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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended: December 31, 2015

Or

 

¨ 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: 000-53380

 

 

Xenith Bankshares, Inc.

Exact name of registrant as specified in its charter

 

 

 

Virginia   80-0229922
State or other jurisdiction of incorporation or organization   I.R.S. Employer Identification No.

One James Center, 901 E. Cary Street, Suite 1700

Richmond, Virginia

  23219
Address of principal executive offices   Zip Code

(804) 433-2200

Registrant’s telephone number including area code

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

 

Common Stock, par value $1.00

 

The NASDAQ Stock Market LLC

Title of each Class   Name of each exchange on which registered

 

 

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

 

 

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

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

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§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 if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  x

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See 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 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 Act).    Yes  ¨    No  x

The aggregate market value of the issuer’s common stock held by non-affiliates as of June 30, 2015: $53,757,869.

APPLICABLE ONLY TO CORPORATE REGISTRANTS

The number of shares outstanding of the issuer’s common stock as of February 29, 2016: 13,089,756 shares.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the Proxy Statement for the Company’s 2016 Annual Meeting of Shareholders.

 

 

 


Table of Contents

XENITH BANKSHARES, INC. AND SUBSIDIARY

2015 ANNUAL REPORT ON FORM 10-K

TABLE OF CONTENTS

 

         Page  
  PART I   
Item 1   Business      3   
Item 1A   Risk Factors      19   
Item 2   Properties      32   
Item 3   Legal Proceedings      32   
Item 4   Mine Safety Disclosures      32   
  PART II   
Item 5   Market for Registrant’s Common Equity, Related Shareholder Matters and Issuer Purchases of Equity Securities      33   
Item 7   Management’s Discussion and Analysis of Financial Condition and Results of Operations      34   
Item 8   Financial Statements and Supplementary Data      60   
Item 9   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure      102   
Item 9A   Controls and Procedures      102   
Item 9B   Other Information      102   
  PART III   
Item 10   Directors, Executive Officers and Corporate Governance      103   
Item 11   Executive Compensation      103   
Item 12   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters      104   
Item 13   Certain Relationships and Related Transactions, and Director Independence      104   
Item 14   Principal Accounting Fees and Services      104   
  PART IV   
Item 15   Exhibits, Financial Statement Schedules      105   

 

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Item 1—Business

Overview

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, a Virginia banking corporation and a member of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Xenith Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients, and select retail banking clients, which we refer to as our target customers. We are focused geographically on the Richmond and Hampton Roads, Virginia and Greater Washington, D.C. metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its eight branches, with one branch located in Herndon, Virginia, two branches located in Richmond, Virginia, three branches located in Suffolk, Virginia, and two branches in Gloucester, Virginia. We also operate a loan production office in Newport News, Virginia.

Our services and products consist primarily of taking deposits from, and making loans to, our target customers within our target markets. We provide a broad selection of commercial and retail banking products, including commercial and industrial loans, commercial and residential real estate loans, and select consumer loans. We offer a wide range of checking, savings and treasury products, including remote deposit capture, automated clearing house transactions, debit cards, 24-hour ATM access, Internet and mobile banking, and bill pay service. We do not engage in any activities other than banking activities.

Unless the context requires otherwise or unless otherwise noted:

 

    all references to “Xenith Bankshares,” “company,” “we,” “our” or “us” are to Xenith Bankshares, Inc. and its wholly-owned subsidiary, Xenith Bank, collectively;

 

    all references to the “Bank” are to Xenith Bank, a wholly-owned subsidiary of Xenith Bankshares, Inc.; and

 

    all references to “BankCap Partners” are to BankCap Partners Fund I, L.P., BCP Fund I Virginia Holdings, LLC, BankCap Partners GP, L.P. and BankCap Equity Fund, LLC, collectively.

Pending Merger of Xenith Bankshares and Hampton Roads Bankshares, Inc.

On February 10, 2016, we announced, in a joint press release with Hampton Roads Bankshares, Inc. (“Hampton Roads Bankshares”), that the companies reached a definitive agreement (the “Merger Agreement”) to merge (the “HRB Merger”). Under the terms of the Merger Agreement, our shareholders will receive 4.4 shares of Hampton Roads Bankshares’ common stock for each share of our common stock. Upon the completion of the HRB Merger, Hampton Roads Bankshares shareholders and our shareholders will own approximately 74% and 26%, respectively, of the shares in the combined company, and its board of directors will consist of 13 persons, eight from Hampton Roads Bankshares and five from Xenith Bankshares. The combined company will adopt the Xenith Bankshares name for the holding company and the Xenith Bank name for the combined bank and will be headquartered in Richmond, Virginia. T. Gaylon Layfield, III, our current President and Chief Executive Officer, will become Chief Executive Officer of the combined company. The completion of the HRB Merger is expected to occur in the third quarter of 2016 and is subject to regulatory approvals, including the approval of the Federal Reserve Board and the Bureau of Financial Institutions of the Commonwealth of Virginia, and the approval of the shareholders of both companies, as well as customary closing conditions. Immediately following the completion of the HRB Merger, the Bank will merge with and into Hampton Roads Bankshares’ wholly-owned subsidiary bank, Bank of Hampton Roads. Upon the completion of the HRB Merger, the combined company, with pro forma assets of approximately $2.9 billion and combined deposits of approximately $2.5 billion as of December 31, 2015, will be the fifth largest community bank by deposits in the Commonwealth of Virginia.

Mergers and Acquisitions

On December 22, 2009, First Bankshares, Inc. (“First Bankshares”) and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity in the merger (the “First Bankshares Merger”). First Bankshares was incorporated in Virginia in 2008 and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002. At the effective time of the First Bankshares Merger, First Bankshares changed its name to Xenith Bankshares, Inc., and SuffolkFirst Bank changed its name to Xenith Bank. Prior to the First Bankshares Merger, Xenith Corporation had no banking charter, did not engage in any banking business, and had no substantial operations.

 

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On June 30, 2014, the company completed the merger of Colonial Virginia Bank (“CVB”) with and into Xenith Bank, with the Bank being the surviving bank (the “CVB Acquisition”). In connection with the CVB Acquisition, we issued an aggregate of 1,618,186 shares of our common stock and paid $658 in cash to the former shareholders of CVB in exchange for their shares of CVB common stock. Pursuant to the CVB Acquisition, we acquired $114.4 million of assets, including $70.1 million in loans and assumed $103.9 million in liabilities, including $101.0 million of deposits.

On July 29, 2011, the Bank acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office of Paragon Commercial Bank, a North Carolina banking corporation (“Paragon”), and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the Paragon branch (the “Paragon Transaction”).

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (“FDIC”) acted as court-appointed receiver of VBB. The Bank acquired total assets of $92.9 million, including $70.9 million in loans. The Bank also assumed liabilities of $86.9 million, including $77.5 million in deposits. The Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The VBB Acquisition was completed without any shared-loss agreement with the FDIC.

Issuances of Stock

On September 25, 2014 and September 29, 2014, we issued and sold in a private placement an aggregate of 880,000 shares of our common stock, $1.00 par value per share, at a price of $6.35 per share to third-party investors for an aggregate purchase price, net of stock issuance costs, of approximately $5.6 million.

In April 2011, we issued and sold 4.6 million shares of our common stock at a public offering price of $4.25 per share, pursuant to an effective registration statement filed with the Securities and Exchange Commission (“SEC”). Net proceeds, after the underwriters’ discount and expenses, were $17.7 million.

On September 21, 2011, as part of the Small Business Lending Fund (the “SBLF”) of the United States Department of the Treasury (“U.S. Treasury”), we entered into a Small Business Lending Fund-Securities Purchase Agreement (the “SBLF Purchase Agreement”) with the Secretary of the U.S. Treasury, pursuant to which we sold 8,381 shares of our Senior Non-Cumulative Perpetual Preferred Stock, Series A (“SBLF Preferred Stock”) to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. On June 30, 2015, we completed the redemption of all of the outstanding 8,381 shares of our SBLF Preferred Stock at an aggregate redemption price of $8.4 million, including accrued but unpaid dividends.

Competition

The Virginia banking landscape is fragmented with many small banks having very little market share for deposits, while the large out-of-state national and super-regional banks control the majority of deposits.

Competition among financial institutions is based on many factors. We believe the most important factors that determine success are the quality and experience of bankers and their relationships with customers. Other factors include the quality of services and products offered, interest rates offered on deposit accounts, interest rates charged on loans, service charges and, in the case of loans to larger commercial borrowers, applicable lending capacity. There are banks with which we compete that have greater financial resources, access to capital and lending capacity, and offer a wider range of services than we do.

We believe our key competitive advantage lies in our ability to target, underwrite and manage commercial and industrial and commercial real estate loans. While these skills may exist within large banks, they generally do not exist at community banks. Our management team and bankers have spent substantially all of their careers working with middle market and small business management teams on their business and strategic plans and providing financing to these businesses in a broad array of industries. Our bankers are skilled salespeople and consultants, with well-honed credit skills, that allow them to work with customers and prospects to determine how and under what conditions we can provide financing and other banking services to meet their needs.

Products and Services

We offer a range of sophisticated and competitively-priced banking products and services, including commercial and consumer checking accounts, money market and savings accounts, and time deposits. We offer secured and unsecured

 

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commercial and industrial loans, commercial real estate loans (including construction and land development loans), residential real estate loans and consumer loans. We also offer comprehensive Internet and mobile banking services. We are a member of multiple automated teller (“ATM”) networks, which provide customers with access to ATMs worldwide.

We provide a high level of personalized service to our customers through our relationship managers and branch personnel. We believe that a banking relationship that includes multiple services, such as loan and deposit services, is the key to profitable and long-lasting customer relationships and that our local focus and local decision-making provide us with a competitive advantage over banks that do not have these attributes.

Deposits and Treasury Management Services

To maintain existing deposits and attract new deposits, we offer a broad product line of deposit and treasury services at competitive rates. We expect to continue to obtain deposits through effectively leveraging our branch offices and solicitation by our relationship managers.

We view treasury management capabilities as key to our middle market business and other target customers and an important factor in building core deposits. We have dedicated treasury sales personnel who are exclusively focused on providing sophisticated cash management services and products to customers. Many of our customers use an account analysis system that allows them to pay for services by holding sufficient levels of deposits with us. The results are that our customers can avoid hard dollar charges for services and our core deposit base is enhanced. Our product offerings include retail and commercial on-line banking (our on-line capabilities include images, statements, stop payment, deposit reporting, account transfers, account reconciliation, and EDI (electronic data interchange) reporting), ACH (automated clearing house), wire transfers (both domestic and international), ZBA (zero balance accounts), sweeps, commercial charge card, commercial lock box and mobile banking services. We also offer fraud prevention tools, including Trusteer®, debit block, check positive pay, ACH positive pay and anomaly detection (identification of non-conforming expected patterns) capabilities. In addition to these services, we offer remote deposit capture, direct deposit and merchant services. Our technology platform is designed and well-suited to support our existing suite of services and products on a greater scale, as well as capable of supporting an expanded product set. We evaluate new products and may choose to offer additional products in the future, as we work to provide our customers an exceptional banking experience.

Types of Lending Products

We offer a broad range of lending products to commercial and industrial, commercial real estate, private banking and select retail clients. Fundamental to our business is to have skilled bankers building full banking relationships with high-quality customers. We believe that there is no substitute for knowing and understanding your customer when seeking attractive risk-adjusted returns in the extension of credit. We continue to evaluate and adapt our product and services offerings as our customer base grows and evolves.

Our loan types include commercial and industrial loans, real estate loans, including commercial income-producing real estate loans, construction and development loans, residential real estate loans, and consumer loans. We believe our target customers often have credit needs that community banks cannot meet, and these customers seek a relationship-oriented banking experience that is increasingly difficult to find at large banks.

Commercial and Industrial Loans. Our commercial borrowers are primarily small to middle market businesses engaged in a broad spectrum of businesses. Commercial and industrial (“C&I”) loans can be a source of working capital, or used to finance the purchase of equipment or to complete an acquisition for these businesses. The terms of these loans vary by purpose and by type of underlying collateral, if any, and we typically require the principals of the business to guarantee the loans. Working capital loans are usually secured by accounts receivable and inventory, and structured as revolving lines of credit with terms not exceeding one year. In some cases, we use an independent third party to assess collateral values and recommend appropriate advance rates (i.e., how much we will lend) based on the value of collateral. We generally perform the on-going monitoring but may use third parties in some cases. For loans secured by accounts receivable or inventory, loan principal is typically repaid as the assets securing the loan are converted into cash. Typically, we make equipment loans for a term of three to five years at fixed or variable interest rates with the loan amortized over the term. Equipment loans are generally secured by the financed equipment at advance rates, which we believe are appropriate given the equipment type and the financial strength of the borrower.

We also make owner-occupied real estate (“OORE”) loans. OORE loans are secured in part by the value of real estate that is generally the offices or production facilities of the borrower. In some cases, the real estate is not held by the commercial enterprise, rather it is owned by the principals of the business or an entity controlled by the principals. We classify OORE loans as C&I loans, as the primary source of repayment of the loan is generally dependent on the financial performance of the commercial enterprise occupying the property, with the real estate being a secondary source of repayment.

 

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Real Estate Loans. We make commercial real estate (“CRE”) loans, construction and land development loans, and residential real estate (“RRE”) loans.

We make CRE loans on income-producing properties. The primary collateral for CRE loans is a first lien mortgage on multi-family, office, warehouse, hotel or retail property, plus assignments of all rents and leases related to the property. Our CRE loans generally have maturity dates that do not exceed five years, with amortization schedules of 15 to 25 years, with both fixed and variable rates of interest. We seek to reduce the risks associated with commercial mortgage lending by focusing our lending in our target markets, and it is generally our policy to obtain personal guarantees from the principals of the borrowers.

When underwriting CRE loans, we consider the liquidity, financial condition, operating performance and reputation of the borrower and any guarantors. We also consider the borrower’s equity investment in the project or property, as well as evidence of market acceptance (pre-leasing for commercial construction, pre-sales for residential construction). For construction and land development loans, proceeds are disbursed periodically with funds advanced tied to the percentage of construction completed. We carefully monitor these loans through site inspections and title rundowns prior to making disbursements. Typically, our loan-to-value benchmark for CRE loans is at or below 80% at inception, with satisfactory debt-service coverage ratios as well.

We also make construction and land development loans generally to builders and developers who are located in our target markets. Our construction and land development loans are intended to provide interim financing on the property and are originated with the general expectation that the borrower will repay the loan through permanent loan financing and/or the sale of the property securing the loan.

Our lending activities include the origination of first and second lien loans, including home equity line of credit loans, secured by RRE that is located primarily in our target markets offered to select customers. These customers would primarily include branch and private banking customers. Our underwriting guidelines include minimum debt coverage ratio and maximum loan to value requirements. Generally, our benchmarks include a maximum loan to value of 80%, at inception.

Consumer Loans. Consumer loans largely include loans to individuals in our target markets and to our branch customers and private banking clients for consumer or business purposes.

Our credit policy provides procedures for making loans to individuals along with the regulatory requirements to ensure that all loan applications are evaluated subject to fair lending requirements. Our credit policy addresses the common credit standards for making loans to individuals, which includes the credit analysis and financial statement requirements, as well as collateral requirements, including insurance coverage where appropriate. Our ability to analyze a borrower’s current financial health and credit history, as well as the value of collateral as a secondary source of repayment, when applicable, are significant factors in determining the credit worthiness of loans to individuals.

Guaranteed Student Loans. During the third and fourth quarters of 2013, we purchased guaranteed student loans, a significant portion of which are guaranteed by the federal government. These loans were originated under the Federal Family Education Loan Program (“FFELP”), authorized by the Higher Education Act of 1965, as amended. Pursuant to the FFELP, the student loans are substantially guaranteed by a guarantee agency and reinsured by the U.S. Department of Education. The purchased loans are also part of the Federal Rehabilitated Loan Program (“FRLP”), under which borrowers on defaulted loans have the one-time opportunity to bring their loans current. These loans, which are then owned by an agency guarantor, are brought current and sold to approved lenders. The Bank is an approved FFELP lender. We do not intend to purchase additional student loans.

Credit Policies and Administration

We seek to maintain a high-quality loan portfolio as an essential part of our business strategy. We follow general credit standards appropriate to each loan type in order to properly assess, price and manage credit risk. These standards are detailed in our credit policy. Material exceptions to these standards require approval of our senior credit staff, Management Credit Committee (“MCC”), or the Credit Policy Committee of our board of directors (“CPC”).

The principal risk associated with each type of loan we make is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and/or the attributes of the borrower’s business or industry segment or personal circumstances. Attributes of the relevant business or industry segment include the competitive environment, customer and supplier power, threat of substitutes, and barriers to entry and exit. We believe the quality of the commercial borrower’s management is the most important factor driving creditworthiness. Management’s ability to properly evaluate changes in the supply and demand characteristics affecting its markets for products and services and to respond effectively to such changes, among other abilities, are significant factors that determine a commercial borrower’s creditworthiness. Our credit policy requires that key risks be identified and measured, documented and mitigated, to the extent possible, to seek to ensure the soundness of our loan portfolio.

 

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We hold a reserve for possible loan and lease losses. Information regarding our allowance for loan and lease losses can be found in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Allowance for Loan and Lease Losses.”

Asset and Liability Management

Our asset and liability management is governed by an asset and liability management (“ALM”) policy. Our ALM policy addresses the following financial management functions: (1) overall asset/liability management and strategy; (2) interest rate risk management; and (3) liquidity risk management. The ALM committee, which is comprised of the Bank’s management, addresses the management of the assets and liabilities of the Bank and is responsible for actively monitoring interest rate risk and liquidity risk. We also have an ALM committee of our board of directors (“ALCO”), which approves our ALM policy and regularly reviews our results and analysis relative to the policy.

We evaluate the impact to our earnings and economic value of equity based on changes in interest rates in an immediate interest rate shock scenario. We evaluate the effect of a change in interest rates of +/- 100 basis points (bps), +/- 200 bps, +/-300 bps and + 400 bps on both net interest income and its impact on the economic value of equity. These impacts are measured relative to policy limits as defined in our ALM policy. As of December 31, 2015, we were within all applicable ALM policy limits, with the exception of the -100 bps and -200 bps interest rate change scenarios, which we believe the occurrence of such to be remote. Additional information regarding our interest rate sensitivity analysis can be found in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity.”

The objective of our liquidity risk management is to ensure that we maintain sufficient liquidity to efficiently address loan demand, deposit fluctuations, debt service requirements and other funding needs. In addition to the day-to-day management of liquidity, we have developed a contingency funding plan that outlines funding alternatives under various stress situations. The contingency funding plan details the conditions and potential causes of the liquidity stress, as well as key action plans for reducing the stress, including the assignment of responsibilities to key personnel.

We also have a capital policy that defines the approach we use to establish, monitor and maintain appropriate capital levels. The capital policy details metrics and thresholds that we review, and it delineates various events and risks that may drive the needs for additional capital, along with our primary capital alternatives.

We also have an investment policy, which addresses permitted investments, investment credit analysis, permitted broker-dealers, safekeeping and accounting classifications. Our investment portfolio serves as both a primary and secondary source of liquidity, and it contributes to net interest margin.

Our contingency funding plan, capital policy and investment policy are also approved by the ALCO.

Supervision and Regulation

General

As a registered bank holding company, Xenith Bankshares is subject to the supervision and regulation of the Federal Reserve and, acting under delegated authority, the Federal Reserve Bank of Richmond pursuant to the Bank Holding Company Act of 1956, as amended (“Bank Holding Company Act”). Xenith Bank is a Virginia banking corporation and a member bank regulated by the Federal Reserve and the Bureau of Financial Institutions of the Virginia State Corporation Commission (the “Bureau of Financial Institutions”). The Bank operates as a wholly-owned subsidiary under Xenith Bankshares, a one bank holding company. Xenith Bankshares and the Bank are required by the Federal Reserve, the FDIC and the Bureau of Financial Institutions, as applicable, to file quarterly financial reports on their respective financial condition and performance. In addition, the Federal Reserve and the Bureau of Financial Institutions conduct periodic on-site examinations of the Bank. We must comply with a variety of reporting requirements and banking regulations. The laws and regulations governing us generally have been promulgated to protect depositors, the deposit insurance funds and the banking system as a whole, and are not intended to protect our shareholders and other creditors. Additionally, we must bear the cost of compliance with reporting and other regulations, and this cost is significant.

The Federal Reserve, Bureau of Financial Institutions and FDIC have the authority and responsibility to ensure that financial institutions are managed in a safe and sound manner and to prevent the continuation of unsafe and unsound practices. Additionally, they must generally approve significant business activities undertaken by financial institutions. Typical examples of such activities requiring approval include the establishment of branch locations, mergers and

 

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acquisitions, capital transactions and major organizational structure changes. Obtaining regulatory approval for these types of activities can be time consuming and expensive and ultimately may not be successful. These agencies regulate most aspects of the Bank’s business, including required reserves against deposits, loans, investments, mergers and acquisitions, borrowings, dividends, and location and number of branch offices.

Insurance of Accounts and Regulatory Assessments

The Bank’s deposit accounts are insured by the Deposit Insurance Fund of the FDIC (“DIF”), up to the maximum legal limits of the FDIC, and are subject to regulation, supervision and regular examination by the Bureau of Financial Institutions and the Federal Reserve.

The Bank is subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon an institution’s average consolidated total assets minus average tangible equity. The FDIC may increase assessments to maintain a strong funding position and reserve ratios of the DIF.

The assessment rates, range from approximately 2.5 bps to 45 bps (depending on applicable adjustments for unsecured debt and brokered deposits), until such time as the FDIC’s reserve ratio equals 1.15%. Once the FDIC’s reserve ratio exceeds 1.15%, the applicable assessment rates may range from 1.5 bps to 40 bps and will continue to decrease as the FDIC reserve ratio exceeds 2% and 2.5%. For the years ended December 31, 2015 and 2014, we reported $719 thousand and $495 thousand, respectively, in expense for FDIC insurance.

The current basic limit on federal deposit insurance coverage is $250,000 per depositor. Under the Federal Deposit Insurance Act (“FDIA”), the FDIC may terminate deposit insurance upon a finding that the institution has engaged in unsafe and unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, rule, order or condition imposed by the FDIC.

Capital Adequacy Guidelines

In July 2013, the Federal Reserve, FDIC and the Office of the Comptroller of the Currency (“OCC”) approved a final rule establishing a regulatory capital framework that implements in the United States the Basel Committee’s Revised Framework to the International Convergence of Capital Management and Capital Standards regulatory capital reforms from the Basel Committee on Banking Supervision (the “Basel Committee”) and certain changes required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 (the “Dodd-Frank Act”) (the “Basel III Rules”). These rules implement higher minimum capital requirements for bank holding companies and banks, include a new common equity Tier 1 capital requirement, and establish criteria that instruments must meet to be considered common equity Tier 1 capital, additional Tier 1 capital or Tier 2 capital. These enhancements are designed to both improve the quality and increase the quantity of capital required to be held by banking organizations, better equipping the U.S. banking system to cope with adverse economic conditions. Among the most important changes are stricter eligibility criteria for regulatory capital instruments that would disallow the inclusion of instruments, such as trust preferred securities, in Tier 1 capital and new constraints on the inclusion of minority interests, mortgage-servicing assets, deferred tax assets and certain investments in the capital of unconsolidated financial institutions. In addition, the Basel III Rules require that most regulatory capital deductions be made from common equity Tier 1 capital.

The minimum capital level requirements applicable to us and the Bank, which began on January 1, 2015 under the Basel III Rules, are: (i) a common equity Tier 1 risk-based capital ratio of 4.5%; (ii) a Tier 1 risk-based capital ratio of 6% (increased from 4%); (iii) a total risk-based capital ratio of 8% (unchanged from the rules effective for the year ended December 31, 2014); and (iv) a Tier 1 leverage ratio of 4% for all institutions. Common equity Tier 1 capital consists of retained earnings and common stock instruments, subject to certain adjustments.

The Basel III Rules also establish a “capital conservation buffer” of 2.5% above the new regulatory minimum risk-based capital requirements. The conservation buffer, when added to the capital requirements, will result in the following minimum ratios: (i) a common equity Tier 1 risk-based capital ratio of 7.0%; (ii) a Tier 1 risk-based capital ratio of 8.5%; and (iii) a total risk-based capital ratio of 10.5%. The capital conservation buffer requirement began to be phased in beginning in January 2016 at 0.625% of risk-weighted assets and will increase by that amount each year until fully implemented in January 2019. An institution would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers, if its capital level is below the buffered ratio.

The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements to meet well-capitalized standards and future regulatory change could impose higher capital standards as a routine matter.

 

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The Basel III Rules also set forth certain changes in the methods of calculating certain risk-weighted assets, which in turn affect the calculation of risk-based ratios. Assets are adjusted under the risk-based guidelines to take into account different risk characteristics, with the categories ranging from 0% (requiring no risk-based capital) for assets such as cash and certain U.S. government and agency securities to 1,250% for certain high risk securities. For the bulk of assets that are typically held by a bank, including certain multi-family residential and CRE loans, C&I loans and consumer loans, the risk weighting falls between 50% and 150%. Residential first mortgage loans on one- to four-family and certain seasoned multi-family RRE loans, which are not 90 days or more past due or nonperforming and which have been made in accordance with prudent underwriting standards, are assigned a 50% level in the risk-weighting system, as are certain privately issued mortgage-backed securities representing indirect ownership of such loans. Under the Basel III Rules, higher or more sensitive risk weights are assigned to various categories of assets, including certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures. In addition, the Basel III Rules include greater recognition of collateral and guarantees, and revised capital treatment for derivatives and repo-style transactions. The Basel III Rules regarding changes to risk weightings were effective beginning January 1, 2015.

In addition, the Basel III Rules include certain exemptions to address concerns about the regulatory burden on community banks. For example, banking organizations with less than $15 billion in consolidated assets as of December 31, 2009 are permitted to include in Tier 1 capital trust preferred securities and cumulative perpetual preferred stock issued and included in Tier 1 capital prior to May 19, 2010 on a permanent basis, without any phase out. Community banks could also make a one-time election in their March 31, 2015 quarterly filing to permanently opt-out of the requirement to include most accumulated other comprehensive income (“AOCI”) components in the calculation of a common equity Tier 1 capital and, in effect, retain the previous AOCI treatment, which is to exclude AOCI from capital. If a company does not make this election, unrealized gains and losses would be included in the calculation of its regulatory capital. The Bank made this one-time election to exclude AOCI in its March 31, 2015 filing. Overall, the Basel III Rules provide some important concessions for smaller, less complex financial institutions.

In December 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained a condition applicable to the Bank that the Bank must operate within the parameters of its business plan, which set forth minimum leverage and risk-based capital ratios of at least 10% and 12%, respectively, through 2012. Subsequent to meeting the requirements set forth in our business plan, we are required to maintain capital ratios categorizing us as “well-capitalized.” As of December 31, 2015, we met all minimum capital adequacy requirements to which we were subject and were categorized as “well-capitalized.” Since December 31, 2015, there are no conditions or events that management believes have changed our status as “well-capitalized.” For additional information regarding our capital ratios, see “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources—Capital Adequacy.”

Prompt Corrective Action

The Basel III Rules also revise the prompt corrective action framework, which is designed to place restrictions on insured depository institutions, including the Bank, if their capital levels do not meet certain thresholds. The prompt correction action rules now include a common equity Tier 1 capital component and increase certain other capital requirements for the various thresholds.

Under the Basel III Rules, once fully phased-in, a commercial bank is:

 

    “well-capitalized” if it has a common equity Tier 1 risk-based capital ratio of 6.5% or greater, Tier 1 risk-based capital ratio of 8% or greater, total risk-based capital ratio of 10% or greater, and a Tier 1 leverage ratio of 5% or greater, and is not subject to any written capital order or directive;

 

    “adequately capitalized” if it has a common equity Tier 1 risk-based capital ratio of 4.5% or greater, Tier 1 risk-based capital ratio of 6% or greater, total risk-based capital ratio of 8% or greater, and a Tier 1 leverage ratio of 4% or greater, and does not meet the definition of “well-capitalized”;

 

    “undercapitalized” if it has a common equity Tier 1 risk-based capital ratio of less than 4.5%, Tier 1 risk-based capital ratio of less than 6%, total risk-based capital ratio of less than 8%, and a Tier 1 leverage ratio of less than 4%;

 

    “significantly undercapitalized” if it has a common equity Tier 1 risk-based capital ratio of less than 3%, Tier 1 risk-based capital ratio of less than 4%, total risk-based capital ratio of less than 6%, and a Tier 1 leverage ratio of less than 3%; or

 

    “critically undercapitalized” if it has a ratio of tangible equity to total assets that is equal to or less than 2%.

 

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The risk-based capital standards of the Federal Reserve explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy. The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a banking organization’s capital adequacy.

A bank having less than the minimum Tier 1 leverage ratio requirement is required, within 60 days of the date as of which it fails to comply with such requirement, to submit a reasonable plan describing the means and timing by which it will achieve its minimum Tier 1 leverage ratio requirements. A bank that fails to file such a plan is deemed to be operating in an unsafe and unsound manner and could be subject to a cease-and-desist order. Any insured depository institution with a Tier 1 leverage ratio that is less than 2% is deemed to be operating in an unsafe and unsound condition pursuant to Section 8(a) of the FDIA and is subject to potential termination of deposit insurance. However, such an institution will not be subject to an enforcement proceeding solely on account of its capital ratios, provided it has entered into and is in compliance with a written agreement to increase its Tier 1 leverage ratio and to take such other action as may be necessary to operate in a safe and sound manner. The capital regulations also provide, among other things, for the issuance of a capital directive, which is a final order issued to a bank that fails to maintain minimum capital or to restore its capital to the minimum capital requirement within a specified time period. Such directive is enforceable in the same manner as a final cease-and-desist order.

Immediately upon becoming undercapitalized, a depository institution becomes subject to the provisions of Section 38 of the FDIA, which: (a) restrict payment of capital distributions and management fees; (b) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (c) require submission of a capital restoration plan; (d) restrict the growth of the institution’s assets; and (e) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions, if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (a) requiring the institution to raise additional capital; (b) restricting transactions with affiliates; (c) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (d) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions.

Any bank holding company that controls a subsidiary bank that has been required to submit a capital restoration plan will be required to provide assurances of compliance by the bank with the capital restoration plan, subject to limitations on the bank holding company’s aggregate liability in connection with providing such required assurances. Failure to restore capital under a capital restoration plan can result in the bank being placed into receivership, if it becomes critically undercapitalized. A bank subject to prompt corrective action also may affect its parent holding company in other ways. These include possible restrictions or prohibitions on dividends or subordinated debt payments to the parent holding company by the bank, as well as limitations on other transactions between the bank and the parent holding company. In addition, the Federal Reserve may impose restrictions on the ability of the bank holding company itself to pay dividends, or require divestiture of holding company affiliates that pose a significant risk to the subsidiary bank, or require divestiture of the undercapitalized subsidiary bank.

Bank Holding Company Regulation

Under the Federal Reserve guidelines, every bank holding company must serve as a “source of strength” for each of its bank subsidiaries. The bank holding company is expected to commit resources to support a subsidiary bank, including at times when the holding company may not be in a financial position to provide such support. A bank holding company’s failure to meet its source of strength obligations may constitute an unsafe and unsound practice or a violation of the Federal Reserve’s regulations, or both. The source-of-strength doctrine most directly affects bank holding companies in situations where the bank holding company’s subsidiary bank fails to maintain adequate capital levels. This doctrine was codified by the Dodd-Frank Act and by the Federal Reserve.

The Bank Holding Company Act limits the investments and activities of bank holding companies. In general, a bank holding company is prohibited from acquiring direct or indirect ownership or control of more than 5% of the voting shares of a company that is not a bank or a bank holding company or from engaging directly or indirectly in activities other than those of banking, managing or controlling banks, providing services for its subsidiaries, and various non-bank activities that are deemed to be closely related to banking. The activities of the company are subject to these legal and regulatory limitations under the Bank Holding Company Act and the implementing regulations of the Federal Reserve. Federal bank regulatory agencies have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary, if the agency determines that divestiture may aid the depository institution’s financial condition.

 

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Currently, BankCap Partners is deemed a bank holding company for Atlantic Capital Bank, N.A. (“ACB”) and the Bank. The position of BankCap Partners as a source of strength to ACB or any other financial institution for which BankCap Partners is deemed to be a bank holding company may limit its ability to serve as a source of strength for the Bank and could adversely affect the Bank’s ability to access resources of BankCap Partners.

A bank for which BankCap Partners is deemed to be a bank holding company may be required to indemnify, or cross-guarantee, the FDIC against losses the FDIC incurs with respect to any other bank controlled by BankCap Partners. In addition, the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) requires that an insured depository institution shall be liable for the loss incurred or anticipated by the FDIC arising from the default of a commonly controlled insured depository institution or any assistance provided by the FDIC to any commonly controlled insured depository institution in danger of default. Accordingly, the Bank may be obligated to provide financial assistance to ACB or any other financial institution for which BankCap Partners is deemed to be a bank holding company. ACB is a Georgia state non-member bank headquartered in Atlanta, Georgia, founded in 2007. ACB operates as a full-service, Atlanta, Georgia-based and locally-managed commercial bank. ACB’s primary geographic market is Metropolitan Atlanta, the state of Georgia, Eastern and Middle Tennessee, and the southeastern United States.

ACB’s common stock is registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and, as a result, ACB files annual, quarterly and current reports, proxy statements or other information with the SEC. Financial and regulatory information about ACB is also included in Reports of Condition and Income (also known as “call reports”) filed by ACB with the FDIC. ACB’s filings with the SEC and call reports, which are publicly available, are not incorporated by reference herein. We have not been, and in the future will not be, involved in the preparation and filing of ACB’s filings with the SEC, its call reports, its other regulatory reports, or the conduct of its business.

Dodd-Frank Act

The Dodd-Frank Act was enacted in July 2010. The complete implementation of the Dodd-Frank Act will result in a major overhaul of the financial institution regulatory system. A summary of certain provisions of the Dodd-Frank Act is set forth below, along with information set forth in the applicable sections of this “Supervision and Regulation” section. Among other things, the Dodd-Frank Act established a new, independent Consumer Financial Protection Bureau (“CFPB”) tasked with protecting American consumers from unfair, deceptive and abusive financial products and practices. The Dodd-Frank Act also created the Financial Stability Oversight Council, which focuses on identifying, monitoring and addressing systemic risks in the financial system. The Financial Stability Oversight Council, among other tasks, makes recommendations for increasingly strict rules for capital, leverage and other requirements as a company’s size and complexity increase. The Dodd-Frank Act also requires the implementation of the “Volcker Rule” for banks and bank holding companies, which prohibits, with certain limited exceptions, proprietary trading, investment in and sponsorship of hedge funds and private equity funds, and generally otherwise limits the relationships with such funds. The Dodd-Frank Act also includes provisions that, among other things, reorganize bank supervision and strengthen the Federal Reserve.

The Dodd-Frank Act includes savings associations and industrial loan companies, as well as banks, in the nationwide deposit limitation. Thus, no acquisition of any financial institution, not just a commercial bank, can be approved if the effect of the acquisition would be to increase the acquirer’s nationwide deposits to more than 10% of all deposits. The Dodd-Frank Act also requires fees charged for debit card transactions to be both “reasonable and proportional” to the cost incurred by the card issuer. In June 2011, the Federal Reserve set the interchange rate cap at $0.24 per transaction. While these restrictions do not apply to banks with less than $10 billion in assets, the rule could affect the competitiveness of debit cards issued by smaller banks.

Although the majority of the Dodd-Frank Act’s rulemaking requirements have been met with finalized rules, approximately one-third of the rulemaking requirements are either still in the proposal stage or have not yet been proposed. Accordingly, it is difficult to anticipate the continued impact this expansive legislation will have on us and our prospects, our customers, our target markets and the financial industry in general.

Incentive Compensation Guidance

The federal banking agencies have issued comprehensive guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of those organizations by encouraging excessive risk-taking. The incentive compensation guidance sets expectations for banking organizations concerning their incentive compensation arrangements and related risk management, control and governance processes. The incentive compensation guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon three primary principles: (1) balanced risk-taking incentives, (2) compatibility with effective controls and risk management, and (3) strong corporate governance. Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or take other actions. In addition, under the incentive compensation

 

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guidance, a banking organization’s federal supervisor may initiate enforcement action if the organization’s incentive compensation arrangements pose a risk to the safety and soundness of the organization. Further, a provision of the Basel III Rules on capital standards, described above, would limit discretionary bonus payments to bank executives if the institution’s regulatory capital ratios fail to exceed certain thresholds. The scope and content of the U.S. banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future.

Consumer Financial Protection Bureau

The CFPB was created under the Dodd-Frank Act to centralize responsibility for consumer financial protection with broad rulemaking, supervision and enforcement authority for a wide range of consumer protection laws that would apply to all banks and thrifts, including the Equal Credit Opportunity Act, Truth in Lending Act (“TILA”), Real Estate Settlement Procedures Act (“RESPA”), Fair Credit Reporting Act, Fair Debt Collection Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act of 1999 (the “GLB Act”) and certain other statutes. Banking institutions with total assets of $10 billion or less remain subject to the supervision and enforcement of their primary federal banking regulator with respect to the federal consumer financial protection laws and such additional regulations as may be adopted by the CFPB.

The CFPB has promulgated rules relating to remittance transfers under the Electronic Fund Transfer Act, which require companies to provide consumers with certain disclosures before the consumer pays for a remittance transfer. The CFPB has also amended certain rules under Regulation C relating to home mortgage disclosure, to reflect a change in the asset size exemption threshold for depository institutions based on the annual percentage change in the Consumer Price Index for Urban Wage Earners and Clerical Workers. In addition, the CFPB promulgated its “Ability-to-Repay/Qualified Mortgage” rules, which amended the TILA’s implementing regulation, Regulation Z (“Regulation Z”). Regulation Z currently prohibits a creditor from making a higher priced mortgage loan without regard to the consumer’s ability to repay the loan. The rule implements sections 1411 and 1412 of the Dodd-Frank Act, which generally requires creditors to make a reasonable, good faith determination of a consumer’s ability to repay any consumer credit transaction secured by a dwelling (excluding an open-end credit plan, timeshare plan, reverse mortgage or temporary loan) and establishes certain protections from liability under this requirement for “qualified mortgages.” The rule also implemented section 1414 of the Dodd-Frank Act, which limits prepayment penalties. Finally, the rule requires creditors to retain evidence of compliance with the rule for three years after a covered loan is consummated. The rule became effective January 10, 2014.

On November 20, 2013, pursuant to section 1032(f) of the Dodd-Frank Act, the CFPB issued the Know Before You Owe TILA/RESPA Integrated Disclosure Rule (“TRID”), which combined the disclosures required under TILA and sections 4 and 5 of RESPA, into a single, integrated disclosure for mortgage loan transactions covered by those laws. TRID, which requires the use of a “Loan Estimate” that must be delivered or placed in the mail no later than the third business day after receiving the consumer’s application and a “Closing Disclosure” that must be provided to the consumer at least three business days prior to consummation, became effective for applications received on or after October 3, 2015 for applicable closed-end consumer credit transactions secured by real property. Creditors must only use the Loan Estimate and Closing Disclosure forms for mortgage loan transactions subject to TRID. All other mortgage loan transactions continue to use the “Good Faith Estimate” and the “Initial Truth-in-Lending Disclosure” at application and the “HUD-1 Settlement Statement” and the “Final Truth-in-Lending Disclosure” at closing. TRID also has new tolerance requirements and record retention requirements. Of note, the creditor must retain evidence of compliance with the Loan Estimate requirements, including providing the Loan Estimate, and the Closing Disclosure requirements for three years after the later of the date of consummation, the date disclosures are required to be made, or the date the action is required to be taken. Additionally, the creditor must retain copies of the Closing Disclosure, including all documents related to the Closing Disclosure, for five years after consummation.

Small Business Lending Fund

The Small Business Jobs and Credit Act of 2010 created the Small Business Lending Fund to invest capital into community banking organizations. Through the fund, the U.S. Treasury invested in financial institutions through the purchase of senior preferred stock or indebtedness. Financial institutions could “buy down” the rate paid on the senior preferred stock to as low as 1% by increasing the level of small business loans, which could be adjusted based on the level of small business loans against a “baseline level.” However, after the four-and-a-half-year period from initial funding, the rate would increase to 9% until the senior preferred stock issued to the U.S. Treasury was redeemed.

On September 21, 2011, we sold 8,381 shares of SBLF Preferred Stock to the Secretary of the U.S. Treasury for a purchase price of $8.4 million. In connection with our participation in the fund, we were required to develop a small business lending plan describing our business strategy and operating goals to address the needs of small businesses in the areas we serve, as well as a plan to provide linguistically and culturally appropriate outreach, where appropriate, to certain groups, as

 

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well as comply with certain reporting requirements. On June 30, 2015, we completed the redemption of all of the outstanding 8,381 shares of our SBLF Preferred Stock, at an aggregate redemption price of $8.4 million, including accrued but unpaid dividends. Our effective dividend rate was 1% for the entire period in which the SBLF Preferred Stock was outstanding.

Gramm-Leach-Bliley Act of 1999

The GLB Act implemented major changes to the statutory framework for providing banking and other financial services in the United States. The GLB Act, among other things, eliminated many of the restrictions on affiliations among banks and securities firms, insurance firms and other financial service providers. A bank holding company that qualifies as a financial holding company will be permitted to engage in activities that are financial in nature or incident or complimentary to financial activities. The activities that the GLB Act expressly lists as financial in nature include insurance activities, providing financial and investment advisory services, underwriting services and limited merchant banking activities.

To be eligible for these expanded activities, a bank holding company must qualify as a financial holding company. To qualify as a financial holding company, each insured depository institution controlled by the bank holding company must be well-capitalized and well-managed and have at least a satisfactory rating under the Community Reinvestment Act of 1977 (See “—Community Reinvestment Act” below). In addition, the bank holding company must file with the Federal Reserve a declaration of its intention to become a financial holding company. The Dodd-Frank Act amended this provision to require that financial holding companies also be well-capitalized and well-managed.

To the extent that the GLB Act allows banks, securities firms and insurance firms to affiliate, the financial services industry may experience further consolidation and greater competition.

Payment of Cash Dividends

Xenith Bankshares is a legal entity separate and distinct from Xenith Bank. Xenith Bankshares does not conduct stand-alone operations; therefore, its ability to pay dividends depends on the ability of Xenith Bank to pay dividends to it. There are various legal limitations applicable to the payment of dividends by Xenith Bank to Xenith Bankshares and to the payment of dividends by Xenith Bankshares to its shareholders, including requirements to maintain capital at or above regulatory minimums. Xenith Bankshares is incorporated under the Virginia Stock Corporation Act, which has restrictions prohibiting the payment of dividends if, after giving effect to the dividend payment, Xenith Bankshares would not be able to pay its debts as they become due in the usual course of business, or if Xenith Bankshares’ total assets would be less than the sum of its total liabilities plus the amount that would be required if Xenith Bankshares were to be dissolved to satisfy the preferential rights upon dissolution of any preferred shareholders.

Consistent with its policy that bank holding companies should serve as a source of financial strength for their subsidiary banks, the Federal Reserve has stated that, as a matter of prudence, a bank holding company generally should not maintain a rate of distributions to shareholders unless its net income has been sufficient to fully fund the distributions, and the prospective rate of earnings retention appears consistent with the bank holding company’s capital needs, asset quality and overall financial condition. Further, the Federal Reserve issued Supervisory Letter SR 09-4 , which provides guidance on the declaration and payment of dividends, capital redemptions and capital repurchases by bank holding companies. Supervisory Letter SR 09-4 provides that, as a general matter, a bank holding company should eliminate, defer or significantly reduce its dividends if: (1) the bank holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends; (2) the bank holding company’s prospective rate of earnings retention is not consistent with the bank holding company’s capital needs, asset quality, and overall current and prospective financial condition; or (3) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Failure to do so could result in a supervisory finding that the bank holding company is operating in an unsafe and unsound manner.

Banking regulators have indicated that Virginia banking organizations should generally pay dividends only (1) from net undivided profits of the bank, after providing for all expenses, losses, interest and taxes accrued or due by the bank, and (2) if the prospective rate of earnings retention appears consistent with the organization’s capital needs, asset quality and overall financial condition. In particular, under the current supervisory practices of the Federal Reserve, prior approval from the Federal Reserve and a supermajority of the Bank’s shareholders is required, if cash dividends declared in any given year exceed net income for that year plus retained earnings of the two preceding years. In addition, under the FDIA, insured depository institutions, such as the Bank, are prohibited from making capital distributions, including the payment of dividends, if after making such distribution, the institution would become “undercapitalized” (as such term is used in the statute).

 

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Under Virginia law, no dividend may be declared or paid out of a bank’s paid-in capital. Xenith Bank may be prohibited under Virginia law from the payment of dividends if the Bureau of Financial Institutions determines that a limitation of dividends is in the public interest and is necessary to ensure our financial soundness, and the Bureau of Financial Institutions may also permit the payment of dividends not otherwise allowed by Virginia law. The terms of our 6.75% subordinated notes due 2025 (the “Subordinated Notes”) (discussed in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Borrowings”) and the terms of our senior unsecured term loan also impose limits on our ability to pay dividends on shares of our common stock.

Loans to Insiders

The Federal Reserve Act and related regulations (such as Regulation O) impose specific restrictions on loans to directors, executive officers and principal shareholders of banks. Under Section 22(h) of the Federal Reserve Act, any loan to a director, executive officer or principal shareholder of a bank, or to entities controlled by any of the foregoing, may not exceed, together with all outstanding loans to such persons or entities controlled by such person, the bank’s loan to one borrower limit. Loans in the aggregate to insiders and their related interests as a class may not exceed two times the bank’s unimpaired capital and unimpaired surplus until the bank’s total deposits equal or exceed $100 million, at which time the aggregate is limited to the bank’s unimpaired capital and unimpaired surplus. Section 22(h) also prohibits loans above amounts prescribed by the appropriate federal banking agency to directors, executive officers and principal shareholders of a bank or bank holding company, and to entities controlled by such persons, unless such loans are approved in advance by a majority of the board of directors of the bank with any “interested” director not participating in the voting. Our policy on loans to insiders establishes a maximum amount, which includes all other outstanding loans to such persons, as to which prior board of director’s approval is required, of the greater of $25,000 or 5% of capital and surplus (up to $500,000). Section 22(h) requires that loans to directors, executive officers and principal shareholders be made in terms and underwriting standards substantially the same as offered in comparable transactions to other persons. The Dodd-Frank Act expanded coverage of transactions with insiders by including credit exposure arising from derivative transactions. In addition, the Dodd-Frank Act prohibits an insured depository institution from purchasing or selling an asset to an executive officer, director or principal shareholder (or any related interest of such a person) unless the transaction is on market terms, and if the transaction exceeds 10% of the institution’s capital, it is approved in advance by a majority of the disinterested directors.

Restrictions on Transactions with Affiliates

The Bank is subject to the provisions of Section 23A of the Federal Reserve Act with respect to affiliates, including Xenith Bankshares. These provisions place limits on the amount of:

 

    loans or extensions of credit to affiliates;

 

    investment in affiliates;

 

    assets that the Bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;

 

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

 

    the Bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

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

The Dodd-Frank Act expanded the scope of Section 23A to include investment funds managed by an institution as an affiliate, as well as other procedural and substantive hurdles.

The Bank also is subject to the provisions of Section 23B of the Federal Reserve Act, which, among other things, prohibits banks from engaging in any transaction with an affiliate unless the transaction is on terms substantially the same, or at least as favorable to the bank, as those prevailing at the time for comparable transactions with non-affiliated companies.

Certain Acquisitions

The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) acquiring more than 5% of the voting stock of any bank or other bank holding company, (2) acquiring all or substantially all of the assets of any bank or bank holding company, or (3) merging or consolidating with any other bank holding company.

 

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Additionally, the Bank Holding Company Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and future prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy. As a result of the USA PATRIOT Act of 2001 (the “Patriot Act”), which is discussed below, the Federal Reserve is required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions. The Dodd-Frank Act also amended the Bank Holding Company Act to require consideration of the extent to which a proposed acquisition, merger or consolidation would result in greater or more concentrated risks to the stability of the U.S. banking or financial system.

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

Change in Bank Control

Subject to various exceptions, the Bank Holding Company Act and the Change in Bank Control Act, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if a person or company acquires 25% or more of any class of voting securities of the bank holding company. Control is reputably presumed to exist if a person or entity acquires 10% or more, but less than 25%, of any class of voting securities and that person or entity, by such acquisition, becomes the single largest holder of that class of voting securities.

Sound Banking Practices

Bank holding companies are not permitted to engage in unsound banking practices. For example, the Federal Reserve’s Regulation Y requires a bank holding company to give the Federal Reserve prior notice of any redemption or repurchase of its own equity securities if the consideration to be paid, together with the consideration paid for any repurchases in the preceding year, is equal to 10% or more of the bank holding company’s consolidated net worth. The Federal Reserve may oppose the transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation. As another example, a holding company could not impair its subsidiary bank’s soundness by causing it to make funds available to non-banking subsidiaries or their customers if the Federal Reserve believed it not prudent to do so.

The Federal Reserve has the authority to prohibit activities of bank holding companies and their non-banking subsidiaries that represent unsafe and unsound banking practices or that constitute violations of laws or regulations. The Federal Reserve can assess civil money penalties for activities conducted on a knowing and reckless basis if those activities caused a substantial loss to a depository institution. The penalties can be as high as $1,000,000 for each day the activity continues.

Anti-Tying Restrictions

The Bank is prohibited from tying the provision of services, such as extensions of credit, to certain other services offered by the Bank, its holding company or its affiliates.

Standards for Safety and Soundness

The Federal Reserve has established safety and soundness standards applicable to the Bank regarding such matters as internal controls, loan documentation, credit underwriting, interest rate risk exposure, asset growth, compensation and other benefits, asset quality and earnings. If the Bank were to fail to meet these standards, the Federal Reserve could require it to submit a written compliance plan describing the steps the Bank will take to correct the situation and the time within which such steps will be taken. The Federal Reserve has authority to issue orders to secure adherence to the safety and soundness standards.

Reserve Requirement

Under a regulation promulgated by the Federal Reserve, depository institutions, including the Bank, are required to maintain cash reserves against a stated percentage of their transaction accounts. Current reserve requirements for calendar year 2016 are as follows:

 

    for transaction accounts totaling $15.2 million or less, a reserve of 0%;

 

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    for transaction accounts in excess of $15.2 million up to and including $110.2 million, a reserve of 3%; and

 

    for transaction accounts in excess of $110.2 million, a reserve requirement of 10%.

The dollar amounts and percentages reported here are all subject to adjustment by the Federal Reserve. As of December 31, 2015, the Bank had a reserve requirement of $12.5 million.

Privacy

Financial institutions are required to disclose their policies for collecting and protecting confidential information. Under the GLB Act, financial institutions may not disclose non-public personal information about a customer to unaffiliated third parties, unless the institution satisfies various disclosure requirements and the consumer has not elected to opt-out of the disclosure (with some exceptions). Additionally, financial institutions generally may not disclose consumer account numbers to any non-affiliated third party for use in telemarketing, direct-mail marketing or other marketing through electronic mail to consumers.

Monetary Policy

Banking is a business that depends on interest rate differentials. In general, the differences between the interest paid by a bank on its deposits and its other borrowings and the interest received by a bank on loans extended to its customers and securities held in its investment portfolio constitute a major portion of earnings. Thus, our earnings and growth will be subject to the influence of economic conditions generally, both domestic and foreign, and also to the monetary and fiscal policies of the U.S. and its agencies, particularly the Federal Reserve, which regulates the supply of money through various means including open market transactions in U.S. government securities. These transactions include the purchase and sale of securities to expand or contract the general liquidity in the financial system. Additionally, the Federal Reserve establishes a target Federal Fund Rate and the Discount Rate. Actions taken by the Federal Reserve influence the general condition of interest rates in the marketplace, which could affect our profitability.

Depending on the Bank’s asset/liability strategy, actions taken by the Federal Reserve may have a positive or negative effect on profitability. We cannot predict the actions of the Federal Reserve, nor can we guarantee that our asset/liability strategy is consistent with action taken by the Federal Reserve.

Brokered Deposit Restrictions

Insured depository institutions that are categorized as adequately capitalized institutions under the FDIA and corresponding federal regulations cannot accept, renew or roll over brokered deposits, without receiving a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on any deposits. Insured depository institutions that are categorized as undercapitalized institutions under the FDIA and corresponding federal regulations may not accept, renew or roll over brokered deposits. The Bank is not currently subject to such restrictions.

Community Reinvestment Act

The Community Reinvestment Act of 1997 and the regulations issued thereunder (“CRA”) requires federal banking regulators to evaluate the record of financial institutions in meeting the credit needs of their local communities, including low- and moderate-income neighborhoods, consistent with the safe and sound operation of those institutions. These factors are also considered in evaluating mergers and acquisitions, and applications to open a branch or facility. Federal regulators are required to provide and make public a written examination report of an institution’s CRA performance. The Bank continues to maintain a satisfactory CRA rating.

Branch and Interstate Banking

The federal banking agencies are authorized to approve interstate bank merger transactions without regard to whether such transaction is prohibited by the law of any state, unless the home state of one of the banks has opted out of the interstate bank merger provisions of the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”) by adopting a law after the date of enactment of the Riegle-Neal Act and prior to June 1, 1997 that applies equally to all out-of-state banks and expressly prohibits merger transactions involving out-of-state banks. Such interstate bank mergers and branch acquisitions, described below, are also subject to the nationwide and statewide insured deposit concentration limitations described in the Riegle-Neal Act.

Under the Dodd-Frank Act, national banks and state banks are able to establish branches in any state, if that state would permit the establishment of the branch by a state bank chartered in that state. Virginia law permits a state bank to establish a branch of the bank anywhere in the state; therefore, a bank with its headquarters outside the Commonwealth of Virginia may establish branches anywhere within Virginia.

 

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Regulatory Enforcement Authority

Federal and state banking law grants substantial enforcement powers to federal and state banking regulators. This enforcement authority includes, among other things, the ability to assess civil money penalties, to issue cease and desist or removal orders, and to initiate injunctive actions against banking organizations and institution-affiliated parties. In general, these enforcement actions may be initiated for violations of laws and regulations and unsafe or unsound practices. Other actions or inactions may provide the basis for enforcement action, including misleading or untimely reports filed with regulatory authorities.

Concentrated Commercial Real Estate Lending Regulations

The Federal Reserve, OCC and FDIC have promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending, if (1) total reported loans for construction, land development and other land represent 100% or more of total capital, or (2) total reported loans secured by multi-family and non-farm residential properties and loans for construction, land development and other land represent 300% or more of total capital, and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices, including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing, and increasing capital requirements. On December 18, 2015, the Federal banking agencies jointly issued a “Statement on Prudent Risk Management for Commercial Real Estate Lending” reminding banks of the need to engage in risk management practices for commercial real estate lending.

Allowance for Loan and Lease Losses

Federal bank regulatory agencies have released the Interagency Policy Statement on the allowance for loan and lease losses to ensure consistency with U.S. generally accepted accounting principles (“GAAP”) and more recent supervisory guidance, including, among other things, considerations for measuring impairment and estimating credit losses and illustrations of effective loss migration analysis. Additionally, the agencies issued 16 Frequently Asked Questions to assist institutions in complying with both GAAP and allowance for loan and lease losses supervisory guidance. Highlights of the statement include the following:

 

    the statement emphasizes that the allowance for loan and lease losses represents one of the most significant estimates in an institution’s financial statements and regulatory reports and that an assessment of the appropriateness of the allowance for loan and lease losses is critical to an institution’s safety and soundness;

 

    each institution has a responsibility to develop, maintain and document a comprehensive, systematic and consistently applied process for determining the amounts of the allowance for loan and lease losses. An institution must maintain an allowance for loan and lease losses that is sufficient to cover estimated credit losses on individual impaired loans as well as estimated credit losses inherent in the remainder of the portfolio; and

 

    the statement updated the previous guidance on the following issues regarding allowance for loan and lease losses: (1) responsibilities of the board of directors, management and bank examiners; (2) factors to be considered in the estimation of allowance for loan and lease losses; and (3) objectives and elements of an effective loan review system.

Monitoring and Reporting Suspicious Activity

Under the Bank Secrecy Act (the “BSA”), financial institutions, including the Bank, are required to monitor and report unusual or suspicious account activity that might signify money laundering, tax evasion or other criminal activities, as well as transactions involving the transfer or withdrawal of amounts in excess of prescribed limits. The BSA is sometimes referred to as an “anti-money laundering” law (“AML”). Several AML acts, including provisions in Title III of the Patriot Act, have been enacted to amend the BSA. The Patriot Act was enacted in response to the September 11, 2001 terrorist attacks and is intended to strengthen the ability of U.S. law enforcement agencies and the intelligence communities to work cohesively to combat terrorism on a variety of fronts. Under the Patriot Act, financial institutions are subject to prohibitions against specified financial transactions and account relationships, as well as enhanced due diligence and “know your customer” standards in their dealings with financial institutions and foreign customers. For example, the enhanced due diligence policies, procedures and controls generally require financial institutions to take reasonable steps:

 

    to conduct enhanced scrutiny of account relationships to guard against money laundering and report any suspicious transaction;

 

    to ascertain the identity of the nominal and beneficial owners of, and the source of funds deposited into, each account as needed to guard against money laundering and report any suspicious transactions;

 

    to ascertain for any foreign bank, the shares of which are not publicly traded, the identity of the owners of the foreign bank, and the nature and extent of the ownership interest of each such owner; and

 

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    to ascertain whether any foreign bank provides correspondent accounts to other foreign banks and, if so, the identity of those foreign banks and related due diligence information.

Under the Patriot Act, financial institutions are also required to establish anti-money laundering programs. The Patriot Act sets forth minimum standards for these programs, including:

 

    the development of internal policies, procedures and controls;

 

    the designation of a compliance officer;

 

    an ongoing employee training program; and

 

    an independent audit function to test the programs.

In addition, under the Patriot Act, the Secretary of the U.S. Treasury has adopted rules addressing a number of related issues, including increasing the cooperation and information sharing between financial institutions, regulators and law enforcement authorities regarding individuals, entities and organizations engaged in, or reasonably suspected based on credible evidence of engaging in, terrorist acts or money laundering activities. Any financial institution complying with these rules will not be deemed to violate the privacy provisions of the GLB Act that are discussed under “—Gramm-Leach-Bliley Act of 1999” above. Finally, under the regulations of the Office of Foreign Asset Control (“OFAC”), banks are required to monitor and block transactions with certain “specially designated nationals” who OFAC has determined pose a risk to U.S. national security. The Financial Crimes Enforcement Network has proposed new regulations that would require financial institutions to obtain beneficial ownership information for certain accounts, however, it has yet to establish final regulations on this topic.

Technology Risk Management and Consumer Privacy

State and federal banking regulators have issued various policy statements emphasizing the importance of technology risk management and supervision in evaluating the safety and soundness of depository institutions with respect to banks that contract with outside vendors to provide data processing and core banking functions. The use of technology related products, services, delivery channels and processes exposes a bank to various risks, particularly operational, privacy, security, strategic, reputation and compliance risk. Banks are generally expected to prudently manage technology related risks as part of their comprehensive risk management policies by identifying, measuring, monitoring and controlling risks associated with the use of technology.

Under Section 501 of the GLB Act, federal banking agencies have established appropriate standards for financial institutions regarding the implementation of safeguards to ensure the security and confidentiality of customer records and information, protection against any anticipated threats or hazards to the security or integrity of such records, and protection against unauthorized access to or use of such records or information in a way that could result in substantial harm or inconvenience to a customer. Among other matters, the rules require each bank to implement a comprehensive written information security program that includes administrative, technical and physical safeguards relating to customer information.

Under the GLB Act, a financial institution must also provide its customers with a notice of privacy policies and practices. Section 502 prohibits a financial institution from disclosing non-public personal information about a customer to nonaffiliated third parties unless the institution satisfies various notice and opt-out requirements, and the customer has not elected to opt out of the disclosure. Under Section 504, the agencies are authorized to issue regulations as necessary to implement notice requirements and restrictions on a financial institution’s ability to disclose non-public personal information about customers to nonaffiliated third parties. Under the final rule the regulators adopted, all banks must develop initial and annual privacy notices that describe in general terms the bank’s information sharing practices. Banks that share non-public personal information about customers with nonaffiliated third parties must also provide customers with an opt-out notice and a reasonable period of time for the customer to opt out of any such disclosure (with certain exceptions). Limitations are placed on the extent to which a bank can disclose an account number or access code for credit card, deposit or transaction accounts to any nonaffiliated third party for use in marketing.

UDAP and UDAAP

Recently, banking regulatory agencies have increasingly used a general consumer protection statute to address “unethical” or otherwise “bad” business practices that may not necessarily fall directly under the purview of a specific banking or consumer finance law. The law of choice for enforcement against such business practices has been Section 5 of the Federal Trade Commission Act (the “FTC Act”), which is the primary federal law that prohibits unfair or deceptive acts or practices (“UDAP”), and unfair methods of competition in or affecting commerce. “Unjustified consumer injury” is the principal focus of the FTC Act. Prior to the Dodd-Frank Act, there was little formal guidance to provide insight to the parameters for compliance with UDAP laws and regulations. However, UDAP laws and regulations have been expanded

 

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under the Dodd-Frank Act to apply to “unfair, deceptive or abusive acts or practices” (“UDAAP”), which have been delegated to the CFPB for rule-making. The federal banking agencies have the authority to enforce such rules and regulations.

Other Regulation

The Bank is subject to a variety of other regulations. State and federal laws restrict interest rates on loans. The TILA and the Home Mortgage Disclosure Act impose information requirements on banks in making loans. The Equal Credit Opportunity Act prohibits discrimination in lending on the basis of race, creed or other prohibited factors. The Fair Credit Reporting Act governs the use and release of information to credit reporting agencies. The Truth in Savings Act requires disclosure of yields and costs of deposits and deposit accounts. Other acts govern confidentiality of consumer financial records, automatic deposits and withdrawals, check settlement, endorsement and presentment, and reporting of cash transactions as required by the Internal Revenue Service.

Future Regulatory Uncertainty

Because federal regulation of financial institutions changes regularly and is the subject of constant legislative debate, we cannot forecast how federal regulation of financial institutions may change in the future and impact our operations. We expect the industry will remain heavily regulated in the near future and that additional laws or regulations may be adopted, further regulating specific banking practices.

Employees

At December 31, 2015, we had 121 employees, including 118 full-time employees. All of our employees were employed by the Bank. None of our employees are represented by a collective bargaining unit, and we believe that relations with our employees are good.

Available Information

We are required to file annual, quarterly and current reports, proxy statements and other information with the SEC. Investors and other interested parties may read and copy any document that we file, including this Annual Report on Form 10-K, at the SEC’s Public Reference Room at 100 F Street, NE, Washington, D.C. 20549. Investors and other interested parties may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. In addition, the SEC maintains an Internet website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC, from which investors and other interested parties can electronically access our SEC filings.

We make available free of charge on or through our website (www.xenithbank.com), our Annual Report on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.

The information on, or that can be accessed through, our website is not, and shall not be deemed to be, a part of this Annual Report on Form 10-K or incorporated into any other filings we make with the SEC.

Executive Officers of the Registrant

The information set forth in Part III, Item 10 under the caption “Executive Officers of the Registrant” (included herein pursuant to Item 401(b) of Regulation S-K) is incorporated by reference into this Part I.

Item 1A—Risk Factors

In addition to the other information included in this Annual Report on Form 10-K, the following factors should be carefully considered in connection with evaluating our business and the forward-looking statements contained herein. Any of the following risks, either alone or taken together, could materially and adversely affect our business, financial condition, liquidity, results of operations, regulatory capital levels and prospects. If one or more of these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, we could be materially and adversely affected. There may be additional risks that we do not presently know or that we currently believe are immaterial that could also materially and adversely affect our business, financial condition, liquidity, results of operations, regulatory capital levels and prospects.

 

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Slow economic growth, especially in our target markets, could materially and adversely affect us.

The 2009 recession contributed to a rise in unemployment and underemployment, a decline in the value of real estate and other assets, and a lack of confidence in the financial markets and the economy both among financial institutions and their customers. Although some improvement is evident, economic growth has been slow and the economic pressure on consumers and commercial borrowers continues to affect the willingness of companies to borrow to fund future growth, which negatively impacts our business. A worsening of economic conditions would likely exacerbate the adverse effects of these difficult market conditions on the banking industry and our business.

Unlike many of our larger competitors, the majority of our middle market business and individual customers are located or doing business in our target markets. As a result, we may be more impacted by local economic conditions than those of larger, more geographically-diverse competitors. Furthermore, based on the size and resources of our middle market and small business customers, our customers may be less able to withstand sustained difficult economic conditions than larger companies with which they compete. Factors that adversely affect the economy in our target markets could reduce our deposit base and demand for our services and products and increase our credit losses. Consequently, we may be adversely affected, potentially materially, by adverse changes in economic conditions in and around Virginia.

Although we have monitored the impact of slow economic growth on the businesses of our customers and on the values of real estate in our target markets and have set discounts and reserves against our loan portfolio, our discounts and reserves may be insufficient.

Fluctuations in interest rates could reduce our operating results as we expect to realize income primarily from the difference between interest earned on our loans and investments and interest paid on our deposits and borrowings.

Like other banks, our operating results are significantly dependent on our net interest income, as we expect to realize income primarily from the difference between interest earned on loans and investments and the interest paid on deposits and borrowings. Interest rate-sensitive assets and liabilities have interest rate terms that are subject to change within a specific time period, due to either maturity or contractual agreements that allow the instruments to reprice prior to maturity. The net position of those assets and liabilities, subject to re-pricing in specified time periods, will positively or negatively affect our operating results. If market interest rates should move contrary to our position, our operating results could be negatively affected, potentially materially. We use financial tools to simulate our interest-rate sensitivity; however, we, nor the tools, can predict fluctuations of market interest rates, which are affected by many factors, including inflation, recession, monetary policy and conditions in domestic and foreign financial markets. Our balance sheet is consistently “asset-sensitive”; therefore, should interest rates change, our assets will reprice faster than our liabilities. Due to the asset-sensitive nature of our balance sheet, we are well-positioned in an increasing rate environment. Although our asset-liability management strategy is intended to manage our risk from changes in market interest rates, continued low interest rates could materially and adversely affect us. See additional discussion in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Interest Rate Sensitivity.”

Changes in market interest rates could reduce the value of our financial assets. Fixed rate investments and loans generally decrease in value as interest rates rise. In addition, volatile interest rates may affect the volume of our lending activities. For example, when interest rates rise, the cost of borrowing increases and loan originations may decrease. This could result in lower net interest income, lower loan origination fee income, and a decline in sales of treasury services. If we are unsuccessful in managing the effects of changes in interest rates, we could be materially and adversely affected.

We face significant competition in our target markets.

The financial services industry, including commercial banking, is highly competitive, and we have encountered and will continue to encounter strong competition for deposits, loans, and other financial services and products in our target markets. Our principal competitors for loans and some or all of our other services and products are other commercial banks and community banks in our target markets. Our principal competitors for deposits include commercial banks, community banks, money market funds, credit unions and trust companies. Our non-bank competitors are not subject to the same degree of regulation as we are and, accordingly, have advantages over us in providing certain products and services. Many of our competitors are significantly larger than we are and have greater access to capital and other resources that permit them to offer attractive terms and broader selections to gain market share for their products and services and also have higher lending capacity and larger branch networks. Weak loan demand has increased competition resulting in aggressive pricing and loosening terms for borrowers. As a result, we could lose business to competitors or be forced to price products and services on less advantageous terms to retain or attract customers, either of which would adversely affect us.

 

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Failure to implement our business strategies could materially and adversely affect us.

We have developed business strategies, which we intend to implement. Our business strategies include organic growth and, where appropriate, growth through acquisitions. Our organic growth may involve an expansion into related banking lines of business and related services and products, which would involve additional risks. Growth through acquisitions also includes risks, which are further discussed below. If we cannot implement our business strategies, we will be hampered in our ability to maintain and grow our business and serve our customers, which would in turn materially and adversely affect us. Even if our business strategies are successfully implemented, they may not have the favorable impact on our operations that we anticipate.

Failure to manage expansion could materially and adversely affect our business.

Our ability to offer services and products and implement our business strategies successfully in a highly competitive market requires an effective planning and management process. Future expansion efforts, internally or through acquisitions, could be expensive and put a strain on our management, financial, operational and technical resources. We may also expand into new markets or lines of business or offer new products or services. To manage growth effectively, we will likely have to continue to enhance our operating systems and controls, as well as integrate new personnel, including relationship managers, and manage expanded operations. If we are unable to grow our business or manage our growth effectively, we could be materially and adversely affected.

We will face risks with respect to future expansion and through acquisitions or mergers.

As described in our Current Report on Form 8-K filed with the SEC on February 16, 2016, we entered into the Merger Agreement, which, subject to regulatory approvals and shareholder approvals and various other conditions, would result in Xenith Bankshares being merged with and into Hampton Roads Bankshares. Our management and board of directors have devoted and will continue to devote a significant amount of time and attention to the HRB Merger. In addition, in connection with the HRB Merger, we have incurred and will continue to incur expenses, which may be significant. Our business and our operating and financial results may be materially adversely affected by the diversion of management’s time and attention and the expenses incurred in connection with the HRB Merger. Additionally, we may seek to acquire or merge with other financial institutions or branches or assets of those institutions.

These activities would involve a number of risks, including:

 

    the time and expense associated with identifying and evaluating potential acquisitions and merger partners, the outcome of which is uncertain;

 

    using inaccurate estimates and judgments or lack of information to evaluate credit, operations, management and market risks with respect to the target institution or its branches or assets;

 

    diluting our existing shareholders in an acquisition or merger;

 

    the time and expense associated with evaluating new markets for expansion, hiring experienced management and opening new offices or branches, as there may be a substantial time lag between these activities and when we generate sufficient assets and deposits to support the costs of the expansion;

 

    investing a significant amount of time and expense negotiating a transaction or working on expansion plans, resulting in management’s time and attention being diverted from the operation of our existing business;

 

    the time and expense associated with integrating the operations and personnel of the combined businesses;

 

    the ability to realize the anticipated benefits of the acquisition or merger;

 

    the inability to realize cost savings or revenues or to implement integration plans associated with acquisitions or mergers;

 

    creating an adverse short-term effect on our results of operations;

 

    losing key employees and customers as a result of an acquisition or a merger that is poorly received or executed;

 

    time and costs associated with regulatory approvals;

 

    inability to obtain additional capital or financing, if necessary, on favorable terms or at all; and

 

    unforeseen adjustments, write-downs, write-offs, or restructuring or other impairment charges.

 

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The failure to complete the HRB Merger could negatively impact our business.

There is no assurance that the conditions to the HRB Merger will be satisfied in a timely manner, or at all, or that the HRB Merger will occur. Further, there is no assurance that any event, change or other circumstances that could give rise to the termination of the Merger Agreement will not occur. If the HRB Merger is not completed, the share price of our common stock may drop to the extent that the current market price of our common stock reflects an assumption that the HRB Merger will be completed. In addition, if the HRB Merger were not to occur, under certain circumstances defined in the Merger Agreement, such as the company entering into a merger or acquisition agreement with another company, we may be required to pay a termination fee of $4.0 million. Certain costs associated with the HRB Merger, which were incurred subsequent to December 31, 2015, may be payable even if the HRB Merger is not completed. Further, a failed transaction may result in negative publicity and a negative impression of us in the investment community. There can be no assurance that our business, these relationships or our financial condition will not be negatively impacted, if the HRB Merger is not completed.

The soundness of other financial institutions with which we do business could adversely affect us.

Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, acting as a counterparty, or other relationships. We have exposure to many different industries and counterparties, including counterparties in the financial industry, such as commercial banks. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions will expose us to risk of loss in the event of default of a counterparty or client. In addition, this risk may be exacerbated when any collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due to us. Our losses from these events could be material.

Our earnings are sensitive to the credit risks associated with lending.

The credit risk associated with C&I loans is a result of several factors, including the concentration of our loan portfolio in a limited number of loans and borrowers, the size of loan balances, which is generally larger than consumer loans, and the effects of general economic conditions on a borrower’s business. Our C&I loan portfolio represented approximately 47.5% of our total loan portfolio as of December 31, 2015. Any significant default by our commercial and industrial customers would materially and adversely affect us.

Our C&I loans include owner-occupied real estate loans that are secured in part by the value of the real estate. Owner-occupied real estate loans represented approximately 16.6% of our total C&I loan portfolio as of December 31, 2015. The primary source of repayment for owner-occupied real estate loans is the cash flow produced by the related commercial enterprise, and the value of the real estate is a secondary source of repayment of the loan.

Our CRE loan portfolio represented approximately 38.8% of our total loan portfolio as of December 31, 2015. CRE loans will typically be larger than consumer loans and may pose greater risks than other types of loans. Underwriting and portfolio management activities cannot eliminate all risks related to these loans. It may be more difficult for commercial real estate borrowers to repay their loans in a timely manner in the current economic climate, as commercial real estate borrowers’ abilities to repay their loans frequently depends on the successful development of their properties. In addition, we may incur losses on CRE loans due to declines in occupancy rates and rental rates, which may decrease property values and may decrease the likelihood that a borrower may find permanent financing alternatives. Given the weaknesses in the commercial real estate market in general, there may be loans where the value of our collateral has been negatively impacted. A further weakening of the commercial real estate market may increase the likelihood of default of these loans, which could negatively impact our loan portfolio’s performance and asset quality. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, we could incur material losses. In addition, banking regulators give greater scrutiny to commercial real estate lending and may require banks with higher levels of commercial real estate loans to implement improved or additional underwriting, internal controls, risk management policies and portfolio stress testing. In banks with certain levels of commercial real estate loan concentrations, regulators may require increased levels of reserves for loan losses, as well as the need for additional capital. Any of these events could increase our costs, require management time and attention, and materially and adversely affect us.

 

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Decisions regarding credit risk in our investment or loan portfolios could be inaccurate and our allowance for loan and lease losses may be inadequate to absorb future losses inherent in our loan portfolio, which could materially and adversely affect us.

Our loan portfolio and a portion of our investment portfolio expose us to credit risk. Of our $140.1 million investment portfolio, $96.2 million, or 68.6%, were securities other than U.S. agency securities as of December 31, 2015. Of the $96.2 million, $88.3 million were securities issued as general obligations of states or political subdivisions. Inherent risks in lending include the deterioration of the credit of borrowers and adverse changes in the industries and competitive environments in which they operate, changes in borrowers’ management and business prospects, fluctuations in interest rates and collateral values, principally real estate, and economic downturns. Making loans is an essential element of our business, and there is a high risk that some portion of the loans we make will not be repaid and, accordingly, will result in losses. Given our size, these losses could be concentrated in one or more borrowers and could be significant.

The risk of loss is affected by a number of factors, including:

 

    credit risks of a particular borrower;

 

    the duration of the loan;

 

    changes in economic or industry conditions; and

 

    in the case of a collateralized loan, risks resulting from uncertainties about the future value of the collateral.

In addition, we may suffer higher credit losses because of federal or state legislation or other regulatory action that reduces the amount that our borrowers are required to pay to us, prohibits or otherwise limits our ability to foreclose on properties or other collateral, or makes foreclosures less economically viable.

As with all financial institutions, our management makes various assumptions and judgments about the ultimate collectability of our loan portfolio, and we maintain an allowance for loan and lease losses and other reserves to absorb anticipated future losses inherent in our portfolio.

In addition, bank regulatory agencies periodically review our allowance for loan and lease losses and may require us to increase reserves or recognize loan charge-offs. Because our allowance methodologies take into account qualitative factors within our institution as well as the external economic environment, there is potential for inconsistencies in our methodology and the methodologies deemed appropriate for us by the bank regulatory agencies.

If management’s assumptions and judgments prove to be inaccurate and our allowance for loan and lease losses is inadequate to absorb future losses inherent in our loan portfolio, or if bank regulatory agencies require us to increase our allowance for loan and lease losses or to recognize loan charge-offs, our capital could be significantly reduced, and we could be materially and adversely affected.

Our decisions regarding the fair value of assets acquired could be different than initially estimated, which could materially and adversely affect our business, financial condition, results of operations and future prospects.

As required by acquisition accounting rules, we record acquired loans at estimated fair values as of the effective date of the acquisition by creating a discount and eliminating the allowance for loan and lease losses. To the extent the credit losses of the purchased loans are greater than fair value adjustments determined at the effective date of acquisitions, we could be materially and adversely affected.

We acquired a significant portion of our loans held for investment in the mergers and acquisitions that we have completed. Although these loans were recorded at their estimated fair values, as of the effective date of the transaction, there is no assurance that the acquired loans will not suffer further deterioration in value resulting in additional charge-offs and a reduction in our net income.

We depend on the accuracy and completeness of information about our customers and counterparties.

In deciding whether to extend credit or enter into other transactions, we rely on information furnished by or on behalf of our customers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of those customers or counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could result in losses that materially and adversely affect us. Even if we receive accurate information, we may misjudge that information and fail to assess the credit risks in a manner that materially and adversely affects us.

 

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Our use of appraisals in deciding whether to make a loan on or secured by real property does not ensure the value of the real property collateral.

In considering whether to make a loan secured by real property, we generally require an appraisal of the property. However, an appraisal is only an estimate of the value of the property at the time the appraisal is made, and an error in fact or judgment could adversely affect the reliability of an appraisal. In addition, events occurring after the initial appraisal may cause the value of the real estate to decrease. As a result of any of these factors, the value of collateral backing a loan may be less than supposed, and if a default occurs, we may not recover the outstanding balance of the loan.

Commercial real estate lending guidance issued by the federal banking regulators could impact our operations and capital requirements.

The Federal Reserve, OCC and FDIC, along with the other federal banking regulators, issued guidance entitled “Concentrations in Commercial Real Estate Lending, Sound Risk Management Practices” directed at financial institutions that have particularly high concentrations of commercial real estate loans within their loan portfolios. This guidance suggests that institutions whose commercial real estate loans exceed certain percentages of capital should implement heightened risk management practices appropriate to their concentration risk and may be required to maintain higher capital ratios than institutions with lower concentrations in commercial real estate lending. These agencies jointly issued a “statement on Prudent Risk Management for Commercial Real Estate Lending” on December 2015 to remind banks of the need to engage in risk management practices for commercial real estate lending. Based on our commercial real estate concentration as of December 31, 2015, we are not subject to additional supervisory analysis but could be in the future, and we believe our credit administration policies to be consistent with the recently published policy statement. Our management has implemented controls to monitor our commercial real estate lending and will continue to enhance and monitor those controls, but we cannot predict the extent to which this guidance may impact our future operations or capital requirements. Also, any risk management practices that we implement may not be effective to prevent losses in our loan portfolio, including our commercial real estate portfolio.

Our ability to maintain regulatory capital levels and adequate sources of funding and liquidity may be adversely affected by market conditions, concentration of customer deposits within certain businesses and industries, and changes in capital requirements made by our regulators.

We are required to maintain certain capital levels sufficient to maintain capital ratios that classify the Bank as “well-capitalized” in accordance with banking regulations. We must also seek to maintain adequate funding sources in the normal course of business to support our lending and investment operations and repay our outstanding liabilities as they become due. Our ability to maintain regulatory capital levels, available sources of funding, and sufficient liquidity could be impacted by the concentration of customer deposits within certain businesses and industries and deteriorating economic and market conditions.

Our failure to meet any applicable regulatory guideline related to our lending activities or any capital requirement otherwise imposed upon us or to satisfy any other regulatory requirement could subject us to certain activity restrictions or to a variety of enforcement remedies available to the regulatory authorities, including limitations on our ability to pay dividends or pursue acquisitions, the issuance by regulatory authorities of a capital directive to increase capital, and the termination of deposit insurance by the FDIC.

In determining the adequacy of our capital levels, we use risk-based capital ratios established by regulations. In July 2013, the Federal Reserve, FDIC and OCC adopted the Basel III Rules, which establish a stricter regulatory capital framework that requires banking organizations to hold more and higher-quality capital to act as a financial cushion to absorb losses and help banking organizations better withstand periods of financial stress. The Basel III Rules increase capital ratios for all banking organizations and introduce a “capital conservation buffer,” which is in addition to each capital ratio. If a banking organization dips into its capital conservation buffer, it would be subject to limitations on certain activities including payment of dividends, share repurchases and discretionary bonuses to executive officers.

In calculating our risk-based ratios, we must apply risk weights to our various asset classes. The Basel III Rules assign higher risk weights to exposures to various categories of assets, including certain credit facilities that finance the acquisition, development or construction of real property, certain exposures or credits that are 90 days past due or on nonaccrual, foreign exposures and certain corporate exposures. The Basel III Rules also require unrealized gains and losses on certain available-for-sale securities holdings to be included for purposes of calculating regulatory capital requirements unless a one-time opt-out is exercised. We made a one-time, election in our March 31, 2015 filing to continue to permanently exclude AOCI from capital. The Basel III Rules also include changes in what constitutes regulatory capital, some of which are subject to a two-year transition period. These changes include the phasing-out of certain instruments as qualifying capital. In addition, Tier 2 capital is no longer limited to the amount of Tier 1 capital included in total capital. Mortgage servicing rights, certain deferred tax assets and investments in unconsolidated subsidiaries over designated percentages of common stock will be required to be deducted from capital, subject to a two-year transition period. The Basel III Rules became effective January 1, 2015. The conservation buffer began to be phased in beginning in 2016 and will take full effect on January 1, 2019.

 

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Although we currently cannot predict the specific impact and long-term effects that the Basel III Rules will have on us and the banking industry more generally, we will be required to maintain higher regulatory capital levels, which could impact our operations, net income and ability to grow. Furthermore, our failure to comply with the minimum capital requirements could result in our regulators taking formal or informal actions against us, which could restrict our future growth or operations.

The CFPB may reshape the consumer financial laws through rulemaking and enforcement of unfair, deceptive or abusive acts or practices, which may directly impact the business operations of depository institutions offering consumer financial products or services including the Bank.

The CFPB has broad rulemaking authority to administer and carry out the purposes and objectives of the “Federal consumer financial laws, and to prevent evasions thereof,” with respect to all financial institutions that offer financial products and services to consumers. The CFPB is also authorized to prescribe rules applicable to any covered person or service provider identifying and prohibiting acts or practices that are “unfair, deceptive, or abusive” in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service (“UDAAP authority”). The potential reach of the CFPB’s broad new rulemaking powers and UDAAP authority on the operations of financial institutions offering consumer financial products or services, including the Bank, is currently unknown.

The Bank is subject to federal and state and fair lending laws, and failure to comply with these laws could lead to material penalties.

Federal and state fair lending laws and regulations, such as the Equal Credit Opportunity Act and the Fair Housing Act, impose nondiscriminatory lending requirements on financial institutions. The Department of Justice, CFPB, and other federal and state agencies are responsible for enforcing these laws and regulations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. A successful challenge to the Bank’s performance under the fair lending laws and regulations could adversely impact the Bank’s rating under the CRA and result in a wide variety of sanctions, including the required payment of damages and civil money penalties, injunctive relief, imposition of restrictions on merger and acquisition activity, and restrictions on expansion activity, which could negatively impact our reputation, business, financial condition and results of operations.

We may not be able to access funding sufficient to support our growth.

Our business strategies are based on access to funding from local customer deposits, such as checking and savings accounts and certificates of deposits. Deposit levels may be affected by a number of factors, including interest rates paid by competitors, general interest rate levels, returns available to customers on alternative investments, and general economic conditions. If our deposit levels fall, we could lose a relatively low cost source of funding, and our costs would increase from alternative funding. If local customer deposits are not sufficient to fund our growth, we will look to outside sources such as borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”), which is a secured funding source. Our ability to access borrowings from the FHLB will be dependent upon whether and the extent to which we can provide collateral. We may also look to federal funds purchased and brokered deposits as discussed below under “—Our use of brokered deposits may be limited or discouraged by bank regulators, which could adversely impact our liquidity” or seek to raise funds through the issuance of shares of our common stock or other equity or equity-related securities or the incurrence of debt as additional sources of liquidity. If we are unable to access funding sufficient to support our growth or are only able to access such funding on unattractive terms, we may not be able to implement our business strategies.

We rely substantially on deposits made by our customers in our target markets, which can be materially and adversely affected by local and general economic conditions.

As of December 31, 2015, $578.9 million, or 65.1%, of our total deposits, consisted of noninterest-bearing demand accounts and interest-bearing savings, money market and demand accounts. The $310.1 million remaining balance of deposits includes time deposits, of which approximately $234.5 million, or 26.4% of our total deposits, are due to mature within one year. Our ability to attract and maintain deposits, as well as our cost of funds, has been and will continue to be significantly affected by rates offered by competitors, alternative investment opportunities, monetary policy and general economic conditions. We have significant deposits from certain customers that are in excess of the FDIC insurance amounts. Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with our Bank is fully insured or may place them in other financial institutions that they perceive as being more secure. The loss of customers that maintain significant deposits with the Bank could have an adverse effect on this critical funding source. If we fail to attract new deposits or maintain existing deposits or are forced to increase interest rates paid to customers to attract and maintain deposits, our net interest income would be negatively impacted, and we could be materially and adversely affected.

 

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Our use of brokered deposits may be limited or discouraged by bank regulators, which could adversely impact our liquidity.

Depositors that invest in brokered deposits are generally interest-rate sensitive and well informed about alternative markets and investments. Consequently, these types of deposits may not provide the same stability to a bank’s deposit base as traditional local retail deposit relationships. Our liquidity may be negatively affected if that funding source experiences supply difficulties due to loss of investor confidence or a flight to other investments. Regulatory developments with respect to wholesale funding, including increased FDIC insurance costs for, or limits on the use of these deposits, may further limit the availability of that alternative. In light of regulatory pressure, there may be a cost premium for locally generated certificates of deposit as compared to brokered deposits, which may increase our cost of funding. As of December 31, 2015, $114.4 million, or 12.9% of our deposits were brokered deposits.

We may not be able to raise additional capital on terms favorable to us or at all.

We may need additional capital to support our business, expand our operations, or maintain our minimum capital requirements; however, we may not be able to raise additional funds through the issuance of shares of our common stock or other equity or equity-related securities or in an acquisition or a merger. Furthermore, the significant amount of our common stock that BankCap Partners owns may discourage other potential investors from acquiring newly-issued shares of our common stock or other equity or equity-related securities.

We may not be able to maintain sufficient liquidity to meet the cash flow requirements of our depositors and other creditors.

Our liquidity is used to make loans and investments and to repay liabilities (including deposits), as they become due or are demanded by depositors and other creditors. Our main source of liquidity is customer deposits. As a part of our liquidity management, we use a number of funding sources in addition to core deposits and repayments and maturities of loans and investments. Potential alternative sources of liquidity include federal funds purchased and investment securities sold under repurchase agreements, as well as the sale of loans, securities (to the extent not pledged as collateral) or other assets, the utilization of available government and regulatory assistance programs, brokered deposits, borrowings from the FHLB, borrowings through the Federal Reserve Bank’s (“FRB”) discount window, borrowings from other banks, and the issuance of our debt securities and equity securities. Without sufficient liquidity from these potential sources, we may not be able to meet the cash flow requirements of our depositors and other creditors, or to operate and grow our business.

As we continue to grow, we may become more dependent on wholesale funding sources, which may include FHLB borrowings and borrowings through the FRB’s discount window. As of December 31, 2015, the Bank had $17.5 million of FHLB borrowings and $114.4 million of brokered deposits outstanding. If we are required to rely more heavily on wholesale funding sources to support our operations or growth in the future and such funding is expensive at such time, our revenues may not increase proportionately to cover our costs. In that case, our operating margins would be reduced, and we could be materially and adversely affected.

We may become subject to significant liabilities in the event the Bank forecloses upon, or takes title to, real property.

When underwriting a commercial or residential real estate loan, we will generally take a lien on the real property and, in some instances upon a default by the borrower, we may foreclose upon and take title to the property, which may lead to potential financial risk for us under applicable environmental laws. We may also take over the management of commercial properties whose owners have defaulted on loans. We may also own and lease premises where branches and other facilities are located. While we have lending, foreclosure and facilities guidelines intended to exclude properties with an unreasonable risk of contamination, hazardous substances could exist on some of the properties that the Bank may own, manage or occupy. We face the risk that environmental laws could force us to clean up the properties at our expense. It may cost much more to remediate a property than the property is worth. We could also be liable for pollution generated by a borrower’s operations, if the Bank takes a role in managing those operations after a default. Many environmental laws impose liability, regardless of whether we knew of, or were responsible for, any contamination that existed or exists for the property. The Bank may also find it difficult or impossible to sell contaminated properties. These costs could be significant and could materially and adversely affect our net income.

The disposition processes related to our nonperforming assets could result in losses in the future that would materially and adversely affect us.

We may incur additional losses relating to an increase in nonperforming loans and other real estate owned (“OREO”), and such losses could be material. When we acquire title to collateral in foreclosures and similar proceedings, we are required by accounting rules to mark such collateral to the then fair market value, less costs of disposal, which could result in a loss. Nonperforming assets adversely affect net income in various ways. While we pay interest expense to fund nonperforming

 

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assets, no interest income is recorded on nonaccrual loans or OREO, thereby adversely affecting income and returns on assets and equity. Additionally, we incur loan administration costs and the costs of maintaining properties carried as OREO. Nonperforming loans and OREO also increase our risk profile, and increases in the level of nonperforming loans and OREO could impact our regulators’ view of appropriate capital levels in light of such risks.

While we seek to manage our problem assets through loan sales, workouts, restructurings, foreclosures and otherwise, decreases in the value of these assets, or in the underlying collateral, or in these borrowers’ results of operations, liquidity or financial condition, whether or not due to economic and market conditions beyond our or their control, could materially and adversely affect us. In addition, the resolution of nonperforming assets requires significant amount of management’s time and attention, diverting their time from other business, which could be detrimental to the performance of their other responsibilities on our behalf.

Given the geographic concentration of our operations, we could be significantly affected by any natural or man-made disaster that affects Virginia and surrounding areas.

Our operations are concentrated in, and our loan portfolio consists almost entirely of, loans to persons and businesses located in and around Virginia. The collateral for many of our loans consists of real and personal property located in areas susceptible to hurricanes and other natural disasters as well as man-made disasters that can cause extensive damage to the general region. Disaster conditions that hit in our target markets would adversely affect the local economies and real estate markets. Adverse economic conditions resulting from such a disaster could negatively affect the ability of our customers to repay their loans and could reduce the value of the collateral securing these loans. Furthermore, damage resulting from any natural or man-made disaster could also result in continued economic uncertainty that could negatively impact businesses in those areas. As a result, we could be materially and adversely affected by any natural or man-made disaster that affects our target markets.

We are dependent on our key personnel, including our executive officers, and the loss of such persons could negatively impact our ability to execute our business strategies.

We will be for the foreseeable future dependent on the services of T. Gaylon Layfield, III, who is our President and Chief Executive Officer; Thomas W. Osgood, who is our Chief Financial Officer and Chief Administrative Officer; Judy C. Gavant, who is our Controller and Principal Accounting Officer; Wellington W. Cottrell, III, who is our Chief Credit Officer; Ronald E. Davis, who is our Chief Operations and Technology Officer; and Edward H. Phillips, Jr., who is our Chief Lending Officer. Should the services of these individuals or other key executive officers become unavailable, we may be unable to find a suitable successor who would be willing to be employed upon the terms and conditions that we would offer. A failure to replace any of these individuals in a timely and effective manner could negatively affect our ability to execute our business strategies and otherwise disrupt our business.

Our business is dependent on technology and an inability to invest in technological improvements or obtain reliable technological support may materially and adversely affect us.

The financial services industry is undergoing rapid technological changes with frequent introductions of new technology-driven services and products. In addition to better serve our customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our ability to grow and compete will depend in part upon our ability to address the needs of customers by using technology to provide services and products that will satisfy their operational needs, while managing the costs of expanding our technology infrastructure. Many competitors have substantially greater resources to invest in technological improvements and third-party support. For the foreseeable future, we expect to rely on third-party service providers for our core technology systems and on other third parties for technical support and related services. If we are unable to implement and market new technology-driven services and products successfully, or if those services and products become unreliable or fail, our customer relationships and operations could be adversely affected, which could materially and adversely affect us.

System failure or breaches, including “hacking,” “cyber fraud” or “identity theft,” of our network security could lead to increased operating costs, as well as litigation and other liabilities.

The computer systems and network infrastructure we use could be vulnerable to unforeseen hardware and cybersecurity issues, including “hacking,” “cyber fraud” and “identity theft.” Our operations are dependent in part upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by our customers and us, including our Internet banking activities, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other

 

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users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us, damage our reputation, and inhibit current and potential customers from our Internet banking services. Each year, we incur expenses to add additional security measures to our computer systems and network infrastructure to mitigate the possibility of cybersecurity breaches, including firewalls and penetration testing. We maintain insurance coverage for certain types of cybersecurity incidents, but there can be no assurance that coverage will exist or be adequate to cover potential losses. A security breach could also subject us to additional regulatory scrutiny and expose us to civil litigation and possible financial liability.

In February 2013, an executive order, Improving Critical Infrastructure Cybersecurity (the “Executive Order”) was released, which is focused primarily on government actions to support critical infrastructure owners and operators in protecting their systems and networks from cyber threats. The Executive Order requires the development of risk-based cybersecurity standards, methodologies, procedures and processes, a so-called “Cybersecurity Framework,” that can be used voluntarily by critical infrastructure companies to address cyber risks. The Executive Order also will steer certain private sector companies to comply voluntarily with the Cybersecurity Framework. In response to the Executive Order, the FFIEC has published cybersecurity guidance, along with observations from recent cybersecurity assessments. These assessments were conducted with the goal of identifying gaps in the regulators’ examination procedures and training that can be used to strengthen the oversight of cybersecurity readiness. If, as a result of the Executive Order, or otherwise, our regulators were to recommend guidance that required us to further implement cyber security infrastructure, we could incur additional costs.

We are subject to extensive regulation in the conduct of our business operations, which could materially and adversely affect us.

The banking industry is heavily regulated by several governmental agencies. Banking regulations are primarily intended to protect depositors, deposit insurance funds and the banking system as a whole, and not shareholders and other creditors. These regulations affect lending practices, capital structure, investment practices, dividend policy, operations and growth, among other things. For example, federal and state consumer protection laws and regulations limit the manner in which banks may offer and extend credit. In addition, the laws governing bankruptcy generally favor debtors, making it more expensive and more difficult to collect from customers who become subject to bankruptcy proceedings.

From time to time, the U.S. Congress and state legislatures consider changing these laws and may enact new laws or amend existing laws to further regulate the financial services industry. In July 2010, the Dodd-Frank Act was enacted, which has resulted, and will continue to result, in sweeping changes in the regulation of financial institutions. The Dodd-Frank Act contains numerous provisions that affect all banks and bank holding companies, including provisions that, among other things:

 

    change the assessment base for the DIF from the amount of insured deposits to total consolidated assets less tangible capital, eliminate the ceiling on the size of the DIF, and increase the floor of the size of the DIF, which generally will require an increase in the level of assessments for institutions with assets in excess of $10 billion;

 

    repeal the federal prohibitions on the payment of interest on demand deposits, thereby generally permitting the payment of interest on all deposit accounts;

 

    centralize responsibility for promulgating regulations under and enforcing federal consumer financial protection laws in a new bureau, the CFPB, that will have direct supervision and examination authority over banks with more than $10 billion in assets;

 

    require the FDIC to seek to make its capital requirements for banks counter-cyclical;

 

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

 

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

 

    establish new rules and restrictions regarding the origination of mortgages; and

 

    permit the Federal Reserve to prescribe regulations regarding interchange transaction fees, and limit them to an amount reasonable and proportional to the cost incurred by the issuer for the transaction in question.

Many of the provisions in the Dodd-Frank Act remain subject to regulatory rule-making and implementation, the effects of which are not yet known. Although we cannot predict the specific impact and long-term effects that the Dodd-Frank Act and the regulations promulgated thereunder will have on us and our prospects, our target markets and the financial industry more generally, we believe that the Dodd-Frank Act and the regulations promulgated thereunder will impose additional administrative burdens that will obligate us to incur additional costs.

 

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Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could, among other things, subject us to additional costs and lower revenues, limit the types of financial services and products we may offer, increase the ability of non-banks to offer competing financial services and products, and require a significant amount of management’s time and attention. Failure to comply with statutes, regulations or policies could result in sanctions by regulatory agencies, civil money penalties or reputational damage, which could materially and adversely affect us.

BankCap Partners is a bank holding company that is deemed to be a multi-bank holding company for two institutions.

Under the Federal Reserve guidelines, every bank holding company must serve as a “source of strength” for each of their bank subsidiaries. Currently, BankCap Partners is deemed a bank holding company for ACB, an Atlanta, Georgia-based bank, and the Bank. The position of BankCap Partners as a source of strength to other depository institutions may limit its ability to serve as a source of strength for the Bank and could adversely affect the Bank’s ability to access resources of BankCap Partners. Federal bank regulatory agencies have additional discretion to require a bank holding company to divest itself of any bank or non-bank subsidiary, if the agency determines that divestiture may aid the depository institution’s financial condition.

The Bank may be obligated to provide financial assistance to any other financial institution as to which BankCap Partners is deemed to be a bank holding company.

A bank for which BankCap Partners is deemed to be a bank holding company may be required to indemnify, or cross-guarantee, the FDIC against losses the FDIC incurs with respect to any other bank controlled by BankCap Partners. In addition, the FDICIA requires that an insured depository institution shall be liable for the loss incurred or anticipated by the FDIC arising from the default of a commonly controlled insured depository institution or any assistance provided by the FDIC to any commonly controlled insured depository institution in danger of default. Accordingly, the Bank may be obligated to provide financial assistance to ACB. Any financial assistance that the Bank is required to provide would reduce our capital and could materially and adversely affect us.

If we fail to maintain an effective system of internal control over financial reporting and disclosure controls and procedures, current and potential shareholders may lose confidence in our financial reporting and disclosures and could subject us to regulatory scrutiny.

Pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 (“Section 404”), we are required to include in our Annual Reports on Form 10-K our management’s assessment of the effectiveness of our internal control over financial reporting. While our management’s assessment included in this Annual Report on Form 10-K for the fiscal year ended December 31, 2015 did not identify any material weaknesses, we cannot guarantee that we will not have any material weaknesses identified by our management or our independent registered public accounting firm in the future.

The Dodd-Frank Act includes a provision to permanently exempt non-accelerated filers from complying with the requirements of Section 404(b), which requires an issuer to include in its Annual Report on Form 10-K an attestation report from the issuer’s independent registered public accounting firm on the issuer’s internal control over financial reporting. Since we were a non-accelerated filer as of June 30, 2015 (the last day of our most recently completed second quarter), we are not required to comply with the requirements of Section 404(b) in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015. However, if the market value of our common stock held by non-affiliates equals $75 million or more as of the end of the last day of our most recently completed second quarter, we will be required to provide an attestation report from our independent registered public accounting firm on our internal controls over financial reporting (“ICFR”) in our Annual Report on Form 10-K for the year in which we equal or exceed the $75 million threshold. Additionally, in accordance with FDICIA, we will be required to provide an attestation report from our independent registered public accounting firm on our ICFR when our total assets as of the beginning of our fiscal year are $1 billion or more.

Compliance with the requirements of Section 404 is expensive and time-consuming. If, in the future, we fail to comply with these requirements in a timely manner, or if our management or independent registered public accounting firm expresses a qualified or otherwise negative opinion on the effectiveness of our ICFR, we could be subject to regulatory scrutiny and a loss of confidence in our ICFR. In addition, any failure to maintain an effective system of disclosure controls and procedures could cause our current and potential shareholders and customers to lose confidence in our financial reporting and disclosure required under the Exchange Act, which could materially and adversely affect us.

 

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The accuracy of our financial statements and related disclosures could be affected if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies.

The preparation of financial statements and related disclosure in conformity with GAAP requires us to make judgments, assumptions and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. Our critical accounting policies, which we summarize in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies,” describe those significant accounting policies and methods used in the preparation of our consolidated financial statements that we consider “critical” because they require judgments, assumptions and estimates about the future that materially impact our consolidated financial statements and related disclosures. For example, material estimates that are particularly susceptible to significant change relate to the determination of our allowance for loan and lease losses, the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans, and the application of acquisition accounting principles relating to mergers and acquisitions. As a result, if future events differ significantly from the judgments, assumptions and estimates in our critical accounting policies, those events could have a material impact on the accuracy of our consolidated financial statements and related disclosures, and ultimately negatively affect our net income.

The market value of our investments may decline, which could cause a decline in our shareholders’ equity and negatively affect our results of operations.

We have designated a portion of our investment portfolio as securities available for sale pursuant to applicable accounting standards relating to accounting for investments. These standards require that unrealized gains and losses in the estimated fair value of the available-for-sale investment securities portfolio be reflected as a separate item in shareholders’ equity, net of tax, as accumulated other comprehensive income. As of December 31, 2015, we had $130.9 million, or 12.6% of our total assets, in securities available for sale at fair value. Shareholders’ equity reflects the unrealized gains and losses, net of tax, of these investments. A portion of our investment portfolio is designated as securities held to maturity pursuant to applicable accounting standards. As of December 31, 2015, we had $9.3 million in held-to-maturity securities. Held-to-maturity securities are recorded at amortized cost; any unrealized gains or losses in our held-to-maturity securities do not result in an adjustment to our shareholders’ equity. Management believes that several factors will affect the market values of our investment securities portfolio. These include changes in interest rates or expectations of changes, the degree of volatility in the securities markets, inflation rates or expectations of inflation, the slope of the interest rate yield curve (i.e., the differences between shorter-term and longer-term interest rates), and reduced investor demand. The decline in the market value of our available-for-sale investment securities portfolio results in a corresponding decline in shareholders’ equity. Lower market values for our available-for-sale and held-to-maturity securities may result in recognition of an other-than-temporary impairment charge to our net income, thus also reducing our shareholders’ equity.

We do not intend to pay dividends on our common stock in the foreseeable future, and we may never pay, or legally be able to pay, dividends.

We have not paid any dividends on our common stock since our inception, and we presently do not intend to pay any dividends on common stock in the foreseeable future. We are a bank holding company that conducts substantially all of our operations through the Bank. As a result, our ability to make dividend payments on our common stock will depend primarily up the receipt of dividends and other distributions from the Bank. The company and the Bank are limited in the amount of dividends that they may pay pursuant to state and federal laws and regulations. See “Item 1—Our Business—Supervision and Regulation—Payment of Cash Dividends.” During 2014, we entered into an agreement with a national bank that provides for an unsecured senior term loan credit facility up to $15 million, which was amended in 2015 to, among other things, increase this maximum available amount to $17 million. The outstanding principal amount of our senior term loan facility was $11.1 million as of December 31, 2015. This agreement imposes restrictions on the ability of the company and the Bank to pay dividends while any event of default exists. In 2015, we issued and sold our Subordinated Notes in the amount of $8.5 million. The terms of the Subordinated Notes restrict the company from paying any dividends while an event of default exists and from paying cash dividends if certain regulatory capital ratios are below prescribed levels. Any future financing arrangements that we enter into may also limit our ability to pay dividends to our shareholders. Accordingly, we may never legally be able to pay dividends to our shareholders of common stock. Further, even if we have earnings and available cash in an amount sufficient to pay dividends to our shareholders of common stock, our board of directors, in its sole discretion, may decide to retain them and therefore not pay dividends in the future.

BankCap Partners owns a significant number of shares of our common stock, which will enable it to influence the vote on all matters submitted to a vote of our shareholders.

As of December 31, 2015, BankCap Partners beneficially owned 3,671,500 shares of our common stock (including warrants to purchase 391,500 shares of our common stock at an exercise price of $11.49 per share, all of which warrants are currently exercisable), representing a 27.4% beneficial ownership of the outstanding shares of our common stock.

 

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In addition, under the terms of the investor rights agreement, BankCap Partners and all of the former directors and executive officers of Xenith Corporation who became directors and executive officers of Xenith Bankshares and who purchased shares of Xenith Corporation common stock in its June 2009 private offering agreed to vote their shares of our common stock in favor of (1) one designee of BankCap Partners for election to our board of directors for so long as BankCap Partners is a registered bank holding company under the Bank Holding Company Act, with respect to Xenith Bankshares, and (2) one additional designee of BankCap Partners for election to our board of directors for so long as BankCap Partners and its affiliates own 25% or more of our outstanding voting capital stock. They have also agreed to vote their shares of our common stock in favor of (1) removing the designee of BankCap Partners on our board of directors at the request of BankCap Partners and the election to our board of directors of a substitute designee of BankCap Partners, and (2) ensuring that any vacancy on our board of directors caused by resignation, removal or death of a BankCap Partners designated director is filled in accordance with the agreement above. Scott A. Reed, a principal of BankCap Partners and a member of our board of directors, is a current designee of BankCap Partners.

Accordingly, BankCap Partners, through its beneficial ownership of our common stock and board rights, will be able to participate in matters that come before our board of directors and influence the vote on all matters submitted to a vote of our shareholders, including the election of directors, amendments to the amended and restated articles of incorporation or amended and restated bylaws, mergers or other business combination transactions, and certain sales of assets outside the usual and regular course of business. The interests of BankCap Partners may not coincide with the interests of our other shareholders, and BankCap Partners could take actions that advance their own interests to the detriment of our other shareholders.

 

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Item 2—Properties

The following table summarizes certain information about our headquarters and the locations of our branch and administrative offices as of December 31, 2015:

 

Office Location    Owned or Leased    Lease Terms    Square Feet  

One James Center (Branch and Headquarters)

901 E. Cary Street, Suite 1700

Richmond, VA 23219

   Leased    Term expires June 30, 2019, with one option to extend for a three-year period      16,131   

Boulders Branch and Operations Center

1011 Boulder Spring Drive, Suite 410

Richmond, VA 23225

   Leased    Term expires March 31, 2017, with one option to extend for a three-year period      10,592   

Dulles Branch and Herndon Office

2325 Dulles Corner Boulevard

Herndon, VA 20171

   Leased    Term expires September 30, 2023, with one option to extend for a five-year period      10,863   

North Suffolk Branch

3535 Bridge Road

Suffolk, VA 23435

   Owned         12,255   

Plaza Branch

1000 N. Main Street

Suffolk, VA 23434

   Leased    Term expires January 31, 2019, with automatic five-year renewals      2,512   

Bosley Branch

100 Bosley Avenue

Suffolk, VA 23434

   Owned         2,596   

Courthouse Branch

6720 Sutton Road

Gloucester, VA 23061

   Owned         4,040   

York River Branch

1553 George Washington Memorial Highway

Gloucester Point, VA 23062

   Owned         11,292   

Loan Production Office

12350 Jefferson Avenue, Suite 150

Newport News, VA 23602

   Leased    Term expires July 31, 2020, with one option to renew for a three-year period      2,146   

We believe that all of our properties are maintained in good operating condition and are suitable and adequate for our operational needs. We also believe adequate properties are available for lease when our existing leases terminate.

Item 3—Legal Proceedings

From time to time, we and the Bank are party, either as a defendant or plaintiff, to lawsuits in the normal course of our business. While any litigation involves an element of uncertainty, management is of the opinion that the liability, if any, resulting from pending legal proceedings will not have a material adverse effect on our financial condition, liquidity or results of operations. Management believes there is no pending or threatened legal proceedings as of December 31, 2015.

Item 4—Mine Safety Disclosures

None.

 

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PART II

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

Market Information

Our common stock trades on The NASDAQ Capital Market under the symbol “XBKS.” As of February 29, 2016, we had 13,089,756 shares of common stock issued and outstanding and approximately 1,282 record holders. The following table sets forth the high and low sales price for our common stock on The NASDAQ Capital Market during the periods indicated.

 

     2015      2014  

Quarter

   High      Low      High      Low  

First

   $ 6.94       $ 5.98       $ 6.20       $ 5.61   

Second

     6.24         5.84         6.45         5.90   

Third

     7.00         5.98         6.76         6.11   

Fourth

     7.49         5.90         6.66         6.09   

Issuer Purchases of Equity Securities

In July 2013, the company’s board of directors approved a share repurchase program under which the company may purchase in the open market or otherwise up to 210,000 shares of its outstanding common stock. There is no guarantee as to the number of shares that will be repurchased by the company, and the program can be discontinued at any time.

The following table presents monthly stock repurchases during the fourth quarter of 2015. All purchases were made using available cash resources and occurred in the open market.

 

Period

  Total Number of
Shares
Purchased
    Average Price
Paid per
Share
    Total Number of
Shares Purchased as
Part of Publicly
Announced Program
    Maximum Number of
Shares that May Yet
Be Purchased Under
the Program
 

October 1, 2015 - October 31, 2015

    600      $ 6.40        600        104,470   

November 1, 2015 - November 30, 2015

    —        $ —          —          104,470   

December 1, 2015 - December 31, 2015

    —        $ —          —          104,470   
 

 

 

     

 

 

   

Total

    600      $ 6.40        600     
 

 

 

     

 

 

   

See “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Issuances and Repurchases of Stock” for additional information.

Dividend Policy

We have not paid dividends on our common stock since our inception, and we presently do not intend to pay any dividends on our common stock in the foreseeable future. We are limited in the amount of dividends that we may pay to our shareholders of common stock pursuant to state and federal laws and regulations. See “Item 1—Business—Supervision and Regulation—Payment of Cash Dividends.” The terms of our Subordinated Notes and the terms of our unsecured senior term loan, discussed in “Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations—Financial Condition—Borrowings,” also impose limits on our ability to pay dividends. Any future financing arrangements that we enter into may also limit our ability to pay dividends to our shareholders of common stock. Accordingly, we may never be able to pay dividends to our shareholders of common stock. Further, even if we have earnings and available cash in an amount sufficient to pay dividends to our shareholders of common stock, our board of directors, in its sole discretion, may decide to retain them and therefore not pay dividends in the future.

 

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

The following is management’s discussion and analysis of our consolidated financial condition, changes in financial condition, results of operations, liquidity, cash flows and capital resources. This discussion should be read in conjunction with the consolidated financial statements and the notes thereto included in “Item 8—Financial Statements and Supplementary Data” below.

All dollar amounts included in the tables in this discussion and analysis are in thousands, except share data. Columns and rows of amounts presented in tables may not total due to rounding.

Overview

Xenith Bankshares, Inc. is a Virginia corporation that is the bank holding company for Xenith Bank, a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Federal Reserve Bank. The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail clients, which we refer to as our target customers. We are focused geographically on the Richmond and Hampton Roads, Virginia and Greater Washington, D.C. metropolitan statistical areas, which we refer to as our target markets. The Bank conducts its principal banking activities through its eight branches, with one branch located in Herndon, Virginia, two branches located in Richmond, Virginia, three branches located in Suffolk, Virginia, and two branches located in Gloucester, Virginia. We also operate a loan production office in Newport News, Virginia. We acquired the three branches located in Suffolk in the merger of Xenith Corporation with and into First Bankshares, the parent company of its wholly-owned subsidiary SuffolkFirst Bank, which is further discussed below. We acquired the two branches in Gloucester and the loan production office in the merger of CVB with and into Xenith Bank on June 30, 2014, which is also further discussed below.

As of December 31, 2015, we had total assets of $1.04 billion, total loans, net of our allowance for loan and lease losses, of $772.2 million, total deposits of $889.0 million and shareholders’ equity of $102.7 million.

Our services and products consist primarily of taking deposits from, and making loans to, our target customers within our target markets. We provide a broad selection of commercial and retail banking products, including commercial and industrial loans, commercial and residential real estate loans, and select consumer loans. We also offer a wide range of checking, savings and treasury products, including remote deposit capture, automated clearing house transactions, debit cards, 24-hour ATM access, Internet and mobile banking, and bill pay service. We do not engage in any activities other than banking activities.

On June 26, 2015, we issued and sold $8.5 million in aggregate principal amount of our 6.75% subordinated notes due 2025. The Subordinated Notes qualify as Tier 2 capital for the company and are redeemable by us no earlier than June 26, 2020, except upon the occurrence of certain events, including their disqualification as Tier 2 capital, as a result of a change in interpretation or application of law or regulation.

On June 30, 2015, we completed the redemption of all of the outstanding 8,381 shares of our SBLF Preferred Stock that we had issued and sold to the U.S. Treasury pursuant to the Small Business Lending Fund program, at an aggregate redemption price of $8.4 million, including accrued but unpaid dividends. Substantially all of the net proceeds from the issuance and sale of the Subordinated Notes were used to fund the redemption.

The primary source of our revenue is net interest income, which represents the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities used to fund those assets. Interest-earning assets include loans, securities, interest-earning deposits and federal funds sold. Interest-bearing liabilities include deposits and borrowings. Sources of noninterest income include service charges on deposit accounts, gains or losses on the sale of securities, earnings on investment in bank owned life insurance and other miscellaneous income. Deposits, FHLB borrowed funds, borrowed funds from other sources and federal funds purchased are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. Measures of our performance include net interest margin, return on average assets (“ROAA”), return on average common equity (“ROAE”), average common equity to average assets and efficiency ratio. Such measures are common performance indicators in the banking industry.

 

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The following table presents selected financial performance measures, as of the dates stated:

 

     For the Years Ended December 31,  
     2015     2014  

Net interest margin (1)

     3.31     3.52

Return on average assets (2)

     0.42     0.16

Return on average common equity (3)

     4.19     1.46

Average common equity to average assets (4)

     9.99     10.81

Efficiency ratio (5)

     74     81

 

(1) Net interest margin is net interest income divided by average interest-earning assets. Average interest-earning assets are presented within the average balances, income and expenses, yields and rates table below.
(2) ROAA is net income divided by average total assets. Average total assets are presented within the average balances, income and expenses, yields, and rates table below.
(3) ROAE is net income divided by average shareholders’ equity less average preferred stock. Average shareholders’ equity is presented within the average balances, income and expenses, yields and rates table below.
(4) Average common equity to average assets is average common shareholders’ equity divided by average total assets. Average common shareholders’ equity is average total shareholders’ equity less preferred stock. Average total assets are presented within the average balances, income and expenses, yields and rates table below.
(5) Efficiency ratio is noninterest expense divided by the sum of net interest income and noninterest income.

Pending Merger of Xenith Bankshares and Hampton Roads Bankshares, Inc.

On February 10, 2016, we announced, in a joint press release with Hampton Roads Bankshares, that the companies have entered into the Merger Agreement. Under the terms of the Merger Agreement, our shareholders will receive 4.4 shares of Hampton Roads Bankshares’ common stock for each share of our common stock. Upon the completion of the HRB Merger, Hampton Roads Bankshares shareholders and our shareholders will own approximately 74% and 26%, respectively, of the shares in the combined company and its board of directors will consist of 13 persons, 8 from Hampton Roads Bankshares and 5 from Xenith Bankshares. Immediately following the completion of the HRB Merger, the Bank will merge with and into Hampton Roads Bankshares’ wholly-owned subsidiary bank, Bank of Hampton Roads. The combined company will adopt the Xenith Bankshares name for the holding company and the Xenith Bank name for the combined bank and will be headquartered in Richmond, Virginia. T. Gaylon Layfield, III, our current President and Chief Executive Officer, will become Chief Executive Officer of the combined company. The completion of the HRB Merger is expected to occur in the third quarter of 2016 and is subject to regulatory approvals, including the approval of the Federal Reserve Board and the Bureau of Financial Institutions of the Commonwealth of Virginia, and the approval of the shareholders of both companies, as well as customary closing conditions. Upon the completion of the HRB Merger, the combined company, with pro forma assets of approximately $2.9 billion and combined deposits of approximately $2.5 billion as of December 31, 2015, will be the fifth largest community bank by deposits in the Commonwealth of Virginia.

Mergers and Acquisitions

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the First Bankshares Merger in which Xenith Corporation was merged with and into First Bankshares, with First Bankshares being the surviving entity in the merger. First Bankshares was incorporated in Virginia on March 4, 2008, and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002. At the effective time of the First Bankshares Merger, First Bankshares changed its name to Xenith Bankshares, Inc., and SuffolkFirst Bank changed its name to Xenith Bank.

Prior to the completion of the First Bankshares Merger on December 22, 2009, Xenith Corporation (formerly Xenith Bank [In Organization]) had no banking charter, did not engage in any banking business, and had no substantial operations. Although the First Bankshares Merger was structured as a merger of Xenith Corporation with and into First Bankshares with First Bankshares being the surviving entity for legal purposes, Xenith Corporation was treated as the acquirer for accounting purposes.

On June 30, 2014, the company completed the CVB Acquisition in which CVB merged with and into the Bank, with the Bank being the surviving bank. At the effective time of the CVB Acquisition, each share of CVB common stock outstanding immediately prior to the effective time of the CVB Acquisition was converted into the right to receive 2.65 shares of Xenith Bankshares common stock (the “Exchange Ratio”) without interest and less applicable amounts for taxes. Remaining fractional shares were exchanged for cash equal to $6.40 multiplied by the fraction of a share of Xenith Bankshares common stock to which such holder would otherwise have been entitled. Based on the Exchange Ratio, an aggregate of 1,618,186 shares of Xenith Bankshares common stock was issued and $658 in cash was paid to the former shareholders of CVB in exchange for their shares of CVB common stock. Options to purchase shares of CVB common stock outstanding at the effective time of the CVB Acquisition were converted into options to purchase shares of Xenith

 

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Bankshares common stock based on the Exchange Ratio. Based on the Exchange Ratio, an aggregate of 39,004 options to purchase shares of CVB common stock were converted into an aggregate of 103,355 options to purchase shares of Xenith Bankshares common stock. Pursuant to the CVB Acquisition, we acquired $114.4 million of assets, including $70.1 million in loans and assumed $103.9 million in liabilities, including $101.0 million of deposits.

Effective on July 29, 2011, we completed the Paragon Transaction, in which we acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office of Paragon and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the branch office.

Also effective on July 29, 2011, we completed the VBB Acquisition, in which we acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of VBB located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission. The FDIC acted as receiver of VBB. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Acquisition Agreement, the Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The VBB Acquisition was completed without any shared-loss agreement with the FDIC.

Issuances and Repurchases of Stock

In June 2015, we completed the redemption of all outstanding 8,381 shares ($8.4 million) of the SBLF Preferred Stock. Substantially all of the net proceeds from the issuance of our Subordinated Notes were used to fund the redemption. During 2015, our dividend on the SBLF Preferred Stock was $42 thousand.

In September 2014, we issued and sold in a private placement an aggregate of 880,000 shares of our common stock, $1.00 par value per share, at a price of $6.35 per share to third-party investors for an aggregate purchase price, net of stock issuance costs, of approximately $5.6 million. A significant portion of the proceeds of the sale of our common stock were contributed to the Bank as equity.

In July 2013, our board of directors authorized a share repurchase program under which we may repurchase in the open market or otherwise up to 210,000 shares of outstanding common stock. There is no guarantee as to the number of shares that will be repurchased, and the program can be discontinued at any time. During 2015, we purchased 11,200 shares of our common stock at an average price of $6.36.

In April 2011, we issued and sold 4.6 million shares of our common stock at a public offering price of $4.25 per share pursuant to an effective registration statement filed with the SEC. Net proceeds, after the underwriters’ discount and expenses, were $17.7 million.

Industry Conditions

The national unemployment rate, seasonally adjusted and as published by the Bureau of Labor Statistics, for December 2015 was reported at 5.0%, a decline from 5.6% in December 2014. In the Fifth District of the Federal Reserve Bank (the “Fifth District”), which includes our target markets, the December 2015 unemployment rate was 5.2%, down from 5.5% at the end of 2014. More specifically, the unemployment rate in Virginia in December 2015 was 4.2%, based on data published by the Fifth District. Additionally, as published by the Fifth District, in the twelve months ended December 2015, all industry sectors in the Fifth District expanded.

The Federal Open Market Committee (the “FOMC”) stated in a January 27, 2016 release that labor market conditions continue to improve even as economic growth slowed late last year (2015). The FOMC stated household spending and business fixed investment have been increasing at moderate rates in recent months, and the housing sector has improved further; however, net exports have been soft and inventory investment slowed.

The FOMC reaffirmed its view that the current  14 to  12 % target range for the federal funds rate remains appropriate given the economic outlook and their current stance of monetary policy remains accommodative, thereby supporting further improvement in labor market conditions and a return to the FOMC’s long-run objective of 2% inflation. Further, the FOMC stated that it is closely monitoring global economic and financial developments and is assessing their implications for the labor market and inflation, and for the balance of risks to the outlook.

Low interest rates and intense competition have put pressure on net interest margins of banks, including the Bank. Banks with which we compete are offering aggressive terms and may be loosening credit underwriting standards. We have seen a particularly sharp increase in competition in the Richmond, Virginia market over the last few years, as new banks have entered this market. Though our commercial real estate business continues to show strong growth in both the Greater Washington and Richmond markets, our commercial and industrial lending business has grown at a slower pace. We anticipate intense competition in our markets until demand and supply are more balanced.

 

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Outlook

In spite of industry and market conditions, we believe we are well positioned to effectively compete in our target markets. We will benefit from (1) our team of skilled bankers, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team. We intend to continue to execute our business strategy by focusing on developing long-term relationships with our target customer base through a team of bankers with significant experience in our target markets, and by executing strategically advantageous combinations.

Intense competition for quality loans, the prolonged low interest rate environment, and increased cost of regulation has put pressure on banks, including the Bank. We remain firm in applying our established credit underwriting practices, providing exceptional customer service, and offering competitive treasury services products, as well as continually monitoring our expenses.

Our pending merger with Hampton Roads Bankshares will provide for a greater pro forma capital base, thus, we believe, allowing us to leverage our C&I and CRE loan focus in all of our target markets.

We may seek to acquire other financial institutions or branches or assets of those institutions. Although our principal acquisition focus will be to expand our presence in our target markets, we may also expand into new markets or related banking lines of business and related services and products. We evaluate strategic combinations to determine what is in the best interest of our company and long-term strategy. Our goal in making these decisions is to maximize shareholder value.

Critical Accounting Policies

General

Our accounting policies are fundamental to an understanding of our consolidated financial position and consolidated results of operations. We believe that our accounting and reporting policies are in accordance with U.S. generally accepted accounting principles (“GAAP”) and conform to general practices within the banking industry. Our financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities and the amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations. Our significant accounting policies are discussed further in the notes to the consolidated financial statements in this Annual Report on Form 10-K.

We consider a policy critical if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate and (2) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe our most critical accounting policy relates to our allowance for loan and lease losses, which reflects the estimated losses in the event of borrower default. An additional accounting policy that we deem critical using these criteria is our accounting methods with respect to purchased credit-impaired loans,which are accounted for under Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). Yield and impairment for purchased credit-impaired loans is based on management’s estimate of probable future cash flows, which are re-estimated on a periodic basis.

If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, adjustments to our estimates would be made and additional provisions for loan losses could be required, which could have a material adverse impact on our results of operations and financial condition.

The following is a summary of our critical accounting policies that are highly dependent on estimates, assumptions and judgments.

Loans

Loans that we originate are carried at their principal amount outstanding plus or minus unamortized fees, origination costs and fair value adjustments for acquired loans. Interest income is recorded as earned on an accrual basis. It is our general policy that accrual of interest income is discontinued when a loan is 90 days or greater past due as to principal or interest or when the collection of principal and/or interest is in doubt, unless the estimated net realizable value of collateral is sufficient to assure collection of both principal and interest and the loan is in the process of collection. Subsequent cash receipts are applied to principal until the loan is in compliance with stated terms. Due to the guarantee of both principal and accrued interest on a significant portion of our guaranteed student loan balances, we do not discontinue the accrual of interest income on these loans when a loan is 90 days or more past due. We use the allowance for loan and lease losses method in providing for possible loan losses.

 

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Management considers loans to be impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (principal and interest) according to the contractual terms of the loan agreement. Factors that influence management’s judgments include loan payment pattern, source of repayment and value of any collateral. A loan would not be considered impaired if an insignificant delay in loan payment occurs and we expect to collect all amounts due. The major sources for identification of loans to be evaluated for impairment include past due and nonaccrual reports, internally generated lists of certain risk ratings and loan review. The value of impaired loans is measured using either the discounted expected cash flow method or the value of collateral method. We consider all of our nonperforming loans to be impaired loans.

Acquired loans are initially recorded at estimated fair value as of the date of acquisition; therefore, any related allowance for loan and lease losses is not carried over or established at acquisition. The difference between contractually required amounts receivable and the acquisition date fair value of loans that are not deemed credit-impaired at acquisition is accreted (recognized) into income over the life of the loan either on a level yield or effective interest yield basis on the underlying principal payments on the loan. Any change in credit quality subsequent to acquisition for these loans is reflected in our allowance for loan and lease losses.

Loans acquired with evidence of credit deterioration since origination and for which it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments are accounted for under ASC 310-30. We concluded that a portion of the loans acquired in the CVB Acquisition and the VBB Acquisition are credit-impaired loans qualifying for accounting under ASC 310-30.

In applying ASC 310-30 to acquired loans, we must estimate the amount and timing of cash flows expected to be collected. The estimation of the amount and timing of expected cash flows to be collected requires significant judgment, including estimated default rates and the amount and timing of prepayments, in addition to other factors. ASC 310-30 allows the purchaser to estimate cash flows on credit-impaired loans on a loan-by-loan basis or aggregate credit-impaired loans into one or more pools if the loans have common risk characteristics. We have estimated cash flows expected to be collected on a loan-by-loan basis.

The excess of cash flows expected to be collected over the estimated fair value of purchased credit-impaired loans is referred to as the accretable yield. This amount is accreted into interest income over the period of expected cash flows from the loan, using the effective interest method. The difference between contractually required payments due and the cash flows expected to be collected, on an undiscounted basis, is referred to as the nonaccretable difference.

ASC 310-30 requires periodic re-evaluation of expected cash flows for purchased credit-impaired loans subsequent to acquisition date. Decreases in expected cash flows attributable to credit will generally result in an impairment charge to earnings such that the accretable yield remains unchanged. Increases in expected cash flows will result in an increase in the accretable yield, which is a reclassification from the nonaccretable difference. The increased accretable yield is recognized in income over the remaining period of expected cash flows from the loan. Any impairment charge recorded as a result of a re-evaluation is recorded as an increase in our allowance for loan and lease losses.

Acquired loans for which we cannot predict the amount or timing of cash flows are accounted for under the cost recovery method, whereby principal and interest payments received reduce the carrying value of the loan until such amount has been received. Amounts received in excess of the carrying value are reported in interest income.

Allowance for Loan and Lease Losses

Our allowance for loan and lease losses consists of (1) a component for collective loan impairment recognized and measured pursuant to FASB ASC Topic 450, “Contingencies,” and (2) a component for individual loan impairment recognized pursuant to FASB ASC Topic 310, “Receivables.

We determine the allowance for loan and lease losses based on a periodic evaluation of our loan portfolio. This evaluation is a combination of quantitative and qualitative analysis. Quantitative factors include loss history for similar types of loans that we originate in our portfolio. We also consider qualitative factors, such as general economic conditions, nationally and in our target markets, as well as threats of outlier events, such as the unexpected deterioration of a significant borrower. These quantitative and qualitative factors are estimates and may be subject to significant change. Increases to our allowance for loan and lease losses are made by charges to the provision for loan and lease losses, which is reflected in our consolidated statements of income. Loans deemed to be uncollectible, in full or in part, are charged against our allowance for loan and lease losses at the time of determination, and recoveries of previously charged-off amounts are credited to our allowance for loan and lease losses.

 

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In assessing the adequacy of our allowance for loan and lease losses as of the end of a reporting period, we also evaluate our loan risk ratings. Each loan is assigned two “risk ratings” at origination. One risk rating is based on our assessment of our borrower’s financial capacity, and the other is based on the type of collateral and estimated loan to value. Our assigned risk ratings generally determine the quantitative factors used in the calculation of our allowance for loan and lease losses. In addition to our assessment of risk ratings, we also consider internal observable data related to trends within the loan portfolio, such as concentrations, aging of the portfolio, changes to our policies and procedures, and external observable data, such as industry and general economic trends.

In evaluating loans accounted for under ASC 310-30, we periodically estimate the amount and timing of cash flows expected to be collected. Upon re-estimation, any deterioration in the timing and/or amount of cash flows results in an impairment charge, which is reported as a provision for loan and lease losses in net income and a component of our allowance for loan and lease losses. A subsequent improvement in the expected timing or amount of future cash flows for those loans could result in the reduction of the allowance for loan and lease losses and an increase in our net income.

In evaluating our acquired guaranteed student loans, our allowance for loan and lease losses is based on historical and expected default rates for these and similar types of loans applied to the portion of carrying value in these loans that is not subject to federal guarantee. We charge off that portion of our student loan carrying value that is not guaranteed, greater than 120 days past due, and is expected to ultimately default. Guaranteed student loans that are past due continue to accrue interest as to the guaranteed portion, as interest is paid under the guarantee to the time the claim, if any, is paid.

Although we use various data and information sources to establish our allowance for loan and lease losses, future adjustments to our allowance for loan and lease losses may be necessary, if conditions, circumstances or events are substantially different from the assumptions used in making the assessments. Such adjustments to original estimates, as necessary, are made in the period in which these factors and other relevant considerations indicate that loss levels may vary from previous estimates.

In addition, various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan and lease losses. Such agencies may require us to recognize additions or reductions to the allowance for loan and lease losses based on their judgments of information available to them at the time of their examination.

Management believes that our allowance for loan and lease losses is adequate. While management uses the best information available to make evaluations, future adjustments may be necessary, if economic and other conditions differ substantially from the assumptions used.

Other Real Estate Owned

Assets acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at estimated fair value less costs of disposal at the date of foreclosure, establishing a new cost basis. Subsequent to foreclosure, management periodically performs valuations and, if required, a reserve is established to reflect the net carrying value of the asset at the lower of the then existing carrying value or the fair value less costs of disposal. Revenue and expenses from operations and changes in the valuation of OREO are included in our consolidated statements of income.

Accounting for Acquisitions

The First Bankshares Merger, the Paragon Transaction, the VBB Acquisition and the CVB Acquisition were determined to be acquisitions of businesses, and in accordance with FASB ASC Topic 805, “Business Combinations” (“ASC 805”), the assets acquired and liabilities assumed in each transaction were recorded at their estimated fair values as of the effective date of the respective transaction. The determination of fair values requires management to make estimates about future cash flows, market conditions and other events, which are highly subjective in nature. Actual results may differ materially from the estimates made.

 

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The following table presents the allocation of the consideration paid in the CVB Acquisition to the acquired assets and assumed liabilities of CVB as of the acquisition date, which was June 30, 2014. The allocation resulted in a bargain purchase gain of $42 thousand.

 

Fair value of assets acquired:

  

Cash and cash equivalents

   $ 12,560   

Securities available for sale

     17,439   

Loans

     70,051   

Premises and equipment

     3,338   

Other real estate owned

     1,186   

Core deposit intangible

     930   

Accrued interest receivable

     318   

Deferred tax asset

     1,898   

Bank owned life insurance

     4,054   

Other assets

     2,658   
  

 

 

 

Total assets

   $ 114,432   
  

 

 

 

Fair value of liabilities assumed:

  

Deposits

   $ 100,985   

Accrued interest payable

     39   

Supplemental executive retirement plan

     2,277   

Other liabilities

     599   
  

 

 

 

Total liabilities

   $ 103,900   
  

 

 

 

Net identifiable assets acquired

   $ 10,532   

Consideration paid:

  

Company’s common shares issued

     1,618,186   

Purchase price per share (1)

   $ 6.40   
  

 

 

 

Value of common stock issued

     10,356   

Estimated fair value of stock options

     133   

Cash in lieu of fractional shares

     1   
  

 

 

 

Total consideration paid

   $ 10,490   
  

 

 

 

Bargain purchase gain

   $ 42   
  

 

 

 

 

(1) The value of the shares of common stock exchanged for shares of CVB common stock was based upon the closing price of the company’s common stock at June 27, 2014, the last trading day prior to the date of completion of the CVB Acquisition.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the cost of an acquired entity over the fair value of the identifiable net assets acquired. Goodwill is tested at least annually for impairment, which requires as a first step the comparison of the fair value of each reporting unit to its carrying value. Fair value, for this purpose, is defined as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.” If the fair value of the reporting unit is determined to be less than the reporting unit’s carrying value of its equity, a second step of the impairment test is required, which involves allocating the fair value of the reporting unit to all of the assets and liabilities of the unit, with the excess of fair value over allocated net assets representing the fair value of the unit’s goodwill. Impairment is measured as the amount, if any, by which the carrying value of the reporting unit’s goodwill exceeds the estimated fair

 

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value of that goodwill. Our recorded goodwill as of December 31, 2015 was $13.0 million, all of which resulted from the First Bankshares Merger. Management has concluded that none of its recorded goodwill was impaired as of the most recent testing date, which was October 31, 2015. There have been no events since the testing date that would indicate the company’s goodwill is impaired.

Other intangible assets, which represent core deposit intangibles, are amortized over their estimated useful life. Our core deposit intangibles were acquired in the First Bankshares Merger, the Paragon Transaction and the CVB Acquisition and are being amortized on a straight-line basis over 10 years. No events have occurred since December 31, 2015 that would indicate impairment in the carrying amounts of intangibles.

We periodically assess whether events or changes in circumstances indicate that the carrying amounts of intangible assets may be impaired.

Income Taxes

We compute our income taxes in accordance with the provisions of FASB ASC Topic 740, “Accounting for Income Taxes,” under which deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statements’ carrying amount of existing assets and liabilities and their respective tax basis. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes.

Deferred tax assets are evaluated for recoverability, and a valuation allowance is provided unless it is more likely than not that these tax benefits will be realized. This determination requires us to evaluate both historical and future factors and to conclude as to the likelihood that our deferred tax assets will be utilized in the future. Management has concluded that, as of December 31, 2015, no valuation allowance is required on our deferred tax asset. Changes in factors in future periods could require us to record a valuation allowance on all or a portion of our deferred tax asset in these periods.

In addition, we are required to establish a tax contingency reserve for any estimated tax exposure items identified based on our tax return filings or anticipated filings. Changes in any tax contingency reserve would be based on specific developments, events or transactions.

Cautionary Notice about Forward-Looking Statements

Certain statements included in this Annual Report on Form 10-K are “forward-looking statements.” All statements other than statements of historical facts contained in this Annual Report on Form 10-K, including statements regarding our plans, objectives and goals, future events or results, our competitive strengths and business strategies, and the trends in our industry are forward-looking statements. The words “believe,” “will,” “may,” “could,” “estimate,” “project,” “predict,” “continue,” “anticipate,” “intend,” “should,” “plan,” “expect,” “appear,” “future,” “likely,” “probably,” “suggest,” “goal,” “potential” and similar expressions, as they relate to us, are intended to identify forward-looking statements. Forward-looking statements made in this Annual Report on Form 10-K reflect beliefs, assumptions and expectations of future events or results, taking into account the information currently available to us. These beliefs, assumptions and expectations may change as a result of many possible events, circumstances or factors, not all of which are currently known to us. If a change occurs, our business, financial condition, liquidity, results of operations and prospects may vary materially from those expressed in, or implied by, our forward-looking statements. Accordingly, you should not place undue reliance on these forward-looking statements. Factors that may cause actual results to differ materially from those contemplated by our forward-looking statements include the risks outlined in “Item 1A—Risk Factors” of this Annual Report on Form 10-K. Except as required by applicable law or regulations, we do not undertake, and specifically disclaim any obligation, to update or revise any forward-looking statement.

Results of Operations

Net Income

For the year ended December 31, 2015, we reported net income of $4.2 million compared to net income of $1.3 million for the year ended December 31, 2014. Income before income tax expense for 2015 was $5.6 million compared to income before income tax expense of $2.1 million for 2014. Income before income tax expense in 2014 included $1.3 million of expenses related to the CVB Acquisition.

 

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The following table presents net income and earnings per common share information for the periods stated:

 

     For the Years Ended December 31,  
     2015      2014  

Net income

   $ 4,183       $ 1,282   
  

 

 

    

 

 

 

Preferred stock dividend

     (42      (84
  

 

 

    

 

 

 

Net income available to common shareholders

   $ 4,141       $ 1,198   
  

 

 

    

 

 

 

Earnings per common share, basic

   $ 0.32       $ 0.10   
  

 

 

    

 

 

 

Earnings per common share, diluted

   $ 0.31       $ 0.10   
  

 

 

    

 

 

 

Net Interest Income

For the year ended December 31, 2015, net interest income was $30.4 million compared to $26.6 million for the year ended December 31, 2014. Interest income in 2015 increased to $36.8 million in 2015, from $31.2 million in 2014, primarily due to higher average balances of loans held for investment and higher average balances and yields on securities, partially offset by lower yields on loans. Interest expense increased to $6.5 million in 2015, from $4.6 million in 2014, primarily due to higher average balances and costs of money market deposits and borrowed funds, partially offset by lower costs of time deposits. Costs of money market deposits increased due to promotions offered in select markets, and higher costs of borrowings are due to the costs of our Subordinated Notes and senior term loan, which are further discussed below in “—Financial Condition—Borrowings.”

As presented in the table below, net interest margin decreased 21 basis points to 3.31% for the year ended December 31, 2015 from 3.52% for the year ended December 31, 2014. Average interest-earning assets increased $173.3 million, while related interest income increased $5.7 million, for the year ended December 31, 2015 compared to the year ended 2014. Average interest-bearing liabilities increased $141.6 million, while related interest expense increased $1.9 million, for the year ended December 31, 2015 compared to the year ended 2014. Yields on interest-earning assets declined 12 basis points to 4.01% for the year ended December 31, 2015 compared to the year ended 2014, and costs of interest-bearing liabilities increased 11 basis points to 0.88% for 2015. Average assets and liabilities in the 2015 period included a full year of those acquired and assumed in the CVB Acquisition, while in the 2014 period average balances included CVB assets and liabilities from the effective date of the merger, June 30, 2014. Our asset yields and net interest margin were negatively impacted by the continued low interest rate environment and competitive pressures for attractive lending opportunities. Higher accretion from our purchased loans, further discussed below, in 2015 compared to 2014 partially offset these margin pressures. Average interest-earning assets as a percentage of total average assets were 93.1% and 93.0%, respectively, for the years ended December 31, 2015 and 2014.

Our loan portfolios acquired in the First Bankshares Merger, the Paragon Transaction, the VBB Acquisition and the CVB Acquisition were discounted to estimated fair values (for expected credit losses and for interest rates) immediately following the merger and the acquisitions, as applicable. A portion of the purchase accounting adjustments (discounts) to record the acquired loans at estimated fair values is being recognized (accreted) into interest income over the remaining life of the loans or the period of estimated cash flows. Amounts received in excess of the carrying value of loans accounted for on cost recovery are accreted into interest income at the time of recovery. Loan discount accretion for the years ended December 31, 2015 and 2014 was $2.2 million and $1.9 million, respectively.

 

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For the year ended December 31, 2014, net interest income was $26.6 million compared to $22.1 million for the year ended December 31, 2013. Interest income in 2014 increased to $31.2 million in 2014, from $25.6 million in 2013, primarily due to higher average balances of loans held for investment, partially reduced by lower yields on these loans. Interest expense increased to $4.6 million in 2014, from $3.5 million in 2013, primarily due to higher average balances of deposits and borrowed funds, partially reduced by lower costs of deposits. Average balances include the addition of CVB for the period from June 30, 2014.

As presented in the table below, net interest margin decreased 37 basis points to 3.52% for the year ended December 31, 2014 from 3.89% for the year ended December 31, 2013. Loan discount accretion for the years ended December 31, 2014 and 2013 was $1.9 million and $2.6 million, respectively. Average interest-earning assets increased $186.7 million, while related interest income increased $5.6 million, for the year ended December 31, 2014 compared to the year ended 2013. Average interest-bearing liabilities increased $168.1 million, while related interest expense increased $1.1 million, for the year ended December 31, 2014 compared to the year ended 2013. Yields on interest-earning assets declined 37 basis points to 4.13% for the year ended December 31, 2014 compared to the year ended 2013, and costs of interest-bearing liabilities decreased 4 basis points to 0.77% for 2014. Our asset yields and net interest margin were negatively impacted by the continued low interest rate environment and competitive pressures for attractive lending opportunities and lower loan discount accretion in the 2014 period compared to the 2013 period. Average interest-earning assets as a percentage of total average assets were 93.0% and 93.8%, respectively, for the years ended December 31, 2014 and 2013.

The following table presents the impact of purchase accounting adjustments on our net interest margin for the periods stated:

 

     For the Years Ended December 31,  
     2015     2014     2013  

Net interest margin

     3.31     3.52     3.89

Purchase accounting adjustments impact (1)

     0.24     0.26     0.47

Net interest margin excluding the impact of purchase accounting adjustments

     3.07     3.26     3.42

 

(1) Purchase accounting adjustments for the years ended December 31, 2015 and December 31, 2014, include both accretion of discounts on acquired loans and an adjustment for interest rates on acquired time deposits. For the year ended December 31, 2013, purchase accounting adjustments include only accretion of discounts on acquired loans.

 

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The following tables provide a detailed analysis of the average yields and rates on average interest-earning assets and average interest-bearing liabilities for the periods stated:

 

     Average Balances, Income and Expenses, Yields and Rates  
     As of and For the Years Ended December 31,  
                                           2015 vs. 2014  
     Average Balances (1)     Yield / Rate     Income / Expense (7) (8)
(9)
     Increase     Change due to (2)  
     2015     2014     2015     2014     2015      2014      (Decrease)     Rate     Volume  

Assets

                    

Interest-earning assets:

                    

Federal funds sold

   $ 25,286     $ 14,702       0.30     0.24   $ 75      $ 36      $ 39     $ 9     $ 30  

Interest-earning deposits

     36,268       18,064       0.31     0.28     112        50        62       6       56  

Investments

     108,490       78,489       3.02     2.30     3,279        1,804        1,475       666       809  

Guaranteed student loans, gross

     64,848       89,934       3.40     3.26     2,207        2,929        (722     127       (849

Loans held for investment, gross (3)

     695,246       555,621       4.55     4.75     31,610        26,409        5,201       (1,191     6,392  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     930,138       756,810       4.01     4.13     37,283        31,228        6,055       (383     6,438  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Allowance for loan and lease losses

     (6,828     (5,806                

Noninterest-earning assets:

                    

Cash and due from banks

     16,200       15,029                  

Premises and fixed assets

     7,820       6,579                  

Other assets

     51,922       40,913                  
  

 

 

   

 

 

                 

Total noninterest-earning assets

     75,942       62,521                  
  

 

 

   

 

 

                 

Total assets

   $ 999,252     $ 813,525                  
  

 

 

   

 

 

                 

Liabilities and Shareholders’ Equity

                    

Interest-bearing liabilities:

                    

Demand deposits

   $ 78,576     $ 40,240       0.51     0.31   $ 401      $ 126      $ 275     $ 109     $ 166  

Savings and money market deposits

     304,043       263,462       0.74     0.64     2,263        1,691        572       291       281  

Time deposits

     320,144       267,002       0.83     0.86     2,663        2,284        379       (65     444  

Federal funds purchased and borrowed funds

     36,300       26,737       3.18     1.89     1,153        506        647       424       223  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest-bearing liabilities

     739,063       597,441       0.88     0.77 %     6,480        4,607        1,873       759       1,114  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

 

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     Average Balances, Income and Expenses, Yields and Rates  
     As of and For the Years Ended December 31,  
                                             2015 vs. 2014  
     Average Balances (1)      Yield / Rate     Income / Expense (7) (8)
(9)
     Increase      Change due to (2)  
     2015      2014      2015     2014     2015      2014      (Decrease)      Rate     Volume  

Noninterest-bearing liabilities:

                       

Noninterest-bearing demand deposits

     148,640        114,796                    

Other liabilities

     7,553        4,970                    
  

 

 

    

 

 

                   

Total noninterest-bearing liabilities

     156,193        119,766                    
  

 

 

    

 

 

                   

Shareholders’ equity

     103,996        96,318                    
  

 

 

    

 

 

                   

Total liabilities and shareholders’ equity

   $ 999,252      $ 813,525                    
  

 

 

    

 

 

                   

Interest rate spread (4)

           3.13     3.36             

Net interest income (5)

             $ 30,803      $ 26,621      $ 4,182      $ (1,142   $ 5,324  
            

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net interest margin (6)

           3.31     3.52             

 

(1) Average balances are computed on a daily basis.
(2) Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.
(3) Nonaccrual loans have been included in the average balances. Guaranteed student loans are excluded.
(4) Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.
(5) Net interest income is interest income less interest expense.
(6) Net interest margin is net interest income divided by average interest-earning assets.
(7) Tax-exempt interest income is stated on a taxable-equivalent basis.
(8) Interest income from loans held for investment in 2015 and 2014 includes $2,222 thousand and $1,922 thousand, respectively, in accretion related to acquired loans.
(9) Interest expense on time deposits in 2015 and 2014 includes a reduction of $58 thousand and $38 thousand, respectively, related to fair value adjustments recorded pursuant to the CVB Acquisition.

 

     Average Balances, Income and Expenses, Yields and Rates  
     As of and For the Years Ended December 31,  
                                           2014 vs. 2013  
     Average Balances (1)     Yield / Rate     Income / Expense (7) (8)
(10)
     Increase     Change due to (2)  
     2014     2013     2014     2013     2014      2013      (Decrease)     Rate     Volume  

Assets

                    

Interest-earning assets:

                    

Federal funds sold

   $ 14,702     $ 5,624       0.24     0.22   $ 36      $ 12      $ 24     $ 1     $ 23  

Interest-earning deposits

     18,064       37,972       0.28     0.26     50        100        (50     5       (55

Investments

     78,489       69,346       2.30     2.10     1,804        1,454        350       148       202  

Guaranteed student loans, gross

     89,934       17,039       3.26     3.09     2,929        527        2,402       30       2,372  

Loans held for investment, gross (3) (9)

     555,621       440,108       4.75     5.35     26,409        23,547        2,862       (2,835     5,697  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Total interest-earning assets

     756,810       570,089       4.13     4.50     31,228        25,640        5,588       (2,651     8,239  
  

 

 

   

 

 

       

 

 

    

 

 

    

 

 

   

 

 

   

 

 

 

Allowance for loan and lease losses

     (5,806     (4,570                

Noninterest-earning assets:

                    

Cash and due from banks

     15,029       8,819                  

Premises and fixed assets

     6,579       5,304                  

Other assets

     40,913       28,428                  
  

 

 

   

 

 

                 

Total noninterest-earning assets

     62,521       42,551                  
  

 

 

   

 

 

                 

Total assets

   $ 813,525     $ 608,070                  
  

 

 

   

 

 

                 

 

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     Average Balances, Income and Expenses, Yields and Rates  
     As of and For the Years Ended December 31,  
                                             2014 vs. 2013  
     Average Balances (1)      Yield / Rate     Income / Expense (7) (8)
(10)
     Increase      Change due to (2)  
     2014      2013      2014     2013     2014      2013      (Decrease)      Rate     Volume  

Liabilities and Shareholders’ Equity

                       

Interest-bearing liabilities:

                       

Demand deposits

   $ 40,240      $ 25,478        0.31     0.20   $ 126      $ 52      $ 74      $ 36     $ 38  

Savings and money market deposits

     263,462        230,167        0.64     0.57     1,691        1,316        375        172       203  

Time deposits

     267,002        152,864        0.86     1.14     2,284        1,744        540        (518     1,058  

Federal funds purchased and borrowed funds

     26,737        20,861        1.89     1.79     506        374        132        22       110  
  

 

 

    

 

 

        

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Total interest-bearing liabilities

     597,441        429,370        0.77     0.81     4,607        3,486        1,121        (288     1,409  
  

 

 

    

 

 

        

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Noninterest-bearing liabilities:

                       

Noninterest-bearing demand deposits

     114,796        88,254                    

Other liabilities

     4,970        2,451                    
  

 

 

    

 

 

                   

Total noninterest-bearing liabilities

     119,766        90,705                    
  

 

 

    

 

 

                   

Shareholders’ equity

     96,318        87,995                    
  

 

 

    

 

 

                   

Total liabilities and shareholders’ equity

   $ 813,525      $ 608,070                    
  

 

 

    

 

 

                   

Interest rate spread (4)

           3.36     3.69             

Net interest income (5)

             $ 26,621      $ 22,154      $ 4,467      $ (2,363   $ 6,830  
            

 

 

    

 

 

    

 

 

    

 

 

   

 

 

 

Net interest margin (6)

           3.52     3.89             

 

(1) Average balances are computed on a daily basis.
(2) Change in interest due to both volume and rates has been allocated in proportion to the absolute dollar amounts of the change in each.
(3) Nonaccrual loans have been included in the average balances. Guaranteed student loans are excluded.
(4) Interest rate spread is the yield on average interest-earning assets less the rate on average interest-bearing liabilities.
(5) Net interest income is interest income less interest expense.
(6) Net interest margin is net interest income divided by average interest-earning assets.
(7) Tax-exempt interest income is stated on a taxable-equivalent basis.
(8) Interest income from loans held for investment in 2014 and 2013 includes $1,922 thousand and $2,644 thousand, respectively, in accretion related to acquired loans.
(9) Balances previously reported as loans held for sale have been reclassified as loans held for investment, gross.
(10) Interest expense on time deposits in 2014 includes a reduction of $38 thousand related to fair value adjustments recorded pursuant to the CVB Acquisition.

Provision for Loan and Lease Losses

The following table presents our provision for loan and lease losses and the dollar and percentage change for the periods stated:

 

     For the Years Ended
December 31,
               
(in thousands)    2015      2014      $ Change      % Change  

Provision for loan and lease losses

   $ 2,599      $ 3,220      $ 621        19
  

 

 

    

 

 

    

 

 

    

 

 

 

Higher provision expense in 2014 was primarily due to amounts recorded for guaranteed student loans. Provision for loan and lease losses related to our guaranteed student loan portfolio was $861 thousand in 2015 compared to $1.8 million in 2014. In the second half of 2014, we increased and accelerated anticipated provision expense due to higher expected losses and the requirement to charge-off that portion of unguaranteed balances greater than 120 days past due with a high probability of default.

 

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Noninterest Income

The following table presents noninterest income and the dollar and percentage change for the periods stated:

 

(in thousands)    For the Years Ended
December 31,
             
     2015     2014     $ Change     % Change  

Noninterest income

        

Service charges on deposit accounts

   $ 618     $ 603     $ 15       2

Net loss on sale and write-down of other real estate owned and other collateral

     (95     (31     (64     -207

Gain on sales of securities

     58       428       (370     -86

Bargain purchase gain

     —          42       (42     -100

Loss on the write-down of equipment and other assets

     (19     (23     4       15

Increase in cash surrender value of bank owned life insurance

     497       363       134       37

Other

     330       297       33       11
  

 

 

   

 

 

   

 

 

   

 

 

 

Total noninterest income

   $ 1,389     $ 1,679     $ (290     -17
  

 

 

   

 

 

   

 

 

   

 

 

 

Lower noninterest income in the 2015 period was primarily due to lower gains on sales of securities and a write-down and loss on the sale of an OREO property, acquired as part of the CVB Acquisition. These items were partially offset by higher earnings from bank owned life insurance (“BOLI”), due to additional investment in the second quarter of 2015 and BOLI acquired in the CVB Acquisition.

Noninterest Expense

The following table presents noninterest expense and the dollar and percentage change for the periods stated:

 

(in thousands)    For the Years Ended
December 31,
               
     2015      2014      $ Change      % Change  

Noninterest expense

           

Compensation and benefits

   $ 12,979      $ 12,497      $ (482      -4

Occupancy

     1,623        1,574        (49      -3

FDIC insurance

     719        495        (224      -45

Bank franchise taxes

     984        912        (72      -8

Technology

     2,249        2,296        47        2

Communications

     388        356        (32      -9

Insurance

     373        339        (34      -10

Professional fees

     1,191        1,597        406        25

Amortization of intangible assets

     458        411        (47      -11

Guaranteed student loan servicing

     446        595        149        25

Other

     2,104        1,898        (206      -11
  

 

 

    

 

 

    

 

 

    

 

 

 

Total noninterest expense

   $ 23,514      $ 22,970      $ (544      -2
  

 

 

    

 

 

    

 

 

    

 

 

 

Higher noninterest expense in the 2015 period was primarily due to higher compensation and benefits, higher FDIC insurance and higher other expense, partially offset by lower professional fees. Higher compensation and benefits in the 2015 period is primarily the result of the addition of relationship managers (and supporting personnel) and the addition of regulatory compliance personnel. Higher FDIC insurance in 2015 was due to higher asset levels, and higher other expense was due to costs associated with the resolution of loans. Noninterest expense in the 2014 period included $1.3 million of costs related to the CVB Acquisition, of which $318 thousand were recorded in compensation and benefits for displaced employees, $533 thousand were recorded in professional fees, and $345 thousand were recorded in technology expenses. Noninterest expense in 2015 included professional fees and technology expenses related to the renegotiation of our core processor servicing agreement.

Income Taxes

The following table presents income tax expense and the dollar and percentage change for the periods stated:

 

     For the Years Ended
December 31,
               
(in thousands)    2015      2014      $ Change      % Change  

Income tax expense

   $ 1,454      $ 786      $ (668      -85
  

 

 

    

 

 

    

 

 

    

 

 

 

Higher Income tax expense in the 2015 period is due to higher income before taxes, partially offset by a lower effective tax rate for the year ended December 31, 2015 (26%) compared to December 31, 2014 (38%). The effective tax rate

 

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in 2015 reflects the benefit of increased tax-exempt income from municipal securities and increased balances of BOLI, the earnings from which are tax-exempt, while the effective tax rate in the 2014 period reflects the non-deductibility of a portion of the transaction costs incurred in the CVB Acquisition.

Financial Condition

Securities

The following tables present information about our securities portfolio as of the dates stated. Weighted average life calculations and weighted average yields are based on the current level of contractual maturities and expected prepayments as of the dates stated. Yields on tax-exempt securities are calculated on a taxable-equivalent yield basis.

 

     December 31, 2015  
     Amortized Cost      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 8,026       $ 7,947         7.75         2.43

Municipals - fixed rate

           

- Tax exempt

     68,025         69,054         9.01         3.96

- Taxable

     10,071         10,002         6.48         2.90

Collateralized mortgage obligations - fixed rate

     7,872         7,830         4.13         2.32

CMBS - fixed rate

     36,712         36,030         6.65         2.27
  

 

 

    

 

 

       

Total securities available for sale

     130,706         130,863         7.80         3.22
  

 

 

    

 

 

       

Securities held to maturity:

           

Municipals - fixed rate

           

- Taxable

     9,270         9,769         6.85         3.39
  

 

 

    

 

 

       

Total securities held to maturity

     9,270         9,769         6.85         3.39
  

 

 

    

 

 

       

Total securities

   $ 139,976       $ 140,632         6.65         3.21
  

 

 

    

 

 

       
     December 31, 2014  
     Amortized Cost      Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 11,513       $ 11,543         5.31         2.19

- Variable rate

     4,136         4,239         6.91         1.68

Municipals - fixed rate

           

- Taxable

     847         848         4.34         1.83

- Tax exempt

     37,825         37,747         8.77         4.04

Collateralized mortgage obligations - fixed rate

     9,974         9,964         3.72         2.04
  

 

 

    

 

 

       

Total securities available for sale

     64,295         64,341         7.19         3.21
  

 

 

    

 

 

       

Securities held to maturity:

           

Municipals - fixed rate

           

- Taxable

     9,279         9,683         8.23         3.40
  

 

 

    

 

 

       

Total securities held to maturity

     9,279         9,683         8.23         3.40
  

 

 

    

 

 

       

Total securities

   $ 73,574       $ 74,024         7.24         3.24
  

 

 

    

 

 

       

 

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Table of Contents
     December 31, 2013  
     Amortized
Cost
     Fair Value      Weighted
Average Life
in Years
     Weighted
Average Yield
 

Securities available for sale:

           

Mortgage-backed securities

           

- Fixed rate

   $ 45,693       $ 45,337         4.54         2.09

- Variable rate

     4,903         4,852         4.20         1.68

Municipals - fixed rate

           

- Taxable

     9,810         8,970         9.23         2.71

- Tax exempt

     1,634         1,573         8.12         2.95

Collateralized mortgage obligations - fixed rate

     8,940         8,453         4.01         2.18
  

 

 

    

 

 

       

Total securities available for sale

   $ 70,980       $ 69,185         5.16         2.17
  

 

 

    

 

 

       

Beginning in late 2014, we transitioned our securities portfolio to include a higher level of municipal securities, increasing both the weighted average life and weighted average yield of the portfolio.

The following table presents a maturity analysis of our securities portfolio as of the date stated. Weighted average yield calculations are based on the current level of contractual maturities and expected prepayments as of the dates stated. Yields on tax-exempt securities are calculated on a taxable-equivalent yield basis.

 

    December 31, 2015  
    Within 1
Year
    Weighted
Average
Yield
    After 1
Year
Through
5 Years
    Weighted
Average
Yield
    After 5
Years
Through
10 Years
    Weighted
Average
Yield
    After 10
Years
    Weighted
Average
Yield
    Total     Weighted
Average
Yield
 

Securities available for sale:

                   

Mortgage-backed securities - fixed rate

  $ —          —     $ 992       2.44   $ 5,282       2.22   $ 1,673       3.06   $ 7,947       2.43

Commercial mortgage-backed securities - fixed rate

    —          —          —          —          36,030       2.27     —          —          36,030       2.27

Municipals - fixed rate

                   

Taxable

    —          —          842       1.85     9,160       2.99     —          —          10,002       2.90

Tax exempt

    —          —          —          —          3,777       2.96     65,277       3.96     69,054       3.90

Collateralized mortgage obligations - fixed rate

    —          —          —          —          —          —          7,830       2.32     7,830       2.32
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total securities available for sale

    —            1,834         54,249         74,780         130,863       3.19
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Securities held to maturity:

                   

Municipals - fixed rate

    —          —          —          —          9,769       3.39     —          —          9,769       3.39
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total securities held to maturity

    —            —            9,769         —            9,769    
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Total securities

  $ —          —     $ 1,834       2.17   $ 64,018       2.58   $ 74,780       3.77   $ 140,632       3.21
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

 

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Loans

The following table presents our loan portfolio, by loan category and percentage to total loans for loans held for investment, as of the dates stated:

 

    December 31,  
    2015     2014     2013     2012     2011  
    Amount     Percent
of
Total
    Amount     Percent
of
Total
    Amount     Percent
of
Total
    Amount     Percent
of
Total
    Amount     Percent
of
Total
 

Commercial and industrial

  $ 370,612       47.6   $ 359,243       47.9   $ 249,687       46.1   $ 284,747       61.3   $ 168,417       51.7

Commercial real estate

    302,814       38.8     267,489       35.6     172,711       31.9     150,796       32.4     126,525       38.8

Residential real estate

    36,190       4.6     40,859       5.4     22,004       4.1     24,291       5.2     25,847       7.9

Consumer

    12,577       1.6     11,456       1.5     3,191       0.6     4,886       1.1     5,285       1.6

Guaranteed student loans

    57,308       7.4     71,780       9.6     94,028       17.3     —          0.0     —          0.0

Overdrafts

    27       0.0     46       0.0     184       0.0     28       0.0     65       0.0
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Loans held for investment

    779,528       100.0     750,873       100.0     541,805       100.0     464,748       100.0     326,139       100.0

Allowance for loan and lease losses

    (7,350       (6,247       (5,305       (4,875       (4,280  
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

Loans held for investment, net of allowance

  $ 772,178       $ 744,626       $ 536,500       $ 459,873       $ 321,859    
 

 

 

     

 

 

     

 

 

     

 

 

     

 

 

   

The following tables provide the maturity analysis of our loan portfolio as of the dates presented based on whether loans are variable-rate or fixed-rate loans:

 

     December 31, 2015  
            Variable Rate      Fixed Rate         
                          Total                    Total         
     Within      1 to 5      After      variable      1 to 5      After      fixed      Total  
     1 year      years      5 years      > 1 year      years      5 years      > 1 year      Maturities  

Commercial and industrial (1)

   $ 188,471       $ 96,239       $ 25,533       $ 121,772       $ 39,865       $ 18,346       $ 58,211       $ 368,454   

Commercial real estate (2)

     81,580         112,673         56,183         168,856         41,185         6,546         47,731         298,167   

Residential real estate (3)

     1,806         8,305         17,064         25,369         6,965         739         7,704         34,879   

Consumer (4)

     10,143         1,143         326         1,469         676         131         807         12,419   

Guaranteed student loans

     18         871         56,419         57,290         —           —           —           57,308   

Overdrafts

     27         —           —           —           —           —           —           27   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 282,045       $ 219,231       $ 155,525       $ 374,756       $ 88,691       $ 25,762       $ 114,453       $ 771,254   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $1.5 million in nonaccrual fixed-rate loans and $685 thousand in nonaccrual variable-rate loans.
(2) Excludes $1.3 million in nonaccrual fixed-rate loans and $3.3 million in nonaccrual variable-rate loans.
(3) Excludes $168 thousand in nonaccrual fixed-rate loans and $1.1 million in nonaccrual variable-rate loans.
(4) Excludes $140 thousand in nonaccrual fixed-rate loans and $17 thousand in nonaccrual variable-rate loans.

 

     December 31, 2014  
            Variable Rate      Fixed Rate         
                          Total                    Total         
     Within      1 to 5      After      variable      1 to 5      After      fixed      Total  
     1 year      years      5 years      > 1 year      years      5 years      > 1 year      Maturities  

Commercial and industrial (1)

   $ 180,100       $ 104,694       $ 15,187       $ 119,881       $ 47,184       $ 9,302       $ 56,486       $ 356,467   

Commercial real estate (2)

     70,633         101,100         46,882         147,982         42,317         3,523         45,840         264,455   

Residential real estate (3)

     3,438         7,294         22,099         29,393         5,176         1,296         6,472         39,303   

Consumer (4)

     8,753         121         938         1,059         1,627         4         1,631         11,443   

Guaranteed student loans

     28         780         70,973         71,753         —           —           —           71,781   

Overdrafts

     46         —           —           —           —           —           —           46   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 262,998       $ 213,989       $ 156,079       $ 370,068       $ 96,304       $ 14,125       $ 110,429       $ 743,495   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $1.4 million in nonaccrual fixed-rate loans and $1.4 million in nonaccrual variable-rate loans.

 

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(2) Excludes $1.8 million in nonaccrual fixed-rate loans and $1.3 million in nonaccrual variable-rate loans.
(3) Excludes $167 thousand in nonaccrual fixed-rate loans and $1.4 million in nonaccrual variable-rate loans.
(4) Excludes $4 thousand in nonaccrual fixed-rate loans and $8 thousand in nonaccrual variable-rate loans.

 

     December 31, 2013  
            Variable Rate      Fixed Rate         
                          Total                    Total         
     Within      1 to 5      After      variable      1 to 5      After      fixed      Total  
     1 year      years      5 years      > 1 year      years      5 years      > 1 year      Maturities  

Commercial and industrial (1)

   $ 102,663       $ 79,277       $ 9,980       $ 89,257       $ 43,496       $ 8,522       $ 52,018       $ 243,938   

Commercial real estate (2)

     57,749         78,167         8,489         86,656         23,029         4,394         27,423         171,828   

Residential real estate (3)

     6,994         3,615         5,006         8,621         5,355         481         5,836         21,451   

Consumer

     2,242         319         69         388         559         2         561         3,191   

Guaranteed student loans

     30         1,247         92,751         93,998         —           —           —           94,028   

Overdrafts

     185         —           —           —           —           —           —           185   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total loans

   $ 169,863       $ 162,625       $ 116,295       $ 278,920       $ 72,439       $ 13,399       $ 85,838       $ 534,621   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) Excludes $1.5 million in nonaccrual fixed-rate loans and $874 thousand in nonaccrual variable-rate loans.
(2) Excludes $384 thousand in nonaccrual fixed-rate loans and $499 thousand in nonaccrual variable-rate loans.
(3) Excludes $119 thousand in nonaccrual fixed-rate loans and $434 thousand in nonaccrual variable-rate loans.

A certain degree of risk is inherent in the extension of credit. Management has established loan and credit policies and guidelines designed to control both the types and amounts of risks we take and to minimize losses. Such policies and guidelines include loan underwriting parameters, loan-to-value parameters, credit monitoring guidelines, adherence to regulations and other prudent credit practices. Loans secured by real estate comprised 58.0% and 57.5% of our loan portfolio as of December 31, 2015 and 2014, respectively. CRE loans are secured by commercial properties. Typically, our loan-to-value ratio benchmark for these loans is at or below 80% at inception, with satisfactory debt-service coverage ratios as well. Residential real estate loans consist of first and second lien loans, including home equity lines and credit loans, secured by residential real estate that is located primarily in our target markets offered to select customers. These customers primarily include branch and private banking customers. Typically, our maximum loan-to-value benchmark for these loans is 80% at inception, with satisfactory debt-to-income ratios as well. The repayment of both RRE and OORE loans depends primarily on the income and cash flows of the borrowers, with the real estate serving as a secondary source of repayment. We classify OORE loans as C&I loans, as the primary source of repayment of the loan is generally dependent on the financial performance of the commercial enterprise occupying the property, with the real estate being a secondary source of repayment.

Allowance for Loan and Lease Losses

The following table presents our allowance for loan and lease losses by loan type and the percent of loans in each category to total loans held for investment, as of the dates stated:

 

     December 31,  
     2015     2014     2013     2012     2011  
     Amount      Percent
of loans
in each
category
to total
loans
    Amount      Percent
of loans
in each
category
to total
loans
    Amount      Percent
of loans
in each
category
to total
loans
    Amount      Percent
of loans
in each
category
to total
loans
    Amount      Percent
of loans
in each
category
to total
loans
 

Balance at end of period applicable to:

                         

Commercial and industrial

   $ 2,095         47.5   $ 2,208         47.9   $ 2,148         46.1   $ 1,523         61.3   $ 748         51.7

Commercial real estate

     4,991         38.8     3,759         35.6     2,756         31.9     3,086         32.4     3,370         38.8

Residential real estate

     205         4.6     175         5.4     194         4.1     245         5.2     133         7.9

Consumer

     —           1.6     —           1.5     12         0.6     21         1.1     29         1.6

Guaranteed student loans

     59         7.5     105         9.6     195         17.3     —           0.0     —           0.0
  

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

   

 

 

    

 

 

 

Total allowance for loan and lease losses

   $ 7,350         100.0   $ 6,247         100.0   $ 5,305         100.0   $ 4,875         100.0   $ 4,280         100.0
  

 

 

      

 

 

      

 

 

      

 

 

      

 

 

    

 

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The following table presents the activity in the allowance for loan and lease losses for the dates stated:

 

     December 31,  
     2015     2014     2013     2012     2011  

Balance at beginning of period

   $ 6,247     $ 5,305     $ 4,875     $ 4,280     $ 1,766  

Charge-offs:

          

Commercial and industrial

     41       30       51       51       333  

Commercial real estate

     452       —          815       1,127       973  

Residential real estate

     72       161       52       —          93  

Consumer

     —          19       16       2       3  

Guaranteed student loans

     907       1,887       —          —          —     

Overdrafts

     10       23       9       9       13  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total charge-offs

     1,482       2,120       943       1,189       1,415  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Recoveries:

          

Commercial and industrial

     —          2       —          —          72  

Commercial real estate

     81       5       —          20       12  

Residential real estate

     —          —          —          —          —     

Consumer

     2       1       —          3       —     

Guaranteed student loans

     —          —          —          —          —     

Overdrafts

     7       7       2       1       2  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total recoveries

     90       15       2       24       86  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net charge-offs

     1,392       2,105       941       1,165       1,329  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Provision for loan and lease losses

     2,599       3,220       1,486       1,819       4,005  

Amount for unfunded commitments

     (58     (107     (115     (59     (162

Other (1)

     (46     (66     —          —          —     
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 7,350     $ 6,247     $ 5,305     $ 4,875     $ 4,280  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) Represents the recovery of a purchased credit-impaired loan’s prior period allowance through accretion income.

Our allowance for loan and lease losses excludes discounts recorded on our acquired loan portfolios, which as of December 31, 2015 and 2014 were $3.4 million and $5.6 million, respectively.

Our allowance for loan and lease losses on guaranteed student loans is based on historical and expected default rates for these and similar types of loans applied to the portion of our carrying value in these loans that is not subject to federal guarantee. We charge-off that portion of our guaranteed student loans that is (1) not subject to federal government guarantee and (2) greater than 120 days past due and has a high probability of loss. Probability of loss is determined by recent loss migration analysis. For a significant portion of loans for which we charged off the unguaranteed portion, a claim has been made against the guarantee, and we have recovered the guaranteed portion.

Our purchased credit-impaired loans accounted for under ASC 310-30 require us to periodically re-evaluate the timing and amount of expected future cash flows. Any deterioration in the timing and/or amount of cash flows results in an impairment charge, which is reported as a provision for loan and lease losses in net income and a component of our allowance for loan and lease losses. If upon re-measurement in a future period, a loan for which an impairment charge has been taken is expected to have cash flows that improve compared to those previously determined, some portion of the impairment could be reversed. For the period ended December 31, 2015, $253 thousand of expense was included in our provision for loan and lease losses related to the re-evaluation of purchased credit-impaired loans, and as of December 31, 2015, our allowance for loan and lease losses included $366 thousand for these loans.

 

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The following table presents the activity in our discounts recorded for acquired loans as of the dates stated:

 

     December 31, 2015      December 31, 2014  

Balance at beginning of period

   $ 5,580       $ 4,441   

Additions

     —           3,046   

Accretion (1)

     (2,222      (1,922

Disposals (2)

     (42      (51

Other (3)

     46         66   
  

 

 

    

 

 

 

Balance at end of period

   $ 3,362       $ 5,580   
  

 

 

    

 

 

 

 

(1) Accretion amounts are reported in interest income.
(2) Disposals represent the reduction of purchase accounting discounts due to the resolution of acquired loans at amounts less than the contractually-owed receivable. Of the 2015 amount, $17 thousand relates to a loan reclassified as OREO.
(3) Represents the recovery of a purchased credit-impaired loan’s prior period allowance through accretion income.

Nonperforming Assets

It is our general policy to discontinue the accrual of interest income on our nonperforming loans. We consider a loan as nonperforming when it is 90 days or greater past due as to principal or interest or when there is serious doubt as to collectability, unless the estimated net realizable value of collateral is sufficient to assure collection of both principal and interest and the loan is in the process of collection. We do not discontinue the accrual of interest income on guaranteed student loans when 90 days or greater past due, as nearly 98% of principal and accrued interest carries a federal guarantee, and interest receivable is guaranteed until a claim against the guarantee, if any, is satisfied. As of December 31, 2015, there were no loans other than guaranteed student loans 90 days or greater past due with respect to principal or interest for which interest was accruing.

As of December 31, 2015 and 2014, we had $533 thousand and $1.1 million, respectively, in OREO. We acquired approximately $1.2 million of OREO in the CVB Acquisition. OREO held at December 31, 2015 consisted of residential properties and undeveloped land.

The following table summarizes our nonperforming assets as of the dates stated:

 

     December 31,  
     2015     2014     2013     2012     2011  

Nonaccrual loans

   $ 8,274      $ 7,377      $ 3,822      $ 5,069      $ 5,862   

Other real estate owned

     533        1,140        199        276        808   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total nonperforming assets

   $ 8,807      $ 8,517      $ 4,021      $ 5,345      $ 6,670   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Nonperforming assets as a percentage of total loans

     1.13     1.13     0.74     1.15     2.05

Nonperforming assets as a percentage of total assets

     0.85     0.93     0.59     0.95     1.40

Net charge-offs as a percentage of average loans

     0.18     0.33     0.20     0.30     0.58

Allowance for loan and lease losses as a percentage of total loans

     0.94     0.83     0.98     1.05     1.31

Allowance for loan and lease losses to nonaccrual loans

     88.83     84.68     138.78     96.16     73.01

Net charge-offs of $1.4 million in the calculation of net charge-offs as a percentage of average loans in 2015 included $907 thousand of charge-offs related to the unguaranteed portion of our student loans that were greater than 120 days past due and had a high probability of loss.

Our allowance for loan and lease losses as a percentage of total loans was 0.94% at December 31, 2015. Our allowance for loan and lease losses for guaranteed student loans is based on the relatively small portion of carrying values that is not covered by the federal government guarantee. We do not hold allowance for loan and lease losses on loans held pursuant to our participation in a mortgage warehouse lending program with a national bank. Loans pursuant to this program are made to

 

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mortgage originators that seek funding to facilitate the origination of residential mortgage loans for sale in the secondary market and are generally held for less than 30 days. The national bank with which we participate in this program has experienced negligible losses from this lending activity. Additionally, our allowance for loan and lease losses does not include remaining discounts (credit-related fair value adjustments) on our acquired loans.

Deposits

Deposits represent our primary source of funds and are comprised of demand and money market deposits, savings deposits and time deposits. Deposits as of December 31, 2015 totaled $889.0 million, an increase of $116.1 million compared to deposits of $772.9 million as of December 31, 2014. Demand deposits, including money market accounts, increased $103.1 million, or 22%, over balances at December 31, 2014, while time deposits increased $12.6 million, or 4%. As of December 31, 2015, $114.4 million of our deposits were in Certificate of Deposit Account Registry Service (“CDARS”), Insured Cash Sweep (“ICS”) and Brokered CDs, which we refer to collectively as brokered deposits. As of December 31, 2014, we held $86.8 million of brokered deposits.

The following table presents the average balances and rates paid, by deposit category, as of the dates stated.

 

     December 31, 2015     December 31, 2014     December 31, 2013  
     Amount      Rate     Amount      Rate     Amount      Rate  

Noninterest-bearing demand deposits

   $ 148,640         —        $ 114,796         —        $ 88,254         —     

Interest-bearing deposits:

               

Demand and money market

     372,203         0.71     295,344         0.61     251,110         0.54

Savings accounts

     10,416         0.29     8,357         0.25     4,535         0.29

Time deposits $100,000 or greater

     238,999         0.77     196,137         0.75     95,490         1.01

Time deposits less than $100,000

     81,145         1.02     70,866         1.14     57,374         1.36
  

 

 

      

 

 

      

 

 

    

Total interest-bearing deposits

     702,763         0.76     570,704         0.72     408,509         0.76
  

 

 

      

 

 

      

 

 

    

Total average deposits

   $ 851,403         0.63   $ 685,500         0.60   $ 496,763         0.63
  

 

 

      

 

 

      

 

 

    

Maturities of large denomination time deposits (equal or greater than $100,000) as of December 31, 2015 were as follows:

 

     Within 3
Months
     3-6 Months      6-12 Months      Over 12
Months
     Total      Percent of
Total Deposits
 

Time deposits

   $ 100,323       $ 29,514       $ 55,853       $ 45,913       $ 231,603         26.05

Borrowings

We have one secured short-term borrowing with the FHLB in the amount of $17.5 million, which matures on March 28, 2016. For the quarter ended December 31, 2015, our effective interest rate on the $17.5 million borrowing, including the effect of a cash flow hedge (discussed below), was 2.44%. This borrowing partially replaced a $20.0 million long-term borrowing that matured on September 28, 2015. Through the nine month period ended September 30, 2015, the effective interest rate on this borrowing, including the effect of a cash flow hedge (discussed below) and the amortization of a prepayment fee from a previous modification, was 1.85%.

In connection with the $20.0 million FHLB borrowing, we had a cash flow hedge (interest rate swap) whereby we paid fixed amounts to a counterparty in exchange for receiving LIBOR-based variable payments over the life of the agreement without the exchange of the underlying notional amount. Upon the maturity of the $20.0 million FHLB borrowing, the associated interest rate swap expired. In connection with our $17.5 million borrowing, we have interest rate swaps whereby we pay fixed amounts to a counterparty and receive LIBOR-based variable payments on the full notional amount of this borrowing. Our objective in using interest rate swaps is to manage our exposure to interest rate movements. The interest rate swaps are designated as cash flow hedges, whereby the effective portion of the hedge is recorded in accumulated other comprehensive income (loss). The amount reported in accumulated other comprehensive income (loss) as of December 31, 2015 and 2014 related to these derivatives was an unrealized loss of $612 thousand (net of tax of $208 thousand) and $267 thousand (net of tax of $138 thousand), respectively. As of December 31, 2015, the ineffective portion of the interest rate swaps was insignificant.

We have an agreement with the counterparty to our cash flow hedges that contains a provision whereby if we fail to maintain our status as a well/an adequate capitalized institution, we could be required to terminate or fully collateralize the

 

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interest rate swaps. Additionally, if we default on any of our indebtedness, including default where repayment has not been accelerated by the lender, we could also be in default on our derivative obligations. We have minimum collateral requirements with our counterparty and, as of December 31, 2015, $886 thousand had been pledged as collateral under the agreement for our interest rate swaps, as the valuation of the interest rate swaps had surpassed the contractually specified minimum transfer amounts of $250 thousand. If we are not in compliance with the terms of the agreements, we could be required to settle obligations under the agreement at termination value. As of December 31, 2015, a hedge liability of $629 thousand was recorded in other liabilities on our consolidated balance sheet related to the cash flow hedges.

On June 26, 2015, we issued and sold $8.5 million in aggregate principal amount of our Subordinated Notes. The Subordinated Notes bear interest at an annual rate of 6.75%, which is payable quarterly in arrears on March 31, June 30, September 30 and December 31. The Subordinated Notes qualify as Tier 2 capital for the company. The Subordinated Notes may not be redeemed by us prior to June 26, 2020, except in the event (i) the Subordinated Notes no longer qualify as Tier 2 capital as a result of a change in interpretation or application of law or regulation, or (ii) of a “Tax Event” (as defined under the Subordinated Note Purchase Agreement). The Subordinated Notes are unsecured and subordinate and junior in right of payments to our secured and general creditors. Additionally, we are not permitted to declare or pay any dividend or make any distribution on our capital stock or any other of our equity securities of any kind, except for dividends payable solely in shares of the our common stock, if the total risk-based capital ratio, Tier 1 risk-based capital ratio, or leverage ratio of the company or the Bank, becomes less than 10.0%, 6.0% or 5.0%, respectively. For the year ended December 31, 2015, the effective interest rate, which includes the amortization of loan origination costs, on the Subordinated Notes was 7.13%.

On September 30, 2014, we entered into an agreement with a national bank that provides for an unsecured senior term loan credit facility up to $15.0 million (the “Credit Agreement”). We borrowed $12.0 million upon the closing of the Credit Agreement on September 30, 2014 and had the right to borrow up to an additional $3.0 million under a delayed-draw term loan commitment (“Delayed Draw Loan”), subject to customary conditions, on or before September 30, 2015. On September 24, 2015, we entered into an amendment to the Credit Agreement (the “Amendment”) that amends certain provisions of the Credit Agreement. Among other things, the Amendment modified the Credit Agreement by (i) increasing our right to borrow under the Delayed Draw Loan to up to an additional $5.0 million, subject to customary conditions, and (ii) extending the date by which we may draw under the Delayed Draw Loan to September 30, 2016. Repayments under the term loans were monthly payments of accrued interest only for the first six months and then, beginning on March 31, 2015, the term loans are repayable in monthly installments of principal, based on a 10-year amortization schedule, plus accrued interest. Unless extended or earlier prepaid, the maturity date of all term loans made under the Credit Agreement is September 30, 2019, at which time all unpaid principal and interest will become due and payable in full. Borrowings under the Credit Agreement bear interest at the 30-day LIBOR in effect from time to time, plus 2.75.% per annum, which was reduced from 30-day LIBOR in effect from time to time, plus 3.5% pursuant to the Amendment. The Credit Agreement is unsecured, but the lender has the benefit of a negative pledge on all of our outstanding capital stock. For the years ended December 31, 2015 and December 31, 2014, the effective interest rate, which includes the amortization of loan origination costs, on the unsecured senior term loan was 3.87% and 3.90%, respectively.

The Credit Agreement contains financial covenants that require: (1) the company to be, and to cause the Bank to be “well-capitalized,” as defined in federal banking regulations, at all times, (2) the Bank’s total risk-based capital ratio to be at least equal to 11.5% as of the last day of each fiscal quarter, (3) the Bank’s ratio of non-performing assets to tangible primary capital to be no more than 30% as of the last day of each fiscal quarter, (4) the Bank’s ratio of loan loss reserves, including loans discounts relating to acquired loans, to non-performing loans to be at least equal to 70% at all times, and (5) the company’s fixed charge coverage ratio, determined on a consolidated basis, to be at least 1.25 to 1.0 at the end of each fiscal quarter for the trailing four fiscal quarters. As of December 31, 2015, we were in compliance with these financial covenants.

We contributed a significant portion of the proceeds under the Credit Agreement to the Bank as equity, and retained the remainder of the proceeds to fund holding company obligations, including obligations under the Credit Agreement for a period of time.

Liquidity and Capital Adequacy

During the year ended December 31, 2015, cash and cash equivalents increased $22.7 million to $61.9 million from $39.2 million at December 31, 2014.

Net cash provided by operating activities was $10.0 million for the year ended December 31, 2015 compared to net cash provided by operating activities of $1.3 million for the year ended December 31, 2014. The greater cash provided by operating activities in the 2015 period compared to the 2014 period was primarily attributable to higher net income and an increase in other liabilities, primarily due to an increase in amounts due to a participant bank.

 

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Net cash used in investing activities was $99.9 million for the year ended December 31, 2015 compared to net cash used in investing activities of $112.8 million for the year ended 2014. The use of cash in the 2015 reflected $28.1 million in increases in net loans held for investment and $67.3 million of net cash outflows for purchases of available-for-sale securities net of proceeds from sales, while net cash used in the 2014 period was primarily due to an net increase of $139.3 million of loans held for investment, offset by proceeds from sales of securities net of purchases of $14.4 million, and $12.6 million of cash acquired in the CVB Acquisition. Of the $99.9 million of net cash used in investing activities in 2015, $67.3 million was used for purchases of securities net of proceeds from sales, and $28.1 million was used to fund net loans.

Net cash provided by financing activities in the years ended December 31, 2015 and 2014 was $112.6 million and $120.0 million, respectively. Cash provided by financing activities in 2015 was primarily from an increase in deposits of $116.2 million, while cash provided in 2014 included $102.8 million in deposit growth. In the 2015 period, net cash provided by financing activities included a net increase in borrowings of $4.9 million and the redemption of all of our outstanding shares of SBLF Preferred Stock. Cash provided in the 2014 period included borrowings under the Credit Agreement and net proceeds from issuances of our common stock.

Liquidity

Liquidity is the ability to generate or acquire sufficient amounts of cash when needed and at a reasonable cost to accommodate deposit withdrawals, payments of debt and operating expenses, fund loan demand, and to achieve stated objectives. These events may occur daily or in other short-term intervals in the normal operation of business. Historical trends may help management predict the amount of cash required. In assessing liquidity, management gives consideration to various factors, including stability of deposits, maturity of time deposits, quality, volume and maturity of assets, sources and costs of borrowings, concentrations of loans and deposits within certain businesses and industries, competition for loans and deposits, and our overall financial condition and cash flows.

Our primary sources of liquidity are cash, due from banks, federal funds sold and securities in our available-for-sale portfolio. We have access to a credit line from our primary correspondent bank in the amount of $30.0 million. This line is for short-term liquidity needs, is subject to the prevailing federal funds interest rate, and can be terminated at any time.

We have six additional uncommitted lines of credit by national banks to borrow federal funds up to $88.0 million in total on an unsecured basis. One line for $10.0 million expires August 1, 2016, and one line for $15.0 million expires September 24, 2016. The remainder of the lines of credit can be cancelled at any time by the lender. As of December 31, 2015, no amounts were outstanding under these uncommitted lines of credit. Borrowings under these arrangements bear interest at the prevailing federal funds rate.

We have secured borrowing facilities with the FHLB and the FRB. The total credit availability as of December 31, 2015 under the FHLB facility was $291.2 million, which is equal to 30% of our total assets, as of the most recent prior quarter-end, and with a pledged lendable collateral value of $47.5 million. Under this facility, as of December 31, 2015, there was one short-term, non-amortizing loan outstanding for $17.5 million, which matures on March 28, 2016. Credit availability under the FRB facility as of December 31, 2015 was $146.1 million, which is also based on pledged collateral. Borrowings under this facility bear the prevailing current rate for primary credit. There were no amounts outstanding under the FRB facility as of December 31, 2015. Total pledged collateral (loans held for investment) for both the FHLB and FRB facilities, was $279.0 million, as of December 31, 2015.

Additionally, we have $5.0 million of capacity under the Credit Agreement, which may be borrowed on or before September 30, 2016, subject to customary conditions. In management’s opinion, we maintain the ability to generate sufficient amounts of cash to cover normal requirements and any additional needs that may arise, within realistic limitations, for the foreseeable future.

Capital Adequacy

Capital management in a regulated financial services industry must properly balance return on equity to shareholders, while maintaining sufficient capital levels and related risk-based capital ratios to satisfy regulatory requirements. Our capital management strategies have been developed to maintain our “well-capitalized” position.

We are subject to various regulatory capital requirements administered by federal and other bank regulators. Failure to meet minimum capital requirements can trigger certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material adverse effect on us. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, we must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items, as calculated under regulatory accounting practices. Capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

 

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On December 7, 2009, BankCap Partners received approval from the Federal Reserve to acquire up to 65.02% of the common stock of First Bankshares (now Xenith Bankshares), and indirectly, SuffolkFirst Bank (now Xenith Bank). The approval order contained a condition applicable to the Bank that provided that the Bank must operate within the parameters of its business plan, which set forth minimum leverage and risk-based capital ratios through 2012. Subsequent to meeting the requirements set forth in this business plan, we are required to maintain capital ratios categorizing us as “well-capitalized.” As of December 31, 2015, we met all minimum capital adequacy requirements to which we were subject and are categorized as “well-capitalized.”

In July 2013, the Federal Reserve approved a final rule establishing a regulatory capital framework for smaller, less complex financial institutions, implementing in the United States the Basel III regulatory capital reforms from the Basel Committee and certain changes required by the Dodd-Frank Act. Information regarding capital requirements to which we are subject can be found in “Item 1—Supervision and Regulation—Capital Adequacy and Guidelines.”

The following table presents our capital ratios, regulatory minimum capital ratios and “well-capitalized” ratios as defined by our regulators as of the dates stated. Since December 31, 2015, there are no conditions or events that management believes have changed our status as “well-capitalized.”

 

     December 31, 2015     December 31, 2014              
     Xenith Bank     Xenith
Bankshares
    Xenith Bank     Xenith
Bankshares
    Regulatory
Minimum
    Well
Capitalized
 

Common equity Tier 1 capital ratio

     11.87     9.91     N/A        N/A        4.50     > 6.50

Tier 1 leverage ratio

     10.28     8.58     10.30     9.34     4.00     > 5.00

Tier 1 risk-based capital ratio

     11.87     9.91     12.15     11.00     6.00     > 8.00

Total risk-based capital ratio

     12.74     11.71     13.00     11.85     8.00     > 10.00

Interest Rate Sensitivity

Interest rate risk management is a part of our overall asset-liability management process. A primary objective of interest rate risk management is to ensure the stability and quality of our primary earnings component, net interest income. This process involves monitoring the company’s balance sheet in order to determine the potential impact that changes in the interest rate environment may have on net interest income. Interest rate-sensitive assets and liabilities have interest rates that are subject to change within a specific time period, due to either maturity or to contractual agreements that allow the instruments to reprice prior to maturity. Interest rate sensitivity management seeks to ensure that both assets and liabilities react to changes in interest rates within a similar time period, thereby minimizing the risk to net interest income. We use interest rate risk measurement tools (simulation models) to help manage this risk.

Earnings simulation modeling. Net interest income is affected by changes in the level of interest rates, the shape of the yield curve and the general market pressures affecting current market interest rates at the time of simulation. Many interest rate indices do not move uniformly, creating certain disunities between them. For example, the spread between a 30-day prime-based asset and a 30-day FHLB borrowing may not be uniform over time. The earnings simulation model projects changes in net interest income caused by the effect of changes in interest rates on interest-earning assets and interest-bearing liabilities. Simulation results are measured as a percentage change in net interest income compared to the static-rate or “base case” scenario. The model considers decreases in asset and liability volumes based on prepayment assumptions as well as rate changes. Rate changes are modeled instantaneously, referred to as a “rate shock.” The model projects only “sensitivities” to interest income and expense and does not project changes in noninterest income, noninterest expense, provision for loan and lease losses or the impact of changing tax rates.

The following table summarizes the results of our earnings “rate shock” simulation model as of the date stated:

 

     Annualized Hypothetical Percentage  
     Change in Net Interest Income  

Linear Change in Market Rate

   December 31, 2015  

Up 200 bps

     14.84

Up 100

     9.75

Base case - no change

     0.00

Down 100

     -2.53

 

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Economic Value of Equity. Economic Value of Equity (“EVE”) represents the market value of equity and is equal to the market value of assets minus the market value of liabilities, with adjustments made for off-balance sheet items. This simulation assesses the risk of loss in market risk sensitive instruments in the event of a sudden and sustained increase or decrease in interest rates, with no effect given to any actions management might take to counter the effect of that interest rate movement.

The following table summarizes the results of our EVE simulation model as of the date stated:

 

     Hypothetical Percentage  
     Change in EVE  

Linear Change in Market Rate

   December 31, 2015  

Up 200 bps

     39.30

Up 100

     23.60

Base case - no change

     0.00

Down 100

     34.80

Our balance sheet consistently has been “asset sensitive,” therefore should interest rates change, our assets will reprice faster than our liabilities. An asset-sensitive balance sheet would result in an increase to net interest income in an increasing rate environment and a decrease in net interest income in a declining rate environment.

Commitments and Contingencies

In the normal course of business, we have commitments under credit agreements to lend to customers as long as there is no material violation of any condition established in the credit agreements. These commitments generally have fixed expiration dates or other termination clauses and may require payments of fees. Because many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

Additionally, we issue letters of credit, which are conditional commitments to guarantee the performance of customers to third parties. The credit risk involved in issuing letters of credit is the same as that involved in extending loans to customers.

These commitments represent outstanding off-balance sheet commitments. The following table presents unfunded loan commitments outstanding, including letters of credit, as of the date stated:

 

     December 31, 2015  

Commercial lines of credit

   $ 177,846   

Commercial real estate

     60,380   

Residential real estate

     12,104   

Consumer

     2,982   

Letters of credit

     7,679   
  

 

 

 

Total commitments

   $ 260,991   
  

 

 

 

We have five non-cancelable agreements to lease four banking facilities and one loan production office with, as of December 31, 2015, remaining terms of approximately one to eight years. The following table presents the current minimum annual commitments under non-cancelable leases in effect at December 31, 2015 for the years stated:

 

Year

   Commitment  

2016

   $ 839   

2017

     925   

2018

     897   

2019

     614   

2020

     375   
  

 

 

 

Total lease commitments

   $  3,650   
  

 

 

 

 

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We have a commitment to invest in a limited partnership that operates as a small business investment company. As of December 31, 2015, we had invested $750 thousand in the limited partnership; an additional $250 thousand will be funded at the request of the general partner of the limited partnership. We also have a $1.0 million commitment to invest in a limited liability company, the purpose of which is to invest in low-income residential rental and/or historic properties.

Additionally, we have commitments under service agreements to make minimum payments over a period of years or incur early termination penalties. The most significant of these agreements is our agreement with our core processor, which expires in December 2020, though is terminable with 180 days notice and payment of financial penalties.

The following table presents current minimum annual commitments under non-cancelable service agreements as of December 31, 2015 for the years stated:

 

Year

   Commitment  

2016

   $ 1,177   

2017

     921   

2018

     905   

2019

     905   

2020

     887   
  

 

 

 

Total contractual commitments

   $ 4,795   
  

 

 

 

Recent Accounting Pronouncements

Recent accounting pronouncements affecting us are described in the notes to the consolidated financial statements included in “Item 8—Financial Statements and Supplementary Data.”

 

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Item 8—Financial Statements and Supplementary Data

REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

Board of Directors and Shareholders

Xenith Bankshares, Inc.

Richmond, Virginia

We have audited the accompanying consolidated balance sheet of Xenith Bankshares, Inc. and Subsidiary (“the Company”) as of December 31, 2015 and 2014 and the related consolidated statements of income, comprehensive income, changes in shareholders’ equity, and cash flows for each of the years then ended. The financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the financial statements based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Xenith Bankshares, Inc. and Subsidiary at December 31, 2015, and the results of their operations and their cash flows for the year then ended, in conformity with accounting principles generally accepted in the United States of America.

/s/ BDO USA, LLP

Richmond, Virginia

March 9, 2016

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED BALANCE SHEETS

AS OF DECEMBER 31, 2015 AND DECEMBER 31, 2014

 

(in thousands, except share data)    December 31, 2015     December 31, 2014  

Assets

    

Cash and cash equivalents

    

Cash and due from banks

   $ 40,242     $ 34,666  

Federal funds sold

     21,703       4,533  
  

 

 

   

 

 

 

Total cash and cash equivalents

     61,945       39,199  

Securities available for sale, at fair value

     130,863       64,341  

Securities held to maturity, at cost (fair value - 2015 - $9,769; 2014 - $9,683)

     9,270       9,279  

Loans, net of allowance for loan and lease losses, 2015 - $7,350; 2014 - $6,247

     772,178       744,626  

Premises and equipment, net

     7,544       8,010  

Other real estate owned, net

     533       1,140  

Goodwill and other intangible assets, net

     15,686       16,143  

Accrued interest receivable

     4,430       3,498  

Deferred tax asset

     6,260       6,343  

Bank owned life insurance

     19,603       14,106  

Other assets

     11,184       11,367  
  

 

 

   

 

 

 

Total assets

   $ 1,039,496     $ 918,052  
  

 

 

   

 

 

 

Liabilities and Shareholders’ Equity

    

Deposits

    

Demand and money market

   $ 568,366     $ 465,253  

Savings

     10,564       10,108  

Time

     310,100       297,550  
  

 

 

   

 

 

 

Total deposits

     889,030       772,911  

Accrued interest payable

     426       276  

Borrowings

     36,861       32,000  

Supplemental executive retirement plan

     2,217       2,295  

Other liabilities

     8,273       4,349  
  

 

 

   

 

 

 

Total liabilities

     936,807       811,831  
  

 

 

   

 

 

 

Shareholders’ equity

    

Preferred stock, $1.00 par value, 25,000,000 shares authorized as of December 31, 2015 and 2014; 0 shares issued and outstanding as of December 31, 2015 and 8,381 shares ($1,000 liquidation value) issued and outstanding as of December 31, 2014

     —          8,381  

Common stock, $1.00 par value, 100,000,000 shares authorized as of December 31, 2015 and 2014; 12,996,622 shares issued and outstanding as of December 31, 2015 and 12,929,834 shares issued and outstanding as of December 31, 2014

     12,997       12,930  

Additional paid-in capital

     86,684       86,016  

Retained earnings (accumulated deficit)

     3,581       (560

Accumulated other comprehensive loss, net of tax

     (573     (546
  

 

 

   

 

 

 

Total shareholders’ equity

     102,689       106,221  
  

 

 

   

 

 

 

Total liabilities and shareholders’ equity

   $ 1,039,496     $ 918,052  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF INCOME

FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014

 

(in thousands, except per share data)    December 31, 2015     December 31, 2014  

Interest income

    

Interest and fees on loans

   $ 33,817     $ 29,338  

Interest on securities

     2,556       1,532  

Interest on federal funds sold and deposits in other banks

     468       316  
  

 

 

   

 

 

 

Total interest income

     36,841       31,186  
  

 

 

   

 

 

 

Interest expense

    

Interest on deposits

     5,327       4,101  

Interest on federal funds purchased and borrowed funds

     1,153       506  
  

 

 

   

 

 

 

Total interest expense

     6,480       4,607  
  

 

 

   

 

 

 

Net interest income

     30,361       26,579  

Provision for loan and lease losses

     2,599       3,220  
  

 

 

   

 

 

 

Net interest income after provision for loan and lease losses

     27,762       23,359  
  

 

 

   

 

 

 

Noninterest income

    

Service charges on deposit accounts

     618       603  

Net loss on sale and write-down of other real estate owned

     (95     (31

Gain on sales of securities

     58       428  

Bargain purchase gain

     —          42  

Loss on the write-down of equipment and other assets

     (19     (23

Increase in cash surrender value of bank owned life insurance

     497       363  

Other

     330       297  
  

 

 

   

 

 

 

Total noninterest income

     1,389       1,679  
  

 

 

   

 

 

 

Noninterest expense

    

Compensation and benefits

     12,979       12,497  

Occupancy

     1,623       1,574  

FDIC insurance

     719       495  

Bank franchise taxes

     984       912  

Technology and data processing

     2,249       2,296  

Communications

     388       356  

Insurance

     373       339  

Professional fees

     1,191       1,597  

Amortization of intangible assets

     458       411  

Guaranteed student loan servicing

     446       595  

Other

     2,104       1,898  
  

 

 

   

 

 

 

Total noninterest expense

     23,514       22,970  
  

 

 

   

 

 

 

Income before income tax expense

     5,637       2,068  

Income tax expense

     1,454       786  
  

 

 

   

 

 

 

Net income

     4,183       1,282  
  

 

 

   

 

 

 

Preferred stock dividend

     (42     (84
  

 

 

   

 

 

 

Net income available to common shareholders

   $ 4,141     $ 1,198  
  

 

 

   

 

 

 

Earnings per common share (basic):

   $ 0.32     $ 0.10  
  

 

 

   

 

 

 

Earnings per common share (diluted):

   $ 0.31     $ 0.10  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014

 

(in thousands)    December 31, 2015     December 31, 2014  

Net income

   $ 4,183     $ 1,282  

Other comprehensive (loss) income, before taxes:

    

Securities available for sale:

    

Unrealized gain arising during the year

     169       2,269  

Reclassification adjustment for gains included in net income

     (58     (428
  

 

 

   

 

 

 

Unrealized gain on available-for-sale securities

     111       1,841  
  

 

 

   

 

 

 

Securities held to maturity:

    

Unrealized loss transferred to held to maturity

     —          (518

Amortization of unrealized loss transferred from available for sale

     55       50  
  

 

 

   

 

 

 

Unrealized loss on held-to-maturity securities

     55       (468
  

 

 

   

 

 

 

Unrealized loss on derivative:

    

Unrealized loss arising during the year

     (406     (571

Reclassification adjustment for losses included in net income

     199       146  
  

 

 

   

 

 

 

Unrealized loss on derivative

     (207     (425
  

 

 

   

 

 

 

Other comprehensive (loss) income, before taxes

     (41     948  
  

 

 

   

 

 

 

Income tax benefit (expense) related to other comprehensive (loss) income

     14       (322
  

 

 

   

 

 

 

Comprehensive income

   $ 4,156     $ 1,908  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY

FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014

 

(in thousands)    Preferred
Stock
    Common
Stock
    Additional
Paid-in
Capital
    Retained
Earnings
(Accumulated
Deficit)
    Accumulated
Other
Comprehensive
Loss
    Total
Shareholders’
Equity
 

Balance - January 1, 2014

   $ 8,381     $ 10,438     $ 71,797     $ (1,758   $ (1,172   $ 87,686  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     —          —          —          1,282       —          1,282  

Share-based compensation expense

     —          —          872       —          —          872  

Issuance of common stock, net

     —          918       4,692       —          —          5,610  

Issuance of common stock for acquisition

     —          1,618       8,871       —          —          10,489  

Cash in lieu of fractional shares for acquisition

     —          —          1       —          —          1  

Repurchase of common stock

     —          (44     (221     —          —          (265

Dividend on preferred stock

     —          —          —          (84     —          (84

Excess tax benefits on stock awards

     —          —          4       —          —          4  

Change in net unrealized gain on available-for-sale securities, net of tax of $626

     —          —          —          —          1,215       1,215  

Change in net unrealized loss on held-to-maturity securities, net of tax of $159

     —          —          —          —          (309     (309

Change in net unrealized loss on derivative, net of tax of $145

     —          —          —          —          (280     (280
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance - December 31, 2014

   $ 8,381     $ 12,930     $ 86,016     $ (560   $ (546   $ 106,221  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

     —          —          —          4,183       —          4,183  

Share-based compensation expense

     —          —          729       —          —          729  

Issuance of common stock

     —          78       (4     —          —          74  

Repurchase of common stock

     —          (11     (60     —          —          (71

Repurchase of preferred stock

     (8,381     —          —          —          —          (8,381

Dividend on preferred stock

     —          —          —          (42     —          (42

Excess tax benefits on stock awards

     —          —          3       —          —          3  

Change in net unrealized gain on available-for-sale securities, net of tax of $38

     —          —          —          —          73       73  

Change in net unrealized loss on held-to-maturity securities, net of tax of $19

     —          —          —          —          36       36  

Change in net unrealized loss on derivative, net of tax of $71

     —          —          —          —          (136     (136
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Balance - December 31, 2015

   $ —        $ 12,997     $ 86,684     $ 3,581     $ (573   $ 102,689  
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE YEARS ENDED DECEMBER 31, 2015 AND 2014

 

(in thousands)    December 31, 2015     December 31, 2014  

Cash flows from operating activities

    

Net income

   $ 4,183     $ 1,282  

Adjustments to reconcile net income to net cash provided by operating activities:

    

Provision for loan and lease losses

     2,599       3,220  

Depreciation and amortization

     1,154       1,142  

Net amortization of securities

     964       416  

Accretion of acquisition accounting adjustments

     (2,279     (1,960

Deferred tax expense (benefit)

     (11     (422

Gain on sales of securities

     (58     (428

Share-based compensation expense

     729       872  

Bargain purchase gain

     —          (42

Net loss on sale and write-down of other real estate owned

     95       31  

Loss on write-down of equipment and other assets

     19       23  

Increase in cash surrender value of bank owned life insurance

     (497     (363

Change in operating assets and liabilities:

    

Accrued interest receivable

     (932     (776

Other assets

     292       (2,384

Accrued interest payable

     150       22  

Other liabilities

     3,581       631  
  

 

 

   

 

 

 

Net cash provided by operating activities

     9,989       1,264  
  

 

 

   

 

 

 

Cash flows from investing activities

    

Cash and cash equivalents acquired in bank acquisition

     —          12,560  

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

     20,346       52,591  

Purchases of available-for-sale securities

     (87,599     (38,201

Net increase in loans

     (28,121     (139,264

Net proceeds from sale of other real estate owned

     762       214  

Purchases of bank owned life insurance

     (5,000     —     

Net purchase of premises and equipment

     (250     (356

Purchases of FRB and FHLB stock

     (2     (335
  

 

 

   

 

 

 

Net cash used in investing activities

     (99,864     (112,791
  

 

 

   

 

 

 

Cash flows from financing activities

    

Net increase in demand, money market and savings deposits

     103,569       53,717  

Net increase in time deposits

     12,607       49,050  

Net increase in borrowed funds

     4,861       12,000  

Issuance of common stock, net of issuance costs

     78       5,615  

Repurchase of common stock

     (71     (265

Redemption of preferred stock

     (8,381     —     

Preferred stock dividend

     (42     (84
  

 

 

   

 

 

 

Net cash provided by financing activities

     112,621       120,033  
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     22,746       8,506  

Cash and cash equivalents

    

Beginning of year

     39,199       30,693  
  

 

 

   

 

 

 

End of year

   $ 61,945     $ 39,199  
  

 

 

   

 

 

 

Supplementary disclosure of cash flow information

    

Cash payments for:

    

Interest

   $ 6,272     $ 4,623  
  

 

 

   

 

 

 

Income taxes

   $ 1,775     $ 1,350  
  

 

 

   

 

 

 

Non-cash transfer of loans to foreclosed assets

   $ 252     $ 65  
  

 

 

   

 

 

 

Non-cash transactions related to bank acquisition

    

Assets acquired

   $ —        $ 101,872  
  

 

 

   

 

 

 

Liabilities assumed

   $ —        $ 103,900  
  

 

 

   

 

 

 

Issuance of common stock for acquisition

   $ —        $ 10,489  
  

 

 

   

 

 

 

See notes to consolidated financial statements.

 

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XENITH BANKSHARES, INC. AND SUBSIDIARY

Notes to Consolidated Financial Statements

For the years ended December 31, 2015 and 2014

Note 1—Organization

General

Xenith Bankshares, Inc. (“Xenith Bankshares” or the “company”) is the bank holding company for Xenith Bank (the “Bank”), a Virginia-based institution headquartered in Richmond, Virginia. As of December 31, 2015, the company, through the Bank, operates eight full-service branches: one branch in Herndon, Virginia, two branches in Richmond, Virginia, three branches in Suffolk, Virginia, and two branches in Gloucester, Virginia. Additionally, the Bank operates one loan production office in Newport News, Virginia.

Background

In December 2009, First Bankshares, Inc. (“First Bankshares”), the bank holding company for SuffolkFirst Bank, and Xenith Corporation completed the merger of Xenith Corporation with and into First Bankshares (the “First Bankshares Merger”), with First Bankshares being the surviving entity in the merger. At the effective time of the First Bankshares Merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the First Bankshares Merger, SuffolkFirst Bank changed its name to Xenith Bank. Although the First Bankshares Merger was structured as a merger of Xenith Corporation with and into First Bankshares, with First Bankshares being the surviving entity for legal purposes, Xenith Corporation was treated as the acquirer for accounting purposes.

Effective on July 29, 2011, the Bank completed the acquisition of select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office of Paragon Commercial Bank, a North Carolina banking corporation, and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the branch office (the “Paragon Transaction”).

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank (“VBB”), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the “VBB Acquisition”). The Federal Deposit Insurance Corporation (the “FDIC”) acted as receiver of VBB. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Acquisition Agreement, the Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The VBB Acquisition was completed without any shared-loss agreement with the FDIC.

On June 30, 2014, the company completed the merger of Colonial Virginia Bank (“CVB”) with and into the Bank, with the Bank being the surviving bank (the “CVB Acquisition”). In the CVB Acquisition, each share of CVB common stock outstanding immediately prior to the effective time of the CVB Acquisition was converted into the right to receive 2.65 shares of Xenith Bankshares common stock (the “Exchange Ratio”) without interest and less applicable amounts for taxes. All fractional shares of Xenith Bankshares common stock that a CVB shareholder would otherwise have been entitled to receive as a result of the CVB Acquisition was aggregated and, if a fractional share resulted from such aggregation, such holder received, instead of the fractional share, an amount in cash equal to $6.40 multiplied by the fraction of a share of Xenith Bankshares common stock to which such holder would otherwise have been entitled. Based on the Exchange Ratio, an aggregate of 1,618,186 shares of Xenith Bankshares common stock was issued and $658 in cash was paid to the former shareholders of CVB in exchange for their shares of CVB common stock. Additionally, based on the Exchange Ratio, an aggregate of 39,004 options to purchase shares of CVB common stock were converted into an aggregate of 103,355 options to purchase shares of Xenith Bankshares common stock.

Pursuant to the CVB Acquisition, the company acquired approximately $114.4 million of assets, including $70.1 million in loans and assumed $103.9 million in liabilities, including $101.0 million of deposits.

In September 2014, the company issued and sold an aggregate of 880,000 shares of its common stock, $1.00 par value per share, at a price of $6.35 per share to third-party investors for an aggregate purchase price, net of stock issuance costs, of approximately $5.6 million.

 

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On June 30, 2015, the company completed the redemption of all of the outstanding 8,381 shares of its senior non-cumulative perpetual preferred stock, Series A, that the company had issued and sold to the U.S. Treasury pursuant to the Small Business Lending Fund program (the “SBLF Preferred Stock”), at an aggregate redemption price of $8.4 million, including accrued but unpaid dividends.

Note 2—Summary of Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Xenith Bankshares and its wholly-owned subsidiary, Xenith Bank. All significant intercompany accounts have been eliminated.

All dollar amounts included in the tables in these notes are in thousands, except per share data, unless otherwise stated.

Use of Estimates

The preparation of the financial statements in conformity with United States generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements, as well as the amounts of income and expenses during the reporting period. Actual results could differ from those estimates. Management considers its most critical estimates susceptible to significant change to include the determination of the allowance for lease and loan losses and its related provision, the yield and impairment for purchased-credit impaired loans, and the determination of estimated fair values of acquired assets and assumed liabilities in connection with business combinations.

Accounting for Acquisitions

The First Bankshares Merger, the Paragon Transaction, the VBB Acquisition and the CVB Acquisition were determined to be acquisitions of businesses and were accounted for under the acquisition method of accounting in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 805, “Business Combinations” (“ASC 805”), with the assets acquired and liabilities assumed pursuant to the business combinations recorded at estimated fair values as of the effective date of the respective acquisitions. The determination of fair values requires management to make estimates about future expected cash flows, market conditions and other future events that are highly subjective in nature and subject to actual results that may differ materially from the estimates made.

In accordance with the framework established by FASB ASC Topic 820, “Fair Value Measurements and Disclosure” (“ASC 820”), the company used a fair value hierarchy to prioritize the information used to form assumptions and estimates in determining fair values. These fair value hierarchies are further discussed below.

Cash and Cash Equivalents

The company considers all highly-liquid debt instruments with original maturities, or maturities when purchased, of three months or less to be cash equivalents. Cash and cash equivalents include cash on hand, due from banks and federal funds sold.

Securities

Marketable securities are classified into three categories:

 

  1. debt securities that the company has the positive intent and ability to hold to maturity are classified as “held-to-maturity securities” and reported at amortized cost;

 

  2. debt and equity securities that are bought and held principally for the purpose of selling them in the near term are classified as “trading securities” and reported at fair value, with unrealized gains and losses included in net income; and

 

  3. debt and equity securities not classified as either held-to-maturity securities or