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Table of Contents

 
 
US Securities and Exchange Commission
Washington, DC 20549
Form 10-Q
Quarterly Report Pursuant To Section 13 or 15(d)
Of the Securities Exchange Act of 1934
For the Quarterly Period Ended June 30, 2011
Commission File Number 000-52099
Yadkin Valley Financial Corporation
(Exact name of registrant specified in its charter)
     
North Carolina   20-4495993
(State of Incorporation)   (I.R.S. Employer Identification No.)
209 North Bridge Street, Elkin, North Carolina 28621
(address of principal executive offices)
336-526-6300
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ 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 definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
             
Large accelerated filer o   Accelerated filer o   Non-accelerated filer o   Smaller reporting company þ
        (Do not check if a smaller reporting company)    
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes þ No o
Common shares outstanding as of August 4, 2011, par value $1.00 per share, were 19,526,188.
 
 

 


 

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
Three and Six Months Ended June 30, 2011 and 2010
         
Part I. Financial Information
       
Item 1. Financial Statements
       
    2  
    3  
    4  
    5  
    6-7  
    8-43  
    44-55  
    56  
    56  
 
       
       
    57  
    57  
    58  
Exhibits
    59-61  
 EX-31.1
 EX-31.2
 EX-32
 EX-101 INSTANCE DOCUMENT
 EX-101 SCHEMA DOCUMENT
 EX-101 CALCULATION LINKBASE DOCUMENT
 EX-101 LABELS LINKBASE DOCUMENT
 EX-101 PRESENTATION LINKBASE DOCUMENT
 EX-101 DEFINITION LINKBASE DOCUMENT
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

1


Table of Contents

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
As of June 30, 2011 and December 31, 2010
                 
    June 30,     December 31,*  
    2011     2010  
    (Amounts in thousands, except share data)  
ASSETS
               
Cash and due from banks
  $ 30,011     $ 31,967  
Federal funds sold
          31  
Interest-bearing deposits
    99,158       197,782  
Securities available-for-sale at fair value (amortized cost $312,882 in 2011 and $297,086 in 2010)
    317,459       298,002  
Gross loans
    1,504,267       1,600,539  
Less: allowance for loan losses
    35,652       37,752  
 
           
Net loans
    1,468,615       1,562,787  
 
               
Loans held-for-sale
    27,737       50,419  
Accrued interest receivable
    7,066       7,947  
Premises and equipment, net
    44,173       45,970  
Other real estate owned
    22,046       25,582  
Federal Home Loan Bank stock, at cost
    7,814       9,416  
Investment in bank-owned life insurance
    25,602       25,278  
Goodwill
          4,944  
Core deposit intangible (net of accumulated amortization of $8,219 in 2011 and $7,615 in 2010)
    4,304       4,907  
Other assets
    27,057       35,562  
 
           
Total Assets
  $ 2,081,042     $ 2,300,594  
 
           
 
               
LIABILITIES AND SHAREHOLDERS’ EQUITY
               
 
               
Deposits
               
Noninterest-bearing demand deposits
  $ 222,556     $ 216,161  
Interest-bearing deposits:
               
NOW, savings and money market accounts
    597,611       589,790  
Time certificates:
               
$100 or more
    409,410       477,030  
Other
    596,218       737,425  
 
           
Total Deposits
    1,825,795       2,020,406  
 
               
Short-term borrowings
    36,532       44,773  
Long-term borrowings
    66,992       71,995  
Capital lease obligations
    2,384       2,402  
Accrued interest payable
    2,748       3,302  
Other liabilities
    12,524       10,259  
 
           
Total Liabilities
    1,946,975       2,153,137  
 
           
 
               
Shareholders’ Equity
               
Preferred stock, no par value, 6,000,000 shares authorized; 49,312 issued and outstanding in 2011 and 2010
    47,080       46,770  
Common stock, $1 par value, 50,000,000 shares authorized; 19,526,188 issued and outstanding in 2011 and 16,147,640 issued and outstanding in 2010
    19,526       16,148  
Warrants
    3,581       3,581  
Surplus
    117,763       114,649  
Accumulated deficit
    (56,717 )     (34,273 )
Accumulated other comprehensive income
    2,834       582  
 
           
Total Shareholders’ Equity
    134,067       147,457  
 
           
Total Liabilities and Shareholders’ Equity
  $ 2,081,042     $ 2,300,594  
 
           
 
*   Derived from audited financial statements
See notes to condensed consolidated financial statements
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Table of Contents

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF INCOME (LOSS) (UNAUDITED)
Three and Six Months Ended June 30, 2011 and 2010
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Amounts in thousands, except per share data)  
INTEREST INCOME:
                               
Interest and fees on loans
  $ 20,768     $ 22,458     $ 42,117     $ 45,416  
Interest on federal funds sold
    9       2       15       2  
Interest and dividends on securities:
                               
Taxable
    1,698       1,170       3,202       2,379  
Non-taxable
    557       492       1,161       1,054  
Interest-bearing deposits
    90       126       205       187  
 
                       
TOTAL INTEREST INCOME
    23,122       24,248       46,700       49,038  
 
                       
INTEREST EXPENSE
                               
Time deposits of $100 or more
    2,541       3,274       5,478       6,635  
Other time and savings deposits
    3,731       4,780       8,112       8,835  
Borrowed funds
    539       596       1,110       1,163  
 
                       
TOTAL INTEREST EXPENSE
    6,811       8,650       14,700       16,633  
 
                       
NET INTEREST INCOME
    16,311       15,598       32,000       32,405  
PROVISION FOR LOAN LOSSES
    10,393       5,809       15,260       10,193  
 
                       
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES
    5,918       9,789       16,740       22,212  
 
                       
NON-INTEREST INCOME:
                               
Service charges on deposit accounts
    1,437       1,486       2,782       2,924  
Other service fees
    967       917       1,929       1,758  
Net gain on sales and fees of mortgage loans
    179       1,876       2,078       3,210  
Net gain on sale of securities
    429       844       522       888  
Income on investment in bank-owned life insurance
    161       191       324       398  
Mortgage banking income
    103       60       311       116  
Other than temporary impairment of securities
    (22 )     (61 )     (42 )     (266 )
Other income
    102       139       244       205  
 
                       
TOTAL NON-INTEREST INCOME
    3,356       5,452       8,148       9,233  
 
                       
NON-INTEREST EXPENSES:
                               
Salaries and employee benefits
    7,793       6,941       15,663       13,604  
Occupancy and equipment expense
    2,330       1,956       4,500       3,922  
Printing and supplies
    156       259       337       533  
Data processing
    381       384       754       697  
Amortization of core deposit intangible
    299       326       603       660  
Communications
    473       435       919       894  
FDIC assessment
    1,328       1,288       2,678       2,118  
Loan collection fees
    465       289       898       561  
Other professional fees
    334       331       612       521  
Net cost of operation of other real estate owned
    2,430       403       3,224       1,199  
Loss on sales and impairment of premises and equipment
    1,195             1,195        
Goodwill impairment
    4,944             4,944        
Other
    2,329       2,368       5,039       4,803  
 
                       
TOTAL NON-INTEREST EXPENSES
    24,457       14,980       41,366       29,512  
 
                       
INCOME (LOSS) BEFORE INCOME TAXES
    (15,183 )     261       (16,478 )     1,933  
INCOME TAX EXPENSE (BENEFIT)
    5,030       (24 )     4,521       733  
 
                       
NET INCOME (LOSS)
    (20,213 )     285       (20,999 )     1,200  
Preferred stock dividend and accretion of preferred stock discount
    674       771       1,445       1,542  
 
                       
NET LOSS TO COMMON SHAREHOLDERS
  $ (20,887 )   $ (486 )   $ (22,444 )   $ (342 )
 
                       
NET LOSS PER COMMON SHARE:
                               
Basic
  $ (1.16 )   $ (0.03 )   $ (1.31 )   $ (0.02 )
Diluted
  $ (1.16 )   $ (0.03 )   $ (1.31 )   $ (0.02 )
CASH DIVIDENDS PER COMMON SHARE
  $     $     $     $  
See notes to condensed consolidated financial statements
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

3


Table of Contents

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPRENHENSIVE INCOME (LOSS) (UNAUDITED)
Three and Six Months Ended June 30, 2011 and 2010
                                 
    Three Months Ended June 30,     Six Months Ended June 30,  
    2011     2010     2011     2010  
    (Amounts in thousands)     (Amounts in thousands)  
NET INCOME (LOSS)
  $ (20,213 )   $ 285     $ (20,999 )   $ 1,200  
 
                               
OTHER COMPREHENSIVE INCOME:
                               
Unrealized holding gains on securities available-for-sale
    3,413       981       4,263       1,597  
Tax effect
    (1,314 )     (378 )     (1,641 )     (614 )
 
                       
 
                               
Unrealized holding gains on securities available-for-sale, net of tax amount
    2,099       603       2,622       983  
 
                               
Reclassification adjustment for realized gains
    (429 )     (844 )     (602 )     (888 )
Tax effect
    165       325       232       342  
 
                       
 
                               
Reclassification adjustment for realized gains, net of tax amount
    (264 )     (519 )     (370 )     (546 )
 
                       
 
                               
OTHER COMPREHENSIVE INCOME, NET OF TAX
    1,835       84       2,252       437  
 
                       
 
                               
COMPREHENSIVE INCOME (LOSS)
  $ (18,378 )   $ 369     $ (18,747 )   $ 1,637  
 
                       
See notes to condensed consolidated financial statements
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Table of Contents

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY (UNAUDITED)
Six Months Ended June 30, 2011 and 2010
                                                                 
                                            Retained     Accumulated        
                                            Earnings     Other     Total  
    Common Stock     Preferred                     (Accumulated     Comprehensive     Shareholders’  
    Shares     Amount     Stock     Warrants     Surplus     Deficit)     Income (loss)     Equity  
    (Amounts in thousands, except share data)  
BALANCE, DECEMBER 31, 2009
    16,129,640     $ 16,130     $ 46,152     $ 3,581     $ 114,574     $ (31,080 )   $ 2,909     $ 152,266  
 
                                                               
Net income
                                  1,200             1,200  
Restricted stock issued
    15,000       15                   (15 )                  
Discount accretion on preferred stock
                309                   (309 )            
Stock option compensation:
                                                               
stock options
                            38                   38  
restricted stock
                            5                   5  
Preferred stock dividends
                                  (1,233 )           (1,233 )
Other comprehensive income
                                        437       437  
 
                                               
 
                                                               
BALANCE, JUNE 30, 2010
    16,144,640     $ 16,145     $ 46,461     $ 3,581     $ 114,602     $ (31,422 )   $ 3,346     $ 152,713  
 
                                               
 
                                                               
BALANCE, DECEMBER 31, 2010
    16,147,640     $ 16,148     $ 46,770     $ 3,581     $ 114,649     $ (34,273 )   $ 582     $ 147,457  
 
                                                               
Net loss
                                  (20,999 )           (20,999 )
Issuance of common stock
    3,233,548       3,233                   3,169                   6,402  
Restricted stock issued
    145,000       145                   (145 )                  
Discount accretion on preferred stock
                310                   (310 )            
Stock option compensation:
                                                               
stock options
                            38                   38  
restricted stock
                            52                   52  
Preferred stock dividends
                                  (1,135 )           (1,135 )
Other comprehensive income
                                        2,252       2,252  
 
                                               
 
                                                               
BALANCE, JUNE 30, 2011
    19,526,188     $ 19,526     $ 47,080     $ 3,581     $ 117,763     $ (56,717 )   $ 2,834     $ 134,067  
 
                                               
See notes to condensed consolidated financial statements
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

5


Table of Contents

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
Six Months Ended June 30, 2011 and 2010
                 
    Six Months Ended June 30,  
    2011     2010  
    (Amounts in thousands)  
CASH FLOWS FROM OPERATING ACTIVITIES:
               
Net income (loss)
  $ (20,999 )   $ 1,200  
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
               
Net amortization of premiums on investment securities
    2,298       467  
Provision for loan losses
    15,260       10,193  
Net gain on sales of mortgage loans
    (2,078 )     (3,210 )
Other than temporary impairment of investments
    42       266  
Impairment of goodwill
    4,944        
Increase in cash surrender value of life insurance
    (324 )     (398 )
Depreciation and amortization
    1,449       1,532  
Loss on sales and impairment of premises and equipment
    1,195       8  
Net losses on other real estate owned
    2,119       1,199  
Gain on sale of securities
    (602 )     (888 )
Amortization of core deposit intangible
    603       660  
Deferred tax provision
    4,036       4,523  
Stock based compensation expense
    90       43  
Originations of mortgage loans held-for-sale
    (363,246 )     (337,208 )
Proceeds from sales of mortgage loans
    388,007       340,591  
Decrease in capital lease obligations
    18       17  
Decrease in accrued interest receivable
    881       263  
Decrease in other assets
    4,001       941  
Increase (decrease) in accrued interest payable
    (554 )     776  
Increase (decrease) in other liabilities
    1,709       (1,511 )
 
           
NET CASH PROVIDED BY OPERATING ACTIVITIES
    38,849       19,464  
 
           
CASH FLOWS FROM INVESTING ACTIVITIES:
               
Purchases of available-for-sale securities
    (76,754 )     (83,414 )
Proceeds from sales of available-for-sale securities
    39,094       29,180  
Proceeds from maturities of available-for-sale securities
    20,168       30,939  
Net decrease in loans
    71,450       4,997  
Proceeds from the redemption of Federal Home Loan Bank stock
    1,602        
Purchases of premises and equipment
    (1,830 )     (2,332 )
Proceeds from the sale of other real estate owned
    8,880       4,115  
 
           
NET CASH PROVIDED BY (USED IN) INVESTING ACTIVITIES
    62,610       (16,515 )
 
           
CASH FLOWS FROM FINANCING ACTIVITIES:
               
Net increase in checking, NOW, money market and savings accounts
    14,215       26,355  
Net increase (decrease) in time certificates
    (208,827 )     105,331  
Net decrease in borrowed funds
    (13,244 )     (4,846 )
Proceeds from the issuance of common stock
    6,402        
Preferred dividends paid
    (616 )     (1,233 )
 
           
NET CASH PROVIDED BY (USED IN) FINANCING ACTIVITIES
    (202,070 )     125,607  
 
           
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Table of Contents

YADKIN VALLEY FINANCIAL CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED), CONTINUED
Six Months Ended June 30, 2011 and 2010
                 
    Six Months Ended June 30,  
    2011     2010  
    (Amounts in thousands)  
NET INCREASE/(DECREASE) IN CASH AND CASH EQUIVALENTS
    (100,611 )     128,556  
CASH AND CASH EQUIVALENTS:
               
Beginning of year
    229,780       92,337  
 
           
End of year
  $ 129,169     $ 220,893  
 
           
SUPPLEMENTARY CASH FLOW INFORMATION:
               
Cash paid for interest
  $ 15,186     $ 16,478  
 
           
Cash paid for income taxes
  $ 26     $ 5  
 
           
 
               
SUPPLEMENTAL DISCLOSURE OF NONCASH
               
INVESTING AND FINANCING ACTIVITIES:
               
Transfer from loans to foreclosed real estate
  $ 7,463     $ 9,164  
 
           
Unrealized gain on investment securities available for sale, net of tax effect
  $ 2,622     $ 983  
 
           
See notes to condensed consolidated financial statements
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Notes to Unaudited Condensed Consolidated Financial Statements
1. Significant Accounting Policies
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of Yadkin Valley Financial Corporation and its subsidiary, Yadkin Valley Bank and Trust Company. On July 1, 2006, Yadkin Valley Bank and Trust Company (the “Bank”) became a subsidiary of Yadkin Valley Financial Corporation (the “Company”) through a one for one share exchange of the then outstanding 10,648,300 shares. Sidus Financial, LLC (“Sidus”) is a single member LLC with the Bank as its single member. Sidus offers mortgage banking services and is headquartered in Greenville, NC. The accompanying unaudited condensed consolidated interim financial statements of the Company have been prepared in conformity with accounting principles generally accepted in the United States of America for interim financial statements and with instructions to Form 10-Q and Regulation S-X. Accordingly, they do not include all of the information and footnotes required by Generally Accepted Accounting Principles (“GAAP”) for complete financial statements. Because the accompanying condensed consolidated financial statements do not include all of the information and footnotes required by GAAP, they should be read in conjunction with the audited consolidated financial statements and accompanying footnotes included with the Company’s 2010 Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on March 10, 2011. Operating results, for the three and six months ended June 30, 2011, do not necessarily indicate the results that may be expected for the year or other interim periods.
In the opinion of management, the accompanying condensed consolidated financial statements contain all the adjustments, all of which are normal recurring adjustments, necessary to present fairly the financial position of the Company as of June 30, 2011 and December 31, 2010, and the results of its operations and cash flows for the three and six months ended June 30, 2011 and 2010. The accounting policies followed are set forth in Note 1 to the Consolidated Financial Statements in the Company’s 2010 Annual Report on Form 10-K.
2. New Accounting Standards
Recently Adopted Accounting Standards
In January 2011, the FASB issued guidance on the “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20 (“ASU 2010-20”).” The provisions of this guidance require the disclosure of more granular information on the nature and extent of troubled debt restructurings and their effect on the allowance for loan and lease losses. The amendments in this guidance defer the effective date related to these disclosures, enabling creditors to provide such disclosures after the FASB completes their project clarifying the guidance for determining what constitutes a troubled debt restructuring. As the provisions of this ASU only defer the effective date of disclosure requirements related to troubled debt restructurings, the adoption of this ASU had no impact on the Company’s statements of income and condition. When the Company adopts the deferred requirements of ASU 2010-20, the Company will have additional disclosures related to its troubled debt restructured loans.
In April 2011, the FASB issued additional guidance regarding “A Creditor’s Determination of Whether a Restructuring is a Troubled Debt Restructuring.” The provisions of this new standard provide additional guidance related to determining whether a creditor has granted a concession, including factors and examples for creditors to consider in evaluating whether a restructuring results in a delay in payment that is insignificant, prohibiting creditors from using the borrower’s effective rate test to evaluate whether a concession has been granted to the borrower, and adding factors for creditors to use in determining whether a borrower is experiencing financial difficulties. A provision in the standard also ends the FASB’s deferral of the additional disclosures about troubled debt restructurings as required by previously released standards. The provisions of this guidance are effective for the Company’s reporting period ending September 30, 2011. The adoption of the standard is not expected to have a material impact on the Company’s
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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statements of income and financial condition, however; this guidance could result in an increase in troubled debt restructured loans. Management is still evaluating the impact of this standard.
In June 2011, the FASB issued Accounting Standards Update No. 2011-05 Presentation of Comprehensive Income (“ASU 2011-05”). This standard eliminates the current option to report other comprehensive income and its components in the statement of changes in shareholders’ equity and is intended to enhance comparability between entities that report under U.S. GAAP and those that report under International Financial Reporting Standards (“IFRS”), and to provide a more consistent method of presenting non-owner transactions that affect an entity’s equity. ASU 2011-05 requirements are effective for public entities as of the beginning of fiscal years beginning after December 15, 2011 and interim and annual periods thereafter. Early adoption is permitted, but full retrospective application is required under both sets of accounting standards. The Company has adopted the standard and the adoption of ASU 2011-05 did not have an impact on the Company’s financial condition, results of operations, or cash flows.
3. Stock-based Compensation
During the three and six months ended June 30, 2011, 6,400 and 20,300 options were vested, respectively. During the three and six months ended June 30, 2010, 4,000 and 25,200 options were vested, respectively. At June 30, 2011, there were 33,600 options unvested and no shares available for grants of options other than shares available under the Omnibus Plan.
There were no restricted shares granted in the second quarter of 2011. During the first quarter of 2011, there were 145,000 shares of restricted stock granted at an average fair value of $2.34 per share. The fair value of each share grant is based on the closing market price of the stock on the date of issuance. The restricted shares granted to date vest over a three-year period. As of June 30, 2011, 1,666 shares of restricted stock are vested and 161,334 shares are nonvested. During the second quarter of 2010, there were 10,000 shares of restricted stock granted at a fair value of $4.99 per share. The fair value of each share grant is based on the closing market price of the stock on the date of issuance. There were 5,000 shares of restricted stock granted at a fair value of $3.71 per share during the first quarter of 2010.
There were no options granted during the first six months of 2011 or 2010.
The compensation expense related to options and restricted shares was $53,725 for the three-month period ended June 30, 2011 and $90,373 for the six-month period ended June 30, 2011. As of June 30, 2011, there was $445,309 of total unrecognized compensation cost related to nonvested share-based compensation arrangements granted under all of the Company’s stock benefit plans. This cost is expected to be recognized over an average vesting period of 2.4 years. The compensation expense related to options was $23,552 for the three-month period ended June 30, 2010 and $43,302 for the six-month period ended June 30, 2010.
There were no options exercised during the three and six months ended June 30, 2011 and 2010.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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4. Investment Securities
Investment securities at June 30, 2011 and December 31, 2010 are summarized as follows:
                                 
    June 30, 2011  
            Unrealized     Unrealized        
    Amortized Cost     Gains     Losses     Fair Value  
    (Amounts in thousands)  
Available-for-sale securities:
                               
 
                               
Securities of U.S. government agencies due:
                               
After 1 but within 5 years
  $ 34,209     $ 276     $     $ 34,485  
 
                       
 
    34,209       276             34,485  
 
                       
 
                               
Government sponsored agencies:
                               
Residential mortgage-backed securities due:
                               
After 1 but within 5 years
    747       24             771  
After 5 but within 10 years
    19,419       791             20,210  
After 10 years
    41,169       977       325       41,821  
 
                       
 
    61,335       1,792       325       62,802  
 
                       
 
                               
Collateralized mortgage obligations due:
                               
After 5 but within 10 years
    18,738       290             19,028  
After 10 years
    130,481       1,261       336       131,406  
 
                       
 
    149,219       1,551       336       150,434  
 
                       
 
                               
Private label collateralized mortgage obligations due:
                               
After 5 but within 10 years
    332       13             345  
After 10 years
    1,265             50       1,215  
 
                       
 
    1,597       13       50       1,560  
 
                       
 
                               
State and municipal securities due:
                               
Within 1 year
    624       4             628  
After 1 but within 5 years
    8,617       414             9,031  
After 5 but within 10 years
    22,895       729       17       23,607  
After 10 years
    33,273       838       343       33,768  
 
                       
 
    65,409       1,985       360       67,034  
 
                       
 
                               
 
                       
Common and preferred stocks:
    1,113       68       37       1,144  
 
                       
 
 
                       
Total available-for-sale securities
  $ 312,882     $ 5,685     $ 1,108     $ 317,459  
 
                       
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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    December 31, 2010  
            Unrealized     Unrealized        
    Amortized Cost     Gains     Losses     Fair Value  
    (Amounts in thousands)  
Available-for-sale securities:
                               
 
                               
Securities of U.S. government agencies due:
                               
After 1 but within 5 years
  $ 14,547     $ 6     $ 3     $ 14,550  
 
                       
 
    14,547       6       3       14,550  
 
                       
 
                               
Government sponsored agencies:
                               
Residential mortgage-backed securities due:
                               
After 1 but within 5 years
    1,040       36             1,076  
After 5 but within 10 years
    7,839       602             8,441  
After 10 years
    41,863       1,132       437       42,558  
 
                       
 
    50,742       1,770       437       52,075  
 
                       
 
                               
Collateralized mortgage obligations due:
                               
After 5 but within 10 years
    16,063       165       57       16,171  
After 10 years
    140,021       672       938       139,755  
 
                       
 
    156,084       837       995       155,926  
 
                       
 
                               
Private label collateralized mortgage obligations due:
                               
After 5 but within 10 years
    406       17             423  
After 10 years
    1,430             148       1,282  
 
                       
 
    1,836       17       148       1,705  
 
                       
 
                               
State and municipal securities due:
                               
Within 1 year
    2,476       18             2,494  
After 1 but within 5 years
    10,680       327       53       10,954  
After 5 but within 10 years
    21,348       413       236       21,525  
After 10 years
    38,260       295       906       37,649  
 
                       
 
    72,764       1,053       1,195       72,622  
 
                       
 
                               
 
                       
Common and preferred stocks:
    1,113       36       25       1,124  
 
                       
 
 
                       
Total available-for-sale securities
  $ 297,086     $ 3,719     $ 2,803     $ 298,002  
 
                       
Mortgage-backed securities are included in maturity groups based upon stated maturity date. At June 30, 2011, $62.8 million of the Bank’s mortgage-backed securities were pass-through securities and $152.0 million were collateralized mortgage obligations. At December 31, 2010, $52.1 million of the Bank’s mortgage-backed securities were pass-through securities and $157.6 million were collateralized mortgage obligations. Actual maturity will vary based on repayment of the underlying mortgage loans.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Gross realized gains on the sale of securities for the three and six months ended June 30, 2011 were $428,664 and $601,900, respectively. Gross realized gains on the sale of securities for the three and six months ended June 30, 2010 were $844,320 and $888,319, respectively. There were no losses on the sale of securities available-for-sale for the three and six month periods ended June 30, 2011 and 2010.
Investment securities with carrying values of approximately $110,847,763 and $111,803,619 at June 30, 2011 and December 31, 2010, respectively, were pledged as collateral for public deposits and for other purposes as required or permitted by law.
The following table presents the gross unrealized losses and fair value of investment securities, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, at June 30, 2011 and December 31, 2010. Securities that have been in a loss position for twelve months or more at June 30, 2011 include one collateralized mortgage obligation, one municipal security and one private label collateralized mortgage obligation. The key factors considered in evaluating the collateralized mortgage obligation, private label collateralized mortgage obligations, and municipal securities were cash flows of this investment and the assessment of other relative economic factors. Securities that have been in a loss position for twelve months or more at December 31, 2010 include one mortgage-backed security, one municipal security and one private label collateralized mortgage obligation. The unrealized losses relate to securities that have incurred fair value reductions due to a shift in demand from non-governmental securities and municipals to U.S. Treasury bonds and governmental agencies due to credit market concerns. The unrealized losses are not likely to reverse until market interest rates decline to the levels that existed when the securities were purchased. None of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption obligations. It is more likely than not that the Company will not have to sell the investments before recovery of their amortized cost bases. For the three and six months ended June 30, 2010, there were no securities available-for-sale deemed to be other than temporarily impaired (“OTTI”).
If management determines that an investment has experienced an other than temporary impairment, the loss is recognized in the income statement.
                                                 
    Less Than 12 Months     12 Months or More     Total  
            Unrealized             Unrealized             Unrealized  
June 30, 2011   Fair value     losses     Fair value     losses     Fair value     losses  
    (Amounts in thousands)  
Securities available-for-sale:
                                               
U.S. government agencies
  $     $     $     $     $     $  
Government sponsored agencies:
                                               
Mortgage-backed securities
    17,007       325                   17,007       325  
Collateralized mortgage obligations
    18,200       308       3,553       28       21,753       336  
Private label collateralized mortgage obligations
                1,215       50       1,215       50  
State and municipal securities
    13,793       356       293       4       14,086       360  
Common and preferred stocks
    74       37                   74       37  
 
                                   
Total temporarily impaired securities
  $ 49,074     $ 1,026     $ 5,061     $ 82     $ 54,135     $ 1,108  
 
                                   
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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    Less Than 12 Months     12 Months or More     Total  
            Unrealized             Unrealized             Unrealized  
December 31, 2010   Fair value     losses     Fair value     losses     Fair value     losses  
    (Amounts in thousands)  
Securities available-for-sale:
                                               
U.S. government agencies
  $ 4,569     $ 3     $     $     $ 4,569     $ 3  
Government sponsored agencies:
                                               
Residential mortgage-backed securities
    21,637       435       136       2       21,773       437  
Collateralized mortgage obligation
    76,925       995                   76,925       995  
Private label collateralized mortgage obligations
                1,283       148       1,283       148  
State and municipal securities
    31,775       1,174       276       21       32,051       1,195  
Common and preferred stocks, and other
    79       25                   79       25  
 
                                   
Total temporarily impaired securities
  $ 134,985     $ 2,632     $ 1,695     $ 171     $ 136,680     $ 2,803  
 
                                   
The aggregate cost of the Company’s cost method investments totaled $9,195,013 at June 30, 2011 and $12,463,510 at December 31, 2010. Cost method investments at June 30, 2011 include $7,814,200 in FHLB stock and $1,380,813 of investments in various trust and financial companies, which are included in other assets. All cost method investments were evaluated for impairment at June 30, 2011 and December 31, 2010. The following factors have been considered in determining the carrying amount of FHLB stock; 1) the recoverability of the par value, 2) the Company has sufficient liquidity to meet all operational needs in the foreseeable future and would not need to dispose of the stock below recorded amounts, 3) redemptions and purchases of the stock are at the discretion of the FHLB, 4) the Company believes the FHLB has the ability to absorb economic losses given the expectation that the various FHLBs’ have a high degree of government support, and 5) the unrealized losses related to securities owned by the FHLB are manageable given the capital levels of the organization. The Company estimated that the fair value equaled or exceeded the cost of each of these investments (that is, the investments were not impaired) on the basis of the redemption provisions of the issuing entities with two exceptions. The Company’s investment in a local community bank was considered to be other than temporarily impaired and $20,000 and $22,154 was charged off in the first and second quarters of 2011, respectively. During the first six months of 2010, the Company’s investment in a financial services company was considered to be OTTI and $27,925 was charged-off. In addition, the Company’s investment in a local community bank was considered to be OTTI and $226,236 was charged-off in 2010. In addition to the impairments listed above, the Company also sold its investment in a financial services company during the first quarter of 2011, resulting in a loss of $79,910.
5. Commitments and Contingencies
In the normal course of business, there are various outstanding commitments and contingent liabilities, such as commitments to extend credit, which are not reflected in the accompanying financial statements. At June 30, 2011, the Company had commitments outstanding of $294.3 million for additional loan amounts. Commitments of Sidus, the Bank’s mortgage lending subsidiary, are excluded from this amount and discussed in the paragraph below. Additional commitments totaling $7.1 million were outstanding under standby letters of credit. Management does not expect any significant losses to result from these commitments.
At June 30, 2011, Sidus had $30.7 million of commitments outstanding to originate mortgage loans held-for-sale at fixed prices and $57.9 million of forward commitments outstanding under best efforts contracts to sell mortgages to agencies and other investors. See Note 8 for additional disclosures on these derivative financial instruments.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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6. Earnings Per Common Share
Basic net income per common share is computed by dividing net income by the weighted average number of shares of common stock outstanding for the reporting periods. Diluted net income available to common shareholders per common 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. The numerators of the basic net income per share computations are the same as the numerators of the diluted net income per common share computations for all the periods presented. Weighted average shares outstanding for the three and six months ended June 30, 2011 excludes 161,334 shares of unvested restricted stock. Weighted average shares outstanding for the three and six months ended June 30, 2010 excludes 5,000 shares of unvested restricted stock. A reconciliation of the denominator of the basic net income per common share computations to the denominator of the diluted net income per common share computations is as follows:
                                 
    Three Months Ended     Six Months Ended  
    June 30     June 30  
    2011     2010     2011     2010  
Basic EPS denominator:
                               
Weighted average number of common shares outstanding
    18,041,174       16,129,640       17,091,130       16,129,640  
Dilutive effect arising from assumed exercise of stock options
                       
 
                       
Diluted EPS denominator
    18,041,174       16,129,640       17,091,130       16,129,640  
For the three months ended June 30, 2011 and 2010, net income (loss) for determining net loss per common share was reported as net income (loss) less the dividend on preferred stock. During the quarter and six months ended June 30, 2011, there were 375,276 warrants and stock options that were not considered dilutive because the exercise prices exceeded the average market price per share. These non-dilutive shares had exercise prices ranging from $3.84 to $19.07 per share. During the quarter ended June 30, 2010, 578,962 warrants and stock options were not considered dilutive because the exercise prices exceeded the average market price per share. These non-dilutive shares had exercise prices ranging from $3.84 to $19.07 per share. Unvested shares of restricted stock and all other common stock equivalents were excluded from the determination of diluted earnings (loss) per share for the three and six months ended June 30, 2011 due to the Company’s loss position for those periods.
7. Shareholders’ Equity
The Bank, as a North Carolina banking corporation, may pay dividends only out of undivided profits as determined pursuant to North Carolina General Statutes Section 53-87. At June 30, 2011 and 2010, there were no undivided profits available for dividend payments. The Bank is currently prohibited from paying dividends to the holding company without prior FDIC and NC Banking Commissioner approval. The Company has committed to regulators that the Bank will maintain a Tier 1 Leverage Ratio of 8%. The Company deferred dividend payments on its Series T and Series T-ACB Preferred Stock and interest payment on the trust preferred securities in the second quarter of 2011. The Company also may be required to defer dividend payments on its Series T and Series T-ACB Preferred Stock and interest payments on the trust preferred securities in the future given liquidity levels at the holding company. Because the Company deferred dividend payments on the Series T and Series T-ACB Preferred Stock and deferred interest
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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payments on its trust preferred securities, the Company is prohibited from paying any dividends on its common stock until all deferred payments have been made in full.
On May 24, 2007, the Board approved a plan to repurchase up to 100,000 shares of the Company’s outstanding common shares (“2007 plan”). There are 28,719 common shares available to purchase under the 2007 plan at June 30, 2011 and December 31, 2010. The Company did not repurchase any common shares during the first three and six months of 2011 or 2010. The Company will be subject to restrictions on share repurchases for so long as it remains a participant in the Capital Purchase Program under the Treasury’s Troubled Asset Relief Program. Generally, the Company must obtain Treasury’s consent for any repurchases that would be made prior to July 24, 2012 (the third anniversary of the second of the Company’s two issuances of securities under this program), and the Company will be prohibited from making any repurchases at any time that it has deferred making dividend payments on the Series T and Series T-ACB preferred stock.
8. Derivatives
The Company currently has derivative instrument contracts consisting of interest rate swaps and interest rate lock commitments and commitments to sell mortgages. The primary objective for each of these contracts is to minimize interest rate risk. The Company’s strategy is to use derivative contracts to stabilize and improve net interest margin and net interest income currently and in future periods. The Company does not enter into derivative financial instruments for speculative or trading purposes. For derivatives that are economic hedges, but are not designated as hedging instruments or otherwise do not qualify for hedge accounting treatment, all changes in fair value are recognized in non-interest income during the period of change.
As part of interest rate risk management, the Company has entered into two interest rate swap agreements to convert certain fixed-rate receivables to floating rates and certain fixed-rate obligations to floating rates. The interest rate swaps are used to provide fixed rate financing while managing interest rate risk and were not designated as hedges. The interest rate swaps pay and receive interest based on a floating rate based on one month LIBOR, with payments being calculated on the notional amount. The interest rate swaps are settled quarterly and mature on June 15, 2016. The interest rate swaps each had a notional amount of $2.1 million at June 30, 2011, representing the amount of fixed-rate receivables outstanding and liabilities outstanding, and are included in other assets and other liabilities at their fair value of $173,323. The Company had a gain of $40,406 on the interest rate swap asset and a loss of $40,406 on the interest rate swap liability for the three months ended June 30, 2011. The Company had a gain of $14,146 on the interest rate swap asset and a loss of $14,146 on the interest rate swap liability for the six months ended June 30, 2011. The Company had a gain of $162,000 on the interest rate swap asset and a loss of $162,000 on the interest rate swap liability for the three and six months ended June 30, 2010. The interest rate swaps had a notional amount of $2.1 million outstanding as of December 31, 2010. The interest rate swaps were not designated as hedges and all changes in fair value are recorded as other income within noninterest income. Fair values for interest rate swap agreements are based upon the amounts required to settle the contracts.
The Company is exposed to certain risks relating to its ongoing mortgage origination business. Sidus, the Bank’s mortgage lending subsidiary, enters into interest rate lock commitments and commitments to sell mortgages. The primary risks managed by derivative instruments are these interest rate lock commitments and forward-loan-sale commitments. Interest rate lock commitments are entered into to manage interest rate risk associated with the Company’s fixed rate loan commitments. The period of time between the issuance of a loan commitment and the closing and sale of the loan generally ranges from 10 to 60 days. Such interest rate lock commitments and forward-loan-sale commitments represent derivative instruments which are required to be carried at fair value. These derivative instruments do not qualify as hedges under the Derivatives and Hedging topic of the FASB Accounting Standards Codification. The fair value of the Company’s interest rate lock commitments is based on the value that can be generated when the underlying loan is sold on the secondary market and is included on the balance sheet in other assets and on the income statement in income from loans. The fair value of the Company’s forward sales commitments is based on changes in the value of the commitment, principally because of changes in interest rates, and is included on the balance sheet in other assets or other liabilities and on the income statement in income from loans.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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At June 30, 2011, Sidus had $30.7 million of commitments outstanding to originate mortgage loans held-for-sale at fixed prices and $57.9 million of forward commitments outstanding for original commitments and outstanding mortgage loans held-for-sale under best efforts contracts to sell mortgages to agencies and other investors. The fair value of forward sales commitments recorded in other liabilities was $92,367 at June 30, 2011. The fair value of the interest rate lock commitments recorded in assets was $16,251 at June 30, 2011. Recognition of losses related to the change in fair value of the interest rate lock commitments and forward sales commitments were $35,422 and $443,693, respectively, for the three months ended June 30, 2011, and are included in other income. Recognition of gains related to the change in fair value of the interest rate lock commitments and losses on forward sales commitments were $16,101 and $157,263, respectively, for the six months ended June 30, 2011, and are included in other income. Recognition of gains related to the change in fair value of the interest rate lock commitments and gains related to forward sales commitments were $85,345 and $55,199, respectively, for the three months ended June 30, 2010, and are included in other income. Recognition of losses related to the change in fair value of the interest rate lock commitments and gains related to forward sales commitments were $3,925 and $61,910, respectively, for the six months ended June 30, 2010, and are included in other income. At December 31, 2010, Sidus had $119.2 million of commitments outstanding to originate mortgage loans held-for-sale at fixed prices and $167.6 million of forward commitments outstanding under best efforts contracts to sell mortgages to agencies and other investors. The fair value of interest rate locks recorded in other assets was $104,810 at December 31, 2010. The fair value of the forward sales commitments recorded in other assets was $161,071 at December 31, 2010.
9. Loans and Allowance for Loan Losses
General. The Bank provides to its customers a full range of short- to medium-term commercial, agricultural, Small Business Administration guaranteed, mortgage, home equity, and personal loans, both secured and unsecured. The Bank also makes real estate mortgage and construction loans.
The following table presents loans at June 30, 2011 and December 31, 2010 by class:
                 
    June 30,     December 31,  
    2011     2010  
    (in thousands)  
Construction and land development
  $ 243,681     $ 300,877  
Commercial real estate:
               
Owner occupied
    351,936       309,198  
Non-owner occupied
    248,960       312,231  
Residential mortgages:
               
1-4 family
    179,372       174,536  
Multifamily
    31,313       29,268  
Home equity lines of credit
    205,308       209,319  
Commercial
    181,473       199,696  
Consumer and other
    61,600       65,003  
 
           
Total
    1,503,643       1,600,128  
Less: Net deferred loan origination fees
    624       411  
Allowance for loan losses
    (35,652 )     (37,752 )
 
           
Loans, net
  $ 1,468,615     $ 1,562,787  
 
           
Real Estate Loans. Real estate loans include construction and land development loans, commercial real estate loans, home equity lines of credit, and residential mortgages.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Commercial real estate loans totaled $600.9 million and $621.4 million at June 30, 2011 and December 31, 2010, respectively. This lending has involved loans secured by owner-occupied commercial buildings for office, storage and warehouse space, as well as non-owner occupied commercial buildings. The Bank generally requires the personal guaranty of borrowers and a demonstrated cash flow capability sufficient to service the debt. Loans secured by commercial real estate may be larger in size and may involve a greater degree of risk than one-to-four family residential mortgage loans. Payments on such loans are often dependent on successful operation or management of the properties.
Construction/development lending totaled $243.7 million and $300.9 million at June 30, 2011 and December 31, 2010, respectively. The Bank originates one to four family residential construction loans for the construction of custom homes (where the home buyer is the borrower) and provides financing to builders and consumers for the construction of pre-sold homes. The Bank generally receives a pre-arranged permanent financing commitment from an outside banking entity prior to financing the construction of pre-sold homes. The Bank also makes commercial real estate construction loans, primarily for owner-occupied properties. The Bank limits its construction lending risk through adherence to established underwriting procedures.
Residential one-to-four family loans amounted to $179.4 million and $174.5 million at June 30, 2011 and December 31, 2010, respectively. The Bank’s residential mortgage loans are typically construction loans that convert into permanent financing and are secured by properties located within the Bank’s market areas.
Commercial Loans. At June 30, 2011 and December 31, 2010, the Bank’s commercial loan portfolio totaled $181.5 million and $199.7 million, respectively. Commercial loans include both secured and unsecured loans for working capital, expansion, and other business purposes. Short-term working capital loans are secured by accounts receivable, inventory and/or equipment. The Bank also makes term commercial loans secured by equipment and real estate. Lending decisions are based on an evaluation of the financial strength, cash flow, management and credit history of the borrower, and the quality of the collateral securing the loan. With few exceptions, the Bank requires personal guarantees and secondary sources of repayment. Commercial loans generally provide greater yields and reprice more frequently than other types of loans, such as real estate loans.
Loans to Individuals. Loans to individuals (consumer loans) include automobile loans, boat and recreational vehicle financing, and miscellaneous secured and unsecured personal loans and totaled $61.6 million and $65.0 million at June 30, 2011 and December 31, 2010, respectively. Consumer loans generally can carry significantly greater risks than other loans, even if secured, if the collateral consists of rapidly depreciating assets such as automobiles and equipment. Repossessed collateral securing a defaulted consumer loan may not provide an adequate source of repayment of the loan. Consumer loan collections are sensitive to job loss, illness and other personal factors. The Bank manages the risks inherent in consumer lending by following established credit guidelines and underwriting practices designed to minimize risk of loss.
Loan Approvals. The Bank’s loan policies and procedures establish the basic guidelines governing its lending operations. The guidelines address the type of loans that the Bank seeks, target markets, underwriting and collateral requirements, terms, interest rate and yield considerations and compliance with laws and regulations. All loans or credit lines are subject to approval procedures and amount limitations. These limitations apply to the borrower’s total outstanding indebtedness to the Bank, including any indebtedness as a guarantor. The policies are reviewed and approved at least annually by the Board of Directors of the Bank. The Bank supplements its own supervision of the loan underwriting and approval process with periodic loan reviews by independent, outside professionals experienced in loan review. Responsibility for loan review and loan underwriting resides with the Chief Credit Officer position. This position is responsible for loan underwriting and approval. On an annual basis, the Board of Directors of the Bank determines officers lending authority. Authorities may include loans, letters of credit, overdrafts, uncollected funds and such other authorities as determined by the Board of Directors.
Substantially all of the Company’s loans have been granted to customers in the Piedmont, foothills, northwestern mountains, and the Research Triangle regions of North Carolina and the upstate region of South Carolina.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Credit Review and Evaluation. The Bank has a credit risk review department that reports to the Chief Credit Officer. The focus of the department is on policy compliance and proper grading of higher credit risk loans as well as new and existing loans on a sample basis. Additional reporting for problem/criticized assets has been developed along with an after-the-fact loan review.
The Bank uses a risk grading program to facilitate the evaluation of probable inherent loan losses and the adequacy of the allowance for loan losses for real estate, commercial and consumer loans. In this program, risk grades are initially assigned by loan officers, reviewed by regional credit officers, and reviewed by internal credit review analysts on a test basis. The Bank strives to maintain the loan portfolio in accordance with conservative loan underwriting policies that result in loans specifically tailored to the needs of the Bank’s market area. Every effort is made to identify and minimize the credit risks associated with such lending strategies.
Loans over $20,000 are risk graded on a scale from 1 (highest quality) to 8 (loss). Acceptable loans at inception are grades 1 through 4, and these grades have underwriting requirements that at least meet the minimum requirements of a secondary market source. If borrowers do not meet credit history requirements, other mitigating criteria such as substantial liquidity and low loan-to-value ratios could be considered and would generally have to be met in order to make the loan. The Bank’s loan policy states that a guarantor may be necessary if reasonable doubt exists as to the borrower’s ability to repay. The Board of Directors has authorized the loan officers to have individual approval authority for risk grade 1 through 4 loans up to maximum exposure limits for each customer. New or renewed loans that are graded 5 (special mention) or lower must have approval from a regional credit officer. Any changes in risk assessments as determined by loan officers, credit administrators, regulatory examiners and management are also considered.
The risk grades, normally assigned by the loan officers when the loan is originated and reviewed by the regional credit officers, are based on several factors including historical data, current economic factors, composition of the portfolio, and evaluations of the total loan portfolio and assessments of credit quality within specific loan types. In some cases the risk grades are assigned by regional executives, depending upon dollar exposure. Because these factors are dynamic, the provision for loan losses can fluctuate. Credit quality reviews are based primarily on analysis of borrowers’ cash flows, with asset values considered only as a second source of payment. Regional credit officers work with lenders in underwriting, structuring and risk grading the Bank’s credits. The Risk Review Officer focuses on lending policy compliance, credit risk grading, and credit risk reviews on larger dollar exposures. Management uses the information developed from the procedures above in evaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality of the loan portfolio and to assist management in determining the appropriate levels of the allowance for loan losses.
The following is a summary of the credit risk grade definitions for all loan types:
“1” — Highest Quality- These loans represent a credit extension of the highest quality. The borrower’s historic (at least five years) cash flows manifest extremely large and stable margins of coverage. Balance sheets are conservative, well capitalized, and liquid. After considering debt service for proposed and existing debt, projected cash flows continue to be strong and provide ample coverage. The borrower typically reflects broad geographic and product diversification and has access to alternative financial markets.
“2” — Good Quality- These loans have a sound primary and secondary source of repayment. The borrower may have access to alternative sources of financing, but sources are not as widely available as they are to a higher graded borrower. This loan carries a normal level of risk, with minimal loss exposure. The borrower has the ability to perform according to the terms of the credit facility. The margins of cash flow coverage are satisfactory but vulnerable to more rapid deterioration than the highest quality loans.
“3” — Satisfactory- The borrowers are a reasonable credit risk and demonstrate the ability to repay the debt from normal business operations. Risk factors may include reliability of margins and cash flows, liquidity, dependence on a
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single product or industry, cyclical trends, depth of management, or limited access to alternative financing sources. Historic financial information may indicate erratic performance, but current trends are positive. Quality of financial information is adequate, but is not as detailed and sophisticated as information found on higher graded loans. If adverse circumstances arise, the impact on the borrower may be significant.
“4” — Satisfactory — Merits Attention- These credit facilities have potential developing weaknesses that deserve extra attention from the account manager and other management personnel. If the developing weakness is not corrected or mitigated, there may be deterioration in the ability of the borrower to repay the bank’s debt in the future.
“5” — Watch or Special Mention — These loans are typically existing loans, made using the passing grades outlined above, that have deteriorated to the point that cash flow is not consistently adequate to meet debt service or current debt service coverage is based on projections. Secondary sources of repayment may include specialized collateral or real estate that is not readily marketable or undeveloped, making timely collection in doubt.
“6” — Substandard- Loans and other credit extensions bearing this grade are considered inadequately protected by the current sound worth and debt service capacity of the borrower or of any pledged collateral. These obligations, even if apparently protected by collateral value, have well-defined weaknesses related to adverse financial, managerial, economic, market, or political conditions jeopardizing repayment of principal and interest as originally intended. Clear loss potential, however, does not have to exist in any individual assets classified as substandard.
“7” — Doubtful (also includes any loans over 90 days past due, excluding sold mortgages )- Loans and other credit extensions graded “7” have all the weaknesses inherent in those graded “6,” with the added characteristic that the severity of the weaknesses makes collection or liquidation in full highly questionable or improbable based upon currently existing facts, conditions, and values. The probability of some loss is extremely high, but because of certain important and reasonably specific factors, the amount of loss cannot be determined.
“8” — Loss- Loans in this classification are considered uncollectible and cannot be justified as a viable asset of the bank. Such loans are to be charged-off or charged-down. This classification does not mean the loan has absolutely no recovery value, but that it is neither practical nor desirable to defer writing off this loan even though partial recovery may be obtained in the future.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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The following is a summary of credit quality indicators by class at June 30, 2011 and December 31, 2010:
Real Estate Credit Exposure as of June 30, 2011
                                                 
            Commercial Real Estate                    
            Non-owner     Owner                    
    Construction     occupied     occupied     1-4 Family     Multifamily     Home Equity  
    (in thousands)  
High Quality
  $     $     $ 129     $ 433     $     $ 141  
Good Quality
    583       131       109       1,814             8,090  
Satisfactory
    33,465       56,265       119,764       96,579       9,329       128,937  
Merits Attention
    115,340       145,150       178,114       58,803       19,535       57,468  
Special Mention
    48,319       26,139       26,501       8,401       713       4,943  
Substandard
    13,990       9,386       9,657       4,190       641       2,828  
Doubtful
    31,984       11,889       17,662       9,152       1,095       2,901  
Loss
                                     
 
                                   
 
  $ 243,681     $ 248,960     $ 351,936     $ 179,372     $ 31,313     $ 205,308  
 
                                   
Other Credit Exposures as of June 30, 2011
                 
            Consumer  
    Commercial     and other  
    (in thousands)  
High Quality
  $ 3,316     $ 2,709  
Good Quality
    6,538       1,759  
Satisfactory
    54,661       31,287  
Merits Attention
    81,243       23,813  
Special Mention
    19,880       1,177  
Substandard
    7,148       211  
Doubtful
    8,687       642  
Loss
          2  
 
           
 
  $ 181,473     $ 61,600  
 
           
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Real Estate Credit Exposure as of December 31, 2010
                                                 
            Commercial Real Estate                    
            Non-owner     Owner                    
    Construction     occupied     occupied     1-4 Family     Multifamily     Home Equity  
    (in thousands)  
High Quality
  $     $     $ 132     $ 440     $     $ 153  
Good Quality
    612       195       1,535       1,924             8,465  
Satisfactory
    53,704       73,825       98,531       95,541       7,964       132,155  
Merits Attention
    124,699       163,648       150,494       55,300       19,922       57,513  
Special Mention
    49,369       37,018       27,478       6,966       90       4,938  
Substandard
    37,798       24,219       15,132       7,117       311       3,012  
Doubtful
    34,695       13,326       15,896       7,248       981       3,083  
Loss
                                   
 
                                   
 
  $ 300,877     $ 312,231     $ 309,198     $ 174,536     $ 29,268     $ 209,319  
 
                                   
Other Credit Exposures as of December 31, 2010
                 
            Consumer  
    Commercial     and other  
    (in thousands)  
High Quality
  $ 5,005     $ 1,952  
Good Quality
    6,620       1,589  
Satisfactory
    63,472       34,841  
Merits Attention
    78,188       24,424  
Special Mention
    31,311       1,224  
Substandard
    6,391       311  
Doubtful
    8,709       662  
Loss
           
 
           
 
  $ 199,696     $ 65,003  
 
           
Nonaccrual loans and past due loans. Nonperforming assets include loans classified as nonaccrual, foreclosed bank-owned property and loans past due 90 days or more on which interest is still being accrued. It is the general policy of the Bank to stop accruing interest for all classes of loans past due 90 days or when it is apparent that the collection of principal and/or interest is doubtful. In addition, certain restructured loans are placed on nonaccrual status until sufficient evidence of timely payment is obtained. When a loan is placed on nonaccrual status, any interest previously accrued but not collected is reversed against interest income in the current period. Amounts received on nonaccrual loans generally are applied first to principal and then to interest only after all principal has been collected. There were no financing receivables past due over 90 days accruing interest as of June 30, 2011 and December 31, 2010.
Nonperforming loans as of June 30, 2011 totaled $68.9 million, or 4.50% of total loans, compared with $65.4 million or 3.96% of total loans, as of December 31, 2010. The Bank aggressively pursues the collection and repayment of all loans. Other nonperforming assets, such as repossessed and foreclosed collateral is aggressively liquidated by the Bank’s collection department. The total number of loans on nonaccrual status has increased from 490 to 525 since December 31, 2010. The increase in nonperforming loans from December 31, 2010 to June 30, 2011 is related primarily to continued deterioration of previously classified loans and the addition of troubled debt restructured loans which will remain on nonaccrual status until sufficient payment evidence is obtained.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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For the six months ended June 30, 2011, the Company recognized interest income on nonaccrual loans of approximately $513,000, as interest is received on performing troubled debt restructured loans. If interest on those loans had been accrued in accordance with the original terms, interest income would have increased by approximately $1.6 million for the six months ended June 30, 2011.
The following is a breakdown of nonaccrual loans as of June 30, 2011 and December 31, 2010:
                 
    June 30, 2011     December 31, 2010  
    (in thousands)  
Financing Receivables on Nonaccrual status
               
Construction
  $ 28,452     $ 25,833  
Commercial Real Estate:
               
Non-owner occupied
    10,619       10,767  
Owner occupied
    13,895       12,829  
Mortgages:
               
1-4 Family first lien
    8,202       7,889  
Multifamily
    1,081       967  
Home Equity lines of credit
    2,604       3,068  
Commercial
    3,480       3,420  
Consumer and other
    565       627  
 
           
Total
  $ 68,898     $ 65,400  
 
           
Past due loans reported in the following table do not include loans granted forbearance terms since payments terms have been modified or extended, although the loans are past due based on original contract terms. All loans with forbearance terms are included and reported as impaired loans.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Loans are considered past due if the required principal and interest income have not been received as of the date such payments were due. The following table presents the Bank’s aged analysis of past due loans:
                                                 
                    Greater                    
    30-59 Days     60-89 Days     Than 90     Total Past              
    Past Due     Past Due     Days     Due     Current     Total Loans  
    (in Thousands)  
June 30, 2011
                                               
Construction
  $ 3,143     $ 2,999     $ 13,134     $ 19,276     $ 224,405     $ 243,681  
Commercial real estate:
                                               
Non-owner occupied
    818       320       2,557       3,695       245,265       248,960  
Owner occupied commercial
    4,763       2,001       5,499       12,263       339,673       351,936  
Commercial
    1,919       2,018       572       4,509       176,964       181,473  
Mortgages:
                                               
Secured 1-4 family- first lien
    1,267       1,334       4,501       7,102       172,270       179,372  
Multifamily
    19       601       233       853       30,460       31,313  
Open ended secured 1-4 family
    1,923       495       1,002       3,420       201,888       205,308  
Consumer and other
    540       208       112       860       60,740       61,600  
 
                                   
Total
  $ 14,392     $ 9,976     $ 27,610     $ 51,978     $ 1,451,665     $ 1,503,643  
 
                                   
                                                 
December 31, 2010
                                               
Construction
  $ 5,747     $ 3,951     $ 11,542     $ 21,240     $ 279,637     $ 300,877  
Commercial real estate:
                                               
Non-owner occupied
    1,616       722       530       2,868       309,363       312,231  
Owner occupied commercial
    5,814       1,635       5,464       12,913       296,285       309,198  
Commercial
    1,086       949       241       2,276       197,420       199,696  
Mortgages:
                                               
Secured 1-4 family- first lien
    3,457       1,988       5,643       11,088       163,448       174,536  
Multifamily
    845       150       40       1,035       28,233       29,268  
Open ended secured 1-4 family
    2,388       211       2,045       4,644       204,675       209,319  
Consumer and other
    669       285       232       1,186       63,817       65,003  
 
                                   
Total
  $ 21,622     $ 9,891     $ 25,737     $ 57,250     $ 1,542,878     $ 1,600,128  
 
                                   
Impaired Loans. Management considers certain loans graded “doubtful” (loans graded 7) or “loss” (loans graded 8) to be individually impaired and may consider “substandard” loans (loans graded 6) individually impaired depending on the borrower’s payment history. The Bank measures impairment based upon probable cash flows or the value of the collateral. Collateral value is assessed based on collateral value trends, liquidation value trends, and other liquidation expenses to determine logical and credible discounts that may be needed. Updated appraisals are required for all impaired loans and typically at renewal or modification of larger loans if the appraisal is more than 12 months old.
Impaired loans for all classes of loans typically include nonaccrual loans, loans over 90 days past due still accruing, troubled debt restructured loans and other potential problem loans considered impaired based on other underlying factors. Troubled debt restructured loans are those for which concessions, including the reduction of interest rates below a rate otherwise available to that borrower or the deferral of interest or principal have been granted due to the borrower’s weakened financial condition. Interest on troubled debt restructured loans is accrued at the restructured rates when it is anticipated that no loss of original principal will occur and a sustained payment performance period is obtained. Due to the borrowers’ inability to make the payments required under the original loan terms, the Bank
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modifies the terms by granting a longer amortized repayment structure or reduced interest rates. Potential problem loans are loans which are currently performing and are not included in nonaccrual or restructured loans above, but about which we have serious doubts as to the borrower’s ability to comply with present repayment terms. These loans are likely to be included later in nonaccrual, past due or troubled debt restructured loans, so they are considered by management in assessing the adequacy of the allowance for loan losses. Impaired loans under $250,000 are typically not individually evaluated for impairment.
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Form 10-Q Quarterly Report June 30, 2011

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The following table presents the Bank’s investment in loans considered to be impaired and related information on those impaired loans as of June 30, 2011 and December 31, 2010:
                                                         
                            Quarter to Date     Year to Date  
            Unpaid             Average     Interest     Average     Interest  
    Recorded     Principal     Related     Recorded     Income     Recorded     Income  
    Investment     Balance     Allowance     Investment     Recognized     Investment     Recognized  
    (in thousands)  
June 30, 2011
                                                       
Impaired loans without a related allowance for loan losses
                                                       
Construction
  $ 20,947     $ 33,900     $     $ 22,835     $ 156     $ 22,020     $ 298  
Commercial real estate:
                                                       
Non-owner occupied
    6,697       9,621             6,640       26       6,294       63  
Owner occupied
    9,820       12,109             10,104       117       10,451       259  
Commercial
    4,736       5,363             2,561       34       2,319       59  
Mortgages:
                                                       
Secured 1-4 family real estate
    3,016       3,818             2,372       26       2,484       42  
Multifamily
    297       308             299       3       302       5  
Open ended secured 1-4 family
    580       595             707       5       813       9  
Consumer and other
                                         
Impaired loans with a related allowance for loan losses
                                                       
Construction
  $ 7,316     $ 8,711     $ 1,136     $ 7,181     $ 52     $ 8,740     $ 148  
Commercial real estate:
                                                       
Non-owner occupied
    3,764       4,235       494       3,866       48       4,993       88  
Owner occupied
    6,759       6,820       1,183       6,498       61       5,891       114  
Commercial
    2,080       2,080       655       5,113       51       5,218       93  
Mortgages:
                                                       
Secured 1-4 family real estate
    1,841       1,871       507       2,601       14       2,331       34  
Multifamily
    443       466       56       447       7       453       16  
Open ended secured 1-4 family
    745       751       237       618       9       720       12  
Consumer and other
    125       132       27       125             129       6  
Total impaired loans
                                                       
Construction
  $ 28,263     $ 42,611     $ 1,136     $ 30,016     $ 208     $ 30,760     $ 446  
Commercial real estate:
                                                       
Non-owner occupied
    10,461       13,856       494       10,506       74       11,287       151  
Owner occupied
    16,579       18,929       1,183       16,602       178       16,342       373  
Commercial
    6,816       7,443       655       7,674       85       7,537       152  
Mortgages:
                                                       
Secured 1-4 family real estate
    4,857       5,689       507       4,973       40       4,815       76  
Multifamily
    740       774       56       746       10       755       21  
Open ended secured 1-4 family
    1,325       1,346       237       1,325       14       1,533       21  
Consumer and other
    125       132       27       125             129       6  
 
                                         
Total impaired loans individually reviewed for impairment
  $ 69,166     $ 90,780     $ 4,295     $ 71,967     $ 609     $ 73,158     $ 1,246  
 
                                         
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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            Unpaid             Average     Interest  
    Recorded     Principal     Related     Recorded     Income  
    Investment     Balance     Allowance     Investment     Recognized  
    (in thousands)  
December 31, 2010
                                       
Impaired loans without a related allowance for loan losses
                                       
Construction
  $ 21,677     $ 32,573     $     $ 11,427     $ 230  
Commercial real estate:
                                       
Non-owner occupied commercial real estate
    5,732       6,660             2,380       99  
Owner occupied commercial real estate
    11,573       13,892             5,109       207  
Commercial
    1,998       2,630             1,226       45  
Mortgages:
                                       
Secured 1-4 family real estate
    3,122       4,056             1,427       64  
Multifamily
    310       315             192       13  
Open ended secured 1-4 family
    953       961             294       12  
Consumer and other
                      72       5  
Impaired loans with a related allowance for loan losses
                                       
Construction
  $ 11,116     $ 12,845     $ 2,141     $ 16,379     $ 263  
Commercial real estate:
                                       
Non-owner occupied commercial real estate
    6,484       6,861       1,096       5,758       141  
Owner occupied commercial real estate
    5,077       5,104       860       4,416       134  
Commercial
    5,435       5,435       1,318       4,266       101  
Mortgages:
                                       
Secured 1-4 family real estate
    2,133       2,225       343       3,270       57  
Multifamily
    469       476       82       159       9  
Open ended secured 1-4 family
    898       898       439       780       14  
Consumer and other
    134       135       35       73       3  
Total impaired loans
                                       
Construction
  $ 32,793     $ 45,418     $ 2,141     $ 27,806     $ 493  
Commercial real estate:
                                       
Non-owner occupied commercial real estate
    12,216       13,521       1,096       8,138       240  
Owner occupied commercial real estate
    16,650       18,996       860       9,525       341  
Commercial
    7,433       8,065       1,318       5,492       146  
Mortgages:
                                       
Secured 1-4 family real estate
    5,255       6,281       343       4,697       121  
Multifamily
    779       791       82       351       22  
Open ended secured 1-4 family
    1,851       1,859       439       1,074       26  
Consumer and other
    134       135       35       145       8  
 
                             
Total impaired loans individually reviewed for impairment
  $ 77,111     $ 95,066     $ 6,314     $ 57,228     $ 1,397  
 
                             
Impaired loans acquired without a related allowance for loan losses includes loans for which no additional reserves have been recorded in excess of credit discounts for purchased impaired loans. Impaired loans acquired with subsequent deterioration and related allowance for loan losses are loans in which additional impairment has been identified in excess of credit discounts resulting in additional reserves. These additional reserves are included in the allowance for loan losses related to purchased impaired loans and were $76,000 and $47,000 as of June 30, 2011 and December 31, 2010, respectively. The following table presents information regarding the change in all purchased impaired loans from the Company’s acquisition of American Community on April 17, 2009 through June 30, 2011.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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    Contractual              
    Principal     Nonaccretable     Carrying  
    Receivable     Difference     Amount  
    (in thousands)  
Balance at December 31, 2009
  $ 5,388     $ 497     $ 4,891  
Change due to payoff received
    (214 )     (20 )     (194 )
Transfer to foreclosed real estate
    (9 )     (159 )     150  
Change due to charge-offs
    (386 )     (246 )     (140 )
 
                 
Balance at June 30, 2010
  $ 4,779     $ 72     $ 4,707  
 
                 
 
                       
Balance at December 31, 2010
  $ 1,655     $ 72     $ 1,583  
Change due to payoff received
    (214 )     (27 )     (187 )
 
                 
Balance at June 30, 2011
  $ 1,441     $ 45     $ 1,396  
 
                 
At June 30, 2011, the outstanding balance of purchased impaired loans from American Community, which includes principal, interest and fees due, was $1.4 million. Because of the uncertainty of the expected cash flows, the Company is accounting for each purchased impaired loan under the cost recovery method, in which all cash payments are applied to principal. Thus, there is no accretable yield associated with the above loans.
Allowance for Loan Losses. The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate for probable losses that have been incurred within the existing portfolio of loans. The primary risks inherent in the Bank’s loan portfolio, including the adequacy of the allowance or reserve for loan losses, are based on management’s assumptions regarding, among other factors, general and local economic conditions, which are difficult to predict and are beyond the Bank’s control. In estimating these risks, and the related loss reserve levels, management also considers the financial conditions of specific borrowers and credit concentrations with specific borrowers, groups of borrowers, and industries.
The allowance for loan losses is adjusted by direct charges to provision expense. Losses on loans are charged against the allowance for loan losses in the accounting period in which they are determined by management to be uncollectible. Recoveries during the period are credited to the allowance for loan losses. The provision for loan losses was $10.4 million for the quarter ended June 30, 2011 as compared to $5.8 million for the quarter ended June 30, 2010; and $15.2 million for the six months ended June 30, 2011 as compared to $10.2 million for the six months ended June 30, 2010. The provision expense is determined by the Bank’s allowance for loan losses model. The components of the model are specific reserves for impaired loans and a general allocation for unimpaired loans. The general allocation has two components, an estimate based on historical loss experience and an additional estimate based on internal and external environmental factors due to the uncertainty of historical loss experience in predicting current embedded losses in the portfolio that will be realized in the future.
In determining the general allowance allocation, the ratios from the actual loss history for the various categories are applied to the homogeneous pools of loans in each category. In addition, to recognize the probability that loans in special mention, doubtful, and substandard risk grades are more likely to have embedded losses, additional reserve factors (“criticized asset factor”) based on the likelihood of loss are applied to the homogeneous pools of weaker graded loans that have not yet been identified as impaired. During the second quarter of 2011, the Company performed its semi-annual update to the criticized asset factor. Changes to the factor included updated loss information and further segregation of loss information by loan type. These changes resulted in an overall reduction in allowances of approximately $831,000.
The portion of the general allocation on environmental factors includes estimates of losses related to interest rate trends, unemployment trends, real estate characteristics, past due and nonaccrual trends, watch list trends, charge-off
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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trends, and underwriting and servicing assessments. During the second quarter of 2011, a new environmental factor was added to reflect changes in real estate market values over the average life of construction and permanent real estate loans. The application of this new factor during the quarter ended June 30, 2011 resulted in additional reserves of approximately $1.3 million. Markets served by the Bank continue to experience softening from the general economy and declines in real estate values. The real estate characteristics component includes trends in real estate concentrations, exceptions to FDIC guidelines for loan-to-value ratios, and changes in real estate market values. Other factors impacting the allowance at June 30, 2011 were watch list trends, unemployment rate trends, and underwriting and servicing assessments.
The following table presents changes in the allowance for loan losses for the three and six months ended June 30, 2011:
                                         
    December 31,                          
    2010     Charge-offs     Recoveries     Provision     June 30, 2011  
    (Amounts in thousands)  
Construction
  $ 12,014     $ 7,875     $ 1,081     $ 5,550     $ 10,770  
Commercial real estate:
                                       
Non owner occupied
    7,150       2,332       52       (590 )     4,280  
Owner occupied
    5,958       2,837       106       3,474       6,701  
Commercial
    4,335       2,024       111       1,598       4,020  
Mortgages:
                                       
Secured 1-4 family- first lien
    3,706       1,780       76       2,512       4,514  
Multifamily
    424       12             114       526  
Open ended secured 1-4 family
    3,298       1,686       81       2,319       4,012  
Consumer and other
    867       413       92       283       829  
 
                             
 
  $ 37,752     $ 18,959     $ 1,599     $ 15,260     $ 35,652  
 
                             
                                         
    March 31,                          
    2011     Charge-offs     Recoveries     Provision     June 30, 2011  
    (Amounts in thousands)  
Construction
  $ 9,592     $ 4,097     $ 1,008     $ 4,267     $ 10,770  
Commercial real estate:
                                       
Non owner occupied
    5,269       1,355       52       314       4,280  
Owner occupied
    7,234       2,098       30       1,535       6,701  
Commercial
    4,939       1,806       43       844       4,020  
Mortgages:
                                       
Secured 1-4 family- first lien
    4,323       1,239       46       1,384       4,514  
Multifamily
    486                   40       526  
Open ended secured 1-4 family
    3,144       1,154       42       1,980       4,012  
Consumer and other
    873       129       56       29       829  
 
                             
 
  $ 35,860     $ 11,878     $ 1,277     $ 10,393     $ 35,652  
 
                             
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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During the first quarter of 2011, the Company underwent a review of loan classifications within the portfolio and noted approximately $40.9 million in reclassifications between non-owner occupied and owner occupied commercial real estate. As a result, allowances for loan losses in those categories were impacted as reserve percentages on certain loans may have increased or decreased based on new classifications.
                                 
                    Reserves for        
    Reserves for             loans        
    loans     Loans     collectively     Loans  
    individually     individually     evaluated     collectively  
    evaluated for     evaluated for     for     evaluated for  
    impairment     impairment     impairment     impairment  
As of June 30, 2011   (Amounts in thousands)  
Construction
  $ 1,136     $ 28,263     $ 9,634     $ 215,418  
Commercial real estate:
                               
Non owner occupied
    494       10,461       3,786       238,499  
Owner occupied
    1,183       16,579       5,518       335,357  
Commercial
    655       6,816       3,365       174,657  
Mortgages:
                               
Secured 1-4 family- first lien
    507       4,857       4,007       174,515  
Multifamily
    56       740       471       30,573  
Open ended secured 1-4 family
    237       1,325       3,774       203,983  
Consumer and other
    27       125       802       61,475  
 
                       
 
  $ 4,295     $ 69,166     $ 31,357     $ 1,434,477  
 
                       
                                 
                    Reserves for        
    Reserves for             loans        
    loans     Loans     collectively     Loans  
    individually     individually     evaluated     collectively  
    evaluated for     evaluated for     for     evaluated for  
    impairment     impairment     impairment     impairment  
As of December 31, 2010   (Amounts in thousands)  
Construction
  $ 2,141     $ 32,793     $ 9,873     $ 268,084  
Commercial real estate:
                               
Non owner occupied
    1,096       12,216       6,054       300,015  
Owner occupied
    860       16,650       5,098       292,548  
Commercial
    1,318       7,433       3,016       192,262  
Mortgages:
                               
Secured 1-4 family- first lien
    343       5,255       3,363       169,281  
Multifamily
    82       779       342       28,489  
Open ended secured 1-4 family
    439       1,851       2,859       207,468  
Consumer and other
    35       134       832       64,869  
 
                       
 
  $ 6,314     $ 77,111     $ 31,437     $ 1,523,016  
 
                       
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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The allowance model is applied to determine the specific allowance balance for impaired loans and the general allowance balance for unimpaired loans grouped by loan type.
The Company’s loan charge-off policy for all loan classes is to charge down loans to net realizable value once a portion of the loan is determined to be uncollectable, and the underlying collateral shortfall is assessed. Unsecured loans (primarily consumer loans) are charged off against the reserve once the loan becomes 90 days past due or it is determined that a portion of the loan is uncollectable. Secured loans (primarily construction, real estate, commercial and other loans) are moved to non-accrual status when the loan becomes 90 days delinquent or a portion of the loan is determined to be uncollectable and supporting collateral is not considered to be sufficient to cover potential losses. Nonaccrual loans are reviewed at least quarterly to determine if all or a portion of the loan is uncollectable. Nonaccrual loans that are determined to be solely collateral dependent are promptly charged down to net realizable value upon determination that they are impaired.
In addition to the allowance for loan losses, the Company also estimates probable losses related to unfunded lending commitments, such as letters of credit, financial guarantees and unfunded loan commitments. Unfunded lending commitments are analyzed and segregated by loan classification. These classifications, in conjunction with an analysis of historical loss experience, current economic conditions, performance trends within specific portfolio segments and any other pertinent information, result in the estimation of the reserve for unfunded lending commitments. The reserve for credit losses related to unfunded lending commitments was $261,000 and $204,000 as of June 30, 2011 and December 31, 2010, respectively.
The Company maintains reserves for mortgage loans sold to agencies and investors in the event that, either through error or disagreement between the parties, the Company is required to indemnify the purchase. The reserves take into consideration risks associated with underwriting, key factors in the mortgage industry, loans with specific reserve requirements, past due loans and potential indemnification by the Company. Reserves are estimated based on consideration of factors in the mortgage industry such as declining collateral values and rising levels of delinquency, default and foreclosure, coupled with increased incidents of quality reviews at all levels of the mortgage industry seeking justification for pushing back losses to loan originators and wholesalers. As of June 30, 2011, the Company had reserves for mortgage loans sold of $2.1 million, and charges against reserves for the three and six months ended June 30, 2011 were $131,000 and $305,000, respectively. For the three and six months ended June 30, 2011 the Company recorded $545,000 and $417,000, respectively, in provision expense related to potential repurchase and warranties exposure on the $185 million in loan sales that occurred during that period. For the three and six months ended June 30, 2010 the Company recorded $229,000 and $469,000, respectively, in provision expense related to potential repurchase and warranties exposure and charges against reserves were $246,000 and $427,000, respectively. For the quarters ended June 30, 2011 and June 30, 2010, the Company did not repurchase any mortgage loans sold. As of December 31, 2010, the Company had reserves for mortgage loans sold of $2.0 million.
10. Fair Value
The Company utilizes fair value measurements to record fair value adjustments for certain assets and liabilities and to determine fair value disclosures. Available-for-sale securities, interest rate swaps, mortgage servicing rights, interest rate lock commitments and forward sale loan commitments are recorded at fair value on a recurring basis. Additionally, from time to time, the Company may be required to record other assets at fair value, such as loans held-for-investment and certain other assets. These nonrecurring fair value adjustments usually involve writing the asset down to fair value or the lower of cost or market value.
Following is a description of valuation methodologies used for assets and liabilities recorded at fair value.
Available-for-Sale Investment Securities
Available-for-sale investment securities are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted prices, if available. If quoted prices are not available, fair values are measured using independent
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions, and other factors such as credit loss assumptions. Level 1 securities include those traded on an active exchange, such as the New York Stock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-counter markets, and money market funds. Level 2 securities include mortgage-backed securities issued by government sponsored entities and private label entities, municipal bonds and corporate debt securities. There have been no changes in valuation techniques for the quarter ended June 30, 2011. Valuation techniques are consistent with techniques used in prior periods.
Interest Rate Locks and Forward Loan Sale Commitments
Sidus, the Company’s mortgage lending subsidiary, enters into interest rate lock commitments and commitments to sell mortgages. At June 30, 2011, the amount of fair value associated with these interest rate lock commitments and forward loan sale commitments was $16,251 and $92,367 respectively. At December 31, 2010, the amount of fair value associated with these interest rate lock commitments and sale commitments was $104,810 and $161,071, respectively. Interest rate locks and forward loan sale commitments are recorded at fair value on a recurring basis. The fair value of forward sales commitments is based on changes in loan pricing between the commitment date and period end, typically month end. The fair value of interest rate lock commitments is based on servicing release premium, origination income net of origination costs, and changes in loan pricing between the commitment date and period end, typically month end. There have been no changes in valuation techniques for the quarter ended June 30, 2011. Valuation techniques are consistent with techniques used in prior periods.
                 
    Interest Rate Lock Commitments  
    Level 3  
    Fair Value     Fair Value  
Balance, March 31, 2011 and 2010
  $ 337,453     $ 214,858  
Gains/losses included in other income
    (321,202 )     179,617  
Transfer in and out
           
 
           
Balance, June 30, 2011 and 2010
  $ 16,251     $ 394,475  
 
           
                 
    Interest Rate Lock Commitments  
    Level 3  
    Fair Value     Fair Value  
Balance, December 31, 2010 and 2009
  $ 104,810     $ (790,608 )
Gains/losses included in other income
    (88,559 )     1,185,083  
Transfer in and out
           
 
           
Balance, June 30, 2011 and 2010
  $ 16,251     $ 394,475  
 
           
Mortgage Servicing Rights
Mortgage servicing rights are recorded at fair value on a recurring basis. A valuation of mortgage servicing rights is performed using a pooling methodology. Similar loans are pooled together and evaluated on a discounted earnings basis to determine the present value of future earnings. The present value of the future earnings is the estimated market value for the pool, calculated using consensus assumptions that a third party purchaser would utilize in evaluating a potential acquisition of the servicing. As such, the Company classifies loan servicing rights as Level 3. There have been no changes in valuation techniques for the quarter ended June 30, 2011. Valuation techniques are consistent with techniques used in prior periods.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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The following table presents a rollforward of mortgage servicing rights from December 31, 2010 to June 30, 2011 and December 31, 2009 to June 30, 2010 and shows that the mortgage servicing rights are classified as Level 3 as discussed above.
                 
    Level 3  
    Fair Value     Fair Value  
    (In thousands)  
Balance, March 31, 2011 and 2010
  $ 2,220     $ 1,941  
Capitalized
    60       80  
Gains/losses included in other income
    (87 )     (61 )
 
           
Balance, June 30, 2011 and 2010
  $ 2,193     $ 1,960  
 
           
                 
    Level 3  
    Fair Value     Fair Value  
    (In thousands)  
Balance, December 31, 2010 and 2009
  $ 2,144     $ 1,918  
Capitalized
    195       181  
Gains/losses included in other income
    (146 )     (139 )
 
           
Balance, June 30, 2011 and 2010
  $ 2,193     $ 1,960  
 
           
Mortgage Loans Held-for-Sale
Loans held-for-sale are carried at lower of cost or market value on a recurring basis. The fair value of loans held-for-sale is based on what secondary markets are currently offering for portfolios with similar characteristics. As such, the Company classifies mortgage loans held-for-sale as Level 2. At June 30, 2011 and December 31, 2010, the cost of the Company’s mortgage loans held-for-sale was less than the market value. Accordingly, at quarter end the Company’s loans held-for-sale were carried at cost. There have been no changes in valuation techniques for the quarter ended June 30, 2011. Valuation techniques are consistent with techniques used in prior periods.
Impaired Loans
The Company does not record loans held-for-investment at fair value on a recurring basis. However, from time to time, a loan is considered impaired and an allowance for loan losses is established. Loans for which it is probable that payment of interest and principal will not be made in accordance with the contractual terms of the loan agreement are considered impaired. Once a loan is identified as individually impaired, management measures impairment in accordance with the Receivables topic of the FASB Accounting Standards Codification. The fair value of impaired loans is estimated using one of several methods, including collateral value, market value of similar debt, enterprise value, liquidation value and discounted cash flows. Those impaired loans not requiring an allowance represent loans for which the fair value of the expected repayments or collateral exceed the recorded investments in such loans. At June 30, 2011, the majority of impaired loans were evaluated based on the fair value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the impaired loan as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the impaired loan as nonrecurring Level 3. There have been no changes in valuation techniques for the quarter ended June 30, 2011. Valuation techniques are consistent with techniques used in prior periods.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Interest Rate Swaps
Interest rate swaps are recorded at fair value on a recurring basis. Fair value measurement is based on discounted cash flow models. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date. As a result, the Company classifies interest rate swaps as Level 3.
The following table presents a rollforward of interest rate swaps from December 31, 2010 to June 30, 2011, and from December 31, 2009 to June 20, 2010 and shows that the interest rate swaps are classified as Level 3 as discussed above.
                 
    Level 3  
    Fair Value- Assets     Fair Value- Liabilities  
    (Amounts in thousands)  
Balance, March 31, 2011
  $ 133     $ 133  
Purchases, sales, issuances and settlements
           
Gains/losses included in other income
    40       40  
 
           
Balance, June 30, 2011
  $ 173     $ 173  
 
           
 
               
Balance, March 31, 2010
  $     $  
Purchases, sales, issuances and settlements
           
Gains/losses included in other income
    162       162  
 
           
Balance, June 30, 2010
  $ 162     $ 162  
 
           
                 
    Level 3  
    Fair Value- Assets     Fair Value- Liabilities  
    (Amounts in thousands)  
Balance, December 31, 2010
  $ 159     $ 159  
Purchases, sales, issuances and settlements
           
Gains/losses included in other income
    14       14  
 
           
Balance, June 30, 2011
  $ 173     $ 173  
 
           
 
               
Balance, December 31, 2009
  $     $  
Purchases, sales, issuances and settlements
           
Gains/losses included in other income
    162       162  
 
           
Balance, June 30, 2010
  $ 162     $ 162  
 
           
Other Real Estate Owned
Other real estate owned (“OREO”) is adjusted to fair value upon transfer of the loans to OREO on a nonrecurring basis. Subsequently, OREO is carried at the lower of carrying value or fair value. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the OREO as nonrecurring Level 3. There have been no changes in valuation techniques for the quarter ended June 30, 2011. Valuation techniques are consistent with techniques used in prior periods.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Assets (liabilities) subjected to recurring fair value adjustments:
                                 
June 30, 2011 (in thousands)   Fair Value     Level 1     Level 2     Level 3  
Available-for-sale securities:
                               
U.S. government agencies
  $ 34,485     $     $ 34,485     $  
Government sponsored agencies:
                               
Residential mortgage-backed securities
    62,802             62,802        
Collateralized mortgage obligations
    150,434             150,434        
Private label collateralized mortgage obligations
    1,560             1,560        
State and municipal securities
    67,034             67,034        
Common and preferred stocks
    1,144       1,144              
Interest rate swap agreements
    173                   173  
Interest rate swap agreements
    (173 )                 (173 )
Interest rate lock commitments
    16                   16  
Forward loan sale commitments
    92             92        
Mortgage servicing rights
    2,193                   2,193  
                                 
December 31, 2010 (in thousands)   Fair Value     Level 1     Level 2     Level 3  
Available-for-sale securities:
                               
U.S. government agencies
  $ 14,550     $     $ 14,550     $  
Government sponsored agencies:
                               
Residential mortgage-backed securities
    52,075             52,075        
Collateralized mortgage obligations
    155,926             155,926        
Private label collateralized mortgage obligations
    1,705             1,705        
State and municipal securities
    72,622             72,622        
Common and preferred stocks
    1,124       1,124              
Interest rate swap agreements
    159                   159  
Interest rate swap agreements
    (159 )                 (159 )
Interest rate lock commitments
    105                   105  
Forward loan sale commitments
    161             161        
Mortgage servicing rights
    2,144                   2,144  
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Assets subjected to nonrecurring fair value adjustments:
                                 
June 30, 2011 (Amounts in thousands)   Fair Value     Level 1     Level 2     Level 3  
Other real estate owned
  $ 6,042     $     $     $ 6,042  
Impaired loans:
                               
Construction
    6,180                   6,180  
Commercial real estate:
                               
Non-owner occupied
    3,270                   3,270  
Owner occupied
    5,576                   5,576  
Commercial
    1,425                   1,425  
Mortgages:
                               
Secured 1-4 family real estate
    1,334                   1,334  
Multifamily
    387                   387  
Open ended secured 1-4 family
    508                   508  
Consumer and other
    98                   98  
 
                               
December 31, 2010
                               
Other real estate owned
  $ 2,941     $     $     $ 2,941  
Impaired loans:
                               
Construction
    8,975                   8,975  
Commercial real estate:
                               
Non-owner occupied
    5,388                   5,388  
Owner occupied
    4,217                   4,217  
Commercial
    4,117                   4,117  
Mortgages:
                               
Secured 1-4 family real estate
    1,790                   1,790  
Multifamily
    387                   387  
Open ended secured 1-4 family
    459                   459  
Consumer and other
    99                   99  
The carrying value of OREO at June 30, 2011 is $22,045,691. At December 31, 2010 the carrying value of OREO was $25,582,234. Other real estate owned with a carrying amounts of $7.3 million were written down to their fair value of $6.0 million for the six months ended June 30, 2011 and have been included in the table above, resulting in a loss of $1.3 million, which was included in earnings.
There were no transfers between valuation levels for any assets during the quarter ended June 30, 2011 or the quarter ended June 30, 2010. If different valuation techniques are deemed necessary, we would consider those transfers to occur at the end of the period when the assets are valued.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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11. Financial Instruments
The following is a summary of the carrying amounts and fair values of the Company’s financial assets and liabilities at June 30, 2011 and December 31, 2009:
                                 
    June 30, 2011     December 31, 2010  
    Carrying     Estimated     Carrying     Estimated  
    amount     fair value     amount     fair value  
    (Amounts in thousands)  
Financial assets:
                               
Cash and cash equivalents
  $ 129,169     $ 129,169     $ 229,780     $ 229,780  
Investment securities
    317,459       317,459       298,002       298,002  
Loans and loans held-for-sale, net
    1,496,352       1,427,010       1,613,206       1,541,071  
Accrued interest receivable
    7,066       7,066       7,947       7,947  
Federal Home Loan Bank stock
    7,814       7,814       9,416       9,416  
Investment in Bank owned life insurance
    25,602       25,602       25,278       25,278  
Interest rate swap agreements
    173       173       159       159  
Interest rate lock commitments
    16       16       105       105  
Forward sales commitments
    92       92       161       161  
Financial liabilities:
                               
Demand deposits, NOW, savings and money market accounts
    820,167       821,360       805,951       805,951  
Time deposits
    1,005,628       1,008,217       1,214,455       1,227,628  
Borrowed funds
    103,524       104,404       116,768       117,741  
Accrued interest payable
    2,748       2,748       3,302       3,302  
Interest rate swap agreements
    173       173       159       159  
The carrying amounts of cash and cash equivalents approximate their fair value.
The fair value of marketable securities is based on quoted market prices, prices quoted for similar instruments, and prices obtained from independent pricing services.
For certain categories of loans, such as installment and commercial loans, the fair value is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar credit ratings and for the same remaining maturities. The cost of fixed rate mortgage loans held-for-sale approximates the lower of cost or market as these loans are typically sold within 60 days of origination. Fair values for adjustable-rate mortgages are based on quoted market prices of similar loans adjusted for differences in loan characteristics. The Company applied an additional illiquidity discount in the amount of 5.0%.
The carrying value of FHLB stock approximates fair value based on the redemption provisions of the FHLB stock.
The investment in bank-owned life insurance represents the cash value of the policies at June 30, 2011 and December 31, 2010. The rates are adjusted annually thereby minimizing market fluctuations.
The fair value of demand deposits and savings accounts is the amount payable on demand at June 30, 2011 and December 31, 2010, respectively. The fair value of fixed-maturity certificates of deposit and individual retirement
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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accounts is estimated using the present value of the projected cash flows using rates currently offered for similar deposits with similar maturities.
The fair values of borrowings are based on discounting expected cash flows at the interest rate for debt with the same or similar remaining maturities and collateral requirements. The carrying values of short-term borrowings, including overnight, securities sold under agreements to repurchase, federal funds purchased and FHLB advances, approximates the fair values due to the short maturities of those instruments. The Company’s credit risk is not material to calculation of fair value because these borrowings are collateralized.
The carrying values of accrued interest receivable and accrued interest payable approximates fair values due to the short-term duration.
Interest rate swaps are recorded at fair value on a recurring basis. Fair value measurement is based on discounted cash flow models. All future floating cash flows are projected and both floating and fixed cash flows are discounted to the valuation date.
Interest rate locks and forward loan sale commitments are recorded at fair value on a recurring basis. The fair value of forward sales commitments is based on changes in loan pricing between the commitment date and period end, typically month end. The fair value of interest rate lock commitments is based on servicing release premium, origination income net of origination costs, and changes in loan pricing between the commitment date and period end, typically month end.
12. Goodwill
Goodwill represents the excess of the cost of an acquisition over the fair value of the net assets acquired. Goodwill impairment testing is performed annually or more frequently if events or circumstances indicate possible impairment. An impairment loss is recorded to the extent that the carrying value of goodwill exceeds its implied fair value.
Goodwill relating to the Sidus acquisition is evaluated by management on an annual basis at October 1st or more frequently if circumstances indicate possible impairment for the Sidus reporting unit. For the first six months of 2011, Sidus has experienced losses of $2.6 million due to declines in revenues and one-time expenses for severance and termination costs. During the quarter ended June 30, 2011, management made the strategic decision to exit out of the wholesale market and concentrate the focus on retail mortgage sales. As a result of these triggering events, goodwill related to the Sidus acquisition was evaluated for impairment as of June 30, 2011.
In performing the first step (“Step 1”) of the goodwill impairment testing and measurement process to identify possible impairment, the estimated fair value of the Sidus reporting unit was developed using the income and market approaches to value Sidus. The income approach consists of discounting projected long-term future cash flows, which are derived from internal forecasts and economic expectations for Sidus. Significant inputs to the income approach include the multiple of earnings derived from recent acquisitions, an annual discount rate of 25% representing investors’ estimated long-term required rate of return, and projected long-term earnings for the reporting units. A significant discount rate has been applied to the projections due to the fact that Sidus has sustained losses for the first six months of 2011 and has recently exited its wholesale business. The market valuation approach utilizes price-to-book value multiple and EBITDA multiples. Significant inputs to the price-to-book value multiple approach include a weighted-average multiple of long-term book value of 0.84 derived from southeast industry data, and long-term tangible book values of 1.06 for the reporting units.
The valuation has declined over the last twelve months as investors have demanded a higher return for equity investments in the mortgage business due to sustained weakness in the industry. Earnings multiples have declined and discount rates have increased as discussed in the paragraph above. These industry trends coupled with losses for the first six months of 2011, changes in the regulatory environment and additional costs associated with those changes,
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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and risks associated with recourse have all decreased expected future earnings and have resulted in management reducing its internal valuations. The lower valuations have resulted in goodwill impairment.
We updated our Step 1 goodwill impairment testing as of June 30, 2011. The results of this Step 1 process indicated that the estimated fair value of Sidus was less than book value, thus requiring a second step (“Step 2”) of the goodwill impairment test in accordance with accounting for Intangibles- Goodwill and other. The Step 2 analysis included an allocation of estimated fair value of the entity and allocated that value to identifiable tangible and intangible assets and liabilities as determined in Step 1. Assumptions included in the fair value of net assets included current market rates for loans. Based on the Step 2 analysis, it was determined that Sidus’ fair value did not support the goodwill recorded; therefore, Sidus has recorded a $4.9 million goodwill impairment charge to write-off all of its goodwill. This non-cash goodwill impairment charge to earnings was recorded as a component of non-interest expense on the consolidated statement of income (loss).
The following table presents changes in the carrying amount of goodwill for the six months ended June 30, 2011:
                         
    Banking Segment     Sidus Segment     Total  
Balance as of December 31, 2010
                       
Goodwill
  $     $ 4,943,872     $ 4,943,872  
Impairment losses
          (4,943,872 )     (4,943,872 )
 
                 
Balance as of June 30, 2011
  $     $     $  
 
                 
 
                       
Accumulated impairment losses
  $ (61,565,768 )   $ (4,943,872 )   $ (66,509,640 )
13. Business Segment Information
The Company has two reportable segments, including the Bank and Sidus Financial, a single member LLC with the Bank as the single member. Sidus is headquartered in Greenville, North Carolina and offers mortgage banking services to its customers throughout the Southeast and MidAtlantic regions. The following table details the results of operations for the three and six months ended June 30, 2011 and 2010 for the Bank and for Sidus.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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    Bank     Sidus     Other     Total  
    (Amounts in thousands)  
For Three Months Ended June 30, 2011
                               
Interest income
  $ 22,754     $ 368     $     $ 23,122  
Interest expense
    6,528       90       193       6,811  
 
                       
Net interest income
    16,226       278       (193 )     16,311  
 
                               
Provision for loan losses
    10,391       2             10,393  
 
                       
Net interest income (loss) after provision for loan losses
    5,835       276       (193 )     5,918  
Other income
    3,183       179       (6 )     3,356  
Other expense
    16,704       7,724       29       24,457  
 
                       
Loss before income taxes
    (7,686 )     (7,269 )     (228 )     (15,183 )
Income taxes
    5,030                   5,030  
 
                       
Net loss
  $ (12,716 )   $ (7,269 )   $ (228 )   $ (20,213 )
 
                       
 
                               
Total assets
  $ 2,059,918     $ 35,486     $ (14,362 )   $ 2,081,042  
Net loans
    1,468,615                   1,468,615  
Loans held for sale
    376       27,361             27,737  
 
                               
For Six Months Ended June 30, 2011
                               
Interest income
  $ 45,951     $ 749     $     $ 46,700  
Interest expense
    14,154       162       384       14,700  
 
                       
Net interest income
    31,797       587       (384 )     32,000  
Provision for loan losses
    15,240       20             15,260  
 
                       
Net interest income (loss) after provision for loan losses
    16,557       567       (384 )     16,740  
Other income
    6,151       2,079       (82 )     8,148  
Other expense
    31,108       10,229       29       41,366  
 
                       
Loss before income taxes
    (8,400 )     (7,583 )     (495 )     (16,478 )
Income taxes
    4,521                   4,521  
 
                       
Net loss
  $ (12,921 )   $ (7,583 )   $ (495 )   $ (20,999 )
 
                       
 
(1)   As an LLC, Sidus passes its pre-tax income through to its single member, the Bank, which is taxed on that income.
 
(2)   Note: The “Other” column includes asset eliminations representing the Bank’s Due from Sidus account ($12,591 in 2011), the Bank’s Investment in Sidus ($3,000 in 2011), and the Bank’s A/R from Sidus ($29 in 2011). Also included in this column are Holding Company assets ($1,258 in 2011) and Holding Company income and expenses.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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    Bank     Sidus     Other     Total  
    (Amounts in thousands)  
For Three Months Ended June 30, 2010
                               
Interest income
  $ 23,835     $ 413     $     $ 24,248  
Interest expense
    8,409       54       187       8,650  
 
                       
Net interest income
    15,426       359       (187 )     15,598  
 
                               
Provision for loan losses
    5,580       229             5,809  
 
                       
Net interest income (loss) after provision for loan losses
    9,846       130       (187 )     9,789  
Other income
    3,609       1,876       (33 )     5,452  
Other expense
    12,834       2,021       125       14,980  
 
                       
Income (loss) before income taxes (benefit)
    621       (15 )     (345 )     261  
Income taxes
    (24 )                 (24 )
 
                       
Net income(loss)
  $ 645     $ (15 )   $ (345 )   $ 285  
 
                       
 
                               
Total assets
  $ 2,217,984     $ 59,823     $ (37,626 )   $ 2,240,181  
Net loans
    1,603,469                   1,603,469  
Loans held for sale
    816       48,726             49,542  
Goodwill
          4,944             4,944  
 
                               
For Six Months Ended June 30, 2010
                               
Interest income
  $ 48,274     $ 764     $     $ 49,038  
Interest expense
    16,201       63       369       16,633  
 
                       
Net interest income
    32,073       701       (369 )     32,405  
Provision for loan losses
    9,964       229             10,193  
 
                       
Net interest income (loss) after provision for loan losses
    22,109       472       (369 )     22,212  
Other income
    6,244       3,211       (222 )     9,233  
Other expense
    25,892       3,399       221       29,512  
 
                       
Income (loss) before income taxes (benefit)
    2,461       284       (812 )     1,933  
Income taxes (benefit)
    733                   733  
 
                       
Net income(loss)
  $ 1,728     $ 284     $ (812 )   $ 1,200  
 
                       
 
(1)   As an LLC, Sidus passes its pre-tax income through to its single member, the Bank, which is taxed on that income.
 
(2)   Note: The “Other” column includes asset eliminations representing the Bank’s Due from Sidus account ($32,477 in 2010), the Bank’s Investment in Sidus ($3,000 in 2010), and the Bank’s A/R from Sidus ($12 in 2010). Also included in this column are Holding Company assets ($2,137 in 2010) and Holding Company income and expenses.
14. Cost Savings Initiatives
During the second quarter of 2011, the Company continued evaluating areas for cost savings as part of the earnings improvement initiative announced in 2010 in order to streamline the organization during this prolonged economic cycle. Additional evaluations of the branch network, Sidus, and staffing levels across all areas of the Bank were performed. As a result of these evaluations, the decision was made to consolidate four additional branch offices across the franchise. This decision was a result of an extensive evaluation of the entire network of branches. These consolidations will take place in the second and third quarters of 2011 and are expected to be completed by the end of August 2011. Severance payments in the amount of $552,000 have been accrued as of June 30, 2011 in salaries and employee benefits expense as part of this consolidation. The Company has also accrued $401,000 in lease termination costs as of June 30, 2011 in connection with the branch closures, and recorded impairment charges on fixed assets in the amount of $1.2 million.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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In addition to the consolidation of branches, the Bank made the decision to exit the wholesale business line at Sidus effective on June 1, 2011 and to reposition the mortgage focus to concentrate primarily on retail consumer mortgages going forward.
15. Property Held-for-Sale
During the quarter ended June 30, 2011, the Company entered into contracts to sell certain property and equipment in connection with the branch closures announced in late 2010 and 2011. As a result, approximately $2.2 million in buildings and furniture have been written down to fair value of $984,000 based on current appraisals and offers. These buildings are now classified as held-for-sale and are included in other assets on the consolidated balance sheet as of June 30, 2011.
16. Private Placement
On May 6, 2011, the Company completed the private placement of 3,081,867 shares of common stock (the “Private Placement”) to accredited investors, including certain of the Company’s officers and directors, for total cash proceeds of $6.4 million. The purchase price per share for investors was at a 10% discount to the weighted average closing sale price of the Company’s common stock on Nasdaq for the 10-day period ending five business days prior to the closing of the Private Placement. On June 23, 2011, the Company’s shareholders approved the Private Placement which permitted the Company pursuant to Nasdaq Rule 5635(c) to issue the Company’s directors and executive officers additional shares of common stock in the amount of 151,681 shares so that the directors and executive officers were able to invest on the same terms as other investors that participated in the Private Placement. The Company issued 3,233,548 shares of common stock in total as a result of the Private Placement. Proceeds received from the Private Placement are expected to be kept at the holding company level for general corporate purposes.
17. Income Taxes
Income tax expense for the three and six months ended June 30, 2011 was $5.0 million and $4.5 million, respectively, compared to income tax benefit of $24,000 for the three months ended June 30, 2010, and income tax expense of $733,000 for the six months ended June 30, 2010. The significant increase is attributable to valuation allowances for deferred tax assets of $11.0 million. The following table presents the provision for income taxes for the six months ended June 30, 2011 and 2010:
                 
    2011     2010  
    (in thousands)  
Current:
               
Federal
  $ 485     $ (2,980 )
State
           
 
           
 
    485       (2,980 )
Deferred:
               
Federal
    (5,912 )     3,086  
State
    (1,052 )     627  
 
           
 
    (6,964 )     3,713  
 
           
 
               
Increase in valuation allowance for deferred tax assets
    11,000        
 
               
 
           
Total income taxes
  $ 4,521     $ 733  
 
           
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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The following table presents the tax effects of significant components of the Company’s net deferred tax assets as of June 30, 2011 and December 31, 2010:
                 
    June 30,     December 31,  
    2011     2010  
    (in thousands)  
Deferred tax assets:
               
Allowance for loan losses
  $ 13,983     $ 14,809  
Other than temporary impairment
    467       467  
Accrued liabilities
    272       529  
OREO property
    1,008       680  
Net operating loss
    10,375       4,652  
Other
    530       515  
 
           
 
    26,635       21,652  
 
           
 
               
Less: Valuation Allowance
    (11,000 )      
 
           
 
  $ 15,635     $ 21,652  
 
           
 
               
Deferred tax liabilities:
               
Unrealized gain on available-for-sale securities
  $ (1,814 )   $ (333 )
FMV adjustment related to mergers
    (185 )     (50 )
Depreciation
    (2,215 )     (2,215 )
Prepaid expenses
    (357 )     (357 )
Core deposit intangible
    (1,692 )     (1,929 )
Noncompete intangible
    (232 )     (232 )
Goodwill
    1,115       (764 )
Other
    (137 )     (137 )
 
           
 
  $ (5,517 )   $ (6,017 )
 
           
 
               
Net deferred tax asset
  $ 10,118     $ 15,635  
 
           
As of June 30, 2011, deferred tax assets of $26.6 million reduced by a valuation allowance of $11.0 million and $5.5 million in deferred tax liabilities, resulted in a net deferred tax asset of approximately $10.1 million. Deferred tax assets of $21.6 million as of December 31, 2010, reduced by $6.0 million in deferred tax liabilities, resulted in a net deferred tax asset of approximately $15.6 million.
In evaluating whether the Company will realize the full benefit of its net deferred tax asset, it considers both positive and negative evidence, including recent earnings trends and projected earnings, asset quality, etc. A valuation allowance is provided when it is more likely than not that some portion of the deferred tax asset will not be realized. Due to a cumulative three-year, pre-tax loss position, significant net operating losses in 2011, and ongoing stress on the Company’s financial performance from elevated credit losses, the Company has reserved $11.0 million against deferred tax assets as of June 30, 2011. In future periods, the Company may be able to reduce some or all of the valuation allowance upon a determination that it will be able to realize such tax savings.
The Company is currently considering and implementing a variety of tax planning strategies in an attempt to increase after tax income and taxable earnings, which will increase the likelihood of the company to recognize its deferred tax assets. These tax planning strategies include repositioning the Company’s municipal securities portfolio to taxable securities and sale of various assets.
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Form 10-Q Quarterly Report June 30, 2011

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The Company’s loss carryforwards for the tax period ending June 30, 2011 include net operating loss carryforwards generated in the acquisition of Cardinal State Bank in 2008 and American Community Bank in 2009. The expiration of the loss carryforwards for the tax period ending June 30, 2011 are as follows:
                 
    Net Operating Loss        
    Carryforward at        
    June 30, 2011     Expiration  
    (Amounts in        
    thousands)        
Cardinal State Bank acquisition
  $ 2,424       2029  
American Community Bank acquisition
    345       2030  
Yadkin Valley Federal Tax
    23,792       2031  
Yadkin Valley State Tax
    27,403       2031  
 
             
Total Loss Carryforwards
  $ 53,964          
 
             
The following table presents a reconciliation of applicable income taxes for the six months ended June 30, 2011 and 2010 to the amount of tax expense computed at the statutory federal income tax rate of 35%:
                 
    2011     2010  
    (Amounts in thousands)  
Tax expense at statutory rate on income before income taxes
  $ (5,767 )   $ 676  
Increases (decreases) resulting from:
               
Tax-exempt interest on investments
    (442 )     (399 )
State income tax, net of federal benefits
    (684 )     408  
Income from bank-owned life insurance
    (113 )     (139 )
Valuation allowance on deferred tax assets
    11,000        
Other
    527       187  
 
           
Total income taxes
  $ 4,521     $ 733  
 
           
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
CAUTIONARY STATEMENT REGARDING FORWARD LOOKING STATEMENTS
The following is our discussion and analysis of certain significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. This commentary should be read in conjunction with the financial statements and the related notes and the other statistical information included in this report.
This report contains statements which constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. Forward-looking statements relate to the financial condition, results of operations, plans, objectives, future performance, and business of our Company. Forward-looking statements are based on many assumptions and estimates and are not guarantees of future performance. Our actual results may differ materially from those anticipated in any forward-looking statements, as they will depend on many factors about which we are unsure, including many factors which are beyond our control. The words “may,” “would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,” “potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,” and “estimate,” as well as similar expressions, are meant to identify such forward-looking statements. Potential risks and uncertainties that could cause our actual results to differ materially from those anticipated in our forward-looking statements include, without limitation, those described under the heading “Risk Factors” in our Annual Report on Form 10-K (as amended) for the year ended December 31, 2010 as filed with the Securities and Exchange Commission (the “SEC”) and the following:
    reduced earnings due to higher credit losses generally and specifically because losses in the sectors of our loan portfolio secured by real estate are greater than expected due to economic factors, including declining real estate values, increasing interest rates, increasing unemployment, or changes in payment behavior or other factors;
 
    reduced earnings due to higher credit losses because our loans are concentrated by loan type, industry segment, borrower type, or location of the borrower or collateral;
 
    the rate of delinquencies and amount of loans charged-off;
 
    the adequacy of the level of our allowance for loan losses;
 
    the amount of our loan portfolio collateralized by real estate, and the weakness in the commercial real estate market;
 
    our efforts to raise capital or otherwise increase and maintain our regulatory capital ratios above the statutory minimums;
 
    the impact of our efforts to raise capital on our financial position, liquidity, capital, and profitability;
 
    adverse changes in asset quality and resulting credit risk-related losses and expenses;
 
    increased funding costs due to market illiquidity, increased competition for funding, and increased regulatory requirements with regard to funding;
 
    significant increases in competitive pressure in the banking and financial services industries;
 
    changes in the interest rate environment which could reduce anticipated or actual margins;
 
    changes in political conditions or the legislative or regulatory environment, including the effect of recent
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      financial reform legislation on the banking industry;
 
    general economic conditions, either nationally or regionally and especially in our primary service area, becoming less favorable than expected resulting in, among other things, a deterioration in credit quality;
 
    our ability to retain our existing customers, including our deposit relationships;
 
    changes occurring in business conditions and inflation;
 
    changes in technology;
 
    changes in monetary and tax policies;
 
    ability of borrowers to repay loans, which can be adversely affected by a number of factors, including changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, business closings or lay-offs, natural disasters, which could be exacerbated by potential climate change, and international instability;
 
    changes in deposit flows;
 
    changes in accounting principles, policies or guidelines;
 
    changes in the assessment of whether a deferred tax valuation allowance is necessary;
 
    our ability to maintain internal control over financial reporting;
 
    our reliance on secondary sources such as Federal Home Loan Bank advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet our liquidity needs;
 
    loss of consumer confidence and economic disruptions resulting from terrorist activities;
 
    changes in the securities markets; and
 
    other risks and uncertainties detailed from time to time in our filings with the SEC.
These risks are exacerbated by the recent developments in national and international financial markets that have persisted over the past several years, and we are unable to predict what effect these uncertain market conditions will continue to have on us. There can be no assurance that these unprecedented developments will not continue to materially and adversely affect our business, financial condition and results of operations.
We have based our forward-looking statements on our current expectations about future events. Although we believe that the expectations reflected in our forward-looking statements are reasonable, we cannot guarantee you that these expectations will be achieved. We undertake no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events, or otherwise.
Overview
The following discussion describes our results of operations for the three and six months periods ended June 30, 2011 and 2010 and also analyzes our financial condition as of June 30, 2011 as compared to December 31, 2010. Like most community banks, we derive most of our income from interest we receive on our loans and investments. Our primary
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source of funds for making these loans and investments is our deposits, on which we pay interest. Consequently, one of the key measures of our success is our amount of net interest income, or the difference between the income on our interest-earning assets, such as loans and investments, and the expense on our interest-bearing liabilities, such as deposits. Another key measure is the spread between the yield we earn on these interest-earning assets and the rate we pay on our interest-bearing liabilities.
Of course, there are risks inherent in all loans, so we maintain an allowance for loan losses to absorb probable losses on existing loans that may become uncollectible. We establish and maintain this allowance by charging a provision for loan losses against our operating earnings. In the following section, we have included a detailed discussion of this process.
In addition to earning interest on our loans and investments, we earn income through fees and other expenses we charge to our customers. We describe the various components of this noninterest income, as well as our noninterest expense, in the following discussion.
The following discussion and analysis also identifies significant factors that have affected our financial position and operating results during the periods included in the accompanying financial statements. We encourage you to read this discussion and analysis in conjunction with the financial statements and the related notes and the other statistical information also included in this report.
The Company does not undertake, and specifically disclaims any obligation, to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or occurrences after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Changes in Financial Position
Total assets at June 30, 2011 were $2,081.0 million, a decrease of $219.6 million, or 9.5%, compared to assets of $2,300.6 million at December 31, 2010. The loan portfolio, net of allowance for losses, was $1,468.6 million compared to $1,562.8 million at December 31, 2010. Gross loans held-for-investment decreased by $96.3 million, or 6.0%. The allowance for loan losses decreased $2.1 million driven primarily by decreases in classified loans for the six months ended June 30, 2011, as well as an overall decrease of $96.3 million in loans held-for-investment. Total watch list and substandard loans were $184.1 million as compared to $252.7 million as of December 31, 2010, a decrease of $68.6 million. Offsetting the decreases in criticized loans and decreases in loan balances were increases in other qualitative factors impacted by increased past dues and nonaccruals. See Note 9 above entitled “Loans and Allowance for Loan Losses” for further discussion of the allowance for loan losses.
Mortgage loans held-for-sale decreased by $22.7 million, or 45.0%, from December 31, 2010 to June 30, 2011 as the Bank continued its strategy of selling mortgage loans mostly to various investors with servicing rights released and to a lesser extent to the Federal National Mortgage Association and the Federal Home Loan Mortgage Corporation with servicing rights retained. These loans are normally held for a period of two to three weeks before being sold to investors. During the second quarter of 2011, the Company made the decision to exit wholesale markets focusing its efforts on retail based mortgage lending leading to the overall decrease in loans held-for-sale as of June 30, 2011. Mortgage loans closed in the first six months of 2011 ranged from a low of $41.0 million in February to a high of $79.8 million in January and totaled $363.2 million. Mortgage loans closed during the six months ended June 30, 2010 totaled $337.2 million.
The securities portfolio increased from $298.0 million at December 31, 2010, to $317.5 million at June 30, 2011, an increase of $19.5 million. The portfolio is comprised of securities of U.S. government agencies (10.9%), mortgage-backed securities (67.7%), state and municipal securities (21.1%), and publicly traded common and preferred stocks (0.3%).
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Form 10-Q Quarterly Report June 30, 2011

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Other assets decreased $8.5 million due largely to the fact that the Company recorded an $11.0 million valuation allowance against deferred tax assets. OREO decreased $3.5 million due to foreclosures in the amount of $7.5 million less dispositions of $8.8 million and losses of $2.1 million for the six months ended June 30, 2011.
Deposits decreased $194.6 million, or 9.6%, comparing June 30, 2011 to December 31, 2010. Overall, noninterest-bearing demand deposits increased $6.4 million, or 3.0%, NOW, savings, and money market accounts increased $7.8 million, or 1.3%, Certificates of deposit (“CODs”) over $100,000 decreased $67.6 million, or 14.2%, and other CODs decreased $141.2 million, or 19.1%. The Bank had advertised several promotional rates for certificates of deposits in the prior year which are now beginning to mature thus leading to a runoff in certificates of deposits in 2011.
Borrowed funds decreased $13.2 million, or 11.3%, comparing June 30, 2011 to December 31, 2010. Repurchase agreements decreased $1.2 million, while advances from FHLB and overnight borrowings decreased $12.0 million. Long term borrowings included $35.0 million in trust preferred securities and advances from the FHLB of $27.0 million. The American Community merger added $10.4 million in trust preferred securities at a rate equal to the three-month LIBOR rate plus 2.80% and will mature in 2033. Yadkin Valley Statutory Trust I (“the Trust”) issued $25.9 million in trust preferred securities at a rate equal to the three-month LIBOR rate plus 1.32%. The trust preferred securities mature in 30 years, and can be called by the Trust without penalty after five years.
Other liabilities and accrued interest payable combined increased by $1.7 million, or 12.6%, from December 31, 2010 to June 30, 2011. Increases in other liabilities included the following: preferred dividends payable $519,000; escrow balances $222,000; commercial remittances $413,000; accrued property taxes $388,000; and accounts payable $452,000. Offsetting the increases in other liabilities was a decrease in accrued interest payable of $554,000, or 16.8%, which resulted from a 9.6% decrease in deposits and timing differences.
At June 30, 2011, total shareholders’ equity was $134.1 million, or a book value of $4.45 per common share, compared to $147.5 million, or a book value of $6.24 per common share, at December 31, 2010. The Company’s equity to assets ratio was 6.44% and 6.41%, at June 30, 2011 and December 31, 2010, respectively.
The following table sets forth the Company’s and the Bank’s various capital ratios as of June 30, 2011, and December 31, 2010. The Company and the Bank exceeded the minimum regulatory capital ratios as of June 30, 2011, as well as the ratios to be considered “well capitalized.” We have committed to regulators that the Bank will maintain a Tier 1 Leverage Ratio of 8%. The recent increase in liquidity caused the Bank to fall below this level. However, the Company has a number of alternatives available to assist the Bank in achieving this ratio including but not limited to raising additional capital, decreasing the asset size of the Bank, and infusing additional capital at the Bank level. The Company completed a private placement offering during the second quarter of 2011 for proceeds of $6.4 million. Although this helped improved capital ratios at the holding company, management continues to monitor capital levels closely and evaluate options which would improve the capital position.
                                   
    June 30, 2011   December 31, 2010  
    Holding           Holding      
    Company   Bank   Company   Bank  
Total risk-based capital ratio
    11.1 %     10.7 %     10.6 %     10.5 %  
Tier 1 risk-based capital ratio
    9.9 %     9.4 %     9.4 %     9.2 %  
Leverage ratio
    7.5 %     7.1 %     7.2 %     7.0 %  
Management of equity is a critical aspect of capital management in any business. The determination of the appropriate amount of equity for a regulated financial institution is affected by a number of factors, including but not limited to, the amount of capital needed to meet regulatory requirements, the amount of “risk equity” the business requires and balance sheet leverage.
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Form 10-Q Quarterly Report June 30, 2011

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Capital adequacy is an important indicator of financial stability and performance. In order to be considered “well capitalized”, the Bank must exceed total risk-based capital ratios of 10%, and Tier 1 risk-based capital ratios of 6% and leverage ratios of 5%. Our goal has been to maintain a “well-capitalized” status for the Bank since failure to meet or exceed this classification affects how regulatory applications for certain activities, including acquisitions, and continuation and expansion of existing activities, are evaluated and could make our customers and potential investors less confident in our Bank.
Liquidity, Interest Rate Sensitivity and Market Risk
The Bank derives the majority of its liquidity from its core deposit base and to a lesser extent from wholesale borrowing. The balance sheet liquidity ratio, measured by the sum of cash (less reserve requirements), investments, and loans held-for-sale reduced by pledged securities, as compared to deposits and short-term borrowings, was 20.2% at June 30, 2011 compared to 23.4% at December 31, 2010. Additional liquidity is provided by $143.6 million in unused credit including federal funds purchased lines provided by correspondent banks as well as credit availability from the FHLB. In addition, the Bank has unpledged marketable securities of $206.6 million available for use as a source of collateral. At June 30, 2011, brokered deposits totaled $28.0 million, or 1.5% of total deposits. Brokered certificates of deposit are primarily short-term with maturities of nine months or less. The Bank also maintains a brokered deposit NOW account to add municipal deposits totaling $3.3 million at June 30, 2011.
The Bank contracted with Promontory Interfinancial Network in 2008 for various services including wholesale CD funding. Promontory’s CDARS® product, One-Way BuySM, enables the Bank to bid on a weekly basis through a private auction for CD terms ranging from four weeks to 260 weeks (approximately five years) with settlement available each Thursday. At June 30, 2011, the balance of funds acquired through the One-Way Buy product totaled $23.4 million, compared to $50.6 million at December 31, 2010.
Promontory also provides a product, CDARS® Reciprocal, which allows the Bank’s customers to place funds in excess of the FDIC insurance limit with Promontory’s network of participating Banks so that the customer is fully insured for the amount deposited. Promontory provides reciprocating funds to the Bank from funds placed at other banks by their customers. The Bank sets its customers’ interest rates when they place deposits through the network and pays/receives the rate difference to/from the other banks whose reciprocal funds are held by the Bank. The overall impact of this process is that the Bank effectively pays the rate offered to its relationship customer. Therefore, the Bank does not consider these funds to be wholesale or brokered funds. In compliance with FDIC reporting requirements, the Bank reports include reciprocal deposits as brokered deposits in its quarterly Federal Financial Institutions Examination Council Call Report. At June 30, 2011, CDARS® reciprocal deposits totaled $13.3 million, compared to $20.2 million at December 31, 2010.
Management continues to assess interest rate risk internally and by utilizing outside sources. The balance sheet is asset sensitive over a three-month period, meaning that there will be more assets than liabilities immediately repricing as market rates change. Over a period of twelve months, the balance sheet remains slightly asset sensitive. We generally would benefit from increasing market interest rates when we have an asset-sensitive, or a positive interest rate gap, and we would generally benefit from decreasing market interest rates when we have liability-sensitive, or a negative interest rate gap.
The Company currently has derivative instrument contracts consisting of interest rate swaps and interest rate lock commitments and commitments to sell mortgages. The primary objective for each of these contracts is to minimize interest rate risk. The Company’s strategy is to use derivative contracts to stabilize and improve net interest margin and net interest income currently and in future periods. The Company has no market risk sensitive instruments held for trading purposes. The Company’s exposure to market risk is reviewed regularly by management.
To be categorized as well capitalized, the Company and the Bank each must maintain minimum amounts and ratios. At June 30, 2011, the Company is well-capitalized for regulatory purposes both at the bank and holding company
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level, however the Bank has committed to regulators that it will maintain a Tier 1 Leverage Ratio of 8%. Although the Bank has currently fallen below this level, the Company has a number of alternatives available to assist the Bank in achieving this ratio including but not limited to raising additional capital, decreasing the asset size of Bank, and infusing additional capital at the Bank level.
Results of Operations
Net loss for the three-month period ended June 30, 2011 was $20.2 million before preferred dividends, compared to a net income of $285,000 in the same period of 2010. Net loss available to common shareholders for the three-month period ended June 30, 2011 was $20.9 million. Net loss available to common shareholders for the three-month period ended June 30, 2010 was $486,000. Basic and diluted losses per common share were $1.16 for the three-month period ended June 30, 2011. Basic and diluted losses per common share were $0.03 for the three month period ended June 30, 2010. On an annualized basis, second quarter results represent a return on average assets of (3.87)% at June 30, 2011 compared to (0.09)% at June 30, 2010, and a return on average equity of (55.25)% compared to (1.26)% at June 30, 2010.
Net loss for the six month period ended June 30, 2011 was $21.0 million before preferred dividends, compared to a net income of $1.2 million in the same period of 2010. Net loss available to common shareholders for the six months ended June 30, 2011 was $22.4 million, compared to a net loss available to common shareholders of $342,000 for the six months ended June 30, 2010. Basic and diluted losses per common share were $1.31 for the six months ended June 30, 2011. Basic and diluted losses per common share were $0.02 for the six months ended June 30, 2010. On an annualized basis, year-to-date results represent a return on average assets of (2.04)% at June 30, 2011 compared to (0.03)% at June 30, 2010, and a return on average equity of (30.39)% compared to (0.45)% at June 30, 2010.
Net Interest Income
Net interest income, the largest contributor to earnings, increased $713,000, or 4.6%, to $16.3 million in the second quarter of 2011, compared with $15.6 million in the same period of 2010. The increase was attributable to a decrease in yields on interest bearing liabilities over 2010 which resulted from the repricing of liabilities to lower rates, as well as a change in the mix of depository accounts from higher yielding CDs to lower yielding money market and savings accounts. Offsetting decrease in interest expense was a compression in loan interest related to increased nonaccrual loans. The net interest margin increased to 3.30% in the second quarter of 2011 from 3.12% in the second quarter of 2010. Excluding the accretion of acquisition related fair market value adjustments, net interest margin for the second quarter of 2011 increased to 3.24% as compared to 2.99% in the second quarter of 2010.
Net interest income for the six months ended June 30, 2011 decreased to $32.0 million from $32.4 million when compared to the same period in 2010. The net interest margin decreased to 3.18% in the first six months of 2011 from 3.28% in the first six months of 2010. The decrease in yield on interest earning assets was due primarily to the accretion of fair market valuations of $1.6 million recorded in connection with the American Community acquisition for the six months ended June 30, 2010 as compared to $596,000 for the six months ended June 30, 2011. Excluding the accretion of acquisition related fair market value adjustments, net interest margin for the six months ended June 30, 2011 decreased to 3.12% as compared to 3.14% for the six months ended June 30, 2010. The Company maintains an asset-sensitive position with respect to the impact of changing rates on net interest income.
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    Six Months Ended June 30, 2011     Six Months Ended June 30, 2010  
    Average             Yield/     Average             Yield/  
Interest Rates Earned and Paid   Balance     Interest     Rate     Balance     Interest     Rate  
    (Dollars in thousands)  
Interest-earning assets:
                                               
Federal funds sold
  $ 12,682     $ 15       0.25 %   $ 1,771     $ 2       0.25 %
Interest-bearing deposits
    170,079       205       0.24 %     172,680       181       0.21 %
Investment securities (1)
    303,651       4,878       3.24 %     180,470       3,904       4.36 %
Total loans (1)(2)(6)
    1,580,639       42,199       5.38 %     1,685,544       45,503       5.44 %
 
                                       
Total interest-earning assets
    2,067,051       47,297       4.61 %     2,040,465       49,590       4.90 %
 
                                           
Non-earning assets
    146,143                       139,284                  
 
                                           
Total assets
  $ 2,213,194                     $ 2,179,749                  
 
                                           
 
                                               
Interest-bearing liabilities:
                                               
Deposits (7):
                                               
NOW and money market
  $ 553,020       2,071       0.75 %   $ 395,115       1,611       0.82 %
Savings
    55,680       56       0.20 %     54,682       71       0.26 %
Time certificates
    1,112,020       11,463       2.08 %     1,230,794       13,788       2.26 %
 
                                       
Total interest bearing deposits
    1,720,720       13,590       1.59 %     1,680,591       15,470       1.86 %
Repurchase agreements sold
    40,050       210       1.06 %     47,600       204       0.86 %
Borrowed funds (7)
    67,458       900       2.69 %     74,158       959       2.61 %
 
                                       
Total interest-bearing liabilities
    1,828,228       14,700       1.62 %     1,802,349       16,633       1.86 %
 
                                           
 
                                               
Non-interest bearing deposits
    220,894                       206,090                  
Shareholders’ equity
    148,952                       154,196                  
Other liabilities
    15,120                       17,114                  
 
                                           
Total average liabilities and shareholders’ equity
  $ 2,213,194                     $ 2,179,749                  
 
                                           
 
                                               
Net interest income (3) and interest rate spread (5)
          $ 32,597       2.99 %           $ 32,957       3.04 %
 
                                       
Net interest margin (4)
                    3.18 %                     3.28 %
 
                                           
 
(1)   Yields related to investment securities and loans exempt from Federal income taxes are stated on a fully tax-equivalent basis, assuming a Federal income tax rate of 35%. The calculation includes an adjustment for the nondeductible portion of interest expense used to fund tax-exempt assets.
 
(2)   The loan average includes loans on which accrual of interest has been discontinued.
 
(3)   The net interest income is the difference between income from earning assets and interest expense.
 
(4)   Net interest margin is net interest income divided by total average earning assets.
 
(5)   Interest spread is the difference between the average interest rate received on earning assets and the average interest rate paid on interest-bearing liabilities.
 
(6)   Interest income on loans for 2011 and 2010 includes $202 and $1,021, respectively, in accretion of fair market value adjustments related to recent mergers
 
(7)   Interest expense on deposits and borrowings in 2011 and 2010 includes $102 and $621, respectively, in accretion of fair market value adjustments related to recent mergers.
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Provisions and Allowance for Loan Losses
Adequacy of the allowance or reserve for loan losses of the Bank is a significant estimate that is based on management’s assumptions regarding, among other factors, general and local economic conditions, which are difficult to predict and are beyond the Bank’s control. In estimating these loss reserve levels, management also considers the financial conditions of specific borrowers and credit concentrations with specific borrowers, groups of borrowers, and industries.
The allowance for loan losses was $35.7 million at June 30, 2011, or 2.37% of loans held-for-investment, as compared to $37.8 million, or 2.36% of loans held-for-investment, at December 31, 2010. Increases in the allowance for loan losses were due to increased charge-offs in the second quarter of 2011 and increases in nonperforming loans since December 31, 2010. Charge-offs in the quarter ended June 30, 2011 increased as additional writedowns were taken on collateral dependent loans. Collateral value is assessed based on collateral value trends, liquidation value trends, and other liquidation expenses to determine logical and credible discounts that may be needed. In response to this deterioration in real estate loan quality, management is aggressively monitoring its classified loans and is continuing to monitor credits with significant weaknesses. These increases were partially offset by decreases in gross loans as well as a decrease in criticized loans not considered impaired. Decreases in criticized loans were due to improvements in loans 30-89 days past due, payoffs and overall improvements in underlying credit exposures.
The allowance model is applied to the loan portfolio quarterly to determine the specific allowance balance for impaired loans and the general allowance balance for performing loans grouped by loan type. Out of the $35.7 million in total allowance for loan losses at June 30, 2011, the specific allowance for impaired loans accounted for $4.3 million, down from $6.3 million at year end as collateral dependent impaired loans are charged down to fair value. The remaining general allowance, $31.4 million, was attributed to performing loans and was down slightly from $31.5 million at year end. The decrease in the general allowance was driven primarily by a decrease in substandard and watch loans of $68.6 million which resulted from additional impairments of construction and commercial real estate loans, for which specific allowances are now calculated, as well as a few significant payoffs and improvements in past dues and underlying credit exposures of previously classified loans. Also contributing to the decrease in the general allowance for loan losses was a 6.0% decrease in gross loans as of June 30, 2011 as compared to December 31, 2010. Offsetting the decreases in criticized loans and decreases in loan balances were increases in other qualitative factors including increasing past dues and nonaccruals. The general allowance, as a percent of loans not individually reviewed for impairment was 2.19% as of June 30, 2011 as compared to 2.06% as of December 31, 2010.
Net loan charge offs (recoveries) were $10.6 million, or 2.73% (annualized), of average loans, for the three months ending June 30, 2011 compared to $6.9 million, or 1.64% (annualized), of average loans for the three months ending June 30, 2010. The increase over last year was the result of increased charge-offs due to the writedown of collateral dependent loans to fair value as real estate values continue to decline. For the six months ended June 30, 2011, net loan charge offs (recoveries) were $17.4 million, or 2.21% (annualized) of average loans compared to $14.5 million, or 1.74% (annualized) of average loans for the six months ended June 30, 2010.
Management considers the allowance for loan losses adequate to cover the estimated losses inherent in the Bank’s loan portfolio as of June 30, 2011. No assurance can be given in this regard, however, especially considering the overall weakness in the commercial real estate market in the Bank’s market areas. Management believes it has established the allowance in accordance with accounting principles generally accepted in the United States of America and will consider future changes to the allowance that may be necessary based on changes in economic and other conditions. Additionally, various regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses. Such agencies may require the recognition of adjustments to the allowances based on their judgments of information available to them at the time of their examinations.
Management realizes that general economic trends greatly affect loan losses. The recent downturn in the real estate market has resulted in increased loan delinquencies, defaults and foreclosures, and we believe that these trends are likely to continue. In some cases, this downturn has resulted in a significant impairment to the value of our collateral
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and our ability to sell the collateral upon foreclosure. 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. If real estate values continue to decline, it is also more likely that we would be required to increase our allowance for loan losses and our net charge-offs which could have a material adverse effect on our financial condition and results of operations. Assurances cannot be made either (1) that further charges to the allowance account will not be significant in relation to the normal activity or (2) that further evaluation of the loan portfolio based on prevailing conditions may not require sizable additions to the allowance and charges to provision expense.
Our real estate portfolio has approximately $243.7 million of construction loans, $600.9 million of commercial real estate loans, $175.4 million in first lien mortgage loans, $205.3 million in home equity lines of credit and $4.0 million in junior lien mortgage loans as of June 30, 2011. We consider our construction and junior lien mortgage loans our riskiest loans within our real estate portfolio. Construction loans are typically comprised of loans to borrowers for real estate to be developed into properties such as sub-divisions or speculative houses. The majority of these borrowers are having financial difficulties. Normally, these loans are repaid with the proceeds from the sale of the developed property. We are also seeing declines in commercial real estate values and the greater degree of strain on these types of real estate loans. The significance of both construction and commercial real estate loans to our overall loan portfolio has caused us to apply a greater degree of scrutiny in analyzing the ultimate collectability of amounts due. Our analysis has resulted in significant charge-offs and increases in nonaccrual loans. Loans are placed on nonaccrual status when the loan is past due 90 days or when it is apparent that the collection of principal and/or interest is doubtful. Net charge-offs (recoveries) of construction and commercial real estate loans were $6.8 million and $5.0 million, respectively, for the six months ended June 30, 2011. For the six months ended June 30, 2010, net charge-offs (recoveries) of construction and commercial real estate loans were $8.9 million and $2.0 million, respectively.
As of June 30, 2011, $8.7 million of our real estate loans had interest reserves including both borrower and bank funded, compared to $21.7 million as of December 31, 2010. There is a risk that an interest reserve could mask problems with a borrower’s willingness and ability to repay the debt consistent with the terms and conditions of the loan obligation, therefore the Company has implemented review policies to identify and monitor all loans with interest reserves.
Nonperforming Assets
Total nonperforming assets (which includes nonaccrual loans, loans over 90 days past due but still accruing, and foreclosed real estate) decreased from $91.0 million to $90.9 million as of December 31, 2010 and June 30, 2011, respectively. Nonperforming assets as a percentage of total assets increased to 4.36% as of June 30, 2011 as compared to 3.95% as of December 31, 2010, due primarily to a decrease in total assets since December 31, 2010. Total OREO decreased from approximately $25.6 million at December 31, 2010 to $22.0 million at June 30, 2011, as the result of $8.9 million in sales, loss on sales of $840,000 and writedowns of $1.3 million, offset by $7.5 million in additions. Total nonaccrual loans increased from $65.4 million, or 3.96% of total loans, at December 31, 2010 to $68.9 million, or 4.50% of total loans, at June 30, 2011. The increases in nonaccrual and impaired loans are the result of continued economic strain in our markets during the past three months. We have analyzed our nonperforming loans to determine what we believe is the amount needed to reserve in the allowance for loan losses based on an assessment of the collateral value or discounted cash flows of the loan. We have downgraded loans for which the probability of collection is uncertain and written down OREO property values where net realizable values have declined. Specific allowance for nonperforming loans accounted for $4.3 million, down from $6.3 million at year end, due to the charge-off of collateral dependent impaired loans to fair value.
The increase in nonperforming loans from December 31, 2010 to June 30, 2011 is related primarily to the continued deterioration of previously classified loans and the addition of troubled debt restructured loans which will remain on nonaccrual status until sufficient payment evidence is obtained. Approximately 48.4% of loans in nonaccrual status are not currently past due. The total number of loans on nonaccrual has increased from 490 to 525 since December 31, 2010. The average nonaccrual loan balance is $131,000 and $131,000 as of December 31, 2010 and June 30, 2011, respectively. At June 30, 2011, 94% of the nonaccrual loans were secured by real estate.
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The largest amount of nonaccrual loans for one customer totaled $3.4 million of land development loans which had previously been charged down to fair market value and no additional reserves were specifically assigned to the loans. Nonaccrual loans also include three other large relationships each totaling $2.1 million, $2.1 million and $2.0 million, respectively. The first relationship is a golf course loan with no reserve required. The second relationship consists of commercial real estate loans with specific reserves of $241,000, and the third relationship consists of a commercial real estate loan with specific reserves of $170,000 due to the fact that the value of collateral exceeds the current loan balances. These loans have been placed in nonaccrual status because of the customers’ inability to pay, collateral deterioration and depressed future industry outlook.
Noninterest Income
Noninterest income consists of all revenues that are not included in interest and fee income related to earning assets. Total noninterest income decreased approximately $2.1 million, or 38.4%, comparing the second quarters of 2011 and 2010. A decrease in the gain on sale of mortgages of $1.7 million made up the majority of the decrease. Other changes in noninterest income include the following:
    Service charges on deposit accounts decreased $49,000, or 3.3%. Service charges on depository accounts, including NOW, savings, and money market account service charges increased 3.0%.
 
    Other service fees increased $50,000 when comparing the second quarter of 2011 to the prior year due primarily to increases in commissions and fees on mutual funds and annuities of $51,000 from the previous year. These increases were offset by decreases in commissions and fees on mortgages originated of $35,000.
 
    Net gain on the sale of mortgages decreased approximately $1.7 million, or 90.4%, as the Company decided to exit wholesale markets in the second quarter of 2011. Mortgage loans sold decreased from $192 million in the second quarter of 2010 to $180 million in the second quarter of 2011.
 
    Net gain on sale of investment securities decreased $415,000, or 49.2%, as the Company sold approximately $34.5 million in securities during the quarter.
 
    Income on investment in bank-owned life insurance (“BOLI”) decreased by 15.7% during the three month period ended June 30, 2011, as the calculation for cost of benefits was updated based on current employee and insurance information.
 
    Mortgage banking income increased approximately $43,000 for the quarter due to an increase in the servicing fees received.
 
    Other income decreased by approximately $37,000, or 26.6%, for the quarter primarily due to a $43,000 decrease in miscellaneous other income in connection with additional income recorded due to merger related items in the prior year.
For the six months ended June 30, 2011, total noninterest income decreased approximately $1.1 million, or 11.8%, as compared to the six months ended June 30, 2010. A decrease in the gain on sale of mortgages of $1.1 million made up the majority of the decrease. Other changes in noninterest income include the following:
    Service charges on deposit accounts decreased $142,000, or 4.9%, as total NSF fees (a major component of service charges) decreased $104,000, or 5.2%, as new legislation regarding overdraft fees was implemented in the third quarter of 2010. Service charges on depository accounts, including NOW, savings, and money market account service charges increased 3.0%.
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    The increase in other service fees of $171,000 was due primarily to increases in commissions and fees on mutual funds and annuities of $275,000 from the previous year. These increases were offset by decreases in commissions and fees on mortgages originated of $134,000.
 
    Net gain in the sale of mortgages decreased approximately $1.1 million, or 35.3%. Although originations increased in 2011, changes in pricing plans led to decreased returns in the wholesale markets. The Company decided to exit the wholesale market during the second quarter of 2011.
 
    Net gain on sale of investment securities also decreased $366,000, or 41.2%, as the Company sold approximately $39.1 million in securities year-to-date.
 
    Income on investment in bank-owned life insurance (“BOLI”) decreased by 18.6% during the six months ended June 30, 201, as the calculation for cost of benefits was updated based on current employee and insurance information.
 
    Mortgage banking income increased approximately $195,000 for the six months ended June 30, 2011 due to an increase in the servicing fees received.
 
    Other income increased by approximately $39,000, or 19.0%, year-to-date primarily due to a $22,000 increase in dividends received from the FHLB of Atlanta, as well as an increase in miscellaneous other income of $14,000.
Noninterest Expense
Total noninterest expenses were $24.5 million for the second quarter of 2011, compared to $15.0 million in the same period of 2010, an increase of $9.5 million, or 63.3%. Noninterest expense includes salaries and employee benefits, occupancy and equipment expenses, and all other operating costs. Noninterest expense to average assets for the quarter ended June 30, 2011 and 2010 was 0.90%, and 0.67%, respectively. Efficiency ratios for the three months ended 2011 and 2010 were 121.07% and 68.75%, respectively. The efficiency ratio is the ratio of noninterest expenses less amortization of intangibles to the total of the taxable equivalent net interest income and noninterest income. Noninterest expenses were $41.4 million for the six months ended June 30, 2011, compared to $29.5 million for the same period of 2010, an increase of $11.9 million or 40.2%. Efficiency ratios for the six months ended June 30, 2011 and 2010 were 100.04% and 68.39%, respectively. The largest contributor to the increase in noninterest expense was a $4.9 million goodwill impairment writedown. See additional disclosures and discussions regarding goodwill impairment in Footnote 12 to the financial statements.
The following is a summary of the fluctuations, other than goodwill impairment, for the quarter and six months ended June 30, 2011 as compared to June 30, 2010.
    Quarter-to-date, salaries and employee benefit expenses increased by $852,000, or 12.3%. The major components of this increase are summarized as follows: Salaries and wages increased by $568,000 due to the accrual of $552,000 in severance costs related to branch closures. Deferral of salaries and benefit costs related to loan originations (which directly offset salary expense), decreased $138,000 due to decreased loan originations in 2011 as compared to 2010. Payroll taxes also increased $68,000 due to the increase in salaries and wages. Employee incentive expense increased $52,000. Other personnel expenses increased $118,000. Commission expenses decreased by $98,000 as mortgage origination production at the Bank decreased.
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      Year-to-date, salaries and employee benefit expenses increased by $2.1 million, or 15.1%, due partially to the fact that in the prior year the Company recorded an adjustment to previously accrued incentive expenses which decreased incentive expenses by $628,000 in 2010. Other major components of this increase are summarized as follows: Salaries and wages increased by $616,000 due to the accrual of $552,000 in severance costs related to branch closures. Related payroll taxes also increased $165,000, and other personnel expenses increased $170,000. Deferral of salaries and benefit costs related to loan originations (which directly offset salary expense), decreased $349,000 due to decreased loan originations in 2011 as compared to 2010. Commission expenses decreased by $26,000 as mortgage origination production at the Bank decreased.
 
    Occupancy and equipment expenses increased by $374,000, or 19.1% for the quarter and $578,000 or 14.7% year-to-date. The increase attributable to the accrual of $401,000 in lease termination costs related to branch closures.
 
    Printing and supplies decreased by $103,000, or 39.8%, comparing the second quarter 2011 with the second quarter 2010. Year-to-date printing and supplies expense decreased $196,000, or 36.8%. Decreases are the result of cost cutting measures by management as well as the introduction of electronic statements for customers who no longer wish to receive paper statements.
 
    Data processing expense decreased $3,000, or 0.8% for the quarter and increased $57,000, or 8.2% for the year. Increase year-over-year is due to normal fluctuations in transaction volume and timing.
 
    Communication expense increased $38,000 or 8.7% for the second quarter compared to the second quarter of 2010. Year-to-date communication expense increased $25,000, or 2.8%.
 
    FDIC assessment expenses increased $40,000 for the quarter and increased $560,000 for the year, due to an increase in average deposits in 2011 as compared to 2010.
 
    Net cost of operation of other real estate owned increased $2.0 million compared to the second quarter of 2010, and year-over-year due to additional writedowns of $1.3 million which resulted from continued declines in real estate values, as well as loss on sales of $800,000.
 
    Quarter-to-date other operating expenses (including other professional fees, loan collection fees and amortization of core deposit intangibles) increased approximately $1.3 million, or 44.7% primarily due to loss on disposal and impairments of fixed assets of $1.2 million related to branch closures. Loan collection fees also increased $176,000.
 
      Year-to-date other operating expenses (including other professional fees, loan collection fees and amortization of core deposit intangibles) increased approximately $1.8 million, or 31.6%. As discussed above, losses on disposal of fixed assets accounted for $1.2 million of the increase. Other increases include a $337,000 increase in loan collection fees and a $91,000 increase in other professional fees.
Income Tax Expense
Income tax expense for the three and six months ended June 30, 2011 was $5.0 million and $4.5 million, respectively, compared to income tax benefit of $24,000 for the three months ended June 30, 2010, and income tax expense of $733,000 for the six months ended June 30, 2010. The significant increase is attributable to valuation allowances for deferred tax assets of $11.0 million recorded in the quarter ended June 30, 2011.
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Item 3. Quantitative and Qualitative Disclosures About Market Risk
Market risk is the risk of loss from adverse changes in market prices and rates. Our market risk arises principally from interest rate risk inherent in our lending, deposit, and borrowing activities. Management actively monitors and manages its interest rate risk exposure. In addition to other risks that we manage in the normal course of business, such as credit quality and liquidity, management considers interest rate risk to be a significant market risk that could potentially have a material effect on our financial condition and results of operations. The information contained in Item 2 in the section captioned “Liquidity, Interest Rate Sensitivity and Market Risk” is incorporated herein by reference. Other types of market risks, such as foreign currency risk and commodity price risk, do not arise in the normal course of our business activities. The acquisition of American Community and expansion into new market areas in North and South Carolina have marketing risks that are mitigated by retaining the American Community brand name in these markets. Credit risk associated with loans acquired in the merger are part of the overall discussion of credit risk in the sections captioned “Provision and Allowance for Loan Losses” and “Non-Performing Assets.”
The primary objective of asset and liability management is to manage interest rate risk and achieve reasonable stability in net interest income throughout interest rate cycles. This is achieved by maintaining the proper balance of rate-sensitive earning assets and rate-sensitive interest-bearing liabilities. The relationship of rate-sensitive earning assets to rate-sensitive interest-bearing liabilities is the principal factor in projecting the effect that fluctuating interest rates will have on future net interest income. Rate-sensitive assets and liabilities are those that can be repriced to current market rates within a relatively short time period. Management monitors the rate sensitivity of earning assets and interest-bearing liabilities over the entire life of these instruments, but places particular emphasis on the next twelve months. Following a period of rate increases (or decreases) net interest income will increase (or decrease) over both a three-month and a twelve-month period.
Item 4. Controls and Procedures
As of the end of the period covered by this report, we conducted an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e). Our disclosure controls and procedures are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is (i) recorded, processed, summarized and reported within the time periods specified in the Securities and Exchange Commission’s rules and forms, and (ii) accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosures.
Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures were effective (1) to provide reasonable assurance that information required to be disclosed by the Company in the reports filed or submitted by it under the Securities Exchange Act was recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and (2) to provide reasonable assurance that information required to be disclosed by the Company in such reports is accumulated and communicated to the Company’s management, including its Chief Executive Officer and Chief Financial Officer, as appropriate to allow for timely decisions regarding required disclosure.
Changes in Internal Control over Financial Reporting
There were no changes in the Company’s internal control over financial reporting during the period covered by this report that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting. The Company reviews its disclosure controls and procedures, which may include its internal control over financial reporting, on an ongoing basis, and may from time to time make changes aimed at enhancing their effectiveness and to ensure that the Company’s systems evolve with its business.
Yadkin Valley Financial Corporation
Form 10-Q Quarterly Report June 30, 2011

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Part II. Other Information
Item 1. Legal Proceedings
We are not a party to, nor are any of our properties subject to, any material legal proceedings, other than legal proceedings that we believe are routine litigation incidental to our business.
Item 6. Exhibits
     
Exhibit #   Description
31.1
  Rule 13a-14(a)/15d-14(a) Certification
 
   
31.2
  Rule 13a-14(a)/15d-14(a) Certification
 
   
32.1
  Section 1350 Certification
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Signatures
Pursuant to the requirements of Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
Yadkin Valley Financial Corporation
         
BY:
  /s/ Joseph H. Towell
 
Joseph H. Towell, President and Chief Executive Officer
   
 
       
BY:
  /s/ Jan H. Hollar
 
Jan H. Hollar, Principal Accounting Officer,
   
 
  Executive Vice President and Chief Financial Officer    
August 4, 2011
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INDEX TO EXHIBITS
     
Exhibit    
Number   Description
 
   
31.1
  Rule 13a-14(a) Certification of the Principal Executive Officer.
 
   
31.2
  Rule 13a-14(a) Certification of the Principal Financial Officer.
 
   
32
  Section 1350 Certifications.
 
   
101
  The following financial statements from the Quarterly Report on Form 10-Q of Yadkin Valley Financial Corporation for the quarter ended June 30, 2011, formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Changes in Shareholders’ Equity and Comprehensive Income (Loss), (iv) Consolidated Statement of Cash Flows and (v) Notes to Consolidated Financial Statements.(1)
(1)   As provided in Rule 406T of Regulation S-T, this information shall not be deemed “filed” for purposes of Section 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934 or otherwise subject to liability under those sections.