Attached files

file filename
EX-3.1 - BYLAWS - VALLEY FINANCIAL CORP /VA/ex31.htm
EX-32.1 - VALLEY FINANCIAL CORP /VA/ex321.htm
EX-31.1 - VALLEY FINANCIAL CORP /VA/ex311.htm
EX-32.2 - VALLEY FINANCIAL CORP /VA/ex322.htm
EX-31.2 - VALLEY FINANCIAL CORP /VA/ex312.htm
o

 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

FORM 10-Q
(Mark One)
[X]
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934

For the Quarterly Period Ended March 31, 2011

[  ]
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:  000-28342

VALLEY FINANCIAL CORPORATION
(Exact name of registrant as specified in its charter)

VIRGINIA
(State or other jurisdiction of incorporation or organization)
 
54-1702380
(I.R.S. Employer Identification No.)
     
36 Church Avenue, S.W.
Roanoke, Virginia
(Address of principal executive offices)
 
 
24011
(Zip Code)
(540) 342-2265
(Registrant’s telephone number, including area code)

Not Applicable
(Former name, former address, and former fiscal year, if changed since last report)

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

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

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.  (Check one):

Large accelerated filer     o                                                                                                                                                                                                                                        Accelerated filer o

Non-accelerated filer       o (Do not check if a smaller reporting company)                                                                                                                                    Smaller reporting company x
                                                           
Indicate by checkmark whether the registrant is a shell company (as defined by Rule 12b-2 of the Exchange Act.)
                                                                                                                                                                                                                                                                                                 Yes  o  No x
 
 
At May 11, 2011, 4,697,256 shares of common stock, no par value, of the registrant were outstanding.
 


 
 

 

VALLEY FINANCIAL CORPORATION
FORM 10-Q
March 31, 2011


TABLE OF CONTENTS
       
Part I.  FINANCIAL INFORMATION
       
 
Item 1
Financial Statements
   
Consolidated Balance Sheets
4
   
Consolidated Statements of Operations
5
   
Consolidated Statements of Cash Flows
6
   
Notes to Consolidated Financial Statements
7
       
 
Item 2
Management's Discussion and Analysis of Financial Condition and Results of Operations
26
       
 
Item 3
Quantitative and Qualitative Disclosures about Market Risk
33
       
 
Item 4
Controls and Procedures
34
       
Part II.  OTHER INFORMATION
 
       
 
Item 1
Legal Proceedings
34
 
Item 1A
Risk Factors
34
 
Item 2
Unregistered Sales of Equity Securities and Use of Proceeds
34
 
Item 3
Defaults Upon Senior Securities
34
 
Item 4
(Removed and Reserved)
34
 
Item 5
Other Information
35
 
Item 6
Exhibits
35
       
SIGNATURES
36
       
EXHIBITS INDEX
37
       
CERTIFICATIONS
45


 
2

 


Forward-Looking and Cautionary Statements

The Private Securities Litigation Reform Act of 1995 (the “1995 Act”) provides a safe harbor for forward-looking statements made by or on our behalf.  These forward-looking statements involve risks and uncertainties and are based on the beliefs and assumptions of our management and on information available at the time these statements and disclosures were prepared.
 
This report includes and incorporates by reference forward-looking statements within the meaning of the 1995 Act. These statements are included throughout this report, and in the documents incorporated by reference in this report, and relate to, among other things, projections of revenues, earnings, earnings per share, cash flows, capital expenditures, or other financial items, expectations regarding acquisitions, discussions of estimated future revenue enhancements, potential dispositions, and changes in interest rates. These statements also relate to our business strategy, goals and expectations concerning our market position, future operations, margins, profitability, liquidity, and capital resources. The words “believe”, “anticipate”, “could”, “estimate”, “expect”, “intend”, “may”, “plan”, “predict”, “project”, “will”, and similar terms and phrases identify forward-looking statements in this report and in the documents incorporated by reference in this report.
 
Although we believe the assumptions upon which these forward-looking statements are based are reasonable, any of these assumptions could prove to be inaccurate and the forward-looking statements based on these assumptions could be incorrect. Our operations involve risks and uncertainties, many of which are outside of our control, and any one of which, or a combination of which, could materially affect our results of operations and whether the forward-looking statements ultimately prove to be correct.
 
Actual results and trends in the future may differ materially from those suggested or implied by the forward-looking statements depending on a number of factors. Factors that may cause actual results to differ materially from those expected include the following:
 
 
 
General economic conditions may deteriorate and negatively impact the ability of borrowers to repay loans and depositors to maintain balances;
 
 
 
General decline in the residential real estate construction and finance market;
 
 
 
Decline in market value of real estate in the Company’s markets;
 
 
 
Changes in interest rates could reduce net interest income and/or the borrower’s ability to repay loans;
 
 
 
Competitive pressures among financial institutions may reduce yields and profitability;
 
 
 
Legislative or regulatory changes, including changes in accounting standards, may adversely affect the businesses that the Company is engaged in;
 
       
 
 
Increased regulatory supervision could limit our ability to grow and could require considerable time and attention of our management and board of directors;
 
 
 
New products developed or new methods of delivering products could result in a reduction in business and income for the Company;
 
 
 
The Company’s ability to continue to improve operating efficiencies;
 
 
 
Natural events and acts of God such as earthquakes, fires and floods;
 
 
 
Loss or retirement of key executives; and
 
 
 
Adverse changes may occur in the securities market.

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein.  We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.

 
3

 

PART 1 – FINANCIAL INFORMATION
Item 1.  Financial Statements.
VALLEY FINANCIAL CORPORATION
CONSOLIDATED BALANCE SHEETS
(In 000s, except share and share data)

   
(Unaudited)
3/31/11
   
(Audited)
12/31/10
 
Assets
           
 
Cash and due from banks
  $ 5,651     $ 4,318  
Interest-bearing deposits in banks
    63,450       19,994  
             Total cash and cash equivalents
    69,101       24,312  
                 
Securities available-for-sale
    143,073       145,894  
Securities held-to-maturity (fair value:  3/31/11: $6,906  ; 12/31/10: $7,868)
    6,640       7,634  
Restricted equity securities
    5,661       5,661  
Loans, net of allowance for loan losses, 3/31/11: $10,500 ; 12/31/10:  $11,003
    525,558       533,291  
Foreclosed assets
    15,887       16,081  
Premises and equipment, net
    7,709       7,736  
Bank owned life insurance
    14,618       14,475  
Accrued interest receivable
    2,555       2,274  
Other assets
    8,601       10,230  
Total assets
  $ 799,403     $ 767,588  
                 
                 
Liabilities and Shareholders’ Equity
               
Liabilities:
               
Noninterest-bearing deposits
  $ 17,039     $ 17,768  
Interest-bearing deposits
    639,706       609,644  
Total deposits
    656,745       627,412  
                 
Federal funds purchased and securities sold under agreements to repurchase
    17,558       17,296  
Short-term borrowings
    15,000       5,000  
Long-term borrowings
    33,000       43,000  
Junior subordinated debentures
    16,496       16,496  
Accrued interest payable
    1,017       1,058  
Other liabilities
    3,762       3,398  
Total liabilities
    743,578       713,660  
                 
Commitments and contingencies
    -       -  
                 
Shareholders' equity:
               
Preferred stock, no par value; 10,000,000 shares authorized; 16,019 shares issued and outstanding at March 31, 2011 and December 31, 2010, respectively
    15,535       15,494  
Common stock, no par value; 10,000,000 shares authorized; 4,697,256 shares issued and outstanding at March 31, 2011 and 4,680,251 shares issued and outstanding at December 31, 2010
    23,598       23,542  
Retained earnings
    17,071       16,011  
Accumulated other comprehensive loss
    (379 )     (1,119 )
Total shareholders’ equity
    55,825       53,928  
Total liabilities and shareholders’ equity
  $ 799,403     $ 767,588  
See accompanying notes to consolidated financial statements
 

 
4

 

VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In 000s, except share and per share data)

   
Three Months Ended
 
   
3/31/11
   
3/31/10
 
Interest Income:
           
     Interest and fees on loans
  $ 7,051     $ 7,331  
     Interest on securities–taxable
    1,013       716  
     Interest on securities-nontaxable
    160       121  
     Interest on deposits in banks
    19       19  
          Total interest income
    8,243       8,187  
Interest Expense:
               
     Interest on deposits
    1,794       2,428  
     Interest on short-term borrowings
    33       258  
     Interest on long-term borrowings
    396       423  
     Interest on junior subordinated debentures
    93       89  
     Interest on federal funds purchased and securities sold
               
         under agreements to repurchase
    11       11  
          Total interest expense
    2,327       3,209  
          Net interest income
    5,916       4,978  
Provision for loan losses
    (436 )     208  
     Net interest income after provision for loan losses
    6,352       4,770  
                 
Noninterest Income:
               
Service charges on deposit accounts
    331       307  
Income earned on bank owned life insurance
    143       134  
Mortgage fee income
    67       16  
Brokerage fee income, net
    55       59  
Realized gain on sale of securities
    14       -  
Other income
    31       21  
        Total noninterest income
    641       537  
                 
Noninterest Expense:
               
Compensation expense
    2,347       1,985  
Occupancy and equipment expense
    393       397  
Data processing expense
    273       282  
Advertising and marketing expense
    79       117  
Insurance expense
    1,047       362  
Audit expense
    61       64  
Legal expense
    303       88  
Franchise tax expense
    124       123  
Deposit expense
    104       93  
Loan expense
    53       78  
Computer software expense
    89       97  
Consulting expense
    97       99  
Foreclosed asset expense, net
    199       78  
Other expense
    289       322  
          Total noninterest expense
    5,458       4,185  
          Income before income taxes
    1,535       1,122  
                 
Income tax expense
    434       274  
          Net income
  $ 1,101     $ 848  
Preferred dividends and accretion of discounts on warrants
    242       239  
          Net income available to common shareholders
  $ 859     $ 609  
                 
Earnings per share
               
Basic earnings per common share
  $ 0.18     $ 0.13  
Diluted earnings per common share
  $ 0.18     $ 0.13  
Weighted average shares outstanding
    4,688,286       4,680,251  
Diluted average shares outstanding
    4,714,961       4,685,799  
Dividends declared per common share
  $ -     $ -  

See accompanying notes to the consolidated financial statements

 
5

 

VALLEY FINANCIAL CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In 000s, except share and per share data)
 
 
   
Three Months Ended
 
   
3/31/11
   
3/31/10
 
Cash flows from operating activities
           
Net income
  $ 1,101     $ 848  
Adjustments to reconcile net income to net cash and cash equivalents provided by operating activities:
               
Provision for loan losses
    (436 )     208  
Depreciation and amortization of bank premises, equipment and software
    186       206  
Stock compensation expense
    56       46  
(Increase) decrease in deferred income tax
    432       (113 )
Net gains on sale of securities
    (14 )     -  
Net (gains) losses on foreclosed and repossessed assets
    88       (18 )
Net losses on equipment disposals
    23       5  
Net amortization of bond premiums/discounts
    380       159  
(Increase) decrease in unearned loan fees
    1       (28 )
(Increase) decrease in accrued interest receivable
    (281 )     22  
(Increase) decrease in other assets
    1,177       (420 )
Increase in value of life insurance contracts
    (143 )     (134 )
Decrease in accrued interest payable
    (41 )     (717 )
Increase in other liabilities
    364       1,947  
Net cash and cash equivalents provided by operating activities
    2,893       2,011  
                 
Cash flows from investing activities
               
Purchases of bank premises, equipment and software
    (162 )     (79 )
Purchases of securities available-for-sale
    (12,897 )     (14,829 )
Proceeds from sales/calls/paydowns/maturities of securities available-for-sale
    16,091       9,119  
Proceeds from sales/calls/paydowns/maturities of securities held-to-maturity
    995       503  
Proceeds from sale of foreclosed and repossessed assets
    1,708       76  
Capitalized costs related to foreclosed assets
    -       (398 )
Decrease in loans, net
    6,566       1,754  
Net cash and cash equivalents provided by / (used in) investing activities
    12,301       (3,854 )
                 
Cash flows from financing activities
               
Increase (decrease) in non-interest bearing deposits
    (729 )     3,159  
Increase in interest bearing deposits
    30,062       22,379  
Proceeds from short-term borrowings
    15,000       -  
Principal repayments of short-term borrowings
    (5,000 )     -  
Principal repayments of long-term borrowings
    (10,000 )     -  
Increase (decrease) in securities sold under agreements to repurchase
    262       (3,336 )
Cash dividends paid
    -       (200 )
Net cash and cash equivalents provided by financing activities
    29,595       22,002  
Net increase in cash and cash equivalents
    44,789       20,159  
                 
Cash and cash equivalents at beginning of year
    24,312       31,878  
Cash and cash equivalents at end of year
  $ 69,101     $ 52,037  
                 
Supplemental disclosure of cash flow information
               
        Cash paid during the period for interest
  $ 2,368     $ 3,926  
        Cash paid during the period for income taxes
  $ -     $ -  
                 
Noncash financing and investing activities
               
        Transfer of loans to foreclosed property
  $ 1,602     $ 405  
        Reclassification of borrowings from long-term to short-term
  $ -     $ 5,000  
                 
See accompanying notes to consolidated financial statements.
               




 
6

 


VALLEY FINANCIAL CORPORATION
Notes to Consolidated Financial Statements
March 31, 2011 (Unaudited)
(In thousands, except share and per share data)

Note 1.  Organization and Summary of Significant Accounting Policies

Valley Financial Corporation (the "Company") was incorporated under the laws of the Commonwealth of Virginia on March 15, 1994, primarily to serve as a holding company for Valley Bank (the "Bank"), which opened for business on May 15, 1995. The Company's fiscal year end is December 31.

The consolidated financial statements of the Company conform to generally accepted accounting principles and to general banking industry practices. The interim period consolidated financial statements are unaudited; however, in the opinion of management, all adjustments of a normal recurring nature which are necessary for a fair presentation of the consolidated financial statements herein have been included. The consolidated financial statements herein should be read in conjunction with the Company's 2010 Annual Report on Form 10-K.

Interim financial performance is not necessarily indicative of performance for the full year.

The Company reports its activities as a single business segment.

Use of Estimates

The preparation of financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period.  Actual results could differ from those estimates.

Subsequent Events

In preparing these financial statements, the Company has evaluated events and transactions for potential recognition or disclosure.

Note 2.  Securities

The carrying values, unrealized gains, unrealized losses, and approximate fair values of available-for-sale and held-to-maturity investment securities at March 31, 2011 are shown in the tables below. As of March 31, 2011, investments (including both available-for-sale and held-to-maturity) and restricted equity securities with amortized costs and fair values of $72,874 and $73,109 respectively, were pledged as collateral for public deposits, a line of credit available from the Federal Home Loan Bank, customer sweep accounts, and for other purposes as required or permitted by law.

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities available-for-sale (“AFS”) as of March 31, 2011 and December 31, 2010 were as follows:
 
   
Amortized
Costs
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Values
 
March 31, 2011
                       
U.S. Government and federal agency
  $ 6,669     $ 90     $ (145 )   $ 6,614  
Government-sponsored enterprises
    41,694       14       (883 )     40,825  
Mortgage-backed securities
    69,734       551       (414 )     69,871  
Collateralized mortgage obligations
    10,165       370       (1 )     10,534  
States and political subdivisions
    15,385       137       (293 )     15,229  
    $ 143,647     $ 1,162     $ (1,736 )   $ 143,073  
 
December 31, 2010
                       
U.S. Government and federal agency
  $ 6,892     $ 71     $ (143 )   $ 6,820  
Government-sponsored enterprises
    34,695       -       (1,198 )     33,497  
Mortgage-backed securities
    76,724       376       (889 )     76,211  
Collateralized mortgage obligations
    13,599       533       (1 )     14,131  
States and political subdivisions
    15,680       93       (538 )     15,235  
    $ 147,590     $ 1,073     $ (2,769 )   $ 145,894  

 
7

 
* Such as FNMA, FHLMC and FHLB.

The amortized costs, gross unrealized gains and losses, and approximate fair values of securities held-to-maturity (“HTM”) as of March 31, 2011 and December 31, 2010 were as follows:

   
Amortized
Costs
   
Unrealized
Gains
   
Unrealized
Losses
   
Fair
Values
 
March 31, 2011
                       
Mortgage-backed securities
  $ 479     $ 27     $ -     $ 506  
Collateralized mortgage obligations
    3,400       189       -       3,589  
States and political subdivisions
    2,761       78       (28 )     2,811  
    $ 6,640     $ 294     $ (28 )   $ 6,906  
December 31, 2010
                               
Mortgage-backed securities
  $ 573     $ 30     $ -     $ 603  
Collateralized mortgage obligations
    3,707       152       -       3,859  
States and political subdivisions
    3,354       85       (33 )     3,406  
    $ 7,634     $ 267     $ (33 )   $ 7,868  

The amortized costs and approximate fair values of our total private-label collateralized mortgage obligations were $3,135 and $3,307 as of March 31, 2011.  The amortized costs and approximate fair values of our total private-label collateralized mortgage obligations were $4,392 and $4,561 as of December 31, 2010.

The following table presents the maturity ranges of securities available-for-sale and held-to-maturity as of March 31, 2011 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.

INVESTMENT PORTFOLIO – MATURITY DISTRIBUTION
  
   
Available for Sale
   
Held to Maturity
 
 
In thousands
 
Amortized
Costs
   
Fair
Value
   
Yield
   
Amortized
Costs
   
Fair
Value
   
Yield
 
U.S. Government and federal agency:
                                   
Within one year
  $ 15     $ 15       5.86 %   $ -     $ -       -  
After one but within five years
    200       202       1.38 %     -       -       -  
After five but within ten years
    5,065       5,058       3.44 %     -       -       -  
After ten years
    1,389       1,339       4.10 %     -       -       -  
Government-sponsored enterprises:
                                               
After five but within ten years
    8,998       8,835       4.06 %     -       -       -  
After ten years
    32,696       31,990       4.85 %     -       -       -  
Obligations of states and subdivisions:
                                               
After one but within five years
    -       -       -       599       630       3.90 %
After five but within ten years
    1,280       1,304       4.66 %     1,104       1,128       4.93 %
After ten years
    14,105       13,925       6.25 %     1,058       1,053       6.72 %
Mortgage-backed securities
    69,734       69,871       2.87 %     479       506       4.31 %
Collateralized mortgage obligations
    10,165       10,534       3.87 %     3,400       3,589       5.56 %
Total
  $ 143,647     $ 143,073             $ 6,640     $ 6,906          
                                                 
Total Securities by Maturity Period *
                                               
Within one year
  $ 15     $ 15             $ -     $ -          
After one but within five years
  $ 200     $ 202             $ 599     $ 630          
After five but within ten years
  $ 15,343     $ 15,197             $ 1,104     $ 1,128          
After ten years
  $ 48,190     $ 47,254             $ 1,058     $ 1,053          
Mortgage-backed securities
  $ 69,734     $ 69,871             $ 479     $ 506          
Collateralized mortgage obligations
  $ 10,165     $ 10,534             $ 3,400     $ 3,589          
Total by Maturity Period
  $ 143,647     $ 143,073             $ 6,640     $ 6,906          


 
8

 


*  Maturities on mortgage-backed securities and collateralized mortgage obligations are not presented in this table because maturities may differ substantially from contractual terms due to early repayments of principal.

The following tables detail unrealized losses and related fair values in the Bank’s available-for-sale and held-to-maturity investment securities portfolios.  This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of March 31, 2011 and December 31, 2010, respectively.

Temporarily Impaired Securities in AFS Portfolio

In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2011
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
US Government and federal agency
  $ 4,258     $ (145 )   $ -     $ -     $ 4,258     $ (145 )
Government-sponsored enterprises*
    33,813       (883 )     -       -       33,813       (883 )
Mortgage-backed securities
    34,947       (414 )     21       (1 )     34,968       (415 )
State and political subdivisions
    9,617       (286 )     666       (7 )     10,283       (293 )
Total
  $ 82,635     $ (1,728 )   $ 687     $ (8 )   $ 83,322     $ (1,736 )
                                                 
December 31, 2010
                                               
US Government and federal agency
  $ 4,336     $ (143 )   $ -     $ -     $ 4,336     $ (143 )
Government-sponsored enterprises*
    30,496       (1,198 )     -       -       30,496       (1,198 )
Mortgage-backed securities
    44,768       (889 )     23       (1 )     44,791       (890 )
State and political subdivisions
    11,887       (538 )     -       -       11,887       (538 )
Total
  $ 91,487     $ (2,768 )   $ 23     $ (1 )   $ 91,510     $ (2,769 )

Temporarily Impaired Securities in HTM Portfolio

 In thousands
 
Less than 12 months
   
Greater than 12 months
   
Total
 
   
Fair
   
Unrealized
   
Fair
   
Unrealized
   
Fair
   
Unrealized
 
March 31, 2011
 
Value
   
Losses
   
Value
   
Losses
   
Value
   
Losses
 
State and political subdivisions
  $ 237     $ (28 )   $ -     $ -     $ 237     $ (28 )
Total
  $ 237     $ (28 )   $ -     $ -     $ 237     $ (28 )
                                                 
December 31, 2010
                                               
State and political subdivisions
  $ 230     $ (33 )   $ -     $ -     $ 230     $ (33 )
Total
  $ 230     $ (33 )   $ -     $ -     $ 230     $ (33 )

Management considers the nature of the investment, the underlying causes of the decline in the market value and the severity and duration of the decline in market value in determining if impairment is other than temporary.  Consideration is given to (1) the length of time and the extent to which the fair value has been less than cost, (2) the financial condition and near-term prospects of the issuer, and (3) the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. Based upon this evaluation at March 31, 2011, there are three securities in the portfolio with unrealized losses for a period greater than 12 months.  We have analyzed each individual security for Other Than Temporary Impairment (“OTTI”) purposes by reviewing delinquencies, loan-to-value ratios, and credit quality and concluded that all unrealized losses presented in the tables above are not related to an issuer’s financial condition but are due to changes in the level of interest rates and no declines are deemed to be other than temporary in nature.


 
9

 

Note 3.  Loans

The major components of loans in the consolidated balance sheets at March 31, 2011 and December 31, 2010 are as follows:

   
3/31/11
   
12/31/10
 
             
Commercial
  $ 91,753     $ 92,809  
Real estate:
               
   Construction and land development
    55,030       57,865  
   Residential, 1-4 families
    126,497       126,657  
   Commercial real estate
    257,762       261,969  
Consumer
    4,729       4,707  
Deferred loan fees
    287       287  
      536,058       544,294  
                 
Allowance for loan losses
    (10,500 )     (11,003 )
Net Loans
  $ 525,558     $ 533,291  

Substantially all one-four family residential and commercial real estate loans collateralize the line of credit available from the Federal Home Loan Bank and substantially all commercial and construction loans collateralize the line of credit with the Federal Reserve Bank of Richmond Discount Window.  The aggregate amount of deposit overdrafts that have been reclassified as loans and included in the consumer category in the above table as of March 31, 2011 and December 31, 2010 was $88 and $102, respectively.

Loan Origination.  The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a periodic basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.

Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate market or in the general economy. Management monitors and evaluates commercial real estate loans based on collateral and risk grade criteria. In addition, management tracks the level of owner-occupied commercial real estate loans versus income producing loans. At March 31, 2011, approximately 44% of the outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties and 51% was secured by income-producing properties.

With respect to construction and development loans that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten utilizing feasibility studies, independent appraisal reviews, sensitivity analysis of absorption and lease rates and financial analysis of the developers and property owners. Construction loans are generally based upon estimates of costs and value associated with the complete project. These estimates may be inaccurate. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by recurring on-site inspections during the construction phase and are considered to have higher risks than other real estate loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the

 
10

 

availability of long-term financing.

Residential real estate loans are secured by deeds of trust on 1-4 family residential properties.  The Bank also serves as a broker for residential real estate loans placed in the secondary market.  There are occasions when a borrower or the real estate does not qualify under secondary market criteria, but the loan request represents a reasonable credit risk.  On these occasions, if the loan meets the Bank’s internal underwriting criteria, the loan will be closed and placed in the Company’s portfolio.  Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of collateral.

The Company routinely makes consumer loans, both secured and unsecured, for financing automobiles, home improvements, education, and personal investments.  The credit history, cash flow and character of individual borrowers is evaluated as a part of the credit decision.  Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property.  Negative changes in a customer’s financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk.  In addition, deterioration in collateral value can add risk to consumer loans.

Risk Management. It is the Company’s policy that loan portfolio credit risk shall be continually evaluated and categorized on a consistent basis.  The Board of Directors recognizes that commercial, commercial real estate and construction lending involve varying degrees of risk, which must be identified, managed, and monitored through established risk rating procedures.  Management’s ability to accurately segment the loan portfolio by the various degrees of risk enables the Bank to achieve the following objectives:
§  
Assess the adequacy of the Allowance for Loan and Lease Losses
§  
Identify and track high risk situations and ensure appropriate risk management
§  
Conduct portfolio risk analysis and make informed portfolio planning and strategic decisions.
§  
Provide risk profile information to management, regulators and independent accountants as requested in a timely manner.

There are three levels of accountability in the risk rating process:
1)  
Risk Identification -  The primary responsibility for risk identification lies with the account officer.  It is the account officer's responsibility for the initial and ongoing risk rating of all notes and commitments in his or her portfolio.  The loan officer is the one individual who is closest to the credit relationship and is in the best position to identify changing risks.  Account officers are required to continually review the risk ratings for their credit relationships and make timely adjustments, up or down, at the time the circumstances warrant a change.  Account officers are responsible for ensuring that accurate and timely risk ratings are maintained at all times.   Account officers are allowed a maximum 30-day period to assess current financial information (e.g. prepare credit analysis) which may influence the current risk rating. Account officers are required to review the risk ratings of loans assigned to their portfolios on a monthly basis and to certify to the accuracy of the ratings.  Certifications are submitted to the Chief Credit Officer and Chief Lending Officer for review.  All risk rating changes (upgrades and downgrades) must be approved by the Chief Credit Officer prior to submission for input onto the Fidelity Commercial Loan System.
2)  
Risk Supervision -  In addition to the account officer’s process of assigning and managing risk ratings, the Chief Credit Officer is responsible for periodically reviewing the risk rating process employed by lending officers.  Through credit administration, the Chief Credit Officer manages the credit process which, among other things, includes maintaining and managing the risk identification process.  The Chief Credit Officer is responsible for the accuracy and timeliness of account officer risk ratings and has the authority to override account officer risk ratings and initiate rating changes, if warranted.  Upgrades from a criticized or classified category to a pass category or upgrades within the criticized/classified categories require the approval of the Senior Loan Committee or Directors’ Loan Committee based upon aggregate exposure. Upgrades must be reported to the Directors' Loan Committee and Board of Directors at their next scheduled meetings.
3)  
Risk Monitoring - Valley Bank has a loan review program to provide an independent validation of portfolio quality. This independent review is intended to assess adherence to underwriting guidelines, proper credit analysis and documentation.  In addition, the loan review process is required to test the integrity, accuracy, and timeliness of account officer risk ratings and to test the effectiveness of the credit administration function's controls over the risk identification process.  Portfolio quality and risk rating accuracy will be evaluated during regularly scheduled portfolio reviews.  Risk Management is required to report all loan review findings to the quarterly joint meeting of the Audit Committee and Directors’ Loan Committee.

Related party loans.  In the ordinary course of business, the Company has granted loans to certain directors, executive officers, significant shareholders and their affiliates (collectively referred to as “related parties”). These loans were made on substantially the same terms and conditions, including interest rates and collateral, as those prevailing at the same time for comparable transactions with other unaffiliated persons, and do not involve more than normal credit risk or present other unfavorable features.

Nonaccrual and Past Due Loans. Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be

 
11

 

unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due. Loans will be placed on nonaccrual status automatically when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of collection.  In this case, the loan will continue to accrue interest despite its past due status.  When interest accrual is discontinued, all unpaid accrued interest is reversed and any payments received are applied to the outstanding principal balance. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.  Nonaccrual loans and an age analysis of past due loans, segregated by class of loans, were as follows:

In thousands
 
30 - 59 Days Past Due
   
60 - 89 Days Past Due
   
90 Days or More Past Due
   
Total Past Due and Accruing
   
Non-accruals
   
Current and Accruing
   
Total Loans
 
March 31, 2011
                                         
Commercial - Non Real Estate
                                         
    Commercial & Industrial
  $ 1,174     $ -     $ -     $ 1,174     $ 1,892     $ 87,706     $ 90,772  
    Business Manager
    -       -       -       -       561       420       981  
Commercial Real Estate
                                                       
    Owner occupied
    1,990       -       -       1,990       1,034       109,172       112,196  
    Income producing
    -       -       -       -       808       129,826       130,634  
    Multifamily
    -       -       -       -       140       14,792       14,932  
Construction & Development
                                                       
    1 - 4 Family
    -       -       679       679       -       20,595       21,274  
    Other
    -       -       1,457       1,457       5,577       25,300       32,334  
    Farmland
    -       -       -       -       -       1,422       1,422  
Residential
                                                       
    Equity Lines
    732       75       -       807       -       29,693       30,500  
    1 - 4 Family
    964       -       -       964       1,749       88,232       90,945  
    Junior Liens
    74       -       -       74       50       4,928       5,052  
Consumer - Non Real Estate
                                                       
    Credit Cards
    2       3       4       9       -       1,187       1,196  
    Other
    28       -       -       28       -       3,505       3,533  
Total
  $ 4,964     $ 78     $ 2,140       7,182     $ 11,811     $ 516,778     $ 535,771  
                                                         
December 31, 2010
                                                       
Commercial - Non Real Estate
                                                       
    Commercial & Industrial
  $ 6     $ -     $ -     $ 6     $ 1,873     $ 89,166     $ 91,045  
    Business Manager
    -       -       -       -       -       1,762       1,762  
Commercial Real Estate
                                                       
    Owner occupied
    880       -       -       880       1,037       112,647       114,564  
    Income producing
    29       -       474       503       969       131,179       132,651  
    Multifamily
    -       -       -       -       140       14,901       15,041  
Construction & Development
                                                       
    1 - 4 Family
    -       679       -       679       -       17,154       17,833  
    Other
    1,458       -       -       1,458       6,360       30,789       38,607  
    Farmland
    -       -       -       -       -       1,426       1,426  
Residential
                                                       
    Equity Lines
    24       65       503       592       43       29,777       30,412  
    1 - 4 Family
    878       112       1,265       2,255       1,820       87,210       91,285  
    Junior Liens
    5       29       -       34       -       4,926       4,960  
Consumer - Non Real Estate
                                                       
    Credit Cards
    17       19       2       38       -       1,168       1,206  
    Other
    43       3       -       46       -       3,456       3,502  
Total
  $ 3,340     $ 907     $ 2,244     $ 6,491     $ 12,242     $ 525,561     $ 554,294  

Nonaccrual loans totaled $29.7 million and loans past due more than ninety days and still accruing totaled $4 thousand as of March 31, 2010.

 
12

 


Had non-accrual loans performed in accordance with their original contract terms, the Company would have recognized additional interest income in the amount of $152 during the quarter ended March 31, 2011, $1,227 during the year ended December 31, 2010 and $418 during the quarter ended March 31, 2010.  There was one restructured loan totaling $224 at March 31, 2011 and no restructured loans at March 31, 2010.

Impaired Loans.  Impaired loans are identified by the Company as loans in which it is determined to be probable that the borrower will not make interest and principal payments according to the contract terms of the loan.  In determining impaired loans, our credit administration department reviews past-due loans, examiner classifications, Bank classifications, and a selection of other loans to provide evidence as to whether the loan is impaired.  All loans rated as substandard are evaluated for impairment by the Bank’s Allowances for Loan and Lease Losses (“ALLL”) Committee.  Once classified as impaired, the ALLL Committee individually evaluates the total loan relationship, including a detailed collateral analysis, to determine the reserve appropriate for each one.  Any potential loss exposure identified in the collateral analysis is set aside as a specific reserve (valuation allowance) in the allowance for loan lease losses.  If the impaired loan is subsequently resolved and it is determined the reserve is no longer required, the specific reserve will be taken back into income on the income statement for the period the determination is made.  Impaired loans, or portions thereof, are charged off when deemed uncollectible.  Impaired loans as of March 31, 2011 and December 31, 2010 are set forth in the following table:


 
13

 



In thousands
 
Recorded Investment
   
Unpaid Principal Balance
   
Related Allowance
   
Average Recorded Investment
   
Interest Income Recognized
 
March 31, 2011
                             
With no related allowance:
                             
Commercial - Non Real Estate
                             
Commercial & Industrial
  $ 2,626     $ 2,954     $ -     $ 3,978     $ 10  
Business Manager
    -       -       -       -       -  
Commercial Real Estate
                                       
Owner occupied
    12,098       12,108       -       12,192       172  
Income producing
    808       830       -       1,004       -  
Multifamily
    140       354       -       354       -  
Construction & Development
                                       
1 - 4 Family
    -       -       -       -       -  
Other
    3,827       3,964       -       4,639       -  
Farmland
    -       -       -       -       -  
Consumer - Non Real Estate
                                       
Credit Cards
    -       -       -       -       -  
Other
    -       -       -       -       -  
Residential
                                       
Equity Lines
    75       75       -       75       -  
1st D/T
    2,129       2,643       -       4,309       23  
Junior Liens
    70       70       -       70       -  
Total loans with no allowance
  $ 21,773     $ 22,998     $ -     $ 26,621     $ 205  
                                         
With an allowance recorded:
                                       
Commercial - Non Real Estate
                                       
Commercial & Industrial
  $ 983       999       16       1,030       16  
Business Manager
    361       561       200       1,067       -  
Construction & Development
                                       
1 - 4 Family
    627       679       52       679       7  
Other
    2,062       4,092       1,145       4,092       15  
Consumer - Non Real Estate
                                       
Other
    18       24       6       26       -  
Residential
                                       
1st D/T
    651       701       50       703       10  
Total loans with an allowance
  $ 4,702     $ 7,056     $ 1,469     $ 7,597     $ 48  
                                         
Total:
                                       
Commercial – Non Real Estate
    3,970       4,514       216       6,075       26  
Commercial Real Estate
    13,046       13,292       -       13,550       172  
Construction & Development
    6,516       8,735       1,197       9,410       22  
Consumer – Non Real Estate
    18       24       6       26       -  
Residential
    2,925       3,489       50       5,157       33  
Totals
  $ 26,475     $ 30,054     $ 1,469     $ 34,218     $ 253  

 
14

 


December 31, 2010
                             
With no related allowance:
                             
Commercial - Non Real Estate
                             
Commercial & Industrial
  $ 2,644     $ 3,676     $ -     $ 2,293     $ 36  
Business Manager
    -       -       -       -       -  
Commercial Real Estate
                                       
Owner occupied
    12,301       12,310       -       12,553       705  
Income producing
    1,801       1,912       -       1,295       58  
Multifamily
    140       354       -       229       -  
Construction & Development
                                       
1 - 4 Family
    679       679       -       639       26  
Other
    4,610       6,241       -       9,773       -  
Farmland
    -