —     
                       

Total other comprehensive loss

     —           —           —           —          (152   $ (152     (152
                       

Total comprehensive loss

     —           —           —           —          —        $ (1,292     —     
                                                           

Balance - December 31, 2009

     1,500,427       $ 15       $ 9,567       $ (2,967   $ (105     $ 6,510   
                                                     

See Notes to Consolidated Financial Statements.

 

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CNB BANCORP, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

     For the Years Ended
December 31,
 

(Dollars in thousands)

   2010     2009  

Cash Flows From Operating Activities

    

Reconciliation of net income (loss) to net cash provided by (used in) operating activities:

    

Net income (loss)

   $ 95      $ (1,140

Provision for loan losses

     91        1,194   

Depreciation and amortization

     83        83   

Net amortization of securities

     75        54   

Realized gain on securities

     (99     (67

Changes in:

    

Interest receivable

     47        5   

Other assets

     72        (213

Interest payable

     (9     (20

Other liabilities

     (30     76   
                

Net cash provided by (used in) operating activities

     325        (28
                

Cash Flows From Investing Activities

    

Purchase of available for sale securities

     (7,751     (8,230

Proceeds from sales, calls and maturities of available for sale securities

     7,491        5,725   

Purchase of restricted securities

     (47     —     

Purchase of property and equipment

     (10     (33

Net (increase) decrease in loans

     495        (1,330
                

Net cash provided by (used in) investing activities

     178        (3,868
                

Cash Flows From Financing Activities

    

Net increase (decrease) in non-interest bearing deposits

     305        (539

Net increase in interest bearing deposits

     1,412        4,057   
                

Net cash provided by financing activities

     1,717        3,518   
                

Net increase (decrease) in cash and cash equivalents

   $ 2,220      $ (378

Cash and Cash Equivalents

    

Beginning

     1,831        2,209   
                

Ending

   $ 4,051      $ 1,831   
                

Supplemental Disclosures of Cash Flow Information

    

Cash payments for interest

   $ 921      $ 1,154   
                

Unrealized gain (loss) on available for sale securities

   $ 56      $ (152
                

Transfer between loans and other real estate owned

   $ 270      $ —     
                

See Notes to Consolidated Financial Statements.

 

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CNB BANCORP, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

 

NOTE 1: Organization and Significant Accounting Policies

CNB Bancorp, Inc. (the Company) was organized on November 12, 2001 to serve as a Virginia bank holding company for Citizens National Bank (the Bank). The Bank was organized as a national bank under the laws of the United States of America to engage in a general banking business serving the community in and around Windsor, Virginia.

The Bank commenced regular operations on April 29, 2003 and is a member of the Federal Deposit Insurance Corporation. It is subject to the regulations of the Office of the Comptroller of the Currency and the State Corporation Commission of Virginia. Consequently, it undergoes periodic examinations by these regulatory authorities.

The accounting and reporting policies of the Company and its subsidiary conform to accounting principles generally accepted in the United States of America and to general practices within the banking industry. The following is a summary of the more significant policies.

Principles of Consolidation

The consolidated financial statements of CNB Bancorp, Inc. and its subsidiary Bank include the accounts of both companies. All material intercompany balances and transactions have been eliminated.

Use of Estimates

In preparing consolidated financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses fair value measurements and the valuation of net deferred tax assets and other real estate.

Cash and Cash Equivalents

For purposes of reporting cash flows, cash and cash equivalents include cash on hand, amounts due from banks and federal funds sold. Generally, federal funds are purchased and sold for one-day periods.

Securities

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income. The Company had no securities classified as held to maturity at December 31, 2010 and 2009.

Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. The Company accounts for the impairment of securities by specifying that (a) if the Company does not have the intent to sell a debt security prior to recovery and (b) it is more likely than not that it will not have to sell the debt security prior to recovery, the security would not be considered other-than-temporarily impaired unless there is a credit loss. When the Company does not intend to sell the security, and it more likely than not it will not have to sell the security before recovery of its cost basis, it will recognize the credit component of an other-than-temporary impairment of a debt security in earnings and the remaining portion in other comprehensive income. Gains and losses on the sale of securities are recorded on the trade date and are determined on the basis of the cost of the securities sold using the specific identification method.

Restricted Securities

The Company has elected to maintain an investment in the capital stock of certain correspondent banks. No ready market exists for this stock, and it has no quoted market value. The Company’s investment in these stocks is recorded at cost.

Restricted securities include Federal Reserve Bank and Community Bankers’ Bank stock.

 

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Loans

The Company’s subsidiary Bank grants mortgages, commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by mortgage loans throughout the Isle of Wight and Southampton counties of Virginia. The ability of debtors to honor their loan contracts is dependent upon the real estate and general economic conditions of this area.

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off generally are reported at their outstanding unpaid principal balances less the allowance for loan losses. Interest income is accrued on the unpaid principal balance.

The accrual of interest on mortgage and commercial loans is discontinued at the time the loan is 90 days delinquent unless the credit is well-secured and in the process of collection. Personal loans are typically charged off no later than 180 days past due. In all cases, loans are placed on non-accrual or charged off at an earlier date if collection of principal or interest is considered doubtful.

All interest accrued but not collected for loans that are placed on non-accrual or charged off is reversed against interest income. The interest on these loans is accounted for using the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Allowance for Loan Losses

The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses for each segment are charged against the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when:

 

   

Management believes that the collectability of the principal is unlikely regardless of delinquency status.

 

   

The loan is a consumer loan and is 120 days past due.

 

   

The loan is a non-consumer loan and is 180 days past due, unless the loan is well secured and recovery is probable.

 

   

The borrower is in bankruptcy, unless the debt has been reaffirmed, is well secured and recovery is probable.

Subsequent recoveries, if any, are credited to the allowance.

The allowance represents an amount that, in management’s judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Management’s judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available. The evaluation also considers the following risk characteristics of each loan segment:

 

   

Consumer real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of collateral.

 

   

Construction and land development loans carry risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may, at any point in time, be less than the principal amount of the loan. Construction loans also bear the risk that the general contractor, who may or may not be a loan customer, may be unable to finish the construction project as planned because of financial pressure unrelated to the project.

 

   

Commercial – non real estate carry risks associated with continued successful operation of a business because the repayment of these loans is generally dependent upon the profitability and cash flows of the business. In addition, there is risk associated with the value of collateral other than real estate which may depreciate over time and cannot be appraised with as much precision.

 

   

Commercial real estate loans carry risks associated with the successful operation of a business or a real estate project, in addition to other risks associated with the ownership of real estate, because the repayment of these loans may be dependent upon the profitability and cash flows of the business or project, and changes in the value of collateral.

 

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Consumer – non real estate loans carry risks associated with the continued credit-worthiness of the borrower and the value of the collateral (e.g., rapidly-depreciating assets such as automobiles), or lack thereof. Consumer loans are more likely than real estate loans to be immediately adversely affected by job loss, divorce, illness or personal bankruptcy.

The allowance consists of specific and general components. The specific component relates to loans that are classified as either doubtful or substandard. For such loans that are also classified as impaired, an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of comparable properties or general market conditions when appropriate. The general component covers non-classified, or performing loans, special mention loans, and those loans classified as substandard that are not impaired. The general component is based on historical loss experience adjusted for changes in the following qualitative factors: value of underlying collateral, lending policy/underwriting practices, national and local economic conditions, portfolio volume and nature, staff experience and depth, levels of past due, levels of non-accrual, portfolio quality, loan review/oversight, impact and effects of concentrations, legal matters, and competition. Non-impaired classified loans are assigned a higher allowance factor which increases with the severity of classification than non-classified loans. The characteristics of the loan ratings are as follows:

 

   

Pass rated loans are to persons or business entities with an acceptable financial condition, appropriate collateral margins, appropriate cash flow to service the existing loan, and an appropriate leverage ratio. The borrower has paid all obligations as agreed and it is expected that this type of payment history will continue. When necessary, acceptable personal guarantors support the loan.

 

   

Special mention loans have a specific defined weakness in the borrower’s operations and the borrower’s ability to generate positive cash flow on a sustained basis. The borrower’s recent payment history is characterized by late payments. The Company’s risk exposure is mitigated by collateral supporting the loan. The collateral is considered to be well-margined, well maintained, accessible and readily marketable.

 

   

Substandard loans are considered to have specific and well-defined weaknesses that jeopardize the viability of the Company’s credit extension. The payment history for the loan has been inconsistent and the expected or projected primary repayment source may be inadequate to service the loan. The estimated net liquidation value of the collateral pledged and/or ability of the personal guarantor(s) to pay the loan may not adequately protect the Company. There is a distinct possibility that the Company will sustain some loss if the deficiencies associated with the loan are not corrected in the near term. A substandard loan would not automatically meet our definition of impaired unless the loan is significantly past due and the borrower’s performance and financial condition provide evidence that it is probable that the Company will be unable to collect all amounts due.

 

   

Substandard nonaccrual loans have the same characteristics as substandard loans; however, they have a non-accrual classification.

 

   

Doubtful rated loans have all the weaknesses inherent in a loan that is classified substandard but with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. The possibility of loss is extremely high.

 

   

Loss rated loans are not considered collectible under normal circumstances and there is no realistic expectation for any future payment on the loan. Loss rated loans are fully charged off.

A loan is considered impaired when, based on current information and events, it is probable that the Company’s subsidiary bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. As of December 31, 2010, the Company did not have any loans classified as troubled debt restructurings.

 

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Loan Fees and Costs

Loan origination and commitment fees and direct loan costs are being recognized as collected and incurred. The use of this method of recognition does not produce results that are materially different from results which would have been produced if such costs and fees were deferred and amortized as an adjustment of the loan yield over the life of the related loan.

Premises and Equipment

Land is carried at cost. Buildings and equipment are carried at cost less accumulated depreciation computed using a straight-line method over the estimated useful lives of the assets. Estimated useful lives range from ten to forty years for buildings and from three to ten years for equipment, furniture, and fixtures. Maintenance and repairs are charged to expense as incurred and major improvements are capitalized.

Foreclosed Property

Assets acquired through, or in lieu of, loan foreclosure are held for sale. They are initially recorded at the lower of the Bank’s cost or the assets’ fair market value at the date of foreclosure, less estimated selling costs thus establishing a new cost basis. Subsequent to foreclosure, valuations of the assets are periodically performed by management. Adjustments are made to the lower of the carrying amount or fair market value of the assets less selling costs. Revenue and expenses from operations and valuation changes are included in net expenses from foreclosed assets. The Bank had foreclosed assets of $270,000 at December 31, 2010 and no foreclosed assets at December 31, 2009.

Income Taxes

Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary difference between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized.

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. Interest and penalties associated with unrecognized tax benefits are classified as additional income taxes in the statements of income.

Earnings per Share

Basic earnings per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period. Diluted earnings per share reflects additional common shares that would have been outstanding if dilutive potential common shares had been issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and warrants, and are determined using the treasury stock method.

Advertising Costs

The Company follows the policy of charging the costs of advertising to expense as incurred. For the years ended December 31, 2010 and 2009, the Company expensed $12,000 and $20,000, respectively, for advertising costs.

Comprehensive Income

Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, are reported as a separate component of the equity section of the consolidated balance sheet, such items, along with net income are components of comprehensive income.

 

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Stock-Based Compensation Plan

The 2003 Stock Incentive Plan was approved by shareholders on August 12, 2003, which authorized 126,255 shares of common stock to be used in the granting of options to employees and directors, and which Plan was last amended by shareholder vote at a special meeting held November 17, 2005. An option’s maximum term is ten years from the date of grant. Options granted under the plan may be subject to a graded vesting schedule.

Applicable accounting guidance requires the costs resulting from all share-based payments be recognized in the financial statements. The Company measures the cost of employee services received in exchange for stock options based on the grant date fair value of these awards as calculated using the Black-Scholes option-pricing model. The cost is recognized over the period the employee is required to provide services for the award. No stock-based compensation was recognized during the years ended December 31, 2010 and 2009 as no options or warrants were granted or vested.

Reclassifications

Certain reclassifications have been made to prior periods to conform to current year presentation.

Recent Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (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 the Accounting Standards Codification (Codification) in December 2009 through the issuance of Accounting Standards Update (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 any, in transferred financial assets. ASU 2009-16 was effective for transfers on or after January 1, 2010. 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 variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into the 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 was 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 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 Securities and Exchange Commission (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 ASU 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 ASU 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 was 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 significantly expands 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 became effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.

On September 15, 2010, the SEC issued Release No. 33-9142, “Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers.” This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Act. SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010.

On September 17, 2010, the SEC issued Release No. 33-9144, “Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management’s Discussion and Analysis.” This interpretive release is intended to improve discussion of liquidity and capital resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant. This release was issued in conjunction with a proposed rule, “Short-Term Borrowings Disclosures,” that would require public companies to disclose additional information to investors about their short-term borrowing arrangements. Release No. 33-9144 became effective on September 28, 2010.

In January 2011, the FASB issued ASU 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20.” The amendments in this ASU temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.

In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance is not expected to have a material impact on the Company’s consolidated financial statements.

The SEC has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting,” which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.

 

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NOTE 2: Securities

The amortized cost and fair value of securities available for sale as of December 31, 2010 and 2009 are as follows:

 

     December 31, 2010  

(Dollars in thousands)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
(Losses)
    Fair
Value
 

U.S. Government and federal agencies

   $ 6,235       $ 63       $ (82   $ 6,216   

Corporate bonds

     500         —           (4     496   

State and municipals, taxable

     1,068         2         (28     1,042   
                                  
   $ 7,803       $ 65       $ (114   $ 7,754   
                                  

 

     December 31, 2009  

(Dollars in thousands)

   Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
(Losses)
    Fair
Value
 

U.S. Government and federal agencies

   $ 5,973       $ 13       $ (85   $ 5,901   

Corporate bonds

     1,012         —           (18     994   

State and municipals, taxable

     534         —           (15     519   
                                  
   $ 7,519       $ 13       $ (118   $ 7,414   
                                  

The amortized cost and estimated fair value of securities at December 31, 2010, by contractual maturity, are shown below. Expected maturities will differ from contractual maturities because issuers may have the right to prepay obligations with or without call or prepayment penalties.

 

(Dollars in thousands)

   Amortized
Cost
     Fair
Value
 

Due in one year or less

   $ —         $ —     

Due after one year through five years

     500         496   

Due after five through ten years

     3,566         3,497   

Due after ten years

     3,737         3,761   
                 
   $ 7,803       $ 7,754   
                 

At December 31, 2010 and 2009, securities with a carrying value of $802,000 and $538,000, respectively, were pledged to secure public deposits and for other purposes required or permitted by law.

Proceeds from the sales, maturities and the calls of securities available for sale in 2010 and 2009 were $7.5 million and $5.7 million, respectively. During 2010 and 2009, the Company realized gains on the disposition of securities of $99,000 and $67,000, respectively.

The primary purpose of the investment portfolio is to generate income and meet liquidity needs of the Company through readily saleable financial instruments. The portfolio is made up of fixed rate bonds, whose prices move inversely with rates. At the end of any accounting period, the investment portfolio has unrealized gains and losses. The Company monitors the portfolio, which is subject to liquidity needs, market rate changes, and credit risk changes, to see if adjustments are needed. The primary concern in a loss situation is the credit quality of the business behind the instrument. The primary cause of impairments is the decline in the prices in the current rate environment. There were four accounts and ten accounts in the portfolio that had unrealized losses at December 31, 2010 and 2009, respectively. These losses are relative to the market rates and the timing of purchases and are not due to credit concerns of the issuers as all accounts are classified as investment grade. The Company does not intend to sell these securities and it is not more likely than not that the Company will be required to sell these securities. Therefore, the Company did not recognize any other-than-temporary impairment losses for the years ended December 31, 2010 or 2009.

 

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Table of Contents
     December 31, 2010  
     Less than 12 months     12 months or more  

(Dollars in thousands)

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

U.S. Government and federal agencies

   $ 2,168       $ (82   $  —         $  —     

Corporate bonds

     496         (4     —           —     

State and municipal bonds, taxable

     509         (28     —           —     
     December 31, 2009  
     Less than 12 months     12 months or more  

(Dollars in thousands)

   Fair
Value
     Unrealized
Losses
    Fair
Value
     Unrealized
Losses
 

U.S. Government and federal agencies

   $ 4,376       $ (64   $ 479       $ (21

Corporate bonds

     —           —          993         (18

State and municipal bonds, taxable

     519         (15     —           —     

 

NOTE 3: Loans

The composition of loans is summarized as follows:

 

     December 31,  

(Dollars in thousands)

   2010      2009  

Commercial - Non Real Estate

     

Commercial and Industrial

   $ 2,758       $ 3,244   

Commercial Real Estate

     

Owner occupied

     9,924         8,645   

Non-owner occupied

     4,254         4,014   

Construction and Land Development

     

Residential

     1,568         2,440   

Commercial

     2,191         1,991   

Consumer - Non Real Estate

     2,889         4,143   

Consumer Real Estate

     

Single Family

     10,869         10,871   

Multifamily

     189         244   

Equity Lines

     1,179         1,151   
                 

Total loans

     35,821         36,743   

Less: Allowance for loan losses

     620         686   
                 

Net loans

   $ 35,201       $ 36,057   
                 

 

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The aging of past due and nonaccrual loans as of December 31, 2010 by class is summarized as follows:

 

(Dollars in thousands)

   30-59 Days
Past Due
     60-89 Days
Past Due
     90 Days Past
Due and Still
Accruing
     Nonaccrual
Loans
     Total Past
Due
     Current      Total Loans  

Commercial - Non Real Estate

                    

Commercial and Industrial

   $ 175       $ —         $ —         $ 87       $ 262       $ 2,496       $ 2,758   

Commercial Real Estate

                    

Owner occupied

     —           355         —           —           355         9,569         9,924   

Non-owner occupied

     —           —           —           —           —           4,254         4,254   

Construction and Land Development

                    

Residential

     —           —           —           —           —           1,568         1,568   

Commercial

     —           174         —           1,014         1,188         1,003         2,191   

Consumer - Non Real Estate

     29         1         —           262         292         2,597         2,889   

Consumer Real Estate

                    

Single Family

     180         119         —           474         773         10,096         10,869   

Multifamily

     —           —           —           —           —           189         189   

Equity Lines

     15         —           —           —           15         1,164         1,179   
                                                              

Total

   $ 399       $ 649       $ —         $ 1,837       $ 2,885       $ 32,936       $ 35,821   
                                                              

 

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Table of Contents

Credit quality as of December 31, 2010 by class is summarized as follows:

 

(Dollars in thousands)

   Pass      Special
Mention
     Sustandard      Doubtful      Loss  

Commercial - Non Real Estate

              

Commercial and Industrial

   $ 2,671       $ —         $ 87       $ —         $ —     

Commercial Real Estate

              

Owner occupied

     9,569         —           355         —           —     

Non-owner occupied

     4,254         —           —           —           —     

Construction and Land Development

              

Residential

     1,568         —           —           —           —     

Commercial

     1,177         —           577         437         —     

Consumer - Non Real Estate

     2,570         57         258         4         —     

Consumer Real Estate

              

Single Family

     10,128         247         494         —           —     

Multifamily

     189         —           —           —           —     

Equity Lines

     1,179         —           —           —           —     
                                            

Total

   $ 33,305       $ 304       $ 1,771       $ 441       $ —     
                                            

 

NOTE 4: Allowance for Loan Losses

Changes in the allowance for loan losses are as follows:

 

     December 31,  

(Dollars in thousands)

   2010     2009  

Balance, beginning

   $ 686      $ 493   

Provision charged to operating expense

     91        1,194   

Loans charged off

     (157     (1,002

Recoveries of loans previously charged off

     —          1   
                

Balance, ending

   $ 620      $ 686   
                

The allowance for loan losses by segment as of December 31, 2010 follows:

 

(Dollars in thousands)

   Commercial -
Non Real
Estate
     Commercial
Real Estate
     Construction      Consumer -
Non Real
Estate
     Consumer
Real Estate
     Unallocated      Total  

Allowance for loan losses:

  

                 

Ending Balance

   $ 109       $ 205       $ 106       $ 77       $ 123       $ —         $ 620   

Indidually evaluated for impairment

     62         34         71         16         31         —           214   

Collectively evaluated for impairment

     47         171         35         61         92         —           406   
                                                              

Loans:

                    

Ending Balance

   $ 2,758       $ 14,178       $ 3,759       $ 2,889       $ 12,237          $ 35,821   

Indidually evaluated for impairment

     87         389         624         250         474         —           1,824   

Collectively evaluated for impairment

     2,671         13,789         3,135         2,639         11,763         —           33,997   
                                                              

 

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Table of Contents

Impaired loans by class as of December 31, 2010 are summarized as follows:

 

(Dollars in thousands)

   Recorded
Investment
     Unpaid
Principal
Balance
     Related
Allowance
     Average
Recorded
Investment
     Interest
Income
Recognized
 

With no related allowance:

              

Construction and Land Development

              

Commercial

   $ 353       $ 655       $ —         $ 368       $ 6   

Consumer Real Estate

              

Single Family

     335         335         —           336         20   

With an allowance recorded:

              

Commercial - Non Real Estate

              

Commercial and Industrial

   $ 87       $ 87       $ 62       $ 133       $ 8   

Construction and Land Development

              

Commercial

     660         787         105         660         16   

Consumer - Non Real Estate

     250         250         16         253         13   

Consumer Real Estate

              

Single Family

     139         139         31         140         8   
                                            

Total

              

Commercial - Non Real Estate

   $ 87       $ 87       $ 62       $ 133       $ 8   

Construction and Land Development

     1,013         1,442         105         1,028         22   

Consumer - Non Real Estate

     250         250         16         253         13   

Consumer Real Estate

     474         474         31         476         28   
                                            

Total

   $ 1,824       $ 2,253       $ 214       $ 1,890       $ 71   
                                            

The Recorded Investment amounts in the table above represent the outstanding principal balance on each loan represented in the table. The Unpaid Principal Balance represents the outstanding principal balance on each loan represented in the table plus any amounts that have been charged off on each loan and/or payments that have been applied towards principal on nonaccrual loans.

 

(Dollars in thousands)

   December 31,
2009
 

Impaired loans without a valuation allowance

   $ 920   

Impaired loans with a valuation allowance

     1,072   
        

Total impaired loans

   $ 2,000   
        

Valuation allowance related to impaired loans

     271   

Total non-accrual loans excluded from impaired loans

     8   

Total loans past due ninety days and still accruing

     —     

 

      December 31,
2009
 

(Dollars in thousands)

  

Average balance of impaired loans

   $ 2,725   

Interest income recognized on impaired loans

     62   

Cash-basis interest included in interest income

     32   

No additional funds are committed to be advanced in connection with impaired loans.

 

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NOTE 5: Premises and Equipment

Premises and equipment as of December 31, 2010 and 2009 consists of the following:

 

(Dollars in thousands)

   2010      2009  

Land

   $ 301       $ 301   

Building

     1,255         1,255   

Furniture, fixtures and equipment

     226         225   

Construction in progress

     9         —     
                 
     1,791         1,781   

Less accumulated depreciation

     421         361   
                 
   $ 1,370       $ 1,420   
                 

Depreciation expense was $60,000 and $63,000 for the years ended December 31, 2010 and 2009, respectively.

 

NOTE 6: Deposits

The aggregate amount of time deposits in denominations of $100,000 or more at December 31, 2010 was $16.6 million and $13.6 million at December 31, 2009. At December 31, 2010, the scheduled maturities of time deposits are as follows:

 

(Dollars in thousands)

      

2011

   $ 17,994   

2012

     6,597   

2013

     9,591   

2014

     184   

2015

     2,089   
        
   $ 36,455   
        

Overdrawn deposit accounts totaling $6,000 at December 31, 2010 and $4,000 at December 31, 2009 were reclassified from deposits to loans.

 

NOTE 7: Earnings (Loss) per Share

For the years ended December 31, 2010 and 2009, the weighted average number of shares outstanding for calculating basic and diluted earnings (loss) per share was 1,500,427. Basic and diluted earnings per share was $0.06 for the year ended December 31, 2010, compared to a loss per share of ($0.76) for the year ended December 31, 2009. Stock options and warrants outstanding for 2010 were 80,527 shares and 81,375 shares, respectively. For 2009, stock options outstanding were 84,027 shares and warrants outstanding were 81,375 shares. For 2010 and 2009, these shares were considered anti-dilutive and, therefore, were not considered in the calculation of diluted earnings per share.

 

NOTE 8: Warrants and Stock Options

In connection with the initial offering of the Company, 153,750 warrants were issued to the original directors to purchase common shares at an exercise price of $6.67 per share. All of the remaining warrants are held by the organizing directors of the Company and fully vested during 2005.

 

     2010      2009  
     Shares      Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Shares     Weighted
Average
Exercise
Price
 
               
               
               

Outstanding at the beginning of year

     81,375       $ 6.67            91,125      $ 6.67   

Granted

     —           —              —          —     

Exercised

     —           —              —          —     

Forfeited

     —           —              (9,750     6.67   
                                           

Outstanding at end of year

     81,375       $ 6.67       $ —           81,375      $ 6.67   
                                           

Warrants exercisable at end of year

     81,375       $ 6.67       $ —           81,375      $ 6.67   
                                           

 

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Table of Contents

The aggregate intrinsic value represents the total pre-tax intrinsic value (the amount by which the current market value of the underlying stock exceeds the exercise price) that would have been received by the holders had they exercised their warrants on December 31, 2010.

 

       Warrants Outstanding and Exercisable  

Exercise Price

     Number      Weighted Average
Remaining
Contractual
Life (in years)
 
$ 6.67         81,375         2.0   

The Company sponsors a stock option plan, which allows employees and directors to increase their personal financial interest in the Company. This plan provides the ability to grant equity-based incentives in the form of either incentive or nonqualified options. The plan authorizes the issuance of up to 126,255 shares of common stock, subject to adjustment for certain recapitalizations.

 

     2010      2009  
     Shares     Weighted
Average
Exercise
Price
     Aggregate
Intrinsic
Value
     Shares     Weighted
Average
Exercise
Price
 

Outstanding at the beginning of year

     84,027      $ 7.17            86,027      $ 7.21   

Granted

     —          —              —          —     

Exercised

     —          —              —          —     

Forfeited

     (3,500     8.63            (2,000     8.67   
                                          

Outstanding at end of year

     80,527      $ 7.11       $ —           84,027      $ 7.17   
                                          

Options exercisable at end of year

     80,527      $ 7.11       $ —           84,027      $ 7.17   
                                          

The following table summarizes options outstanding at December 31, 2010.

 

       Options Outstanding and Exercisable  

Exercise Price

     Number      Weighted Average Remaining
Contractual Life (in years)
     Weighted Average Exercise
Price
 
$ 6.67         62,625         5.0       $ 6.67   
  8.33         1,125         3.5         8.33   
  8.67         16,777         5.0         8.67   
                                
$ 7.11         80,527         5.0       $ 7.11   
                                

 

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NOTE 9: Income Taxes

The Company files income tax returns in the U.S. federal jurisdiction and the state of Virginia. With few exceptions, the Company is no longer subject to U.S. federal, state and local income tax examinations by tax authorities for years prior to 2007.

The tax effects of temporary differences that give rise to significant portions of the deferred tax assets and deferred tax liabilities at December 31, 2010 and 2009 are presented below:

 

(Dollars in thousands)

   2010     2009  

Deferred tax assets

    

Allowance for loan losses

   $ 127      $ 391   

Net operating loss

     790        379   

Stock options

     43        43   

Other

     30        40   
                

Deferred tax assets

     990        853   

Deferred tax liabilities

    

Fixed assets, net

     (10     (14
                

Less: Valuation allowance

     (980     (839
                

Net deferred tax assets (liabilities)

   $ —        $ —     
                

The provision for income taxes charged to operations for the period ended December 31, 2010 and 2009, consists of the following:

 

(Dollars in thousands)

   2010     2009  

Current tax expense

  

$

 —  

  

  $ —     

Deferred tax expense (benefit)

     (34     (212

Change in valuation allowance

     34        212   
                
   $ —        $ —     
                

Under the provisions of the Internal Revenue Code, the Company has approximately $1,116,000 of net operating loss carryforwards which can be offset against future taxable income. The carryforwards expire through December 31, 2025. The full realization of the tax benefits associated with the carryforwards depends predominately upon the recognition of ordinary income during the carryforward period.

 

NOTE 10: Employee Benefit Plans

The Company has a 401(k) Profit Sharing Plan covering employees who are at least 18 years of age. Employees may contribute compensation subject to certain limits based on federal tax laws. The Company makes discretionary matching contributions equal to 50 percent of an employee’s compensation contributed to the Plan, up to 6 percent of the employee’s compensation. Employer contributions vest to the employee over a five-year period.

For the years ended December 31, 2010 and 2009, expense incurred related to this retirement plan was $18,000 and $30,000, respectively.

 

NOTE 11: Related Party Transactions

Loans to directors and officers totaled $1,952,000 and $2,316,000 at December 31, 2010 and 2009, respectively. New advances and repayments during 2010 equaled $122,000 and $486,000, respectively. All such loans are performing in accordance with their terms and were made on substantially the same terms as those prevailing at the time for comparable transactions with unrelated parties. Deposits of directors and officers totaled $507,000 and $524,000 at December 31, 2010 and 2009, respectively.

 

NOTE 12: Regulatory Requirements and Restrictions

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the Federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Company’s and Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the

 

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Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (as set forth in the following table) of Total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of December 31, 2010 and 2009, that the Company and the Bank meet all capital adequacy requirements to which they are subject. As of December 31, 2010, the most recent notification from the Office of the Comptroller of the Currency categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the following table. There are no conditions or events since the notification that management believes have changed the Bank’s category. The Company’s and Bank’s actual capital amounts (in thousands) and ratios as of December 31, 2010 and 2009 are also presented in the table.

 

      Actual     Minimum
Capital
Requirement
    Minimum
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 

(Dollars in thousands)

   Amount      Ratio     Amount      Ratio     Amount      Ratio  

As of December 31, 2010:

               

Total Capital ( to Risk-Weighted Assets)

               

Consolidated

   $ 7,163         19.84   $ 2,889         8.00     N/A         N/A   

Bank

   $ 6,978         19.32   $ 2,889         8.00   $ 3,611         10.00

Tier 1 Capital (to Risk-Weighted Assets)

               

Consolidated

   $ 6,710         18.58   $ 1,444         4.00     N/A         N/A   

Bank

   $ 6,524         18.07   $ 1,444         4.00   $ 2,167         6.00

Tier 1 Capital (to Average Assets)

               

Consolidated

   $ 6,710         13.63   $ 1,969         4.00     N/A         N/A   

Bank

   $ 6,524         13.26   $ 1,969         4.00   $ 2,461         5.00

As of December 31, 2009:

               

Total Capital ( to Risk-Weighted Assets)

               

Consolidated

   $ 7,077         19.26   $ 2,940         8.00     N/A         N/A   

Bank

   $ 6,835         18.60   $ 2,940         8.00   $ 3,674         10.00

Tier 1 Capital (to Risk-Weighted Assets)

               

Consolidated

   $ 6,615         18.00   $ 1,470         4.00     N/A         N/A   

Bank

   $ 6,373         17.34   $ 1,470         4.00   $ 2,205         6.00

Tier 1 Capital (to Average Assets)

               

Consolidated

   $ 6,615         13.70   $ 1,931         4.00     N/A         N/A   

Bank

   $ 6,373         13.20   $ 1,931         4.00   $ 2,414         5.00

The Company and Bank may pay dividends only out of retained earnings. At December 31, 2010, no retained earnings were available for the payment of dividends.

 

NOTE 13: Financial Instruments with Off-Balance-Sheet Risk and Credit Risk

The Company is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and commercial lines of credit. Those instruments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The same credit policies are used in making commitments as for on-balance-sheet instruments.

As of December 31, 2010 and 2009, reserves of $50,000 were required as deposits with Community Bankers Bank.

 

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Unfunded commitments under lines of credit are commitments for possible future extensions of credit to existing customers. Those lines of credit may not be drawn upon to the total extent to which the Company is committed. At December 31, 2010 and 2009, the Company had unfunded commitments under lines of credit of $2.9 million and $2.7 million, respectively.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary by the Company upon extension of credit, is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, property and equipment, and income-producing commercial properties. At December 31, 2010 and 2009, the Company did not have any commitments to extend credit.

Commercial and standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. Essentially all letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting those commitments, if deemed necessary. At December 31, 2010 and 2009, the Company did not have any commercial or standby letters of credit.

The Company did not have deposits in financial institutions in excess of amounts insured by the Federal Deposit Insurance Corporation (FDIC) at December 31, 2010 and 2009.

 

NOTE 14: Fair Value Measurements

The Company uses fair value measurements to record fair value adjustments to certain assets and liabilities and to determine fair value disclosure. In accordance with the Fair Value Measurements and Disclosures topic of FASB ASC, the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. 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 estimate may not be realized in an immediate settlement of an instrument.

Fair value guidance provides a consistent definition of fair value, which focuses on exit price in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 – Valuation is based on quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date. Level 1 assets and liabilities generally include debt and equity securities that are traded in an active exchange market. Valuations are obtained from readily available pricing sources for market transactions involving identical assets or liabilities.

Level 2 – Valuation is based on inputs other than quoted prices included with Level 1 that are observable for the asset or liability, either directly or indirectly. The valuation may be based on quoted prices for similar assets or liabilities; quoted prices in market that are not active; or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the asset or liability.

Level 3 – Valuation is based on unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets of liabilities. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which determination of far value requires significant management judgment or estimation.

 

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A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.

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 financial statements:

Securities available for sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that considers observable market data (Level 2). Restricted securities are recorded at cost based on the redemption provisions of the correspondent banks and therefore are not included in the following table.

The following tables present the balances of financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2010 and 2009:

 

     Fair Value Measurements at December 31, 2010 Using  

Description (Dollars in thousands)

   Balance as of
December 31, 2010
     Quoted Prices in
Active Markets for
Identical Assets
     Significant Other
Observable
Inputs
     Significant
Unobservable
Inputs
 
      (Level 1)      (Level 2)      (Level 3)  

Assets:

           

U.S. Government and federal agencies

   $ 6,216       $ —         $ 6,216       $ —     

Corporate bonds

     496         —           496         —     

State and municipals, taxable

     1,042         —           1,042         —     
                                   
   $ 7,754       $ —         $ 7,754       $ —     
                                   

 

      Fair Value Measurements at December 31, 2009 Using  

Description (Dollars in thousands)

   Balance as of
December 31, 2009
     Quoted Prices in
Active Markets for
Identical Assets
     Significant Other
Observable
Inputs
     Significant
Unobservable
Inputs
 
      (Level 1)      (Level 2)      (Level 3)  

Assets:

           

U.S. Government and federal agencies

   $ 5,901       $ —         $ 5,901       $ —     

Corporate bonds

     994            994      

State and municipals, taxable

     519         —           519         —     
                                   
   $ 7,414       $ —         $ 7,414       $ —     
                                   

Certain assets are measured at fair value on a nonrecurring basis in accordance with generally accepted accounting principles. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.

The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:

Impaired Loans. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).

 

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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

Operations.

The value of foreclosed real estate owned is determined utilizing an income or market valuation approach based on an appraisal conducted by and independent, licensed appraiser outside of the Company using observable market data (Level 2). Any fair value adjustments are recorded in the period incurred in the consolidated statements of operations.

The following table summarizes the Company’s financial assets that were measured at fair value on a nonrecurring basis during the period.