EASTERN VIRGINIA BANKSHARES INC - FORM 10-Q

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EXCEL - IDEA: XBRL DOCUMENT - EASTERN VIRGINIA BANKSHARES INC	Financial_Report.xls
EX-32.1 - EXHIBIT 32.1 - EASTERN VIRGINIA BANKSHARES INC	v385238_ex32-1.htm
EX-31.2 - EXHIBIT 31.2 - EASTERN VIRGINIA BANKSHARES INC	v385238_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - EASTERN VIRGINIA BANKSHARES INC	v385238_ex31-1.htm
EX-32.2 - EXHIBIT 32.2 - EASTERN VIRGINIA BANKSHARES INC	v385238_ex32-2.htm

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

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

For the quarterly period ended June 30, 2014

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

For the transition period from ______________ to ______________

Commission File Number: 000-23565

EASTERN VIRGINIA BANKSHARES, INC.

(Exact name of registrant as specified in its charter)

VIRGINIA	54-1866052
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

330 Hospital Road, Tappahannock, Virginia	22560
(Address of principal executive offices)	(Zip Code)

(804) 443-8400

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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

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

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

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

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

The number of shares of the registrant’s Common Stock outstanding as of August 11, 2014 was 11,868,367.

EASTERN VIRGINIA BANKSHARES, INC.

INDEX

PART I.	FINANCIAL INFORMATION

Item 1.	Financial Statements

	Consolidated Balance Sheets as of June 30, 2014 (unaudited) and December 31, 2013	2

	Consolidated Statements of Income (unaudited) for the Three Months Ended June 30, 2014 and June 30, 2013	3

	Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Three Months Ended June 30, 2014 and June 30, 2013	4

	Consolidated Statements of Income (unaudited) for the Six Months Ended June 30, 2014 and June 30, 2013	5

	Consolidated Statements of Comprehensive Income (Loss) (unaudited) for the Six Months Ended June 30, 2014 and June 30, 2013	6

	Consolidated Statements of Shareholders’ Equity (unaudited) for the Six Months Ended June 30, 2014 and June 30, 2013	7

	Consolidated Statements of Cash Flows (unaudited) for the Six Months Ended June 30, 2014 and June 30, 2013	8

	Notes to the Interim Consolidated Financial Statements (unaudited)	9

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	68

Item 4.	Controls and Procedures	68

PART II.	OTHER INFORMATION

Item 1.	Legal Proceedings	69

Item 1A.	Risk Factors	69

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	69

Item 3.	Defaults Upon Senior Securities	69

Item 4.	Mine Safety Disclosures	69

Item 5.	Other Information	69

Item 6.	Exhibits	70

	SIGNATURES	71

PART I - FINANCIAL INFORMATION

Item 1. Financial Statements

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Balance Sheets

(dollars in thousands, except share and per share amounts)

	June 30, 2014			December 31, 2013
	(unaudited)
Assets:
Cash and due from banks	$	12,319		$	13,944
Interest bearing deposits with banks		3,603			5,402
Federal funds sold		641			-
Securities available for sale, at fair value		227,632			234,935
Securities held to maturity, at carrying value (fair value of $34,403 and $34,521, respectively)		34,077			35,495
Restricted securities, at cost		7,230			5,549
Loans, net of allowance for loan losses of $14,618 and $14,767, respectively		683,375			642,430
Deferred income taxes, net		15,530			18,937
Bank premises and equipment, net		21,525			21,446
Accrued interest receivable		3,762			3,893
Other real estate owned, net of valuation allowance of $108 and $254, respectively		601			800
Goodwill		15,970			15,970
Bank owned life insurance		21,432			21,158
Other assets		8,386			7,115
Total assets	$	1,056,083		$	1,027,074

Liabilities and Shareholders' Equity:
Liabilities
Noninterest-bearing demand accounts	$	139,066		$	126,861
Interest-bearing deposits		682,460			707,601
Total deposits		821,526			834,462
Federal funds purchased and repurchase agreements		3,482			3,009
Short-term borrowings		76,760			41,940
Trust preferred debt		10,310			10,310
Accrued interest payable		341			1,324
Other liabilities		2,904			3,080
Total liabilities		915,323			894,125

Shareholders' Equity
Preferred stock, $2 par value per share, authorized 10,000,000 shares, issued and outstanding:
Series A; $1,000 stated value per share, 24,000 shares fixed rate cumulative perpetual preferred		24,000			24,000
Series B; 5,240,192 shares non-voting mandatorily convertible non-cumulative preferred		10,480			10,480
Common stock, $2 par value per share, authorized 50,000,000 shares, issued and outstanding 11,862,367 including 58,400 and 73,500 nonvested shares in 2014 and 2013, respectively		23,608			23,578
Surplus		42,706			42,697
Retained earnings		43,232			39,581
Warrant		1,481			1,481
Accumulated other comprehensive loss, net		(4,747	)		(8,868	)
Total shareholders' equity		140,760			132,949

Total liabilities and shareholders' equity	$	1,056,083		$	1,027,074

The accompanying notes are an integral part of the consolidated financial statements.

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share amounts)

	Three Months Ended
	June 30,
	2014		2013
Interest and Dividend Income
Interest and fees on loans	$	8,562	$	9,052
Interest on investments:
Taxable interest income		1,338		1,307
Tax exempt interest income		204		151
Dividends		89		83
Interest on deposits with banks		4		40
Total interest and dividend income		10,197		10,633

Interest Expense
Deposits		978		1,226
Federal funds purchased and repurchase agreements		5		5
Short-term borrowings		36		-
Long-term borrowings		-		1,187
Trust preferred debt		88		87
Total interest expense		1,107		2,505
Net interest income		9,090		8,128
Provision for Loan Losses		-		600
Net interest income after provision for loan losses		9,090		7,528
Noninterest Income
Service charges and fees on deposit accounts		837		729
Debit/credit card fees		378		375
Gain on sale of available for sale securities, net		109		58
Gain on sale of bank premises and equipment		-		25
Other operating income		315		263
Total noninterest income		1,639		1,450
Noninterest Expenses
Salaries and employee benefits		4,748		4,146
Occupancy and equipment expenses		1,267		1,271
Telephone		211		310
FDIC expense		305		596
Consultant fees		279		213
Collection, repossession and other real estate owned		89		126
Marketing and advertising		270		246
Loss on sale of other real estate owned		28		118
Impairment losses on other real estate owned		6		133
Other operating expenses		1,316		1,046
Total noninterest expenses		8,519		8,205
Income before income taxes		2,210		773
Income Tax Expense		555		100
Net Income	$	1,655	$	673
Effective dividend on Series A Preferred Stock		541		376

Net income available to common shareholders	$	1,114	$	297
Income per common share: basic	$	0.10	$	0.04
Income per common share: diluted	$	0.06	$	0.04

The accompanying notes are an integral part of the consolidated financial statements.

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) (unaudited)

(dollars in thousands)

	Three Months Ended
	June 30,
	2014			2013
Net income	$	1,655		$	673
Other comprehensive income (loss), net of tax:
Unrealized securities gains (losses) arising during period (net of tax, $893 and $3,109, respectively)		1,732			(6,034	)
Amortization of unrealized losses on securities transferred from available for sale to held to maturity (net of tax, $26 and $0, respectively)		52			-
Less: reclassification adjustment for securities gains included in net income (net of tax, $37 and $20, respectively)		(72	)		(38	)
Other comprehensive income (loss)		1,712			(6,072	)
Comprehensive income (loss)	$	3,367		$	(5,399	)

The accompanying notes are an integral part of the consolidated financial statements.

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Income (unaudited)

(dollars in thousands, except per share amounts)

	Six Months Ended
	June 30,
	2014		2013
Interest and Dividend Income
Interest and fees on loans	$	17,112	$	18,008
Interest on investments:
Taxable interest income		2,845		2,729
Tax exempt interest income		417		239
Dividends		191		169
Interest on deposits with banks		8		65
Total interest and dividend income		20,573		21,210

Interest Expense
Deposits		1,965		2,500
Federal funds purchased and repurchase agreements		10		10
Short-term borrowings		71		-
Long-term borrowings		-		2,361
Trust preferred debt		176		174
Total interest expense		2,222		5,045
Net interest income		18,351		16,165
Provision for Loan Losses		250		1,200
Net interest income after provision for loan losses		18,101		14,965
Noninterest Income
Service charges and fees on deposit accounts		1,659		1,495
Debit/credit card fees		687		708
Gain on sale of available for sale securities, net		489		525
Gain on sale of bank premises and equipment		5		26
Other operating income		691		644
Total noninterest income		3,531		3,398
Noninterest Expenses
Salaries and employee benefits		9,334		8,295
Occupancy and equipment expenses		2,586		2,527
Telephone		422		565
FDIC expense		637		1,183
Consultant fees		622		429
Collection, repossession and other real estate owned		156		252
Marketing and advertising		437		480
Loss on sale of other real estate owned		15		155
Impairment losses on other real estate owned		11		143
Other operating expenses		2,477		2,132
Total noninterest expenses		16,697		16,161
Income before income taxes		4,935		2,202
Income Tax Expense		1,284		449
Net Income	$	3,651	$	1,753
Effective dividend on Series A Preferred Stock		1,059		752

Net income available to common shareholders	$	2,592	$	1,001
Income per common share: basic	$	0.22	$	0.15
Income per common share: diluted	$	0.15	$	0.14

The accompanying notes are an integral part of the consolidated financial statements.

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income (Loss) (unaudited)

(dollars in thousands)

	Six Months Ended
	June 30,
	2014			2013
Net income	$	3,651		$	1,753
Other comprehensive income (loss), net of tax:
Unrealized securities gains (losses) arising during period (net of tax, $2,248 and $3,192, respectively)		4,364			(6,197	)
Amortization of unrealized losses on securities transferred from available for sale to held to maturity (net of tax, $41 and $0, respectively)		80			-
Less: reclassification adjustment for securities gains included in net income (net of tax, $166 and $179, respectively)		(323	)		(346	)
Other comprehensive income (loss)		4,121			(6,543	)
Comprehensive income (loss)	$	7,772		$	(4,790	)

The accompanying notes are an integral part of the consolidated financial statements.

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Shareholders’ Equity (unaudited)

For the Six Months Ended June 30, 2014 and 2013

(dollars in thousands)

													Accumulated
			Preferred		Preferred								Other
	Common		Stock		Stock					Retained			Comprehensive
	Stock		Series A (1)		Series B		Surplus			Earnings			Income (Loss)			Total
Balance, December 31, 2012	$	12,060	$	25,177	$	-	$	19,521		$	42,517		$	436		$	99,711
Net income											1,753						1,753
Other comprehensive (loss)														(6,543	)		(6,543	)
Preferred stock discount				152							(152	)					-
Stock based compensation								14									14
Issuance of common stock in private placements		9,300						9,354									18,654
Issuance of preferred stock in private placements		-		-		10,480		11,080			-			-			21,560
Balance, June 30, 2013	$	21,360	$	25,329	$	10,480	$	39,969		$	44,118		$	(6,107	)	$	135,149

Balance, December 31, 2013	$	23,578	$	25,481	$	10,480	$	42,697		$	39,581		$	(8,868	)	$	132,949
Net income											3,651						3,651
Other comprehensive income														4,121			4,121
Stock based compensation								39									39
Restricted common stock vested		30		-		-		(30	)		-			-			-
Balance, June 30, 2014	$	23,608	$	25,481	$	10,480	$	42,706		$	43,232		$	(4,747	)	$	140,760

(1) For the purposes of this table, Preferred Stock Series A includes the effect of the warrant issued in connection with the sale of the Series A Preferred Stock and the discount on such preferred stock.

The accompanying notes are an integral part of the consolidated financial statements.

Eastern Virginia Bankshares, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (unaudited)

(dollars in thousands)

	Six Months Ended
	June 30,
	2014			2013
Operating Activities:
Net income	$	3,651		$	1,753
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		250			1,200
Depreciation and amortization		1,048			1,037
Stock based compensation		39			14
Net amortization of premiums and accretion of discounts on investment securities, net		1,626			2,199
(Gain) realized on securities available for sale transactions, net		(489	)		(525	)
(Gain) on sale of bank premises and equipment		(5	)		(26	)
Loss on sale of other real estate owned		15			155
Impairment losses on other real estate owned		11			143
Loss on LLC investments		23			11
Deferred income taxes		1,284			852
Net change in:
Accrued interest receivable		131			83
Other assets		(1,568	)		(613	)
Accrued interest payable		(983	)		125
Other liabilities		(176	)		401
Net cash provided by operating activities		4,857			6,809
Investing Activities:
Purchase of securities available for sale		(17,000	)		(57,631	)
Purchase of restricted securities		(5,228	)		-
Purchases of bank premises and equipment		(1,127	)		(834	)
Purchases of bank owned life insurance		-			(10,000	)
Net change in loans		(41,484	)		8,514
Proceeds from:
Maturities, calls, and paydowns of securities available for sale		9,053			14,772
Maturities, calls, and paydowns of securities held to maturity		1,248			-
Sales of securities available for sale		20,527			32,393
Sale of restricted securities		3,547			302
Sale of bank premises and equipment		5			26
Sale of other real estate owned		462			2,950
Net cash (used in) investing activities		(29,997	)		(9,508	)
Financing Activities:
Net change in:
Demand, interest-bearing demand and savings deposits		(13,723	)		10,847
Time deposits		787			(6,949	)
Federal funds purchased and repurchase agreements		473			389
Short-term borrowings		34,820			-
Net proceeds from issuance of common stock in private placements		-			18,654
Net proceeds from issuance of preferred stock in private placements		-			21,560
Net cash provided by financing activities		22,357			44,501
Net (decrease) increase in cash and cash equivalents		(2,783	)		41,802
Cash and cash equivalents, January 1		19,346			46,599
Cash and cash equivalents, June 30	$	16,563		$	88,401
Supplemental disclosure:
Interest paid	$	3,205		$	4,920
Supplemental disclosure of noncash investing and financing activities:
Unrealized gains (losses) on securities available for sale	$	6,123		$	(9,914	)
Loans transferred to other real estate owned	$	(289	)	$	(1,095	)

The accompanying notes are an integral part of the consolidated financial statements.

EASTERN VIRGINIA BANKSHARES, INC. AND SUBSIDIARIES

Notes to the Interim Consolidated Financial Statements

(unaudited)

Note 1. Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying unaudited consolidated financial statements of Eastern Virginia Bankshares, Inc. (the “Parent”) and its subsidiaries, EVB Statutory Trust I (the “Trust”), and EVB (the “Bank”) and its subsidiaries, are in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”) for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (“SEC”). Accordingly, these financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. Operating results for the three and six months ended June 30, 2014 are not necessarily indicative of the results that may be expected for the year ending December 31, 2014. These interim consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013 (the “2013 Form 10-K”).

The accompanying unaudited consolidated financial statements include the accounts of the Parent, the Bank and its subsidiaries, collectively referred to as the “Company.” All significant intercompany balances and transactions have been eliminated in consolidation. In addition, the Parent owns the Trust which is an unconsolidated subsidiary. The subordinated debt owed to the Trust is reported as a liability of the Parent.

Nature of Operations

Eastern Virginia Bankshares, Inc. is a bank holding company headquartered in Tappahannock, Virginia that was organized and chartered under the laws of the Commonwealth of Virginia on September 5, 1997 and commenced operations on December 29, 1997. The Company conducts its primary operations through its wholly-owned bank subsidiary, EVB. Two of EVB’s three predecessor banks, Bank of Northumberland, Inc. and Southside Bank, were established in 1910. The third bank, Hanover Bank, was established as a de novo bank in 2000. In April 2006, these three banks were merged and the surviving bank was re-branded as EVB. The Bank provides a full range of banking and related financial services to individuals and businesses through its network of retail branches. With twenty-one retail branches, the Bank serves diverse markets that primarily are in the counties of Essex, Gloucester, Hanover, Henrico, King and Queen, King William, Lancaster, Middlesex, New Kent, Richmond, Northumberland, Southampton, Surry, Sussex and the City of Colonial Heights. The Bank operates under a state bank charter and as such is subject to regulation by the Virginia State Corporation Commission Bureau of Financial Institutions (the “Bureau”) and the Board of Governors of the Federal Reserve System (the “Federal Reserve”).

The Bank owns EVB Financial Services, Inc., which in turn has a 100% ownership interest in EVB Investments, Inc. and through March 31, 2011 a 50% ownership interest in EVB Mortgage, LLC. EVB Investments, Inc. is a full-service brokerage firm offering a comprehensive range of investment services. EVB Mortgage, LLC was formed to originate and sell residential mortgages. Due to the uncertainties surrounding potential regulatory pressures regarding the origination and funding of mortgage loans on one to four family residences, the Company decided in March 2011 to cease the operations of EVB Mortgage, LLC as a joint venture with Southern Trust Mortgage, LLC. On April 1, 2011, the Company entered into an independent contractor agreement with Southern Trust Mortgage, LLC. Under the terms of this agreement, the Company advises and consults with Southern Trust Mortgage, LLC and facilitates the marketing and brand recognition of their mortgage business. In addition, the Company provides Southern Trust Mortgage, LLC with offices at five retail branches in the Company’s market area and access to office equipment at these locations during normal business hours. For its services, the Company receives fixed monthly compensation from Southern Trust Mortgage, LLC in the amount of $1 thousand, which is adjustable on a quarterly basis. On May 15, 2014, the Bank acquired a 4.9% ownership interest in Southern Trust Mortgage, LLC.

The Bank had a 75% ownership interest in EVB Title, LLC, which primarily sold title insurance to the mortgage loan customers of the Bank and EVB Mortgage, LLC. Effective January 2014, the Bank ceased operations of EVB Title, LLC due to low volume and profitability. The Bank has a 2.33% ownership in Bankers Insurance, LLC, which primarily sells insurance products to customers of the Bank, and other financial institutions that have an equity interest in the agency. The Bank also has a 100% ownership interest in Dunston Hall LLC, POS LLC, Tartan Holdings LLC and ECU-RE LLC which were formed to hold the title to real estate acquired by the Bank upon foreclosure on property of real estate secured loans. The financial position and operating results of all of these subsidiaries are not significant to the Company as a whole and are not considered principal activities of the Company at this time. The Parent’s stock trades on the NASDAQ Global Select Market under the symbol “EVBS.”

Basis of Presentation

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, impairment of loans, impairment of securities, the valuation of other real estate owned, the projected benefit obligation under the defined benefit pension plan, the valuation of deferred taxes, goodwill impairment and fair value of financial instruments. In the opinion of management, all adjustments, consisting only of normal recurring adjustments, which are necessary for a fair presentation of the results of operations in these interim financial statements, have been made. Certain prior year amounts have been reclassified to conform to the 2014 presentation. These reclassifications have no effect on previously reported net income.

Recent Accounting Pronouncements

In January 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-01, “Investments—Equity Method and Joint Ventures (Topic 323): Accounting for Investments in Qualified Affordable Housing Projects (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. Under the proportional amortization method, an entity amortizes the initial cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense (benefit). The amendments in this ASU should be applied retrospectively to all periods presented. A reporting entity that uses the effective yield method to account for its investments in qualified affordable housing projects before the date of adoption may continue to apply the effective yield method for those preexisting investments. The amendments in this ASU are effective for public business entities for annual periods and interim reporting periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-01 to have a material impact on its consolidated financial statements.

In January 2014, the FASB issued ASU 2014-04, “Receivables—Troubled Debt Restructurings by Creditors (Subtopic 310-40): Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure (a consensus of the FASB Emerging Issues Task Force).” The amendments in this ASU clarify that an in substance repossession or foreclosure occurs, and a creditor is considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan, upon either (1) the creditor obtaining legal title to the residential real estate property upon completion of a foreclosure or (2) the borrower conveying all interest in the residential real estate property to the creditor to satisfy that loan through completion of a deed in lieu of foreclosure or through a similar legal agreement. Additionally, the amendments require interim and annual disclosure of both (1) the amount of foreclosed residential real estate property held by the creditor and (2) the recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure according to local requirements of the applicable jurisdiction. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. The Company is currently assessing the impact that ASU 2014-04 will have on its consolidated financial statements.

In April 2014, the FASB issued ASU 2014-08, “Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity.” The amendments in this ASU change the criteria for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization’s operations and financial results and include disposals of a major geographic area, a major line of business, or a major equity method investment. The new guidance requires expanded disclosures about discontinued operations that will provide financial statement users with more information about the assets, liabilities, income, and expenses of discontinued operations. Additionally, the new guidance requires disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. The amendments in the ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2014. Early adoption is permitted. The Company does not expect the adoption of ASU 2014-08 to have a material impact on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-09, “Revenue from Contracts with Customers (Topic 606).” This ASU applies to any entity using U.S. GAAP that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards. The guidance supersedes the revenue recognition requirements in “Revenue Recognition (Topic 605),” most industry-specific guidance, and some cost guidance included in “Revenue Recognition—Construction-Type and Production-Type Contracts (Subtopic 605-35).” The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. To be in alignment with the core principle, an entity must apply a five step process including: identification of the contract(s) with a customer, identification of performance obligations in the contract(s), determination of the transaction price, allocation of the transaction price to the performance obligations, and recognition of revenue when (or as) the entity satisfies a performance obligation. Additionally, the existing requirements for the recognition of a gain or loss on the transfer of nonfinancial assets that are not in a contract with a customer have also been amended to be consistent with the guidance on recognition and measurement. The amendments in this ASU are effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-09 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-11, “Transfers and Servicing (Topic 860): Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures.” This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements. The new guidance eliminates sale accounting for repurchase-to-maturity transactions and supersedes the guidance under which a transfer of a financial asset and a contemporaneous repurchase financing could be accounted for on a combined basis as a forward agreement. The amendments in the ASU also require a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. Additional disclosures will be required for the nature of collateral pledged in repurchase agreements and similar transactions accounted for as secured borrowings. The amendments in this ASU are effective for the first interim or annual period beginning after December 15, 2014. However, the disclosure for transactions accounted for as secured borrowings is required to be presented for annual periods beginning after December 15, 2014, and interim periods beginning after March 15, 2015. Early adoption is not permitted. The Company is currently assessing the impact that ASU 2014-11 will have on its consolidated financial statements.

In June 2014, the FASB issued ASU 2014-12, “Compensation – Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” The new guidance applies to reporting entities that grant employees share-based payments in which the terms of the award allow a performance target to be achieved after the requisite service period. The amendments in the ASU require that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. Existing guidance in “Compensation – Stock Compensation (Topic 718)” should be applied to account for these types of awards. The amendments in this ASU are effective for annual periods and interim periods within those annual periods beginning after December 15, 2015. Early adoption is permitted, and reporting entities may choose to apply the amendments in the ASU either on a prospective or retrospective basis. The Company is currently assessing the impact that ASU 2014-12 will have on its consolidated financial statements.

Note 2. Investment Securities

The amortized cost and estimated fair value, with gross unrealized gains and losses, of securities at June 30, 2014 and December 31, 2013 were as follows:

(dollars in thousands)	June 30, 2014
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
Available for Sale:	Cost		Gains		Losses		Value
Obligations of U.S. Government agencies	$	14,990	$	-	$	915	$	14,075
SBA Pool securities		86,790		22		2,386		84,426
Agency mortgage-backed securities		30,897		156		566		30,487
Agency CMO securities		44,076		154		938		43,292
Non agency CMO securities		1,041		-		4		1,037
State and political subdivisions		55,010		416		2,035		53,391
Pooled trust preferred securities		456		292		-		748
FNMA and FHLMC preferred stock		10		166		-		176
Total	$	233,270	$	1,206	$	6,844	$	227,632

(dollars in thousands)	December 31, 2013
			Gross		Gross		Estimated
	Amortized		Unrealized		Unrealized		Fair
Available for Sale:	Cost		Gains		Losses		Value
Obligations of U.S. Government agencies	$	14,989	$	-	$	1,599	$	13,390
SBA Pool securities		89,531		35		3,531		86,035
Agency mortgage-backed securities		36,261		104		1,111		35,254
Agency CMO securities		43,277		62		1,961		41,378
Non agency CMO securities*		1,304		2		-		1,306
State and political subdivisions		60,834		177		4,669		56,342
Pooled trust preferred securities		467		282		-		749
FNMA and FHLMC preferred stock		22		459		-		481
Total	$	246,685	$	1,121	$	12,871	$	234,935

*The combined unrealized loss on these securities was less than $1.

(dollars in thousands)	June 30, 2014
			Unrealized
			Losses				Gross		Gross		Estimated
	Amortized		Recorded		Carrying		Unrealized		Unrealized		Fair
Held to Maturity:	Cost		in AOCI*		Value		Gains		Losses		Value
Agency CMO securities	$	12,346	$	90	$	12,256	$	104	$	26	$	12,334
State and political subdivisions		22,580		759		21,821		303		55		22,069
Total	$	34,926	$	849	$	34,077	$	407	$	81	$	34,403

*Represents the unrealized holding gain or loss at the date of transfer from available for sale to held to maturity, net of any accretion.

(dollars in thousands)	December 31, 2013
			Unrealized
			Losses				Gross		Gross		Estimated
	Amortized		Recorded		Carrying		Unrealized		Unrealized		Fair
Held to Maturity:	Cost		in AOCI*		Value		Gains		Losses		Value
Agency CMO securities	$	12,598	$	98	$	12,500	$	-	$	547	$	11,953
State and political subdivisions		23,867		872		22,995		4		431		22,568
Total	$	36,465	$	970	$	35,495	$	4	$	978	$	34,521

*Represents the unrealized holding gain or loss at the date of transfer from available for sale to held to maturity, net of any accretion.

There are no securities classified as “Trading” at June 30, 2014 or December 31, 2013. During the fourth quarter of 2013, the Company transferred securities with an amortized cost of $35.5 million, previously designated as “Available for Sale”, to “Held to Maturity” classification. The fair value of those securities as of the date of the transfer was $34.5 million, reflecting a gross unrealized loss of $994 thousand. The gross unrealized loss was recorded in Accumulated Other Comprehensive Income and is being amortized over the remaining life of the securities as an adjustment to interest income, beginning during the fourth quarter of 2013. The Company’s mortgage-backed securities consist entirely of residential mortgage-backed securities. The Company does not hold any commercial mortgage-backed securities. The Company’s mortgage-backed securities all have a guaranty of principal payment by an agency of, or an agency sponsored by, the U.S. government and are rated Aaa and AA+ by Moody and S&P, respectively, with no subprime issues.

The Company’s pooled trust preferred securities include one senior issue of Preferred Term Securities XXVII which is current on all payments and on which the Company took an impairment charge in the third quarter of 2009 to reduce the Company’s book value to the market value at September 30, 2009. As of June 30, 2014, that security has an estimated fair value that is $292 thousand greater than its amortized cost after impairment. During the second quarter of 2010, the Company recognized an impairment charge in the amount of $77 thousand on the Company’s investment in Preferred Term Securities XXIII mezzanine tranche, thus reducing the book value of this investment to $0. The decision to recognize the other-than-temporary impairment was based upon an analysis of the market value of the discounted cash flow for the security as provided by Moody’s at June 30, 2010, which indicated that the Company was unlikely to recover any of its remaining investment in these securities.

The amortized cost, carrying value and estimated fair values of securities at June 30, 2014, by the earlier of contractual maturity or expected maturity, are shown below. Expected maturities may differ from contractual maturities because issuers may have the right to call or prepay obligations without penalties.

(dollars in thousands)	June 30, 2014
Available for Sale:	Amortized Cost		Estimated Fair Value

Due in one year or less	$	4,558	$	4,271
Due after one year through five years		50,405		50,335
Due after five years through ten years		152,322		147,189
Due after ten years		25,985		25,837
Total	$	233,270	$	227,632

(dollars in thousands)	June 30, 2014
Held to Maturity:	Carrying Value		Estimated Fair Value

Due in one year or less	$	-	$	-
Due after one year through five years		9,696		9,756
Due after five years through ten years		23,634		23,887
Due after ten years		747		760
Total	$	34,077	$	34,403

Proceeds from the sales of securities available for sale for the six months ended June 30, 2014 and 2013 were $20.5 million and $32.4 million, respectively. Net realized gains on the sales of securities available for sale for the six months ended June 30, 2014 and 2013 were $489 thousand and $525 thousand, respectively. Proceeds from maturities, calls and paydowns of securities available for sale for the six months ended June 30, 2014 and 2013 were $9.1 million and $14.8 million, respectively. Proceeds from maturities, calls and paydowns of securities held to maturity for the six months ended June 30, 2014 were $1.2 million. There were no securities classified as held to maturity for the six months ended June 30, 2013.

The Company pledges securities to secure public deposits, balances with the Federal Reserve Bank of Richmond (the “Reserve Bank”) and repurchase agreements. Securities with an aggregate book value of $53.9 million and an aggregate fair value of $53.8 million were pledged at June 30, 2014. Securities with an aggregate book value of $88.8 million and an aggregate fair value of $85.0 million were pledged at December 31, 2013.

Securities in an unrealized loss position at June 30, 2014, by duration of the period of the unrealized loss, are shown below:

	June 30, 2014
(dollars in thousands)	Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
Obligations of U.S. Government agencies	$	-	$	-	$	14,075	$	915	$	14,075	$	915
SBA Pool securities		11,336		121		68,127		2,265		79,463		2,386
Agency mortgage-backed securities		3,188		119		14,463		447		17,651		566
Agency CMO securities		23,562		338		15,254		626		38,816		964
Non agency CMO securities		346		3		56		1		402		4
State and political subdivisions		5,684		58		40,659		2,032		46,343		2,090
Total	$	44,116	$	639	$	152,634	$	6,286	$	196,750	$	6,925

The Company reviews the investment securities portfolio on a quarterly basis to monitor its exposure to other-than-temporary impairment that may result due to adverse economic conditions and associated credit deterioration. A determination as to whether a security’s decline in market value is other-than-temporary takes into consideration numerous factors and the relative significance of any single factor can vary by security. Some factors the Company may consider in the other-than-temporary impairment analysis include the length of time the security has been in an unrealized loss position, changes in security ratings, financial condition of the issuer, as well as security and industry specific economic conditions. In addition, the Company may also evaluate payment structure, whether there are defaulted payments or expected defaults, prepayment speeds, and the value of any underlying collateral. For certain securities in unrealized loss positions, the Company will enlist independent third-party firms to prepare cash flow analyses to compare the present value of cash flows expected to be collected from the security with the amortized cost basis of the security.

Based on the Company’s evaluation, management does not believe any unrealized loss at June 30, 2014, represents an other-than-temporary impairment as these unrealized losses are primarily attributable to current financial market conditions for these types of investments, particularly changes in interest rates, which rose during 2013 causing bond prices to decline, and are not attributable to credit deterioration. During the first six months of 2014, interest rates have fallen, specifically in the middle and long-end of the yield curve, which has caused bond prices to rise and thereby reduced the amount of unrealized losses. At June 30, 2014, there are 150 debt securities with fair values totaling $196.8 million considered temporarily impaired. Of these debt securities, 34 with fair values totaling $44.1 million were in an unrealized loss position of less than 12 months and 116 with fair values totaling $152.7 million were in an unrealized loss position of 12 months or more. Because the Company intends to hold these investments in debt securities until recovery of the amortized cost basis and it is more likely than not that the Company will not be required to sell these investments before a recovery of unrealized losses, the Company does not consider these investments to be other-than-temporarily impaired at June 30, 2014 and no impairment has been recognized. At June 30, 2014, there are no equity securities in an unrealized loss position.

Securities in an unrealized loss position at December 31, 2013, by duration of the period of the unrealized loss, are shown below.

	December 31, 2013
(dollars in thousands)	Less than 12 months				12 months or more				Total
	Fair		Unrealized		Fair		Unrealized		Fair		Unrealized
Description of Securities	Value		Loss		Value		Loss		Value		Loss
Obligations of U.S. Government agencies	$	5,436	$	558	$	7,954	$	1,041	$	13,390	$	1,599
SBA Pool securities		68,163		3,131		11,156		400		79,319		3,531
Agency mortgage-backed securities		21,834		863		4,172		248		26,006		1,111
Agency CMO securities		39,860		1,962		7,788		546		47,648		2,508
Non agency CMO securities*		67		-		-		-		67		-
State and political subdivisions		61,316		3,455		11,855		1,645		73,171		5,100
Total	$	196,676	$	9,969	$	42,925	$	3,880	$	239,601	$	13,849

*The combined unrealized loss on these securities was less than $1.

The table below presents a roll forward of the credit loss component recognized in earnings (referred to as “credit-impaired debt securities”) on debt securities held by the Company for which a portion of an other-than-temporary impairment was recognized in other comprehensive income during 2009. Changes in the credit loss component of credit-impaired debt securities were:

	Six Months Ending
(dollars in thousands)	June 30, 2014
Balance, beginning of period	$	339
Additions
Initial credit impairments		-
Subsequent credit impairments		-
Reductions
Subsequent chargeoff of previously impaired credits		-
Balance, end of period	$	339

The Company’s investment in Federal Home Loan Bank of Atlanta (“FHLB”) stock totaled $4.5 million and $3.2 million at June 30, 2014 and December 31, 2013, respectively. FHLB stock is generally viewed as a long-term investment and as a restricted investment security, which is carried at cost, because there is no market for the stock other than the FHLBs or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on the ultimate recoverability of the par value rather than by recognizing temporary declines in value. Because the FHLB generated positive net income for each quarterly period beginning July 1, 2013, and ending June 30, 2014, the Company does not consider this investment to be other-than-temporarily impaired at June 30, 2014 and no impairment has been recognized. FHLB stock is included in a separate line item on the consolidated balance sheets (Restricted securities, at cost) and is not part of the Company’s securities available for sale portfolio. The Company’s restricted securities also include investments in the Reserve Bank and Community Bankers Bank, which are carried at cost.

Note 3. Loan Portfolio

The following table sets forth the composition of the Company’s loan portfolio in dollar amounts and as a percentage of the Company’s total gross loans at the dates indicated:

	June 30, 2014						December 31, 2013
(dollars in thousands)	Amount			Percent			Amount			Percent
Commercial, industrial and agricultural	$	56,991			8.16	%	$	53,673			8.17	%
Real estate - one to four family residential:
Closed end first and seconds		240,805			34.50	%		218,472			33.25	%
Home equity lines		97,572			13.98	%		99,839			15.19	%
Total real estate - one to four family residential		338,377			48.48	%		318,311			48.44	%
Real estate - multifamily residential		19,932			2.86	%		18,077			2.75	%
Real estate - construction:
One to four family residential		17,168			2.46	%		16,169			2.46	%
Other construction, land development and other land		24,827			3.56	%		21,690			3.30	%
Total real estate - construction		41,995			6.02	%		37,859			5.76	%
Real estate - farmland		7,207			1.03	%		8,172			1.24	%
Real estate - non-farm, non-residential:
Owner occupied		128,322			18.38	%		126,569			19.26	%
Non-owner occupied		75,804			10.86	%		74,831			11.39	%
Total real estate - non-farm, non-residential		204,126			29.24	%		201,400			30.65	%
Consumer		15,125			2.17	%		16,782			2.55	%
Other		14,240			2.04	%		2,923			0.44	%
Total loans		697,993			100.00	%		657,197			100.00	%
Less allowance for loan losses		(14,618	)					(14,767	)
Loans, net	$	683,375					$	642,430

The following table presents the aging of the recorded investment in past due loans as of June 30, 2014 by class of loans:

(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Total Current*		Total Loans
Commercial, industrial and agricultural	$	71	$	8	$	139	$	218	$	56,773	$	56,991
Real estate - one to four family residential:
Closed end first and seconds		6,310		967		1,870		9,147		231,658		240,805
Home equity lines		563		194		331		1,088		96,484		97,572
Total real estate - one to four family residential		6,873		1,161		2,201		10,235		328,142		338,377
Real estate - multifamily residential		-		-		-		-		19,932		19,932
Real estate - construction:
One to four family residential		288		-		132		420		16,748		17,168
Other construction, land development and other land		10		-		-		10		24,817		24,827
Total real estate - construction		298		-		132		430		41,565		41,995
Real estate - farmland		-		-		590		590		6,617		7,207
Real estate - non-farm, non-residential:
Owner occupied		198		37		2,060		2,295		126,027		128,322
Non-owner occupied		-		-		623		623		75,181		75,804
Total real estate - non-farm, non-residential		198		37		2,683		2,918		201,208		204,126
Consumer		122		16		65		203		14,922		15,125
Other		5		-		-		5		14,235		14,240
Total loans	$	7,567	$	1,222	$	5,810	$	14,599	$	683,394	$	697,993

* For purposes of this table only, the "Total Current" column includes loans that are 1-29 days past due.

The following table presents the aging of the recorded investment in past due loans as of December 31, 2013 by class of loans:

(dollars in thousands)	30-59 Days Past Due		60-89 Days Past Due		Over 90 Days Past Due		Total Past Due		Total Current*		Total Loans
Commercial, industrial and agricultural	$	2,083	$	170	$	383	$	2,636	$	51,037	$	53,673
Real estate - one to four family residential:
Closed end first and seconds		6,217		1,513		2,564		10,294		208,178		218,472
Home equity lines		700		303		353		1,356		98,483		99,839
Total real estate - one to four family residential		6,917		1,816		2,917		11,650		306,661		318,311
Real estate - multifamily residential		-		-		-		-		18,077		18,077
Real estate - construction:
One to four family residential		112		176		132		420		15,749		16,169
Other construction, land development and other land		167		-		137		304		21,386		21,690
Total real estate - construction		279		176		269		724		37,135		37,859
Real estate - farmland		808		-		590		1,398		6,774		8,172
Real estate - non-farm, non-residential:
Owner occupied		2,933		-		3,074		6,007		120,562		126,569
Non-owner occupied		1,779		-		23		1,802		73,029		74,831
Total real estate - non-farm, non-residential		4,712		-		3,097		7,809		193,591		201,400
Consumer		283		21		166		470		16,312		16,782
Other		7		-		-		7		2,916		2,923
Total loans	$	15,089	$	2,183	$	7,422	$	24,694	$	632,503	$	657,197

* For purposes of this table only, the "Total Current" column includes loans that are 1-29 days past due.

The following table presents nonaccrual loans, loans past due 90 days and accruing interest, and restructured loans at the dates indicated:

	June 30,		December 31,
(dollars in thousands)	2014		2013
Nonaccrual loans	$	9,770	$	11,018
Loans past due 90 days and accruing interest		-		-
Restructured loans (accruing)		16,383		16,026

At June 30, 2014 and December 31, 2013, there were approximately $4.0 million and $4.2 million, respectively, in troubled debt restructurings (“TDRs”) included in nonaccrual loans.

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 to cover the principal and interest. If a loan or a portion of a loan 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 collectability of principal or interest on loans, it is management’s practice to place such loans on a 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. These policies are applied consistently across our loan portfolio.

Loans may be returned to accrual status when all principal and interest amounts contractually due (including arrearages) are reasonably assured of repayment within an acceptable period of time, and there is a sustained period of repayment performance by the borrower, in accordance with the contractual terms of interest and principal.

The following table presents the recorded investment in nonaccrual loans by class at June 30, 2014 and December 31, 2013:

	Nonaccrual
	June 30,		December 31,
(dollars in thousands)	2014		2013
Commercial, industrial and agricultural	$	139	$	383
Real estate - one to four family residential:
Closed end first and seconds		4,411		5,630
Home equity lines		506		688
Total real estate - one to four family residential		4,917		6,318
Real estate - construction:
One to four family residential		132		318
Other construction, land development and other land		-		137
Total real estate - construction		132		455
Real estate - farmland		590		590
Real estate - non-farm, non-residential:
Owner occupied		2,914		3,074
Non-owner occupied		623		23
Total real estate - non-farm, non-residential		3,537		3,097
Consumer		455		175
Total loans	$	9,770	$	11,018

At June 30, 2014 and December 31, 2013, the Company did not have any loans past due 90 days and accruing interest.

The Company uses a risk grading system for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans. Loans are graded on a scale from 1 to 9. Non-impaired real estate and commercial loans are assigned an allowance factor which increases with the severity of risk grading. A general description of the characteristics of the risk grades is as follows:

Pass Grades

Risk Grade 1 loans have little or no risk and are generally secured by cash or cash equivalents;

Risk Grade 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;

Risk Grade 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;

Risk Grade 4 loans are satisfactory loans with borrowers not as strong as risk grade 3 loans but may exhibit a higher degree of financial risk based on the type of business supporting the loan; and

Risk Grade 5 loans are loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay.

Special Mention

Risk Grade 6 loans have increasing potential weaknesses beyond those at which the loan originally was granted and if not addressed could lead to inadequately protecting the Company’s credit position.

Classified Grades

Risk Grade 7 loans are substandard loans and are inadequately protected by the current sound worth or paying capacity of the obligor or the collateral pledged. These have well defined weaknesses that jeopardize the liquidation of the debt with the distinct possibility the Company will sustain some loss if the deficiencies are not corrected;

Risk Grade 8 loans are doubtful of collection and the possibility of loss is high but pending specific borrower plans for recovery, its classification as a loss is deferred until its more exact status is determined; and

Risk Grade 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as a bank asset is not warranted.

The Company uses a past due grading system for consumer loans, including one to four family residential first and seconds and home equity lines. The past due status of a loan is based on the contractual due date of the most delinquent payment due. The past due grading of consumer loans is based on 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. The consumer loans are segregated between performing and nonperforming loans. Performing loans are those that have made timely payments in accordance with the terms of the loan agreement and are not past due 90 days or more. Nonperforming loans are those that do not accrue interest, are greater than 90 days past due and accruing interest or considered impaired. Non-impaired consumer loans are assigned an allowance factor which increases with the severity of past due status. This component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the loan portfolio.

The allocation methodology applied by the Company includes management’s ongoing review and grading of the loan portfolio into criticized loan categories (defined as specific loans warranting either specific allocation, or a classified status of substandard, doubtful or loss). The allocation methodology focuses on evaluation of several factors, including but not limited to: evaluation of facts and issues related to specific loans, management’s ongoing review and grading of the loan portfolio, consideration of migration analysis and delinquency experience on each portfolio category, trends in past due and nonaccrual loans, the level of classified loans, the risk characteristics of the various classifications of loans, changes in the size and character of the loan portfolio, concentrations of loans to specific borrowers or industries, existing economic conditions, the fair value of underlying collateral, and other qualitative and quantitative factors which could affect potential credit losses. Because each of the criteria used is subject to change, the allocation of the allowance for loan losses is made for analytical purposes and is not necessarily indicative of the trend of future loan losses in any particular loan category. The total allowance is available to absorb losses from any segment of the portfolio. In determining the allowance for loan losses, the Company considers its portfolio segments and loan classes to be the same.

The following table presents commercial loans by credit quality indicator at June 30, 2014:

(dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Impaired		Total
Commercial, industrial and agricultural	$	49,473	$	2,407	$	2,847	$	84	$	2,180	$	56,991
Real estate - multifamily residential		19,932		-		-		-		-		19,932
Real estate - construction:
One to four family residential		16,290		229		350		-		299		17,168
Other construction, land development and other land		8,445		3,896		6,825		-		5,661		24,827
Total real estate - construction		24,735		4,125		7,175		-		5,960		41,995
Real estate - farmland		6,284		333		590		-		-		7,207
Real estate - non-farm, non-residential:
Owner occupied		93,515		8,276		12,121		-		14,410		128,322
Non-owner occupied		52,355		6,079		7,008		-		10,362		75,804
Total real estate - non-farm, non-residential		145,870		14,355		19,129		-		24,772		204,126
Total commercial loans	$	246,294	$	21,220	$	29,741	$	84	$	32,912	$	330,251

The following table presents commercial loans by credit quality indicator at December 31, 2013:

(dollars in thousands)	Pass		Special Mention		Substandard		Doubtful		Impaired		Total
Commercial, industrial and agricultural	$	44,571	$	3,851	$	3,229	$	22	$	2,000	$	53,673
Real estate - multifamily residential		18,077		-		-		-		-		18,077
Real estate - construction:
One to four family residential		14,890		235		738		-		306		16,169
Other construction, land development and other land		6,638		7,104		4,634		-		3,314		21,690
Total real estate - construction		21,528		7,339		5,372		-		3,620		37,859
Real estate - farmland		6,288		338		1,068		-		478		8,172
Real estate - non-farm, non-residential:
Owner occupied		87,187		13,341		15,983		-		10,058		126,569
Non-owner occupied		43,406		15,533		7,520		-		8,372		74,831
Total real estate - non-farm, non-residential		130,593		28,874		23,503		-		18,430		201,400
Total commercial loans	$	221,057	$	40,402	$	33,172	$	22	$	24,528	$	319,181

At June 30, 2014 and December 31, 2013, the Company did not have any loans classified as Loss.

The following table presents consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at June 30, 2014:

(dollars in thousands)	Performing		Nonperforming		Total
Real estate - one to four family residential:
Closed end first and seconds	$	228,954	$	11,851	$	240,805
Home equity lines		96,824		748		97,572
Total real estate - one to four family residential		325,778		12,599		338,377
Consumer		14,678		447		15,125
Other		13,775		465		14,240
Total consumer loans	$	354,231	$	13,511	$	367,742

The following table presents consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at December 31, 2013:

(dollars in thousands)	Performing		Nonperforming		Total
Real estate - one to four family residential:
Closed end first and seconds	$	205,860	$	12,612	$	218,472
Home equity lines		99,311		528		99,839
Total real estate - one to four family residential		305,171		13,140		318,311
Consumer		16,314		468		16,782
Other		2,451		472		2,923
Total consumer loans	$	323,936	$	14,080	$	338,016

The Company measures impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are considered impaired loans. TDRs occur when we agree to modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions can be temporary and are made in an attempt to avoid foreclosure and with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated. These concessions could include, without limitation, rate reductions to below market rates, payment deferrals, forbearance, and, in some cases, forgiveness of principal or interest.

At the time of a TDR, the loan is placed on nonaccrual status. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance (typically six months) in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed.

The following table presents a rollforward of the Company’s allowance for loan losses for the six months ended June 30, 2014:

	Beginning Balance										Ending Balance
(dollars in thousands)	January 1, 2014		Charge-offs			Recoveries		Provision			June 30, 2014
Commercial, industrial and agricultural	$	1,787	$	(290	)	$	30	$	(331	)	$	1,196
Real estate - one to four family residential:
Closed end first and seconds		2,859		(304	)		211		(188	)		2,578
Home equity lines		1,642		(54	)		13		244			1,845
Total real estate - one to four family residential		4,501		(358	)		224		56			4,423
Real estate - multifamily residential		79		-			-		29			108
Real estate - construction:
One to four family residential		364		-			6		(69	)		301
Other construction, land development and other land		1,989		-			2		501			2,492
Total real estate - construction		2,353		-			8		432			2,793
Real estate - farmland		116		-			-		11			127
Real estate - non-farm, non-residential:
Owner occupied		3,236		-			27		(1,144	)		2,119
Non-owner occupied		1,770		-			3		855			2,628
Total real estate - non-farm, non-residential		5,006		-			30		(289	)		4,747
Consumer		387		(86	)		55		(1	)		355
Other		538		(26	)		14		343			869
Total	$	14,767	$	(760	)	$	361	$	250		$	14,618

The following table presents a rollforward of the Company’s allowance for loan losses for the six months ended June 30, 2013:

	Beginning Balance										Ending Balance
(dollars in thousands)	January 1, 2013		Charge-offs			Recoveries		Provision			June 30, 2013
Commercial, industrial and agricultural	$	2,340	$	(559	)	$	102	$	485		$	2,368
Real estate - one to four family residential:
Closed end first and seconds		2,876		(269	)		33		523			3,163
Home equity lines		720		(58	)		1		105			768
Total real estate - one to four family residential		3,596		(327	)		34		628			3,931
Real estate - multifamily residential		62		-			-		(2	)		60
Real estate - construction:
One to four family residential		419		(51	)		31		(106	)		293
Other construction, land development and other land		3,897		(950	)		67		(694	)		2,320
Total real estate - construction		4,316		(1,001	)		98		(800	)		2,613
Real estate - farmland		41		-			-		(11	)		30
Real estate - non-farm, non-residential:
Owner occupied		5,092		(449	)		-		562			5,205
Non-owner occupied		4,093		(1,534	)		-		234			2,793
Total real estate - non-farm, non-residential		9,185		(1,983	)		-		796			7,998
Consumer		215		(75	)		58		46			244
Other		583		(72	)		20		58			589
Total	$	20,338	$	(4,017	)	$	312	$	1,200		$	17,833

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class based on impairment method as of June 30, 2014:

	Allowance allocated to loans:						Total Loans:
(dollars in thousands)	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total
Commercial, industrial and agricultural	$	42	$	1,154	$	1,196	$	2,180	$	54,811	$	56,991
Real estate - one to four family residential:
Closed end first and seconds		1,416		1,162		2,578		9,981		230,824		240,805
Home equity lines		-		1,845		1,845		417		97,155		97,572
Total real estate - one to four family residential		1,416		3,007		4,423		10,398		327,979		338,377
Real estate - multifamily residential		-		108		108		-		19,932		19,932
Real estate - construction:
One to four family residential		173		128		301		299		16,869		17,168
Other construction, land development and other land		1,382		1,110		2,492		5,661		19,166		24,827
Total real estate - construction		1,555		1,238		2,793		5,960		36,035		41,995
Real estate - farmland		-		127		127		-		7,207		7,207
Real estate - non-farm, non-residential:
Owner occupied		944		1,175		2,119		14,410		113,912		128,322
Non-owner occupied		1,648		980		2,628		10,362		65,442		75,804
Total real estate - non-farm, non-residential		2,592		2,155		4,747		24,772		179,354		204,126
Consumer		114		241		355		382		14,743		15,125
Other		302		567		869		465		13,775		14,240
Total	$	6,021	$	8,597	$	14,618	$	44,157	$	653,836	$	697,993

The following table presents the balance in the allowance for loan losses and the recorded investment in loans by portfolio class based on impairment method as of December 31, 2013:

	Allowance allocated to loans:						Total Loans:
(dollars in thousands)	Individually evaluated for impairment		Collectively evaluated for impairment		Total		Individually evaluated for impairment		Collectively evaluated for impairment		Total
Commercial, industrial and agricultural	$	612	$	1,175	$	1,787	$	2,000	$	51,673	$	53,673
Real estate - one to four family residential:
Closed end first and seconds		1,833		1,026		2,859		10,048		208,424		218,472
Home equity lines		-		1,642		1,642		175		99,664		99,839
Total real estate - one to four family residential		1,833		2,668		4,501		10,223		308,088		318,311
Real estate - multifamily residential		-		79		79		-		18,077		18,077
Real estate - construction:
One to four family residential		180		184		364		306		15,863		16,169
Other construction, land development and other land		802		1,187		1,989		3,314		18,376		21,690
Total real estate - construction		982		1,371		2,353		3,620		34,239		37,859
Real estate - farmland		-		116		116		478		7,694		8,172
Real estate - non-farm, non-residential:
Owner occupied		1,223		2,013		3,236		10,058		116,511		126,569
Non-owner occupied		617		1,153		1,770		8,372		66,459		74,831
Total real estate - non-farm, non-residential		1,840		3,166		5,006		18,430		182,970		201,400
Consumer		104		283		387		302		16,480		16,782
Other		311		227		538		472		2,451		2,923
Total	$	5,682	$	9,085	$	14,767	$	35,525	$	621,672	$	657,197

The following table presents loans individually evaluated for impairment by class of loans as of June 30, 2014:

(dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial, industrial and agricultural	$	2,180	$	2,180	$	290	$	1,890	$	42	$	2,184	$	64
Real estate - one to four family residential:
Closed end first and seconds		9,981		10,081		3,462		6,519		1,416		10,033		178
Home equity lines		417		417		417		-		-		213		-
Total real estate - one to four family residential		10,398		10,498		3,879		6,519		1,416		10,246		178
Real estate - construction:
One to four family residential		299		299		-		299		173		360		4
Other construction, land development and other land		5,661		5,661		-		5,661		1,382		5,173		157
Total real estate - construction		5,960		5,960		-		5,960		1,555		5,533		161
Real estate - non-farm, non-residential:
Owner occupied		14,410		15,896		10,013		4,397		944		11,492		95
Non-owner occupied		10,362		10,362		4,676		5,686		1,648		8,558		139
Total real estate - non-farm, non-residential		24,772		26,258		14,689		10,083		2,592		20,050		234
Consumer		382		382		25		357		114		457		11
Other		465		465		8		457		302		471		-
Total loans	$	44,157	$	45,743	$	18,891	$	25,266	$	6,021	$	38,941	$	648

The following table presents loans individually evaluated for impairment by class of loans as of December 31, 2013:

(dollars in thousands)	Recorded Investment		Unpaid Principal Balance		Recorded Investment With No Allowance		Recorded Investment With Allowance		Related Allowance		Average Recorded Investment		Interest Income Recognized
Commercial, industrial and agricultural	$	2,000	$	2,000	$	-	$	2,000	$	612	$	1,712	$	97
Real estate - one to four family residential:
Closed end first and seconds		10,048		10,148		2,008		8,040		1,833		8,727		498
Home equity lines		175		175		175		-		-		382		-
Total real estate - one to four family residential		10,223		10,323		2,183		8,040		1,833		9,109		498
Real estate - construction:
One to four family residential		306		306		-		306		180		794		9
Other construction, land development and other land		3,314		5,662		-		3,314		802		8,581		161
Total real estate - construction		3,620		5,968		-		3,620		982		9,375		170
Real estate - farmland		478		478		478		-		-		428		32
Real estate - non-farm, non-residential:
Owner occupied		10,058		11,544		6,730		3,328		1,223		10,472		506
Non-owner occupied		8,372		8,372		4,357		4,015		617		9,353		348
Total real estate - non-farm, non-residential		18,430		19,916		11,087		7,343		1,840		19,825		854
Consumer		302		302		-		302		104		203		22
Other		472		472		9		463		311		504		-
Total loans	$	35,525	$	39,459	$	13,757	$	21,768	$	5,682	$	41,156	$	1,673

The following tables present, by class of loans, information related to loans modified as TDRs during the three and six months ended June 30, 2014 and 2013:

	Three Months Ended June 30, 2014						Three Months Ended June 30, 2013
(dollars in thousands)	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance*		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance*
Real estate - one to four family residential:
Closed end first and seconds		3	$	512	$	513		2	$	225	$	225
Consumer		2		385		385		-		-		-
Total		5	$	897	$	898		2	$	225	$	225

*The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

	Six Months Ended June 30, 2014						Six Months Ended June 30, 2013
(dollars in thousands)	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance*		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance*
Real estate - one to four family residential:
Closed end first and seconds		3	$	512	$	513		4	$	570	$	570
Real estate - non-farm, non-residential:
Non-owner occupied		-		-		-		1		164		164
Consumer		2		385		385		-		-		-
Total		5	$	897	$	898		5	$	734	$	734

* The period end balances are inclusive of all partial paydowns and charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

The following tables present, by class of loans, information related to loans modified as TDRs that subsequently defaulted (i.e., 90 days or more past due following a modification) during the three and six months ended June 30, 2014 and 2013 and were modified as TDRs within the 12 months prior to default:

	Three Months Ended June 30, 2014				Three Months Ended June 30, 2013
(dollars in thousands)	Number of Loans		Recorded Balance		Number of Loans		Recorded Balance
Real estate - one to four family residential:
Closed end first and seconds		-	$	-		1	$	55
Real estate - non-farm, non-residential:
Non-owner occupied		-		-		1		164
Total		-	$	-		2	$	219

	Six Months Ended June 30, 2014				Six Months Ended June 30, 2013
(dollars in thousands)	Number of Loans		Recorded Balance		Number of Loans		Recorded Balance
Real estate - one to four family residential:
Closed end first and seconds		-	$	-		2	$	234
Real estate - non-farm, non-residential:
Non-owner occupied		-		-		1		164
Total		-	$	-		3	$	398

Note 4. Deferred Income Taxes

As of June 30, 2014 and December 31, 2013, the Company had recorded net deferred income tax assets of approximately $15.5 million and $18.9 million, respectively. The realization of deferred income tax assets is assessed quarterly and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed. Management’s assessment is primarily dependent on historical taxable income and projections of future taxable income, which are directly related to the Company’s core earnings capacity and its prospects to generate core earnings in the future. Projections of core earnings and taxable income are inherently subject to uncertainty and estimates that may change given the uncertain economic outlook, banking industry conditions and other factors. Further, management has considered future reversals of existing taxable temporary differences and limited, prudent and feasible tax-planning strategies, such as changes in investment security income (tax-exempt to taxable), additional sales of loans and sales of branches/buildings with an appreciated asset value over the tax basis. Based upon an analysis of available evidence, management has determined that it is “more likely than not” that the Company’s deferred income tax assets as of June 30, 2014 will be fully realized and therefore no valuation allowance to the Company’s deferred income tax assets was recorded. However, the Company can give no assurance that in the future its deferred income tax assets will not be impaired because such determination is based on projections of future earnings and the possible effect of certain transactions which are subject to uncertainty and based on estimates that may change due to changing economic conditions and other factors. Due to the uncertainty of estimates and projections, it is possible that the Company will be required to record adjustments to the valuation allowance in future reporting periods.

The Company’s ability to realize its deferred income tax assets may be limited if the Company experiences an ownership change as defined by Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). For additional information see Part I, Item 1A. “Risk Factors” included in the 2013 Form 10-K.

Note 5. Bank Premises and Equipment

Bank premises and equipment are summarized as follows:

	June 30,			December 31,
(dollars in thousands)	2014			2013

Land and improvements	$	6,425		$	6,421
Buildings and leasehold improvements		22,917			22,678
Furniture, fixtures and equipment		20,467			19,765
Construction in progress		377			212
		50,186			49,076
Less accumulated depreciation		(28,661	)		(27,630	)
Net balance	$	21,525		$	21,446

Depreciation and amortization of bank premises and equipment for the six months ended June 30, 2014 and 2013 amounted to $1.0 million for both periods, respectively.

Note 6. Borrowings

Federal funds purchased and repurchase agreements. The Company has unsecured lines of credit with SunTrust Bank, Community Bankers Bank and Pacific Coast Bankers Bank for the purchase of federal funds in the amount of $20.0 million, $15.0 million and $5.0 million, respectively. These lines of credit have a variable rate based on the lending bank’s daily federal funds sold rate and are due on demand. Repurchase agreements are secured transactions and generally mature the day following the day sold. Customer repurchases are standard transactions that involve a Bank customer instead of a wholesale bank or broker. The Company offers this product as an accommodation to larger retail and commercial customers that request safety for their funds beyond the Federal Deposit Insurance Corporation (“FDIC”) deposit insurance limits. The Company does not use or have any open repurchase agreements with broker-dealers.

The tables below present selected information on federal funds purchased and repurchase agreements during the six months ended June 30, 2014 and the year ended December 31, 2013:

Federal funds purchased	June 30,			December 31,
(dollars in thousands)	2014			2013
Balance outstanding at period end	$	-		$	-
Maximum balance at any month end during the period	$	5		$	-
Average balance for the period	$	140		$	14
Weighted average rate for the period		0.72	%		0.79	%
Weighted average rate at period end		0.00	%		0.00	%

Repurchase agreements	June 30,			December 31,
(dollars in thousands)	2014			2013
Balance outstanding at period end	$	3,482		$	3,009
Maximum balance at any month end during the period	$	3,482		$	3,770
Average balance for the period	$	3,189		$	3,475
Weighted average rate for the period		0.59	%		0.60	%
Weighted average rate at period end		0.59	%		0.60	%

Short-term borrowings. Short-term borrowings consist of advances from the FHLB, which are secured by a blanket floating lien on all qualifying closed-end and revolving open-end loans that are secured by 1-4 family residential properties. Short-term advances from the FHLB at June 30, 2014 consisted of $1.2 million using a daily rate credit, which was due on demand, and $75.6 million in fixed rate one month advances. Short-term advances from the FHLB at December 31, 2013 consisted of $18.9 million using a daily rate credit, which was due on demand, and a $23.0 million fixed rate one month advance.

The table below presents selected information on short-term borrowings during the six months ended June 30, 2014 and the year ended December 31, 2013:

Short-term borrowings	June 30,			December 31,
(dollars in thousands)	2014			2013
Balance outstanding at period end	$	76,760		$	41,940
Maximum balance at any month end during the period	$	76,760		$	62,124
Average balance for the period	$	70,754		$	16,963
Weighted average rate for the period		0.20	%		0.22	%
Weighted average rate at period end		0.21	%		0.23	%

Long-term borrowings. Long-term borrowings consist of advances from the FHLB, which are secured by a blanket floating lien on all qualifying closed-end and revolving open-end loans that are secured by 1-4 family residential properties. During August 2013, the Company restructured its FHLB advances with the prepayment of $107.5 million in higher rate long-term advances. The long-term advances that were extinguished were fixed rate advances with a weighted average remaining maturity of 3.5 years and a current weighted average interest rate of 4.14%; $94.0 million of the prepaid FHLB advances were callable quarterly by the FHLB. The prepayment of the FHLB advances triggered a prepayment penalty of $11.5 million, or $0.67 per fully diluted share at September 30, 2013, all of which was recognized in the third quarter of 2013. The Company also paid off the remaining $10.0 million higher rate long-term FHLB advance at maturity during September 2013. The $107.5 million convertible advances had fixed rates of interest unless the FHLB would have exercised its option to convert the interest on these advances from fixed rate to variable rate. At June 30, 2014 and December 31, 2013, the Company had no long-term FHLB advances outstanding.

The Company’s line of credit with the FHLB can equal up to 25% of the Company’s gross assets or approximately $264.5 million at June 30, 2014. This line of credit totaled $212.0 million with approximately $121.7 million available at June 30, 2014. As of June 30, 2014 and December 31, 2013, loans with a carrying value of $305.9 million and $285.6 million, respectively, are pledged to the FHLB as collateral for borrowings. Additional loans are available that can be pledged as collateral for future borrowings from the FHLB above the current lendable collateral value. Short-term borrowings outstanding under the FHLB line of credit were $76.8 million and $41.9 million as of June 30, 2014 and December 31, 2013, respectively.

Note 7. Income Per Common Share

The following tables show the weighted average number of common shares used in computing income per common share and the effect on the weighted average number of shares of potential dilutive common stock.

	Three Months Ended
	June 30, 2014		June 30, 2013
Weighted average common shares outstanding for basic income per common share		11,862,367		7,040,413
Effect of dilutive securities, stock options		-		-
Effect of dilutive securities, Series B Preferred Stock		5,240,192		1,094,106
Weighted average common shares outstanding for diluted income per common share		17,102,559		8,134,519
Basic income per common share	$	0.10	$	0.04
Diluted income per common share	$	0.06	$	0.04

	Six Months Ended
	June 30, 2014		June 30, 2013
Weighted average common shares outstanding for basic income per common share		11,862,367		6,557,664
Effect of dilutive securities, stock options		-		-
Effect of dilutive securities, Series B Preferred Stock		5,240,192		550,075
Weighted average common shares outstanding for diluted income per common share		17,102,559		7,107,739
Basic income per common share	$	0.22	$	0.15
Diluted income per common share	$	0.15	$	0.14

At June 30, 2014 and 2013, options to acquire 145,437 and 179,412 shares of common stock, respectively, were not included in computing diluted income per common share because their effects were anti-dilutive.

On June 12, 2013, the Company issued 5,240,192 shares of a new series of non-voting mandatorily convertible non-cumulative preferred stock (the “Series B Preferred Stock”) through private placements to certain investors. For more information related to the conversion rights on these preferred shares, see Note 11 – Preferred Stock and Warrant.

Note 8. Stock Based Compensation Plans

On September 21, 2000, the Company adopted the Eastern Virginia Bankshares, Inc. 2000 Stock Option Plan (the “2000 Plan”) to provide a means for selected key employees and directors to increase their personal financial interest in the Company, thereby stimulating their efforts and strengthening their desire to remain with the Company. Under the 2000 Plan, up to 400,000 shares of Company common stock could be granted in the form of stock options. On April 17, 2003, the shareholders approved the Eastern Virginia Bankshares, Inc. 2003 Stock Incentive Plan, amending and restating the 2000 Plan (the “2003 Plan”) still authorizing the issuance of up to 400,000 shares of common stock under the plan, but expanding the award types available under the plan to include stock options, stock appreciation rights, common stock, restricted stock and phantom stock. Under the terms of the 2003 Plan document, after April 17, 2013 no awards of shares of common stock may be granted under the 2003 Plan. Any awards previously granted under the 2003 Plan that were outstanding as of April 17, 2013 remain outstanding and will vest in accordance with their regular terms.

On April 19, 2007, the Company’s shareholders approved the Eastern Virginia Bankshares, Inc. 2007 Equity Compensation Plan (the “2007 Plan”) to enhance the Company’s ability to recruit and retain officers, directors, employees, consultants and advisors with ability and initiative and to encourage such persons to have a greater financial interest in the Company. The 2007 Plan authorizes the Company to issue up to 400,000 additional shares of common stock pursuant to grants of stock options, stock appreciation rights, common stock, restricted stock, performance shares, incentive awards and stock units. There were 322,000 shares still available to be granted as awards under the 2007 Plan as of June 30, 2014.

Accounting standards require companies to recognize the cost of employee services received in exchange for awards of equity instruments, such as stock options, based on the fair value of those awards at the date of grant.

Accounting standards also require that new awards to employees eligible for retirement prior to the awards becoming fully vested be recognized as compensation cost over the period through the date that the employee first becomes eligible to retire and is no longer required to provide service to earn the award. The Company’s stock options granted to eligible participants are being recognized, as required, as compensation cost over the vesting period except in the instance where a participant reaches normal retirement age of 65 prior to the normal vesting date. There was no remaining unrecognized compensation expense related to stock options.

Stock option compensation expense is the estimated fair value of options granted, amortized on a straight-line basis over the requisite service period for each stock option award. There were no stock options granted or exercised in the six months ended June 30, 2014 and 2013.

A summary of the Company’s stock option activity and related information is as follows:

						Remaining		Aggregate
	Options			Weighted Average		Contractual Life		Intrinsic Value
	Outstanding			Exercise Price		(in years)		(in thousands)
Stock options outstanding at January 1, 2014		152,287		$	19.09
Forfeited		(6,850	)		20.25
Stock options outstanding at June 30, 2014		145,437		$	19.03		2.15	$	-

Stock options exercisable at June 30, 2014		145,437		$	19.03		2.15	$	-

* Intrinsic value is the amount by which the fair value of the underlying common stock exceeds the exercise price of a stock option on exercise date.

The table below summarizes information concerning stock options outstanding and exercisable at June 30, 2014:

Stock Options Outstanding					Stock Options Exercisable
				Weighted
				Average
Exercise		Number		Remaining	Exercise		Number
Price		Outstanding		Term	Price		Exercisable
$	19.92		23,950	0.00 years*	$	19.92		23,950
$	20.57		32,662	1.00 years	$	20.57		32,662
$	21.16		38,325	2.25 years	$	21.16		38,325
$	19.25		26,750	3.25 years	$	19.25		26,750
$	12.36		23,750	4.25 years	$	12.36		23,750
$	19.03		145,437	2.15 years	$	19.03		145,437

*These options expire on July 1, 2014.

On November 18, 2013, the Company granted 38,000 shares of restricted stock under the 2007 Plan to its executive officers in the form of Troubled Asset Relief Program (“TARP”) compliant restricted stock awards. All of these shares are subject to time vesting over a five year period, and generally vest 40% on the second anniversary of the grant date and 20% on each of the third, fourth and fifth anniversaries of the grant date. On June 29, 2012, the Company granted 34,000 shares of restricted stock under the 2007 Plan to its executive officers in the form of TARP compliant restricted stock awards. All of these shares are subject to time vesting over a five year period, and generally vest 40% on the second anniversary of the grant date and 20% on each of the third, fourth and fifth anniversaries of the grant date.

For the three and six months ended June 30, 2014, restricted stock compensation expense was $19 thousand and $39 thousand, respectively, compared to restricted stock compensation expense of $7 thousand and $14 thousand, respectively, for the three and six months ended June 30, 2013. Restricted stock was included in salaries and employee benefits expense in the consolidated statements of income. Restricted stock compensation expense is accounted for using the fair market value of the Company’s common stock on the date the restricted shares were awarded, which was $6.70 per share for the 2013 award and $3.72 per share for the 2012 award. No restricted stock was granted or forfeited during the six months ended June 30, 2014.

A summary of the status of the Company’s nonvested shares in relation to the Company’s restricted stock awards as of June 30, 2014, and changes during the six months ended June 30, 2014, is presented below; the weighted average price is the weighted average fair value at the date of grant:

				Weighted-Average
	Shares			Price
Nonvested as of January 1, 2014		73,500		$	5.30
Vested		(15,100	)		3.93
Nonvested as of June 30, 2014		58,400		$	5.66

At June 30, 2014, there was $300 thousand of total unrecognized compensation expense related to restricted stock awards. This unearned compensation is being amortized over the remaining vesting period for the time based shares.

Note 9. Employee Benefit Plan – Pension

The Company has historically maintained a defined benefit pension plan covering substantially all of the Company’s employees. The plan was amended January 28, 2008 to freeze the plan with no additional contributions for a majority of participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan. No additional participants have been added to the plan. The plan was again amended February 28, 2011 to freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants have remained frozen in the plan since such action was taken. Effective January 1, 2012, the plan was amended and restated as a cash balance plan. Under a cash balance plan, participant benefits are stated as an account balance. An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan. Each participants’ account will be credited with an “interest” credit each year. The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year. Components of net periodic pension benefit related to the Company’s pension plan were as follows for the periods indicated:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
(dollars in thousands)	2014			2013			2014			2013

Components of Net Periodic Pension Benefit
Interest cost	$	111		$	115		$	223		$	230
Expected return on plan assets		(186	)		(176	)		(372	)		(352	)
Amortization of prior service cost		2			2			4			4
Recognized net actuarial loss		-			31			-			62
Net periodic pension benefit	$	(73	)	$	(28	)	$	(145	)	$	(56	)

The Company made no contributions to the pension plan during 2013. The Company has not determined at this time how much, if any, contributions to the plan will be made for the year ending December 31, 2014.

Note 10. Fair Value Measurements

Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. U.S. GAAP requires that valuation techniques maximize the use of observable inputs and minimize the use of unobservable inputs. U.S. GAAP also establishes a fair value hierarchy which prioritizes the valuation inputs into three broad levels. Based on the underlying inputs, each fair value measurement in its entirety is reported in one of the three levels. These levels are:

Level 1 – Valuation is based upon quoted prices (unadjusted) for identical instruments traded in active markets.

Level 2 – Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model based valuation techniques for which all significant assumptions are observable in the market or can be corroborated by observable market data for substantially the full term of the assets or liabilities.

Level 3 – Valuation is determined using model-based techniques with significant assumptions not observable in the market.

U.S. GAAP allows an entity the irrevocable option to elect fair value (the fair value option) for the initial and subsequent measurement for certain financial assets and liabilities on a contract-by-contract basis. The Company has not made any fair value option elections as of June 30, 2014.

Following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy.

Assets Measured at Fair Value on a Recurring Basis

Securities Available For Sale. Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2). In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within Level 3 of the valuation hierarchy. Currently, all of the Company’s available for sale securities are considered to be Level 2 securities.

The following table summarizes financial assets measured at fair value on a recurring basis as of June 30, 2014 and December 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Assets Measured at Fair Value on a Recurring Basis at June 30, 2014 Using

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		June 30,
	(Level 1)		(Level 2)		(Level 3)		2014
	(dollars in thousands)
Assets
Securities available for sale
Obligations of U.S. Government agencies	$	-	$	14,075	$	-	$	14,075
SBA Pool securities		-		84,426		-		84,426
Agency mortgage-backed securities		-		30,487		-		30,487
Agency CMO securities		-		43,292		-		43,292
Non agency CMO securities		-		1,037		-		1,037
State and political subdivisions		-		53,391		-		53,391
Pooled trust preferred securities		-		748		-		748
FNMA and FHLMC preferred stock		-		176		-		176
Total securities available for sale	$	-	$	227,632	$	-	$	227,632

Assets Measured at Fair Value on a Recurring Basis at December 31, 2013 Using

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		December 31,
	(Level 1)		(Level 2)		(Level 3)		2013
	(dollars in thousands)
Assets
Securities available for sale
Obligations of U.S. Government agencies	$	-	$	13,390	$	-	$	13,390
SBA Pool securities		-		86,035		-		86,035
Agency mortgage-backed securities		-		35,254		-		35,254
Agency CMO securities		-		41,378		-		41,378
Non agency CMO securities		-		1,306		-		1,306
State and political subdivisions		-		56,342		-		56,342
Pooled trust preferred securities		-		749		-		749
FNMA and FHLMC preferred stock		-		481		-		481
Total securities available for sale	$	-	$	234,935	$	-	$	234,935

Assets Measured at Fair Value on a Non-Recurring Basis

Certain assets are measured at fair value on a non-recurring basis in accordance with U.S. GAAP. These adjustments to fair value usually result from the application of fair value accounting or impairment write-downs of individual assets.

Impaired Loans. Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the allowance for loan losses are measured at fair value on a non-recurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the consolidated statements of income.

Other Real Estate Owned. Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2). If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a non-recurring basis. Any initial fair value adjustment is charged against the allowance for loan losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the consolidated statements of income.

The following table summarizes assets measured at fair value on a non-recurring basis as of June 30, 2014 and December 31, 2013, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:

Assets Measured at Fair Value on a Non-Recurring Basis at June 30, 2014 Using

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		June 30,
	(Level 1)		(Level 2)		(Level 3)		2014
	(dollars in thousands)
Assets
Impaired loans	$	-	$	-	$	19,245	$	19,245
Other real estate owned	$	-	$	-	$	601	$	601

Assets Measured at Fair Value on a Non-Recurring Basis at December 31, 2013 Using

	Quoted Prices in		Significant Other		Significant
	Active Markets for		Observable		Unobservable		Balance at
	Identical Assets		Inputs		Inputs		December 31,
	(Level 1)		(Level 2)		(Level 3)		2013
	(dollars in thousands)
Assets
Impaired loans	$	-	$	-	$	16,086	$	16,086
Other real estate owned	$	-	$	-	$	800	$	800

The following table displays quantitative information about Level 3 Fair Value Measurements as of June 30, 2014 and December 31, 2013:

Quantitative information about Level 3 Fair Value Measurements at June 30, 2014

Fair Value

Valuation Technique(s)

Unobservable Input

Range (Weighted Average)

(dollars in thousands)

Assets

Impaired loans

19,245

Discounted appraised value

Selling cost

0% - 32% (12%)

Discount for lack of marketability and age of appraisal

0% - 11% (3%)

Other real estate owned

601

Discounted appraised value

Selling cost

10% (10%)

Discount for lack of marketability and age of appraisal

0% - 34% (14%)

Quantitative information about Level 3 Fair Value Measurements at December 31, 2013

Fair Value

Valuation Technique(s)

Unobservable Input

Range (Weighted Average)

(dollars in thousands)

Assets

Impaired loans

16,086

Discounted appraised value

Selling cost

0% - 32% (12%)

Discount for lack of marketability and age of appraisal

0% - 20% (6%)

Other real estate owned

800

Discounted appraised value

Selling cost

10% (10%)

Discount for lack of marketability and age of appraisal

0% - 28% (13%)

Fair Value of Financial Instruments

U.S. GAAP requires disclosure of the fair value of financial assets and financial liabilities, including those financial assets and financial liabilities that are not measured and reported at fair value on a recurring basis or non-recurring basis. The methodologies and assumptions for estimating the fair value of financial assets and financial liabilities that are measured at fair value on a recurring or non-recurring basis are discussed above. The methodologies and assumptions for other financial assets and financial liabilities are discussed below:

Cash and Short-Term Investments. For those short-term instruments, the carrying amount is a reasonable estimate of fair value.

Investment Securities. For securities and marketable equity securities held for investment purposes, fair values are based on quoted market prices or dealer quotes. For other securities held as investments, fair value equals quoted market price, if available. If a quoted market price is not available, fair value is estimated using quoted prices for similar securities. All securities prices are provided by independent third party vendors.

Restricted Securities. The carrying amount approximates fair value based on the redemption provisions of the correspondent banks.

Loans. The fair value of performing loans is estimated by discounting the future cash flows using the current rates at which similar loans would be made to borrowers with similar remaining maturities. This calculation ignores loan fees and certain factors affecting the interest rates charged on various loans such as the borrower’s creditworthiness and compensating balances and dissimilar types of real estate held as collateral. The fair value of impaired loans is measured as described within the Impaired Loans section of this note.

Bank Owned Life Insurance. Bank owned life insurance represents insurance policies on officers of the Company. The cash values of the policies are estimated using information provided by insurance carriers. The policies are carried at their cash surrender value, which approximates fair value.

Deposits. The fair value of demand deposits, savings accounts, and certain money market deposits is the amount payable on demand at the reporting date. The fair value of fixed maturity certificates of deposit is estimated using market rates for deposits of similar remaining maturities.

Short-Term Borrowings. The carrying amounts of federal funds purchased and other short-term borrowings maturing within 90 days approximate their fair values. Fair values of other short-term borrowings are estimated using discounted cash flow analyses based on the current incremental borrowing rates for similar types of borrowing arrangements.

Long-Term Borrowings. The fair values of the Company’s long-term borrowings are estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued Interest Receivable and Accrued Interest Payable. The carrying amounts of accrued interest approximate fair value.

Off-Balance Sheet Financial Instruments. The fair value of commitments to extend credit is estimated using the fees currently charged to enter similar agreements, taking into account the remaining terms of the agreements and the present credit worthiness of the counterparties. For fixed-rate loan commitments, fair value also considers the difference between current levels of interest rates and the committed rates.

The fair value of standby letters of credit is based on fees currently charged for similar agreements or on the estimated cost to terminate them or otherwise settle the obligations with the counterparties at the reporting date. The fair value of guarantees of credit card accounts previously sold is based on the estimated cost to settle the obligations with the counterparty at the reporting date. At June 30, 2014 and December 31, 2013, the fair value of loan commitments, standby letters of credit and credit card guarantees are not significant and are not included in the table below.

The estimated fair value and the carrying value of the Company’s recorded financial instruments are as follows:

			Fair Value Measurements at June 30, 2014 Using

			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable		Balance at
			Identical Assets		Inputs		Inputs		June 30,
	Carrying Amount		(Level 1)		(Level 2)		(Level 3)		2014
			(dollars in thousands)
Assets:
Cash and short-term investments	$	12,960	$	12,960	$	-	$	-	$	12,960
Interest bearing deposits with banks		3,603		3,603		-		-		3,603
Securities available for sale		227,632		-		227,632		-		227,632
Securities held to maturity		34,077		-		34,403		-		34,403
Restricted securities		7,230		-		7,230		-		7,230
Loans, net		683,375		-		-		692,075		692,075
Bank owned life insurance		21,432		-		21,432		-		21,432
Accrued interest receivable		3,762		-		3,762		-		3,762
Total	$	994,071	$	16,563	$	294,459	$	692,075	$	1,003,097

Liabilities:
Noninterest-bearing demand deposits	$	139,066	$	139,066	$	-	$	-	$	139,066
Interest-bearing deposits		682,460		-		626,733		-		626,733
Federal funds purchased and repurchase agreements		3,482		3,482		-		-		3,482
Short-term borrowings		76,760		76,760		-		-		76,760
Trust preferred debt		10,310		-		10,310		-		10,310
Accrued interest payable		341		-		341		-		341
Total	$	912,419	$	219,308	$	637,384	$	-	$	856,692

			Fair Value Measurements at December 31, 2013 Using

			Quoted Prices in		Significant Other		Significant
			Active Markets for		Observable		Unobservable		Balance at
			Identical Assets		Inputs		Inputs		December 31,
	Carrying Amount		(Level 1)		(Level 2)		(Level 3)		2013
			(dollars in thousands)
Assets:
Cash and short-term investments	$	13,944	$	13,944	$	-	$	-	$	13,944
Interest bearing deposits with banks		5,402		5,402		-		-		5,402
Securities available for sale		234,935		-		234,935		-		234,935
Securities held to maturity		35,495		-		34,521		-		34,521
Restricted securities		5,549		-		5,549		-		5,549
Loans, net		642,430		-		-		653,125		653,125
Bank owned life insurance		21,158		-		21,158		-		21,158
Accrued interest receivable		3,893		-		3,893		-		3,893
Total	$	962,806	$	19,346	$	300,056	$	653,125	$	972,527

Liabilities:
Noninterest-bearing demand deposits	$	126,861	$	126,861	$	-	$	-	$	126,861
Interest-bearing deposits		707,601		-		614,747		-		614,747
Federal funds purchased and repurchase agreements		3,009		3,009		-		-		3,009
Short-term borrowings		41,940		41,940		-		-		41,940
Trust preferred debt		10,310		-		10,310		-		10,310
Accrued interest payable		1,324		-		1,324		-		1,324
Total	$	891,045	$	171,810	$	626,381	$	-	$	798,191

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of the Company’s normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. The Company attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. The Company monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Note 11. Preferred Stock and Warrant

On January 9, 2009, the Company signed a definitive agreement with the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008 to participate in the Treasury’s Capital Purchase Program. Pursuant to this agreement, the Company sold 24,000 shares of its Series A fixed rate cumulative perpetual preferred stock, liquidation value $1,000 per share (the “Series A Preferred Stock”), to the Treasury for an aggregate purchase price of $24 million. The Series A Preferred Stock paid a cumulative dividend at a rate of 5% for the first five years, and effective January 9, 2014, pays a rate of 9%. As part of its purchase of the Series A Preferred Stock, the Treasury was also issued a warrant to purchase up to 373,832 shares of the Company’s common stock at an initial exercise price of $9.63 per share. If not exercised, the warrant expires after ten years. On October 21, 2013, the Treasury sold all 24,000 shares of Series A Preferred Stock that were held by Treasury to private investors.

Accounting for the issuance of the Series A Preferred Stock included entries to the equity portion of the Company’s consolidated balance sheet to recognize the Series A Preferred Stock at the full amount of the issuance, the warrant and discount on the Series A Preferred Stock at values calculated by discounting the future cash flows by a prevailing interest rate that a similar security would receive in the current market environment. At the time of issuance, that discount rate was determined to be 12%. The fair value of the warrant of $950 thousand was calculated using the Black-Scholes model with inputs of 7 year volatility, average rate of quarterly dividends, 7 year Treasury strip rate and the exercise price of $9.63 per share exercisable for up to 10 years. The present value of the Series A Preferred Stock using a 12% discount rate was $14.4 million. The Series A Preferred Stock discount determined by the allocation of discount to the warrant was accreted quarterly over a 5 year period on a constant effective yield method at a rate of approximately 6.4%. Allocation of the Series A Preferred Stock discount and the warrant as of January 9, 2009 is provided in the tables below:

Warrant Value	2009
Series A Preferred Stock	$	24,000,000
Price	$	9.63
Warrant - shares		373,832
Value per warrant	$	2.54
Fair value of warrant	$	949,533

NPV of Series A Preferred Stock
@ 12% discount rate	(dollars in thousands)
			Relative			Relative
	Fair Value		Value %			Value
$24 million 1/09/2009
NPV of Series A Preferred Stock (12% discount rate)	$	14,446		93.8	%	$	22,519
Fair value of warrant		950		6.2	%		1,481
	$	15,396		100.0	%	$	24,000

On May 15, 2014, the Company deferred its fourteenth consecutive dividend on the Series A Preferred Stock. Deferral of dividends on the Series A Preferred Stock does not constitute an event of default. Dividends on the Series A Preferred Stock are, however, cumulative, and the Company has accumulated the dividends in accordance with the terms of the Series A Preferred Stock and U.S. GAAP and reflected the accumulated dividends as a portion of the effective dividend on Series A Preferred Stock on the consolidated statements of income. As of June 30, 2014, the Company had accumulated $4.7 million for dividends on the Series A Preferred Stock. In addition, because dividends on the Series A Preferred Stock have not been paid for more than six quarters, the authorized number of directors on the Company’s Board of Directors has increased by two, and the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board of Directors at any annual meeting (or a special meeting called for that purpose) until all owed and unpaid dividends on the Series A Preferred Stock have been paid. To date, the holders of the Series A Preferred Stock have not yet exercised this right. On July 24, 2014, the Company declared $5.5 million of current and all deferred but accumulated dividends on its Series A Preferred Stock, payable on August 15, 2014.

In connection with its private placements, on June 12, 2013, the Company issued 5,240,192 shares of its Series B Preferred Stock for a gross purchase price of $23.8 million, or $4.55 per share. The Series B Preferred Stock has no maturity date. The holders of Series B Preferred Stock are entitled to receive dividends if, as and when declared by the Company’s Board of Directors, in an identical form of consideration and at the same time, as those dividends or distributions that would have been payable on the number of whole shares of the Company’s common stock that such shares of Series B Preferred Stock would be convertible into upon satisfaction of certain conditions. The Company will not pay any dividends with respect to its common stock unless an equivalent dividend also is paid to the holders of Series B Preferred Stock. The Series B Preferred Stock ranks junior with regard to dividends to any class or series of capital stock of the Company the terms of which expressly provide that such class or series will rank senior to the common stock or the Series B Preferred Stock as to dividend rights and/or as to rights on liquidation, dissolution or winding up of the Company, including the Series A Preferred Stock.

For a summary of the terms of the Series B Preferred Stock, including the conditions under which shares of Series B Preferred Stock convert into shares of the Company’s common stock, see the Company’s Current Report on Form 8-K filed with the SEC on June 14, 2013 and the exhibits thereto.

Note 12. Trust Preferred Debt

On September 17, 2003, $10 million of trust preferred securities were placed through EVB Statutory Trust I in a pooled underwriting totaling approximately $650 million. The trust issuer has invested the total proceeds from the sale of the trust preferred securities in Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Junior Subordinated Debentures”) issued by the Parent. The trust preferred securities pay cumulative cash distributions quarterly at a variable rate per annum, reset quarterly, equal to the 3-month LIBOR plus 2.95%. As of June 30, 2014 and December 31, 2013, the interest rate was 3.18% and 3.19%, respectively. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities have a mandatory redemption date of September 17, 2033, and became subject to varying call provisions beginning September 17, 2008. The Parent has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the debentures and other related documents. The Parent’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Parent.

The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. The portion of the securities not considered as Tier 1 capital will be included in Tier 2 capital. At June 30, 2014 and December 31, 2013, all of the trust preferred securities qualified as Tier 1 capital.

Subject to certain exceptions and limitations, the Company is permitted to elect from time to time to defer regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities. If the Company defers interest payments on the Junior Subordinated Debentures for more than 20 consecutive quarters, the Company would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable.

From June 2011 to March 2014, the Company deferred its regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities due to prohibitions on such payments under provisions of regulatory agreements as disclosed in Note 14 – Regulatory Agreements. On June 17, 2014, the Company paid all current and deferred interest on these outstanding Junior Subordinated Debentures.

Note 13. Capital Requirements

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of their assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weightings and other factors. Prompt corrective action provisions are not applicable to bank holding companies.

During 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and a revised risk weighting framework, and other related changes to the prompt corrective action framework. For a summary of these regulatory changes, refer to Part I, Item 1. “Business” under the heading “Regulation and Supervision—Capital Requirements” in the 2013 Form 10-K.

As of June 30, 2014, the most recent notification from the Reserve Bank categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the following tables. There are no conditions or events since the notification that management believes have changed the Bank’s category. A comparison of the June 30, 2014 and December 31, 2013 capital ratios of the Company and the Bank with minimum regulatory guidelines is as follows:

							Minimum To Be
As of June 30, 2014							Well-Capitalized
				Minimum			Under Prompt
				Capital			Corrective Action
	Actual Capital			Requirements			Provisions
Total Risk-Based Capital Ratio:
Company		20.03	%		8.00	%		N/A
Bank		14.80	%		8.00	%		10.00	%

Tier 1 Risk-Based Capital Ratio:
Company		18.77	%		4.00	%		N/A
Bank		13.54	%		4.00	%		6.00	%

Leverage Ratio:
Company		12.66	%		4.00	%		N/A
Bank		9.13	%		4.00	%		5.00	%

							Minimum to be
As of December 31, 2013							Well-Capitalized
				Minimum			Under Prompt
				Capital			Corrective Action
	Actual Capital			Requirements			Provisions
Total Risk-Based Capital Ratio:
Company		19.48	%		8.00	%		N/A
Bank		13.98	%		8.00	%		10.00	%

Tier 1 Risk-Based Capital Ratio:
Company		18.22	%		4.00	%		N/A
Bank		12.71	%		4.00	%		6.00	%

Leverage Ratio:
Company		12.06	%		4.00	%		N/A
Bank		8.43	%		4.00	%		5.00	%

Note 14. Regulatory Agreements

The Company and the Bank were formerly parties to formal and informal agreements with federal and state banking regulators, as summarized below.

On February 17, 2011, the Parent and the Bank entered into a written agreement with the Reserve Bank and the Bureau (the “Written Agreement”). The Written Agreement was terminated on July 30, 2013. The Written Agreement had required the Bank, among other things, to develop plans for improving numerous aspects of the Bank’s operations and management, required the Bank to improve asset quality, restricted certain types of credit extensions and imposed a number of measures designed to preserve the Bank’s capital.

On September 5, 2013, the Parent and the Bank entered into a memorandum of understanding with the Reserve Bank and the Bureau (the “MOU”). The MOU was terminated effective March 13, 2014.

Under the terms of the MOU, the Parent and the Bank had agreed that the Parent would not, without prior written approval of the Reserve Bank and the Bureau, (a) declare or pay dividends of any kind, or make any payments on the Parent’s trust preferred securities; (b) incur or guarantee any debt; or (c) purchase or redeem any shares of the Parent’s stock. In addition, under the MOU the Parent and the Bank had agreed to review and revise the allowance for loan and lease losses methodology (“ALLL”), and on a quarterly basis submit to the Reserve Bank and the Bureau a copy of the internally calculated ALLL worksheet.

Note 15. Accumulated Other Comprehensive Income (Loss)

The changes in accumulated other comprehensive income (loss) for the six months ended June 30, 2014 and 2013 are summarized as follows:

	Unrealized Securities Gains (Losses)			Adjustments Related to Pension Plan			Accumulated Other Comprehensive Income (Loss)
	(dollars in thousands)
Balance at December 31, 2013	$	(8,396	)	$	(472	)	$	(8,868	)
Other comprehensive income before reclassification		4,364			-			4,364
Reclassification adjustment for gains included in net income		(323	)		-			(323	)
Net amortization of unrealized losses on securities transferred from available for sale to held to maturity		80			-			80
Net current period other comprehensive income		4,121			-			4,121
Balance at June 30, 2014	$	(4,275	)	$	(472	)	$	(4,747	)

Balance at December 31, 2012	$	1,924		$	(1,488	)	$	436
Other comprehensive (loss) before reclassification		(6,197	)		-			(6,197	)
Reclassification adjustment for gains included in net income		(346	)		-			(346	)
Net current period other comprehensive (loss)		(6,543	)		-			(6,543	)
Balance at June 30, 2013	$	(4,619	)	$	(1,488	)	$	(6,107	)

Reclassifications of gains on securities available for sale are reported in the consolidated statements of income as “Gain on sale of available for sale securities, net” with the corresponding income tax effect being reflected as a component of income tax expense.

During the three and six months ended June 30, 2014 and 2013, the Company reported gains on the sale of available for sale securities and amortization of unrealized losses on securities transferred from available for sale to held to maturity as shown in the following table:

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2014			2013			2014			2013
	(dollars in thousands)

Gains on sale of available for sale securities	$	109		$	58		$	489		$	525
Less: tax effect		(37	)		(20	)		(166	)		(179	)
Net gains on the sale of available for sale securities	$	72		$	38		$	323		$	346

Amortization of unrealized losses on securities transferred from available for sale to held to maturity	$	(78	)	$	-		$	(121	)	$	-
Less: tax effect		26			-			41			-
Net amortization of unrealized losses on securities transferred from available for sale to held to maturity	$	(52	)	$	-		$	(80	)	$	-

Note 16. Proposed Acquisition

On May 29, 2014, the Company entered into a definitive agreement and plan of reorganization pursuant to which the Company will acquire Virginia Company Bank (“VCB”), pursuant to a merger of VCB with and into EVB, with EVB surviving, in a cash and stock transaction. VCB is a Virginia state chartered bank with total assets of approximately $133 million at June 30, 2014 with locations in Newport News, Williamsburg and Hampton, Virginia. The agreement and plan of reorganization has been unanimously approved by the boards of directors of both companies. The transaction is expected to close in the fourth quarter of 2014, pending regulatory approvals, the approval of VCB’s common shareholders and satisfaction of other customary closing conditions.

Note 17. Subsequent Events

The Company evaluated subsequent events that have occurred after the balance sheet date, and through the date the financial statements were issued. There are two types of subsequent events: (1) recognized, or those that provide additional evidence about conditions that existed at the date of the balance sheet, including the estimates inherent in the process of preparing financial statements, and (2) nonrecognized, or those that provide evidence about conditions that did not exist at the date of the balance sheet but arose after that date.

Based on this evaluation, the Company did not identify any recognized or nonrecognized subsequent events that would have required adjustment to or disclosure in the financial statements.

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

We present management’s discussion and analysis of financial information to aid the reader in understanding and evaluating our financial condition and results of operations. This discussion provides information about the major components of our results of operations, financial condition, liquidity and capital resources. This discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements presented elsewhere in this report and the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in the 2013 Form 10-K. Operating results include those of all our operating entities combined for all periods presented.

Internet Access to Corporate Documents

Information about the Company can be found on the Company’s investor relations website at http://www.evb.org. The Company posts its annual reports, quarterly reports, current reports, definitive proxy materials and any amendments to those documents as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. All such filings are available at no charge. The information on the Company’s website is not, and shall not be deemed to be, a part of this Quarterly Report on Form 10-Q or incorporated into any other filings the Company makes with the SEC.

Forward Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q that are not historical facts may constitute “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, certain statements may be contained in the Company’s future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or Board of Directors, including those relating to products or services, the performance or disposition of portions of the Company’s asset portfolio, future changes to the Bank’s branch network, the payment of dividends and the ability to realize deferred tax assets; (iii) statements of future financial performance and economic conditions; (iv) statements regarding the adequacy of the allowance for loan losses; (v) statements regarding the effect of future sales of investment securities or foreclosed properties; (vi) statements regarding the Company’s liquidity; (vii) statements of management’s expectations regarding future trends in interest rates, real estate values, and economic conditions generally and in the Company’s markets; (viii) statements regarding future asset quality, including expected levels of charge-offs; (ix) statements regarding potential changes to laws, regulations or administrative guidance; (x) statements regarding business initiatives related to and the use of proceeds from the private placements (“the Private Placements”) and the rights offering (the “Rights Offering”) the Company completed in 2013, including expected future interest expenses and net interest margin following the prepayment of long-term FHLB advances; and (xi) statements of assumptions underlying such statements. Words such as “believes,” “anticipates,” “expects,” “intends,” “targeted,” “continue,” “remain,” “will,” “should,” “may” and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

factors that adversely affect our business initiatives related to the use of proceeds from the Rights Offering and the Private Placements, including, without limitation, changes in market conditions that adversely affect our ability to dispose of or work out assets adversely classified by us on advantageous terms or at all;

our ability and efforts to assess, manage and improve our asset quality;

the strength of the economy in the Company’s target market area, as well as general economic, market, political, or business factors;

¨	changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries, decline in real estate values in our markets, or in the repayment ability of individual borrowers or issuers;

the effects of our adjustments to the composition of our investment portfolio;

the impact of government intervention in the banking business;

an insufficient allowance for loan losses;

our ability to meet the capital requirements of our regulatory agencies;

changes in laws, regulations and the policies of federal or state regulators and agencies, including rules to implement the Basel III capital framework and for calculating risk weighted assets;

adverse reactions in financial markets related to the budget deficit of the United States government;

changes in the interest rates affecting our deposits and loans;

the loss of any of our key employees;

changes in our competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and our ability to compete effectively against other financial institutions in our banking markets;

our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth;

changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services;

our ability to maintain internal control over financial reporting;

our ability to realize our deferred tax assets, including in the event we experience an ownership change as defined by Section 382 of the Code;

our ability to raise capital as needed by our business;

our reliance on secondary sources, such as FHLB advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet our liquidity needs;

possible changes to our Board of Directors, including in connection with the Private Placements and deferred dividends on our Series A Preferred Stock;

the future prospects of the combined organization following the acquisition of VCB; and

other circumstances, many of which are beyond our control.

All of the forward-looking statements made in this report are qualified by these factors, and there can be no assurance that the actual results anticipated by the Company will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, the Company or its business or operations. The reader should refer to risks detailed under Item 1A. “Risk Factors” included in the 2013 Form 10-K and otherwise included in our periodic and current reports filed with the SEC for specific factors that could cause our actual results to be significantly different from those expressed or implied by our forward-looking statements.

The Company cautions the reader that the above list of important factors is not all-inclusive. These forward-looking statements are made as of the date of this report, and the Company undertakes no obligation to update any forward-looking statements to reflect the impact of any circumstances or events, including unanticipated events, that arise after the date the forward-looking statements are made.

Critical Accounting Policies

The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.

Allowance for Loan Losses

The Company establishes the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower’s ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. For more information see the section titled “Asset Quality” within this Item 2.

Impairment of Loans

The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due, according to the contractual terms of the loan agreement. The Company does not consider a loan impaired during a period of insignificant payment shortfalls if we expect the ultimate collection of all amounts due. Impairment is measured on a loan by loan basis for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s obtainable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans, representing consumer, one to four family residential first and seconds and home equity lines, are collectively evaluated for impairment. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are also considered impaired loans. A TDR occurs when the Company, for economic or legal reasons related to the borrower’s financial condition, grants a concession (including, without limitation, rate reductions to below-market rates, payment deferrals, forbearance and, in some cases, forgiveness of principal or interest) to the borrower that it would not otherwise consider. For more information see the section titled “Asset Quality” within Item 2.

Impairment of Securities

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 (i) the Company intends to sell the security or (ii) 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 likely than not that the Company will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis 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, impairment is considered to be other-than-temporary based on the Company’s ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the Company’s best estimate of the present value of cash flows expected to be collected from 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.

Other Real Estate Owned

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at estimated fair market value of the property, less estimated disposal costs, if any. Any excess of cost over the estimated fair market value less costs to sell 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.

Goodwill

With the adoption of ASU 2011-08, “Intangible-Goodwill and Other-Testing Goodwill for Impairment,” the Company is no longer required to perform a test for impairment unless, based on an assessment of qualitative factors related to goodwill, it determines that it is more likely than not that the fair value of goodwill is less than its carrying amount. If the likelihood of impairment is more than 50 percent, the Company must perform a test for impairment and we may be required to record impairment charges. In assessing the recoverability of the Company’s goodwill, all of which was recognized in connection with the acquisition of branches in 2003 and 2008, the Company must make assumptions in order to determine the fair value of the respective assets. Major assumptions used in the impairment analysis were discounted cash flows, merger and acquisition transaction values (including as compared to tangible book value), and stock market capitalization. The Company completed the annual goodwill impairment test during the fourth quarter of 2013 and determined there was no impairment to be recognized in 2013. If the underlying estimates and related assumptions change in the future, the Company may be required to record impairment charges.

Retirement Plan

The Company has historically maintained a defined benefit pension plan. Effective January 28, 2008, the Company took action to freeze the plan with no additional contributions for a majority of participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan. No additional participants have been added to the plan. The plan was again amended on February 28, 2011 to freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants have remained frozen in the plan since such action was taken. Effective January 1, 2012, the plan was amended and restated as a cash balance plan. Under a cash balance plan, participant benefits are stated as an account balance. An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan. Each participant’s account will be credited with an “interest” credit each year. The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year. Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Company’s actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.

Accounting for Income Taxes

Determining the Company’s effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Company’s tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.

The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is “more likely than not” that all or a portion of the deferred tax asset will not be realized. “More likely than not” is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed. For more information, see Item 1. “Financial Statements,” under the heading “Note 4. Deferred Income Taxes” in this Quarterly Report on Form 10-Q and Item 8. “Financial Statements and Supplementary Data,” under the headings “Note 1. Summary of Significant Accounting Policies” and “Note 10. Income Taxes” in the 2013 Form 10-K.

For further information concerning accounting policies, refer to Item 8. “Financial Statements and Supplementary Data,” under the heading “Note 1. Summary of Significant Accounting Policies” in the 2013 Form 10-K.

Business Overview

The Company provides a broad range of personal and commercial banking services including commercial, consumer and real estate loans. We complement our lending operations with an array of retail and commercial deposit products and fee-based services. Our services are delivered locally by well-trained and experienced bankers, whom we empower to make decisions at the local level, so they can provide timely lending decisions and respond promptly to customer inquiries. Having been in many of our markets for over 100 years, we have established relationships with and an understanding of our customers. We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.

The Company is committed to delivering strong long-term earnings using a prudent allocation of capital, in business lines where we have demonstrated the ability to compete successfully. During the first six months of 2014, the national and local economies continued to show limited signs of recovery with the main challenges continuing to be persistent unemployment above historical levels and uneven economic growth. Local markets also experienced harsh winter weather during the first quarter of 2014 that further slowed economic activity. Macro-economic and political issues continue to temper the global economic outlook and as such the Company remains cautiously optimistic regarding the limited signs of improvement seen in our local markets. Despite this, the Company believes that our local markets are poised for stronger growth in the coming months and years than the economic recovery has provided in our markets in recent periods.

Strategic Initiatives and Pending Acquisition of Virginia Company Bank

The Company has used a portion of the gross proceeds from its Private Placements and Rights Offerings in 2013 (the “2013 Capital Initiative”) for general corporate purposes, including strengthening its balance sheet, the accelerated resolution and disposition of assets adversely classified by the Company (consisting of other real estate owned and classified loans), and improvement of the Company’s balance sheet through the restructuring of FHLB advances. During the third quarter of 2013, the Company prepaid $107.5 million of its long-term FHLB advances, and also accelerated the resolution and disposition of adversely classified assets. The extinguishment of the higher rate long-term FHLB advances triggered an $11.5 million prepayment penalty that was fully recognized during the third quarter of 2013. During May 2014, the Company announced its intent to repay up to $15.0 million of the Company’s Series A Preferred Stock originally issued to the Treasury through TARP. The Company plans to effectuate a portion of this repayment through one or more transactions during the second half of 2014. During the remainder of 2014, the Company also plans to focus on online and mobile banking options offered to the Bank’s customers, including introducing or improving the Bank’s portfolio of internet and mobile banking products and services. As the Company executes these business strategies, senior management and the board of directors will continue to evaluate other initiatives that they believe will best position the Company for long-term success. While the Company largely has worked through the economic challenges of the past few years, the Company will look at the remainder of 2014 and into 2015 as an opportunity to strengthen its current branch network in existing markets and explore business development initiatives and strategic opportunities to grow the Company’s business. The Company completed one such initiative – the acquisition of a 4.9% interest in Southern Trust Mortgage, LLC – during May 2014.

In addition, on May 29, 2014, the Company announced the signing of a definitive merger agreement pursuant to which the Company would acquire VCB via a merger of VCB with and into EVB, with EVB surviving (such acquisition, the “Acquisition”). For more information on this pending acquisition refer to Item 1. “Financial Statements,” under the heading “Note 16. Proposed Acquisition” in this Quarterly Report on Form 10-Q and the Company’s Current Report on Form 8-K filed with the SEC on May 30, 2014.

Summary of Second Quarter 2014 and Year to Date Operating Results and Financial Condition

Table 1: Performance Summary
	Three Months Ended June 30,
(dollars in thousands, except per share data)	2014			2013
Net income ⁽¹⁾	$	1,655		$	673
Net income available to common shareholders ⁽¹⁾	$	1,114		$	297
Basic income per common share	$	0.10		$	0.04
Diluted income per common share	$	0.06		$	0.04
Return on average assets (annualized)		0.43	%		0.11	%
Return on average common shareholders' equity (annualized)		4.76	%		1.48	%
Net interest margin (tax equivalent basis)		3.82	%		3.21	%

	Six Months Ended June 30,
(dollars in thousands, except per share data)	2014			2013
Net income ⁽¹⁾	$	3,651		$	1,753
Net income available to common shareholders ⁽¹⁾	$	2,592		$	1,001
Basic income per common share	$	0.22		$	0.15
Diluted income per common share	$	0.15		$	0.14
Return on average assets (annualized)		0.50	%		0.19	%
Return on average common shareholders' equity (annualized)		5.68	%		2.58	%
Net interest margin (tax equivalent basis)		3.88	%		3.22	%

(1) The difference between net income and net income available to common shareholders is the effective dividend to holders
of the Company’s Series A Preferred Stock.

The Company’s results continue to be positively impacted by asset quality improvements and the extinguishment of long-term FHLB advances in the third quarter of 2013, as discussed in greater detail below. The prepayment of these advances has significantly improved the Company’s financial position and net interest margin for the three and six months ended June 30, 2014 as compared to the three and six months ended June 30, 2013.

For the three months ended June 30, 2014, the following were significant factors in the Company’s reported results:

Increase in net interest income of $962 thousand from the same period in 2013, principally due to a $1.4 million decrease in interest expense that was primarily driven by the elimination of higher-rate, longer term FHLB advances during the third quarter of 2013 and the current low rate environment;

Net interest margin (tax equivalent basis) increased 61 basis points to 3.82% during the second quarter of 2014 as compared to 3.21% for the same period in 2013;

No provision for loan losses during the second quarter of 2014 compared to $600 thousand for the same period in 2013, reflecting the Company’s conservative approach to provisioning for the allowance for loan losses in prior periods and a reduction in net charge-offs to $288 thousand for the second quarter of 2014 from $2.3 million in the same period of 2013;

Increase in nonperforming assets of $1.6 million from March 31, 2014 to June 30, 2014 due primarily to the Company placing three loans on nonaccrual status as a result of the continued deteriorating financial condition of the borrowers in the second quarter of 2014;

Expenses related to FDIC insurance premiums declined to $305 thousand, compared to $596 thousand for the same period in 2013, as the Company faced lower FDIC insurance assessment rates following termination of the Written Agreement;

Other operating expenses increased $270 thousand during the second quarter of 2014 as compared to the same period in 2013 and was driven primarily by higher legal and professional fees; and

Increase in the effective dividend on preferred stock of $165 thousand from the same period in 2013 due primarily to the dividend rate of the Company’s Series A Preferred Stock increasing from 5% to 9% in the first quarter of 2014.

For the six months ended June 30, 2014, the following were significant factors in the Company’s reported results:

Increase in net interest income of $2.2 million from the same period in 2013, principally due to a $2.8 million decrease in interest expense due to the same factors as discussed for the three month comparison above;

Net interest margin (tax equivalent basis) increased 66 basis points to 3.88% for the six months ended June 30, 2014 as compared to 3.22% for the same period in 2013;

Provision for loan losses of $250 thousand compared to $1.2 million for the same period in 2013, reflecting a reduction in net charge-offs to $399 thousand for the six months ended June 30, 2014, from $3.7 million in the same period of 2013;

Decrease in nonperforming assets of $1.4 million during the first six months of 2014 as compared to December 31, 2013 due to the Company’s continued focus on credit quality initiatives to improve its asset quality and resolve nonperforming assets;

Expenses related to FDIC insurance premiums of $637 thousand, compared to $1.2 million for the same period in 2013;

Other operating expenses increased $345 thousand during the first six months of 2014 as compared to the same period in 2013 and was driven primarily by higher legal and professional fees; and

Increase in the effective dividend on preferred stock of $307 thousand from the same period in 2013 due primarily to the dividend rate of the Company’s Series A Preferred Stock increasing from 5% to 9% in the first quarter of 2014.

Capital Management

As we first reported in our Quarterly Report on Form 10-Q for March 31, 2011, the Company has taken actions to preserve capital by deferring its regular quarterly cash dividend with respect to its Series A Preferred Stock which the Company originally issued to the Treasury in connection with the Company’s participation in the Treasury’s Capital Purchase Program in January 2009. On October 21, 2013, the Treasury sold all 24,000 shares of Series A Preferred stock held by Treasury to private investors. On May 15, 2014, the Company deferred its fourteenth consecutive dividend on the Series A Preferred Stock. As of June 30, 2014, the Company had accumulated $4.7 million for dividends on the Series A Preferred Stock. In addition, because dividends on the Series A Preferred Stock have not been paid for more than six quarters, the authorized number of directors on the Company’s Board of Directors has increased by two, and the holders of the Series A Preferred Stock have the right, voting as a class, to elect two directors to the Company’s Board of Directors at any annual meeting (or a special meeting called for that purpose) until all owed and unpaid dividends on the Series A Preferred Stock have been paid. To date the holders of the Series A Preferred Stock have not yet exercised this right. The Company is also not currently paying dividends on its common stock and Series B Preferred Stock.

On July 24, 2014, the Company declared $5.5 million of current and all deferred but accumulated dividends on its Series A Preferred Stock, payable on August 15, 2014.

The Company had also previously deferred regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities beginning with the second quarter of 2011, as permitted under the related indenture. During the second quarter of 2014, the Company paid all current and deferred interest on its outstanding Junior Subordinated Debentures.

The actions to suspend and defer dividend and interest payments to preserve capital, while difficult, have been necessary to ensure the financial strength of the Company. As economic conditions improve, and as the Company is able to generate earnings to support its current and future capital needs, the Company plans to restore dividends on its common stock and Series B Preferred Stock. For additional information about regulatory capital requirements applicable to the Company and the Company’s former formal and informal regulatory agreements, refer to Item 1. “Financial Statements,” under the headings “Note 13. Capital Requirements” and “Note 14. Regulatory Agreements,” respectively in this Quarterly Report on Form 10-Q.

Results of Operations

As discussed above, the Company’s results of operations for the three and six months ended June 30, 2014 were primarily driven by improved net interest margins related to the extinguishment of long-term FHLB advances in the third quarter of 2013. These improved financial results were achieved despite decreased yields on the Company’s loan portfolio, the largest segment of earning assets, during the three and six months ended June 30, 2014 as compared to the same periods in 2013. Additionally, a reduced provision for loan losses positively impacted earnings during the three and six months ended June 30, 2014. Credit quality continues to receive significant management attention to ensure that the Company continues to identify credit problems and improve the quality of its asset portfolio, with reduced levels of nonperforming assets from December 31, 2011 to June 30, 2014 demonstrating the Company’s positive asset quality progress. The Company remains diligent and focused on the management of its credit quality and is fully committed to quickly and aggressively addressing problem credits. Additional analysis and breakout of the Company’s nonperforming assets are presented later in this Item 2 under the caption “Asset Quality”. The remainder of this analysis discusses the results of operations under the component sections of net interest income and net interest margin, noninterest income, noninterest expense and income taxes.

Net Interest Income and Net Interest Margin

Net interest income, the fundamental source of the Company’s earnings, is defined as the difference between income on earning assets and the cost of funds supporting those assets. Significant categories of earning assets are loans and investment securities, while deposits and short-term borrowings represent the major portion of interest-bearing liabilities. The level of net interest income is impacted primarily by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to previous periods of operations and the yield of our interest earning assets compared to our cost of funding these assets.

Net interest margin is calculated by expressing tax-equivalent net interest income as a percentage of average interest earning assets, and represents the Company’s net yield on its earning assets. Net interest margin is an indicator of the Company’s effectiveness in generating income from its earning assets. The net interest margin is affected by the structure of the balance sheet as well as by competitive pressures, Federal Reserve Board policies and the economy. The spread that can be earned between interest earning assets and interest-bearing liabilities is also dependent to a large extent on the slope of the yield curve, which in recent periods has been significantly impacted by initiatives of the Federal Reserve Board intended to lower long-term interest rates.

Table 2 presents the average balances of assets and liabilities, the average yields earned on such assets (on a tax equivalent basis) and rates paid on such liabilities, and the net interest margin for the three and six months ended June 30, 2014 and 2013.

Table 2: Average Balance Sheet and Net Interest Margin Analysis

(dollars in thousands)

	Three Months Ended June 30,
	2014								2013
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate (1)			Balance			Expense		Rate (1)
Assets:
Securities
Taxable	$	236,634		$	1,338		2.27	%	$	257,275		$	1,307		2.04	%
Restricted securities		6,779			89		5.27	%		8,949			83		3.72	%
Tax exempt (2)		29,521			294		3.99	%		22,988			218		3.80	%
Total securities		272,934			1,721		2.53	%		289,212			1,608		2.23	%
Interest bearing deposits in other banks		5,097			4		0.31	%		58,826			40		0.27	%
Federal funds sold		121			-		0.00	%		114			-		0.00	%
Loans, net of unearned income (3)		685,491			8,562		5.01	%		674,528			9,052		5.38	%
Total earning assets		963,643			10,287		4.28	%		1,022,680			10,700		4.20	%
Less allowance for loan losses		(14,898	)							(18,992	)
Total non-earning assets		98,403								94,736
Total assets	$	1,047,148							$	1,098,424

Liabilities & Shareholders' Equity:
Interest-bearing deposits
Checking	$	259,279		$	233		0.36	%	$	246,254		$	234		0.38	%
Savings		89,334			30		0.13	%		90,779			40		0.18	%
Money market savings		113,929			116		0.41	%		127,579			134		0.42	%
Large dollar certificates of deposit (4)		99,525			307		1.24	%		129,854			428		1.32	%
Other certificates of deposit		124,096			292		0.94	%		129,523			390		1.21	%
Total interest-bearing deposits		686,163			978		0.57	%		723,989			1,226		0.68	%
Federal funds purchased and repurchase agreements		3,274			5		0.61	%		3,432			5		0.58	%
Short-term borrowings		68,547			36		0.21	%		-			-		0.00	%
Long-term borrowings		-			-		0.00	%		117,500			1,187		4.05	%
Trust preferred debt		10,310			88		3.42	%		10,310			87		3.38	%
Total interest-bearing liabilities		768,294			1,107		0.58	%		855,231			2,505		1.17	%
Noninterest-bearing liabilities
Demand deposits		134,605								126,706
Other liabilities		4,801								7,261
Total liabilities		907,700								989,198
Shareholders' equity		139,448								109,226
Total liabilities and shareholders' equity	$	1,047,148							$	1,098,424

Net interest income (2)				$	9,180							$	8,195

Interest rate spread (2)(5)							3.70	%							3.03	%
Interest expense as a percent of average earning assets							0.46	%							0.98	%
Net interest margin (2)(6)							3.82	%							3.21	%

Notes:

(1)

Yields are annualized and based on average daily balances.

(2)

Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%, with a $90 adjustment for 2014 and a $67 adjustment in 2013.

(3)

Nonaccrual loans have been included in the computations of average loan balances.

(4)

Large dollar certificates of deposit are certificates issued in amounts of $100 or greater.

(5)

Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.

(6)

Net interest margin is the net interest income, calculated on a fully taxable basis, expressed as a percentage of average earning assets.

(dollars in thousands)

	Six Months Ended June 30,
	2014								2013
	Average			Income/		Yield/			Average			Income/		Yield/
	Balance			Expense		Rate (1)			Balance			Expense		Rate (1)
Assets:
Securities
Taxable	$	238,849		$	2,845		2.40	%	$	261,544		$	2,729		2.10	%
Restricted securities		7,006			191		5.50	%		9,088			169		3.75	%
Tax exempt (2)		29,893			600		4.05	%		17,968			344		3.86	%
Total securities		275,748			3,636		2.66	%		288,600			3,242		2.27	%
Interest bearing deposits in other banks		6,288			8		0.26	%		54,514			65		0.24	%
Federal funds sold		132			-		0.00	%		234			-		0.00	%
Loans, net of unearned income (3)		681,821			17,112		5.06	%		674,306			18,008		5.39	%
Total earning assets		963,989			20,756		4.34	%		1,017,654			21,315		4.22	%
Less allowance for loan losses		(14,842	)							(19,674	)
Total non-earning assets		98,946								91,764
Total assets	$	1,048,093							$	1,089,744

Liabilities & Shareholders' Equity:
Interest-bearing deposits
Checking	$	258,234		$	461		0.36	%	$	245,404		$	470		0.39	%
Savings		89,757			60		0.13	%		89,529			80		0.18	%
Money market savings		116,494			241		0.42	%		129,950			283		0.44	%
Large dollar certificates of deposit (4)		100,143			608		1.22	%		128,327			859		1.35	%
Other certificates of deposit		124,591			595		0.96	%		131,262			808		1.24	%
Total interest-bearing deposits		689,219			1,965		0.57	%		724,472			2,500		0.70	%
Federal funds purchased and repurchase agreements		3,329			10		0.61	%		3,363			10		0.60	%
Short-term borrowings		70,754			71		0.20	%		-			-		0.00	%
Long-term borrowings		-			-		0.00	%		117,500			2,361		4.05	%
Trust preferred debt		10,310			176		3.44	%		10,310			174		3.40	%
Total interest-bearing liabilities		773,612			2,222		0.58	%		855,645			5,045		1.19	%
Noninterest-bearing liabilities
Demand deposits		132,074								122,171
Other liabilities		4,745								7,226
Total liabilities		910,431								985,042
Shareholders' equity		137,662								104,702
Total liabilities and shareholders' equity	$	1,048,093							$	1,089,744

Net interest income (2)				$	18,534							$	16,270

Interest rate spread (2)(5)							3.76	%							3.03	%
Interest expense as a percent of average earning assets							0.46	%							1.00	%
Net interest margin (2)(6)							3.88	%							3.22	%

Notes:

(1)

Yields are annualized and based on average daily balances.

(2)

Income and yields are reported on a tax equivalent basis assuming a federal tax rate of 34%, with a $183 adjustment for 2014 and a $105 adjustment in 2013.

(3)

Nonaccrual loans have been included in the computations of average loan balances.

(4)

Large dollar certificates of deposit are certificates issued in amounts of $100 or greater.

(5)

Interest rate spread is the average yield on earning assets, calculated on a fully taxable basis, less the average rate incurred on interest-bearing liabilities.

(6)

Net interest margin is the net interest income, calculated on a fully taxable basis, expressed as a percentage of average earning assets.

Interest Income and Expense

Net interest income and net interest margin

Net interest income in the second quarter of 2014 increased $962 thousand, or 11.8%, when compared to the second quarter of 2013. Net interest income in the six months ended June 30, 2014 increased $2.2 million, or 13.5%, when compared to the same period in 2013. The Company’s net interest margin increased to 3.82% and 3.88% for the three and six months ended June 30, 2014, representing 61 and 66 basis point increases, respectively, over the Company’s net interest margins for the three and six months ended June 30, 2013.

The most significant factors impacting net interest income and net interest margin during these periods were as follows:

Positive Impacts:

Extinguishment of higher-rate long-term FHLB advances during the third quarter of 2013, which drove declines in the Company’s interest expense and rate paid on average interest-bearing liabilities;

Decreases in the average balances of and average rates paid on total interest-bearing deposits;

Increasing yields on the investment securities portfolio driven by increases in interest rates over the comparable periods and rebalancing efforts during late 2013 and the first half of 2014, which largely consisted of accelerated prepayments on lower yield Agency mortgage-backed and Agency CMO securities and a greater allocation of the portfolio to SBA Pool securities and higher yielding, longer duration municipal securities; and

Increasing average loan balances.

Negative Impacts:

Decreasing yields on the Company’s loan portfolio; and

Decreasing average balances of interest bearing deposits in other banks.

Total interest income

Total interest income decreased 4.1% and 3.0% for the three and six month periods ended June 30, 2014, as compared to the same periods in 2013, respectively. These declines in total interest income were driven primarily by declines in the yield on the loan portfolio and a decrease in average investment securities. These declines were partially offset by higher yields on investment securities and higher average loan balances.

Loans

Average loan balances increased for both the three and six month periods ended June 30, 2014, as compared to the same periods in 2013, due primarily to the purchase of $27.2 million in performing one-to-four family residential mortgage loans in the first quarter of 2014 and the origination of a line of credit to fund loan originations through Southern Trust Mortgage, LLC (balance of $11.6 million as of June 30, 2014) in the second quarter of 2014. These additions to the Company’s loan portfolio were partially offset by weak loan demand in the Company’s markets as a result of the continuing challenging economic conditions, such that the Company’s average loan balances increased $11.0 million and $7.5 million for the three and six months ended June 30, 2014, as compared to average balances for the same periods in 2013. In addition, due to the historically low interest rate environment, loans were originated during the second quarter and first six months of 2014 at much lower yields than seasoned loans in the Company’s loan portfolio, which has contributed significantly to average yields on the loan portfolio declining 37 and 33 basis points for the three and six months ended June 30, 2014, as compared to the same periods in 2013. Total average loans were 71.1% of total average interest-earning assets for the three months ended June 30, 2014, compared to 66.0% for the three months ended June 30, 2013. Total average loans were 70.7% of total average interest-earning assets for the six months ended June 30, 2014, compared to 66.3% for the six months ended June 30, 2013.

Investment securities

Average investment securities balances declined 5.6% and 4.5% for the three and six month periods ended June 30, 2014, as compared to the same periods in 2013, due to the Company’s efforts to rebalance the securities portfolio, while the yields on investment securities increased 30 and 39 basis points for the three and six months ended June 30, 2014 as compared to the same periods in 2013. Increasing yields on the investment securities portfolio were driven by increases in interest rates over the comparable periods and portfolio rebalancing efforts during late 2013 and the first half of 2014, which largely consisted of accelerated prepayments on lower-yield Agency mortgage-backed and Agency CMO securities and allocating a greater proportion of the portfolio to SBA Pool securities and higher yielding, longer duration municipal securities.

Interest bearing deposits in other banks

Average interest bearing deposits in other banks decreased significantly for both the three and six month periods ended June 30, 2014, as compared to the same periods in 2013, due to the overall decrease in our average total deposits, the purchase of $27.2 million in performing one-to-four family mortgage loans in the first quarter of 2014 and declines in average total borrowings that were largely due to extinguishing the Company’s long-term FHLB advances during the third quarter of 2013.

Interest-bearing deposits

Average total interest-bearing deposit balances and related rates paid decreased for both the three and six month periods ended June 30, 2014, as compared to the same periods in 2013, contributing to the reductions in interest expense in the second quarter and first six months of 2014. Retail deposits continued to shift from higher priced certificates of deposit and money market savings accounts to lower priced checking (or “NOW”) accounts.

Borrowings

Average total borrowings and related rates paid on average total borrowings decreased for both the three and six month periods ended June 30, 2014, as compared to the same periods in 2013, significantly driving the reduction in interest expense in the second quarter and first half of 2014. These decreases were primarily due to the extinguishment of $117.5 million higher rate long-term FHLB advances during the third quarter of 2013. The long-term FHLB advances were partially replaced with short-term FHLB advances at a significantly lower rate.

Noninterest Income

Noninterest income is comprised of all sources of income other than interest income on our earning assets. Significant revenue items include fees collected on certain deposit account transactions, debit and credit card fees, other general services, earnings from other investments we own in part or in full, gains or losses from investments, and gains or losses on sales of investment securities, loans, and fixed assets.

The following tables depict the components of noninterest income for the three and six months ended June 30, 2014 and 2013:

Table 3: Noninterest Income
	Three Months Ended June 30,
(dollars in thousands)	2014		2013		Change $			Change %
Service charges and fees on deposit accounts	$	837	$	729	$	108			14.8	%
Debit/credit card fees		378		375		3			0.8	%
Gain on sale of available for sale securities, net		109		58		51			87.9	%
Gain on sale of bank premises and equipment		-		25		(25	)		-100.0	%
Other operating income		315		263		52			19.8	%
Total noninterest income	$	1,639	$	1,450	$	189			13.0	%

	Six Months Ended June 30,
(dollars in thousands)	2014		2013		Change $			Change %
Service charges and fees on deposit accounts	$	1,659	$	1,495	$	164			11.0	%
Debit/credit card fees		687		708		(21	)		-3.0	%
Gain on sale of available for sale securities, net		489		525		(36	)		-6.9	%
Gain on sale of bank premises and equipment		5		26		(21	)		-80.8	%
Other operating income		691		644		47			7.3	%
Total noninterest income	$	3,531	$	3,398	$	133			3.9	%

Key changes in the components of noninterest income for the three and six months ended June 30, 2014, as compared to the same periods in 2013, are discussed below:

Service charges and fees on deposit accounts increased due to increases in service charge fees on checking accounts;

Gain on sale of available for sale securities, net increased for the second quarter of 2014 compared to the same period of 2013 and was primarily the result of the Company adjusting the composition of the investment portfolio as part of the Company’s overall asset/liability management strategy. The Company generated gains during the first six months of 2014 by selling a portion of its previously impaired agency preferred securities (FNMA & FHLMC) to remove classified assets from the Company’s balance sheet and to fund purchases of taxable securities to increase the Company’s sources of taxable income. The Company will continue to strategically evaluate opportunities to further adjust the composition of its investment portfolio through the balance of 2014;

Gain on sale of bank premises and equipment decreased as disposal gains on company vehicles were recognized in the second quarter of 2013 with no such gain being recognized in the second quarter of 2014; and

Other operating income increased for the three and six months ended June 30, 2014, as compared to the same periods in 2013, primarily due to higher earnings from bank owned life insurance policies during 2014, and with respect to the three months ended June 30, 2014, higher earnings from the Bank’s subsidiaries compared to the second quarter of 2013.

Noninterest Expense

Noninterest expense includes all expenses with the exception of those paid for interest on borrowings and deposits. Significant expense items included in this component are salaries and employee benefits, occupancy and other operating expenses.

The following tables depict the components of noninterest expense for the three and six months ended June 30, 2014 and 2013:

Table 4: Noninterest Expense
	Three Months Ended June 30,
(dollars in thousands)	2014		2013		Change $			Change %
Salaries and employee benefits	$	4,748	$	4,146	$	602			14.5	%
Occupancy and equipment expenses		1,267		1,271		(4	)		-0.3	%
Telephone		211		310		(99	)		-31.9	%
FDIC expense		305		596		(291	)		-48.8	%
Consultant fees		279		213		66			31.0	%
Collection, repossession and other real estate owned		89		126		(37	)		-29.4	%
Marketing and advertising		270		246		24			9.8	%
Loss on sale of other real estate owned		28		118		(90	)		-76.3	%
Impairment losses on other real estate owned		6		133		(127	)		-95.5	%
Other operating expenses		1,316		1,046		270			25.8	%
Total noninterest expenses	$	8,519	$	8,205	$	314			3.8	%

	Six Months Ended June 30,
(dollars in thousands)	2014		2013		Change $			Change %
Salaries and employee benefits	$	9,334	$	8,295	$	1,039			12.5	%
Occupancy and equipment expenses		2,586		2,527		59			2.3	%
Telephone		422		565		(143	)		-25.3	%
FDIC expense		637		1,183		(546	)		-46.2	%
Consultant fees		622		429		193			45.0	%
Collection, repossession and other real estate owned		156		252		(96	)		-38.1	%
Marketing and advertising		437		480		(43	)		-9.0	%
Loss on sale of other real estate owned		15		155		(140	)		-90.3	%
Impairment losses on other real estate owned		11		143		(132	)		-92.3	%
Other operating expenses		2,477		2,132		345			16.2	%
Total noninterest expenses	$	16,697	$	16,161	$	536			3.3	%

Key changes in the components of noninterest expense for the three and six months ended June 30, 2014, as compared to the same periods in 2013, are discussed below:

Salaries and employee benefits increased for the three and six month periods due to annual merit increases, lower deferred compensation on loan originations (which increased current compensation expense) and higher group term insurance costs;

Telephone expenses decreased for the three and six month periods as a result of changing vendors during the first quarter of 2014 which generated cost savings;

FDIC expense decreased for the three and six month periods due to lower base assessment rates resulting from the improvement in the Bank’s overall composite rating in connection with the termination of the Written Agreement in July 2013, and corresponding decreases in FDIC insurance assessment rates during 2014;

Consultant fees increased for the three and six months periods due to additional consulting charges that were related to compliance and loan operations;

Collection, repossession and other real estate owned expenses decreased for the three and six month periods due to declines in carrying balances of OREO and classified assets;

Marketing and advertising expense was elevated for the three month period due to increased expenditures on television, radio and newspaper advertising. However, for the six month period, marketing and advertising expense declined due to lower expenditures on television, radio and newspaper advertising that were partially offset by new branch opening expenses in the same period of 2013;

Loss on the sale of other real estate owned declined for the three and six month periods and were driven by lower OREO balances and stabilization of real estate prices in our markets;

Impairment losses on other real estate owned have decreased as OREO balances have continued to decline and real estate prices in our markets have continued to stabilize; and

Other operating expenses increased for the three and six month periods primarily due to higher legal and professional services primarily related to the Company’s investment in Southern Trust Mortgage, LLC, and increased customer check and coupon incentives.

Income Taxes

The Company recorded income tax expense of $555 thousand for the three months ended June 30, 2014, compared to income tax expense of $100 thousand for the same period of 2013, reflecting a $455 thousand increase in income tax expense.

The Company recorded income tax expense of $1.3 million for the six months ended June 30, 2014, compared to income tax expense of $449 thousand for the same period of 2013, reflecting a $835 thousand increase in income tax expense. The increase in income tax expense from the second quarter and first six months of 2013 to the same periods of 2014 was the result of the Company’s pretax income increasing by approximately $1.4 million and $2.7 million, respectively, partially offset by increases in the amount of tax-exempt income on investment securities (as the Company rebalanced its securities portfolio during 2013) and increases in tax-exempt income from bank owned life insurance policies.

Asset Quality

Provision and Allowance for Loan Losses

The allowance for loan losses is a reserve for estimated credit losses on individually evaluated loans determined to be impaired as well as estimated credit losses inherent in the loan portfolio, and is based on periodic evaluations of the collectability and historical loss experience of loans. A provision for loan losses, which is a charge against earnings, is recorded to bring the allowance for loan losses to a level that, in management’s judgment, is appropriate to absorb probable losses in the loan portfolio. Actual credit losses are deducted from the allowance for loan losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent. Subsequent recoveries, if any, are credited to the allowance for loan losses.

The allowance for loan losses is comprised of a specific allowance for identified problem loans and a general allowance representing estimations done pursuant to either FASB ASC Topic 450 “Accounting for Contingencies”, or FASB ASC Topic 310 “Accounting by Creditors for Impairment of a Loan.” The specific component relates to loans that are classified as impaired, and is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. For collateral dependent loans, an updated appraisal will be ordered if a current one is not on file. Appraisals are performed by independent third-party appraisers with relevant industry experience. Adjustments to the appraised value may be made based on recent sales of like properties or general market conditions when deemed appropriate. The general component covers non-classified or performing loans and those loans classified as substandard, doubtful or loss that are not impaired. The general component is based on migration analysis adjusted for qualitative factors, such as economic conditions, interest rates and unemployment rates. The Company uses a risk grading system for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans. Loans are graded on a scale from 1 to 9. Non-impaired real estate and commercial loans are assigned an allowance factor which increases with the severity of risk grading. A general description of the characteristics of the risk grades is as follows:

Pass Grades

Risk Grade 1 loans have little or no risk and are generally secured by cash or cash equivalents;

Risk Grade 2 loans have minimal risk to well qualified borrowers and no significant questions as to safety;

Risk Grade 3 loans are satisfactory loans with strong borrowers and secondary sources of repayment;

Risk Grade 4 loans are satisfactory loans with borrowers not as strong as risk grade 3 loans but may exhibit a higher degree of financial risk based on the type of business supporting the loan; and

Risk Grade 5 loans are loans that warrant more than the normal level of supervision and have the possibility of an event occurring that may weaken the borrower’s ability to repay.

Special Mention

Classified Grades

Risk Grade 9 loans are loss loans which are considered uncollectable and of such little value that their continuance as a bank asset is not warranted.

The Company's ALL Committee is responsible for assessing the overall appropriateness of the allowance for loan losses and monitoring the Company's allowance for loan losses methodology, particularly in the context of current economic conditions and a rapidly changing regulatory environment. The ALL Committee at least annually reviews the Company's allowance for loan losses methodology.

For financial periods prior to and including the quarter ended September 30, 2013, in lieu of applying a migration analysis the Company considered historical loss experience based on a rolling three year average of historical loan loss experience. For more information, see the information contained in Part I, Item 7 of the 2013 Form 10-K under the heading “Asset Quality – Provision and Allowance for Loan Losses.”

Management believes that the level of the allowance for loan losses is appropriate in light of the credit quality and anticipated risk of loss in the loan portfolio. While management uses available information to recognize losses on loans, future additions to the allowance for loan losses may be necessary based on changes in economic conditions. In addition, various regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses. Such agencies may require the Company to recognize additions to the allowance for loan losses through increased provisions for loan losses or may require that certain loan balances be charged-off or downgraded into classified loan categories when their credit evaluations differ from those of management based on their judgments about information available to them at the time of their examinations.

The following table presents the Company’s loan loss experience for the periods indicated:

Table 5: Allowance for Loan Losses
	Six Months Ended June 30,
(dollars in thousands)	2014			2013
Average loans outstanding*	$	681,821		$	674,306
Allowance for loan losses, January 1	$	14,767		$	20,338
Charge-offs:
Commercial, industrial and agricultural		(290	)		(559	)
Real estate - one to four family residential:
Closed end first and seconds		(304	)		(269	)
Home equity lines		(54	)		(58	)
Real estate - construction:
One to four family residential		-			(51	)
Other construction, land development and other land		-			(950	)
Real estate - non-farm, non-residential:
Owner occupied		-			(449	)
Non-owner occupied		-			(1,534	)
Consumer		(86	)		(75	)
Other		(26	)		(72	)
Total loans charged-off		(760	)		(4,017	)
Recoveries:
Commercial, industrial and agricultural		30			102
Real estate - one to four family residential:
Closed end first and seconds		211			33
Home equity lines		13			1
Real estate - construction:
One to four family residential		6			31
Other construction, land development and other land		2			67
Real estate - non-farm, non-residential:
Owner occupied		27			-
Non-owner occupied		3			-
Consumer		55			58
Other		14			20
Total recoveries		361			312
Net charge-offs		(399	)		(3,705	)
Provision for loan losses		250			1,200
Allowance for loan losses, June 30	$	14,618		$	17,833
Ratios:
Ratio of allowance for loan losses to total loans outstanding, end of period		2.09	%		2.66	%
Ratio of annualized net charge-offs to average loans outstanding during the period		0.12	%		1.11	%
*Net of unearned income and includes nonaccrual loans.

As a result of taking a conservative approach to provision for loan losses in prior periods in light of uncertain economic and financial market conditions, the Company made provision for loan losses of $0 and $250 thousand, respectively for the three and six months ended June 30, 2014, as compared to $600 thousand and $1.2 million for the same period of 2013. Net charge-offs for the three and six months ended June 30, 2014 were $288 thousand and $399 thousand, respectively, compared to $2.3 million and $3.7 million, respectively for the same periods of 2013. This represents, on an annualized basis, 0.17% and 0.12% of average loans outstanding for the three and six months ended June 30, 2014 and 1.36% and 1.11% of average loans outstanding for the same periods of 2013. The contribution to the provision in the first six months of 2014 and 2013 was made in response to sustained credit quality issues in our loan portfolio as well as current market conditions, both nationally and in our markets, which indicate that credit quality issues may adversely impact our loan portfolio and our earnings in future periods. The provision for loan losses declined during the first six months of 2014 compared to the same period of 2013 in part due to asset quality improvements made during 2013 and 2014.

Net charge-offs decreased $3.3 million, or 89.2%, from the six months ended June 30, 2013 to the same period of 2014 due to improvements in some of the Company’s credit quality metrics, including continued decreases in nonperforming assets, and other factors, which are reflective of slowly improving economic conditions. However, the Company continues to aggressively focus on credit quality initiatives to improve its asset quality and resolve nonperforming assets.

The allowance for loan losses at June 30, 2014 was $14.6 million, compared with $14.8 million at December 31, 2013. This represented 2.09% of period end loans at June 30, 2014, compared with 2.25% of year end loans at December 31, 2013.

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

Table 6: Allocation of Allowance for Loan Losses

	At June 30,					At December 31,
	2014					2013
(dollars in thousands)	Allowance		Percent			Allowance		Percent
Commercial, industrial and agricultural	$	1,196		8.16	%	$	1,787		8.17	%
Real estate - one to four family residential:
Closed end first and seconds		2,578		34.50	%		2,859		33.25	%
Home equity lines		1,845		13.98	%		1,642		15.19	%
Real estate - multifamily residential		108		2.86	%		79		2.75	%
Real estate - construction:
One to four family residential		301		2.46	%		364		2.46	%
Other construction, land development and other land		2,492		3.56	%		1,989		3.30	%
Real estate - farmland		127		1.03	%		116		1.24	%
Real estate - non-farm, non-residential:
Owner occupied		2,119		18.38	%		3,236		19.26	%
Non-owner occupied		2,628		10.86	%		1,770		11.39	%
Consumer		355		2.17	%		387		2.55	%
Other		869		2.04	%		538		0.44	%
Total allowance for loan losses	$	14,618		100.00	%	$	14,767		100.00	%

(Percent is portfolio loans in category divided by total loans)

Tabular presentations of commercial loans by credit quality indicator and consumer loans, including one to four family residential first and seconds and home equity lines, by payment activity at June 30, 2014 and December 31, 2013 can be found under Item 1. “Financial Statements,” under the heading “Note 3. Loan Portfolio.”

Nonperforming Assets

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at estimated fair market value of the property, less estimated disposal costs, if any. Cost includes loan principal and accrued interest. Any excess of cost over the estimated fair market value less costs to sell 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. Net operating income or expenses of such properties are included in collection, repossession and other real estate owned expenses.

The following table presents information concerning nonperforming assets as of and for the six months ended June 30, 2014 and the year ended December 31, 2013:

Table 7: Nonperforming Assets
	June 30,			December 31,
(dollars in thousands)	2014			2013			Change $			Change %
Nonaccrual loans*	$	9,770		$	11,018		$	(1,248	)		-11.3	%
Loans past due 90 days and accruing interest		-			-			-			-
Total nonperforming loans		9,770			11,018			(1,248	)		-11.3	%
Other real estate owned		601			800			(199	)		-24.9	%
Total nonperforming assets	$	10,371		$	11,818		$	(1,447	)		-12.2	%

Nonperforming assets to total loans and other real estate owned		1.48	%		1.80	%
Allowance for loan losses to nonaccrual loans		149.61	%		134.03	%
Annualized net charge-offs to average loans for the period		0.12	%		1.11	%
Allowance for loan losses to period end loans		2.09	%		2.25	%

* Includes $4.0 million and $4.2 million in nonaccrual TDRs at June 30, 2014 and December 31, 2013, respectively.

The following table presents the change in the OREO balance for the six months ended June 30, 2014 and 2013:

Table 8: OREO Changes
	June 30,
(dollars in thousands)	2014			2013			Change $			Change %
Balance at the beginning of period, gross	$	1,054		$	5,558		$	(4,504	)		-81.0	%
Transfers from loans		289			1,095			(806	)		-73.6	%
Sales proceeds		(462	)		(2,950	)		2,488			84.3	%
Previously recognized impairment losses on disposition		(157	)		-			(157	)		-100.0	%
Loss on disposition		(15	)		(155	)		140			90.3	%
Balance at the end of period, gross		709			3,548			(2,839	)		-80.0	%
Less valuation allowance		(108	)		(954	)		846			88.7	%
Balance at the end of period, net	$	601		$	2,594		$	(1,993	)		-76.8	%

The following table presents the change in the valuation allowance for OREO for the six months ended June 30, 2014 and 2013:

Table 9: OREO Valuation Allowance Changes
	June 30,
(dollars in thousands)	2014			2013

Balance at the beginning of period	$	254		$	811
Valuation allowance		11			143
Charge-offs		(157	)		-
Balance at the end of period	$	108		$	954

Nonperforming assets were $10.4 million or 1.48% of total loans and other real estate owned at June 30, 2014 compared to $11.8 million or 1.80% at December 31, 2013. Nonperforming assets increased from 2007 through 2010 as a result of the continued challenging economic conditions which significantly increased unemployment, reduced profitability of local businesses, and reduced the ability of many of our customers to keep their loans current. Nonperforming assets began to trend downward during 2011, continued this trend throughout 2012 and 2013 and decreased by $1.4 million during the first six months of 2014. The sluggish economic recovery and continuing asset quality issues in the Company’s loan portfolio have prompted the Company to maintain the heightened level of the allowance for loan losses as compared to historical levels, which is 149.61% of nonaccrual loans at June 30, 2014, compared to 134.03% at December 31, 2013. Nonperforming loans decreased $1.2 million or 11.3% during the six months ended June 30, 2014 to $9.8 million.

Nonaccrual loans were $9.8 million at June 30, 2014, a decrease of approximately $1.2 million or 11.3% from $11.0 million at December 31, 2013. Of the current $9.8 million in nonaccrual loans, $9.2 million or 93.9% is secured by real estate in our market area. Of these real estate secured loans, $4.9 million are residential real estate, $3.5 million are commercial properties, $590 thousand are farmland, and $132 thousand are real estate construction. Nonaccrual loans increased $1.5 million during the second quarter of 2014 and was primarily due to the Company placing three loans on nonaccrual status as a result of the continued deteriorating financial condition of the borrowers.

As of June 30, 2014 and December 31, 2013, there were no loans past due 90 days and still accruing interest.

Other real estate owned, net of valuation allowance at June 30, 2014 was $601 thousand, a decrease of $199 thousand or 24.9% from $800 thousand at December 31, 2013. The balance of other real estate owned at June 30, 2014 was comprised of 10 properties of which $423 thousand are residential real estate, $165 thousand are real estate construction properties and $13 thousand are commercial properties. During the six months ended June 30, 2014, new foreclosures included four properties totaling $289 thousand transferred from loans. Sales of seven other real estate owned properties for the six months ended June 30, 2014 resulted in a net loss of $15 thousand. Subsequent to June 30, 2014, one property was sold resulting in a net loss of approximately $25 thousand that will be recognized in the third quarter of 2014. The remaining properties are being actively marketed and the Company does not anticipate any material losses associated with these properties. The Company recorded losses of $11 thousand in its consolidated statements of income for the six months ended June 30, 2014, due to valuation adjustments on other real estate owned properties as compared to $143 thousand for the same period of 2013. Asset quality continues to be a top priority for the Company. The Company continues to allocate significant resources to the expedient disposition and collection of nonperforming and other lower quality assets, as demonstrated by the $2.0 million, or 76.8%, decrease in other real estate owned from June 30, 2013 to June 30, 2014. For more information on asset disposition strategies, see “Strategic Initiatives and Pending Acquisition of Virginia Company Bank” in this Item 2.

As discussed earlier in this Item 2, the Company measures impaired loans based on the present value of expected future cash flows discounted at the effective interest rate of the loan or, as a practical expedient, at the loan’s observable market price or the fair value of the collateral if the loan is collateral dependent. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. TDRs are considered impaired loans. TDRs occur when we agree to modify the original terms of a loan by granting a concession due to the deterioration in the financial condition of the borrower. These concessions can be temporary and are made in an attempt to avoid foreclosure and with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated. These concessions could include, without limitation, rate reductions to below market rates, payment deferrals, forbearance, and, in some cases, forgiveness of principal or interest.

A tabular presentation of loans individually evaluated for impairment by class of loans at June 30, 2014 and December 31, 2013 can be found under Item 1. “Financial Statements,” under the heading “Note 3. Loan Portfolio.”

At June 30, 2014, the balance of impaired loans was $44.2 million, for which there were specific valuation allowances of $6.0 million. At December 31, 2013, the balance of impaired loans was $35.5 million, for which there were specific valuation allowances of $5.7 million. The average balance of impaired loans was $38.9 million for the six months ended June 30, 2014, compared to $41.2 million for the year ended December 31, 2013. Impaired loans increased by approximately $8.7 million from December 31, 2013 to June 30, 2014, primarily due to the deteriorating financial condition of two large commercial relationships. The Company’s balance of impaired loans remains elevated over historical levels as a result of the continued challenging economic conditions which have significantly increased unemployment, reduced profitability of local businesses, and reduced the ability of many of our customers to keep their loans current.

The following table presents the balances of TDRs at June 30, 2014 and December 31, 2013:

Table 10: Troubled Debt Restructurings (TDRs)
	June 30,		December 31,
(dollars in thousands)	2014		2013		Change $			Change %

Performing TDRs	$	16,383	$	16,026	$	357			2.2	%
Nonperforming TDRs*		3,963		4,188		(225	)		-5.4	%
Total TDRs	$	20,346	$	20,214	$	132			0.7	%

* Included in nonaccrual loans in Table 7: Nonperforming Assets.

Financial Condition

Summary

At June 30, 2014, the Company had total assets of $1.06 billion, an increase of $29.0 million or 2.8% from $1.03 billion at December 31, 2013. The increase in total assets was principally the result of increases in restricted securities, loans, short-term borrowings and shareholders’ equity, and partially offset by decreases in cash and short-term investments, interest bearing deposits with banks, investment securities, deferred income taxes and interest-bearing deposits.

Table 11: Balance Sheet Changes
	June 30,		December 31,
(dollars in thousands)	2014		2013		Change $			Change %
Total assets	$	1,056,083	$	1,027,074	$	29,009			2.8	%
Cash and short-term investments		12,960		13,944		(984	)		-7.1	%
Interest bearing deposits with banks		3,603		5,402		(1,799	)		-33.3	%
Securities available for sale, at fair value		227,632		234,935		(7,303	)		-3.1	%
Securities held to maturity, at carrying value		34,077		35,495		(1,418	)		-4.0	%
Restricted securities, at cost		7,230		5,549		1,681			30.3	%
Total loans		697,993		657,197		40,796			6.2	%
Deferred income taxes, net		15,530		18,937		(3,407	)		-18.0	%
Other real estate owned, net		601		800		(199	)		-24.9	%
Bank owned life insurance		21,432		21,158		274			1.3	%
Total deposits		821,526		834,462		(12,936	)		-1.6	%
Total borrowings		90,552		55,259		35,293			63.9	%
Total shareholders' equity		140,760		132,949		7,811			5.9	%

Investment Securities

The investment portfolio plays a primary role in the management of the Company’s interest rate sensitivity. In addition, the portfolio serves as a source of liquidity and is used as needed to meet collateral requirements, such as those related to secure public deposits, balances with the Reserve Bank and repurchase agreements. The investment portfolio consists of held to maturity and available for sale securities. We classify securities as available for sale or held to maturity based on our investment strategy and management’s assessment of our intent and ability to hold the securities until maturity. Management determines the appropriate classification of securities at the time of purchase. If management has the intent and the Company has the ability at the time of purchase to hold the investment securities to maturity, they are classified as investment securities held to maturity and are stated at amortized cost, adjusted for amortization of premiums and accretion of discounts using the interest method. Investment securities which the Company may not hold to maturity are classified as investment securities available for sale, as management has the intent and ability to hold such investment securities for an indefinite period of time, but not necessarily to maturity. Securities available for sale may be sold in response to changes in market interest rates, changes in prepayment risk, increases in loan demand, general liquidity needs and other similar factors and are carried at estimated fair value.

Table 12: Investment Securities
	June 30,		December 31,
(dollars in thousands)	2014		2013		Change $			Change %

Available for Sale (at Estimated Fair Value):
Obligations of U.S. Government agencies	$	14,075	$	13,390	$	685			5.1	%
SBA Pool securities		84,426		86,035		(1,609	)		-1.9	%
Agency mortgage-backed securities		30,487		35,254		(4,767	)		-13.5	%
Agency CMO securities		43,292		41,378		1,914			4.6	%
Non agency CMO securities		1,037		1,306		(269	)		-20.6	%
State and political subdivisions		53,391		56,342		(2,951	)		-5.2	%
Pooled trust preferred securities		748		749		(1	)		-0.1	%
FNMA and FHLMC preferred stock		176		481		(305	)		-63.4	%
Total	$	227,632	$	234,935	$	(7,303	)		-3.1	%

	June 30,		December 31,
(dollars in thousands)	2014		2013		Change $			Change %

Held to Maturity (at Carrying Value):
Agency CMO securities	$	12,256	$	12,500	$	(244	)		-2.0	%
State and political subdivisions		21,821		22,995		(1,174	)		-5.1	%
Total	$	34,077	$	35,495	$	(1,418	)		-4.0	%

Total investment securities were $261.7 million at June 30, 2014, reflecting a decrease of $8.7 million or 3.2% from $270.4 million at December 31, 2013. The available for sale portfolio had an unrealized (loss), net of tax benefit, of ($3.7) million at June 30, 2014 compared with an unrealized (loss), net of tax benefit, of ($7.8) million at December 31, 2013. These unrealized (losses) as of June 30, 2014 are principally due to financial market conditions for these types of investments, particularly changes in interest rates, which rose during 2013 causing bond prices to decline and was partially offset by a decrease in interest rates, specifically in the middle and long-end of the yield curve, during the first six months of 2014 which has caused bond prices to rise and thereby reduce the amount of unrealized losses.

The decrease in the investment portfolio during the first six months of 2014 was the result of our continued effort to restructure the composition of our securities portfolio. These decreases were partially offset by the result of mark-to-market adjustments related to decreases to the mid to long term interest rate curve during the first six months of 2014. Net unrealized losses on available for sale investment securities were $5.6 million at June 30, 2014, compared to net unrealized losses of $11.8 million at December 31, 2013. Management continues to restructure the composition of our securities portfolio to strategically deploy excess cash into available for sale investment securities as investment opportunities are available; however, due to relatively scarce suitable investment opportunities, a portion of our excess funding remains in lower yielding interest bearing deposits with banks. During 2013 and during the first six months of 2014, management continued to allocate a greater portion of the investment portfolio to SBA Pool securities. The SBA Pool securities are modified mortgage pass-through securities that are assembled using the guaranteed portion of SBA loans and as such are unconditionally guaranteed as to principal and accrued interest by the U.S. government. Management continues to invest in these SBA Pool securities because they qualify under current risk-weighting regulations as 0% risk weighted assets, which more efficiently uses capital to produce a reasonable rate of return. Approximately 36.5% of the SBA Pool securities are adjustable rate products which will assist the Company with mitigating interest rate risk. In addition, for liquidity planning purposes, these securities provide an investment that may be pledged as collateral to secure public deposits, balances with the Reserve Bank and repurchase agreements. As part of our overall asset/liability management strategy, we are targeting our investment portfolio to be approximately 20% of our total assets. As of June 30, 2014 and December 31, 2013, our investment portfolio was 24.8% and 26.3%, respectively, of total assets.

Loans

The Company offers an array of lending and credit services to customers including mortgage, commercial and consumer loans. A substantial portion of the loan portfolio is represented by commercial and residential mortgage loans in our market area. The ability of our debtors to honor their contracts is dependent upon the real estate and general economic conditions in our market area. The loan portfolio is the largest component of earning assets and accounts for the greatest portion of total interest income. Total loans were $698.0 million at June 30, 2014, an increase of approximately $40.8 million or 6.2% from $657.2 million at December 31, 2013. The following table sets forth the composition of the Company’s loan portfolio at the dates indicated.

Table 13: Loan Portfolio
	June 30,		December 31,
(dollars in thousands)	2014		2013		Change $			Change %

Commercial, industrial and agricultural	$	56,991	$	53,673	$	3,318			6.2	%
Real estate - one to four family residential:
Closed end first and seconds		240,805		218,472		22,333			10.2	%
Home equity lines		97,572		99,839		(2,267	)		-2.3	%
Total real estate - one to four family residential		338,377		318,311		20,066			6.3	%
Real estate - multifamily residential		19,932		18,077		1,855			10.3	%
Real estate - construction:
One to four family residential		17,168		16,169		999			6.2	%
Other construction, land development and other land		24,827		21,690		3,137			14.5	%
Total real estate - construction		41,995		37,859		4,136			10.9	%
Real estate - farmland		7,207		8,172		(965	)		-11.8	%
Real estate - non-farm, non-residential:
Owner occupied		128,322		126,569		1,753			1.4	%
Non-owner occupied		75,804		74,831		973			1.3	%
Total real estate - non-farm, non-residential		204,126		201,400		2,726			1.4	%
Consumer		15,125		16,782		(1,657	)		-9.9	%
Other		14,240		2,923		11,317			387.2	%
Total loans	$	697,993	$	657,197	$	40,796			6.2	%

The increase in loans was primarily due to the purchase of $27.2 million in performing one-to-four family mortgage loans in the first quarter of 2014 and the origination of a line of credit to fund loan originations through Southern Trust Mortgage, LLC (balance of $11.6 million as of June 30, 2014 that is included in other loans) in the second quarter of 2014, and partially offset by the impacts of weak loan demand in the Bank’s markets, the natural amortization of the portfolio, additional charge-offs and payment curtailments on outstanding credits.

Deposits

The Company’s predominant source of funds is depository accounts. The Company’s deposit base, which is provided by individuals and businesses located within the communities served, is comprised of demand deposits, savings and money market accounts, and time deposits. The Company augments its deposit base through conservative use of brokered deposits, including through the Certificate of Deposit Account Registry Service program (“CDARS”). The Company’s balance sheet growth is largely determined by the availability of deposits in its markets, the cost of attracting the deposits and the prospects of profitably utilizing the available deposits by increasing the loan or investment portfolios.

Total deposits were $821.5 million as of June 30, 2014, a decrease of approximately $12.9 million or 1.6% from $834.5 million as of December 31, 2013. The following table sets forth the composition of the Company’s deposits at the dates indicated.

Table 14: Deposits
	June 30,		December 31,
(dollars in thousands)	2014		2013		Change $			Change %
Noninterest-bearing deposits	$	139,066	$	126,861	$	12,205			9.6	%

Interest-bearing deposits:
Demand deposits	$	257,621	$	272,343	$	(14,722	)		-5.4	%
Money market deposits		111,035		121,491		(10,456	)		-8.6	%
Savings deposits		88,827		89,577		(750	)		-0.8	%
Time deposits		224,977		224,190		787			0.4	%
Total interest-bearing deposits	$	682,460	$	707,601	$	(25,141	)		-3.6	%

During the first six months of 2014, the Company continued to see a shift from interest-bearing retail time deposits to lower cost non-maturity noninterest-bearing retail deposits as our consumers are willing to forego the yield on longer-term products in order to have more readily available access to their funds. The Company believes the increase in our noninterest-bearing deposits during the six months ended June 30, 2014 is primarily the result of customers seeking the liquidity and safety of deposit accounts in light of the weak economic recovery in our markets and continuing economic uncertainty in general. The Company saw a reduction in interest-bearing retail deposits, including those to counties and municipalities that were driven primarily by changes in the timing of cyclical deposit activity from the end of 2013 and into the first quarter of 2014. While the Company believes that it offers competitive interest rates on all deposit products and competitive features on deposit products, the continued weak loan demand, coupled with our ongoing deposit re-pricing strategy, have allowed for some deposit attrition particularly from depositors seeking higher yields at our competitors or from other investment vehicles. At June 30, 2014 and December 31, 2013, the Company had $30.4 million and $21.2 million in brokered certificates of deposits, and these deposits supported the slight growth in the Company’s time deposit portfolio during the first six months of 2014. The interest rates paid on these deposits are consistent, if not lower, than the market rates offered in our local area. Amounts included in these brokered certificates of deposits also include deposits under the CDARS program.

Borrowings

The Company’s ability to borrow funds through non-deposit sources provides additional flexibility in meeting the liquidity needs of customers while enhancing its cost of funds structure. Total borrowings were $90.6 million at June 30, 2014, an increase of approximately $35.3 million or 63.9% from $55.3 million at December 31, 2013. The significant increase in borrowings was primarily driven by the necessity to fund the purchase of $27.2 million in performing one-to-four family mortgage loans during the first quarter of 2014 and the origination of a line of credit to fund loan originations to Southern Trust Mortgage, LLC (balance of $11.6 million as of June 30, 2014) in the second quarter of 2014 through short-term FHLB advances. The Company will continue to consider lower cost, short-term borrowings as a favorable funding option and may use these funding sources in connection with executing the Company’s strategic initiatives during the remainder of 2014 and into 2015.

Off-Balance Sheet Arrangements

As of June 30, 2014, there have been no material changes to the off-balance sheet arrangements disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Contractual Obligations

As of June 30, 2014, there have been no material changes outside the ordinary course of business to the contractual obligations disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Liquidity

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. Our liquidity is provided from cash and due from banks, interest bearing deposits with other banks, federal funds sold, repayments from loans, sales of loans, increases in deposits, lines of credit from the FHLB and three correspondent banks, sales of investments, interest and dividend payments received from investments and maturing investments. Our ability to maintain sufficient liquidity may be affected by numerous factors, including economic conditions nationally and in our markets and available borrowing capacity under certain of our borrowing sources. Depending on our liquidity levels, our capital position, conditions in the capital markets and other factors, we may from time to time consider the issuance of debt, equity or other securities, or other possible capital market transactions, the proceeds of which could provide additional liquidity for operations.

The 2013 Capital Initiative added $50.0 million of gross proceeds to the Company’s liquidity. The Company deployed a portion of these proceeds during the third quarter of 2013 to execute certain of the Company’s strategic initiatives including the prepayment of higher rate long-term FHLB advances and the accelerated resolution and disposition of adversely classified assets. The Company expects to continue deploying a portion of these proceeds to execute additional business initiatives during 2014. For more information see “Strategic Initiatives and Pending Acquisition of Virginia Company Bank” in this Item 2.

As a result of our management of liquid assets and our ability to generate liquidity through liability funding, we believe that we maintain overall liquidity to satisfy our depositors’ requirements and to meet customers’ credit needs. We also take into account any liquidity needs generated by off-balance sheet transactions such as commitments to extend credit, commitments to purchase securities and standby letters of credit.

We monitor and plan our liquidity position for future periods. Liquidity strategies are implemented and monitored by our Asset/Liability Committee.

Cash, cash equivalents and federal funds sold totaled $16.6 million as of June 30, 2014 compared to $19.3 million as of December 31, 2013. At June 30, 2014, cash, cash equivalents, federal funds sold and unpledged securities available for sale were $224.8 million or 21.3% of total assets, compared to $203.8 million or 19.8% of total assets at December 31, 2013.

As disclosed in the Company’s consolidated statement of cash flows, net cash provided by operating activities was $4.9 million, net cash used in investing activities was $30.0 million and net cash provided by financing activities was $22.3 million for the six months ended June 30, 2014. Combined, this contributed to a $2.8 million decrease in cash and cash equivalents for the six months ended June 30, 2014.

The Company maintains access to short-term funding sources as well, including federal funds lines of credit with three correspondent banks up to $40.0 million and the ability to borrow from the FHLB up to $212.0 million. The Company has no reason to believe these arrangements will not be renewed at maturity. Additional loans and securities are available that can be pledged as collateral for future borrowings from the FHLB above the current lendable collateral value.

Certificates of deposit of $100,000 or more, maturing in one year or less, totaled $67.7 million at June 30, 2014. Certificates of deposit of $100,000 or more, maturing in more than one year, totaled $50.3 million at June 30, 2014.

As of June 30, 2014, and other than referenced in this Quarterly Report on Form 10-Q, the Company was not aware of any other known trends, events or risks that have or are reasonably likely to have a material impact on our liquidity. As of June 30, 2014, the Company has no material commitments or long-term debt for capital expenditures.

Capital Resources

The assessment of capital adequacy depends on such factors as asset quality, liquidity, earnings performance, and changing competitive conditions and economic forces. The Company regularly reviews the adequacy of the Company’s capital. The Company maintains a capital structure that it believes will assure an adequate level of capital to support anticipated asset growth and to absorb potential losses.

The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on our financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, banks must meet specific capital guidelines that involve quantitative measures of the bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. Capital amounts and classification are also subject to qualitative judgments by the regulators about components (such as interest rate risk), risk weighting, and other factors.

Quantitative measures established by regulation to ensure capital adequacy require that the Bank maintain minimum amounts and ratios of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of June 30, 2014, the Bank meets all capital adequacy requirements to which it is subject.

As of June 30, 2014, the Bank was categorized as “well capitalized,” the highest level of capital adequacy. To be categorized as well capitalized, the Bank must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios. The Company’s and the Bank’s actual capital ratios as of June 30, 2014 and December 31, 2013 are presented under Item 1. “Financial Statements,” under the heading “Note 13. Capital Requirements.”

In July 2013, the federal bank regulatory agencies adopted rules to implement the Basel III capital framework and for calculating risk-weighted assets, as modified by the U.S. federal bank regulators. The Basel III Capital Rules are effective for the Company and the Bank on January 1, 2015 (subject to a phase-in period for certain portions of the new rules). For a summary of these final rules, see Part I, Item 1 under the heading “Regulation and Supervision – Capital Requirements” included in the 2013 Form 10-K.

Cash Dividends

The Bank, as a Virginia banking corporation, may pay dividends only out of retained earnings. In addition, regulatory authorities may limit payment of dividends by any bank, when it is determined that such limitation is in the public interest and necessary to ensure financial soundness of the bank. Regulatory agencies place certain restrictions on dividends paid and loans or advances made by the Bank to the Company. The amount of dividends the Bank may pay to the Company, without prior approval, is limited to current year earnings plus retained net profits for the two preceding years. For the six months ended June 30, 2014 and 2013, no cash dividends have been paid from the Bank to the Company.

For the six months ended June 30, 2014 and 2013, the Company paid out no cash dividends to common or preferred shareholders.

The Company’s Board of Directors determines whether to declare dividends and the amount of any dividends declared. Such determinations by the Board take into account the Company’s financial condition, results of operations and other relevant factors, including any relevant regulatory restrictions.

On July 24, 2014 the Company declared $5.5 million of current and all deferred but accumulated dividends on its Series A Preferred Stock, payable on August 15, 2014. During May 2014, the Company announced its intent to repay up to $15.0 million of the Company’s Series A Preferred Stock originally issued to the Treasury through TARP. The Company plans to effectuate a portion of this repayment through one or more transactions during the second half of 2014.

The Parent and the Bank were subject to additional limitations and regulatory restrictions and could not declare or pay dividends to shareholders (including any payments by the Parent on its trust preferred debt) under the terms of the Written Agreement and the MOU, when such agreements were effective. The MOU was terminated effective March 13, 2014. Additional information about the Written Agreement and the MOU can be found under Item 1. “Financial Statements,” under the heading “Note 14. Regulatory Agreements.”

Effects of Inflation

The effect of changing prices on financial institutions is typically different from other industries as the Company’s assets and liabilities are monetary in nature. The primary effect of inflation on the Company’s operations is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are significantly impacted by changes in the inflation rate, they do not necessarily change at the same time or in the same magnitude as the inflation rate.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

There have been no significant changes from the quantitative and qualitative disclosures made in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013.

Item 4. Controls and Procedures

The Company’s management, including the Company’s Chief Executive Officer and the Chief Financial Officer, has evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and the Chief Financial Officer have concluded that the Company’s disclosure controls and procedures were effective as of June 30, 2014 to ensure that information required to be disclosed by the Company in reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms and that such information is accumulated and communicated to the Company’s management, including the Company’s principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that the Company’s disclosure controls and procedures will detect or uncover every situation involving the failure of persons within the Company or its subsidiary to disclose material information required to be set forth in the Company’s periodic reports.

Management of the Company is also responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act). There were no changes in the Company’s internal control over financial reporting during the Company’s second quarter ended June 30, 2014 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of operations, the Company and its subsidiaries may become a party to legal proceedings, or property of the Company or its subsidiaries may become subject to legal proceedings. As of June 30, 2014 and based on information currently available, there are no pending legal proceedings to which the Company, or any of its subsidiaries, is a party or to which the property of the Company or any of its subsidiaries is subject that, in the opinion of management, may materially impact the financial condition of the Company.

Item 1A. Risk Factors

There have been no material changes in the risk factors faced by the Company from those disclosed under Part I, Item 1A. “Risk Factors” in the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. These risk factors could materially affect our business, financial condition or future results. Additional risks not presently known to us, or that we currently deem immaterial, may also adversely affect our business, financial condition or results of operations.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

In January 2001, the Company announced a stock repurchase program by which management was authorized to repurchase up to 300,000 shares of the Company’s common stock. This plan was amended in 2003 and the number of shares by which management is authorized to repurchase is up to 5% of the outstanding shares of the Company’s common stock on January 1 of each year. There is no stated expiration date for the program. During the six months ended June 30, 2014, the Company did not repurchase any of its common stock.

In connection with the MOU with the Reserve Bank and the Bureau, as previously described, the Company was subject to additional limitations and regulatory restrictions and could not purchase or redeem shares of its stock without prior regulatory approval. The MOU was terminated effective March 13, 2014.

Item 3. Defaults Upon Senior Securities

None.

Item 4. Mine Safety Disclosures

None.

Item 5. Other Information

None.

Item 6. Exhibits

2.1		Agreement and Plan of Reorganization, dated as of May 29, 2014 by and among Eastern Virginia Bankshares, Inc., EVB and Virginia Company Bank (incorporated by reference to Exhibit 2.1 to the Company’s Form 8-K filed May 30, 2014).
3.1		Amended and Restated Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective December 29, 2008 (incorporated by reference to Exhibit 3.1 to the Company’s Annual Report on Form 10-K filed March 10, 2009).
3.1.1		Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective January 6, 2009 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed January 13, 2009).
3.1.2		Articles of Amendment to the Articles of Incorporation of Eastern Virginia Bankshares, Inc., effective June 10, 2013 (incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed June 14, 2013).
3.2		Bylaws of Eastern Virginia Bankshares, Inc., as amended June 4, 2013 (incorporated by reference to Exhibit 3.2 to the Company’s Current Report on Form 8-K filed June 14, 2013).
31.1		Rule 13a-14(a) Certification of Chief Executive Officer.
31.2		Rule 13a-14(a) Certification of Chief Financial Officer.
32.1		Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350.
32.2		Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350.
101		The following materials from Eastern Virginia Bankshares, Inc. Quarterly Report on Form 10-Q for the quarter ended June 30, 2014, formatted in XBRL (Extensible Business Reporting Language), filed herewith: (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) (unaudited), (iv) Consolidated Statements of Shareholders’ Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to the Interim Consolidated Financial Statements (unaudited).

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Eastern Virginia Bankshares, Inc.
(Registrant)

Date:	August 14, 2014	/s/ Joe A. Shearin
		Joe A. Shearin
		President and Chief Executive Officer
		(Principal Executive Officer)

Date:	August 14, 2014	/s/ J. Adam Sothen
		J. Adam Sothen
		Executive Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

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EASTERN VIRGINIA BANKSHARES INC Reports