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EX-21.1 - EXHIBIT 21.1 - Cordia Bancorp Incv339858_ex21-1.htm
EX-31.2 - EXHIBIT 31.2 - Cordia Bancorp Incv339858_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Cordia Bancorp Incv339858_ex31-1.htm
EX-32.1 - EXHIBIT 32.1 - Cordia Bancorp Incv339858_ex32-1.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

 

 

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2012

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ____________________ to ____________________

 

 Commission file number: 001-35852

 

 

Cordia Bancorp Inc.

(Exact name of registrant as specified in its charter)

Virginia   26-4700031
(State or other jurisdiction of
incorporation or organization)
  (I.R.S. Employer
Identification No.)

 

11730 Hull Street Road, Midlothian, Virginia   23112
(Address of principal executive offices)   (Zip Code)

 

Registrant’s telephone number, including area code (804) 763-1333

 

Securities registered under Section 12(b) of the Act:

Title of each class   Name of each exchange on which registered

Common Stock, $0.01 par value 

  The NASDAQ Stock Market, LLC

 

Securities registered under Section 12(g) of the Act: None

 

 

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

 

Indicate by check mark if the issuer is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. ¨

 

Indicate by check mark if the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the 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 ¨.    No x.

 

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

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

 

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

 

Large accelerated filer

¨

 

Accelerated filer

¨

 

Non-accelerated filer

¨

(Do not check if a smaller reporting company)

 

Smaller reporting company

x

 

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

 

The registrant’s common stock was not publicly traded as of the last business day of the registrant’s most recently completed second fiscal quarter.

 

The number of shares of common stock outstanding as of March 15, 2013 was 2,077,605. 

 

Documents Incorporated by Reference

 

None.

 

 
 

 

    Page
     
PART I
     
Item 1. Business 2
Item 1A. Risk Factors 15
Item 1B. Unresolved Staff Comments 20
Item 2. Properties 20
Item 3. Legal Proceedings 20
Item 4. Mine Safety Disclosures 20
     
PART II
     
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities 20
Item 6. Selected Financial Data 21
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations 22
Item 7A. Quantitative and Qualitative Disclosures about Market Risk 40
Item 8. Financial Statements and Supplementary Data 41
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure 82
Item 9A Controls and Procedures 82
Item 9B. Other Information 82
     
PART III
     
Item 10. Directors, Executive Officers and Corporate Governance 83
Item 11. Executive Compensation 87
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters 90
Item 13. Certain Relationships, and Related Transactions, and Director Independence 91
Item 14. Principal Accounting Fees and Services 93
     
PART IV
     
Item 15. Exhibits, Financial Statement Schedules 93
     
SIGNATURES
     
Signatures   96

 

 
 

 

CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

 

This report contains forward-looking statements. Any statements about our expectations, beliefs, plans, predictions, forecasts, objectives, assumptions or future events or performance are not historical facts and may be forward-looking. These statements are often, but not always, made through the use of words or phrases such as “anticipate,” “believes,” “can,” “could,” “may,” “predicts,” “potential,” “should,” “will,” “estimate,” “plans,” “projects,” “continuing,” “ongoing,” “expects,” “intends” and similar words or phrases. Accordingly, these statements are only predictions and involve estimates, known and unknown risks, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Our actual results could differ materially from those anticipated in such forward-looking statements as a result of several factors more fully described under the caption “Risk Factors” and elsewhere in this report.

 

Any or all of the forward-looking statements in this report may turn out to be inaccurate. The inclusion of this forward-looking information should not be regarded as a representation by us or any other person that the future plans, estimates or expectations contemplated by us will be achieved. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our respective financial condition, results of operations, business strategy and financial needs. There are important factors that could cause actual results, level of activity, performance or achievements to differ materially from the results, level of activity, performance or achievements expressed or implied by the forward-looking statements including, but not limited to, statements regarding:

 

changes in general economic and financial market conditions;
   
changes in the regulatory environment;
   
economic conditions generally and in the financial services industry;
   
changes in the economy affecting real estate values;
   
our ability to achieve loan and deposit growth;
   
the completion of future acquisitions or business combinations and our ability to integrate the acquired business into our business model;
   
projected population and income growth in our targeted market areas; and
   
volatility and direction of market interest rates and a weakening of the economy which could materially impact credit quality trends and the ability to generate loans.

 

All forward-looking statements are necessarily only estimates of future results, and actual results may differ materially from expectations. You are, therefore, cautioned not to place undue reliance on such statements which should be read in conjunction with the other cautionary statements that are included elsewhere in this report. In particular, you should consider the numerous risks described in the “Risk Factors” section of this report. Further, any forward-looking statement speaks only as of the date on which it is made and we undertake no obligation to update or revise any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

 

1
 

 

PART I

 

Item 1.Business

 

General

 

Cordia Bancorp Inc. (“Cordia”or the “Company”) was incorporated in 2009 by a team of former bank CEOs, directors and advisors seeking to invest in undervalued or troubled community banks in the Mid-Atlantic and Southeast. On December 10, 2010, Cordia purchased $10,300,000 of the common stock of Bank of Virginia (“BOVA” or the “Bank”) at a price of $7.60 per share, resulting in the ownership of 59.8% of the outstanding shares. On August 28, 2012, Cordia purchased an additional $3,000,000 of BOVA common stock at a price of $3.60 per share. Cordia’s principal business activity is the ownership of the outstanding shares of common stock of BOVA. On March 29, 2013, Cordia and BOVA completed a share exchange pursuant to which each outstanding share of BOVA common stock held by persons other than Cordia was exchanged for .664 of a share of Cordia common stock. As a result of the share exchange, BOVA became a wholly-owned subsidiary of Cordia.

 

Cordia does not own or lease any property, but instead uses the premises, equipment and other property of BOVA. Because Cordia does not have any business activities separate from the operations of BOVA, the information in this document regarding the business of Cordia reflects the activities of Cordia and BOVA on a consolidated basis. References to ‘‘we’’ and ‘‘our’’ in this document refer to Cordia and BOVA, collectively.

 

BOVA was incorporated in the state of Virginia in September 2002 and commenced business on January 12, 2004. BOVA is headquartered in Midlothian, Virginia and is primarily engaged in the business of accepting demand, savings and time deposits and providing consumer and commercial loans to the general public. BOVA is state chartered and is a member of the Federal Reserve System.

 

Marketing Focus and Business Strategy

 

BOVA is organized to serve consumers and small- to mid-size businesses and professional concerns. We believe that we can be successful by offering a superior level of customer service with a management team more focused on the needs of our borrowers than many of our competitors. We believe that this approach is enthusiastically supported by many members of the community. BOVA competes directly with a number of institutions in the local area, including larger regional and super-regional banks, as well as international institutions that tend to have less emphasis on interaction with the customers than the community banks in our target market. BOVA offers traditional loan and deposit products for commercial and consumer purposes.

 

Our banking strategy includes these primary elements:

 

provide personalized relationship banking to all of our customers at a higher level of service than that provided by nationwide and regional banks, which are among our primary competitors;
   
staff BOVA with executive and lending officers who have extensive experience, relationships, and visibility in the Richmond commercial banking market;
   
offer an array of products and services and innovative banking technologies on a competitive basis;
   
focus on reliable and profitable market niches, such as small and medium size businesses;
   
enhance income through a fair but profitable schedule of fees for all bank products and services;
   
add additional branches or loan offices throughout our market area as regulatory and economic conditions may allow; and
   
raise additional capital to support organic growth as well as acquisitions of other depository institutions.

 

2
 

 

Written Agreement

 

On January 14, 2010, BOVA entered into a Written Agreement with the Federal Reserve Bank of Richmond (the ‘‘Federal Reserve’’) and the Virginia Bureau of Financial Institutions. Under the terms of the Written Agreement, BOVA must obtain the prior approval of the Federal Reserve, the Director of the Division of

 

Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System, and the Virginia Bureau of Financial Institutions before it may declare or pay dividends. In addition, the Bank may not extend or renew any credit to or for the benefit of any borrower whose extension of credit or a portion thereof has been charged off or classified ‘‘loss’’ as long as such credit remains uncollected or, without prior approval of BOVA’s Board of Directors, extend or renew any credit to or for the benefit of any borrower whose extension of credit has been classified ‘‘doubtful’’ or ‘‘substandard.’’ The Written Agreement also required, among other things, that BOVA:

 

strengthen board oversight of BOVA’s management and operations;
   
strengthen credit risk management practices, particularly management of commercial real estate concentrations, and take steps to reduce the risk of concentrations;
   
improve BOVA’s position on outstanding past due and other problem loans in excess of $500,000;
   
implement ongoing review and grading of BOVA’s loan portfolio by a qualified independent party or by qualified staff that is independent of BOVA’s lending function;
   
review and revise the allowance for loan and lease losses policy and ensure the maintenance of adequate allowance for loan and lease losses;
   
maintain sufficient capital at BOVA;
   
implement a policy to prevent conflicts of interest between BOVA and BOVA’s directors, officers and employees.

 

Failure to comply with the Written Agreement could subject BOVA to the assessment of civil monetary penalties, further regulatory sanctions and/or other regulatory enforcement actions.

 

We believe that BOVA is in substantial compliance with the Written Agreement. BOVA has addressed the requirements of the Written Agreement, including improving asset quality and credit risk management and maintaining capital at a level that satisfies regulatory well capitalized standards. In certain areas, our regulators have identified matters requiring ongoing attention to maintain full compliance with the provisions of the Written Agreement, and we believe that BOVA has maintained such compliance.

 

Location and Service Area

 

BOVA’s market area is primarily in the greater Richmond metropolitan region, with a focus on an area within a twenty-five mile radius of our main office in Midlothian, Virginia. BOVA has two branches in Chesterfield County, Virginia and one branch in Henrico, Virginia.

 

Additionally, BOVA also leases buildings located at 15001 Dogwood Villas Drive Chesterfield, Virginia, and 2000 Snead Avenue Colonial Heights, Virginia, both of which house an ATM. The Dogwood Villas branch houses BOVA’s deposit operations, electronic banking, and compliance functions as well. The Snead Avenue branch was leased in pursuit of expanding BOVA’s footprint into the Colonial Heights market.

 

Richmond, Virginia, Virginia’s state capital, is a city with historic significance and charm, as well as close proximity to recreational attractions such as the Atlantic Ocean, the Blue Ridge Mountains and the Shenandoah Valley, Washington, D.C., well known theme parks, major educational institutions and many other amenities. Additionally, the city and surrounding area is in close proximity to other large metropolitan areas, including Norfolk, Virginia and Washington, D.C., and is the center point for two growth corridors coming down US 95 from the Northern Virginia community and up US 64 from the Tidewater area. Like the rest of the country, the greater Richmond area continues to be impacted by a weak economy, rising unemployment, decreasing real estate values, and sluggish consumer confidence. This economic environment has adversely impacted our customer base.

 

3
 

 

BOVA’s locations in Chesterfield and Henrico County and the city of Colonial Heights, Virginia, are generally south and west of Downtown Richmond. They offer BOVA business opportunities and the potential of strong economic growth through their commercial and industrial enterprises, an educated work force, well-designed and developed infrastructure and a competitive tax structure. This is reflected by the area’s major commercial employers such as Altria, Genworth Financial, Markel Corporation, Pfizer Pharmaceuticals, Hewlett Packard, Kraft Foods, WellPoint, United Parcel Service, Verizon, Philip Morris, Dupont and others. This economic environment has historically offered a wealth of job opportunities for the residents of the Richmond area.

 

In 2004, BOVA’s initial strategy was to build a strong community banking franchise and branch network in the Chesterfield market and expand the franchise into bordering communities in the Richmond metropolitan area. Since 2009, management has spent much of its time and effort on issues resulting from a deterioration in BOVA’s asset quality. The regional economic problems affected many of BOVA’s borrowers resulting in reduced business traffic for our customers, business closures, increased unemployment and collateral deterioration. In this rapidly changing and declining economic environment, BOVA curtailed aggressive loan growth, focused on managing asset quality and losses, and offset asset decline by managing down its deposit balances. At the same time, management realigned and recapitalized BOVA to provide a platform for careful and controlled growth in the future.

 

Lending Services

 

BOVA offers a full range of short-to-medium term commercial and personal loans, in addition to its core lending in owner and non-owner occupied commercial real estate loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements), and purchase of equipment and machinery. Consumer loans and lines of credit include secured and unsecured loans for financing automobiles, home improvements, education and personal investments. The Bank does not currently provide new loans for land acquisition, development and construction. Historically, the Bank has not originated significant volume of one- to four family residential loans.

 

In November 2012, the Company commenced a new loan program through which it purchases a 100% participation in government agency conforming mortgage loans, up to an aggregate of $30 million, from Stonegate Mortgage Corporation (“Stonegate”). The mortgage loans are designated as held for sale at the time of purchase. The loans are pre-sold to either FNMA or GNMA with servicing retained by Stonegate and the Company does not retain any interest after the loans are sold into the secondary market. These loans consist primarily of fixed-rate, single-family residential mortgage loans which meet the underwriting characteristics of the previously mentioned government sponsored enterprises (conforming loans). In addition, the Company requires a firm purchase commitment from a permanent investor equal to or greater than the purchase price before a pool of loans can be purchased, virtually eliminating interest rate risk. The Company earns interest at the note rate for each loan for the time it owned the loan, and pays per loan original and marketing.

 

Banking Services

 

BOVA offers a full range of deposit services that include interest-bearing and non interest-bearing checking accounts, commercial accounts, savings and money market accounts, as well as certificates of deposit and individual retirement accounts (IRAs). We solicit these accounts from individuals, businesses, and other organizations. These accounts are tailored to our principal market area at rates competitive to those offered in our market area. All deposit accounts are insured by the Federal Deposit Insurance Corporation (‘‘FDIC’’) up to the maximum amount allowed by law (subject to aggregation rules).

 

Other Deposit Banking Services

 

BOVA offers online banking, remote deposit capture, mobile banking, text banking, safe deposit boxes, cashier’s checks, banking by mail, and direct deposit. BOVA is associated with a worldwide Automated Teller Machines (‘‘ATMs’’) network that is convenient for and offered free to our customers. BOVA also offers debit card and credit card services through a correspondent bank, as well as 24-hour telephone banking. BOVA is committed to meeting the challenges technology and provides its customers with the latest technological bank products.

 

4
 

 

Market Share and Competition

 

As of June 30, 2012, there were 375 banking offices, representing 37 financial institutions, operating in the Richmond, Virginia metropolitan statistical area (‘‘MSA’’) and holding just over $73.8 billion in deposits including $151.7 million held by Bank of Virginia or 0.21% of the MSA. Within the MSA, our primary market is Chesterfield County, where we had $115.5 million, or 2.9% of a $3.9 billion market base. In addition, our remaining deposits come from our small but growing presence in Henrico County. We believe that our management team and the economic and demographic dynamics of our service area combined with our business strategy will allow us to gain a larger share of both areas’ deposits.

 

The financial services industry is highly competitive and changes in the competitive landscape continue to affect all aspects of BOVA’s business. Our competitors include large national, super regional and regional banks like Wachovia Bank/Wells Fargo, Bank of America, SunTrust and BB&T, as well as numerous community banks competing for the same customer base.

 

On a broad view, competition among providers of financial products and services continues to increase, with consumers having the opportunity to select from a growing variety of traditional and nontraditional alternatives. The industry continues to consolidate, which affects competition by eliminating some regional and community institutions, while strengthening the franchises of acquirers. The ability of non bank financial entities to provide services previously reserved for commercial banks has also intensified competition. In addition, many financial services entities are experiencing significant challenges as a result of the economic crisis, resulting in continued bank and thrift failures and significant intervention from the U.S. Government.

 

In the two Virginia counties in which BOVA operates, the strongest competition is other local community banks, savings and loan associations, credit unions, mortgage companies, finance companies, and insurance companies and others providing financial services. Many competitors have greater capital resources and more access to long-term, lower cost sources of funding. They may have extensive advertising campaigns, larger branch networks, and offer a broader selection of services and products. Some competitors have other advantages, such as tax exemption in the case of credit unions, and lesser regulation in the case of mortgage companies and specialty finance companies. These various factors make deposit competition strong among institutions in our primary market area.

 

Funding Activities

 

Deposits are the primary source of funds for BOVA’s lending and investing activities and their cost is the largest category of interest expense. Scheduled payments, as well as prepayments, and maturities from portfolios of loans and investment securities also provide a stable source of funds. Federal Home Loan Bank (‘‘FHLB’’) advances and other secured borrowings all provide supplemental liquidity sources. BOVA’s funding activities are monitored and governed through BOVA’s overall asset-liability management process. BOVA conducts its funding activities in compliance with all applicable laws and regulations. The following is a brief description of the various sources of funds used by BOVA.

 

Deposits. Deposits, BOVA’s most attractive source of funding because of their stability and relative cost, are attracted principally from clients within BOVA’s branch network and our general market area. We offer a broad selection of deposit instruments to individuals and businesses, including noninterest-bearing checking accounts, interest-bearing checking accounts, savings accounts, money market deposit accounts, certificates of deposit and individual retirement accounts. Deposit account terms vary with respect to the minimum balance required, the time period the funds must remain on deposit and service charge schedules. Interest rates paid on specific deposit types are determined based on (i) the interest rates offered by competitors, (ii) the anticipated amount and timing of funding needs, (iii) the availability and cost of alternative sources of funding, and (iv) the anticipated future economic and interest rate conditions. Historically, BOVA has also obtained a modest portion of its deposit base through wholesale funding products.

 

Federal Home Loan Bank (‘‘FHLB’’) Borrowings and Other Borrowings. BOVA’s ability to borrow funds from non deposit sources provides additional flexibility in meeting its liquidity needs as well as managing its cost of funds. Non-deposit funding options include Federal Funds purchased, securities sold under repurchase agreements, and short-term and long-term FHLB borrowings.

 

5
 

 

Investment Activities

 

BOVA invests in securities that comply with all applicable regulations and that meet with Board approval. Permissible securities are U.S. government and agency debt obligations; agency guaranteed mortgage-backed securities; state, county, and municipal securities; money market instruments; mutual funds; corporate bonds and trust preferred securities. A balanced maturity distribution is sought in order to minimize the market exposure of investments in any one year. BOVA’s investment activities are governed internally by a written, Board-approved policy. The investment policy is carried out by BOVA’s Chief Executive Officer conjunction with the Asset-Liability Committee (‘‘ALCO’’).

 

Investment strategies are reviewed by the Board’s ALCO based on the interest rate environment, balance sheet mix, actual and anticipated loan demand, funding opportunities and the overall interest rate sensitivity of BOVA. In general, the investment portfolio is managed in a manner appropriate to the attainment of the following goals: (i) to provide a sufficient balance of liquid securities to meet unanticipated deposit and loan fluctuations and overall funds management objectives; (ii) to provide eligible securities to secure public funds, trust deposits as prescribed by law and other borrowings; and (iii) to earn an appropriate return on funds invested that is commensurate with policy objectives.

 

Employees

 

As of December 31, 2012, BOVA had 47 full-time equivalent employees. Management of BOVA considers its relations with employees to be excellent. No employees are represented by a union or any similar group, and BOVA has never experienced any strike or labor dispute.

 

SUPERVISION AND REGULATION

 

The regulatory framework applicable to Cordia and BOVA is designed to protect depositors, federal deposit insurance funds and the banking system as a whole, and not to protect security holders. Such statutes, regulations and policies are continually under review by Congress, state legislatures, and federal and state regulators. A change in statutes, regulations or regulatory policies, including changes in interpretation or implementation thereof, could have a material effect on our business.

 

General

 

As a bank holding company, Cordia is subject to regulation, examination and supervision by the Board of Governors of the Federal Reserve under the Bank Holding Company Act of 1956, as amended (the “BHCA”), and by the Virginia Bureau of Financial Institutions (“VBFI”). BOVA is a Virginia state-chartered commercial bank and a member of the Federal Reserve Bank of Richmond, and its deposits are insured by the FDIC. It is subject to regulation, examination and supervision by the Federal Reserve and the VBFI. Numerous federal and state laws, as well as regulations promulgated by the Federal Reserve, the FDIC and state banking regulators, govern almost all aspects of the operation of BOVA.

 

Bank Holding Company Regulation

 

The BHCA limits a bank holding company’s business to owning or controlling banks and engaging in other banking-related activities. Bank holding companies must obtain the Federal Reserve’s approval before they: (1) acquire direct or indirect ownership or control of any voting shares of any bank that results in total ownership or control, directly or indirectly, of more than 5% of the voting shares of such bank; (2) merge or consolidate with another bank holding company; or (3) acquire substantially all of the assets of any additional banks. Subject to certain state laws, such as age and contingency restrictions, a bank holding company that is adequately capitalized and adequately managed may acquire the assets of both in-state banks and out-of-state banks. With certain exceptions, the BHCA prohibits bank holding companies from acquiring direct or indirect ownership or control of voting shares in any company that is not a bank or a bank holding company unless the Federal Reserve determines that the activities of such company are incidental or closely related to the business of banking. If a bank holding company is well-capitalized and meets certain criteria specified by the Federal Reserve, it may engage de novo in certain permissible non-banking activities without prior Federal Reserve approval.

 

6
 

 

A number of provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”), a few of which are described here, affect the regulation and operations of banks and bank holding companies. Pursuant to the Dodd-Frank Act, the FDIC is given back-up supervisory authority over bank holding companies engaging in conduct that poses a foreseeable and material risk to the Deposit Insurance Fund (“DIF”), and the Federal Reserve gains heightened authority to examine, prescribe regulations and take action with respect to all of a bank holding company’s subsidiaries. A newly created agency, the Office of Financial Research, has authority to collect data from all financial institutions for the purpose of studying threats to U.S. financial stability.

 

Holding companies of banks chartered under Virginia law are subject to applicable provisions of Virginia’s banking laws and to the examination, supervision and enforcement powers of the VBFI. Among other powers, the VBFI has the authority to issue and enforce cease and desist orders on such holding companies.

 

Change in Control

 

Subject to certain exceptions, the BHCA and the Change in Bank Control Act, together with regulations promulgated thereunder, require Federal Reserve approval prior to any person or company acquiring “control” of a bank or bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% or more of any class of voting securities. Control is rebuttably presumed to exist if a person acquires 10% or more, but less than 25%, of any class of an institution’s voting securities and either that institution has registered securities under Section 12 of the Exchange Act or no other person owns a greater percentage of that class of voting securities immediately after the transaction. In certain cases, a company may also be presumed to have control under the Bank Holding Company Act if it acquires 5% or more of any class of voting securities.

 

Pursuant to the Dodd-Frank Act, a bank holding company may acquire control of an out-of-state bank only if the bank holding company is well-capitalized and well-managed, and interstate merger transactions are prohibited unless the resulting bank would be well-capitalized and well-managed following the transaction. Virginia state law requires that the VBFI approve in advance any proposed change of control of a Virginia state-chartered bank. Under Virginia law, a person is deemed to control another entity if (1) it owns 25% or more of the voting shares of the entity, (2) the person is presumed to control the entity under the BHCA, or (3) the VBFI determines that the person exercises a controlling influence over the management and policies of the entity.

 

Capital Requirements

 

The Federal Reserve has adopted guidelines pursuant to which it assesses the adequacy of capital in examining and supervising state-chartered member banks such as BOVA. These guidelines include quantitative measures that assign risk weightings to assets and off-balance sheet items and that define and set minimum regulatory capital requirements. Bank holding companies with consolidated assets of less than $500 million that are not engaged in significant nonbanking activities, do not conduct significant off-balance sheet activities, and do not have a material amount of debt or equity securities outstanding that are registered with the SEC are not subject to the Federal Reserve’s capital adequacy guidelines for bank holding companies.

 

Prompt corrective action regulations provide five classifications: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized, although these terms are not used to represent overall financial condition. If adequately capitalized, regulatory approval is required to accept broker deposits. If undercapitalized, capital distributions are limited, as is asset growth and expansion, and capital restoration plans are required. As of December 31, 2012, BOVA’s capital levels were above those currently required to be deemed “well-capitalized.” Management believes that, under current regulatory capital regulations, BOVA will continue to meet its minimum capital requirements in the foreseeable future.

 

In June 2012, the federal banking regulators issued final rules substantially amending the regulatory risk-based capital rules applicable to bank holding companies and depository institutions. The final rules set forth certain changes for the calculation of risk-weighted assets, which we will be required to utilize beginning January 1, 2013. The rule utilizes an increased number of credit risk exposure categories and risk weights, and also addresses: (i) a proposed alternative standard of creditworthiness consistent with Section 939A of the Dodd-Frank Act; (ii) revisions to recognition of credit risk mitigation; (iii) rules for risk weighting of equity exposures and past due loans; (iv) revised capital treatment for derivatives and repo-style transactions; and (v) disclosure requirements for top-tier banking organizations with $50 billion or more in total assets that are not subject to the “advance approach rules” that apply to banks with greater than $250 billion in consolidated assets.

 

7
 

 

On August 30, 2012, the federal banking agencies issued proposed rules that would implement the “Basel III” regulatory capital reforms and changes required by the Dodd-Frank Act. “Basel III” refers to two consultative documents released by the Basel Committee on Banking Supervision in December 2009, the rules text released in December 2010, and loss absorbency rules issued in January 2011, which include significant changes to bank capital, leverage and liquidity requirements.

 

The proposed rules include new risk-based capital and leverage ratios, which would be phased in from 2013 to 2019, and would revise the definition of what constitutes “capital” for purposes of calculating those ratios. The proposed new minimum capital level requirements applicable to Cordia and BOVA under the proposals would be: (i) a new common equity Tier 1 capital ratio of 4.5%; (ii) a Tier 1 capital ratio of 6% (increased from 4%); (iii) a total capital ratio of 8% (unchanged from current rules); and (iv) a Tier 1 leverage ratio of 4% for all institutions. The proposed rules would also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum capital requirements, which must consist entirely of common equity Tier 1 capital and would result in the following minimum ratios: (i) a common equity Tier 1 capital ratio of 7.0%, (ii) a Tier 1 capital ratio of 8.5%, and (iii) a total capital ratio of 10.5%. The new capital conservation buffer requirement would be phased in beginning in January 2016 at 0.625% of risk-weighted assets and would increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on paying dividends, engaging in share repurchases, and paying discretionary bonuses if its capital level falls below the buffer amount. These limitations would establish a maximum percentage of eligible retained income that could be utilized for such actions.

 

As noted, capital requirements will likely be increasing over the next several years as a result of the implementation of the Dodd-Frank Act and the U.S. federal banking regulators’ implementation of the Basel III standards. If a depository institution fails to remain well-capitalized, it becomes subject to a variety of enforcement remedies that increase as the capital condition worsens.

 

Bank Holding Companies as a Source of Strength

 

Federal Reserve law requires that a bank holding company serve as a source of financial and managerial strength to each bank that it controls and, under appropriate circumstances, to commit resources to support each such controlled bank. This support may be required at times when the bank holding company may not have the resources to provide the support.

 

Under the prompt corrective action provisions, if a controlled bank is undercapitalized, then the regulators could require the bank holding company to guarantee the bank’s capital restoration plan. In addition, if the Federal Reserve believes that a bank holding company’s activities, assets or affiliates represent a significant risk to the financial safety, soundness or stability of a controlled bank, then the Federal Reserve could require the bank holding company to terminate the activities, liquidate the assets or divest the affiliates. The regulators may require these and other actions in support of controlled banks even if such actions are not in the best interests of the bank holding company or its stockholders. Because Cordia is a bank holding company, Cordia is viewed as a source of financial and managerial strength for any controlled depository institutions, like BOVA.

 

The Dodd-Frank Act also directs federal bank regulators to require that all companies that directly or indirectly control an insured depository institution serve as sources of financial strength for the institution. The term “source of financial strength” is defined under the Dodd-Frank Act as the ability of a company to provide financial assistance to its insured depository institution subsidiaries in the event of financial distress. The appropriate federal banking agency for such a depository institution may require reports from companies that control the insured depository institution to assess their abilities to serve as sources of strength and to enforce compliance with the source-of-strength requirements. The appropriate federal banking agency may also require a holding company to provide financial assistance to a bank with impaired capital. Under this requirement, in the future we could be required to provide financial assistance to BOVA should it experience financial distress.

 

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In addition, capital loans by us to BOVA will be subordinate in right of payment to deposits and certain other indebtedness of BOVA. In the event of our bankruptcy, any commitment by us to a federal bank regulatory agency to maintain the capital of BOVA will be assumed by the bankruptcy trustee and entitled to a priority of payment.

 

FDICIA Prompt Corrective Action

 

The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) established a system of prompt corrective action to resolve the problems of undercapitalized insured depository institutions. Under this system, the federal banking regulators are required to rate insured depository institutions on the basis of five capital categories as described above under “Capital Requirements.” The federal banking regulators are also required to take mandatory supervisory actions and are authorized to take other discretionary actions with respect to insured depository institutions in the three undercapitalized categories, the severity of which will depend upon the capital category in which the insured depository institution is assigned. Generally, subject to a narrow exception, FDICIA requires the banking regulators to appoint a receiver or conservator for an insured depository institution that is critically undercapitalized. The federal banking regulations specify the relevant capital level for each category.

 

FDICIA generally prohibits a depository institution from making any capital distribution, including payment of a dividend, or paying any management fee to its holding company if the depository institution would thereafter be undercapitalized. See “Dividends.” “Undercapitalized” depository institutions are also subject to restrictions on borrowing from the Federal Reserve System, may not accept brokered deposits absent a waiver from the FDIC, and are subject to growth limitations. In addition, a depository institution’s holding company must guarantee a capital plan, up to an amount equal to the lesser of 5% of the depository institution’s assets at the time it becomes undercapitalized or the amount of the capital deficiency when the institution fails to comply with the plan. Federal banking regulators may not accept a capital plan without determining, among other things, that the plan is based on realistic assumptions and is likely to succeed in restoring the depository institution’s capital. If a depository institution fails to submit an acceptable plan, it is treated as if it is significantly undercapitalized.

 

“Significantly undercapitalized” depository institutions may be subject to a number of requirements and restrictions, including orders to sell sufficient voting stock to become adequately capitalized, requirements to reduce total assets, and cessation of receipt of deposits from correspondent banks. “Critically undercapitalized” institutions are subject to the appointment of a receiver or conservator.

 

Virginia state law gives the VBFI powers similar to those granted to the FDIC under the prompt corrective action provisions of FDICIA.

 

Dividends

 

Cordia is a legal entity separate and distinct from BOVA and its subsidiaries. The principal source of funds for Cordia’s payment of any future dividends on its capital stock and principal and interest on its debt is dividends from BOVA. Various federal and state statutory provisions and regulations limit the amount of dividends, if any, Cordia and BOVA may pay without regulatory approval.

 

The Federal Reserve has authority to prohibit a bank holding company from paying dividends or making other distributions. The Federal Reserve has issued a policy statement that a bank holding company should not pay cash dividends unless its net income available to common stockholders has been sufficient to fully fund the dividends and the prospective rate of earnings retention appears to be consistent with the holding company’s capital needs, asset quality and overall financial condition. Accordingly, a bank holding company should not pay cash dividends that exceed its net income or that can only be funded in ways that weaken the bank holding company’s financial health, such as by borrowing. The Dodd-Frank Act imposes, and Basel III (described above) once in effect will impose, additional restrictions on the ability of banking institutions to pay dividends.

 

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Dividends that may be paid by a member bank without the express approval of the Federal Reserve are limited to that bank’s retained net profits for the preceding two calendar years plus retained net profits up to the date of any dividend declaration in the current calendar year. Retained net profits, as defined by the Federal Reserve, consist of net income less dividends declared during the period.

 

Federal bank regulators have the authority to prohibit BOVA from engaging in unsafe or unsound practices in conducting its business, and the payment of dividends, depending on the bank’s financial condition, could be deemed an unsafe or unsound practice. The ability of BOVA to pay dividends in the future will continue to be influenced by bank regulatory policies and capital guidelines, and is subject to regulatory approval.

 

Deposit Insurance and Assessments

 

Deposits held by BOVA are insured by the DIF as administered by the FDIC. The Dodd-Frank Act raised the standard maximum deposit insurance amount to $250,000 per depositor, per insured depository institution for each account ownership category. Effective December 31, 2010, and continuing through December 31, 2012, the Dodd-Frank Act provided unlimited FDIC insurance for all noninterest-bearing transaction accounts, regardless of amount.

 

The FDIC maintains the DIF by assessing each depository institution an insurance premium. The amount of the FDIC assessments paid by a DIF member institution is based on its relative risk of default as measured by the company’s FDIC supervisory rating, and other various measures, such as the level of brokered deposits, secured debt and debt issuer ratings.

 

In February 2011, the FDIC redefined the deposit insurance assessment base, and updated the assessment rates. The DIF assessment base rate currently ranges from 2.5 to 45 basis points for institutions that do not trigger factors for brokered deposits and unsecured debt, and higher rates for those that do trigger those risk factors.

 

The Dodd-Frank Act effects further changes to the law governing deposit insurance assessments. There is no longer an upper limit for the reserve ratio designated by the FDIC each year, and the maximum reserve ratio may not be less than 1.35% of insured deposits, or the comparable percentage of the assessment base. Under prior law the maximum reserve ratio was 1.15%. The Dodd-Frank Act permits the FDIC until September 30, 2020 to raise the reserve ratio to 1.35%. The FDIC is required to offset the effect of increased assessments necessitated by the Dodd-Frank Act on insured depository institutions with total consolidated assets of less than $10 billion. The Dodd-Frank Act also eliminates requirements under prior law that the FDIC pay dividends to member institutions if the reserve ratio exceeds certain thresholds. In lieu of dividends, the FDIC will adopt lower rate schedules when the reserve ratio exceeds certain thresholds.

 

All FDIC-insured depository institutions must pay a quarterly assessment to provide funds for the payment of interest on bonds issued by the Financing Corporation, a federal corporation chartered under the authority of the Federal Housing Finance Board. The bonds, which are referred to as FICO bonds, were issued to capitalize the Federal Savings and Loan Insurance Corporation.

 

Transactions with Affiliates and Insiders

 

A variety of legal limitations restrict BOVA from lending or otherwise supplying funds or in some cases transacting business with Cordia or its nonbank subsidiaries. BOVA is subject to Sections 23A and 23B of the Federal Reserve Act and Federal Reserve Regulation W. Section 23A places limits on the amount of covered transactions which include loans or extensions of credit to, investments in or certain other transactions with, affiliates as well as the amount of advances to third parties collateralized by the securities or obligations of affiliates. The aggregate of all covered transactions is limited to 10% of the bank’s capital and surplus for any one affiliate and 20% for all affiliates. Furthermore, within the foregoing limitations as to amount, each covered transaction must meet specified collateral requirements ranging from 100% to 130%. Also, banks are prohibited from purchasing low quality assets from an affiliate.

 

Section 23B, among other things, prohibits an institution from engaging in certain transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with nonaffiliated companies. Except for limitations on low quality asset purchases and transactions that are deemed to be unsafe or unsound, Regulation W generally excludes affiliated depository institutions from treatment as affiliates. Transactions between a bank and any of its subsidiaries that are engaged in certain financial activities may be subject to the affiliated transaction limits. The Federal Reserve also may designate bank subsidiaries as affiliates.

 

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Banks are also subject to quantitative restrictions on extensions of credit to executive officers, directors, principal shareholders, and their related interests. In general, such extensions of credit (1) may not exceed certain dollar limitations, (2) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties and (3) must not involve more than the normal risk of repayment or present other unfavorable features. Certain extensions of credit also require the approval of a bank’s board of directors.


The Dodd-Frank Act expands the 23A and 23B affiliate transaction rules. Among other things, upon the statutory changes’ effective date, the scope of the definition of “covered transaction” under 23A will expand, collateral requirements will increase and certain exemptions will be eliminated.

 

Standards for Safety and Soundness

 

The Federal Deposit Insurance Act requires the federal bank regulators to prescribe the operational and managerial standards for all insured depository institutions relating to: (1) internal controls; (2) information systems and audit systems; (3) loan documentation; (4) credit underwriting; (5) interest rate risk exposure; and (6) asset quality.

 

The regulators also must prescribe standards for earnings, and stock valuation, as well as standards for compensation, fees and benefits. The Interagency Guidelines Prescribing Standards for Safety and Soundness set forth the safety and soundness standards used to identify and address problems at insured depository institutions before capital becomes impaired. Under the rules, if a regulator determines that a bank fails to meet any standards prescribed by the guidelines, the regulator may require the bank to submit an acceptable plan to achieve compliance, consistent with deadlines for the submission and review of such safety and soundness compliance plans.

 

Regulatory Examination

 

Cordia and BOVA must undergo regular on-site examinations by the appropriate banking agency. A bank regulator conducting an examination has complete access to the books and records of the examined institution. The results of the examination are confidential. The cost of examinations may be assessed against the examined institution as the agency deems necessary or appropriate.

 

State Law and Regulation

 

BOVA, as a Virginia state-chartered institution, is subject to regulation by the VBFI, which conducts regular examinations to ensure that its operations and policies conform with applicable law and safe and sound banking practices. Among other things, state law regulates the amount of credit that can be extended to any one borrower and the amount of money that can be invested in various types of assets. BOVA generally cannot extend credit to any one borrower in an amount greater than 15% of the sum of BOVA’s capital, surplus and loan loss reserve. State law also regulates the types of loans BOVA can make.

 

Community Reinvestment Act

 

The Community Reinvestment Act (the “CRA”) requires that the appropriate federal bank regulator evaluate the record of our banking subsidiary in meeting the credit needs of its local community, including low and moderate income neighborhoods. These evaluations are considered in evaluating mergers, acquisitions, and applications to open a branch or facility. Failure to adequately meet these criteria could result in additional requirements and limitations on the bank. As of Cordia’s last CRA regulatory exam, BOVA received a rating of “satisfactory.”

 

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Consumer Protection Regulations

 

Retail activities of banks are subject to a variety of statutes and regulations designed to protect consumers. The Dodd-Frank Act established the Consumer Financial Protection Bureau (the “CFPB”) that, together with the statute’s changes to consumer protection laws such as limits on debit card interchange fees and provisions on mortgage-related matters, will likely increase the compliance costs of consumer banking operations. Interest and other charges collected or contracted for by banks are subject to state usury laws and federal laws concerning interest rates. In January 2012, a director was appointed to lead the CFPB and the CFPB began exercising its full range of powers. The CFPB has exclusive authority to require reports and conduct examinations, for purposes of ensuring compliance with federal consumer financial laws and related matters, of insured depository institutions with more than $10 billion of assets. For insured depository institutions with assets of $10 billion or less, the CFPB can require reports and conduct examinations on a sample basis.

 

Loan operations are also subject to federal laws applicable to credit transactions, such as:

 

the federal Truth-In-Lending Act and Regulation Z issued by the Federal Reserve, governing disclosures of credit terms to consumer borrowers;
the Home Mortgage Disclosure Act and Regulation C issued by the Federal Reserve, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
the Equal Credit Opportunity Act and Regulation B issued by the Federal Reserve, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
the Fair Credit Reporting Act and Regulation V issued by the Federal Reserve, governing the use and provision of information to consumer reporting agencies;
the Fair Debt Collection Act, governing the manner in which consumer debts may be collected by collection agencies; and
the guidance of the various federal agencies charged with the responsibility of implementing such federal laws.

 

Deposit operations also are subject to:

 

the Truth in Savings Act and Regulation DD issued by the Federal Reserve, which requires disclosure of deposit terms to consumers;
Regulation CC issued by the Federal Reserve, which relates to the availability of deposit funds to consumers;
the Right to Financial Privacy Act, which imposes a duty to maintain the confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records; and
the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of ATMs and other electronic banking services.

 

Commercial Real Estate Lending

 

Lending operations that involve concentrations of commercial real estate loans are subject to enhanced scrutiny by federal banking regulators. The regulators have advised financial institutions of the risks posed by commercial real estate lending concentrations. Such loans generally include land development, construction loans and loans secured by multifamily property, and nonfarm, nonresidential real property where the primary source of repayment is derived from rental income associated with the property. The guidance identifies institutions with the following characteristics as potentially being exposed to excessive risk concentrations and that may warrant greater supervisory scrutiny:

 

total construction and land development loans represent 100% or more of the institution’s total risk-based capital, or
   
total commercial real estate loans, as defined, represent 300% or more of the institution’s total risk-based capital, and the outstanding balance of the institution’s commercial real estate loan portfolio has increased by 50% or more during the prior 36 months.

 

The Dodd-Frank Act contains provisions on credit risk retention that require federal banking regulators to adopt regulations mandating the retention of 5% of the credit risk of certain assets transferred, sold or conveyed through issuances of asset-backed securities. Implementing regulations will provide for the allocation of the risk retention obligation between securitizers and originators of loans.

 

Branching

 

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Interstate Act”) permits nationwide interstate banking and branching under certain circumstances. This legislation generally authorizes interstate branching and relaxes federal law restrictions on interstate banking. Currently, bank holding companies may purchase banks in any state, and states may not prohibit these purchases. Additionally, banks are permitted to merge with banks in other states, as long as the home state of neither merging bank has opted out under the legislation. The Interstate Act requires regulators to consult with community organizations before permitting an interstate institution to close a branch in a low-income area.

 

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Virginia enacted “opting in” legislation in accordance with the Interstate Act, allowing banks to engage in interstate merger transactions, subject to certain “aging” requirements. Once an out-of-state bank has acquired a bank within the state, either through merger or acquisition of all or substantially all of the bank’s assets, the out-of-state bank may open additional branches within the state. In addition, an out-of-state bank may establish a de novo branch in Virginia or acquire a branch in Virginia if the out-of-state bank’s home state gives Virginia banks substantially the same or more favorable rights to establish and maintain branches in that state. 

 

Anti-Tying Restriction

 

In general, a bank may not extend credit, lease, sell property, or furnish any services or fix or vary the consideration for products and services on the condition that (1) the customer obtain or provide some additional credit, property, or services from or to the bank or bank holding company or their subsidiaries, or (2) the customer not obtain some other credit, property, or services from a competitor, except to the extent reasonable conditions are imposed to assure the soundness of the credit extended. A bank may, however, offer combined-balance products and may otherwise offer more favorable terms if a customer obtains two or more traditional bank products. Also, certain foreign transactions are exempt from the general rule.

 

Anti-Money Laundering

 

Financial institutions must maintain anti-money laundering programs that include established internal policies, procedures, and controls; a designated compliance officer; an ongoing employee training program; and the periodic testing of the program. BOVA is prohibited from entering into specified financial transactions and account relationships and must meet enhanced standards for due diligence in dealings with foreign financial institutions and foreign customers. We also must take reasonable steps to conduct enhanced scrutiny of account relationships to guard against money laundering and to report any suspicious transactions. Recent laws provide law enforcement authorities with increased access to financial information maintained by banks. Anti-money requirements have been substantially strengthened as a result of the Uniting and Strengthening America by Providing Appropriate Tools Required to Intercept and Obstruct Terrorism Act of 2001 (the “USA Patriot Act”), enacted in 2001 and renewed in 2006 and extended, in part, in 2011. Bank regulators routinely examine institutions for compliance with these requirements and must consider compliance in connection with the regulatory review of applications.

 

The USA Patriot Act amended, in part, the Bank Secrecy Act and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. The statute also creates enhanced information collection tools and enforcement mechanics for the U.S. government, including: (1) requiring standards for verifying customer identification at account opening; (2) promulgating rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering; (3) requiring reports by nonfinancial trades and businesses filed with the Treasury’s Financial Crimes Enforcement Network for transactions exceeding $10,000; and (4) mandating the filing of suspicious activities reports if a bank believes a customer may be violating U.S. laws and regulations. The statute also requires enhanced due diligence requirements for financial institutions that administer, maintain, or manage private bank accounts or correspondent accounts for non-U.S. persons.

 

The Federal Bureau of Investigation may send bank regulators lists of the names of persons suspected of involvement in terrorist activities. Cordia may be subject to a request for a search of its records for any relationships or transactions with persons on those lists and may be required to report any identified relationships or transactions. Furthermore, the Office of Foreign Assets Control (“OFAC”) is responsible for helping to ensure that U.S. entities do not engage in transactions with certain prohibited parties, as defined by various Executive Orders and Acts of Congress. OFAC has sent, and will send, bank regulators lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts, known as Specially Designated Nationals and Blocked Persons. If we find a name on any transaction, account or wire transfer that is on an OFAC list, we must freeze such account, file a suspicious activity report and notify the appropriate authorities.

 

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Privacy and Credit Reporting

 

Financial institutions are required to disclose their policies for collecting and protecting confidential customer information. Customers generally may prevent financial institutions from sharing nonpublic personal financial information with nonaffiliated third parties, with some exceptions, such as the processing of transactions requested by the consumer. Financial institutions generally may not disclose certain consumer or account information to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing. Federal and state bank regulators have prescribed standards for maintaining the security and confidentiality of consumer information, and we are subject to such standards, as well as certain federal and state laws or standards for notifying consumers in the event of a security breach. 

 

Enforcement Powers

 

Banks and their “institution-affiliated parties,” including directors, management, employees, agents, independent contractors and consultants, such as attorneys and accountants, and others who participate in the conduct of the institution’s affairs, are subject to potential civil and criminal penalties for violations of law, regulations or written orders of a government agency. Violations can include failure to timely file required reports, filing false or misleading information or submitting inaccurate reports. Civil penalties may be as much as $1 million a day for such violations and criminal penalties for some financial institution crimes may include imprisonment for 20 years. Regulators have flexibility to commence enforcement actions against institutions and institution-affiliated parties, and the FDIC has the authority to terminate deposit insurance. When issued by a banking regulator, cease-and-desist orders or other regulatory agreements may, among other things, require affirmative action to correct any harm resulting from a violation or practice, including restitution, reimbursement, indemnifications or guarantees against loss. A financial institution may also be ordered to restrict its growth, dispose of certain assets, rescind agreements or contracts, or take other actions determined to be appropriate by the ordering agency. Federal and state banking regulators also may remove a director or officer from an insured depository institution (or bar them from the industry) if a violation is willful or reckless.

 

EXECUTIVE OFFICERS

 

The following individuals currently serve as executive officers of Cordia and BOVA.

 

Name   Position
Jack Zoeller   President and Chief Executive Officer of Cordia
    Chairman of the Board and Chief Executive Officer of BOVA
Don Andree   Senior Vice President, Special Assets of BOVA
Roy Barzel   Executive Vice President and Chief Credit Officer of BOVA
David Bushnell   Chief Risk Officer and Acting Chief Financial Officer of Cordia
Kim Destro   Senior Vice President and Principal Accounting Officer of Cordia and BOVA
Richard Dickinson   President and Chief Operating Officer of BOVA
Vera Primm   Senior Vice President, Controller and Interim Chief Financial Officer of BOVA
Christy Quesenbery   Senior Vice President, Operations of BOVA
Robert Sims   Senior Vice President, Retail Banking of BOVA

 

Below is information about our executive officers who are not also directors. Ages presented are as of December 31, 2012.

 

Don Andree joined BOVA as Senior Vice President — Special Assets in May 2011. Prior to BOVA, Mr. Andree spent 14 years at SunTrust Bank where his most recent position was Regional Manager for the Special Assets/Residential Builder group in the Mid-Atlantic Region. Formerly he served as Regional Credit Officer for greater Richmond and western Virginia. Age 59.

 

Roy Barzel joined BOVA as Executive Vice President and Chief Credit Officer in April 2011. Prior to joining BOVA, Mr. Barzel spent 25 years at SunTrust Bank where his most recent position was Senior Vice President and Regional Credit Officer for commercial real estate in the Mid-Atlantic region. Formerly he served as the Senior Credit Officer for residential builders and land developers for all of SunTrust. Age 61.

 

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Kim Destro joined Cordia and BOVA as Senior Vice President and Principal Accounting Officer in January 2013 after consulting for the bank during the summer of 2012. Prior to joining Cordia and BOVA, Ms. Destro served as Chief Financial Officer for Bank of Maine, Waterford Village Bank and Greater Buffalo Savings Bank. Age 55.

 

Richard Dickinson has served as President of BOVA since January 2012. From May 2011 to his appointment as President, Mr. Dickinson served as Executive Vice President and Chief Operating Officer. Prior to joining BOVA, Mr. Dickinson spent his career with SunTrust Bank, serving in a variety of senior lending, credit and special asset positions, primarily in Richmond and most recently as Senior Credit Officer and Executive Vice President of Commercial Real Estate for all of SunTrust. Age 52.

 

Vera Primm joined BOVA as its Controller and Interim Chief Financial Officer in October 2012. She previously served at Peoples Bank of Virginia in Richmond, Virginia as Senior Vice President and Chief Financial Officer from its opening in April 2002 through its acquisition in July 2012. Previous to that she served 10 years as Chief Financial Officer of the Richmond-based bank subsidiary of F&M National Corporation. Age 58.

 

Christy Quesenbery joined BOVA as Senior Vice President — Operations in November 2011. Prior to Bank of Virginia, Ms. Quesenbery had over 30 years of banking experience, including most recently four years as Senior Vice President and Chief Administrative Officer at Virginia Partners Bank in Fredericksburg. Age 54.

 

Robert Sims joined BOVA as Senior Vice President — Retail Banking in September 2012. Prior to joining BOVA, Mr. Sims was President/Founder of Sims Development Group in Stuart, FL from 2011 to 2012. Prior to that he served 24 years in senior retail, marketing and treasury positions in three banking institutions, including most recently as Senior Vice President of NBT Bancorp. Age 47.

 

Item 1A.Risk Factors

 

RISK FACTORS

 

The current economic conditions pose significant challenges that could adversely affect our financial condition and results of operations.

 

Our success depends to a large degree on the general economic conditions in Chesterfield and Henrico Counties and the greater Richmond, Virginia metropolitan region that comprises our market. Our market has experienced a significant downturn in which we have seen falling home prices, rising foreclosures and an increased level of commercial and consumer delinquencies. If economic conditions do not improve or continue to decline, we could experience any of the following consequences, each of which could further adversely affect our business:

 

demand for our products and services could decline;
   
problem assets and foreclosures may increase; and
   
loan losses may increase.

 

We could experience further adverse consequences in the event of a prolonged economic downturn in our market due to our exposure to commercial loans across various lines of business. A prolonged economic downturn could adversely affect collateral values or cash flows of the borrowing businesses, and as a result our primary source of repayment could be insufficient to service the debt. Another adverse consequence in the event of a prolonged economic downturn in our market could be the loss of collateral value on commercial and real estate loans that are secured by real estate located in our market area. A further significant decline in real estate values in our market would mean that the collateral for many of our loans would provide less security. As a result, we would be more likely to suffer losses on defaulted loans because our ability to fully recover on defaulted loans by selling the real estate collateral would be diminished. In addition, a number of our loans are dependent on successful completion of real estate projects and demand for homes, both of which could be affected adversely by a decline in the real estate markets.

 

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Future economic conditions in our market will depend on factors outside of our control such as political and market conditions, broad trends in industry and finance, legislative and regulatory changes, changes in government, military and fiscal policies and inflation.

 

BOVA has been operating under a Written Agreement with the Federal Reserve Bank of Richmond and the Virginia Bureau of Financial Institutions, which could continue to require us to dedicate a significant amount of management attention and resources to comply with the agreement.

 

BOVA entered into a Written Agreement with the Federal Reserve Bank of Richmond (the ‘‘Federal Reserve’’) and the Virginia Bureau of Financial Institutions on January 14, 2010. Among other things, the Written Agreement required BOVA to develop and implement written plans to improve its credit risk management and compliance systems, oversight functions, operating and financial management and capital plans. BOVA continues to be subject to the Written Agreement but over the last three years, our management team and Board of Directors have focused considerable time and attention on taking corrective actions to comply with its terms. We have employed third party consultants and advisors to assist us in complying with the Written Agreement, which has and could continue to increase our non-interest expense and reduce our earnings.

 

While we believe we have timely responded to and have substantially complied with the terms of the Written Agreement, in certain areas, full implementation of current efforts are required to achieve and maintain full compliance with the provisions of the Written Agreement. There also is no guarantee that we will successfully satisfy all of the Federal Reserve’s and Virginia Bureau of Financial Institution’s concerns in the Written Agreement or that we will be able to continue to comply with it. If we do not comply with the Written Agreement, we could be subject to the assessment of civil monetary penalties, further regulatory sanctions and/or other regulatory enforcement actions.

 

Our ability to pursue BOVA’s longer-term strategic goals is dependent upon future regulatory approval, which is unlikely to be obtained if the Written Agreement is not fully complied with and ultimately lifted by BOVA’s regulators. The share exchange will have no direct impact on the Written Agreement. Further, no regulatory approvals for the share exchange are required under the Written Agreement.

 

An inability to maintain our regulatory capital position could continue to adversely affect our operations.

 

At December 31, 2012, BOVA was classified as ‘‘well capitalized’’ for regulatory capital purposes. However, impairments to BOVA’s loan or securities portfolio, declines in BOVA’s earnings or a combination of these or other factors could change BOVA’s capital position in a relatively short period of time. If we are unable to remain ‘‘well capitalized,’’ we will not be able to renew or accept brokered deposits without prior regulatory approval or offer interest rates on our deposit accounts that are significantly higher than the average rates in our market area. As a result, it could be more difficult for us to attract new deposits as our existing brokered and other deposits mature and do not rollover and to retain or increase non-brokered deposits. If we are not able to attract new deposits, our ability to fund our loan portfolio may be adversely affected. In addition, we would pay higher insurance premiums to the FDIC, which will reduce our earnings. Another adverse consequence of a decline in regulatory capital is that additional capital would be harder to raise.

 

Cordia may be unsuccessful in raising additional capital as needed, and a successful capital raise would dilute existing shareholders and possibly cause our stock price to decline.

 

At December 31, 2012, BOVA was classified as ‘‘well capitalized’’ for regulatory capital purposes. Nevertheless, Cordia may have a need to raise additional capital. Cordia may be unsuccessful in raising additional capital if the market is not receptive to offerings by small community banks. Furthermore, if we are successful in raising additional capital, the issuance of additional equity securities could be dilutive to holders of our common stock and the market price of our common stock could decline as a result of any such sales. Management cannot predict or estimate the amount, timing or nature of any future equity offerings. Thus, our shareholders bear the risk of our future offerings reducing the market price of our common stock and diluting their stock holdings. There is no assurance that any such offering or issuance of equity securities may be able to be completed.

 

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Our allowance for loan losses may not be adequate to cover actual losses.

 

Like all financial institutions, we maintain an allowance for loan losses to provide for probable losses. Our allowance for loan losses may not be adequate to cover actual loan losses and future provisions for loan losses could materially and adversely affect our operating results. The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Our allowance for loan losses is determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, changes in the size and composition of the loan portfolio, and industry information. Also included in management’s estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain.

 

The application of the acquisition method of accounting impacted Cordia’s allowance for loan losses. Under the acquisition method of accounting, all loans were recorded in Cordia’s financial statements at their fair value at the time of acquisition and the related allowance for loan losses was eliminated because the fair value at the time was determined by the net present value of the expected cash flows taking into account estimated credit quality. We may in the future determine that our estimates of fair value are too high, in which case we would provide for additional loan losses associated with acquired loans.

 

The amount of future losses is susceptible to changes in economic, operating and other conditions, including changes in interest rates, which may be beyond our control, and these losses may exceed current estimates. Federal regulatory agencies, as an integral part of their examination process, review our loans and allowance for loan losses. Although the management believes that our allowance for loan losses is adequate to provide for probable losses, there are no assurances that future increases in the allowance for loan losses will not be needed or that regulators will not require us to increase our allowance. Either of these occurrences could materially and adversely affect our earnings and profitability.

 

BOVA’s small-to-medium sized business clientele may have limited financial resources to weather a prolonged downturn or continued stress period in the economy.

 

We target our commercial development and marketing strategy primarily to serve the banking and financial services needs of small and medium sized businesses. These businesses generally have less capital or borrowing capacity than larger entities. If general economic conditions negatively impact this major economic sector in the markets in which we operate, our results of operations and financial condition may be adversely affected.

 

Continued difficult market conditions, especially the decline in real estate values, could adversely affect BOVA.

 

Dramatic declines in the housing market, with falling home prices and increasing foreclosures, unemployment and under-employment, have negatively impacted the credit performance of all types of loans and resulted in significant write-downs of asset values by financial institutions. Many lenders and institutional investors have reduced or ceased providing new funding to borrowers. This tightening of credit has led to an increased level of commercial and consumer delinquencies, lack of consumer confidence, increased market volatility and widespread reduction of business activity generally. These conditions have adversely affected our business and results of operations. Any worsening of these conditions would likely exacerbate the adverse effects of these difficult market conditions on us and others in the banking industry. Furthermore, BOVA’s loan portfolio is heavily collateralized by real estate. If BOVA’s borrowers are unable to service their loans, a decline in the real estate value could prevent BOVA from being fully repaid.

 

Changes in the fair value of our securities may reduce our stockholders’ equity and net income.

 

At December 31, 2012, we had securities classified as available for sale totaling $18.5 million. At such date, the aggregate net unrealized gain on available-for-sale securities totaled $79 thousand. We increase or decrease stockholders’ equity by the amount of the change in the unrealized gain or loss (the difference between the estimated fair value and the amortized cost) of the available-for-sale securities portfolio, under the category of accumulated other comprehensive income. Therefore, a decline in the estimated fair value of this portfolio will result in a decline in reported stockholders’ equity, as well as book value per common share and tangible book value per common share. This decrease will occur even though the securities are not sold. In the case of debt securities, if these securities are never sold and there are no credit impairments, the decrease will be recovered at the maturity of the securities. In the case of equity securities that have no stated maturity, the declines in fair value may or may not be recovered over time.

 

17
 

 

The application of the acquisition method of accounting impacted the carrying value of Cordia’s investment portfolio. Under the acquisition method of accounting, all investment securities were recorded in Cordia’s financial statements at their fair value at the time of acquisition and the related unrealized loss or gain was eliminated. At December 31, 2012, all of the acquired securities had been sold. The remainder of the portfolio is recorded at fair value, with the related unrealized gain or loss impacting shareholder’s equity.

 

We conduct periodic reviews and evaluations of its entire securities portfolio to determine if the decline in the fair value of any security below its cost basis is other-than-temporary. Factors that we considered in our analysis of debt securities include, but are not limited to, intent to sell the security, evidence available to determine if it is more likely than not that we will have to sell the securities before recovery of the amortized cost, and probable credit losses. Probable credit losses are evaluated based upon, but are not limited to: the present value of future cash flows, the severity and duration of the decline in fair value of the security below its amortized cost, the financial condition and near-term prospects of the issuer, whether the decline appears to be related to issuer conditions or general market or industry conditions, the payment structure of the security, failure of the security to make scheduled interest or principal payments, and changes to the rating of the security by rating agencies. We generally view changes in fair value for debt securities caused by changes in interest rates as temporary, which is consistent with our experience. If we deem such decline to be other-than-temporary, the security is written down to a new cost basis and the resulting loss is charged to earnings as a component of noninterest income. For the year ended December 31, 2012, we did not have any other-than-temporary impairment (“OTTI”) in its securities portfolio.

 

We continue to monitor the fair value of its entire securities portfolio as part of its ongoing OTTI evaluation process. No assurance can be given that we will not need to recognize OTTI charges related to securities in the future.

 

BOVA is subject to interest rate risk that may negatively affect its financial performance.

 

BOVA’s earnings and cash flows are largely dependent upon its net interest income. Net interest income is the difference between interest income earned on interest-earning assets, such as loans and securities, and interest expense paid on interest-bearing liabilities, such as deposits and borrowed funds. Interest rates are highly sensitive to many factors that are beyond BOVA’s control, including general economic conditions and policies of various governmental and regulatory agencies and, in particular, the Federal Reserve Board. Changes in monetary policy, including changes in interest rates, could influence not only the interest BOVA receives on loans and securities and the amount of interest it pays on deposits and borrowings, but such changes could also affect (i) BOVA’s ability to originate loans and obtain deposits, and (ii) the fair value of BOVA’s financial assets and liabilities. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, BOVA’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings.

 

BOVA may lose members of its management team and have difficulty attracting skilled personnel.

 

BOVA’s success depends, in large part, on its ability to attract and retain key people. Competition for the best people can be intense and BOVA may not be able to hire such people or to retain them. The unexpected loss of services of key personnel of BOVA could have a material adverse impact on its business because of their skills, knowledge of BOVA’s market, years of industry experience and the difficulty of promptly finding qualified replacement personnel. In addition, recent regulatory proposals and guidance relating to compensation may negatively impact BOVA’s ability to retain and attract skilled personnel.

 

The financial soundness of other financial institutions could adversely affect us.

 

Our ability to engage in routine funding transactions could be affected adversely by the actions and commercial soundness of other financial institutions. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, may lead to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us is liquidated at prices insufficient to recover the full amount of our financial exposure. There is no assurance that any such losses would not materially and adversely affect our results of operations.

 

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Our profitability may suffer because of rapid and unpredictable changes in the highly regulated environment in which we operate.

 

The banking industry is subject to extensive regulation by state and federal banking authorities. Many of the banking regulations that govern us are intended to protect depositors, the public or the insurance fund maintained by the FDIC rather than our shareholders. Banking regulations affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. These requirements may constrain our rate of growth, and changes in regulations could adversely affect it. The burden imposed by these federal and state regulations may place banks at a competitive disadvantage compared to less regulated competitors. We may be particularly susceptible to this risk due to the constraints that are imposed on us by our Written Agreement with the Federal Reserve and the Virginia Bureau of Financial Institutions. In addition, the cost of compliance with regulatory requirements, including the cost of complying with the Written Agreement, could adversely affect our ability to operate profitably.

 

Regulation of the financial services industry is undergoing major changes, and future legislation could increase our cost of doing business or harm our competitive position.

 

In 2010 and 2011, in response to the financial crisis and recession that began in 2008, significant regulatory and legislative laws were enacted resulting in broader reform and increased regulation impacting financial institutions. The Dodd-Frank Act has created a significant shift in the way financial institutions operate. The agencies most affected by the enactment were the FDIC, the Federal Reserve and the Securities and Exchange Commission and the way the agencies oversee the financial system. Any future legislative changes could have a material impact on the profitability of Cordia, the value of assets held for investment or collateral for loans. They could require changes to business practices or force us to discontinue businesses and potentially expose us to additional costs, liabilities, enforcement action and reputational risk.

 

Our future success will depend on our ability to compete effectively in the highly competitive financial services industry.

 

We face substantial competition in all phases of our operations from a variety of different competitors that include other banks, both large and small and numerous less regulated financial services businesses. In particular, there is very strong competition for financial services in the market areas in which we conduct our business. Our future growth and success will depend on our ability to compete effectively in this highly competitive environment. Many of our competitors offer products and services that we do not offer, and many have substantially greater resources, such as greater capital resources and more access to longer term, lower costs funding sources. Many also have greater name recognition and market presence that benefit them in attracting business. In addition, larger competitors may be able to price loans and deposits more aggressively than we do. Our larger competitors generally have easier access to capital, and often on better terms. Some of the financial services organizations with which we compete are not subject to the same degree of regulation as is imposed on bank holding companies and federally insured state-chartered Banks, national banks and federal savings institutions. As a result, these non bank competitors have certain advantages over us in accessing funding and in providing various services.

 

Other competitors are subject to similar regulation but have the advantages of larger established customer bases, higher lending limits, extensive branch networks, numerous automated teller machines, greater advertising-marketing budgets or other factors. Some of our competitors have other advantages, such as tax exemption in the case of credit unions, and lesser regulation in the case of mortgage companies and specialty finance companies. Deposit competition is strong among institutions in our primary market area.

 

We have operational risk that could impact our ability to provide services to our customers.

 

We have potential operational risk exposure throughout our organization. Integral to our performance is the continued effectiveness and efficiency of our technical systems, operational infrastructure, relationships with third parties and key individuals involved in our ongoing activities. Failure by any or all of these resources subjects us to risks that may vary in size, scale and scope. This includes but is not limited to operational or technical failures, unlawful tampering with our information technology infrastructure, terrorist activities, ineffectiveness or exposure due to interruption in third party support, as well as the loss of key individuals or failure of key individuals to perform properly.

 

19
 

 

We do not plan to pay cash dividends in the foreseeable future.

 

We do not expect to pay cash dividends on our common stock in the foreseeable future. Our ability to declare and pay cash dividends will depend, among other things, upon restrictions imposed by the reserve and capital requirements of Virginia law and federal banking regulations, our income and financial condition, tax considerations, and general business conditions. In addition, we are currently prohibited by our Written Agreement from paying any cash dividends without the prior written approval of the Federal Reserve Bank of Richmond, the Director of the Division of Banking Supervision and Regulation of the Board of Governors of the Federal Reserve System and the Virginia Bureau of Financial Institutions.

 

Item 1B.Unresolved Staff Comments

 

None

 

Item 2.Properties

 

BOVA owns two branch locations. The main office located at 11730 Hull Street Rd., Midlothian, Virginia 23112 is approximately 9,000 square feet and also houses most support operations. The Patterson branch is at 10501 Patterson Road, Richmond, Virginia. BOVA’s other four facilities presently in operation are leased. Two leased facilities, (906 Branchway Road, Richmond, Virginia and 4023 West Hundred Road, Chester, Virginia) are full service branches and include drive-up access and safe deposit boxes. The latter branch contains a lease provision allowing for the purchase of the location at a predefined price. The Woodlake retail branch was closed in 2011 with regulatory approval and the building is now used for operational support offices and houses an ATM. This lease is for ten years with four 5-year renewal terms available after the initial term. The fourth leased property in Colonial Heights, Virginia has a two-year term, initiated in June 2011, with an option to buy. The property has the potential to be a full service branch or a loan production office and is currently functioning as an ATM location. All of BOVA’s properties are in good operating condition and are adequate for BOVA’s present needs. In addition, Bank Management routinely evaluates expansion prospects and target market areas for future development.

 

Item 3.Legal Proceedings

 

Neither the Company nor the Bank is a party to, nor is any of their property the subject of, any material legal proceedings other than ordinary routine litigation incident to their businesses.

 

Item 4.Mine Safety Disclosures

 

Not applicable

 

PART II

 

Item 5.Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities

 

Shares of Cordia common stock are listed and trade on the Nasdaq Capital Market under the symbol “BVA.” Cordia’s common stock was not publicly traded during 2012 or 2011. Cordia has not paid any dividends on its common stock since its formation. As of March 15, 2013, there were approximately 52 holders of record of Cordia common stock.

 

Cordia did not repurchase any of its common stock during the quarter ended December 31, 2012 and did not have any outstanding repurchase authorizations during that period.

 

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See Item 1 – Business – Supervision and Regulation – Dividends for more information relating to restrictions on dividends.

 

Recent Sales of Unregistered Securities

 

On August 28, 2012, Cordia sold 566,500 shares of Series C common stock in a private placement to existing shareholders and other accredited investors for aggregate gross proceeds of $2,832,500. No commission was paid with respect to the sale of the securities. The offering was exempt from registration under the Securities Act of 1933, as amended, pursuant to Section 4(a)(2) of said Act and Rule 506 thereunder insofar as the offering was made without the use of general solicitation and only to accredited investors.

 

Pursuant to the terms of the Series C common stock, on December 31, 2012, each share of Series C common stock outstanding converted into one share of Cordia common stock and the authorized shares of Series C common stock reverted to undesignated shares.

 

Item 6.Selected Financial Data

 

(Dollars in thousands, except per share amounts)  As of and for the year ended December 31, 
   2012   2011   2010 
Balance Sheet Summary               
Loans, net of unearned income  $113,070   $106,947   $137,553 
Allowance for loan losses   2,110    2,285    50 
Securities   18,511    25,578    34,956 
Total assets   178,696    165,551    212,526 
Deposits   154,428    147,980    183,023 
Other indebtedness   10,000    5,113    10,450 
Stockholders’ equity   13,139    11,135    17,260 
Book value per share  $4.24   $4.39   $6.54 
                
Summary of Earnings:               
Total interest income  $8,441   $10,369   $673 
Total interest expense   1,552    1,778    464 
Net interest income before provision for loan losses   6,889    8,591    209 
Provision for loan losses   588    2,763    50 
Net interest income after provision for loan losses   6,301    5,828    159 
Non-interest income   252    120    26 
Non-interest expense   7,279    13,243    851 
(Loss) before non-controlling interest   (726)   (7,295)   (411)
Less non-controlling interest   182    2,881    92 
Net (loss) income attributable to Cordia   (544)   (4,414)   (319)
Per Share Data:               
Weighted average shares outstanding, basic and diluted   1,705,112    1,497,982    1,051,213 
Basic and diluted (loss) earnings per share  $(0.32)  $(2.95)  $(0.30)
Selected Ratios:               
Return on average assets   (0.44)   (3.91)%   N/M 
Return on average equity   (5.80)   (64.00)%   N/M 
Average equity to average assets   7.52    6.11%   N/M 
Capital Ratios(1):               
Leverage ratio   8.71%   7.34%   7.85%
Total risk-based capital   13.55%   12.06%   12.21%

 


(1) Ratios are for Bank of Virginia

 

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Item 7.Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

The following discussion is intended to assist the reader in understanding and evaluating the financial condition and results of operations of Cordia and its majority owned subsidiary, Bank of Virginia (“BOVA”). This discussion and analysis should be read in conjunction with Cordia’s financial statements and related notes thereto located elsewhere in this report. The following discussion pertains to our historical results, which includes the operations of BOVA subsequent to the purchase of a majority interest in such entity on December 10, 2010.

 

General

 

Cordia was incorporated in 2009. Its founders were former bank CEOs, directors and advisors seeking to invest in undervalued or troubled community banks in the Mid-Atlantic and Southeast. Aside from the shares of BOVA common stock, Cordia’s only other asset totaled $227 thousand at December 31, 2012, consisting primarily of cash. As of December 31, 2012, Cordia held approximately 67.4% of the outstanding shares of BOVA common stock.

 

BOVA is a state chartered bank headquartered in Midlothian, Virginia with total assets of approximately $180 million at December 31, 2012. BOVA provides retail banking services to individuals and commercial customers through three banking locations in Chesterfield County, Virginia and one in Henrico County, Virginia.

 

Executive Overview

 

We spent much of 2012 and 2011 condensing the balance sheet as we worked through asset quality issues, recruited new staff, and reorganized our lending and deposit activities while addressing the requirements of BOVA’s Written Agreement. Interest income was down primarily from lower asset volume. Interest expense decreased as a result of aggressive deposit repricing as well as a lower volume of certificates of deposits. Noninterest expense decreased through management action to minimize controllable expenses and a restructure of management personnel.

 

During 2011, BOVA hired a new credit management team which included a Chief Credit Officer, a Chief Operating Officer who also serves as BOVA’s senior lending officer, and a Senior Vice President responsible for working out problem loans and seeking recoveries. In 2011, the new credit management team dedicated a large portion of its time to portfolio management, including establishing new credit underwriting disciplines, training staff, resolving problem assets, as well as performing a detailed assessment of the accuracy of credit risk grades and BOVA’s allowance for loan losses. Moreover, BOVA engaged a third-party loan review firm to review the accuracy of this completed work. 

 

During 2012, BOVA continued to deploy its new credit disciplines as resolutions of problem assets and new loan originations accelerated. In addition, BOVA hired three business development officers who specialize in commercial lending and have brought portions of their portfolios to the bank, as well as originating high-quality loans through new customer contacts. These officers are also stressing the value of a total relationship and are instrumental in bringing accompanying deposit relationships. BOVA is also partnering with other business entities to participate in loan programs which would bring increased loan production to the bank without a compromise of asset quality or capital risk. Management has continued to price deposits conservatively, particularly time deposits, in order to control margin erosion and has been successful in increasing deposits, primarily in transaction and savings, while reducing the cost of funds.

 

During the first quarter of 2013, the Company substantially increased its lending and funding activities. Bank of Virginia’s residential mortgage program, involving participations in held-for-sale loans originated by Stonegate Mortgage Corporation and packaged primarily for sale to Government Sponsored Enterprises such as Ginnie Mae and Fannie Mae, was increased from $30 million to $60 million. The Bank also launched a new initiative partnering with GradCapital, LLC to purchase rehabilitated student loans backed by the government’s guarantee and serviced by Xerox Education Services. Approximately $35 million of such loans were purchased during the quarter. The Bank also significantly expanded its deposit base, primarily involving institutional money market and certificate of deposit accounts, at average rates lower than the Bank’s prevailing retail rates.

 

22
 

 

  

Results of Operations

 

Net Income

 

There was a consolidated net loss of $726 thousand for the year ended December 31, 2012 compared to a net consolidated loss of $7.3 million for the year ended December 31, 2011. Net interest income before the provision for loan losses declined 19.8% or $1.7 million from $8.6 million for 2011 to $6.9 million for 2012. The major factor contributing to the decrease in net interest income in 2012 was a decrease in average interest-earning assets and a significant increase in average interest-bearing deposit liability accounts.

 

Net Interest Income

 

Net interest income is the largest component of our income, and is affected by the interest rate environment and the volume and the composition of interest-earning assets and interest-bearing liabilities. Our interest-earning assets include loans, investment securities, interest-bearing deposits in other banks, and federal funds sold. Our interest-bearing liabilities include deposits and advances from the FHLB.

 

Net interest income declined $1.7 million from $8.6 million for the year ended December 31, 2011 to $6.9 million for the year ended December 31, 2012. Interest income declined $1.9 million from $10.4 million during 2011 to $8.4 million for 2012. A decrease of $14.5 million in the average balance of loans held for investment combined with a 73 basis point decrease in the average yield drove the decrease in interest income. This decrease was the result of the continued low interest rate environment and reduced amortization of the fair value discount on the loan portfolio during 2012 compared to 2011. Also contributing to the reduction in interest income was a reduction in the securities available for sale portfolio and a corresponding $12.9 million increase in lower yielding average interest-bearing deposits with the Federal Reserve Bank.

 

Interest expense for the year ended December 31, 2012 was $1.6 million, compared to $1.8 million for the year ended December 31, 2011. This reduction of $226 thousand was due to lower interest expense on deposits as a result of a concerted effort to allow higher-priced time deposits to roll off as they matured as well as promotion of transaction and savings accounts. Interest expense on FHLB borrowings was $23 thousand for 2012, compared to $56 thousand for 2011. The decline in FHLB interest expense was primarily the result of reduced FHLB borrowings.

 

Average Balances and Yields

 

The following tables present information regarding average balances of assets and liabilities, the total dollar amounts of interest income and dividends from average interest-earning assets, the total dollar amounts of interest expense on average interest-bearing liabilities, and the resulting yields and costs. The yields and costs for the periods indicated are derived by dividing income or expense by the average balances of assets or liabilities, respectively, for the periods presented.

 

23
 

 

   Year ended December 31, 
   2012   2011 
   Average      Yield/   Average      Yield/ 
   Balance   Interest   Rate   Balance   Interest   Rate 
Earning Assets:                              
Loan held for investment (1)  $113,101   $7,784    6.88%   127,586   $9,710    7.61%
Securities available for sale   18,250    587    3.22%   29,082    610    2.10%
Fed funds and deposits with Banks   32,503    70    0.25%   19,565    49    0.25%
Total Earning Assets   163,854   $8,441    5.15%   176,233   $10,369    5.88%
Allowance for loan losses   (5,744)             (7,646)          
Other Assets   8,467              18,724           
Total  $166,577              187,311           
Interest-Bearing  Liabilities:                              
Demand Deposits  $13,362    81    0.61%   9,861    40    0.41%
Savings Deposits   21,385    109    0.51%   19,981    120    0.60%
Time Deposits   98,099    1,339    1.48%   117,876    1,562    1.33%
FHLB Borrowings   3,251    23    0.74%   8,781    56    0.64%
                               
Total Interest-bearing liabilities   136,097    1,552    1.14%   156,499    1,778    1.22%
Demand deposits   17,026              15,545           
Other Liabilities   926              828           
Stockholders' Equity   12,528              14,439           
Total  $166,577              187,311           
                               
Net Interest Income       $6,889             $8,591      
Net Interest Rate Spread (2)             4.01%             4.66%
Net Interest Margin (3)             4.20%             4.87%

 

 

(1) Non-accrual loans are included in average balances outstanding, with no related interest income during non-accrual period.

(2) Represents the difference between the yield on earning assets and cost of funds.

(3) Represents net interest income divided by average interest-earning assets.

 

24
 

 

The table below analyzes interest income, interest expense and net interest income for the year ended December 31, 2011 compared to the year ended December 31, 2012.

 

   Increase (Decrease) Due to Changes in: 
(Dollars in thousands)  Average   Average   Increase 
  Volume   Rate     (Decrease) 
Interest income:               
Loans  $(1,044)  $(882)  $(1,926)
Securities available for sale   53    (76)   (23)
Fed funds and deposits with Banks   21   -    21 
Total interest income   (970)   (958)   (1,928)
Interest expense:               
Demand Deposits   17   24    41 
Savings Deposits   10   (21)   (11)
Time Deposits   (680)   457    (223)
FHLB Borrowings   (44)   11   (33)
Total interest expense   (697)   471    (226)
Change in net interest income  $(273)  $(1,429)  $(1,702)

 

Provision for Loan Losses

 

The allowance for loan and lease losses (“ALLL”) model that was used by the legacy management team was built by an outside consulting firm and was a generalized model, using a specific and general reserve.

 

This model calculated the historical loss component by utilizing a ratio of losses to total loans in a given quarter. This loss ratio was then applied to all loans rated Special Mention or better and used as a predictor of future losses. This methodology did not take into account the portfolio composition or the losses attributed to each component of the mix. Current management analyzed net charge offs for the previous twelve quarters ending December 31, 2012 using the call report loan types and then weighted the quarters, weighting more recent quarters more heavily. The weighting ratios were the same as used in the old model. Current management also engaged an independent firm to conduct a loan review to ascertain overall asset quality in the loan portfolio and to evaluate potential losses by segment.

 

In addition, management reviewed the types of loans it is originating compared to the legacy portfolio. In the commercial portfolio, the Bank is concentrating on business loans secured by various types of owner-occupied real estate and other business assets. It is not actively pursuing acquisition and development or construction loans. In the retail portfolio, emphasis is placed on well-collateralized loans to stable consumers. As illustrated in the financial presentations, problem loans as a percentage of the portfolio continue to decrease. As a result of these measures, management determined that the level of both general reserves and specific reserves associated with impaired loans could be reduced in 2012.

 

Since its initial analysis in 2011, management has continued to enhance the ALLL process with the identification and use of additional metrics, including:

 

·Identification of outstanding balances for all new loans made since June 30, 2011 (to evaluate them separately from the legacy loans);
·Identification of all renewed legacy loans since June 30, 2011 risk rated 3 or better;
·Enhance granularity in the calculation.
·More detailed analysis of required specific reserves, including projections of charge-offs and recoveries.

 

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These metrics have enabled the Bank to more closely project the needed ALLL and thus determine the level of provision to be made on a regular basis. Management presented the methodology change to its external audit firm which agreed that BOVA’s methodology change was appropriate.

 

The acquisition accounting used at the date of Cordia’s investment (December 10, 2010) analyzed the loan portfolio using the same segments as the revised allowance model at BOVA and established anticipated credit marks based on each individual segment; therefore a change in methodology was not required on a consolidated basis. New loans originated after December 10, 2010 follow the BOVA revised allowance methodology. Residential loans held for sale are not included in the ALLL calculations by virtue of their high credit quality and short holding period.

 

The allowance for loan losses is increased by charges to income and decreased by charge-offs, net of recoveries. Improving credit underwriting, recoveries of loans previously charged-off, and effective management of lower quality loans combined with a lower volume of nonperforming assets has lowered the risk in the loan portfolio. As a result, provision expense was $588 thousand during 2012, compared to $2.8 million during 2011. This amount reflected our emphasis on early detection of problem loans, accurate assessment of the extent of losses, and aggressive management of those loans through restructures, refinancing with other institutions, or other means of mitigating potential losses. To lead our management of problem loans, we hired a highly skilled and seasoned Chief Credit Officer and Senior Vice President of Special Assets during the second quarter of 2011. The allowance for loan losses was $2.1 million at December 31, 2012, compared to $2.3 million at December 31, 2011.

 

An analysis of the changes in the allowance for loan losses is presented under the caption “—Allowance for Loan Losses.”on page.

 

Non-interest Income

 

Noninterest income for the year ended December 31, 2012 was $252 thousand, compared to $120 thousand for the year ended December 31, 2011. The improvement was primarily the result of a decreased net loss on the sale of available for sale securities from ($283 thousand) in 2011 to ($30 thousand) in 2012. NSF fees declined $25 thousand from $98 thousand for 2011 to $73 thousand for 2012 as a result of lower volumes of overdrafts and the impact of Regulation E on the ability to charge for overdrafts caused by use of debit cards.

 

The following table sets forth the principal components of non-interest income for the year ended December 31, 2012 and 2011.

 

   Year Ended 
   December 31, 
(Dollars in thousands)  2012   2011 
Service charges on deposit accounts  $134   $181 
Net loss on sale of AFS securities    (30)   (283)
Other fee income, net   148    222 
Total non-interest income  $252   $120 

 

Non-interest Expense

 

Noninterest expense declined $5.9 million, or 45.0%, from $13.2 million for the year ended December 31, 2011 to $7.3 million for the year ended December 31, 2012. Non-interest expense totaled $13.2 million for the year ended December 31, 2011 and included a goodwill impairment loss of $5.9 million, which represents all of the goodwill recorded in the BOVA acquisition.

 

Between December 2011 and December 2012, BOVA hired a senior vice president of retail banking, three commercial business development officers, an additional loan operations employee and a loan workout manager. As a result, salary and employee benefits increased $231 thousand to $3.7 million for the year ended December 31, 2012 when compared to $3.4 million for the year ended December 31, 2011. Significant expense reductions were realized from FDIC insurance assessment, a gain on the sale of OREO, legal and professional fees and occupancy expense.

 

26
 

 

The following table sets forth the primary components of non-interest expense for the years ended December 31, 2012 and 2011.

 

   For the year ended
December 31,
 
(Dollars in thousands)  2012   2011 
Salaries and employee benefits  $3,680   $3,449 
Occupancy expense   562    589 
Equipment expense   290    326 
Data processing expense   400    377 
Marketing expense   110    102 
Legal and professional fees   569    646 
Bank franchise tax   94    146 
FDIC assessment   363    507 
Goodwill impairment loss   -    5,882 
(Gain) loss on sale of OREO   (86)   38 
Other real estate expenses   182    203 
Other operating expenses   1,115    978 
Total non-interest expense  $7,279   $13,243 

 

Income Tax Expense

 

Under the provisions of the Internal Revenue Code, BOVA has approximately $19.3 million of net operating loss carryforwards. Due to the change in control of BOVA in December 2010, the amount of the loss carryforward available to offset taxable income is limited to approximately $254 thousand per year for twenty years.

 

Financial Condition

 

Loans

 

Loans represent the largest category of earning assets and typically provide higher yields than the other types of earning assets. Loans carry inherent credit and liquidity risks associated with the creditworthiness of our borrowers and general economic conditions At December 31, 2012, total loans (net of reserves) were $111.0 million versus $104.7 million at December 31, 2011.

 

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The following table sets forth the composition of the loan portfolio by category at the dates indicated and highlights our general emphasis on commercial and commercial real-estate lending.

 

   December 31, 
   2012   2011   2010 
(Dollars in thousands)  Amount   Percent   Amount   Percent   Amount   Percent 
Commercial Real Estate:                              
Acquisition, development and construction  $3,313    2.9%  $6,065    5.7%  $9,539    6.9%
Non-owner occupied   30,747    27.2%   30,644    28.7%   30,696    22.3%
Owner occupied   39,570    35.0%   31,790    29.7%   33,924    24.7%
Commercial and industrial   23,488    20.8%   19,492    18.2%   33,125    24.1%
Consumer:                              
Residential mortgage   7,260    6.4%   8,003    7.5%   23,817    17.3%
HELOC   8,395    7.4%   10,298    9.6%   3,886    2.8%
Other   297    0.3%   655    0.6%   2,566    1.9%
Total loans   113,070    100.0%   106,947    100.0%   137,553    100.0%
Allowance for loan losses   (2,110)        (2,285)        (50)     
Total loans, net of allowance  $110,960        $104,662        $137,503      

 

The largest component of the loan portfolio is comprised of various types of commercial real estate loans. At December 31, 2012, commercial real estate loans totaled $73.6 million or 65.1% of the total portfolio, of which, acquisition, development and construction loans were $3.3 million. The second largest component, commercial and industrial loans, totaled $23.5 million and represented 20.8% of the total loan portfolio. Consumer loans, which were comprised principally of residential mortgage and home equity loans, totaled $16.0 million, or 14.2% of the portfolio.

 

At December 31, 2012, single family residential mortgage loans totaled $7.3 million while home equity lines totaled $8.4 million. Residential real estate loans consisted of first and second mortgages on single or multi-family residential dwellings.

 

Our loan portfolio also includes consumer lines of credit and installment loans. At December 31, 2012, those consumer loans totaled $297 thousand and represented 0.3% of the total loan portfolio. We do not engage in foreign lending, credit card lending or lease financing.

 

The repayment of maturing loans in the loan portfolio is also a source of liquidity for Cordia. The following tables set forth our loans maturing within specified intervals after the dates indicated. These tables were prepared based on the contractually outstanding balance and the contractual maturity date. These balances differ from the general ledger balances because of certain purchase accounting adjustments.

 

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Loan Maturity Schedule
December 31, 2012

 

(Dollars in thousands)  One Year or
Less
   Over One
Year
Through
Five Years
   Over Five
Years
   Total 
Commercial Real Estate:                    
Acquisition, development and construction  $1,175   $2,212   $-   $3,387 
Commercial   22,853    35,964    12,873    71,690 
Commercial and industrial   5,637    16,608    1,396    23,641 
Consumer   4,690    6,534    4,842    16,066 
   $34,355   $61,318   $19,111   $114,784 
Loans maturing after one year with:                    
Fixed interest rates  $40,544                
Floating interest rates   39,885                
   $80,429                

 

The information presented in the above table is based on the contractual maturities of the individual loans, including loans which may be subject to renewal at their maturities. Renewal of such loans is subject to review and credit approval as well as modification of terms. Consequently, we believe the treatment in the above table presents fairly the maturity and repricing structure of the loan portfolio as shown in the above table.

 

Residential mortgage loans held for sale have stated maturities generally of 15 to 30 years, but typically are held 15-30 days and in any event no longer than 45 days without a waiver in the Bank’s sole discretion.

 

Allowance for Loan Losses

 

At December 31, 2012, our allowance for loan losses was $2.1 million, or 1.9% of total loans outstanding and 22.1% of non-performing loans.  At December 31, 2011, our allowance for loan losses was $2.3 million, or 2.1% of total loans and 21.81% of non-performing loans. 

 

In the currently weak economic environment, levels of non-performing assets remain at elevated levels. These trends along with management's evaluation of the loan portfolio have led to the requirement for a higher allowance for loan losses than historical levels. However, these reserve levels have been gradually declining since late 2011 due to the success of the Bank’s workout and recovery efforts as well as improvement in the overall quality of the Bank’s loan portfolio.

 

Management has developed policies and procedures for evaluating the overall quality of the loan portfolio, the timely identification of potential problem credits and impaired loans and the establishment of an appropriate allowance for loan losses. The acquired loan portfolio was originally recorded at fair value, which includes a credit mark-to-market, based on the acquisition method of accounting. Loans renewed (performing loans acquired) or originated since the date of our initial investment are evaluated and an appropriate allowance for loan losses is established. Any worsening of acquired impaired loans since the date of the Cordia’s investment in BOVA is evaluated for further impairment. Additional impairment on acquired impaired loans is recorded through the provision for loan losses. Any improvement in cash flows of acquired impaired loans is amortized as a yield adjustment over the remaining life of the loans. A fuller explanation may be found in the table under the caption “Loans With Deteriorated Credit Quality” regarding accretable and nonaccretable discount. Loan losses are charged against the allowance when management believes the uncollectability of a loan is confirmed, which decreases the balance of the allowance. Subsequent recoveries, if any, are credited back to the allowance.

 

29
 

 

The allowance consists of a specific component allocated to impaired loans and a general component allocated to the aggregate of all unimpaired loans. The amount of the allowance is established through the application of a standardized model, the components of which are: an impairment analysis of identified loans to determine the level of any specific reserves needed on impaired loans, and a broad analysis of historical loss experience, economic factors and portfolio-related environmental factors to determine the level of general reserves needed. The model inputs include an evaluation of historical charge-offs, the current trends in delinquencies, and adverse credit migration and trends in the size and composition of the loan portfolio, including concentrations in higher risk loan types. Consideration is also given to the results of regulatory examinations.

 

The allowance for loan losses is evaluated quarterly by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the specific borrowers’ ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available. The use of various estimates and judgments in our ongoing evaluation of the required level of allowance can significantly affect our results of operations and financial condition and may result in either greater provisions to increase the allowance or reduced provisions based upon management’s current view of portfolio and economic conditions and the application of revised estimates and assumptions. The allowance consists of specific and general components. The specific component relates to loans that are classified as substandard or worse. For such loans that are also classified as impaired, a specific allowance is established. The general component covers loans graded special mention or better and is based on an analysis of historical loss experience, national and local economic factors, and environmental factors specific to the loan portfolio composition.

 

Changes affecting the allowance for loan losses for the years ended December 31, 2012, 2011 and 2010 are summarized in the following table.

 

The following table represents the allocation of the allowance for loan losses at the dates indicated. Notwithstanding these allocations, the entire allowance is available to absorb loan losses in any loan category.

 

   For the year ended December 31, 
   2012   2011   2010 
             
Allowance at beginning of period  $2,285   $50   $- 
                
Provision for loan losses   588    2,763    50 
                
Charge-offs:               
Commercial real estate   (635)   (528)   - 
Commercial and industrial   (286)   -    - 
Consumer   (223)   -    - 
Total charge-offs   (1,144)   (528)   - 
                
Recoveries:               
Commercial real estate   346    -    - 
Commercial and industrial   16    -    - 
Consumer   19    -    - 
Total recoveries   381    -    - 
Net charge-offs   (763)   (528)   - 
Allowance at end of period  $2,110   $2,285   $50 
                
Allowance to nonperforming loans   22.10%   21.81%   0.72%
Allowance to total loans outstanding at end of period   1.87%   2.14%   0.04%
Net Charge-offs to average loans during the period   0.70%   0.43%   NA 

 

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Included in the above table is the activity related to the portion of the allowance for loan losses for loans acquired with deteriorated credit quality. Because of the nature and limited number of these loans, they are individually evaluated for additional impairment on a quarterly basis. Activity related only to that portion of the allowance for loan losses is as follows:

 

   For the year ended December 31, 
   2012   2011   2010 
Allowance at beginning of period  $387    910    - 
Provision for loan losses   406           
                
Charge-offs:               
Commercial real estate   229    523    - 
Commercial and industrial   -    -    - 
Consumer   27    -    - 
Total charge-offs   256    523    - 
                
Recoveries:               
Net charge-offs   256    523    - 
Allowance at end of period  $537   $387   $- 

 

   At December 31, 2012   At December 31, 2011 
(Dollars in thousands)  Amount   % of
Allowance
to Total
Allowance
   % of
Loans in
Category
to Total
Loans
   Amount   % of
Allowance
to Total
Allowance
   % of
Loans in
Category
to Total
Loans
 
Commercial real estate  $810    38.34%   65.1%  $1,266    55.40%   64.10%
Commercial and industrial   782    37.06%   20.8%   569    24.91%   18.20%
Consumer   518    24.60%   14.1%   450    19.69%   17.70%
Total allowance for loan losses  $2,110    100.00%   100.00%  $2,285    100.00%   100.00%

 

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Asset Quality

 

Risk Rating Process

 

On a quarterly basis, the process of estimating the allowance for loan losses begins with review of the risk rating assigned to individual loans. Through this process, loans graded substandard or worse are evaluated for impairment in accordance with ASC Topic 310 “Accounting by Creditors for Impairment of a Loan”. Refer to Note 4 of the Notes to the Consolidated Financial Statements for more detail.

 

The following is the distribution of loans by credit quality and class as of December 31, 2012 and 2011.

 

December 31, 2012   Commercial Real Estate           Consumer        
(In thousands)
Credit Quality by Class
  Acq-Dev
Construction
    Non-Owner
Occupied
    Owner
Occupied
    Commercial
and
Industrial
    Residential
Mortgage
    HELOC     Other     Total  
1 Highest Quality   $ -     $ -     $ -     $ -     $ -     $ -     $ 1     $ 1  
2 Above Average Quality     -       -       3,082       1,088       119       86       3       4,378  
3 Satisfactory     392       6,261       19,727       6,598       4,074       3,969       186       41,207  
4 Pass     319       13,094       9,649       12,215       1,844       2,263       69       39,453  
5 Special Mention     -       5,769       1,668       1,351       684       274       16       9,762  
6 Substandard     -       188       481       570       32       347       22       1.640  
7 Doubtful     -       -       -       -       -       552       -       552  
      711       25,312       34,607       21,822       6,753       7,491       297       96,993  
Loans acquired with deteriorating credit quality     2,602       5,435       4,963       1,666       507       904       -       16,077  
Total loans   $ 3,313     $ 30,747     $ 39,570     $ 23,488     $ 7,260     $ 8,395     $ 297     $ 113,070  

 

December 31, 2011   Commercial Real Estate           Consumer        
(In thousands)
Credit Quality by Class
  Acq-Dev
Construction
    Non-Owner
Occupied
    Owner
Occupied
    Commercial
and
Industrial
    Residential
Mortgage
    HELOC     Other     Total  
1 Highest Quality   $ -     $ -     $ -     $ 47     $ -     $ -     $ 2     $ 49  
2 Above Average Quality     -       -       581       627       166       60       -       1,434  
3 Satisfactory     544       6,290       17,132       5,433       3,849       6,202       298       39,748  
4 Pass     119       9,548       5,339       4,801       1,945       2,040       187       23,979  
5 Special Mention     -       6,527       2,188       6,570       1,343       882       112       17,622  
6 Substandard     371       -       237       603       -       162       36       1,409  
7 Doubtful     -       -       -       -       -       24       -       24  
      1,034       22,365       25,477       18,081       7,303       9,370       635       84,265  
Loans acquired with deteriorating credit quality       5,031         8,279         6,313         1,411         700         928         20         22,682  
Total loans   $ 6,065     $ 30,644     $ 31,790     $ 19,492     $ 8,003     $ 10,298     $ 655     $ 106,947  

 

As shown in the tables above, substandard and doubtful loans were $2.2 million at December 31, 2012, or 1.97% of the total loan portfolio. This compares to $1.4 million at December 31, 2011. Special mention loans decreased $7.9 million from $17.6 million at December 31, 2011 to $9.8 million at December 31, 2012 and loans graded “pass” increased $15.5 million from $24.0 million at December 31, 2011 to $39.5 million at December 31, 2012, as loan balances in these two categories migrated to other credit quality classes. Loans acquired by Cordia in December 2010 with deteriorating credit quality have declined $6.6 million from $22.7 million at December 31, 2011 to $16.1 million at December 31, 2012.

 

During 2011, we hired a new credit management team which included a Chief Credit Officer, a Chief Operating Officer (promoted in 2012 to President of BOVA) who also serves as the Bank’s senior lending officer, and a Senior Vice President responsible for working out problem loans and seeking recoveries. The new credit management team dedicated a large portion of its time in 2011 to portfolio management, including new credit underwriting disciplines, training staff, resolving problem assets, as well as performing a detailed assessment of the accuracy of credit risk grades and assuring the Bank is appropriately reserved. Moreover, we engaged a third-party loan review firm to review the accuracy of this completed work.  At December 31, 2012, we believe that credit risk grades are accurate and the reserves established subsequent to our investment in BOVA are at appropriate levels. 

 

The Bank has continued to employ its third party loan review firm, Thurmond Clower & Associates, for annual reviews and periodic special assignments.  The most recent review was completed in April 2012.  The scope of the 2012 loan file review totaled approximately 80% of the Bank’s exposure and included the following:

 

32
 

 

 

·All classified loans or total relationship exposures over $250,000;

 

·All other loans or total relationship exposures over $500,000;

 

·A random sample of pass-rated loans determined by the loan review firm under $500,000;

 

·All loans past due as of the review date;

 

·All loans of $50,000 or more rated "Watch" or higher as of the date of the review;

 

·All OREO properties;

 

·All insider loans, including loans to directors, significant shareholders, and executive management granted since the last review;

 

·Any loans that management or the board of directors requested be reviewed;

 

·Annually review of the allowance for loan and lease loss reserve and methodology; and

 

·Annually review of all adversely graded loans in excess of $150,000.

 

Nonperforming Assets

 

The past due status of a loan is based on the contractual due date of the most delinquent payment due. Loans, including impaired loans, are generally classified as nonaccrual if they are past due as to maturity or payment of principal or interest for a period of more than 90 days, unless such loans are well-secured and in the process of collection. Loans greater than 90 days past due may remain on an accrual status if management determines it has adequate collateral and cash flow to cover the principal and interest or is in the process of refinancing. If a loan or a portion of a loan that is delinquent more than 90 days is adversely classified, or is partially charged off, the loan is generally classified as nonaccrual. Additionally, whenever management becomes aware of facts or circumstances that may adversely impact the full collectability of principal and interest of a loan, it is placed on nonaccrual status immediately, rather than delaying such action until the loans become 90 days past due.

 

When a loan is placed on nonaccrual status, previously accrued and uncollected interest is reversed, and the amortization of related deferred loan fees or costs is suspended. While a loan is classified as nonaccrual and the future collectability of the recorded loan balance is doubtful, collections of interest and principal are generally applied as a reduction to principal outstanding. When the future collectability of the recorded loan balance is expected, interest income may be recognized on a cash basis. In the case where a nonaccrual loan has been partially charged off, recognition of interest on a cash basis is limited to that which would have been recognized on the recorded loan balance at the contractual interest rate. Cash interest receipts in excess of that amount are recorded as recoveries to the allowance for loan losses until prior charge-offs have been fully recovered.

 

Loans placed on non-accrual status may be returned to accrual status after:

 

·payments are received for a minimum of six (6) consecutive months in accordance with the loan documents, and any doubt as to the loan's full collectability has been removed; or

 

·the loan is restructured and supported by a well-documented credit evaluation of the borrower's financial condition and the prospects for full payment.

 

When a loan is returned to accrual status after restructuring the risk rating remains unchanged until a satisfactory payment history is re-established typically for at least six months.

 

Nonperforming assets totaled $9.5 million, or 8.4% of total assets at December 31, 2012 and are comprised of non-accrual loans of $5.5 million, accruing troubled debt restructures (“TDR’s”) of $2.1 million and repossessed collateral of $1.8 million. The balance of nonperforming assets at December 31, 2011 was $11.7 million or 7.1% of total assets. The decrease at December 31, 2012 from December 31, 2011 was a result of management’s aggressive approach to workout and resolution of problem loans.

 

33
 

 

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at the estimated fair market value of the property, less estimated disposal costs. Any excess of the principal over the estimated fair market value at the time of acquisition is charged to the allowance for loan losses. The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings. Development and improvement costs relating to property are capitalized unless such added costs cause the properties recorded value to exceed the estimated fair market value. Net operating income or expenses of such properties are included in collection, repossession and other real estate owned expenses.

 

A summary of nonperforming assets, including troubled debt restructurings, as of the dates indicated follows:

 

   For the year ended December 31, 
(Dollars in thousands)  2012   2011   2010 
Non-accrual loans  $5,471   $7,949   $6,915 
Accruing troubled debt restructurings:               
Commercial real estate:               
Non-owner occupied   1,373    1,999    - 
Commercial and industrial   687    531    - 
Total accruing TDRs   2,060    2,530    - 
                
Real estate owned   1,768    1,262    551 
Total nonperforming assets  $9,299   $11,741   $7,466 
                
Nonaccrual troubled debt restructurings               
Non-owner occupied commercial real estate   -    419    - 
Residential mortgages   -    27    - 
               
Total nonaccrual loans to total loans   4.84%   7.43%   5.03%
Total nonaccrual loans to total assets   3.06%   4.80%   3.25%
Total nonperforming assets to total assets   5.65%   7.09%   3.51%
                
Total loans   113,070    106,947    137,553 
Total assets   178.696    165,551    212,526 

 

Loans With Deteriorated Credit Quality

 

In the acquisition of BOVA certain loans were acquired which showed evidence of deterioration in credit quality. These loans are accounted for under the guidance of ASC 310-30. Information related to these loans as of the dates indicated is provided in the following table.

 

(In thousands)  2012   2011   2010 
Contract principal balance  $16,718   $24,338   $37,083 
Accretable discount   (476)   (366)   - 
Nonaccretable discount   (165)   (1,290)   (7,249)
Book value of loans  $16,077   $22,682   $29,834 

 

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Investment Securities

 

The total securities portfolio (excluding restricted securities) was $18.5 million at December 31, 2012 as compared to $25.6 million at December 31, 2011. All securities were designated as available for sale and were recorded at estimated market value.

 

Amortized cost and fair values of securities available for sale are as follows:

 

   For the year ended December 31, 
   2012   2011   2010 
(Dollars in thousands)  Amortized
Cost
   Estimated
Fair
Value
   Amortized
Cost
   Estimated
Fair
Value
   Amortized
Cost
   Estimated
Fair
Value
 
U.S. Government agencies  $3,425   $3,455   $-   $-   $5,208   $5,198 
Agency guaranteed mortgage-backed securities   15,007    15,056    25,556    25,578    20,583    20,399 
Municipal   -    -    -    -    9,766    9,359 
Total  $18,432   $18,511   $25,556   $25,578   $35,557   $34,956 

 

The portfolio is available to support liquidity needs of BOVA as well as a source of interest income. Sales of available for sale securities were $9.7 million during the year ended December 31, 2012 and $17.9 million during the year ended December 31, 2011. During 2012 and 2011, we liquidated our position in certain U.S. Government agency and municipal securities while increasing the balance and shortening the maturities of our agency-guaranteed mortgage-backed securities.

 

This strategy reduced our portfolio yield while also reducing our interest rate and liquidity risk. We take into account the risk-weighting category of a security so as to minimize any adverse effect it may have on BOVA’s risk-weighted capital ratio.

 

As of December 31, 2012, we had unrealized losses of $33 thousand on four of our agency-guaranteed mortgage-backed securities with an aggregate fair value of $3.7 million. All of the unrealized losses are attributable to increases in interest rates and not to credit deterioration. Currently, we do not believe that it is probable that we will be unable to collect all amounts due according to the contractual terms of the investments. Because the decline in market value is attributable to changes in interest rates and not to credit quality and because it is not likely we will be required to sell the investments before recovery of their amortized cost bases, we do not consider these investments to be other-than-temporarily impaired at December 31, 2012.

 

The following tables set forth the scheduled maturities and average yields of securities available for sale at December 31, 2012.

 

   Within One Year   After One Year
Within Five Years
   After Five
Years
Within Ten
Years
   After Ten
Years
   Total 
(Dollars in thousands)  Amount   Yield   Amount   Yield   Amount   Yield   Amount   Yield     
U.S. Government Agencies  $-        $-    -   $-    -   $3,455    1.96%   3,455 
Agency guaranteed mortgage-backed securities   -    -    610    0.18%   5,257    1.99%   9,189    1.28%   15,056 
Total  $-        $610        $5,257        $12,644        $18,511 

 

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Deposits and Other Interest-Bearing Liabilities

 

At December 31, 2012, total deposits were $154.4 million, compared to $148.0 million at December 31, 2011. Core deposits, which by FDIC guidelines exclude certificates of deposit of $100,000 or more, are derived predominantly from the local retail and commercial market and provide a relatively stable funding source for our loan portfolio and other earning assets. Our core deposits were $113.3 million at December 31, 2012, or 73.2% of total deposits, compared to $102.3 million at December 31, 2011, or 69.1% of total deposits. Deposits, and particularly core deposits, have been the primary source of funding and have enabled us to successfully meet both our short-term and long-term liquidity needs. We anticipate that such deposits will continue to be our primary source of funding in the future. Our loan-to-deposit ratio was 73.2% at December 31, 2012 and 72.3% at December 31, 2011.

 

The following table sets forth our deposits by category at the dates indicated.

 

   At December 31, 
   2012   2011   2010 
(Dollars in thousands)  Amount   Percent   Amount   Percent   Amount   Percent 
Noninterest-bearing demand accounts  $19,498    12.6%  $16,833    11.4%  $14,506    7.9%
NOW accounts   14,830    9.6%   11,597    7.8%   7,479    4.1%
Savings and money market accounts   24,563    15.9%   18,089    12.2%   19,010    10.4%
Time deposits - less than $100,000   54,142    35.1%   55,776    37.7%   77,055    42.1%
Time deposits - $100,000 or more   41,395    26.8%   45,685    30.9%   64,973    35.5%
Total  $154,428    100.0%  $147,980    100.0%  $183,023    100.0%

 

At December 31, 2012, 44.8% of our time deposits over $100,000 had maturities within twelve months. Large certificate of deposit customers tend to be more sensitive to interest rate levels, making these deposits less reliable sources of funding for liquidity planning purposes in comparison to core deposits. As a result of measured efforts to reduce dependency on these non-core deposits, transaction and savings account products with attractive rates and features were promoted, thus increasing those balances as a percentage of total deposits from 31.4% at December 31, 2011 to 38.2% at December 31, 2012. Even with gradual rate reductions in these categories, balances are increasing.

 

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The maturity distribution of our time deposits of $100,000 or more and other time deposits at December 31, 2012, is set forth in the following table:

 

   December 31, 2012 
(Dollars in thousands)  Time
Deposits
of $100k
and
greater
   Time
Deposits
of Less
Than
$100k
   Total 
Months to maturity:            
Three months or less  $7,041   $9,759   $11,958 
Over three to twelve months   11,120    19,914    35,876 
One to three years   15,272    13,489    28,761 
Over three years   7,962    10,980    18,942 
Total  $41,395   $54,142   $95,537 

 

At December 31, 2012, 37.6% of time deposits mature in the three to twelve months time frame. This is indicative of customers’ reluctance to extend maturities in the current economy. Management monitors maturity trends in time deposits as part of its overall asset liability management strategy.

 

Liquidity and Capital Resources

 

Liquidity

 

Liquidity management involves monitoring our sources and uses of funds in order to meet our short-term and long-term cash flow requirements while optimizing profits. Liquidity represents an institution’s ability to meet present and future financial obligations, including through the sale of existing assets or the acquisition of additional funds through short-term borrowings. BOVA’s primary access to liquidity comes from several sources: operating cash flows from payments received on loans and mortgage-backed securities, increased deposits, and cash reserves. BOVA’s secondary sources of liquidity are Federal Funds sold, unpledged securities available for sale, and borrowings from correspondent banks, the FHLB and the Federal Reserve Bank‘s Discount Window. Liquidity strategies are implemented and monitored by the Asset/Liability Committee (“ALCO”) of our BOVA Board of Directors.

 

BOVA’s deposit base grew by 4.4% from $148.0 million at December 31, 2011 to $154.4 million at December 31, 2012. In a concerted effort to reduce its funding costs BOVA allowed high-cost time deposits to roll out of the Bank during 2011 and the first half of 2012 and concentrated on generation of more reasonably-price core deposit growth. In the second half of 2012, BOVA gradually increased its retail deposit base in anticipation of funding a $30 million residential mortgage held for sale loan program that commenced in December 2012. Core deposits at December 31, 2012 were 73.27% of total deposits compared to $69.17% at December 31, 2011. As it looks to implement other loan growth initiatives for 2013, BOVA has developed several funding strategies, including judicious use of brokered and institutional deposits, to augment core deposit growth and further reduce the cost of funds. Development of several sources of funding beyond core deposit growth ensures maximum liquidity access without dependence on higher cost sources of funds.

 

BOVA maintains an investment portfolio of available for sale marketable securities that may be used for liquidity purposes by either pledging them through repo transactions against borrowings from the FHLB or a correspondent bank or by selling them on the open market. Those securities consist primarily of U.S. Government agency debt securities. To the extent any securities are pledged against borrowing from one credit facility, the borrowing ability of other secured borrowing facilities would be reduced by a like amount.

 

Borrowings

 

Throughout 2011 and as of December 31, 2012, BOVA had a $10.0 million committed repo line with a correspondent bank through which borrowings could be made against the pledge of marketable securities subject to mark-to-market valuations and standard collateral borrowing ratios. This line was unused during 2011 and 2012 and remains fully available. BOVA also maintains a $2.5 million secured line of credit as well as a $5.0 million unsecured lines of credit with other correspondent banks that were available for direct borrowings or Federal Funds purchased.

 

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BOVA is a member of the Federal Home Loan Bank of Atlanta (FHLB), which provides access to additional lines of credit and other products offered by the FHLB. These borrowings are largely secured by BOVA’s loan portfolio. The FHLB maintains a blanket security agreement on qualifying collateral. As of December 31, 2012, BOVA had $10 million in secured borrowings outstanding with the FHLB Atlanta against pledged eligible mortgage loan collateral, at a stated interest rate of 1.62%. There were $5.1 million in FHLB advances as of December 31, 2012. As of December 31, 2012, BOVA had a total credit availability of $25.6 million at the FHLB which could be accessed through pledging a combination of eligible mortgage loan collateral and investment securities. The FHLB offers a variety of floating and fixed rate loans at terms ranging from overnight to 20 years; therefore, BOVA can match borrowings mitigating interest rate risk. BOVA is also a member in good standing of the Federal Reserve Bank System and has approved access to the Federal Reserve Bank Discount Window where it can borrow short-term funds against the pledge of loans and securities.

 

Liquidity Contingency Plan

 

Historically BOVA has maintained both a retail branch-based and an asset-based liquidity strategy and has not depended materially on brokered deposits or utilized securitization as sources of liquidity. BOVA strives to follow regulatory guidance in the management of liquidity risk and has established a Board-approved Contingency Funding Plan (CFP) that prescribes liquidity risk limits and guidelines and includes pro forma cash flow analyses of BOVA’s sources and uses of funds under various liquidity scenarios. BOVA’s CFP includes funding alternatives that can be implemented if access to normal funding sources is reduced.

 

We are not aware of any trends, events or uncertainties that are reasonably likely to have a material adverse effect on our short term or long term liquidity. Based on the current and expected liquidity needs, including any liquidity needs associated with loan growth or generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit, we expect to be able to meet our obligations for the next twelve months.

 

Capital

 

BOVA is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a material effect on our financial statements. Under the regulatory capital adequacy guidelines BOVA must meet specific capital guidelines that are based on quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Our capital amounts and classifications are also subject to qualitative judgments by the regulators.

 

Quantitative measures established by regulation to ensure capital adequacy require financial institutions to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). At December 31, 2012, BOVA met all capital adequacy requirements to which it was subject. BOVA is also required to maintain capital at a minimum level as a proportion of quarterly average assets, which is known as the leverage ratio. The minimum levels to be considered well-capitalized are 5% for tier 1 leverage ratio, 6% for tier 1 risk-based capital ratio, and 10% for total risk-based capital ratio.

 

BOVA exceeded all the regulatory capital requirements at the dates indicated and was considered well-capitalized, as set forth in the following table.

 

(Dollars in thousands)  December 31,
2012
   December 31,
2011
   December 31,
2010
 
Tier 1 capital  $14,939   $12,221   $6,661 
Tier 2 capital   1,515    1,490    1,995 
Total qualifying capital  $16,454   $13,711   $8,656 
Total risk-adjusted assets  $113,321   $113,674   $52,788 
                
Tier 1 leverage ratio   8.71%   7.34%   7.85%
Tier 1 risk-based capital ratio   12.31%   10.75%   10.90%
Total risk-based capital ratio   13.55%   12.06%   12.21%

 

Cordia is considered a small bank holding company, based on its asset size under $500 million. Accordingly it is exempt from Federal regulatory guidelines related to leverage ratios and risk-based capital.

 

Interest Rate Sensitivity

 

The pricing and maturity of assets and liabilities are monitored and managed in order to diminish the potential adverse impact that changes in rates could have on net interest income. The principal monitoring techniques employed by us are the Economic Value of Equity (EVE) and Net Interest Income or Earnings at Risk (NII or EaR) and the repricing “gap.” EVE and NII are cash flow and earnings simulation modeling techniques which predict likely economic outcomes given various interest rate scenarios. The repricing gap is the positive or negative dollar difference between the balance of assets and liabilities that are subject to interest rate repricing within a given period of time.

 

Interest rate sensitivity can be managed by closely matching the interest rate repricing periods of assets or liabilities at the time they are acquired and by adjusting that match as the balance sheet grows or the mix of asset and liability characteristics or interest rates change. That adjustment can be accomplished by selling securities available for sale, replacing an asset or liability at maturity with those of different characteristics, or adjusting the interest rate during the life of an asset or liability. Managing the amount of different assets and liabilities that reprice in a given time interval may help to hedge the risk and minimize the impact on net interest income of rising or falling interest rates.

 

At December 31, 2012, BOVA’s cumulative gap to assets was 5.5% compared to 1.3% at December 31, 2011.  This change is a direct reflection of strategic realignment of the securities portfolio, continued shift toward variable rate loans, and the rolldown of higher-priced time deposits.   Continued management of the balance sheet and its interest-sensitive components has resulted in a positive cumulative gap throughout all repricing periods with the exception of the overnight period, which is due to the immediately-repriceable nature of checking, savings, and money market accounts.   Application of a 200 basis point rate increase to the margin resulted in a $145 thousand improvement to the margin or a 3.24% change.  Application of a 200 basis point rate increase resulted in a 12.69% appreciation in equity compared to a 1.72% appreciation at December 31, 2011, whereas a decrease of 100 basis points results in an 8.42% depreciation in equity, compared to a 1.82% depreciation in equity at December 31, 2011.

 

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Off-Balance Sheet Risk/Commitments and Contingencies

 

Through our operations, we have made contractual commitments to extend credit in the ordinary course of our business activities. These commitments are legally binding agreements to lend money to our customers at predetermined interest rates for a specified period of time. At December 31, 2012, we had issued commitments to extend credit of $12.0 million through various types of commercial lending arrangements. The majority of these commitments to extend credit had variable rates.

 

We evaluate each customer’s credit worthiness for such commitments on a case-by-case basis in the same manner as for the approval of a direct loan. The amount of collateral obtained, if deemed necessary by us upon extension of credit, is based on our credit evaluation of the borrower. Collateral varies but may include accounts receivable, inventory, property, plant and equipment, commercial and residential real estate.

 

Contractual obligations as of December 31, 2012 are summarized in the following table.

 

       Payments due by period 
(Dollars in thousands)  Total   Less
than
One
Year
   One to
Three
Years
   Three to
Five
Years
   More
than Five
Years
 
Time deposits  $95,537    47,750    28,710    19,077    - 
Operating lease obligations   1,582    266    519    492    305 
Total  $97,119   $48,016   $29,229   $19,569   $305 

 

Critical Accounting Policies

 

Cordia’s financial statements are prepared in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. Cordia’s financial position and results of operations are affected by management’s application of accounting policies, including judgments made to arrive at the carrying value of assets and liabilities and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our financial position and/or results of operations.

 

Estimates, assumptions, and judgments are necessary principally when assets and liabilities are required to be recorded at estimated fair value, when a decline in the value of an asset carried on the financial statements at fair value warrants an impairment write-down or valuation reserve to be established, or when an asset or liability needs to be recorded based upon the probability of occurrence of a future event. Carrying assets and liabilities at fair value inherently results in more financial statement volatility. The fair values and the information used to record valuation adjustments for certain assets and liabilities are either based on quoted market prices or provided by third party sources, when available. When third party information is not available, valuation adjustments are estimated in good faith by management primarily through the use of internal or third party modeling techniques and/or appraisal estimates.

 

Cordia’s accounting policies are fundamental to understanding Management’s Discussion and Analysis. The following is a summary of Cordia’s “critical accounting policies.” In addition, the disclosures presented in the Notes to the Consolidated Financial Statements and in this section provide information on how significant assets and liabilities are valued in the financial statements and how those values are determined.

 

Business Combinations

 

Cordia accounts for its business combinations under the acquisition method of accounting, a cost allocation process which requires the cost of an acquisition to be allocated to the individual assets acquired and liabilities assumed based on their estimated fair values. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, Cordia relies on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques.

 

Acquired Loans with Specific Credit-Related Deterioration.

 

Acquired loans with specific credit deterioration are accounted for by Cordia in accordance with FASB Accounting Standards Codification 310-30. Certain acquired loans, those for which specific credit-related deterioration, since origination, is identified, are recorded at fair value reflecting the present value of the amounts expected to be collected. Income recognition on these loans is based on a reasonable expectation about the timing and amount of cash flows to be collected. Acquired loans deemed impaired and considered collateral dependent, with the timing of the sale of loan collateral indeterminate, remain on non-accrual status and have no accretable yield.

 

Allowance for Loan Losses

 

We monitor and maintain an allowance for loan losses to absorb losses inherent in the loan portfolio. We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

 

We evaluate loans graded substandard or worse individually for impairment. These evaluations are based upon expected discounted cash flows or collateral values. If the evaluation shows that the loan’s expected discounted cash flows or underlying collateral is not sufficient to repay the loan as agreed in accordance with the terms of the loan, then a specific reserve is established for the amount of impairment, which represents the difference between the principal amount of the loan less the expected discounted cash flows or value of the underlying collateral, net of selling costs.

 

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For loans without individual measures of impairment which are loans graded special mention or better, we make estimates of losses for pools of loans grouped by similar characteristics, including the type of loan as well as the assigned loan classification. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade and the predominant collateral type for the group. The resulting estimate of losses for pools of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 

The amount of estimated impairment for individually evaluated loans and pools of loans is added together for a total estimate of loan losses. This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made through a charge to the income statement. If the estimate of losses is less than the existing allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance is reduced by way of a credit to the provision for loan losses. We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is materially overstated. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made in future periods. These additional provisions may be material to the Financial Statements.

 

Impact of Inflation

 

Since the assets and liabilities of financial institutions such as BOVA are primarily monetary in nature, interest rates have a more significant effect on BOVA’s performance than do the effects of changes in the general rate of inflation and changes in prices of goods and services. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. As discussed previously, we seek to manage the relationships between interest sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation.

 

Item 7A.Quantitative and Qualitative Disclosures about Market Risk

 

The information required by this Item 7A is incorporated by reference to information appearing in the MD&A Section of this Annual Report on Form 10-K, more specifically in the sections entitled “Interest Rate Sensitivity” and “Liquidity Contingency Plan.

 

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Item 8.Financial Statements and Supplementary Data

 

Consolidated Balance Sheets

As of December 31, 2012 and 2011 (In thousands, except per share data)

 

   2012   2011 
Assets        
Cash and due from banks  $4,234   $4,167 
Federal funds sold and interest bearing deposits with banks   7,747    23,250 
Total cash and cash equivalents   11,981    27,417 
Securities available for sale, at fair market value   18,511    25,578 
Restricted securities   1,156    1,134 
Loans held for sale   28,949    - 
Loans net of allowance for loan losses of $2,110 and $2,285  in 2012 and 2011, respectively   110,960    104,662 
Premises and equipment, net   4,392    4,528 
Accrued interest receivable   419    426 
Other real estate owned, net of valuation allowance   1,768    1,262 
Other assets   560    544 
Total assets  $178,696   $165,551 
           
Liabilities and Stockholders’ Equity          
Deposits          
Non-interest bearing  $19,498   $16,833 
Savings and interest-bearing demand   39,393    29,686 
Time, $100,000 and over   41,395    45,685 
Other time   54,142    55,776 
Total deposits   154,428    147,980 
Accrued expenses and other liabilities   1,129    1,323 
FHLB borrowings   10,000    5,113 
Total liabilities   165,557    154,416 
           
Stockholders’ Equity          
Preferred stock, 2,000 shares authorized, $0.01 par value,          
none issued and outstanding   -    - 
Common stock:          
Series A – 0 and 60,000,000 shares authorized at December 31,          
2012 and 2011, respectively, $0.01 par          
value, 0 and 404,187 issued and outstanding at          
December 31, 2012 and 2011, respectively          
(0 and 578,125 restricted shares, respectively)   -    4 
Series B – 0 and 60,000,000 shares authorized at December 31,          
2012 and 2011 respectively, $0.01 par          
value, 0 and 1,106,918 issued and outstanding at          
December 31, 2012 and 2011, respectively   -    11 
Series C –5,000,000 and 60,000,000 shares authorized at December 31,          
2012 and 2011, respectively, none issued and outstanding   -    - 
Common stock – 120,000,000 shares authorized, $0.01        
par value, 75,000,000 shares currently undesignated.          
At December 31, 2012, 2,077,605 shares were          
outstanding (excluding 578,125 restricted shares)   21    - 
Additional paid-in capital   14,428    11,760 
Retained deficit   (5,701)   (5,157)
Accumulated other comprehensive income   56    22 
Noncontrolling interest   4,334    4,495 
Total stockholders’ equity  $13,139   $11,135 
Total liabilities and stockholders’ equity  $178,696   $165,551 

 

See Notes to Consolidated Financial Statements

 

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Consolidated Statements of Operations

For the years ended December 31, 2012 and 2011 (In thousands, except per share data)

 

   2012   2011 
Interest income        
Interest and fees on loans  $7,784   $9,710 
Investment securities   587    610 
Federal funds sold and deposits with banks   70    49 
Total interest income   8,441    10,369 
Interest expense          
Interest on deposits   1,529    1,722 
Interest on FHLB borrowings   23    56 
Total interest expense   1,552    1,778 
Net interest income   6,889    8,591 
Provision for loan losses   588    2,763 
Net interest income after provision for loan losses   6,301    5,828 
Non-interest income          
Service charges on deposit accounts   134    181 
Net loss on sale of available for sale securities   (30)   (283)
Other fee income   148    222 
Total non-interest income   252    120 
Non-interest expense          
Salaries and employee benefits   3,680    3,449 
Occupancy expense   562    589 
Equipment expense   290    326 
Data processing   400    377 
Marketing expense   110    102 
Legal and professional   569    646 
Bank franchise tax   94    146 
FDIC assessment   363    507 
Goodwill impairment loss   -    5,882 
(Gain) loss on sale of OREO, net   (86)   38 
Other real estate expense   182    203 
Other operating expenses   1,115    978 
Total non-interest expense   7,279    13,243 
Consolidated net loss   (726)   (7,295)
Less: Net loss-noncontrolling interest   182    2,881 
Net loss attributable to Cordia Bancorp, Inc.  $(544)  $(4,414)
Basic loss per share  $(0.32)  $(2.95)
Diluted loss per share  $(0.32)  $(2.95)
Weighted average shares outstanding, basic   1,705,112    1,497,982 
Weighted average shares outstanding, diluted   1,705,112    1,497,982 

 

See Notes to Consolidated Financial Statements

 

42
 

 

Consolidated Statements of Comprehensive Income (Loss)

For the years ended December 31, 2012 and 2011 (In thousands)

 

       Non-     
   Cordia   controlling     
   Bancorp   Interest   Total 
                
Net loss, 2011  $(4,414)  $(2,881)  $(7,295)
                
Unrealized gains on available-for-sale securities:               
Unrealized holding gains during the period   206    134    340 
Reclassification adjustment   171    112    283 
Other comprehensive income   377    246    623 
                
Comprehensive loss, 2011  $(4,037)  $(2,635)  $(6,672)
                
Net loss, 2012  $(544)  $(182)  $(726)
                
Unrealized gains on available-for-sale securities:               
Unrealized holding gains during the period   16    10    26 
Reclassification adjustment   18    12    30 
Other comprehensive income   34    22    56 
                
Comprehensive loss, 2012  $(510)  $(160)  $(670)

 

See Notes to Consolidated Financial Statement

 

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Consolidated Statements of Changes in Stockholders’ Equity

For the years ended December 31, 2012 and 2011 (In thousands)

 

   Cordia Stock                     
   Series
A
   Series
B
   Series
C
   Common   Additional
Paid-in
Capital
   Retained
Deficit
   Accumulated
Other
Comprehensive
Income (Loss)
   Non-
controlling
Interest
   Total 
Balance December 31, 2010  $4   $11   $   $   $11,213   $(743)  $(355)  $7,130   $17,260 
Stock issuance costs                       (1)                  (1)
Common stock issued                       550                   550 
Redemption of shares                       (2)                  (2)
Net loss                            (4,414)        (2,881)   (7,295)
Other comprehensive income                                 377    246    623 
Balance December 31, 2011   4    11              11,760    (5,157)   22    4,495    11,135 
Conversion of Series A and Series B to Common stock   (4)   (11)        15                        - 
Issuance of Series C shares             6         2,794                   2,800 
Stock issuance costs                       (126)                  (126)
Conversion of Series C shares to Common shares             (6)   6                        - 
Net loss                            (544)        (182)   (726)
Other comprehensive income                                 34    22    56 
Balance December 31, 2012  $-   $-   $-   $21   $14,428   $(5,701)  $56   $4,335   $13,139 

 

See Notes to Consolidated Financial Statements

 

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Consolidated Statements of Cash Flows

As of December 31, 2012 and 2011 (In thousands)

 

   2012   2011 
Cash flows from operating activities          
Net loss  $(726)  $(7,295)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:          
Net amortization of premium on investment securities   157    237 
Depreciation and amortization   381    395 
Provision for loan losses   588    2,763 
Gain on sale of fixed assets   -    (9)
Loss on available for sale securities   30    283 
Impairment of OREO   -    25 
(Gain) loss on sale of OREO   (86)   38 
Goodwill impairment   -    5,882 
Increase in loans purchased for resale   (28,949)   - 
Change in assets and liabilities:          
Decrease in accrued interest receivable   5    348 
(Increase) decrease in other assets   (52)   61 
Decrease in accrued expense and other liabilities   (193)   (470)
Net cash (used in) provided by operating activities   (28,845)   2,258 
Cash flows from investing activities          
Purchases of securities available for sale   (9,554)   (17,906)
(Issuance) redemptions of restricted securities, net   (22)   301 
Proceeds from sales/maturities of available for sale securities   11,222    19,993 
Proceeds from sale of OREO   976    975 
Proceeds from sale of fixed assets   -    9 
Payments on mortgage-backed securities   5,323    7,394 
Net (increase) decrease in loans   (9,085)   26,974 
Purchases of premises and equipment   (142)   (112)
Net cash (used in) provided by investing activities   (1,282)   37,628 
Cash flows from financing activities          
Proceeds from sale of stock, net   2,674    547 
Net increase (decrease) in demand, savings, interest-bearing checking and money market deposits   12,372    5,524 
Net decrease in time deposits   (5,355)   (39,523)
FHLB advance   10,000    - 
Repayment of FHLB borrowings   (5,000)   (5,000)
Net cash provided by (used in) financing activities   14,691    (38,452)
Net (decrease) increase in cash and cash equivalents   (15,436)   1,434 
Cash and cash equivalents at beginning of period   27,417    25,983 
Cash and cash equivalents at end of period  $11,981   $27,417 
Supplemental disclosure of cash flow information          
Cash payments for interest  $2,241   $3,533 
Supplemental disclosure of noninvesting activities          
Fair value adjustment for securities  $56   $623 
Other real estate owned transfer from loans  $1,396   $1,749 

 

See Notes to Consolidated Financial Statements

 

45
 

 

Note 1. Organization and Summary of Significant Accounting Policies

 

Organization

 

Cordia Bancorp Inc. (“Company” or “Cordia”) was incorporated in 2009 by a team of former bank CEOs, directors and advisors seeking to invest in undervalued community banks in the Mid-Atlantic and Southeast. The Company was approved as a bank holding company by the Board of Governors of the Federal Reserve in November 2010 and granted the authority to purchase a majority interest in Bank of Virginia (“Bank”or “BOVA”) at that time.

 

On December 10, 2010, Cordia purchased $10.3 million of BOVA’s common stock at a price of $7.60 per share, resulting in the ownership of 59.8% of the outstanding shares. On August 28, 2012, Cordia purchased an additional $3.0 million of BOVA common stock at a price of $3.60 per share increasing their ownership to 67.4%. At December 31, 2012 its ownership was 67.4%. Cordia’s principal business is the ownership of BOVA. Because Cordia does not have any business activities separate from the operations of BOVA, the information in this document regarding the business of Cordia reflects the activities of Cordia and BOVA on a consolidated basis. References to “we” and “our” in this document refer to Cordia and BOVA, collectively.

 

The Company is authorized to issue 200 million shares of common stock having a par value of $.01 per share and 2,000 shares of preferred stock having a par value of $.01 per share. Of the 200 million shares of common stock, the Company was previously authorized to issue 60 million series A shares, 60 million series B shares, 60 million series C shares and 80 million shares undesignated. Effective July 27, 2012, following a shareholder vote in favor of reclassification of the series A and series B shares, the Company is authorized to issue 120 million shares of common stock, five million series C common shares and 75 million undesignated shares.

 

In 2009 and 2010, the Company raised in a private placement an aggregate of $955,000 by selling 982,312 net shares of Series A Common Stock to its directors and officers at an average price of $0.97 per share. These funds were used to fund the organization and early stage expenses of the Company. These directors and officers entered into agreements with the Company which provided for initial vesting of an incremental percentage of these shares as well as time vesting over four years for the remaining shares, subject to substantial reductions in number of shares ultimately owned if the Company was not successful in pursuing its growth strategy. See Item 12. “Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters” and Item 13. “Certain Relationships, and Related Transactions, and Director Independence.”

 

The Bank was organized under the laws of the Commonwealth of Virginia to engage in a general banking business serving the communities in and around the Richmond, Virginia metropolitan area. The Bank commenced regular operations on January 12, 2004, and is a member of the Federal Reserve System, Federal Deposit Insurance Corporation and the Federal Home Loan Bank of Atlanta. The Bank is subject to the regulations of the Federal Reserve System and the State Corporation Commission of Virginia. Consequently, it undergoes periodic examinations by these regulatory authorities.

 

Principles of Consolidation

 

The accompanying consolidated financial statements include all accounts of the Company and the Bank. All material intercompany balances and transactions have been eliminated in consolidation.

 

Noncontrolling interest reflects the ownership interest of the minority shareholders of the Bank. Items of income (loss) and other comprehensive income (loss) applicable to Bank operations are allocated to the noncontrolling interest account based on the average ownership percentage of the minority shareholders.

 

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Summary of Significant Accounting Policies

 

The accounting and reporting policies of the Company are in accordance with accounting principles generally accepted in the United States of America and conform to general practices within the banking industry. The more significant of these policies are summarized below.

 

(a) Use of Estimates

 

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

 

(b) Cash and Cash Equivalents

 

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

 

(c) Securities

 

Debt securities that management has the positive intent and ability to hold to maturity are classified as “held to maturity” and recorded at amortized cost. Securities not classified as held to maturity, including equity securities with readily determinable fair values, are classified as “available for sale” and recorded at estimated fair value. The Company classifies all securities as available for sale. Other securities, such as Federal Reserve Bank stock and Federal Home Loan Bank stock, are carried at cost and are listed on the balance sheet as restricted securities.

 

In estimating other than temporary impairment losses management considers, (1) the length of time and extent to which the fair value has been less than cost, (2) the financial condition and near term prospects of the issuer, and (3) our ability to retain our investment for a period of time sufficient to allow for any anticipated recovery in fair value.

 

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Company intends to sell the security or (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more-than-likely that the Company will be required to sell the security before recovery, management must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.

 

For equity securities carried at cost as restricted securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until a recovery of value. Other-than-temporary impairment of an equity security results in a write-down that must be included in income. The Company regularly reviews each security for other-than-temporary impairment based on criteria that include the extent to which costs exceed market price, the duration that market decline, the financial health of and specific prospects for the issuer, management’s best estimate of the present value of cash flows expected to be collected on these debt securities, the Company’s intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery. The Company adjusts amortization or accretion on each bond on a level yield basis monthly.

 

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(d) Loans Held For Sale

 

Secondary market mortgage loans are designated as held for sale at the time of their origination. These loans are pre-sold with servicing released and the Company does not retain any interest after the loans are sold. These loans consist primarily of fixed-rate, single-family residential mortgage loans which meet the underwriting characteristics of certain government–sponsored enterprises (conforming loans). In addition, the Company requires a firm purchase commitment from a permanent investor before a loan can be committed, thus limiting interest rate risk. Loans held for sale are carried at the lower of cost or fair value. Gains on sales of loans are recognized at the loan closing date and are included in noninterest income. In February 2013, a proposal to increase the line to $60 million was approved by the board of directors.

 

(e) Loans

 

The Bank grants commercial and consumer loans to customers. A substantial portion of the loan portfolio is represented by commercial loans throughout the greater Richmond, Virginia metropolitan area. The ability of the Bank’s debtors to honor their contracts is dependent upon numerous factors including the collateral performance, general economic conditions, as well as the underlying strength of borrowers and guarantors.

 

Loans that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are generally reported at their outstanding unpaid principal balances adjusted for the allowance for loan losses and net deferred fees and costs. Interest income is accrued on the unpaid principal balance. Loan origination and commitment fees and certain direct costs are deferred and the net amount is amortized as an adjustment of the related loan’s yield. The Bank is amortizing these amounts on an effective interest method over the loan’s contractual life or to the pay-off date if the balance is repaid prior to maturity. There are no current commitments to purchase loans at this time. Loans are recorded based on purpose, collateral and repayment period. Interest is calculated on a 365/360 for commercial loans and 365/365 for consumer loans. Interest is accrued on a daily basis.

 

The past due status of a loan is based on the contractual due date of the most delinquent payment due. Each loan will be placed in one of the following categories: current, 1-29 days past due, 30-59 days past due, 60-89 days past due and over 90 days past due. Generally, the accrual of interest on a loan is discontinued at the time the loan becomes 90 days delinquent unless the credit is well-secured or in process of collection or refinancing.

 

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

 

In situations where, for economic or legal reasons related to a borrower’s financial condition, management may grant a concession to the borrower that it would not otherwise consider, the related loan is classified as a troubled debt restructuring (TDR). Management strives to identify borrowers in financial difficulty early and work with them to modify their loan to more affordable terms before their loan reaches nonaccrual status. These modified terms may include rate reductions, principal forgiveness, payment forbearance, re-amortization, and other actions intended to minimize the economic loss and to avoid foreclosure or repossession of the collateral. In cases where borrowers are granted new terms that provide for a reduction of either interest or principal, management measures any impairment on the restructuring as noted above for impaired loans. There were three loans with an aggregate principal balance of $2.1 million classified as TDRs as of December 31, 2012, while there were five loans with an aggregate principal balance of $3.4 million classified as TDRs as of December 31, 2011.

 

Acquired loans with specific credit deterioration are accounted for by Cordia in accordance with FASB Accounting Standards Codification 310-30. Certain acquired loans, those for which specific credit-related deterioration, since origination, is identified, are recorded at fair value reflecting the present value of the amounts expected to be collected. Income recognition on these loans is based on a reasonable expectation about the timing and amount of cash flows to be collected. Acquired loans deemed impaired and considered collateral dependent, with the timing of the sale of loan collateral indeterminate, remain on non-accrual status and have no accretable yield.

 

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(f) Allowance for Loan Losses

 

The allowance for loan losses (ALL) is increased by charges to income and decreased by charge-offs, net of recoveries. The allowance is established and maintained at a level management deems adequate to cover losses inherent in the portfolio as of the balance sheet date and is based on management’s evaluation of the risks in the loan portfolio and changes in the nature and volume of loan activity. There are risks inherent in all loans, so an allowance is maintained for loans to absorb probable losses on existing loans that may become uncollectible. The allowance is established and maintained as losses are estimated to have occurred through a provision for loan losses charged to earnings, which increases the balance of the allowance. Loan losses for all segments are charged against the allowance when management believes the uncollectability of a loan is confirmed, which decreases the balance of the allowance. Subsequent recoveries, if any, are credited back to the allowance.

 

The amount of the allowance is established through the application of a standardized model, the components of which are: an impairment analysis of specific loans to determine the level of any specific reserves needed, a broad analysis of historical loss experience and economic and environmental factors to determine the level of general reserves needed.

 

The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectability of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.

 

In order for the ALL methodology to be considered valid and for Management to make the determination if any deficiencies exist in the process, the Bank at a minimum requires:

 

·A review of trends in loan volume, delinquencies, restructurings and concentrations;
·Tests of source documents and underlying assumptions to determine that the established methodology develops reasonable loss estimates; and
·An evaluation of the appraisal process of the underlying collateral which may be accomplished by periodically comparing the appraised value to the actual sales price on selected properties sold.

 

Note 4 includes additional discussion of how the allowance is quantified. The use of various estimates and judgments in the Bank’s ongoing evaluation of the required level of allowance can significantly affect the Bank’s results of operations and financial condition and may result in either greater provisions against earnings to increase the allowance or reduced provisions based upon management’s current view of portfolio and economic conditions and the application of revised estimates and assumptions.

 

The specific component of the allowance relates to loans that are classified as either doubtful or substandard. For such loans that are also classified as impaired, a loan level allowance is established. The evaluation of the need for a specific reserve involves the identification of impaired loans and an analysis of those loans’ repayment capacity from both primary (cash flow) and secondary (real estate and non real estate collateral or guarantors) sources and making specific reserve allocations to impaired loans that exhibit inherent weaknesses and various credit risk factors. All available collateral is analyzed and valued, with discounts applied according to the age of any real estate appraisals or the liquidity of other asset classes. The analysis is compared to the aggregate Bank loan exposure, giving consideration to the Bank’s lien preference and other actual and contingent obligations of the borrower. Any loan guarantors are rated and their value weighted based on an analysis of the guarantor’s net worth, including liabilities, liquid assets, and annual cash flows and total contingent liabilities.

 

The impairment of a loan occurs when it is probable that the Bank will be unable to collect all amounts due according to the contractual terms of the loan agreement. We do not consider a loan impaired during a period of insignificant delay in payment if we expect the ultimate collection of all amounts due. Impairment is measured as the difference between the recorded investment in the loan and the evaluation of the present value of expected future cash flows or the observable market price of the loan or collateral value of the impaired loan when that cash flow or collateral value is lower than the carrying value of that loan. Loans that are collateral dependent, that is, loans where repayment is expected to be provided solely by the underlying collateral, and for which management has determined foreclosure is probable, are measured for impairment based on the fair value of the collateral as described above.

 

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The general component covers non classified loans and special mention loans and is based on historical loss experience adjusted for qualitative factors.

 

The model estimates future loan losses by analyzing historical loss experience and other trends within the portfolio, including trends in delinquencies and charge-offs, the opinions of regulators, changes in the growth rate, size and composition of the loan portfolio, particularly the level of special mention rated loans, the level of past due loans, the level of home equity loans and commercial real estate loans in aggregate and as a percentage of capital, and industry information.

 

A component of the general allowance for unimpaired loans is established based on a weighted average historical loss factor for the prior twelve quarters (with more weight given to the more recent quarters) and the level of unimpaired loans.

 

Also included in management’s estimates for loan losses are considerations with respect to the impact of local and national economic trends, the outcomes of which are uncertain. These events may include, but are not limited to, a general slowdown in the national or local economy, national and local unemployment rates, local real estate values, fluctuations in overall lending rates, political conditions, legislation that may directly or indirectly affect the banking industry and economic conditions affecting the specific geographic area in which the Bank conducts business.

 

The allowance model is a fluid model which includes several factors that can be adjusted to reflect rapid changes in the economic environment, loan portfolio trends and individual borrowers' financial condition and risk, the interpretation of which can have significant impact on the perceived allowance needed.

 

(g) Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the assets' estimated useful lives. Estimated useful lives range from 10 to 30 years for buildings and 3 to 10 years for autos, furniture, fixtures and equipment. The value of land is carried at cost. Cost is based on the fair value at the date of the acquisition of Bank of Virginia.

 

(h) Other Real Estate Owned

 

Assets acquired through, or in lieu of, loan foreclosure are held for sale. They are initially recorded at the assets’ fair market value at the date of foreclosure, less estimated selling costs thus establishing a new cost basis. Subsequent to foreclosure, valuations of the assets are periodically performed by management. Adjustments are made to the lower of the carrying amount or fair market value of the assets less selling costs. Revenue and expenses from operations are included in net expenses from foreclosed assets. The Bank’s investment in foreclosed assets totaled $1.8 million and $1.3 million at December 31, 2012 and 2011, respectively.

 

(i) Goodwill and Other Intangibles

 

FASB ASC 805, Business Combinations, requires that the acquisition method of accounting be used for all business combinations. With acquisitions, the Company is required to record assets acquired, including any intangible assets, and liabilities assumed at fair value, which involves relying on estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation methods. The Company records goodwill per ASC 350, Intangibles-Goodwill and Others. Accordingly, goodwill is no longer subject to amortization over its estimated useful life, but is subject to at least an annual assessment for impairment by applying a fair value-based test. Additionally, under ASC 350, acquired intangible assets (such as core deposit intangibles) are separately recognized if the benefit of the assets can be sold, transferred, licensed, rented, or exchanged, and amortized over their useful lives. ASC 350 discontinues any amortization of goodwill and other intangible assets with indefinite lives, but requires an impairment review at least annually or more often if certain conditions exist. The Company followed ASC 350 and determined that core deposit intangibles will be amortized over their estimated useful life. Core deposit intangibles are evaluated for impairment in accordance with ASC 350. Goodwill was determined to be impaired in 2011.

 

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(j) Income Taxes

 

Deferred taxes are provided on a liability method whereby deferred tax assets are recognized for deductible temporary differences, operating loss carryforwards, and tax credit carryforwards. Deferred tax liabilities are recognized for taxable temporary differences.

 

Temporary differences are the differences between the reported amounts of assets and liabilities and their tax bases. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, the recognition of the asset is less than probable. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.

 

When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the positions taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is recognized as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination. As of December 31, 2012 and 2011, the Company had recorded no such liability.

 

Interest and penalties associated with the unrecognized tax benefits would be classified as additional income taxes in the statements of operations.

 

Banks operating in Virginia are not subject to Virginia State Income Tax, but are subjected to Virginia Bank Franchise Taxes.

 

(k) Marketing Costs

 

The Company follows the policy of charging the production costs of marketing/advertising to expense as incurred unless the advertising campaign extends for a significant time period, in which case, such costs will be amortized to expense over the duration of the advertising campaign.

 

(l) Comprehensive Income

 

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

 

(m) Loss Per Share

 

Basic loss per share represents income available to common shareholders divided by the weighted-average number of common shares outstanding during the period.  Diluted earnings per share reflect 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. 

 

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The calculation for basic and diluted earnings per common share for the years ended December 31, 2012 and 2011, is as follows:

 

(In thousands)  2012   2011 
         
Net loss attributable to Company  $(544)  $(4,414)
           
Weighted average basic and dilutive shares outstanding   1,705,112    1,497,982 
           
Basic and diluted loss per common share  $(0.32)  $(2.95)

 

For the years ended December 31, 2012 and 2011, 578,125 shares of unvested Series A Common Stock were excluded from the computation of basic and diluted earnings per common share. All other vested and unvested Series A shares, which carry all rights and privilege of a stockholder with respect to the stock, including the right to vote, were included in the per common share calculation.

 

(n) Stock Option Plan

 

Authoritative accounting guidance requires the costs resulting from all share-based payments to employees be recognized in the financial statements. Stock-based compensation is estimated at the date of grant, using the Black-Scholes option valuation model for determining fair value. The Bank recognized stock-based compensation expense of $34.7 thousand and $11.8 thousand in 2012 and 2011, respectively. There were no Cordia stock options outstanding at December 31, 2012 and 2011.

 

(o) Fair Value Measurements

 

Fair values of financial instruments are estimated using relevant market information and other assumptions as more fully disclosed in Note 14. Fair value estimates involve uncertainties and matters of significant judgment. Changes in assumptions or market conditions could significantly affect the estimates.

 

(p) Transfer of Assets

 

Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when 1) the assets have been isolated from the Company – put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership; 2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets; and 3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity of the ability to unilaterally cause the holder to return specified assets.

 

(q) Reclassification

 

In certain circumstances, reclassifications have been made to prior period information to conform to the 2012 presentation. Such reclassifications had no effect on previously reported shareholders’ equity or net loss.

 

Recent Accounting Pronouncements

 

In April 2011, the FASB issued ASU 2011-03, “Transfers and Servicing (Topic 860) – Reconsideration of Effective Control for Repurchase Agreements.” The amendments in this ASU remove from the assessment of effective control (1) the criterion requiring the transferor to have the ability to repurchase or redeem the financial assets on substantially the agreed terms, even in the event of default by the transferee and (2) the collateral maintenance implementation guidance related to that criterion. The amendments in this ASU were effective for the first interim or annual period beginning on or after December 15, 2011. The guidance should be applied prospectively to transactions or modifications of existing transactions that occur on or after the effective date. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

 

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In May 2011, the FASB issued ASU 2011-04, “Fair Value Measurement (Topic 820) – Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRSs.” This ASU is the result of joint efforts by the FASB and International Accounting Standards Board (IASB) to develop a single, converged fair value framework on how (not when) to measure fair value and what disclosures to provide about fair value measurements. The ASU is largely consistent with existing fair value measurement principles in U.S. GAAP (Topic 820), with many of the amendments made to eliminate unnecessary wording differences between U.S. GAAP and International Financial Reporting Standards (IFRS). The amendments were effective for interim and annual periods beginning after December 15, 2011 with prospective application. The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

 

In June 2011, the FASB issued ASU 2011-05, “Comprehensive Income (Topic 220) – Presentation of Comprehensive Income.” The new guidance amends disclosure requirements for the presentation of comprehensive income. The amended guidance eliminates the option to present components of other comprehensive income (“OCI”) as part of the statement of changes in shareholders’ equity. All changes in OCI must be presented either in a single continuous statement of comprehensive income or in two separate but consecutive financial statements. The guidance does not change the items that must be reported in OCI. The Company adopted this guidance effective 2012, and has elected to present two separate but consecutive financial statements.

 

In September 2011, the FASB issued ASU 2011-08, “Intangible – Goodwill and Other (Topic 350) – Testing Goodwill for Impairment.”  The amendments in this ASU permit an entity to first assess qualitative factors related to goodwill to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether it is necessary to perform the two-step goodwill test described in Topic 350.  The more-likely-than-not threshold is defined as having a likelihood of more than 50 percent.  Under the amendments in this ASU, an entity is not required to calculate the fair value of a reporting unit unless the entity determines that it is more likely than not that its fair value is less than its carrying amount.  The amendments in this ASU are effective for annual and interim goodwill impairment tests performed for fiscal years beginning after December 15, 2011. Early adoption is permitted, including for annual and interim goodwill impairment tests performed as of a date before September 15, 2011, if an entity’s financial statements for the most recent annual or interim period have not yet been issued.  The adoption of the new guidance did not have a material impact on the Company's consolidated financial statements.

 

In December 2011, the FASB issued ASU 2011-11, “Balance Sheet (Topic 210) – Disclosures about Offsetting Assets and Liabilities.” This ASU requires entities to disclose both gross information and net information about both instruments and transactions eligible for offset in the balance sheet and instruments and transactions subject to an agreement similar to a master netting arrangement. An entity is required to apply the amendments for annual reporting periods beginning on or after January 1, 2013, and interim periods within those annual periods. An entity should provide the disclosures required by those amendments retrospectively for all comparative periods presented. The Company does not expect the adoption of ASU 2011-11 to have a material impact on its consolidated financial statements.

 

In July 2012, the FASB issued ASU 2012-02, “Intangibles – Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment.” The amendments in this ASU apply to all entities that have indefinite-lived intangible assets, other than goodwill, reported in their financial statements. The amendments in this ASU provide an entity with the option to make a qualitative assessment about the likelihood that an indefinite-lived intangible asset is impaired to determine whether it should perform a quantitative impairment test. The amendments also enhance the consistency of impairment testing guidance among long-lived asset categories by permitting an entity to assess qualitative factors to determine whether it is necessary to calculate the asset’s fair value when testing an indefinite-lived intangible asset for impairment. The amendments are effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company does not expect the adoption of ASU 2012-02 to have a material impact on its consolidated financial statements.

 

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In January 2013, the FASB issued ASU 2013-01, “Balance Sheet (Topic 210): Clarifying the Scope of Disclosures about Offsetting Assets and Liabilities.” The amendments in this ASU clarify the scope for derivatives accounted for in accordance with Topic 815, Derivatives and Hedging, including bifurcated embedded derivatives, repurchase agreements and reverse repurchase agreements and securities borrowing and securities lending transactions that are either offset or subject to netting arrangements. An entity is required to apply the amendments for fiscal years, and interim periods within those years, beginning on or after January 1, 2013. The Company does not expect the adoption of ASU 2013-01 to have a material impact on its consolidated financial statements.

 

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” The amendments in this ASU require an entity to present (either on the face of the statement where net income is presented or in the notes) the effects on the line items of net income of significant amounts reclassified out of accumulated other comprehensive income. In addition, the amendments require a cross-reference to other disclosures currently required for other reclassification items to be reclassified directly to net income in their entirety in the same reporting period. Companies should apply these amendments for fiscal years, and interim periods within those years, beginning on or after December 15, 2012. The Company is currently assessing the impact that ASU 2011-03 will have on its consolidated financial statements.

 

Note 2. Business Combination

 

On December 10, 2010, the Company purchased 1,355,263 newly issued shares of the common stock of the Bank of Virginia, which gave it a 59.8% ownership interest. In accordance with ASC 805-10, this transaction is considered a business combination. Under the acquisition method of accounting, the assets and liabilities of the Bank were marked to fair value and goodwill was recorded for the excess of consideration paid over net fair value received. Based on the consideration paid and the fair value of the assets received and the liabilities assumed, goodwill of $5.9 million was recorded. Goodwill was determined to be impaired in its entirety during the fourth quarter of 2011. In addition to goodwill, other assets and liabilities of the Bank of Virginia were marked to their respective fair value as of December 10, 2010.

 

(In thousands)     
      
Investment in Bank of Virginia  $10,300 
Cash and cash equivalents   15,716 
Investment securities   35,914 
Loans   138,681 
Premises and equipment   4,823 
Core deposit intangibles   249 
Other assets   4,993 
Fair value of assets acquired   200,376 
Deposits   185,164 
FHLB borrowings   10,473 
Other liabilities   1,689 
Fair value of liabilities assumed   197,326 
      
Minority interest   7,468 
Goodwill  $5,882 

 

 

These estimated fair values differed substantially in some cases from the carrying amounts of the assets and liabilities reflected in the financial statements of BOVA which, in most cases were valued at historical cost. Subsequent to that date, the fair value adjustments are being amortized over the expected life of the related asset or liability or otherwise adjusted as required by GAAP.

 

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At the time of the Company’s initial investment in the Bank, a third party expert was hired to assist in determining the fair value of assets acquired and liabilities assumed in accordance with authoritative accounting guidance.

 

The most significant asset acquired in the transaction was the $150.5 million loan portfolio at a fair value discount of $11.8 million. The estimated fair value of the performing portion of the portfolio was approximately $107 million. The fair value mark on the performing loans of $2.2 million is being accreted to interest income over the remaining lives of the loans in accordance with FASB Accounting Standards Codification (“ ASC” ) 10-0 (formerly SFAS 91). The estimated lives vary according to the expected maturity of loans within each segment and range between 14 and 52 months.

 

Certain loans, those for which specific credit-related deterioration since origination was identified, were recorded at fair value. Income recognition on these loans is based on expectations about the timing and amount of cash flows to be collected. Acquired loans deemed impaired and considered collateral dependent, with the timing of the sale of loan collateral indeterminate, remain on non-accrual status and have no accretable yield.

 

In accordance with U.S. GAAP, there was no carryover of the allowance for loan losses that had been previously recorded by the Bank.

 

The Company acquired an investment portfolio with a fair value of $35.9 million. The fair value of the investment portfolio was determined by taking into account market prices obtained from independent valuation sources. The total fair value adjustment at the time of Cordia’s initial investment was $920 thousand. The fair value adjustment is accreted into income over the life of the security. If the security is sold or called prior to maturity, the realized gain or loss is calculated as the difference between the current book value and the sale or call proceeds. The current book value includes the accretion of the fair value adjustment recorded to date.

 

In connection with the transaction, the Company acquired other real estate owned with a fair value of $551 thousand. Other real estate owned was measured at fair value less cost to sell.

 

The Company also acquired premises and equipment with a fair value of $4.8 million. Evaluations for all owned locations were obtained. The fair value adjustment assigned to land of $603 thousand will not be amortized. The fair value adjustment assigned to bank buildings of $252 thousand is being amortized over the remaining lives of the properties of approximately 25 years. The adjustment will reduce depreciation expense during the amortization period. The Company also acquired several lease obligations in connection with the merger. The unfavorable lease position totaled $822 thousand and is being amortized as a reduction to occupancy expense over the remaining lives of the leases of 8.75 years.

 

The core deposit intangible of $249 thousand was valued by an independent third party using a discounted cash flow analysis to determine the market value of the acquired deposits to fund operations versus using comparable term (to maturity) wholesale borrowing. The core deposit intangible is being amortized into expense over the estimated lives of the acquired core deposits of 84 months.

 

The fair value of savings and transaction deposit accounts acquired was assumed to approximate their carrying value as these accounts have no stated maturity and are payable on demand. The fair value of time deposits was calculated using a discounted cash flow analyses that calculated the present value of the projected cash flows from the portfolio. This valuation adjustment totaled $1.8 million and is being amortized into income as a reduction in interest expense over the remaining maturities of the time deposits or approximately 24 months.

 

The fair value of the Federal Home Loan Bank of Atlanta advances was determined based on the discounted cash flows of future payments. This adjustment to the face value of the borrowings was $473 thousand and was amortized to reduce interest expense over the remaining lives of the respective borrowings maturing through August 2012.

 

Direct costs related to the acquisition were expensed as incurred.

 

55
 

 

The following fair value adjustments remain on acquired assets and liabilities as of the dates indicated (dollars in thousands):

 

   December 31, 2012   December 31, 2011 
Loans  $1,714   $3,387 
Investment securities   -    263 
Property & equipment   (837)   (846)
Core deposit intangible   175    210 
FHLB advances   -    (113)
Time deposits   (169)   (738)
Building lease obligation   (634)   (728)

 

There has been no change in the estimated lives originally assigned as of the date of acquisition for property and equipment, core deposit intangible, Federal Home Loan Bank advances, time deposits and the unfavorable lease. Federal Home Loan Bank advances were repaid in their entirety during 2012 and full amortization of the original fair value mark has occurred. The mark on loans has changed significantly as charge-offs and payoffs have occurred since the acquisition date. Also, performing acquired loans have declined significantly due to payoffs and maturities of the original acquired loans to $44.5 million and $65.9 million at December 31, 2012 and December 31, 2011, respectively. Due to calls, maturities and sales of investment securities, none of the acquired securities are remaining at December 31, 2012.

 

Interest income is impacted by the accretion of the fair value discount on the loan portfolio as well as the accretion of the accretable discount on loans acquired with deteriorated credit quality. Interest income is also impacted by the change in accretion on the investment securities that is the result of the reset of the amortized book value amount to the fair value as of the day of the investment. Interest expense is impacted by the amortization of the premiums on time deposits and the FHLB advances. Net interest income is impacted by the combination of all of these items.

 

The provision for loan losses is significantly impacted by these acquisition accounting adjustments. The credit risk associated with the loan portfolio is reflected in the fair value determination as of the day of the investment by Cordia. Accordingly, on the day of the investment, there is no allowance for loan losses related to the purchased loans on the balance sheet of Cordia, while there is a significant allowance for loan losses on the balance sheet of BOVA.

 

Non-interest income is impacted by the gain or loss on the sale of investment securities. Because investments owned on the day of the investment by Cordia have a different book basis, the amount of the gain or loss on the sale of these investments that is reported by Cordia differs from the amounts reported by BOVA. Noninterest expense is impacted by the depreciation adjustment that is the result of a fair value discount recorded on certain branch locations, rent adjustment related to certain lease commitments being above market as of the day of the investment and amortization of the core deposit intangible.

 

The net effect of the amortization, depreciation and accretion associated with Cordia’s purchase adjustments had the following impact on the consolidated financial statements:

 

   December 31, 2012   December 31, 2011 
Loans  $(545)  $(522)
Investment securities   (129)   (297)
Property & equipment   8    6 
Core deposit intangible   (36)   (27)
FHLB advances   112    113 
Time deposits   569    487 
Building lease obligation   94    70 
      Net impact to net income  $73   $(170)

 

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Note 3. Securities

 

Amortized cost and fair values of securities available for sale at December 31, 2012 and 2011 are as follows:

 

          Estimated 
   Amortized   Gross Unrealized   Fair 
   Cost   Gains   Losses   Value 
2012                
U.S Government Agencies  $3,425   $30   $-   $3,455 
Agency Guaranteed Mortgage- backed securities   15,007    82    33    15,056 
Total  $18,432   $112   $33   $18,511 
2011                    
Agency Guaranteed Mortgage- backed securities  $25,556   $125   $103   $25,578 
Total  $25,556   $125   $103   $25,578 

 

The amortized cost and fair value of securities available for sale as of December 31, 2012, by contractual maturity are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties. They are as follows:

 

   Amortized
Cost
   Estimated
Fair
Value
 
December 31, 2012        
1 year or less  $-   $- 
Over 1 year through 5 years   596    610 
Over 5 years through 10 years   5,269    5,257 
Over 10 years   12,567    12,644 
Total  $18,432   $18,511 

 

As of December 31, 2012, the portfolio is concentrated in average maturities of over ten years. The portfolio is available to support liquidity needs of the Company. Sales of available for sale securities were $9.7 million in 2012 and $17.8 million during 2011. In 2012, gross realized gains were $82.3 thousand with corresponding losses of $112.3 thousand.

 

Management does not believe any individual unrealized loss position as of December 31, 2012 represents an other-than-temporary impairment. Management evaluates securities for other-than-temporary impairment at least on a quarterly basis and more frequently when economic or market concerns warrant such evaluation. Consideration is given to (i) the intent of the Company to sell the security, (ii) whether it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, and (iii) whether the Company expects to recover the securities’ entire amortized cost basis regardless of the Company’s intent to sell the security. Furthermore, the Company believes the value is attributable to changes in market interest rates and not the credit quality of the issuer.

 

The Company had no investments in a continuous unrealized loss position for more than 12 months as of December 31, 2012 or 2011.

 

As of December 31, 2012, the Company had unrealized losses on four of its Agency Guaranteed Mortgage-backed securities of $33 thousand with an aggregate fair value of $3.7 million. All of the unrealized losses are attributable to increases in interest rates and not to credit deterioration. Currently, the Company does not believe that it is probable that it will be unable to collect all amounts due according to the contractual terms of the investments. Because the decline in market value is attributable to changes in interest rates and not to credit quality and because it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other-than-temporarily impaired at December 31, 2012.

 

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There were no held to maturity securities at December 31, 2012 and 2011.

 

Mortgage-backed securities with a combined market value of $2.0 million and $1.9 million were pledged to secure public funds with the State of Virginia at December 31, 2012 and 2011, respectively. In addition, we had $2.9 million mortgage-backed securities pledged to cover a relationship with our main correspondent bank as of December 31, 2012.

 

Note 4.Allowance for Loan Losses and Credit Quality

 

The Bank categorizes its loan receivables into three main categories which are commercial real estate loans, commercial and industrial loans, and consumer loans. Each category of loan has a different level of credit risk. Real estate loans are generally safer than loans secured by other assets because the value of the underlying collateral is generally ascertainable and does not fluctuate as much as other assets. Owner occupied commercial real estate loans are generally the least risky type of commercial real estate loan. Non owner occupied commercial real estate loans and construction and development loans contain more risk. Commercial loans, which can be secured by real estate or other assets, or which can be unsecured, are generally more risky than commercial real estate loans. Consumer loans may be secured by residential real estate, automobiles or other assets or may be unsecured. Those secured by residential real estate are the least risky and those that are unsecured are the most risky type of consumer loans. Any type of loan which is unsecured is generally more risky than a secured loan. These levels of risk are general in nature, and many factors including the creditworthiness of the borrower or the particular nature of the secured asset may cause any type of loan to be more or less risky than another. In the commercial real estate category of the loan portfolio the segments are acquisition-development-construction, non owner occupied and owner occupied. In the consumer category of the loan portfolio the segments are residential real estate, home equity lines of credit and other. Management has not further divided its seven segments into classes. This provides Management and the Board with sufficient information to evaluate the risks within the Bank’s portfolio.

 

Under the Bank’s residential mortgage held for sale loan program commenced in December 2012, no loan loss allowance is required due to the high quality and short holding period of the loans that are held for sale.

 

Below is a table that exhibits the loans by class at December 31, 2012 and 2011.

 

   Composition of loan portfolio
At December 31,
 
(In thousands)  2012   2011 
Commercial Real Estate:          
Acquisition, development, and construction  $3,313   $6,065 
Non owner occupied   30,747    30,644 
Owner occupied   39,570    31,790 
Commercial and industrial   23,488    19,492 
Consumer:          
Residential mortgage   7,260    8,003 
Home equity lines of credit   8,395    10,298 
Other   297    655 
Total loans  $113,070   $106,947 
Allowance for loan losses   (2,110)   (2,285)
Total loans, net of allowance  $110,960   $104,662 

 

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Acquired in the acquisition of Bank of Virginia, and included in the table above, are loans acquired with evidence of deterioration in credit quality. These loans are accounted for under the guidance ASC 310-30. Information related to these loans is as follows:

 

(In thousands)  2012   2011 
Contract principal balance  $16,718   $24,338 
Accretable discount   (476)   (366)
Nonaccretable discount   (165)   (1,290)
Book value of loans  $16,077   $22,682 

 

A discount is applied to these loans such that the carrying amount approximates the cash flows expected to be received from the borrower or from the liquidation of collateral. Due to a high level of uncertainty regarding the timing and amount of these cash flows in December 2010, Management initially considered the entire discount to be nonaccretable. However, due to improvement in the status of some credits, some discount was transferred to accretable during 2012 and 2011. Cash flows received on these loans will be applied on a cost recovery method, whereby payments are applied first to the loan balance. When the loan balance is fully recovered, payments will then be applied to income. Any future reductions in carrying value as a result of deteriorating credit quality will require an allowance for loan losses related to these loans.

 

A summary of changes to the accretable and nonaccretable discounts during 2012 and 2011 are as follows:

 

(in thousands)  Accretable
Discount
   Nonaccretable
Discount
 
Balance, December 31, 2010  $-   $7,249 
Charge-offs related to loans covered by ASC 310-30   -    (5,037)
Transfer to accretable discount   922    (922)
Balance, December 31, 2011  $366   $1,290 
Charge-offs related to loans covered by ASC 310-30   -    (361)
Transfer to accretable discount   764    (764)
Discount accretion   (654)   - 
Balance, December 31, 2012  $476   $165 

 

RISK RATING PROCESS

 

On a quarterly basis, the process of estimating the Allowance for Loan Loss begins with Management’s review of the risk rating assigned to individual credits. Through this process, loans adversely risk rated are evaluated for impairment based on ASC 310-40.

 

Risk Grades

 

The following is a summary of the risk rating definitions the Bank uses to assign a risk grade to each loan within the portfolio:

 

Grade 1 - Highest Quality Loans have little to no risk and are generally secured by liquid collateral and/or a low loan-to-value ratio.
   
Grade 2 - Above Average Quality Loans have minimal risk to well qualified borrowers and no significant questions as to safety.
   
Grade 3 - Satisfactory Loans are satisfactory loans with financially sound borrowers and secondary sources of repayment.

 

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Grade 4 - Pass Loans are satisfactory loans with borrowers not as financially strong as risk grade 3 loans, but may exhibit a higher degree of financial risk based on the type of business supporting the loan.
   
Grade 5- Special Mention Loans to borrowers that exhibit potential credit weakness or a downward trend that warrant additional supervision. While potentially weak, the loan is currently marginally acceptable and no loss of principal or interest is envisioned.
   
Grade 6 – Substandard Borrowers with one or more well defined weaknesses that jeopardize the orderly liquidation of the debt. Normal repayment from the borrower is in jeopardy, although no loss of principal is envisioned. Possibility of loss or protracted workout exists if immediate corrective action is not taken.
   
Grade 7 – Doubtful Loans with all the weaknesses inherent in a Substandard classification, with the added provision that the weaknesses make collection of debt in full highly questionable and improbable, based on currently existing facts, conditions, and values. Serious problems exist to the point where a partial loss of principal is likely.
   
Grade 8 – Loss Borrower is deemed incapable of repayment of the entire principal. A Charge-off is required for the portion of principal management has deemed it will not be repaid.

 

The following is the distribution of loans by credit quality and class as of December 31, 2012 and 2011.

 

December 31, 2012  Commercial Real Estate       Consumer     
(In thousands)
Credit Quality by Class
  Acq-Dev
Construction
   Non-Owner
Occupied
   Owner
Occupied
   Commercial
and
Industrial
   Residential
Mortgage
   HELOC   Other   Total 
1 Highest Quality  $-   $-   $-   $-   $-   $-   $1   $1 
2 Above Average Quality   -    -    3,082    1,088    119    86    3    4,378 
3 Satisfactory   392    6,261    19,727    6,598    4,074    3,969    186    41,207 
4 Pass   319    13,094    9,649    12,215    1,844    2,263    69    39,453 
5 Special Mention   -    5,769    1,668    1,351    684    274    16    9,762 
6 Substandard   -    188    481    570    32    347    22    1.640 
7 Doubtful   -    -    -    -    -    552    -    552 
    711    25,312    34,607    21,822    6,753    7,491    297    96,993 
Loans acquired with deteriorating credit quality   2,602    5,435    4,963    1,666    507    904    -    16,077 
Total loans  $3,313   $30,747   $39,570   $23,488   $7,260   $8,395   $297   $113,070 

 

December 31, 2011  Commercial Real Estate       Consumer     
(In thousands)
Credit Quality by Class
  Acq-Dev
Construction
   Non-Owner
Occupied
   Owner
Occupied
   Commercial
and
Industrial
   Residential
Mortgage
   HELOC   Other   Total 
1 Highest Quality  $-   $-   $-   $47   $-   $-   $2   $49 
2 Above Average Quality   -    -    581    627    166    60    -    1,434 
3 Satisfactory   544    6,290    17,132    5,433    3,849    6,202    298    39,748 
4 Pass   119    9,548    5,339    4,801    1,945    2,040    187    23,979 
5 Special Mention   -    6,527    2,188    6,570    1,343    882    112    17,622 
6 Substandard   371    -    237    603    -    162    36    1,409 
7 Doubtful   -    -    -    -    -    24    -    24 
    1,034    22,365    25,477    18,081    7,303    9,370    635    84,265 
Loans acquired with deteriorating credit quality   5,031    8,279    6,313    1,411    700    928    20    22,682 
Total loans  $6,065   $30,644   $31,790   $19,492   $8,003   $10,298   $655   $106,947 

 

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A summary of the balances of loans outstanding by days past due, including accruing and non-accruing loans by portfolio class as of December 31, 2012 and 2011 was as follows:

 

    Commercial Real Estate           Consumer        

December 31, 2012

 

(In thousands)

  Acq-Dev
Construction
    Non-Owner
Occupied
    Owner
Occupied
    Commercial
and
Industrial
    Residential
Mortgage
    HELOC     Other     Total  
30-59 days   $ -     $ 480     $ -     $ 139     $ -     $ 30     $ -     $ 649  
60-89 days     -       -       -       -       -       -       -       -  
>90 days     420       -       2,599       740       180       739       -       4,678  
Total past due     420       480       2,599       879       180       769       -       5,327  
Current     2,893       30,267       36,971       22,609       7,080       7,626       297       107,743  
Total loans   $ 3,313     $ 30,747     $ 39,570     $ 23,488     $ 7,260     $ 8,395     $ 297     $ 113,070  
>90 days still accruing   $ -     $ -     $ -     $ -     $ -     $ -     $ -     $ -