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XBKS > SEC Filings for XBKS > Form 10-Q on 9-Nov-2012All Recent SEC Filings

Show all filings for XENITH BANKSHARES, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for XENITH BANKSHARES, INC.


9-Nov-2012

Quarterly Report


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

The following is management's discussion and analysis of the company's consolidated financial condition, changes in financial condition, results of operations, liquidity, cash flows and capital resources. This discussion should be read in conjunction with the consolidated financial statements and accompanying notes in Part I, Item 1, "Financial Statements" in this Quarterly Report on Form 10-Q ("Form 10-Q") and Part II, Item 8, "Financial Statements and Supplementary Data" in the company's Annual Report on Form 10-K for the year ended December 31, 2011 ("2011 Form 10-K"). The data presented as of September 30, 2012 and for the three and nine-month periods ended September 30, 2012 and 2011 is derived from our unaudited interim financial statements and include, in the opinion of management, all adjustments, consisting solely of normal recurring accruals, necessary for a fair presentation of the data for such period. The data presented as of December 31, 2011 is derived from our audited financial statements as of and for the year ended December 31, 2011, which is included in the 2011 Form 10-K.

All references to "Xenith Bankshares", "our company", "we", "our" or "us" are to Xenith Bankshares, Inc. and its wholly-owned subsidiary, Xenith Bank, collectively. All references to "the Bank" are to Xenith Bank.

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

BUSINESS OVERVIEW

Xenith Bankshares is a Virginia corporation that is the bank holding company for Xenith Bank, which is a Virginia banking corporation organized and chartered pursuant to the laws of the Commonwealth of Virginia and a member of the Federal Reserve. The Bank is a full-service, locally-managed commercial bank specifically targeting the banking needs of middle market and small businesses, local real estate developers and investors, private banking clients and select retail banking clients, which we refer to as our target customers. We are geographically focused on the Washington, D.C.-MD-VA-WV, Richmond-Petersburg, VA, and the Norfolk-Virginia Beach-Newport News, VA-NC metropolitan statistical areas, which we refer to as our target markets. As of September 30, 2012, the Bank conducts its principal banking activities through its six branches, with one branch located in Tysons Corner, Virginia, two branches located in Richmond, Virginia, and three branches located in Suffolk, Virginia. We acquired the three branches located in Suffolk, Virginia in the merger with First Bankshares, Inc., the parent company of its wholly-owned subsidiary SuffolkFirst Bank. SuffolkFirst Bank opened its first branch in Suffolk, Virginia in 2003 under the name of SuffolkFirst Bank. All of the former SuffolkFirst Bank branches operate under the name Xenith Bank. As of September 30, 2012, we had total assets of $558.0 million, total loans, net of the allowance for loan and lease losses, of $411.1 million, total deposits of $448.1 million and shareholders' equity of $87.2 million.

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

During the first quarter of 2012, the Bank began participating in a nationwide warehouse lending program with a major commercial bank (the "participating bank") by entering into a sub-participation agreement with the participating bank. The participating bank and the Bank extend credit nationwide to mortgage companies that originate single-family residential mortgage loans for sale in the secondary market. Pursuant to the sub-participation agreement, the Bank purchases participations from the participating bank with respect to selected non-bank mortgage originators that seek funding to facilitate the origination of mortgage loans. The originators underwrite and close mortgage loans consistent with established standards of approved investors and, once the loans close, the originators deliver the loans to the investors. Substantially all of the loans are conforming loans. Typically, the Bank, together with the participating bank, purchases up to an aggregate of a 99% participation interest with the originators financing the remaining 1%. These loans are held for short periods, usually less than 30 days and more typically 10-25 days. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis. As of September 30, 2012, we had $74.6 million in loans held for sale.

The primary source of our revenue is net interest income, which represents the difference between interest income on interest-earning assets and interest expense on interest-bearing liabilities used to fund those assets. Interest-earning assets include loans, available-for-sale securities, and cash on deposit with other banks. Interest-bearing liabilities include deposits and borrowings. Sources of noninterest income include service charges on deposit accounts, gains on the sale of securities, derivative income, and other miscellaneous income. Deposits and Federal Home Loan Bank borrowed funds are our primary sources of funding. Our largest expenses are interest on our funding sources and salaries and related employee benefits. Measures of our performance include net interest margin, return on average assets, return on average equity, and efficiency ratio, which is calculated by dividing noninterest expense by the sum of net interest income and noninterest income.


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

                                        Three Months Ended           Nine Months Ended
                                           September 30,               September 30,
                                        2012            2011         2012           2011
    Net interest margin (1)                4.54 %        5.01 %         4.58 %       4.76 %
    Return on average assets               1.09 %        1.65 %         1.39 %       1.33 %
    Return on average common equity        7.97 %        9.66 %         9.64 %       6.98 %
    Efficiency ratio (2)                     75 %          37 %           80 %         62 %

(1) Net interest margin is the percentage of net interest income divided by average interest-earning assets.

(2) Efficiency ratio is total noninterest expense divided by the sum of net interest income and total nonnterest income.

Merger of First Bankshares, Inc. and Xenith Corporation

First Bankshares, Inc. ("First Bankshares") was incorporated in Virginia in 2008, and was the holding company for SuffolkFirst Bank, a community bank founded in the City of Suffolk, Virginia in 2002.

On December 22, 2009, First Bankshares and Xenith Corporation, a Virginia corporation, completed the merger of Xenith Corporation with and into First Bankshares (the "merger"), with First Bankshares being the surviving entity in the merger. The merger was completed in accordance with the terms of an agreement of merger and related plan of merger, dated as of May 12, 2009, as amended. At the effective time of the merger, First Bankshares amended its amended and restated articles of incorporation to, among other things, change its name to Xenith Bankshares, Inc. In addition, following the completion of the merger, SuffolkFirst Bank changed its name to Xenith Bank.

Acquisitions

Effective on July 29, 2011, the Bank acquired select loans totaling $58.3 million and related assets associated with the Richmond, Virginia branch office (the "Paragon Branch") of Paragon Commercial Bank, a North Carolina banking corporation ("Paragon"), and assumed select deposit accounts totaling $76.6 million and certain related liabilities associated with the Paragon Branch (the "Paragon Transaction"). The Paragon Transaction was completed in accordance with the terms of the Amended and Restated Purchase and Assumption Agreement, dated as of July 25, 2011 (the "Paragon Agreement"), between the Bank and Paragon. Under the terms of the Paragon Agreement, Paragon retained the real and personal property associated with the Paragon Branch and, following the receipt of required regulatory approvals, the Paragon Branch was closed. At the closing of the Paragon Transaction, Paragon made a cash payment to the Bank in the amount of $17.3 million, which represents the excess of approximately all of the liabilities assumed at a premium of 3.92%, over approximately all of the assets acquired at a discount of 3.77%.

Also effective on July 29, 2011, the Bank acquired substantially all of the assets, including all loans, and assumed certain liabilities, including all deposits, of Virginia Business Bank ("VBB"), a Virginia banking corporation located in Richmond, Virginia, which was closed on July 29, 2011 by the Virginia State Corporation Commission (the "VBB Acquisition"). The Federal Deposit Insurance Corporation ("FDIC") acted as receiver of VBB. The VBB Acquisition was completed in accordance with the terms of the Purchase and Assumption Agreement, dated as of July 29, 2011 (the "VBB Agreement"), among the FDIC, receiver for VBB, the FDIC and the Bank. The Bank acquired total assets of $92.9 million, including $70.9 million in loans, and assumed liabilities of $86.9 million, including $77.5 million in deposits. Under the terms of the VBB Agreement, the Bank received a discount of $23.8 million on the net assets and did not pay a deposit premium. The Bank also received a cash payment from the FDIC in the amount of $17.8 million based on the difference between the discount received ($23.8 million) and the net assets of VBB ($5.9 million). The VBB Acquisition was completed without any shared-loss agreement.

Industry Conditions

Across the country, the recent recession and tepid recovery have impacted businesses, consumers and real estate values, and has taken a toll on banks. Since the beginning of 2009, the FDIC has closed approximately 440 failed banks. Georgia, Florida, California and Illinois account for over half of all the failures. In Virginia, there have been four failures (none in 2012), one of which was Virginia Business Bank, the assets and liabilities of which we acquired in July 2011. Besides the number of actual bank failures, the recession and weak recovery have taken a toll on many banks that are still operating. In our target markets alone, there are numerous banks that are undercapitalized, have high levels of criticized and non-performing assets, and some are under written agreements with their regulators requiring that they address their short-comings. Anticipated regulatory policy would impose further requirements on banks, many of which are underperforming. Additionally, there is uncertainty concerning future capital requirements.

The Federal Open Market Committee ("FOMC") publicly stated on October 24, 2012 that the economy continued to expand moderately in recent months with some improvements in household spending, but a slowing in business investment. The housing sector shows some improvement, though from depressed levels. The FOMC expects that "a highly accommodative stance for


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monetary policy will remain appropriate for a considerable amount of time after the economic recovery strengthens" and anticipates that "exceptionally low levels for the federal funds rate are likely to be warranted at least through mid-2015." The FOMC also stated that it is maintaining its existing policy of purchasing agency securities and reinvesting principal payments from its securities holdings. The unemployment rate, as published by the Bureau of Labor Statistics, ended the third quarter of 2012 at 7.8%, its lowest level since early 2009.

Our nation's unemployment and underemployment problems have led to a prolonged period of very low interest rates, squeezing the net interest margins of banks and making it harder to make a profit.

Outlook

We believe we are well positioned to take advantage of competitive opportunities. We believe that we will benefit from (1) our strong capital base, which we believe will allow us to compete effectively with both the larger, more established super-regional and national banks, as well as the smaller, locally managed community banks operating in our target markets, (2) our advantageous market locations in our target markets, (3) our variety of banking services and products, and (4) our experienced management team and board of directors. We intend to execute our business strategy by focusing on developing long-term relationships with our target customer base through a team of bankers with significant experience in our target markets.

In our continuing evaluation of our business strategy, we believe properly priced acquisitions can complement our organic growth. We may seek to acquire other financial institutions or branches or assets of those institutions. Although our principal acquisition focus is to expand our presence in our target markets, we may also expand into new markets or lines of business or offer new services or products. We evaluate potential acquisitions to determine what is in the best interest of our company. Our goal in making these decisions is to maximize shareholder value.

Critical Accounting Policies

Our accounting policies are fundamental to an understanding of our consolidated financial position and consolidated results of operations. We believe that our accounting and reporting policies are in accordance with Generally Accepted Accounting Principles in the United States of America ("GAAP") and conform to general practices within the banking industry. Our financial position and results of operations are affected by management's application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in our consolidated financial position or results of operations or both our consolidated financial position and results of operations.

We consider a policy critical if (1) the accounting estimate requires assumptions about matters that are highly uncertain at the time of the accounting estimate and (2) different estimates that could reasonably have been used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on our financial statements. Using these criteria, we believe that our most critical accounting policy relates to the allowance for loan and lease losses, which reflects our estimate of losses in the event of borrower default. An additional accounting policy that we deem critical using these criteria is our measurement of probable cash flows with respect to acquired credit-impaired loans accounted for under Financial Accounting Standards Board ("FASB") Accounting Standards Codification ("ASC") Topic 310-30, "Loans and Debt Securities Acquired with Deteriorated Credit Quality" ("ASC 310-30"). Yield and impairment for acquired credit-impaired loans is based on management's estimate of future cash flows, which are re-estimated on a periodic basis. If the financial condition of our borrowers were to deteriorate, resulting in an impairment of their ability to make payments, adjustments to our estimates would be made and additional provisions for loan and lease losses could be required, which could have a material adverse impact on our results of operations and financial condition. Further discussion of the estimates used in determining the allowance for loan and lease losses is contained in the discussion under "- Financial Condition - Allowance for Loan and Lease Losses" below and in measuring impairment for acquired credit-impaired loans is contained under "- Financial Condition - Allowance for Loan and Lease Losses - Acquired Loans" below.

Based on the above criteria, we also deem the evaluation of evidence in connection with the determination of the need for a valuation allowance on our deferred tax assets to be a critical accounting policy. This determination requires us to evaluate both historical and future factors and to conclude as to the likelihood that our deferred tax assets will be utilized in the future. Changes in factors in future periods could require us to record a valuation allowance for all or a portion of our deferred tax assets in these periods. Further discussion of the factors considered in determining the need for a valuation allowance is contained in the discussion under "- Results of Operations- Income Taxes" below.

Our critical accounting policies are discussed in detail in Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations - Critical Accounting Policies" and "Summary of Significant Accounting Policies" in the notes to the consolidated financial statements in our 2011 Form 10-K. Since December 31, 2011, there have been no changes in these policies that have had or could reasonably be expected to have a material impact on our results of operations or financial condition.


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RESULTS OF OPERATIONS

Net Income

For the three months ended September 30, 2012, net income was $5.9 million, compared to net income of $6.8 million for the three months ended September 30, 2011. For the nine months ended September 30, 2012, net income was $7.0 million, compared to net income of $4.2 million for the nine months ended September 30, 2011. Net income in both the three- and nine-month periods ended September 30, 2012 includes an income tax benefit of $5.0 million resulting from the reversal of the valuation allowance against our net deferred tax asset, while net income in the same periods ended September 30, 2011 includes the bargain purchase gain of $8.7 million realized on the VBB Acquisition.

The following table presents our net income and earnings per common share information for the periods stated. In April 2011, common shares outstanding increased 4.6 million as a result of the completion of our underwritten public offering of shares of our common stock. In September 2011, we received $8.4 million from the U.S. Department of Treasury pursuant to its Small Business Lending Fund Program ("SBLF") and issued 8,381 shares of Senior Non-Cumulative Perpetual Preferred Stock, Series A.

                                                   For the Three Months Ended September 30,
                                                    2012                               2011
Net income                                   $            5,903                 $            6,789

Preferred stock dividend                                    (21 )                               (2 )

Net income available to common
shareholders                                 $            5,882                 $            6,787

Earnings per common share, basic
and diluted                                  $             0.56                 $             0.65


                                                    For the Nine Months Ended September 30,
                                                    2012                               2011
Net income                                   $            7,047                 $            4,232

Preferred stock dividend                                    (68 )                               (2 )

Net income available to common
shareholders                                 $            6,979                 $            4,230

Earnings per common share, basic
and diluted                                  $             0.67                 $             0.48

Net Interest Income

For the three months ended September 30, 2012, net interest income was $5.8 million compared to $4.8 million for the three months ended September 30, 2011, an increase of $1.0 million. Higher net interest income was primarily due to higher average loan balances, partially offset by lower yields on loans held for investment and higher balances of interest-bearing deposits and higher costs of time deposits. As presented in the table below, net interest margin for the three-month period ended September 30, 2012 was 4.54%, a 47 basis point decrease from 5.01% for the same period in 2011. Net interest margin is defined as the percentage of net interest income to average interest-earning assets. Excluding the effect of acquisition accounting adjustments, net interest margin for the three months ended September 30, 2012 increased 28 basis points, to 3.72%, from 3.44% for the same period in 2011.

Average interest-earning assets and related interest income increased $127.1 million and $1.2 million, respectively, for the three-month period ended September 30, 2012 compared to the same period in 2011. Average interest-bearing liabilities and related interest expense increased $81.1 million and $172 thousand, respectively, for the three-month period ended September 30, 2012 compared to the same period in 2011. Yields on interest-earning assets decreased 54 basis points to 5.31%, and costs of interest-bearing liabilities decreased 5 basis points to 1.03%, when comparing the three-month period ended September 30, 2012 to the same period in 2011. Average interest-earning assets as a percentage of total assets increased to 95.1% for the three-month period ended September 30, 2012, from 93.7% for the same period in 2011.

For the nine months ended September 30, 2012, net interest income was $16.5 million compared to $10.5 million for the nine months ended September 30, 2011, an increase of $6.0 million. Contributing to higher net interest income was higher average loan balances, partially offset by lower yields on interest-earning assets and higher balances of interest-bearing deposits and higher costs of time deposits. Higher average balances of loans and deposits are partially a result of the 2011 acquisitions, which occurred on July 29, 2011. As presented in the table below, net interest margin for the nine months ended September 30, 2012 was 4.58%, an 18 basis point decrease from the same period ended September 30, 2011. Excluding the effect of acquisition accounting adjustments, net interest margin for the nine months ended September 30, 2012 was 3.84%, a 39 basis point increase from 3.45% for the same period in 2011.

Average interest-earning assets and related interest income increased $187.0 million and $7.2 million, respectively, for the nine-month period ended September 30, 2012 compared to the same period in 2011. Average interest-bearing liabilities and related interest expense increased $134.8 million and $1.2 million, respectively, for the nine-month period ended September 30, 2012 compared to the same period in 2011. Yields on interest-earning assets decreased 17 basis points to 5.41%, and costs of interest-bearing liabilities increased 6 basis points to 1.11%, when comparing the nine-month period ended September 30, 2012 to the same period in 2011. Average interest-earning assets as a percentage of total assets increased to 94.8% for the nine-month period ended September 30, 2012, from 92.1% for the same period in 2011. Increases in average interest-earning assets and interest-bearing liabilities for both the three- and nine-month periods was partially due to our third quarter 2011 acquisitions.


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Our loan portfolios acquired in the merger, the Paragon Transaction and VBB Acquisition were discounted to estimated fair value (for credit and interest rates) as of the acquisition dates. A portion of the discounts taken to record the acquired loans at estimated fair value is being recognized (accreted) into interest income over the estimated remaining life of the loans or the period of expected cash flows from the loans. Amounts received in excess of the carrying value of loans accounted for on cost recovery are also accreted into interest income at the time of recovery. Loan discount accretion for the three months ended September 30, 2012 and 2011 was $1.1 million and $1.2 million, respectively. The effect of this accretion on net interest margin was 82 basis points and 129 basis points, respectively, for the three-month periods ended September 30, 2012 and 2011. For the nine-month periods ended September 30, 2012 and 2011, loan discount accretion was $2.7 million and $2.1 million, respectively. The effect of this accretion on net interest margin was 74 basis points and 94 basis points, respectively, for the nine months ended September 30, 2012 and 2011.

Time deposits acquired in the merger were also adjusted to fair value at the date of the merger for interest rates. The total adjustment at the date of the merger was $2.1 million and was amortized as a reduction of interest expense over a two-year period beginning December 2009. The effect of this amortization was a decrease in interest expense of $270 thousand for the three-month period ended September 30, 2011 and $810 thousand for the nine-month period ended September 30, 2011. This fair value adjustment had no effect on the three- and nine-month periods ended September 30, 2012. The effect of this adjustment on net interest margin in the three- and nine-month periods ended September 30, 2011 was 28 basis points and 37 basis points, respectively.


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The following table provides a detailed analysis of the effective yields and rates on average interest-earning assets and average interest-bearing liabilities as of and for the periods stated. The average balances and other statistical data used in this table were calculated using daily average balances.

                                                                                   Average Balances, Income and Expenses, Yields and Rates
                                                                                     As of and For the Three Months Ended September 30,
                                                                                                                                                     2012 vs. 2011
                                               Average Balances (1)            Yield / Rate            Income /Expense (7), (8)           Increase          Change due to (2)
                                                2012           2011          2012        2011           2012               2011          (Decrease)         Rate         Volume
Assets
Interest-earning assets:
Federal funds sold                           $    2,297      $   1,089        0.22 %      0.46 %    $          1       $          1     $          0      $     (1 )     $     1
. . .
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