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HMPR > SEC Filings for HMPR > Form 10-Q on 8-Nov-2012All Recent SEC Filings

Show all filings for HAMPTON ROADS BANKSHARES INC

Form 10-Q for HAMPTON ROADS BANKSHARES INC


8-Nov-2012

Quarterly Report


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

Forward-Looking Statements

This Form 10-Q contains "forward-looking statements" within the meaning of the U.S. Private Securities Litigation Reform Act of 1995. When or if used in this quarterly report or any Securities and Exchange Commission filings, other public or shareholder communications, or in oral statements made with the approval of an authorized executive officer, the words or phrases "anticipate," "would be," "will allow," "intends to," "will likely result," "are expected to," "will continue," "is anticipated," "is estimated," "is projected," or similar expressions are intended to identify "forward-looking statements."

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy, and other future conditions. Because forward-looking statements relate to the future, they are subject to inherent uncertainties, risks, and changes in circumstances that are difficult to predict. Our actual results may differ materially from those contemplated by the forward-looking statements. They are neither statements of historical fact nor guarantees or assurances of future performance. Therefore, we caution you against relying on any of these forward-looking statements.

For a discussion of the risks, uncertainties, and assumptions that could affect our future events, developments, or results, you should carefully review the risk factors summarized below and the more detailed discussion in the "Risk Factors" section in our 2011 Form 10-K. Our risks include, without limitation, the following:

We incurred significant losses in 2009, 2010, 2011, and expect to incur significant losses in 2012, although at a lower level than in the previous years. While we expect to return to profitability in 2013, we can make no assurances to that effect;

Our capital needs could dilute your investment or otherwise affect your rights as a shareholder.

The determination of the appropriate balance of our allowance for loan losses is merely an estimate of the inherent risk of loss in our existing loan portfolio and may prove to be incorrect. If such estimate is proven to be materially incorrect and we are required to increase our allowance for loan losses, our results of operations, financial condition, and the value of our Common Stock would be materially adversely affected;

We have had, and may continue to have, large numbers of problem loans and difficulties with our loan administration, which could increase our losses related to loans;

If the value of real estate in the markets we serve were to further decline materially, a significant portion of our loan portfolio could become further under-collateralized, which could have a material adverse effect on our loan losses, results of operations, and financial condition;

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

The Company and BOHR have entered into a Written Agreement with the FRB and the Virginia Bureau of Financial Institutions that subjects the Company and BOHR to significant restrictions and requires us to designate a significant amount of our resources to complying with the agreement, and it may have a material adverse effect on our operations and the value of our securities;

The formal investigation by the SEC may result in penalties, sanctions, or a restatement of our previously issued financial statements;

The Company has received a grand jury subpoena from the United States Department of Justice, Criminal Division. The Company has been advised that it is not a target at this time, and we do not believe we will become a target, but there can be no assurances as to the timing or eventual outcome of the related investigation;

FDIC insurance assessments could increase from our prior inability to maintain a "well-capitalized" status, which will further decrease earnings;

Our commercial real estate and equity line lending may expose us to a greater risk of loss and hurt our earnings and profitability;

A significant amount of our loan portfolio contains loans used to finance construction and land development, and these types of loans subject our loan portfolio to a higher degree of credit risk;

We are not paying dividends on our Common Stock and are currently prevented from doing so. The failure to resume paying dividends on our Common Stock may adversely affect the value of our Common Stock; and

Sales, or the perception that sales could occur, of large amounts of our Common Stock may depress our stock price.


Table of Contents

HAMPTON ROADS BANKSHARES, INC.

PART I. FINANCIAL INFORMATION

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

Our forward-looking statements could be incorrect in light of these risks, uncertainties, and assumptions. The future events, developments, or results described in this report could turn out to be materially different. We have no obligation to publicly update or revise our forward-looking statements after the date of this report and you should not expect us to do so.

Overview

Throughout the first nine months of 2012, economic activity in the markets in which our borrowers operate remained at historically low levels; however, the levels of loan delinquencies and rates of default continue to improve. The Company reported a net loss for the nine month period ended September 30, 2012, primarily resulting from additions to our provision for loan losses, the impact of nonaccrual loans on interest income, losses on foreclosed real estate and repossessed assets, and other expenses related to the resolution of problem loans. In light of past performance and the current economic environment, additional provisions for loan losses may be necessary to supplement the allowance for loan losses in the future. As a result, while we expect that slowly improving economic conditions will continue to reduce the rate of additional provisions for loan losses and impairments of foreclosed real estate, we may continue to incur significant credit costs, which may continue to adversely impact our financial condition and results of operations throughout 2012. As of September 30, 2012, the Company exceeded the regulatory capital minimums and BOHR and Shore were considered "well capitalized" under the risk-based capital standards.

Our primary source of revenue is net interest income earned by our bank subsidiaries. Net interest income represents interest and fees earned from lending and investment activities less the interest paid on deposits and borrowings. Net interest income may be impacted by variations in the volume and mix of interest-earning assets and interest-bearing liabilities, changes in the yields earned and the rates paid, level of non-performing assets, and the level of noninterest-bearing liabilities available to support earning assets. In addition to net interest income, noninterest income is another important source of revenue. Noninterest income is derived primarily from service charges on deposits and mortgage banking revenue. Losses on the sale or impairment of our foreclosed real estate and repossessed assets are recognized in noninterest income. Other factors that impact net loss attributable to Hampton Roads Bankshares, Inc. are the provision for loan losses and noninterest expense.

The following is a summary of our financial condition as of September 30, 2012 and our financial performance for the three and nine month periods then ended.

Assets were $2.1 billion. Total assets decreased by $95.4 million or 4% from $2.2 billion at December 31, 2011. The decrease in assets was primarily associated with an $87.8 million or 6% decrease in gross loans and a $19.6 million or 31% decrease in foreclosed real estate and repossessed assets partially offset by an $8.8 million or 3% increase in investment securities available for sale.

Investment securities available for sale increased $8.8 million to $293.3 million during the first nine months of 2012 from $284.5 million at December 31, 2011. The increase was primarily a result of purchases of mortgage-backed securities.

Gross loans decreased by $87.8 million or 6% during the nine months ended September 30, 2012 from $1.5 billion at December 31, 2011. The decrease in gross loans was attributed to charge-offs of nonperforming loans as well as pay downs and maturities of loans that exceeded new loans originated.

Allowance for loan losses at September 30, 2012 decreased $20.5 million to $54.4 million from $74.9 million at December 31, 2011 as net charge-offs, primarily on credits with specific reserves, exceeded additional provisions for loan losses. Both the absolute and relative levels of non-performing loans, particularly newly identified problem credits, decreased during the nine months ended September 30, 2012.

Deposits decreased $167.1 million or 9% from $1.8 billion at December 31, 2011 as a result of decreases of $122.8 million in time deposits under $100 thousand and $57.2 million in time deposits over $100 thousand offset by a $26.6 million increase in noninterest-bearing demand deposits. Declines in deposits resulted from the Company's strategy of reducing interest rates in an effort to improve earnings, increasing net interest margin, and reducing excess liquidity.


Table of Contents

HAMPTON ROADS BANKSHARES, INC.

PART I. FINANCIAL INFORMATION

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

Net loss attributable to Hampton Roads Bankshares, Inc. for the three and nine months ended September 30, 2012 was $5.9 million or $0.05 per common diluted share and $19.5 million or $0.32 per common diluted share, respectively, as compared with net loss attributable to Hampton Roads Bankshares, Inc. of $26.7 million or $0.77 per common diluted share and $77.2 million or $2.28 per common diluted share for the three and nine months, respectively, ended September 30, 2011. The net loss for the nine months ended September 30, 2012 was primarily attributable to provision for loan losses expense of $14.1 million, the impact of nonaccrual loans on interest income, and losses on foreclosed real estate and repossessed assets of $14.4 million.

Net interest income decreased $1.7 million and $5.3 million for the three and nine months, respectively, ended September 30, 2012 as compared to the same period in 2011. The decrease was due primarily to the decreases in interest-earning assets during those time periods, partially offset by a decline in our funding costs.

Provision for loan losses for the three and nine months, respectively, ended September 30, 2012 was $2.5 million and $14.1 million, an 86% and 74% decrease over the comparable periods in 2011. The decrease was due to a reduction in newly identified problem loans and continuing declines in loans outstanding.

Noninterest income for the three and nine months, respectively, ended September 30, 2012 was $2.2 million and $7.3 million, a 1387% and 37% increase over the comparative periods in 2011. This was largely due to increases in mortgage banking revenue offset by the loss of insurance revenue resulting from the sale of our insurance subsidiary in August 2011 and lower amounts of losses on foreclosed real estate.

Noninterest expense was $20.4 million and $59.1 million for the three and nine months, respectively, ended September 30, 2012, which was a decrease of 15% and 26% over the comparable periods for 2011, as a result of cost saving initiatives throughout the operations of the Company, a one-time adjustment to our FDIC insurance expense that affected the first quarter of 2011, and a decrease in salaries and employee benefits.

Our effective tax rate was 0% for the nine months ended September 30, 2012 compared to (2.88)% for the comparable period in 2011. These rates differ from the statutory rate due to the valuation allowance against the Company's deferred tax assets.

During 2011 and the first nine months of 2012, we have been focused on reducing operating expenses. As part of these efforts, we have sold or consolidated 18 branches since December 31, 2010, reducing our branch total to 40 at September 30, 2012.

Critical Accounting Policies

GAAP is complex and requires management to apply significant judgment to various accounting, reporting, and disclosure matters. Management must use assumptions, judgments, and estimates when applying these principles where precise measurements are not possible or practical. These policies are critical because they are highly dependent upon subjective or complex judgments, assumptions, and estimates. Our judgments, assumptions, and estimates may be incorrect and changes in such judgments, assumptions, and estimates may have a significant impact on the consolidated financial statements and the accompanying footnotes. Actual results, in fact, could differ materially from those estimates. We consider our policies on allowance for loan losses, deferred income taxes, and estimates of fair value on financial instruments to be critical accounting policies. Refer to our 2011 Form 10-K for further discussion of these policies.

Material Trends and Uncertainties

Currently, the U.S. economy appears to be slowly recovering from one of its longest and most severe economic recessions in recent history. It is not clear at this time how quickly the economy will recover. In addition, the U.S. housing market continues to struggle with excess inventory (both completed houses and available lots) and the effects of home price depreciation.


Table of Contents

HAMPTON ROADS BANKSHARES, INC.

PART I. FINANCIAL INFORMATION

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

We experienced a significant deterioration in credit quality throughout 2009 and 2010. Problem loans and non-performing assets rose and led to significant increases to the allowance for loan losses. During 2011 the Company had a significant reduction in newly identified problem loans and continued declines in loans outstanding due to pay downs and charge offs, and, as a result, we decreased the provision for loan losses significantly. This trend continued into the first nine months of 2012, and the Company decreased its provision for loan losses by $39.6 million during the first nine months of 2012 compared to the same period in 2011. In light of continued economic weakness, previously current borrowers have and may continue to default and real estate values have and may continue to decline; therefore, significant additional provisions for loan losses may be necessary to supplement the allowance for loan losses in the future. As a result, we may incur significant credit costs throughout the remainder of 2012, which would continue to adversely impact our financial condition, our results of operations, and the value of our Common Stock.

While we expect continued improvements in our results of operations for the remainder of 2012, we still expect a net loss for the year although a smaller loss than in previous years. We do not expect to return to profitability on an annual basis until at least 2013.

Impaired loans have decreased by $47.7 million since December 31, 2011. At September 30, 2012, the Company had $163.9 million in impaired loans and at December 31, 2011, we had $211.6 million. The majority of the decrease is from an $11.2 million decrease in impaired commercial and industrial loans and a $33.4 million decrease in impaired construction loans.

Our net interest income declined during the first nine months of 2012 compared to the same time period in 2011 as a result of a decline in the levels of earning assets and the related reduction of interest income, partially offset by declines in our funding costs. Our net interest margin increased to 3.61% for the nine months ended September 30, 2012 compared to 3.14% for the nine months ended September 30, 2011.

The Company determined that a valuation allowance on its deferred tax asset should be recognized beginning December 31, 2009. It remains uncertain whether we will realize this asset. Internal Revenue Code Section 382 ("Section 382") limitations related to the capital raised and resulting change in control for tax purposes during the third quarter of 2010 add further uncertainty as to the realizability of the deferred tax assets in future periods. While net operating losses incurred after our 2010 change in control (for tax purposes) are not limited, we have not recognized any benefit in our consolidated financial statements due to the continued uncertainty of our ability to realize such deferred tax assets and our lack of profitability.

The value of the collateral underlying our loans has been falling due to the continued deterioration of economic conditions in the markets we serve. This decline diminishes our ability to recover on defaulted loans by selling the collateral, making it more likely that we would suffer additional losses on defaulted loans. Additionally, our decrease in asset quality and collateral value has required additions to our allowance for loan losses through increased provisions for loan losses as well as impairments of foreclosed real estate, which negatively impacts our operating results. We expect this trend to continue until economic conditions significantly improve. Further, the Company expects that losses on the sale of foreclosed real estate will continue to be elevated in the fourth quarter of 2012.

On November 2, 2010, the Company received from the DOJ a grand jury subpoena to produce information principally relating to the merger of Gateway Financial Holdings, Inc. ("GFH") into the Company on December 31, 2008 and to loans made by GFH and its wholly-owned subsidiary, Gateway Bank & Trust Co. before GFH's merger with the Company. The DOJ has informed the Company that it is not a target of the investigation at this time, and we are fully cooperating. Although we do not believe this matter will have a material adverse affect on the Company, we can give no assurances as to the timing or eventual outcome of this investigation.

In April 2011, the SEC informed the Company that it is conducting a formal investigation related to certain accounting matters. For a further discussion of this matter, see "Risk Factors - The formal investigation by the SEC may result in penalties, sanctions, or a restatement of our previously issued financial statements" in our 2011 Form 10-K.

On August 24, 2012, the Company announced that it completed the sale of deposits associated with the Company's Wilmington, North Carolina branch to First Bancorp.


Table of Contents

HAMPTON ROADS BANKSHARES, INC.

PART I. FINANCIAL INFORMATION

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

On September 21, 2012, the Company announced that it completed the sale of all deposits and selected assets associated with its branches in Preston Corners and Chapel Hill, North Carolina to Bank of North Carolina, a subsidiary of BNC Bancorp.

On September 27, 2012, the Company announced the closing of a public common stock rights offering (the "Rights Offering"). The Company issued 21,000,687 shares of common stock, at a price of $0.70 per share, to holders of its common stock who elected to participate in the Rights Offering. Total proceeds from the Rights Offering were $14.7 million.

In connection with the Rights Offering, the Company was a party to a Standby Purchase Agreement with the following entities or their affiliates or managed funds: The Carlyle Group, L.P. ("Carlyle"), Anchorage Capital Group, L.L.C. ("Anchorage"), and CapGen Capital Group VI LP ("CapGen" and, together with Carlyle and Anchorage, the "Investors"). The Standby Purchase Agreement provided that the Investors would purchase from the Company, at the subscription price, a portion of the shares, if any, up to an aggregate of 53,518,176 shares, not subscribed for in the Rights Offering (the "Standby Purchase"). On September 27, 2012, pursuant to the terms of the Standby Purchase Agreement, the Investors purchased a total of 43,287,161 shares of the Company's common stock at $0.70 per share in the Standby Purchase. Anchorage purchased 16,007,143 shares, CapGen purchased 11,272,875 shares and Carlyle purchased 16,007,143 shares. Total proceeds from the Standby Purchase were $30.3 million.

For further discussion of the material trends and uncertainties that may affect our results and financial condition, refer to the risk factors contained in this report.

ANALYSIS OF RESULTS OF OPERATIONS

Net Interest Income. Net interest income, a major component of our earnings, is the difference between the income generated by interest-earning assets reduced by the cost of interest-bearing liabilities. Net interest margin, which is calculated by expressing annualized net interest income as a percentage of average interest-earning assets, is an indicator of effectiveness in generating income from earning assets. Net interest income and net interest margin may be significantly impacted by the market interest rates (rate) and the mix and volume of interest-earning assets and interest-bearing liabilities (volume), changes in the yields earned and rates paid, and the level of noninterest-bearing liabilities available to support interest-earning assets. Our management team strives to maximize net interest income through prudent balance sheet administration, maintaining appropriate risk levels as determined by our Asset / Liability Committee and the Board of Directors.

Net interest income for the nine months ended September 30, 2012 was $48.7 million, a decrease of $5.3 million from $54.0 million for the nine months ended September 30, 2011. The decrease in net interest income for the nine months was primarily the result of a decrease of $13.9 million in interest income from loans partially offset by the decrease in interest expense on deposits of $8.3 million for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. Our net interest margin increased to 3.61% for the nine months ended September 30, 2012 from 3.14% during the nine months ended September 30, 2011. The increase in net interest margin from the prior period is due primarily to an overall reduction in the cost of funds and a change in the mix of interest-earning assets out of overnight funds sold and due from FRB into loans and investments.

Net interest income for the three months ended September 30, 2012 was $15.8 million, a decrease of $1.8 million from $17.6 million for the three months ended September 30, 2011. The decrease in net interest income for the three months was primarily the result of a decrease of $4.0 million in interest income from loans partially offset by the decrease in interest expense on deposits of $2.3 million for the three months ended September 30, 2012 compared to the three months ended September 30, 2011. Our net interest margin increased to 3.56% for the three months ended September 30, 2012 from 3.19% during the three months ended September 30, 2011.

Our interest-earning assets consist of loans, investment securities, overnight funds sold and due from FRB, and interest-bearing deposits in other banks. Interest income on loans, including fees, decreased $4.0 million and $13.9 million to $17.9 million and $56.0 million for the three and nine months, respectively, ended September 30, 2012 compared to the same periods during 2011. This decrease was predominantly a result of a $235.5 million decrease in average loan balance (excluding average nonaccrual loans) as well as the 36-basis point decrease in average yield during the nine months ended September 30, 2012 compared to the same time period during 2011. Interest income on


Table of Contents

HAMPTON ROADS BANKSHARES, INC.

PART I. FINANCIAL INFORMATION

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

investment securities decreased $298 thousand and $1.4 million to $2.0 million and $6.0 million for the three and nine months, respectively, ended September 30, 2012 compared to the same periods during 2011. This decrease was due to a $28.8 million decrease in average investment securities as well as a 33-basis point decrease in average yield during the nine months ended September 30, 2012 compared to the same time period during 2011. Interest income on overnight funds sold and due from FRB decreased $177 thousand and $445 thousand for the three and nine months, respectively, ended September 30, 2012 compared to the same periods during 2011. The decrease for the nine months ended September 30, 2012 was largely due to the $235.1 million decrease in average overnight funds sold and due from FRB and a 2-basis point decrease in the average interest yield on overnight funds sold and due from FRB.

Our interest-bearing liabilities consist of deposit accounts and borrowings. Interest expense on deposits decreased $2.3 million and $8.3 million to $2.9 million and $9.9 million for the three and nine months, respectively, ended September 30, 2012 compared to the same periods during 2011. This decrease resulted from a $493.5 million decrease in average interest-bearing deposits and a 34-basis point decrease in the average interest rate paid on interest-bearing deposits for the nine months ended September 30, 2012 compared to the nine months ended September 30, 2011. A reduction in the average rate paid on interest-bearing demand deposits to 0.41% and 0.38% for the first three and nine months, respectively, of 2012 from 0.54% and 0.63% for the first three and nine months, respectively, of 2011 as well as the reduction of the average rate paid on time deposits to 1.16% and 1.25% for the first three and nine months, respectively, of 2012 from 1.45% and 1.58% for the first three and nine months, respectively, of 2011 contributed significantly toward the decrease in overall deposit rates. Our average rate on savings deposits decreased from 0.17% and 0.21% during the three and nine months, respectively, ended September 30, 2011 to 0.12% and 0.13% during the three and nine months, respectively, ended September 30, 2012. Interest expense on borrowings, which consisted of FHLB borrowings and other borrowings, decreased $469 thousand and $2.1 million to $1.2 million and $3.6 million for the three and nine months, respectively, ended September 30, 2012 compared to the same periods during 2011. The 100-basis point decrease in the nine month average interest rate paid on borrowings and the $17.0 million decrease in the nine month average borrowings produced this result. To promote liquidity and enhance current earnings by way of reduction in interest expense and after a review of the Company's current level of assumed interest rate risk, during the third quarter of 2011, the Company modified certain advances with the FHLB. A majority of the Company's existing fixed-rate advances were restructured as floating rate obligations at a fixed spread to three month LIBOR with maturities ranging from 2.75 to 4 years.


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