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| EVBS > SEC Filings for EVBS > Form 10-Q on 7-Aug-2009 | All Recent SEC Filings |
7-Aug-2009
Quarterly Report
We present management's discussion and analysis of financial information to aid the reader in understanding and evaluating our financial condition and results of operations. This discussion provides information about our major components of the results of operations, financial condition, liquidity and capital resources. This discussion should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented elsewhere in this report and in the 2008 Form 10-K. Operating results include those of all our operating entities combined for all periods presented.
We provide a broad range of personal and commercial banking services including commercial, consumer and real estate loans. We complement our lending operations with an array of retail and commercial deposit products and fee-based services. Our services are delivered locally by well-trained and experienced bankers whom we empower to make decisions at the local level so that they can provide timely lending decisions and respond promptly to customer inquiries. We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.
CRITICAL ACCOUNTING POLICIES
General
Our financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (GAAP). The financial information contained within our statements is, to a significant extent, financial information that is based on measures of the financial effects of transactions and events that have already occurred. A variety of factors could affect the ultimate value that is obtained either when earning income, recognizing an expense, recovering an asset or relieving a liability. For example, we use historical loss factors as one factor in determining the inherent loss that may be present in our loan portfolio. Actual losses could differ substantially from the historical factors that we use. In addition, GAAP itself may change from one previously acceptable method to another method. Although the economics of our transactions would be the same, the timing of events that would impact our transactions could change.
Allowance for Loan Losses
The allowance for loan losses is an estimate of the losses that may be sustained in our loan portfolio. The allowance is based on two basic principles of accounting: (i) Statement of Financial Accounting Standards (SFAS) No.5, Accounting for Contingencies, which requires that losses be accrued when their occurrence is probable and estimable and (ii) SFAS No.114, Accounting by Creditors for Impairment of a Loan, which requires that losses be accrued based on the differences between the value of the collateral, present value of future cash flows or values that are observable in the secondary market and the loan balance.
We evaluate non-performing loans individually for impairment, such as nonaccrual loans, loans past due 90 days or more, restructured loans and other loans selected by management as required by SFAS No. 114. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of the impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under SFAS No. 5.
For loans without individual measures of impairment, we make estimates of losses
for groups of loans as required by SFAS No. 5. Loans are grouped by similar
characteristics, including the type of loan, the assigned loan grade and general
collateral type. A loss rate reflecting the expected loss inherent in a group of
loans is derived based upon historical loss rates for each loan type, the
predominant collateral type for the group and the terms of the loan. The
resulting estimates of losses for groups of loans are adjusted for relevant
environmental factors and other conditions of the portfolio of loans including:
borrower or industry concentrations; levels and trends in delinquencies,
charge-offs and recoveries; changes in risk selection; level of experience,
ability and depth of lending staff; and national and local economic conditions.
The amounts of estimated losses for loans individually evaluated for impairment and groups of loans are added together for a total estimate of loan losses. The estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be considered. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether a reduction to the allowance would be necessary. While management uses the best information available to establish the allowance for loan losses, future adjustments to the allowance may be necessary if economic conditions differ substantially from the assumptions used in making the valuations. Such adjustments would be made in the relevant period and may be material to the Consolidated Financial Statements.
Impairment of Securities
Impairment of securities occurs when the fair value of a security is less than
its amortized cost basis. For debt securities, impairment is considered
other-than-temporary and recognized in its entirety in net income if either
(1) we intend to sell the security or (2) it is more likely than not that we
will be required to sell the security before recovery of its amortized cost
basis. If, however, we do not intend to sell the security before recovery, we
must determine what portion of the impairment is attributable to a credit loss,
which occurs when the amortized cost basis of the security exceeds the present
value of the cash flows expected to be collected from the security. If there is
no credit loss, there is no other-than-temporary impairment. If there is a
credit loss, other-than-temporary impairment exists, and the credit loss must be
recognized in earnings on the statements of income and the remaining portion of
impairment must be recognized in other
comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on our ability and intent to hold the investment until recovery of fair value. Other-than-temporary impairment of an equity security results in a loss that must be included in earnings on the statements of income. On a quarterly basis we review each investment security for other-than-temporary impairment based on criteria that includes cost exceeding market value by 20% or greater, the duration of the market decline, the financial health of and specific prospects for the issuer, out best estimate of the cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we could be required to sell the security before recovery.
Goodwill and Intangible Assets
SFAS No. 141, Business Combinations, requires the purchase method of accounting be used for all business combinations initiated after June 30, 2001. For purchase acquisitions, we are required to record assets acquired, including identifiable intangible assets, and liabilities at their fair value, which in many instances involves estimates based on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analysis or other valuation techniques. Effective January 1, 2001, we adopted SFAS No. 142 Goodwill and Other Intangible Assets ("SFAS 142") which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of SFAS No. 142 discontinue the amortization of goodwill and intangible assets with indefinite lives, but require at least an annual impairment review and more frequently if certain impairment indicators are in evidence. Additionally, we adopted SFAS No. 147 Acquisitions of Certain Financial Institutions, on January 1, 2002, and determined that core deposit intangibles will continue to be amortized over their estimated useful lives.
Goodwill totaled $16.0 million at both June 30, 2009 and December 31, 2008. Based on the testing of goodwill for impairment, no impairment charges have been recorded. Core deposit intangible assets are being amortized over the period of expected benefit, which ranges from 2.39 to 7.0 years. Core deposit intangibles, net of amortization, amounted to $359 thousand and $503 thousand, at June 30, 2009 and December 31, 2008, respectively, and are included in other assets.
OVERVIEW
Second quarter results for 2009 reflect the impact of continued volatility and uncertainty in the current recessionary economic environment. Our financial statements reflect the local impact of this recession with large increases in average federal funds sold, limited loan growth, high loan loss provision, an increase in Other Real Estate Owned ("OREO"), lower interest income as a result of the rapid rate declines in late 2008, decreased noninterest income, including a securities impairment, and an increase in noninterest expense primarily as a result of our branch expansion last year. These changes are not limited to just our bank. Community banks including our Company rely primarily on earnings from lending in the local markets that they serve. Community banks are living with the hardship of their customers and neighbors and being impacted by the slowing of loan payments resulting in deterioration in asset quality. We hold pooled trust preferred debt and a significant number of banks have either deferred making interest payments on their pooled trust preferred debt or have defaulted on that debt. Deterioration of our trust preferred investments resulted in a $3.9 million impairment charge in the quarter. At June 30, the FDIC, which liquidates failed banks, assessed a special charge on all member banks, in addition to the already increased quarterly fee. These unusual occurrences have obscured the core performance of many financial institutions and potentially could continue to do so until the economy comes out of this recession.
With the Treasury Capital Purchase Program ("CPP"), banks have been put in another unusual position. They have large amounts of cash from the Treasury's purchase of preferred stock, but nowhere to effectively invest the funds. The Federal Reserve has pushed interest rates to historic lows with the result that fed funds rates and other short-term interest rates yield approximately 0.25%, compared to the 5% dividend being paid on the Treasury investment. In an effort to deal with this issue, we have looked at other secure short term investment options to increase our earnings. While these excess funds increase our ability to lend, the recession has created a hesitation by customers to take on debt. This hesitation combined with industry wide tighter credit quality standards than a year ago has slowed demand for credit.
While we continue to be well capitalized, our financial statements reflect the local impact of these issues. In addition to the valuation issues, the increased deposit insurance expense and merger expenses, our balance sheet shows large increases in loan loss provision compared to historical levels, collection expense, OREO, past due loans and bankruptcies. In spite of all the negatives that we see around us, there are some signs that the economy is changing. Some of the leading economic indicators are sporadically moving sideways or even up. As these changes become more
pronounced, the possibility of improvement in the economy becomes more likely. This may take some time to materialize, meaning we will continue to live with our hardships and those of our customers and neighbors and the impact of slower loan payments which deteriorate our asset quality.
At the beginning of the second quarter, management announced on April 3, 2009, a definitive merger agreement with First Capital Bancorp, Inc. ("FCVA") in the Richmond marketplace. This strategic alliance is expected to close early in the fourth quarter of 2009. This business combination should enhance the position of the Company in the faster growth markets in and around Richmond, Virginia. With both companies well capitalized, the anticipation of operational savings by utilizing existing capacity and the strong skills in both businesses, management expects to see a much stronger company going into 2010. Under the purchase approach to accounting for a combination like this, all merger related expenses are recognized on the books as they occur, thereby resulting in lower earnings until the merger closes. Gains when the transaction is completed are expected to more than cover the upfront expenses.
A $3.9 million securities impairment charge, a $507 thousand FDIC special
assessment and $308 thousand of merger related expenses resulted in a net income
(loss) available to common shareholders of $2.1 million for the second quarter
of 2009, compared to $1.3 million net income in the second quarter of 2008. Net
interest income was $8.2 million in the second quarter of both 2009 and 2008, a
meaningful improvement compared to the $641 thousand decrease from the first
quarter of 2009 compared to the first quarter 2008. Noninterest income,
including the impairment charge, was ($2.3) million for the second quarter, a
$4.2 million decline from $1.9 million for the three months ended June 30, 2008.
Noninterest expense increased $977 thousand from $7.1 million in the second
quarter of 2008 to $8.0 million for the second quarter of 2009. This increase
was primarily from a $699 thousand increase in FDIC expense and $308 thousand in
merger expense. The emerging trend of smaller decreases in loan interest income
and larger decreases in deposit costs resulted in an improved net interest
margin for the second quarter at 3.27% compared to 3.12% in the first quarter of
2009. While the second quarter 2009 net interest margin is below the 3.59% for
the second quarter of 2008, it appears to have reversed the quarter to quarter
downward trend. Average earning assets growth for the second quarter of 2009
increased $88.2 million compared to the second quarter of 2008. Average loans
were $57.3 million above the average loans for the second quarter of 2008.
Federal funds sold increased to $38.6 million compared to $5.7 million in the
same quarter of the prior year while the average yield decreased from 2.11% to
0.19%. Average interest-bearing deposit balances increased $104.0 million, or
$46.7 million more than loan growth in the second quarter of 2009.
Investment income declined, partially from lower rates on new investments, but more from the Treasury conservatorship of FNMA and FHLMC which eliminated our agency preferred stock dividends and the temporary elimination of dividends from the Atlanta FHLB. Loan loss provision for the second quarter was $750 thousand compared to $1.3 million in 2008. For the year, the provision is $1.7 million compared to $1.8 million through the first six months of 2008. Management still sees risk in the loan portfolio and expects to continue higher provision expense through the remainder of 2009. Without the merger and FDIC increases, other noninterest expenses were down except for occupancy and marketing. Our branch expansion and infrastructure changes in 2008 resulted in the increased occupancy expense.
Looking to the rest of the year, we are still looking for the federal government's economic stimulus plan to revive loan demand. In an effort to assist our customers, we initiated a special loan program in the second quarter to relieve some of the payment pressure and we continue to explore other loan products to assist our customers. On a linked quarter basis, interest income on loans increased $621 thousand while interest expense on deposits increased $125 thousand which points to a change in future income. Over the remainder of the year we anticipate $240 million in certificates of deposit repricing at lower rates which should further enhance the net interest margin. The Federal Reserve continues to focus on reviving the economy, so we do not anticipate any major rate changes unless inflation is rekindled by an economic expansion. The Treasury CPP investment has enhanced our capital position as the parent infused the bank with $20 million more of regulatory capital. We anticipate increased loan losses in the short run and have prepared for that expectation. We have quality individuals managing our past due loans and foreclosed properties to minimize our potential losses. As the economy recovers, we are positioned to take advantage of all opportunities that present themselves.
Financial Condition
Return on average assets ("ROA") for the second quarter of 2009 declined to (0.78%), compared to 0.50% in the same quarter of 2008, and return on common average equity ("ROE") declined to (11.28%) compared to 5.57% for the
quarter ended June 30, 2008. For the first six months of 2009, ROA declined to (0.33%), compared to 0.81% for the same period in 2008, and ROE declined to (4.64%) compared to 8.64% for the period ended June 30, 2008. For the second quarter of 2009 the net loss was $1.8 million, and the net loss after $372 thousand effective preferred dividend was $2.1 million compared to net income of $1.3 million in the second quarter of 2008. For the six months ended June 30, 2009, the net loss was $1.0 million and the net loss after effective preferred dividend was $1.8 million compared to net income of $3.9 million for the first six months of 2008.
Total assets at June 30, 2009 were $1.10 billion, up $46.7 million, or 4.4%, from $1.05 billion at year-end 2008 and up $70.5 million, or 6.9% from June 30, 2008, when total assets were $1.03 billion. This increase is the result of strong deposit growth, particularly in the first quarter of 2009 and the addition of $24 million from the issuance of preferred stock. Loan growth through June 30, 2009 was $13.5 million, or 1.6% compared to the 2008 year-end balance. Actual loan growth in the second quarter compared to first quarter 2009 was $3.7 million or less than 1%. For the quarter, total average assets were $1.1 billion, an increase of 9.48% compared to $1.01 billion in the second quarter of 2008. For the quarter ended June 30, 2009, average total loans, net of unearned income were $830.9 million, an increase of $57.3 million, or 7.4%, from $773.6 million for the same period in 2008. For the six months ended June 30, 2009, total average assets were $1.1 billion, an increase of $120.5 million compared to $969.7 million for the same period in 2008. At June 30, 2009, net loans as a percent of total assets were 75.8%, as compared to 76.9% at December 31, 2008. While this portfolio should be able to generate a strong earnings stream, the current economic uncertainty overshadows our near term earnings.
At June 30, 2009, the investment portfolio totaled $168.8 million, an increase of $6.9 million from $161.9 million at December 31, 2008 and up $300 thousand compared to $168.5 million at June 30, 2008. Interest rates during the first six-month period of 2009 were fairly steady and low compared to the same quarter in the prior year. Our unrealized loss decreased $4.6 million compared to year-end 2008. The reported balances for 2009 are after the $3.9 million impairment taken at the end of the second quarter. We continue to monitor the payment streams of these instruments focusing on the deferred payments and defaulted payments. Potential for more impairment exists but is dependent on the level of banks that may defer or default on their interest payments. For more detail, see securities Note 2 to the consolidated financial statements earlier in the document. Most of the funds that are invested in the investment portfolio are part of management's effort to balance interest rate risk and to provide liquidity. Our participation in the TARP Capital Purchase Program was an effort to increase liquidity, recognizing the potential liquidity impact that the increase in unrealized losses could have and to assist in our loan growth.
Total deposits continued to grow. At June 30, 2009 deposits were $848.3 million an increase of $78.7 million, or 10.2%, from $769.6 million at the same point in 2008 and up $34.7 million from the year-end 2008 balance of $813.5 million. Deposits decreased $4.4 million compared to the first quarter balance of $852.6 million. This is primarily the result of the maturity of $27 million of brokered deposits during the first six months of 2009. The cost of deposits is projected to continue to decrease as large blocks of certificates of deposit reprice over the next six months. On an average basis, deposits increased $97.4 million from $760.3 million in the second quarter of 2008 to $857.7 million for the same period in 2009. All of the increase was in interest-bearing deposits, primarily in core money market and NOW accounts. Deposit prices are evaluated frequently by our asset liability committee and adjusted as needed to reflect the competitive rate environment.
FHLB borrowings at June 30, 2009 totaled $123.9 million, a $10.7 million, or 8.0%, decrease compared to $134.6 million at December 31, 2008 and an $11.4 million decrease from $135.4 million at June 30, 2008. With the large balance in federal funds sold, we do not anticipate additional borrowing this year. Over the remainder of the year, we expect to cover our funding needs by attracting lower cost deposits and anticipate maturing certificates of deposit will re-price at lower rates.
SFAS No. 115 requires the Company to show the effect of market changes in the value of securities available for sale. The effect of the change in market value of securities, net of income taxes, is reflected in a line titled "Accumulated other comprehensive (loss), net" in the Shareholders' Equity section of the Consolidated Balance Sheets. The securities portion was a $10.4 million loss at June 30, 2009 a decrease of $1.4 million from an $11.8 million loss at December 31, 2008 and an increase of $1.7 million compared to an $8.1 million loss at June 30, 2008. The unrealized loss on securities is presented as a value at one specific point in time but fluctuates significantly over time depending on interest rate changes. The valuation is particularly erratic in these stressed economic times. Also included in this line item is a $3.2 million loss related to the market decrease in the value of the pension plan (SFAS No. 158).
RESULTS OF OPERATIONS
Net Income
With the addition of the preferred stock on our balance sheet, we need to analyze income on two levels: income from operations and income available to common shareholders. Preferred dividends and accretion of discount on the preferred stock are recorded before any dividends are paid to the common stock holders.
With the inclusion of the unusual items mentioned earlier, net income available to common shareholders was ($2.1) million compared to $1.3 million in the second quarter of 2008. Diluted and basic earnings per common share decreased $0.57 to a loss of $0.36, compared to $0.21 income for the same quarter in 2008. Without the $3.9 million securities impairment, the $507 thousand FDIC special assessment and the merger expense of $308 thousand, the Company would have had positive pretax income. Net interest income for the quarter was $8.2 million for both 2009 and 2008. There was an actual decrease of $47 thousand for the quarter ended June 30, 2009, when compared to the same period in 2008. The second quarter decrease is $594 thousand less than the decline in the first quarter of 2009. Interest and fees on loans were down $119 thousand, or 0.9 %, while deposit costs were down $179 thousand, or 3.4 % compared to second quarter 2008. Interest income on investments declined by $259 thousand compared to the second quarter in 2008. While we have made some adjustments in our portfolio that has resulted in increased income from tax exempt securities, these increases could not overcome the loss of FNMA and FHLMC securities income and the loss of the FHLB dividend. Federal funds sold with an average balance of $38.6 million and a yield of only 0.19% earned $18 thousand during the second quarter. During the quarter, we moved $14 million from Fed funds to a category called interest-bearing deposits in other banks. These funds, which had an average balance in the second quarter of $5.6 million, earned $15 thousand with a yield of 1.08%. This earnings stream should improve in the third quarter of 2009. We continue to explore other higher earning investment alternatives to improve earnings on this large pool of funds. Interest bearing liabilities expense decreased $328 thousand for the second quarter compared to the same period in 2008 and had decreases in all categories. With the falling deposit costs, we are anticipating an improvement of the squeeze on our net interest margin in the second half of the year. Loan loss provision for the second quarter 2009 was $750 thousand, a decline of $550 thousand from $1.3 million in the second quarter 2008, when the company started making major increases to our reserve for loan losses.
Noninterest income for the second quarter 2009 was ($2.3) million, compared to $1.9 million in 2008's second quarter, a decline of $4.2 million, or 217%. Excluding the impact of the securities impairment mentioned above, noninterest income was down $281 thousand at $1.7 million for the second quarter 2009 compared to $1.9 million for the same period in 2008. Deposit fees declined $68 thousand and investment fees were down $23 thousand, while 2008 had a $128 thousand gain on a fixed assets sale and $130 thousand gain on an LLC investment.
Noninterest expense for the second quarter of 2009 increased $977 thousand, or 13.8% compared to 2008 from $7.1 million in 2008 to $8.0 million in second quarter 2009. This increase was primarily from the $507 thousand FDIC assessment and the $308 thousand in merger expenses. Occupancy expense increased $187 thousand due to our branch expansions in 2008. Telephone and other operating expense decreased $126 and $133 thousand, respectively. Management continues to monitor controllable expenses closely.
For the six months ended June 30, 2009, net income before the preferred dividend was ($1.05) million, a decrease of ($5.0) million compared to $3.9 million at the same date in 2008. Net interest income decreased $688 thousand with a decrease of $1.2 million in interest income offset by a decrease in interest expense of $517 thousand. Loan loss provision expense was $1.7million through June 30, 2009 down $100 thousand from $1.8 million in 2008. Management is confident that the repricing strategies put in place to counter the mismatch of interest income and expense is working. Noninterest income for the first six months of 2009 was ($712) thousand, a decrease of $5.3 million compared to 2008's $4.6 million. In addition to the items mentioned in the second quarter review above, we had a $1.3 million actuarial gain on pension curtailment in 2008. Without the unusual items in both years, noninterest income decreased $354 thousand as a result of a 5% decrease in deposit fees and a 19% decline in other operating income. (See table below.) Noninterest expense increased $1.8 million from $13.7 million in 2008 to $15.4 million for the period ended June 30, 2009. Of that increase, $1.2 million is from a $924 thousand increase in FDIC expense and the $308 thousand merger expenses taken
in the second quarter of 2009. The remainder of the increase is from $291 . . .
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