Southern National Bancorp
Southern National Bancorp of Virginia Inc (Form: 10-Q, Received: 08/12/2010 09:57:36)
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended June 30, 2010

Commission File No. 001-33037

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Virginia   20-1417448

(State or other jurisdiction of

incorporation or organization)

 

(I.R.S. Employer

Identification No.)

6830 Old Dominion Drive

McLean, Virginia 22101

(Address of principal executive offices) (zip code)

(703) 893-7400

(Registrant’s telephone number, including area code)

 

 

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

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

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

 

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

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

As of August 2, 2010, there were 11,590,212 shares of common stock outstanding.

 

 

 


Table of Contents

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

FORM 10-Q

June 30, 2010

INDEX

 

         PAGE
PART 1 - FINANCIAL INFORMATION   
Item 1 - Financial Statements   
 

Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009

   2
 

Consolidated Statements of Income and Comprehensive Income (Loss) for the three and six months ended June 30, 2010 and 2009

   3
 

Consolidated Statements of Changes in Stockholders’ Equity for the six months ended June 30, 2010

   4
 

Consolidated Statements of Cash Flows for the six months ended June 30, 2010 and 2009

   5
 

Notes to Consolidated Financial Statements

   6-18
Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations    19-31
Item 3 – Quantitative and Qualitative Disclosures about Market Risk    32-34
Item 4 – Controls and Procedures    35
PART II - OTHER INFORMATION   
Item 1 – Legal Proceedings    35
Item 1A – Risk Factors    35
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds    36
Item 3 – Defaults Upon Senior Securities    36
Item 4 – (Removed and Reserved)    36
Item 5 – Other Information    36
Item 6 – Exhibits    36
Signatures    37
Certifications    38-40


Table of Contents

ITEM I - FINANCIAL INFORMATION

PART I - FINANCIAL STATEMENTS

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

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

 

     June 30,
2010
    December 31,
2009
 
ASSETS     
Cash and cash equivalents:             

Cash and due from financial institutions

   $ 2,348      $ 2,858   

Interest-bearing deposits in other financial institutions

     8,701        5,212   
                

Total cash and cash equivalents

     11,049        8,070   
                

Securities available for sale, at fair value

     17,558        18,505   
                

Securities held to maturity, at amortized cost (fair value of $53,746 and $57,841, respectively)

     52,530        57,696   
                
Covered loans, net of unearned income      101,492        111,989   
Non-covered loans, net of unearned income      361,904        350,298   
                

Total loans, net of unearned income

     463,396        462,287   

Less allowance for loan losses

     (5,443     (5,172
                

Net loans

     457,953        457,115   
                

Stock in Federal Reserve Bank and Federal Home Loan Bank

     6,775        5,940   

Bank premises and equipment, net

     4,775        3,225   

Goodwill

     8,713        8,713   

Core deposit intangibles, net

     3,387        3,858   

FDIC indemnification asset

     18,758        19,408   

Bank-owned life insurance

     14,290        14,014   

Other real estate owned

     5,252        3,537   

Deferred tax assets, net

     4,514        4,559   

Other assets

     7,616        6,034   
                

Total assets

   $ 613,170      $ 610,674   
                
LIABILITIES AND STOCKHOLDERS’ EQUITY     

Noninterest-bearing demand deposits

   $ 33,440      $ 33,339   

Interest-bearing deposits:

    

NOW accounts

     14,431        17,499   

Money market accounts

     164,722        130,131   

Savings accounts

     5,096        4,398   

Time deposits

     238,026        270,424   
                

Total interest-bearing deposits

     422,275        422,452   
                

Total deposits

     455,715        455,791   
                

Securities sold under agreements to repurchase and other short-term borrowings

     20,374        22,020   

Federal Home Loan Bank (FHLB) advances

     35,000        30,000   

Other liabilities

     2,725        5,739   
                

Total liabilities

     513,814        513,550   
                

Commitments and contingencies (See Note 5)

     —          —     

Stockholders’ equity:

    

Preferred stock, $.01 par value. Authorized 5,000,000 shares; no shares issued and outstanding

     —          —     

Common stock, $.01 par value. Authorized 45,000,000 shares; issued and outstanding, 11,590,212 shares at June 30, 2010 and December 31, 2009

     116        116   

Additional paid in capital

     96,431        96,444   

Retained earnings

     6,119        4,053   

Accumulated other comprehensive loss

     (3,310     (3,489
                

Total stockholders’ equity

     99,356        97,124   
                

Total liabilities and stockholders’ equity

   $ 613,170      $ 610,674   
                

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME (LOSS)

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

 

     For the Three Months Ended
June 30,
    For the Six Months Ended
June 30,
 
     2010     2009     2010     2009  

Interest and dividend income :

        

Interest and fees on loans

   $ 7,829      $ 4,860      $ 15,443      $ 9,464   

Interest and dividends on taxable securities

     684        675        1,418        1,456   

Interest and dividends on other earning assets

     48        36        91        77   
                                

Total interest and dividend income

     8,561        5,571        16,952        10,997   
                                

Interest expense:

        

Interest on deposits

     1,790        1,764        3,593        3,831   

Interest on borrowings

     330        317        657        630   
                                

Total interest expense

     2,120        2,081        4,250        4,461   
                                

Net interest income

     6,441        3,490        12,702        6,536   
                                

Provision for loan losses

     1,450        545        2,750        1,025   
                                

Net interest income after provision for loan losses

     4,991        2,945        9,952        5,511   
                                

Noninterest income:

        

Account maintenance and deposit service fees

     235        138        476        270   

Income from bank-owned life insurance

     137        140        276        288   

Net gain on other real estate owned

     19        30        39        117   

Gain on sales of securities available for sale

     —          —          —          223   

Total other-than-temporary impairment losses

     (4     (5,367     (10     (5,367

Portion of loss recognized in other comprehensive income (before taxes)

     —          4,504        —          4,504   
                                

Net credit impairment losses recognized in earnings

     (4     (863     (10     (863

Other

     148        53        293        57   
                                

Total noninterest income (loss)

     535        (502     1,074        92   
                                

Noninterest expenses:

        

Salaries and benefits

     1,523        936        3,164        1,999   

Occupancy expenses

     527        387        1,069        774   

Furniture and equipment expenses

     151        125        305        246   

Amortization of core deposit intangible

     236        182        472        363   

Virginia franchise tax expense

     184        140        368        282   

FDIC assessment

     212        313        401        487   

Data processing expense

     159        79        314        159   

Telephone and communication expense

     101        63        220        128   

Decrease in FDIC indemnification asset

     406        —          650        —     

Other operating expenses

     528        249        1,042        469   
                                

Total noninterest expenses

     4,027        2,474        8,005        4,907   
                                

Income (loss) before income taxes

     1,499        (31     3,021        696   

Income tax expense (benefit)

     474        (54     955        147   
                                

Net income

   $ 1,025      $ 23      $ 2,066      $ 549   
                                

Other comprehensive income (loss):

        

Unrealized gain on available for sale securities

   $ 161      $ 8      $ 222      $ 133   

Realized amount on securities sold, net

     —          —          —          (223

Non-credit component of other-than-temporary impairment on held-to-maturity securities

     33        (4,504     109        (4,504

Accretion of amounts previously recorded upon transfer to held-to-maturity from available-for-sale

     (31     1,833        (61     1,865   
                                

Net unrealized gain (loss)

     163        (2,663     270        (2,729

Tax effect

     55        (905     91        (927
                                

Other comprehensive income (loss)

     108        (1,758     179        (1,802
                                

Comprehensive income (loss)

   $ 1,133      $ (1,735   $ 2,245      $ (1,253
                                

Earnings per share, basic and diluted

   $ 0.09      $ 0.00      $ 0.18      $ 0.08   
                                

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2010

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

 

     Common
Stock
   Additional
Paid in
Capital
    Retained
Earnings
   Accumulated
Other
Comprehensive
Loss
    Comprehensive
Income
   Total  

Balance—January 1, 2010

   $ 116    $ 96,444      $ 4,053    $ (3,489      $ 97,124   

Stock-based compensation expense

        35                35   

Additional cost of 2009 common stock issuance

        (48             (48

Comprehensive income:

               

Net income

          2,066      $ 2,066      2,066   

Change in unrealized gain on available-for-sale securities (net of tax, $75)

             147        147      147   

Change in unrecognized loss on securities held to maturity for which a portion of OTTI has been recognized (net of tax, $16 and accretion, $61 and amounts recorded into other comprehensive income at transfer)

             32        32      32   
                   

Total comprehensive income

             $ 2,245   
                                             

Balance—June 30, 2010

   $ 116    $ 96,431      $ 6,119    $ (3,310      $ 99,356   

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2010 AND 2009

(dollars in thousands) (Unaudited)

 

     2010     2009  

Operating activities:

    

Net income

   $ 2,066      $ 549   

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

    

Depreciation

     276        258   

Amortization of core deposit intangible

     472        363   

Decrease in FDIC indemnification asset

     650        —     

Other amortization , net

     88        (16

Provision for loan losses

     2,750        1,025   

Earnings on bank-owned life insurance

     (276     (288

Stock based compensation expense

     35        25   

Gain on sales of securities

     —          (223

Impairment on securities

     10        863   

Net gain on other real estate owned

     (39     (117

Net increase in other assets

     (1,685     (738

Net decrease in other liabilities

     (3,014     (671
                

Net cash and cash equivalents provided by operating activities

     1,333        1,030   
                

Investing activities:

    

Proceeds from sales of securities available for sale

     —          9,852   

Proceeds from paydowns, maturities and calls of securities available for sale

     1,126        1,161   

Purchases of securities held to maturity

     —          (4,210

Proceeds from paydowns, maturities and calls of securities held to maturity

     5,308        7,092   

Loan originations and payments, net

     (5,940     (25,123

Net increase in stock in Federal Reserve Bank and Federal Home Loan Bank

     (835     (423

Proceeds from sale of other real estate owned

     583        634   

Purchases of bank premises and equipment

     (1,826     (39
                

Net cash and cash equivalents used in investing activities

     (1,584     (11,056
                

Financing activities:

    

Net increase (decrease) in deposits

     (76     5,364   

Proceeds from Federal Home Loan Bank advances

     5,000        —     

Net decrease in securities sold under agreement to repurchase and other short-term borrowings

     (1,646     (2,670

Additional cost of 2009 common stock issuance

     (48     —     
                

Net cash and cash equivalents provided by financing activities

     3,230        2,694   
                

Increase (decrease) in cash and cash equivalents

     2,979        (7,332

Cash and cash equivalents at beginning of period

     8,070        14,762   
                

Cash and cash equivalents at end of period

   $ 11,049      $ 7,430   
                

Supplemental Disclosure of Cash Flow Information

    

Cash payments for:

    

Interest

   $ 4,566      $ 4,891   

Income taxes

     880        380   

Supplemental schedule of noncash investing and financing activities

    

Transfer from non-covered loans to other real estate owned

     2,352        498   

See accompanying notes to consolidated financial statements.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2010

1. ACCOUNTING POLICIES

Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a Virginia state chartered bank which commenced operations on April 14, 2005. The principal activities of Sonabank are to attract deposits and originate loans as permitted under applicable banking regulations. Sonabank operates 12 branches in Virginia located in Fairfax County (Reston, McLean and Fairfax), in Charlottesville, Warrenton (2), Leesburg (2), South Riding, Front Royal, New Market and Clifton Forge, and we also have a branch in Rockville, Maryland.

The consolidated financial statements include the accounts of Southern National Bancorp of Virginia, Inc. and its subsidiary. Significant inter-company accounts and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with U. S. generally accepted accounting principles (“U. S. GAAP”) for interim financial information and instructions for Form 10-Q and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by U. S. GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in SNBV’s Form 10-K for the year ended December 31, 2009.

Use of Estimates

The preparation of the consolidated financial statements in conformity with U. S. generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the carrying value of investment securities, other than temporary impairment of investment securities, the valuation of goodwill and intangible assets, the FDIC indemnification asset, mortgage servicing rights, other real estate owned and deferred tax assets.

Reclassifications

Some items in the prior year financial statements were reclassified to conform to the current presentation, and the reclassifications had no impact on prior period net income or shareholders’ equity.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

Recent Accounting Pronouncements

In June 2009, the FASB issued ASC 860-10, “Accounting for Transfers of Financial Assets—an amendment of ASC 860.” This statement removes the concept of a qualifying special-purpose entity from Statement 140 and removes the exception from applying ASC 810 (revised December 2003), Consolidation of Variable Interest Entities, to qualifying special-purpose entities. The objective in issuing this Statement is to improve the relevance, representational faithfulness, and comparability of the information that a reporting entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The participating interest definition in this statement applies to transfers of government-guaranteed portions of loans, such as those guaranteed by the Small Business Administration (“SBA”). In this regard, if a seller transfers the guaranteed portion on an SBA loan at a premium, the seller is obligated by the SBA to refund the premium to the purchaser if the loan is repaid within 90 days of the transfer. Under this statement, this premium refund obligation is a form of recourse, which means that the transferred guaranteed portion the loan does not meet the definition of a participating interest for the 90-day period that the premium refund obligation exists. As a result, the transfer must be accounted for as a secured borrowing during this period. After the 90 day period, assuming the transferred guaranteed portion and the retained unguaranteed portion of the SBA loan now meet the definition of a participating interest, the transfer of the guaranteed portion can accounted for as a sale if all of the conditions for sale accounting in the statement are met. Adoption of this statement will result in a 90 day delay in recognizing the sale and gain on sale of the guaranteed portions of any SBA loans.

On June 12, 2009, the FASB issued ASC 810-10, Amendments to FASB Interpretation No. 46(R) . this guidance amends ASC 810 to replace the quantitative-based risks and rewards calculation for determining which enterprise, if any, has a controlling financial interest in a variable interest entity with a qualitative approach focused on identifying which enterprise has the power to direct the activities of a variable interest entity (VIE) that most significantly impact the entity’s economic performance and (1) the obligation to absorb losses of the entity or (2) the right to receive benefits from the entity. Unlike ASC 810, this Statement requires ongoing reconsideration of whether (1) an entity is a VIE and (2) an enterprise is the primary beneficiary of a VIE. It is expected that the amendments will result in more entities consolidating VIEs that previously were not consolidated The Statement will also require additional disclosures about an enterprise’s involvement in variable interest entities. This Statement must be applied as of the beginning of each reporting entity’s first annual reporting period that begins after November 15, 2009, for interim periods within that first annual reporting period and for interim and annual reporting periods thereafter. The impact of adoption was not material to our results of operations or financial position.

2. STOCK- BASED COMPENSATION

In 2004, the Board of Directors adopted a stock option plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and employees. As of December 31, 2009, options to purchase an aggregate of 281,675 shares of common stock were outstanding and 20,825 shares remained available for issuance . The 2010 Stock Awards and Incentive Plan was approved by the Board of Directors in January 2010 and approved by the stockholders at the Annual Meeting in April 2010. The 2010 plan authorized the reservation of 700,000 shares of common stock for the granting of stock

 

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awards. The options granted to officers and employees are incentive stock options and the options granted to non-employee directors are non-qualified stock options. The purpose of the plan is to afford key employees an incentive to remain in the employ of SNBV and to assist in the attracting and retaining of non-employee directors by affording them an opportunity to share in SNBV’s future success. Under the plan, the option’s price cannot be less than the fair market value of the stock on the grant date. The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule.

SNBV granted 4,000 options during the first six months of 2010. The fair value of each option granted is estimated on the date of grant using the Black-Scholes options-pricing model. The following weighted-average assumptions were used to value options granted in the six months ended June 30, 2010:

 

Dividend yield

     0.00

Expected life

     10 years   

Expected volatility

     42.47

Risk-free interest rate

     3.74

Weighted average fair value per option granted

   $ 4.48   

 

   

We have paid no dividends.

 

   

Due to SNBV’s short existence, the volatility was estimated using historical volatility of comparative publicly traded financial institutions in the Virginia market combined with that of SNBV for periods approximating the expected option life.

 

   

The risk-free interest rate was developed using the U. S. Treasury yield curve for periods equal to the expected life of the options on the grant date. An increase in the risk-free interest rate will increase stock compensation expense on future option grants.

For the three and six months ended June 30, 2010, stock-based compensation expense was $18 thousand and $35 thousand, respectively, compared to $13 thousand and $25 thousand for the same periods last year. As of June 30, 2010, unrecognized compensation expense associated with the stock options was $233 thousand which is expected to be recognized over a weighted average period of 3.4 years.

A summary of the activity in the stock option plan during the three months ended June 30, 2010 follows (dollars in thousands):

 

     Shares     Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
   Aggregate
Intrinsic
Value

Options outstanding, beginning of period

   281,675      $ 8.56      

Granted

   4,000        7.61      

Forfeited

   (13,250     8.53      

Exercised

   —          —        
              

Options outstanding, end of period

   272,425      $ 8.55    6.3    $ 72
                        

Vested or expected to vest

   272,425      $ 8.55    6.3    $ 72

Exercisable at end of period

   186,015      $ 9.03    5.3    $ 14

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

3. SECURITIES

The amortized cost and fair value of securities available-for-sale were as follows (in thousands):

 

June 30, 2010

   Amortized
Cost
   Gross
Unrealized
    Fair
Value
      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 4,777    $ 131    $ —        $ 4,908

SBA guaranteed loan pools

     12,432      196      —          12,628

FHLMC preferred stock

     16      6      —          22
                            

Total

   $ 17,225    $ 333    $ —        $ 17,558
                            

December 31, 2009

   Amortized
Cost
   Gross
Unrealized
    Fair
Value
      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 4,967    $ —      $ (53   $ 4,914

SBA guaranteed loan pools

     13,412      151      (13     13,550

FHLMC preferred stock

     16      25      —          41
                            

Total

   $ 18,395    $ 176    $ (66   $ 18,505
                            

The carrying amount and fair value of securities held-to-maturity were as follows (in thousands):

 

June 30, 2010

   Carrying
Amount
   Gross
Unrecognized
    Fair
Value
      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 40,558    $ 1,903    $ —        $ 42,461

Residential government-sponsored collateralized mortgage obligations

     263      13      —          276

Other residential collateralized mortgage obligations

     1,424      —        —          1,424

Trust preferred securities

     10,285      763      (1,463     9,585
                            
   $ 52,530    $ 2,679    $ (1,463   $ 53,746
                            

December 31, 2009

   Carrying
Amount
   Gross
Unrecognized
    Fair
Value
      Gains    Losses    

Residential government-sponsored mortgage-backed securities

   $ 45,369    $ 1,173    $ (169   $ 46,373

Residential government-sponsored collateralized mortgage obligations

     398      21      —          419

Other residential collateralized mortgage obligations

     1,577      —        —          1,577

Trust preferred securities

     10,352      —        (880     9,472
                            
   $ 57,696    $ 1,194    $ (1,049   $ 57,841
                            

The fair value and carrying amount, if different, of debt securities as of June 30, 2010, by contractual maturity were as follows (in thousands). Securities not due at a single maturity date, primarily mortgage-backed securities and collateralized mortgage obligations, are shown separately.

 

     Held to Maturity    Available for Sale
     Carrying
Amount
   Fair Value    Fair Value    Amortized
Cost

Due in one to five years

   $ —      $ —      $ 237    $ 236

Due in five to ten years

     —        —        1,507      1,492

Due after ten years

     10,285      9,585      10,884      10,704

Residential government-sponsored mortgage-backed securities

     40,558      42,461      4,908      4,777

Residential government-sponsored collateralized mortgage obligations

     263      276      —        —  

Other residential collateralized mortgage obligations

     1,424      1,424      —        —  
                           

Total

   $ 52,530    $ 53,746    $ 17,536    $ 17,209
                           

During the three and six months ended June 30, 2010, there were no sales of securities. During the first six months of 2009, we sold $9.9 million of available-for-sale mortgage-backed securities resulting in a gross gain of $223 thousand, and the tax provision related to the gain was $76 thousand.

Securities with a carrying amount of approximately $58.4 million and $40.1 million at June 30, 2010 and December 31, 2009, respectively, were pledged to secure public deposits, repurchase agreements and a line of credit for advances from the Federal Home Loan Bank of Atlanta (“FHLB”).

SNBV monitors the portfolio which is subject to liquidity needs, market rate changes and credit risk changes to see if adjustments are needed. At June 30, 2010 and December 31, 2009, some

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

securities’ fair values were below cost. As outlined in the table below, there were securities with stated maturities totaling approximately $8.0 million in the portfolio that are considered temporarily impaired at June 30, 2010. Because the decline in fair value is attributable to changes in interest rates and illiquidity, and not credit quality, and because we do not have the intent to sell these securities and it is likely that we will not be required to sell the securities before their anticipated recovery, management does not consider these securities to be other-than-temporarily impaired as of June 30, 2010. The following tables present information regarding securities in a continuous unrealized loss position as of June 30, 2010 and December 31, 2009 (in thousands) by duration of time in a loss position:

 

June 30, 2010                                  
     Less than 12 months     12 Months or More     Total  
Available for Sale    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
 

Residential government-sponsored mortgage-backed securities

   $ —      $ —        $ —      $ —        $ —      $ —     

SBA guaranteed loan pools

     —        —          —        —          —        —     
                                             
   $ —      $ —        $ —      $ —        $ —      $ —     
                                             
     Less than 12 months     12 Months or More     Total  
Held to Maturity    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
 

Residential government-sponsored mortgage-backed securities

   $ —      $ —        $ —      $ —        $ —      $ —     

Trust preferred securities

     —        —          7,993      (1,463     7,993      (1,463
                                             
   $ —      $ —        $ 7,993    $ (1,463   $ 7,993    $ (1,463
                                             
December 31, 2009                                  
     Less than 12 months     12 Months or More     Total  
Available for Sale    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
 

Residential government-sponsored mortgage-backed securities

   $ 4,914    $ (53   $ —      $ —        $ 4,914    $ (53

SBA guaranteed loan pools

     819      (13     —        —          819      (13
                                             
   $ 5,733    $ (66   $ —      $ —        $ 5,733    $ (66
                                             
     Less than 12 months     12 Months or More     Total  
Held to Maturity    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
    Fair value    Unrealized
Losses
 

Residential government-sponsored mortgage-backed securities

   $ 14,039    $ (169   $ —      $ —        $ 14,039    $ (169

Trust preferred securities

     —        —          8,094      (880     8,094      (880
                                             
   $ 14,039    $ (169   $ 8,094    $ (880   $ 22,133    $ (1,049
                                             

As of June 30, 2010, we owned pooled trust preferred securities as follows:

 

Security

  Tranche
Level
  Ratings
When  Purchased
  Current Ratings   Par Value   Book Value   Estimated
Fair
Current
  Current
Defaults  and
Deferrals
  % of Current
Defaults  and
Deferrals
to Current
Collateral
    Previously
Recognized
Cumulative
Other
Comprehensive

Loss (1)
   
    Moody’s   Fitch   Moody’s   Fitch                
    (in thousands)

Investment Grade:

 

ALESCO VII A1B

  Senior   Aaa   AAA   A3   A   $ 8,639   $ 7,694   $ 6,534   $ 189,056   30   $ 322  

MMCF II B

  Senior Sub   A3   AA-   Baa2   BB     573     526     522     34,000   27     47  

MMCF III B

  Senior Sub   A3   A-   Baa3   B     695     679     431     27,000   23     16  
                                       
              9,907     8,899     7,487       $ 385  
                                       
                                              Cumulative
Other
Comprehensive
Loss (2)
  Cumulative
OTTI
Related to
Credit Loss
(2)

Other Than Temporarily Impaired:

                       

TPREF FUNDING II

  Mezzanine   A1   A-   Caa3   C     1,500     478     583     115,100   33     780   $ 242

TRAP 2007-XII C1

  Mezzanine   A3   A   Ca   C     2,035     125     321     137,705   28     1,331     579

TRAP 2007-XIII D

  Mezzanine   NR   A-   NR   NR     2,032     —       38     260,250   35     —       2,032

MMC FUNDING XVIII

  Mezzanine   A3   A-   Ca   C     1,035     84     121     99,682   31     481     470

ALESCO V C1

  Mezzanine   A2   A   Ca   C     2,041     557     506     99,442   29     971     513

ALESCO XV C1

  Mezzanine   A3   A-   Ca   C     3,064     29     200     240,100   36     476     2,559

ALESCO XVI C

  Mezzanine   A3   A-   Ca   C     2,042     113     329     147,250   29     749     1,180
                                           
              13,749     1,386     2,098       $ 4,788   $ 7,575
                                           

Total

            $ 23,656   $ 10,285   $ 9,585        
                                   

 

(1) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion
(2) Pre-tax

We have evaluated each of these securities for potential impairment under ASC 325, and have reviewed each of the issues’ collateral participants using various techniques including the ratings provided in the Bank Financial Quarterly published by IDC Financial Publishing, Inc. We have also reviewed the interest and principal coverage of each of the tranches we own. In performing a detailed cash flow analysis of each security, we work with independent third parties to identify our best estimate of the cash flow estimated to be collected. If this estimate results in a present

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an other than temporary impairment (“OTTI”) is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following assumptions:

 

   

We assume that 1% of the remaining performing collateral will default or defer in the third quarter of 2010 and 50 basis points per annum thereafter.

 

   

We assume recoveries of 25% with a two year lag on all defaults and deferrals.

 

   

We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security.

 

   

Our securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve plus original spread to discount projected cash flows to present values.

These assumptions resulted in no OTTI recognition on the trust preferred securities during the second quarter of 2010.

We also own $1.7 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was downgraded from B to CCC by Standard and Poors in September 2009, and it was downgraded from BBB to CC by Fitch in August 2009. The fair market value is $1.4 million. We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support, determined that an OTTI does exist as of June 30, 2010 in the amount of $3.5 thousand. The assumptions used in the analysis included a 5% prepayment speed, 10% default rate, a 40% loss severity (which is roughly equivalent to the cumulative severity of the past 12 months) and an accounting yield of 4.75%.

The following table presents a roll forward of the credit losses for the trust preferred securities and the residential collateralized mortgage obligation recognized in earnings for the period ended June 30, 2010 (in thousands):

 

Amount of cumulative other-than-temporary impairment related to credit loss prior to January 1, 2010

   $ 7,714

Amounts related to credit loss for which another-than-temporary impairment was not previously recognized

     10
      

Amount of cumulative other-than-temporary impairment related to credit loss as of June 30, 2010

   $ 7,724
      

4. LOANS AND ALLOWANCE FOR LOAN LOSSES

The following table summarizes the composition of our loan portfolio as of June 30, 2010 and December 31, 2009:

 

     Covered Loans    Non-covered
Loans
    Total Loans     Covered Loans    Non-covered
Loans
    Total
Loans
 
     June 30, 2010     December 31, 2009  

Mortgage loans on real estate:

              

Commercial

   $ 20,025    $ 152,918      $ 172,943      $ 24,494    $ 146,295      $ 170,789   

Construction loans to residential builders

     —        1,614        1,614        —        5,436        5,436   

Other construction and land loans

     1,342      42,892        44,234        3,498      42,564        46,062   

Residential 1-4 family

     32,189      62,751        94,940        33,815      61,024        94,839   

Multi- family residential

     2,532      13,723        16,255        2,570      10,726        13,296   

Home equity lines of credit

     42,928      11,421        54,349        44,235      10,532        54,767   
                                              

Total real estate loans

     99,016      285,319        384,335        108,612      276,577        385,189   

Commercial loans

     2,316      74,603        76,919        3,184      70,757        73,941   

Consumer loans

     160      2,504        2,664        193      3,528        3,721   
                                              

Gross loans

     101,492      362,426        463,918        111,989      350,862        462,851   

Less unearned income on loans

     —        (522     (522     —        (564     (564
                                              

Loans, net of unearned income

   $ 101,492    $ 361,904      $ 463,396      $ 111,989    $ 350,298      $ 462,287   
                                              

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

As part of the Greater Atlantic acquisition, the Bank and the FDIC entered into a loss sharing agreement on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans.”

The covered loans acquired in the Greater Atlantic transaction are and will continue to be subject to our internal and external credit review. As a result, if and when credit deterioration is noted subsequent to the acquisition date, such deterioration will be measured through our loss reserving methodology and a provision for credit losses will be charged to earnings with a partially offsetting noninterest income item reflecting the increase to the FDIC indemnification asset. There has been no provision recorded on covered loans since acquisition.

The following summarizes activity in the allowance for loan losses for the six months ended June 30, 2010 and 2009 (in thousands):

 

     2010     2009  

Balance, beginning of period

   $ 5,172      $ 4,218   

Provision charged to operations

     2,750        1,025   

Recoveries credited to allowance

     98        84   
                

Total

     8,020        5,327   

Loans charged off

     (2,577     (756
                

Balance, end of period

   $ 5,443      $ 4,571   
                

Non-covered loans identified as impaired in accordance with ASC 310 totaled $1.9 million with allocated allowance for loan losses in the amount of $507 thousand as of June 30, 2010. This compares to $4.2 million of impaired loans with allocated allowance for loan losses in the amount of $554 thousand at December 31, 2009. Nonaccrual loans were $1.9 million and $4.2 million at June 30, 2010 and December 31, 2009, respectively. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.

Covered loans identified as impaired in accordance with ASC 310 totaled $5.5 million as of June 30, 2010 and $4.9 million at December 31, 2009. Nonaccrual loans were $3.0 million and $5.1 million at June 30, 2010 and December 31, 2009, respectively. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

5. FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

SNBV is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit and funding risk in excess of the amount recognized in the consolidated balance sheet. Letters of credit are written conditional commitments issued by SNBV to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling $3.9 million and $3.8 million as of June 30, 2010 and December 31, 2009, respectively.

Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer’s creditworthiness on a case-by-case basis.

At June 30, 2010 and December 31, 2009, we had unfunded lines of credit and undisbursed construction loan funds totaling $115.0 million and $121.7 million, respectively. Our approved loan commitments were $7.2 million and $850 thousand at June 30, 2010 and December 31, 2009, respectively.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

6. EARNINGS PER SHARE

The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (dollars in thousands, except per share data):

 

     Income
(Numerator)
   Weighted
Average
Shares
(Denominator)
   Per
Share
Amount

For the three months ended June 30, 2010

        

Basic EPS

   $ 1,025    11,590    $ 0.09

Effect of dilutive stock options and warrants

     —      4      —  
                  

Diluted EPS

   $ 1,025    11,594    $ 0.09
                  

For the three months ended June 30, 2009

        

Basic EPS

   $ 23    6,799    $ 0.00

Effect of dilutive stock options and warrants

     —      —        —  
                  

Diluted EPS

   $ 23    6,799    $ 0.00
                  

For the six months ended June 30, 2010

        

Basic EPS

   $ 2,066    11,590    $ 0.18

Effect of dilutive stock options and warrants

     —      4      —  
                  

Diluted EPS

   $ 2,066    11,594    $ 0.18
                  

For the six months ended June 30, 2009

        

Basic EPS

   $ 549    6,799    $ 0.08

Effect of dilutive stock options and warrants

     —      —        —  
                  

Diluted EPS

   $ 549    6,799    $ 0.08
                  

There were 411,719 and 412,432 anti-dilutive options and warrants during the three and six months ended June 30, 2010, respectively, and there were 397,925 anti-dilutive options and warrants during the three and six months ended June 30, 2009.

7. FAIR VALUE

ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability

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

Securities Available for Sale

Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

characteristics, or discounted cash flow. Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of SNBV’s available-for-sale debt securities are considered to be level 2 securities.

Assets measured at fair value on a recurring basis are summarized below:

 

          Fair Value Measurements Using
(dollars in thousands)    Total at
June 30, 2010
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Financial assets:

           

Available for sale securities

           

Residential government-sponsored mortgage-backed securities

   $ 4,908    $ —      $ 4,908    $ —  

SBA guaranteed loan pools

     12,628      —        12,628      —  

FHLMC preferred stock

     22      22      —        —  
                           

Total available-for-sale securities

   $ 17,558    $ 22    $ 17,536    $ —  
                           
          Fair Value Measurements Using
(dollars in thousands)    Total at
December 31, 2009
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Financial assets:

           

Available for sale securities

           

Residential government-sponsored mortgage-backed securities

   $ 4,914    $ —      $ 4,914    $ —  

SBA guaranteed loan pools

     13,550      —        13,550      —  

FHLMC preferred stock

     41      41      —        —  
                           

Total available-for-sale securities

   $ 18,505    $ 41    $ 18,464    $ —  
                           

Assets and Liabilities Measured on a Non-recurring Basis:

Trust Preferred Securities Classified as Held-to-Maturity

Management utilized guidance in ASC 820-10 to value these securities. The base input in calculating fair value is a Bloomberg Fair Value Index yield curve for single issuer trust preferred securities which correspond to the ratings of the securities we own. We also use composite rating indices to fill in the gaps where the bank rating indices did not correspond to the ratings in our portfolio. When a bank index that matches the rating of our security is not available, we used the bank index that most closely matches the rating, adjusted by the spread between the composite index that most closely matches the security’s rating and the composite index with a rating that matches the bank index used. Then, we use the adjusted index yield, which is further adjusted by a liquidity premium, as the discount rate to be used in the calculation of the present value of the same cash flows used to evaluate the securities for OTTI. The liquidity premiums were derived in consultation with a securities advisor. The liquidity premiums we used ranged from .25% to 5%, and the adjusted discount rates ranged from 6.40% to 16.41%. Due to current market conditions as well as the limited trading activity of these securities, the market value of the securities is highly sensitive to assumption changes and market volatility. We have determined that our trust preferred securities are classified within Level 3 of the fair value hierarchy.

Based on our analysis in the first six months of 2010, there were no OTTI charges on trust preferred securities. There were OTTI charges on trust preferred securities totaling $863 thousand during the first six months of 2009.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

Other Residential Collateralized Mortgage Obligation Classified as Held-to Maturity

The fair value was estimated within Level 2 fair value hierarchy, as the fair value is based on either pricing models, quoted market prices of securities with similar characteristics, or discounted cash flows. We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support. The assumptions used in the analysis included a 5% prepayment speed, 10% default rate, a 40% loss severity and an accounting yield of 4.75%. Based on this analysis, an OTTI existed as of June 30, 2010 in the amount of $3.5 thousand. There was an OTTI on this security in the amount of $10 thousand for the six months ended June 30, 2010, and there was no OTTI for the same period last year.

Other Securities Classified as Held-to-Maturity

Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of securities with similar characteristics, or discounted cash flow. Level 2 securities would include U. S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, securities are classified within level 3 of the valuation hierarchy. Currently, all of SNBV’s other securities classified as held-to-maturity are considered to be level 2 securities.

Impaired Loans

ASC 820-10 applies to loans measured for impairment using the practical expedients permitted by ASC 310 at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. Fair value is classified as Level 3 in the fair value hierarchy. Non-covered loans identified as impaired in accordance with ASC 310 totaled $1.9 million as of June 30, 2010 with an allocated allowance for loan losses totaling $507 thousand compared to a carrying amount of $4.2 million with an allocated allowance for loan losses totaling $554 thousand at December 31, 2009. Provision expense related to the impaired loans at June 30, 2010 totaled $30 thousand and $430 thousand during the three and six months ended June 30, 2010. Provision expense related to impaired loans totaled $140 thousand during the three and six months ended June 30, 2009.

Other Real Estate Owned (OREO)

OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or internal market evaluation less cost to sell. OREO is further evaluated quarterly for any additional impairment. Fair value is classified as Level 3 in the fair value hierarchy.

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

Assets measured at fair value on a non-recurring basis are summarized below:

 

          Fair Value Measurements Using
(dollars in thousands)    Total at
June 30,  2010
   Quoted Prices in
Active  Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Other residential collateralized mortgage obligations

   $ 1,424    $ —      $ 1,424    $ —  

Impaired non-covered loans

     1,362      —        —        1,362
          Fair Value Measurements Using
(dollars in thousands)    Total at
December 31,  2009
   Quoted Prices in
Active Markets for
Identical Assets
(Level 1)
   Significant
Other
Observable
Inputs
(Level 2)
   Significant
Unobservable
Inputs
(Level 3)

Trust preferred securities, held to maturity

   $ 1,378    $ —      $ —      $ 1,378

Other residential collateralized mortgage obligations

     1,577      —        1,577      —  

Impaired non-covered loans

     3,636      —        —        3,636

Impaired covered loans

     4,933      —        —        4,933

Non-covered other real estate owned

     2,797      —        —        2,797

Covered other real estate owned

     740      —        —        740

Fair Value of Financial Instruments

The carrying amount and estimated fair values of financial instruments were as follows (in thousands):

 

     June 30, 2010    December 31, 2009
     Carrying
Amount
   Fair
Value
   Carrying
Amount
   Fair
Value

Financial assets:

           

Cash and cash equivalents

   $ 11,049    $ 11,049    $ 8,070    $ 8,070

Securities available for sale

     17,558      17,558      18,505      18,505

Securities held to maturity

     52,530      53,746      57,696      57,841

Stock in Federal Reserve Bank and Federal Home Loan Bank

     6,775      n/a      5,940      n/a

Net uncovered loans

     356,461      358,312      345,126      348,978

Net covered loans

     101,492      102,138      111,989      111,989

Accrued interest receivable

     2,299      2,299      2,167      2,167

FDIC indemnification asset

     18,758      18,758      19,408      19,408

Financial liabilities:

           

Deposits:

           

Demand deposits

     47,871      47,871      50,838      50,838

Money market and savings accounts

     169,818      169,818      134,529      134,529

Certificates of deposit

     238,026      240,221      270,424      272,073

Securities sold under agreements to repurchase and other short-term borrowings

     20,374      20,374      22,020      22,020

FHLB advances

     35,000      35,629      30,000      30,441

Accrued interest payable

     438      438      753      753

 

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)—Continued

June 30, 2010

 

Carrying amount is the estimated fair value for cash and cash equivalents, accrued interest receivable and payable, demand deposits, short-term debt, and variable rate loans that reprice frequently and fully. For fixed rate loans or deposits and for variable rate loans with infrequent repricing or repricing limits, fair value is based on discounted cash flows using current market rates applied to the estimated life. It was not practicable to determine the fair value of Federal Reserve Bank and Federal Home Loan Bank stock due to restrictions placed on its transferability. Fair value of long-term debt is based on current rates for similar financing. The FDIC indemnification asset was measured at estimated fair value on the date of acquisition. The fair value was determined by discounting estimated future cash flows using the long-term risk free rate plus a premium. Subsequent additions to the asset are valued at par as it is anticipated that these amounts will be shortly received. The fair value of off-balance-sheet items is not considered material.

 

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ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of SNBV. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report on Form 10-K for the year ended December 31, 2009. Results of operations for the three and six month periods ended June 30, 2010 are not necessarily indicative of results that may be attained for any other period.

SPECIAL CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” and similar words, or the negatives of these words, are intended to identify forward-looking statements.

Many possible events or factors could affect our future financial results and performance and could cause our actual results to differ materially from the expectations of future results we express or imply in any forward-looking statements. In addition to the Risk Factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2009, factors that could contribute to those differences include, but are not limited to:

 

   

our limited operating history;

 

   

changes in the strength of the United States economy in general and the local economies in our market areas adversely affect our customers and their ability to transact profitable business with us, including the ability of our borrowers to repay their loans according to their terms or a change in the value of the related collateral;

 

   

changes in the availability of funds resulting in increased costs or reduced liquidity;

 

   

our reliance on brokered deposits;

 

   

a deterioration or downgrade in the credit quality and credit agency ratings of the securities in our securities portfolio;

 

   

impairment concerns and risks related to our investment portfolio of collateralized mortgage obligations, agency mortgage-backed securities and pooled trust preferred securities;

 

   

the incurrence and possible impairment of goodwill associated with an acquisition and possible adverse short-term effects on our results of operations;

 

   

increased credit risk in our assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of our total loan portfolio;

 

   

the concentration of our loan portfolio in loans collateralized by real estate;

 

   

our level of construction and land development and commercial real estate loans;

 

   

changes in the levels of loan prepayments and the resulting effects on the value of our loan portfolio;

 

   

the failure of assumptions underlying the establishment of and provisions made to the allowance for loan losses;

 

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our ability to expand and grow our business and operations, including the establishment of additional branches and acquisition of additional branches and banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities;

 

   

changes in interest rates and market prices, which could reduce our net interest margins, asset valuations and expense expectations;

 

   

increased competition for deposits and loans adversely affecting rates and terms;

 

   

increases in FDIC deposit insurance premiums and assessments;

 

   

the continued service of key management personnel;

 

   

increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;

 

   

our ability to acquire, operate and maintain cost effective and efficient systems without incurring unexpectedly difficult or expensive but necessary technological changes; and

 

   

fiscal and governmental policies of the United States federal government.

Forward-looking statements are not guarantees of performance or results. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We believe we have chosen these assumptions or bases in good faith and that they are reasonable. We caution you, however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. When considering forward-looking statements, you should keep in mind the risk factors and other cautionary statements in this prospectus. These statements speak only as of the date of this Quarterly Report on Form 10-Q. Except as required by applicable law, we undertake no obligation to update publicly these statements in light of new information or future events.

OVERVIEW

Southern National Bancorp of Virginia, Inc. (“SNBV”) is a corporation formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank (“Sonabank”) a Virginia state bank. Sonabank was originally chartered as a national bank under the laws of the United States of America on April 14, 2005. On January 1, 2009, Sonabank converted from a nationally chartered bank to a state chartered bank and moved its headquarters from Charlottesville to McLean, Virginia. Sonabank is now regulated by the State Corporation Commission of Virginia and the Federal Reserve Bank of Richmond. Sonabank conducts full-service banking operations in Charlottesville, Clifton Forge, Leesburg, Warrenton, New Market, Front Royal, South Riding and Fairfax County in Virginia and in Rockville, Maryland. We also have loan production offices in Charlottesville, Fredericksburg, Warrenton and Richmond in Virginia. We have administrative offices in Warrenton and an executive office in Georgetown, Washington, D.C where senior management is located.

RESULTS OF OPERATIONS

Net Income

Net income for the quarter ended June 30, 2010 was $1.0 million and $2.1 million for the six months ended June 30, 2010, compared to $23 thousand and $549 thousand during the second quarter and the first six months of 2009. Earnings in the three and six months ended June 30, 2010 were positively affected by the Greater Atlantic Bank and Millennium loan purchase transactions. Earnings in the second quarter and first half of 2009 were adversely impacted by OTTI charges of $863 thousand before tax on several of Sonabank’s trust preferred securities. There were no OTTI charges on the trust preferred securities during the first six months of 2010.

 

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Net Interest Income

Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings.

Net interest income for the three months ended June 30, 2010 was $6.4 million compared to $3.5 million for the same period last year. Average interest-earning assets for the three months ended June 30, 2010 increased $150.4 million over the same period in 2009. Average loans outstanding increased by $140.9 million in the second quarter of 2010 compared to the second quarter of 2009. Average investment securities increased by $8.2 million in the quarter ended June 30, 2010, compared to the same period last year. The average yield on interest-earning assets increased from 5.60% in 2009 to 6.25% in 2010. Average interest-bearing liabilities for the three months ended June 30, 2010 increased $132.4 million compared to the same period in 2009. Average interest-bearing deposits increased by $126.9 million, while average borrowings increased by $5.5 million compared to the second quarter of 2009. The average cost of interest-bearing liabilities decreased from 2.44% in 2009 to 1.79% in 2010. The interest rate spread for the three months ended June 30, 2010 increased from 3.16% to 4.46% compared to the same period last year. The net interest margin for the three months ended June 30, 2010 increased to 4.70% from 3.51% compared to the same period last year.

Net interest income for the six months ended June 30, 2010 was $12.7 million compared to $6.5 million for the same period last year. Average interest-earning assets for the six months ended June 30, 2010 increased $152.0 million over the same period in 2009. Average loans outstanding increased by $145.4 million in the first half of 2010 compared to the first six months of 2009. Average investment securities increased by $7.8 million in the six months ended June 30, 2010, compared to the same period last year. The average yield on interest-earning assets increased from 5.58% in 2009 to 6.22% in 2010. Average interest-bearing liabilities for the six months ended June 30, 2010 increased $135.7 million compared to the same period in 2009. Average interest-bearing deposits increased by $131.2 million, while average borrowings increased by $4.5 million compared to the first six months of 2009. The average cost of interest-bearing liabilities decreased from 2.64% in 2009 to 1.80% in 2010. The interest rate spread for the six months ended June 30, 2010 increased from 2.94% to 4.42% compared to the same period last year. The net interest margin for the six months ended June 30, 2010 increased to 4.66% from 3.32% compared to the same period last year.

The significant improvement in the net interest income was attributable to:

 

   

The impact of the Greater Atlantic Bank and Millennium loan purchase transactions. The accretion of the discount on the Greater Atlantic Bank loans contributed $635 thousand to second quarter net interest income and $1.3 million to net interest income for the six months ended June 30, 2010.

 

   

The bottoming of the decline in interest rates in the first quarter of 2009. The prime rate was 3.25% at the end of the first quarter of 2009 and it remained at that level at the end of the second quarter of 2010.

 

   

Our practice of establishing floor rates on loans as they mature or roll over notwithstanding the index rates. On non-SBA loans we have been establishing floors ranging from 6% to 7  1 / 2 %.

 

   

The cost of funds decreased from 1.81% in the first quarter of 2010 to 1.79% in the second quarter despite the implementation of a strategy of encouraging customers to purchase certificates of deposit (cds) with longer maturities to protect against possible future rises in interest rates. In addition, there has been a change in the deposit mix from cds into money market accounts which have a lower cost of funds.

 

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We have reduced rates on deposit accounts as much as we can without harming relationships. Moreover, we are concerned with the probability that rates will rise and to the extent possible have positioned ourselves for this eventuality.

The following table details average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:

 

     Average Balance Sheets and Net Interest
Analysis For the Quarters Ended
 
     6/30/2010     6/30/2009  
     Average
Balance
    Interest
Income/
Expense
   Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
   Yield/
Rate
 
     (Dollar amounts in thousands)  

Assets

              

Interest-earning assets:

              

Loans, net of unearned income (1) (2)

   $ 461,725      $ 7,829    6.80   $ 320,873      $ 4,860    6.08

Investment securities

     71,890        684    3.81     63,729        675    4.24

Other earning assets

     15,892        48    1.21     14,478        36    1.00
                                  

Total earning assets

     549,507        8,561    6.25     399,080        5,571    5.60
                      

Allowance for loan losses

     (5,812          (4,492     

Total non-earning assets

     68,490             41,683        
                          

Total assets

   $ 612,185           $ 436,271        
                          

Liabilities and stockholders’ equity

              

Interest-bearing liabilities:

              

NOW accounts

   $ 15,513        11    0.29   $ 6,959        2    0.10

Money market accounts

     171,355        707    1.65     48,225        191    1.59

Savings accounts

     5,033        9    0.68     2,248        3    0.55

Time deposits

     227,439        1,063    1.87     234,991        1,568    2.68
                                  

Total interest-bearing deposits

     419,340        1,790    1.71     292,423        1,764    2.42

Borrowings

     55,118        330    2.40     49,624        317    2.56
                                  

Total interest-bearing liabilities

     474,458        2,120    1.79     342,047        2,081    2.44
                      

Noninterest-bearing liabilities:

              

Demand deposits

     33,150             22,341        

Other liabilities

     6,568             2,221        
                          

Total liabilities

     514,176             366,609        

Stockholders’ equity

     98,009             69,662        
                          

Total liabilities and stockholders’ equity

   $ 612,185           $ 436,271        
                          

Net interest income

       6,441          3,490   
                      

Interest rate spread

        4.46        3.16

Net interest margin

        4.70        3.51

 

(1) Includes loan fees in both interest income and the calculation of the yield on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.

 

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Table of Contents
     Average Balance Sheets and Net Interest
Analysis For the Six Months Ended
 
     6/30/2010     6/30/2009  
     Average
Balance
    Interest
Income/
Expense
   Yield/
Rate
    Average
Balance
    Interest
Income/
Expense
   Yield/
Rate
 
     (Dollar amounts in thousands)  

Assets

              

Interest-earning assets:

              

Loans, net of unearned income (1) (2)

   $ 460,503      $ 15,443    6.76   $ 315,063      $ 9,464    6.06

Investment securities

     73,372        1,418    3.87     65,618        1,456    4.44

Other earning assets

     15,341        91    1.20     16,500        77    0.94
                                  

Total earning assets

     549,216        16,952    6.22     397,181        10,997    5.58
                      

Allowance for loan losses

     (5,554          (4,376     

Total non-earning assets

     70,263             41,898        
                          

Total assets

   $ 613,925           $ 434,703        
                          

Liabilities and stockholders’ equity

              

Interest-bearing liabilities:

              

NOW accounts

   $ 15,371        23    0.30   $ 7,366        4    0.10

Money market accounts

     158,959        1,340    1.70     49,438        391    1.59

Savings accounts

     4,852        16    0.66     2,135        4    0.39

Time deposits

     241,900        2,214    1.85     230,933        3,432    3.00
                                  

Total interest-bearing deposits

     421,082        3,593    1.72     289,872        3,831    2.67

Borrowings

     55,289        657    2.40     50,809        630    2.50
                                  

Total interest-bearing liabilities

     476,371        4,250    1.80     340,681        4,461    2.64
                      

Noninterest-bearing liabilities:

              

Demand deposits

     33,344             22,592        

Other liabilities

     6,653             1,984        
                          

Total liabilities

     516,368             365,257        

Stockholders’ equity

     97,557             69,446        
                          

Total liabilities and stockholders’ equity

   $ 613,925           $ 434,703        
                          

Net interest income

     $ 12,702        $ 6,536   
                      

Interest rate spread

        4.42        2.94

Net interest margin

        4.66        3.32

 

(1) Includes loan fees in both interest income and the calculation of the yield on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.

Provision for Loan Losses

The provision for loan losses is a current charge to earnings made in order to increase the allowance for loan losses to a level deemed appropriate by management based on an evaluation of the loan portfolio, current economic conditions, changes in the nature and volume of lending, historical loan loss experience and other known internal and external factors affecting loan collectability. Our loan loss allowance is calculated by segmenting the loan portfolio by loan type and applying risk factors to each segment. The risk factors are determined by considering peer data, internal and external factors affecting loan collectability, as well as applying management’s judgment.

The provision for loan losses was $1.5 million for the quarter ended June 30, 2010 compared to $545 thousand for the second quarter of 2009. For the six months ended June 30, 2010, the provision for loan losses was $2.8 million compared to $1.0 million for the same period last year.

Net charge-offs during the second quarter were $1.4 million and $2.5 million for the first half of 2010 compared to $435 thousand and $672 thousand during the same periods in 2009 as credit quality continued to be a challenge for our loan portfolio. $1.0 million of the second quarter charge-offs related to a commercial property that was charged down to the appraised value contained in a new appraisal report dated May 25, 2010.

 

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Noninterest Income

The following table presents the major categories on noninterest income for the three and six months ended June 30, 2010 and 2009:

 

     For the Three Months Ended
June 30,
 
     2010     2009     Change  
     (dollars in thousands)  

Account maintenance and deposit service fees

   $ 235      $ 138      $ 97   

Income from bank-owned life insurance

     137        140        (3

Net gain on other real estate owned

     19        30        (11

Net impairment losses recognized in earnings

     (4     (863     859   

Other

     148        53        95   
                        

Total noninterest income (loss)

   $ 535      $ (502   $ 1,037   
                        
     For the Six Months Ended
June 30,
 
     2010     2009     Change  
     (dollars in thousands)  

Account maintenance and deposit service fees

   $ 476      $ 270      $ 206   

Income from bank-owned life insurance

     276        288        (12

Net gain on other real estate owned

     39        117        (78

Net impairment losses recognized in earnings

     (10     (863     853   

Gain on securities

     —          223        (223

Other

     293        57        236   
                        

Total noninterest income

   $ 1,074      $ 92      $ 982   
                        

During the second quarter of 2010 Sonabank had noninterest income of $535 thousand compared to noninterest loss of $502 thousand during the second quarter of 2009. Noninterest income for the second quarter of 2010 included account maintenance and deposit service fees of $235 thousand compared to $138 thousand for the same period last year resulting from the increased number of deposit accounts acquired from the Greater Atlantic Bank and Millennium Branch acquisitions. Other noninterest income included fees in the amount of $105 thousand earned on short-term letters of credit which expired in June 2010 for the three months ended June 30, 2010, compared to $0 for the same period last year. The second quarter of 2009 included OTTI charges of $863 thousand.

Noninterest income increased to $1.1 million in the first six months of 2010 from $92 thousand in the first six months of 2009. Noninterest income for the first six months of 2010 included account maintenance and deposit service fees of $476 thousand compared to $270 thousand for the same period last year resulting from the increased number of deposit accounts acquired from the Greater Atlantic Bank and Millennium Branch acquisitions. Other noninterest income included fees in the amount of $227 thousand earned on short-term letters of credit which expired in June 2010 for the six months ended June 30, 2010, compared to $1 thousand for the same period last year. During the six months ended June 30, 2009, we recognized OTTI charges in the amount of $863 thousand, partially offset by a gain on the sale of available-for-sale securities in the amount of $223 thousand.

 

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Noninterest Expense

The following table presents the major categories on noninterest expense for the three and six months ended June 30, 2010 and 2009:

 

     For the Three Months Ended
June 30,
 
     2010    2009    Change  
     (dollars in thousands)  

Salaries and benefits

   $ 1,523    $ 936    $ 587   

Occupancy expenses

     527      387      140   

Furniture and equipment expenses

     151      125      26   

Amortization of core deposit intangible

     236      182      54   

Virginia franchise tax expense

     184      140      44   

FDIC assessment

     212      313      (101

Data processing expense

     159      79      80   

Telephone and communication expense

     101      63      38   

Decrease in FDIC indemnification asset

     406      —        406   

Other operating expenses

     528      249      279   
                      

Total noninterest expense

   $ 4,027    $ 2,474    $ 1,553   
                      
     For the Six Months Ended
June 30,
 
     2010    2009    Change  
     (dollars in thousands)  

Salaries and benefits

   $ 3,164    $ 1,999    $ 1,165   

Occupancy expenses

     1,069      774      295   

Furniture and equipment expenses

     305      246      59   

Amortization of core deposit intangible

     472      363      109   

Virginia franchise tax expense

     368      282      86   

FDIC assessment

     401      487      (86

Data processing expense

     314      159      155   

Telephone and communication expense

     220      128      92   

Decrease in FDIC indemnification asset

     650      —        650   

Other operating expenses

     1,042      469      573   
                      

Total noninterest expense

   $ 8,005    $ 4,907    $ 3,098   
                      

Noninterest expenses were $4.0 million and $8.0 million during the second quarter and the first half of 2010, respectively, compared to $2.5 million and $4.9 million during the same periods in 2009. The decrease in the FDIC indemnification asset resulting from loans identified with evidence of credit deterioration at acquisition that paid off in 2010 added $406 thousand during the second quarter and $650 thousand during the first half of 2010 to noninterest expense. The amortization of the Greater Atlantic Bank core deposit intangible added $50 thousand during the second quarter and $100 thousand during the first half of 2010. The remaining increases were primarily attributable to the costs of operating a thirteen branch system rather than an eight branch system. At June 30, 2010, we had 107 full-time equivalent employees compared to 64 at June 30, 2009. FDIC assessment expense decreased by $101 thousand during the second quarter

 

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of 2010 compared to the same period last year, and it decreased by $86 thousand for the six months ended June 30, 2010 compared to last year. The FDIC assessment expense for 2009 included a special assessment in the amount of $190 thousand in the second quarter. The lack of a special assessment in 2010 was offset by the growth in deposits primarily from the Greater Atlantic Bank and Millennium branch acquisitions. Data processing, on-line banking and ATM-related expenses increased by $112 thousand for the second quarter and $252 thousand for the six months ended June 30, 2010, compared to the same periods last year. Virginia franchise tax expense increased by $44 thousand and $86 thousand for the quarter and the first six months of 2010, respectively, compared to last year. Consulting and legal expense also increased by $50 thousand and $107 thousand for the three and six months ended June 30, 2010, respectively, compared to the same periods last year.

Despite the costs associated with the acquisitions of Greater Atlantic Bank and the Millennium Branch, noninterest expenses were well controlled, and our efficiency ratio improved to 53.5% in the first half of 2010 compared to 68.6% in the same period last year.

FINANCIAL CONDITION

Balance Sheet Overview

Total assets of Southern National Bancorp of Virginia were $613.2 million as of June 30, 2010 up from $610.7 million as of December 31, 2009. Net loans receivable increased from $457.1 million at the end of 2009 to $458.0 million at June 30, 2010. Two large loans in the non-covered portfolio totaling approximately $6.4 million were paid off, one on a project completed and refinanced and the other as a result of our borrower being acquired by a larger company. Loans in the amount of $2.4 million were transferred from the non-covered loan portfolio to OREO. There were also principal repayments in the covered portfolio acquired in the Greater Atlantic transaction, including large repayments on three loans totaling approximately $3.2 million.

The increase in bank premises and equipment was due to the purchase of certain fixed assets of Greater Atlantic from the FDIC in the amount of $1.6 million.

Total deposits were $455.7 million at June 30, 2010 compared to $455.8 million at December 31, 2009. Brokered certificates of deposit decreased from $70.0 million as of December 31, 2009 to $50.0 million at June 30, 2010, while other certificates of deposit decreased by $12.4 million. Money market accounts increased by $34.6 million during the six months ended June 30, 2010. Noninterest-bearing deposits were $33.4 million at June 30, 2010 and $33.3 million at December 31, 2009.

Loan Portfolio

As part of the Greater Atlantic acquisition, the Bank and the FDIC entered into a loss sharing agreement on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.” Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans.”

The following table summarizes the composition of our loan portfolio as of June 30, 2010 and December 31, 2009:

 

     Covered Loans    Non-covered Loans     Total Loans     Covered Loans    Non-covered Loans     Total Loans  
     June 30, 2010     December 31, 2009  

Mortgage loans on real estate:

              

Commercial

   $ 20,025    $ 152,918      $ 172,943      $ 24,494    $ 146,295      $ 170,789   

Construction loans to residential builders

     —        1,614        1,614        —        5,436        5,436   

Other construction and land loans

     1,342      42,892        44,234        3,498      42,564        46,062   

Residential 1-4 family

     32,189      62,751        94,940        33,815      61,024        94,839   

Multi- family residential

     2,532      13,723        16,255        2,570      10,726        13,296   

Home equity lines of credit

     42,928      11,421        54,349        44,235      10,532        54,767   
                                              

Total real estate loans

     99,016      285,319        384,335        108,612      276,577        385,189   

Commercial loans

     2,316      74,603        76,919        3,184      70,757        73,941   

Consumer loans

     160      2,504        2,664        193      3,528        3,721   
                                              

Gross loans

     101,492      362,426        463,918        111,989      350,862        462,851   

Less unearned income on loans

     —        (522     (522     —        (564     (564
                                              

Loans, net of unearned income

   $ 101,492    $ 361,904      $ 463,396      $ 111,989    $ 350,298      $ 462,287   
                                              

 

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Asset Quality

We will generally place a loan on nonaccrual status when it becomes 90 days past due. Loans will also be placed on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Cash payments received while a loan is categorized as nonaccrual will be recorded as a reduction of principal as long as doubt exists as to future collections.

In accordance with regulatory guidance we obtain appraisals, prior to closing, on all real estate loans. In the event that a real estate loan becomes non-performing or a problem loan, collateral fair market value is reassessed either by obtaining a new appraisal or an internal evaluation, and our exposure is reduced, if necessary, to fair market value, less cost to sell, either through a charge off or by establishing a specific reserve. In accordance with regulatory guidance a new appraisal is obtained in the event of foreclosure and we record other real estate owned at the lower of our recorded investment in the loan or fair value less our estimated costs to sell.

Our loss and delinquency experience on our loan portfolio has been limited by a number of factors, including our underwriting standards and the relatively short period of time since the loans were originated. Whether our loss and delinquency experience in the area of our portfolio will increase significantly depends upon the value of the real estate securing loans and economic factors such as the overall economy of the region.

Non-covered Loans and Assets

Non-covered loans identified as impaired in accordance with ASC 310 totaled $1.9 million with allocated allowance for loan losses in the amount of $507 thousand as of June 30, 2010. This compares to $4.2 million of impaired loans with allocated allowance for loan losses in the amount of $554 thousand at December 31, 2009. Nonaccrual loans were $1.9 million and $4.2 million at June 30, 2010 and December 31, 2009, respectively. The decrease in impaired and nonaccrual loans is due to the transfer of a commercial real estate loan in the amount of $1.9 million from loans to OREO and additional charge offs totaling $400 thousand on commercial loans that were impaired at December 31, 2009. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.

Non-covered nonperforming assets decreased slightly from $7.0 million at December 31, 2009 to $6.9 million at June 30, 2010.

There was a migration from non-accrual loans to OREO during the quarter as Sonabank foreclosed on one commercial property and two residential properties in the non-covered portfolio. The rest of our non-covered OREO balance continues to be comprised of one property, which contains 33 finished 2 to 4 acre lots in Culpeper, Virginia. There are no new developments on that property. We continue to monitor the fair value of this property to ensure our carrying value is realizable.

 

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Sonabank has an internal loan review and a loan committee, both of which provide on-going monitoring to identify and address issues with problem loans. The loan loss provision is determined after consideration of all known relevant internal and external factors affecting loan collectability to maintain the allowance for loan and lease losses at a level necessary to absorb estimated credit losses. We believe the allowance for loan losses is sufficient to cover probable incurred credit losses at June 30, 2010.

The following table sets forth selected asset quality ratios as of the dates indicated:

 

     As of  
     June 30,
2010
    December 31,
2009
 

Allowance for loan losses to total non-covered loans

   1.50   1.48

Non-covered nonperforming assets to total non-covered assets

   1.35   1.40

Non-covered nonperforming assets total non-covered loans

   1.91   1.99

Covered Loans and Assets

Covered loans identified as impaired in accordance with ASC 310 totaled $5.5 million as of June 30, 2010 and $4.9 million at December 31, 2009. Nonaccrual loans were $3.0 million and $5.1 million at June 30, 2010 and December 31, 2009, respectively. At June 30, 2010 and December 31, 2009, there were no loans past due 90 days or more and accruing interest.

In the Greater Atlantic covered OREO portfolio we have a property with several apartment units in Georgia with a current carrying value of $197 thousand. Two single family residential properties in the amount of $271 thousand in the covered portfolio have been sold at an immaterial gain.

Securities

Investment securities, available for sale and held to maturity, were $70.1 million at June 30, 2010 and $76.2 million at December 31, 2009.

 

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As of June 30, 2010 we owned pooled trust preferred securities as follows:

 

Security

  Tranche
Level
  Ratings                      

Current

  % of
Current
Defaults
and
Deferrals
    Previously
Recognized
Cumulative
   
    When   Current           Estimated   Defaults   to     Other    
    Purchased   Ratings   Par   Book   Fair   and   Current     Comprehensive  
    Moody’s   Fitch   Moody’s   Fitch   Value   Value   Value   Deferrals   Collateral     Loss (1)  
        (in thousands)  

Investment Grade:

     

ALESCO VII A1B

  Senior   Aaa   AAA   A3   A   $ 8,639   $ 7,694   $ 6,534   $ 189,056   30   $ 322  

MMCF II B

  Senior Sub   A3   AA-   Baa2   BB     573     526     522     34,000   27     47  

MMCF III B

  Senior Sub   A3   A-   Baa3   B     695     679     431     27,000   23     16  
                                       
              9,907     8,899     7,487       $ 385  
                                       
                                              Cumulative
Other
Comprehensive
Loss (2)
  Cumulative
OTTI
Related to
Credit

Loss (2)

Other Than Temporarily Impaired:

                       

TPREF FUNDING II

  Mezzanine   A1   A-   Caa3   C     1,500     478     583     115,100   33     780   $ 242

TRAP 2007-XII C1

  Mezzanine   A3   A   Ca   C     2,035     125     321     137,705   28     1,331     579

TRAP 2007-XIII D

  Mezzanine   NR   A-   NR   NR     2,032     —       38     260,250   35     —       2,032

MMC FUNDING XVIII

  Mezzanine   A3   A-   Ca   C     1,035     84     121     99,682   31     481     470

ALESCO V C1

  Mezzanine   A2   A   Ca   C     2,041     557     506     99,442   29     971     513

ALESCO XV C1

  Mezzanine   A3   A-   Ca   C     3,064     29     200     240,100   36     476     2,559

ALESCO XVI C

  Mezzanine   A3   A-   Ca   C     2,042     113     329     147,250   29     749     1,180
                                           
              13,749     1,386     2,098       $ 4,788   $ 7,575
                                           

Total

            $ 23,656   $ 10,285   $ 9,585        
                                   

 

(1) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion
(2) Pre-tax

We have evaluated each of these securities for potential impairment under ASC 325, and have reviewed each of the issues’ collateral participants using various techniques including the ratings provided in the Bank Financial Quarterly published by IDC Financial Publishing, Inc. We have also reviewed the interest and principal coverage of each of the tranches we own. In performing a detailed cash flow analysis of each security, we work with independent third parties to identify our best estimate of the cash flow estimated to be collected. If this estimate results in a present value of expected cash flows that is less than the amortized cost basis of a security (that is, credit loss exists), an other than temporary impairment (“OTTI”) is considered to have occurred. If there is no credit loss, any impairment is considered temporary. The cash flow analysis we performed included the following assumptions:

 

   

We assume that 1% of the remaining performing collateral will default or defer in the third quarter of 2010 and 50 basis points per annum thereafter.

 

   

We assume recoveries of 25% with a two year lag on all defaults and deferrals.

 

   

We assume no prepayments for 10 years and then 1% per annum for the remaining life of the security.

 

   

Our securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve plus original spread to discount projected cash flows to present values.

These assumptions resulted in no OTTI recognition on the trust preferred securities during the second quarter of 2010.

We also own $1.7 million of SARM 2005-22 1A2. This residential collateralized mortgage obligation was downgraded from B to CCC by Standard and Poors in September 2009, and it was downgraded from BBB to CC by Fitch in August 2009. The fair market value is $1.4 million. We have evaluated this security for potential impairment and, based on our review of the trustee report, shock analysis and current information regarding delinquencies, nonperforming loans and credit support, determined that an OTTI does exist as of June 30, 2010 in the amount of $3.5 thousand. The assumptions used in the analysis included a 5% prepayment speed, 10% default rate, a 40% loss severity (which is roughly equivalent to the cumulative severity of the past 12 months) and an accounting yield of 4.75%.

 

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Liquidity and Funds Management

The objective of our liquidity management is to assure the ability to meet our financial obligations. These obligations include the payment of deposits on demand or at maturity, the repayment of borrowings at maturity and the ability to fund commitments and other new business opportunities. We obtain funding from a variety of sources, including customer deposit accounts, customer certificates of deposit and payments on our loans and investments. Historically, our level of core deposits has been insufficient to fully fund our lending activities. As a result, we have sought funding from additional sources, including institutional certificates of deposit and available-for-sale investment securities. In addition, we maintain lines of credit from the Federal Home Loan Bank of Atlanta and utilize securities sold under agreements to repurchase and reverse repurchase agreement borrowings from approved securities dealers.

We prepare a monthly cash flow report which forecasts weekly cash needs and availability for the coming three months, based on forecasts of loan closings from our pipeline report and other factors.

During the three and six month periods ended June 30, 2010, we funded our financial obligations with deposits, securities sold under agreements to repurchase and borrowings from the Federal Home Loan Bank of Atlanta. At June 30, 2010, we had $115.0 million of unfunded lines of credit and undisbursed construction loan funds. Our approved loan commitments were $7.2 million at June 30, 2010. Management anticipates that funding requirements for these commitments can be met from the normal sources of funds.

Capital Resources

The following table provides a comparison of our leverage and risk-weighted capital ratios and the leverage and risk-weighted capital ratios of the bank at the dates indicated to the minimum and well-capitalized regulatory standards (dollars in thousands):

 

     Actual     Required
For Capital
Adequacy Purposes
    To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
   Amount    Ratio     Amount    Ratio     Amount    Ratio  

June 30, 2010

               

SNBV

               

Tier 1 risk-based capital ratio

   $ 89,891    20.76   $ 17,323    4.00     N/A    N/A   

Total risk-based capital ratio

     95,284    22.00     34,646    8.00     N/A    N/A   

Leverage ratio

     89,891    15.00     23,969    4.00     N/A    N/A   

Sonabank

               

Tier 1 risk-based capital ratio

   $ 86,446    19.97   $ 17,317    4.00   $ 25,976    6.00

Total risk-based capital ratio

     91,838    21.21     34,634    8.00     43,293    10.00

Leverage ratio

     86,446    14.43     23,969    4.00     29,962    5.00

December 31, 2009

               

SNBV

               

Tier 1 risk-based capital ratio

   $ 87,208    17.32   $ 20,146    4.00     N/A    N/A   

Total risk-based capital ratio

     92,380    18.34     40,292    8.00     N/A    N/A   

Leverage ratio

     87,208    17.37     20,084    4.00     N/A    N/A   

Sonabank

               

Tier 1 risk-based capital ratio

   $ 83,764    16.63   $ 20,143    4.00   $ 30,214    6.00

Total risk-based capital ratio

     88,936    17.66     40,286    8.00     50,357    10.00

Leverage ratio

     83,764    16.68     20,084    4.00     25,105    5.00

The increase in the risk-based capital ratios as of June 30, 2010 compared to December 31, 2009, is primarily the result of assigning a 20% risk weight to the assets covered under the FDIC loss-sharing

 

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agreement. A Financial Institution Letter was issued in the first quarter of 2010 which clarified that exposures that are covered under an FDIC loss-sharing agreement may be assigned a 20% risk weight.

The most recent regulatory notification categorized Sonabank as well capitalized under the regulatory framework for prompt corrective action. There are no conditions or events since that notification that management believes have changed Sonabank’s category.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

We are engaged primarily in the business of investing funds obtained from deposits and borrowings into interest-earning loans and investments. Consequently, our earnings depend to a significant extent on our net interest income, which is the difference between the interest income on loans and other investments and the interest expense on deposits and borrowings. To the extent that our interest-bearing liabilities do not reprice or mature at the same time as our interest-earning assets, we are subject to interest rate risk and corresponding fluctuations in net interest income. We have employed asset/liability management policies that seek to manage our interest income, without having to incur unacceptable levels of credit or investment risk.

We use a duration gap of equity approach to manage our interest rate risk, and we review quarterly interest sensitivity reports prepared for us by FTN Financial using the Sendero ALM Analysis System. This approach uses a model which generates estimates of the change in our market value of portfolio equity (MVPE) over a range of interest rate scenarios. MVPE is the present value of expected cash flows from assets, liabilities and off-balance sheet contracts using standard industry assumptions about estimated loan prepayment rates, reinvestment rates and deposit decay rates.

The following tables are based on an analysis prepared by FTN Financial setting forth an analysis of our interest rate risk as measured by the estimated change in MVPE resulting from instantaneous and sustained parallel shifts in the yield curve (plus or minus 300 basis points, measured in 100 basis point increments) as of June 30, 2010 and December 31, 2009, and all changes are within our ALM Policy guidelines:

 

Change in Interest Rates in Basis Points (Rate Shock)

   Sensitivity of Market Value of Portfolio Equity
As of June 30, 2010
 
   Market Value of Portfolio Equity     Market Value of
Portfolio Equity as a % of
 
   Amount    $ Change
From Base
    % Change
From Base
    Total
Assets
    Portfolio
Equity

Book Value
 
     (Dollar amounts in thousands)  

Up 300

   $ 101,594    $ 610      0.60   16.57   102.25

Up 200

     102,626      1,642      1.63   16.74   103.29

Up 100

     102,671      1,687      1.67   16.74   103.34

Base

     100,984      —        0.00   16.47   101.64

Down 100

     96,381      (4,603   -4.56   15.72   97.01

Down 200

     92,467      (8,517   -8.43   15.08   93.07

Down 300

     90,060      (10,924   -10.82   14.69   90.64

 

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     Sensitivity of Market Value of Portfolio Equity
As of December 31, 2009
 

Change in Interest Rates in Basis Points (Rate Shock)

   Market Value of Portfolio Equity     Market Value of
Portfolio Equity as a % of
 
   Amount    $ Change
From Base
    % Change
From Base
    Total
Assets
    Portfolio
Equity
Book Value
 
     (Dollar amounts in thousands)  

Up 300

   $ 91,216    $ (4,877   -5.08   14.92   93.92

Up 200

     93,099      (2,994   -3.12   15.23   95.86

Up 100

     94,666      (1,427   -1.49   15.48   97.47

Base

     96,093      —        0.00   15.72   98.94

Down 100

     94,855      (1,238   -1.29   15.51   97.66

Down 200

     92,570      (3,523   -3.67   15.14   95.31

Down 300

     89,569      (6,524   -6.79   14.65   92.22

Our interest rate sensitivity is also monitored by management through the use of a model run by FTN Financial that generates estimates of the change in the net interest income over a range of interest rate scenarios. Net interest income depends upon the relative amounts of interest-earning assets and interest-bearing liabilities and the interest rates earned or paid on them. In this regard, the model assumes that the composition of our interest sensitive assets and liabilities existing at June 30, 2010 and December 31, 2009 remains constant over the period being measured and also assumes that a particular change in interest rates is reflected uniformly across the yield curve regardless of the duration to maturity or repricing of specific assets and liabilities. All changes are within our ALM Policy guidelines.

 

Change in Interest Rates in Basis Points (Rate Shock)

   Sensitivity of Net Interest Income
As of June 30, 2010
 
   Adjusted Net Interest Income    Net Interest Margin  
   Amount    $ Change
From Base
   Percent     % Change
From Base
 
     (Dollar amounts in thousands)  

Up 300

   $ 26,979    $ 3,755    4.90   0.67

Up 200

     25,877      2,653    4.71   0.48

Up 100

     24,624      1,400    4.48   0.25

Base

     23,224      —      4.23   0.00

Down 100

     23,663      439    4.31   0.08

Down 200

     23,859      635    4.35   0.12

Down 300

     23,871      647    4.35   0.12

 

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Change in Interest Rates in Basis Points (Rate Shock)

   Sensitivity of Net Interest Income
As of December 31, 2009
 
   Adjusted Net Interest Income    Net Interest Margin  
   Amount    $ Change
From Base
   Percent     % Change
From Base
 
     (Dollar amounts in thousands)  

Up 300

   $ 26,288    $ 2,814    4.45   0.47

Up 200

     25,358      1,884    4.30   0.32

Up 100

     24,392      918    4.14   0.16

Base

     23,474      —      3.98   0.00

Down 100

     24,214      740    4.11   0.13

Down 200

     24,240      766  &