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UBSH > SEC Filings for UBSH > Form 10-K on 13-Mar-2013All Recent SEC Filings

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Annual Report


The following discussion and analysis provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company and its subsidiaries. This discussion and analysis should be read in conjunction with the "Consolidated Financial Statements" and the "Notes to the Consolidated Financial Statements" presented in Item 8 "Financial Statements and Supplementary Data" contained in Item 8 of this Form 10-K.



The accounting and reporting policies of the Company and its subsidiaries are in accordance with GAAP and conform to general practices within the banking industry. The Company's 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 the Company's consolidated financial position and/or results of operations.

The more critical accounting and reporting policies include the Company's accounting for the allowance for loan losses, mergers and acquisitions, and goodwill and intangible assets. The Company's accounting policies are fundamental to understanding the Company's consolidated financial position and consolidated results of operations. Accordingly, the Company's significant accounting policies are discussed in detail in Note 1 "Summary of Significant Accounting Policies" in the "Notes to the Consolidated Financial Statements" contained in Item 8 of this Form 10-K.

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

Allowance for Loan Losses ("ALL")

The provision for loan losses charged to operations is an amount sufficient to bring the allowance for loan losses to an estimated balance that management considers adequate to absorb potential losses in the portfolio. Loans are charged against the allowance when management believes the collectability of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management's determination of the adequacy of the allowance is based on an evaluation of the composition of the loan portfolio, the value and adequacy of collateral, current economic conditions, historical loan loss experience, and other risk factors. Management believes that the allowance for loan losses is adequate. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company's allowance for loan losses. Such agencies may require the Company to make adjustments to the allowance based on their judgments about information available to them at the time of their examination.

The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. The credit reviews consist of reviews by its Internal Audit group (or, prior to March 1, 2012, its Credit Administration group) and reviews performed by an independent third party. Upon origination, each commercial loan is assigned a risk rating ranging from one to nine, with loans closer to one having less risk, and this risk rating scale is the Company's primary credit quality indicator. Consumer loans are generally not risk rated, the primary credit quality indicator for this portfolio segment is delinquency status. The Company has various committees that review and ensure that the allowance for loan losses methodology is in accordance with GAAP and loss factors used appropriately reflect the risk characteristics of the loan portfolio.

The Company's ALL consists of specific, general and unallocated components.

Specific Reserve Component - The specific reserve component relates to impaired loans exceeding $500,000. A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Upon being identified as impaired, an allowance is established when the discounted cash flows of the impaired loan is lower than the carrying value of that loan for loans not considered to be collateral dependent. The significant majority of the Company's impaired loans are collateral dependent. The impairment of collateral dependent loans is measured based on the fair value of the underlying collateral (based on independent appraisals), less selling costs, compared to the carrying value of the loan. The Company obtains independent appraisals from a pre-approved list of independent, third party, appraisal firms located in the market in which the collateral is located. The Company's approved appraiser list is continuously maintained to ensure the list only includes such appraisers that have the experience, reputation, character, and knowledge of the respective real estate market. At a minimum, it is ascertained that the appraiser is currently licensed in the state in which the property is located, experienced in the appraisal of properties similar to the property being appraised, has knowledge of current real estate market conditions and financing trends, and is reputable. The Company's internal real estate valuation group performs either a technical or administrative review of all appraisals obtained. A technical review will ensure the overall quality of the appraisal while an administrative review ensures that all of the required components of an appraisal are present. Generally, independent appraisals are updated every 12 to 24 months or as necessary. The Company's impairment analysis documents the date of the appraisal used in the analysis, whether the officer preparing the report deems it current, and, if not, allows for internal valuation adjustments with justification. Adjustments to appraisals generally include discounts for continued market deterioration subsequent to the appraisal date. Any adjustments from the appraised value to carrying value are documented in the impairment analysis, which is reviewed and approved by senior credit administration officers and the Special Assets Loan Committee. External appraisals are the primary source to value collateral dependent loans; however, the Company may also utilize values obtained through broker price opinions or other valuations sources. These alternative sources of value are used only if deemed to be more representative of value based on updated information regarding collateral resolution. Impairment analyses are updated, reviewed and approved on a quarterly basis at or near the end of each reporting period.

General Reserve Component - The general reserve component covers non-impaired loans, and impaired loans below $500,000, and is derived from an estimate of credit losses adjusted for various environmental factors applicable to both commercial and consumer loan segments. The estimate of credit losses is a function of the product of net charge-off historical loss experience to the loan balance of the loan portfolio averaged during the preceding twelve quarters, as management has determined this to adequately reflect the losses inherent in the loan portfolio. The environmental factors consist of national, local and portfolio characteristics and are applied to both the commercial and consumer segments. The following table shows the types of environmental factors management considers:

                                ENVIRONMENTAL FACTORS
         Portfolio                     National                      Local
Experience and ability of      Interest rates              Level of economic activity
lending team
Depth of lending team          Inflation                   Unemployment
Pace of loan growth            Unemployment                Competition
Franchise expansion            Gross domestic product      Military/government impact
Execution of loan risk         General market risk and
rating process                 other concerns
Degree of oversight /          Legislative and
underwriting standards         regulatory environment
Value of real estate serving
as collateral
Delinquency levels in
Charge-off levels in
Credit concentrations /
nature and volume of
the portfolio

Unallocated Component - This component may be used to cover uncertainties that could affect management's estimate of probable losses. The unallocated component of the allowance reflects the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio. Together, the specific, general, and any unallocated allowance for loan loss represents management's estimate of losses inherent in the current loan portfolio. Though provisions for loan losses may be based on specific loans, the entire allowance for loan losses is available for any loan management deems necessary to charge-off. At December 31, 2012, there were no material amounts considered unallocated as part of the allowance for loan losses.

Impaired Loans

A loan is considered impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. A loan that is classified substandard or worse is considered impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower's prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis by either the present value of expected future cash flows discounted at the loan's effective interest rate, the loan's obtainable market price, or the fair value of the collateral if the loan is collateral dependent. The impairment loan policy is the same for each of the seven classes within the commercial portfolio segment.

For the consumer loan portfolio segment, large groups of smaller balance homogeneous loans are collectively evaluated for impairment. This evaluation subjects each of the Company's homogenous pools to a historical loss factor derived from net charge-offs experienced over the preceding twelve quarters. The Company applies payments received on impaired loans to principal and interest based on the contractual terms until they are placed on nonaccrual status at which time all payments received are applied to reduce the principal balance and recognition of interest income is terminated as previously discussed.

Mergers and Acquisitions

The Company's merger and acquisition strategy focuses on high-growth areas with strong market demographics and targets organizations that have a comparable corporate culture, strong performance and good asset quality, among other factors.

Business combinations are accounted for under Accounting Standards Codifications ("ASC") 805, Business Combinations, using the acquisition method of accounting. The acquisition method of accounting requires an acquirer to recognize the assets acquired and the liabilities assumed at the acquisition date measured at their fair values as of that date. To determine the fair values, the Company will continue to rely on third party valuations, such as appraisals, or internal valuations based on discounted cash flow analyses or other valuation techniques. Under the acquisition method of accounting, the Company will identify the acquirer and the closing date and apply applicable recognition principles and conditions. Costs that the Company expects, but is not obligated to incur in the future, to implement its plan to exit an activity of an acquiree or to terminate the employment of or relocate an acquiree's employees are not liabilities at the acquisition date. The Company does not recognize these costs as part of applying the acquisition method. Instead, the Company recognizes these costs as expenses in its post-combination financial statements in accordance with other applicable GAAP.

Acquisition-related costs are costs the Company incurs to effect a business combination. Those costs include advisory, legal, accounting, valuation, and other professional or consulting fees. Some other examples of costs to the Company include systems conversions, integration planning consultants and advertising costs. The Company will account for acquisition-related costs as expenses in the periods in which the costs are incurred and the services are received, with one exception. The costs to issue debt or equity securities will be recognized in accordance with other applicable GAAP. These acquisition-related costs are included within the Consolidated Statements of Income classified within the noninterest expense caption.

Goodwill and Intangible Assets

The Company follows ASC 805, Business Combinations, using the acquisition method of accounting for business combinations and ASC 350, Goodwill and Other Intangible Assets, which prescribes the accounting for goodwill and intangible assets subsequent to initial recognition. The provisions of this guidance discontinued the amortization of goodwill and intangible assets with indefinite lives but require an impairment review at least annually and more frequently if certain impairment indicators are evident.

Goodwill totaled $59.4 million for the years ended December 31, 2012 and 2011, respectively. Based on the testing of goodwill for impairment, there were no impairment charges for 2012, 2011, or 2010.

The Company used the acquisition method of accounting when acquiring First Market Bank and recorded $26.4 million of core deposit intangible, $1.2 million of trademark intangible and $1.1 million in goodwill. None of the goodwill recognized is deductible for income tax purposes. Core deposit intangible assets are being amortized over the periods of expected benefit, which range from 4 to 14 years. The core deposit intangible on that acquisition is being amortized over an average of 4.3 years using an accelerated method and the trademark intangible is being amortized over three years using the straight-line method.

In connection with the acquisition of the Harrisonburg branch, the Company recorded $1.8 million of goodwill and $9,500 of core deposit intangibles. The core deposit intangible of $9,500 was expensed in the second quarter of 2011. The recorded goodwill was allocated to the community banking segment of the Company and is deductible for tax purposes.

Total core deposit intangibles, net of amortization, amounted to $15.8 million and $20.7 million as of December 31, 2012 and 2011, respectively.

Amortization expense of core deposit intangibles for the years ended December 31, 2012, 2011, and 2010 totaled $4.9 million, $6.1 million, and $7.3 million, respectively. Amortization expense of the trademark intangible for the years ended December 31, 2012 and 2011 was $400,000 for both years and $367,000 for the year ended December 31, 2010.


The accompanying consolidated financial statements and accompanying notes, for prior periods reflect certain reclassifications in order to conform to the current presentation.

The primary reclassification that occurred during 2012 related to how the Company reports commissions paid on the origination of mortgage loans held for sale and debit and credit card interchange costs. Commissions paid on the origination of mortgage loans held for sale have been netted against the related gains on sales of mortgages loans revenue amounts. In addition, debit and credit card interchange costs incurred have been netted against the related debit and credit card interchange income. Management considers the net presentation to more accurately reflect the net contribution to the consolidated financial results for the mortgage segment and the debit and credit card products. As shown below, the results of the reclassifications are not considered material and have no effect on previously reported net earnings available to comment shareholders and earnings per share: (Dollars in thousands):

                                                              2012                                                    2011                                                    2010
                                           Prior                              Current              Prior                              Current              Prior                              Current
                                        Presentation        Reclass         Presentation        Presentation        Reclass         Presentation        Presentation        Reclass         Presentation
Net Interest Income after provision    $      142,155      $      -        $      142,155      $      139,560      $      -        $      139,560      $      127,208      $      -        $      127,208
Noninterest income                     $       59,018      $ (17,950 )     $       41,068      $       43,777      $ (10,813 )     $       32,964      $       47,298      $ (13,081 )     $       34,217
Noninterest expense                    $      151,429      $ (17,950 )     $      133,479      $      141,628      $ (10,813 )     $      130,815      $      143,001      $ (13,081 )     $      129,920
Income tax expense                     $       14,333      $      -        $       14,333      $       11,264      $      -        $       11,264      $        8,583      $      -        $        8,583
Net income                             $       35,411      $      -        $       35,411      $       30,445      $      -        $       30,445      $       22,922      $      -        $       22,922


Net Income

Net income for the year ended December 31, 2012 increased $5.0 million, or 16.3%, from the prior year. Net income available to common shareholders increased $7.6 million, or 27.5%, from the prior year, which included preferred dividends and discount accretion on preferred stock of $2.7 million. Return on average equity for the year ended December 31, 2012 was 8.13% compared to 6.90% for the prior year while return on average assets was 0.89% compared to 0.79% for the prior year. Earnings per share was $1.37, an increase of $0.30, or 28.0%, from $1.07 for the year ended December 31, 2011. Prior year earnings per share included preferred dividends and discount accretion on preferred stock of $2.7 million, or $0.10 per share.

The $5.0 million increase in net income was principally a result of higher net gains on sales of mortgage loans driven by higher origination volumes, lower provision for loan losses, reductions in FDIC insurance expense due to changes in the assessment base and rate, lower core deposit intangible amortization expense, and an increase in account service charges and net debit and credit card interchange fees. Partially offsetting these results were higher salaries and benefits related to the addition of mortgage loan originators and support personnel in 2012 and lower net interest income driven by reductions in interest income on interest-earning assets that outpaced the impact of lower costs on interest-bearing liabilities.

For the year ended December 31, 2011 compared to the year ended December 31, 2010, net income increased $7.5 million, or 32.8%, from $22.9 million to $30.4 million. Net income available to common shareholders, which deducts from net income the dividends and discount accretion on preferred stock, was $27.8 million for the year ended December 31, 2011 compared to $21.0 million for the year ended December 31, 2010. This represented an increase in earnings per common share, on a diluted basis, of $0.24 to $1.07 from $0.83. The repayment of the preferred stock assumed in the FMB acquisition accelerated the amortization of the related discount of approximately $982,000, which reduced earnings available to common shareholders by $0.02 per share. Return on average common equity for the year ended December 31, 2011 was 6.90%, while return on average assets was 0.79%, compared to 5.50% and 0.61%, respectively, for the year ended December 31, 2010.

The $7.5 million increase in net income for the year ended December 31, 2011 was largely attributable to increases in net interest income, the absence of nonrecurring prior year acquisition costs, and a decline in provision for loan loss.

Net Interest Income

Net interest income, which represents the principal source of earnings for the Company, is the amount by which interest income exceeds interest expense. The net interest margin is net interest income expressed as a percentage of average earning assets. Changes in the volume and mix of interest-earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income, the net interest margin, and net income.

The decline in the general level of interest rates over the last five years has placed downward pressure on the Company's earning asset yields and related interest income. The decline in earning asset yields, however, has been offset principally by the repricing of money market deposit accounts and certificates of deposits, and lower borrowing costs. During the third quarter of 2012, the Company modified its fixed rate convertible Federal Home Loan Bank of Atlanta ("FHLB") advances to floating rate advances, which resulted in reducing the Company's FHLB borrowing costs. The Federal Open Market Committee's commitment to keep rates exceptionally low for an extended period and the resulting flatter yield curve (i.e., longer term interest rates not significantly higher than short term rates) could negatively affect the Bank's net interest margin as lower deposit rates may not offset lower earning asset yields. The Company believes that its net interest margin will continue to decline modestly over the next several quarters as decreases in earning asset yields are projected to outpace declines in rates paid on interest-bearing liabilities.

                                                  Year-over-year results
                                                    Twelve Months Ended
                                                   Dollars in thousands
                                         12/31/12         12/31/11         Change
 Average interest-earning assets        $ 3,649,865      $ 3,518,643      $ 131,222
 Interest income (FTE)                  $   186,086      $   193,399      $  (7,313 )
 Yield on interest-earning assets              5.10 %           5.50 %          (40 ) bps
 Average interest-bearing liabilities   $ 2,922,373      $ 2,875,242      $  47,131
 Interest expense                       $    27,508      $    32,713      $  (5,205 )
 Cost of interest-bearing liabilities          0.94 %           1.14 %          (20 ) bps
 Cost of funds                                 0.75 %           0.93 %          (18 ) bps
 Net Interest Income (FTE)              $   158,577      $   160,686      $  (2,109 )
 Net Interest Margin (FTE)                     4.34 %           4.57 %          (23 ) bps
 Net Interest Margin, core (FTE) (1)           4.24 %           4.37 %          (13 ) bps

(1) The core net interest margin, fully taxable equivalent ("FTE") excludes the impact of acquisition accounting accretion and amortization adjustments in net interest income.

For the year ended December 31, 2012, tax-equivalent net interest income was $158.6 million, a decrease of $2.1 million, or 1.3%, when compared to the same period last year. The tax-equivalent net interest margin decreased by 23 basis points to 4.34% from 4.57% in the prior year. The decline in the net interest margin was principally due to the continued decline in accretion on the acquired net earning assets (10 bps) and a decline in the yield on interest-earning assets that outpaced the reduction in the cost of interest-bearing liabilities (13 bps). Lower interest-earning asset income was principally due to lower yields on loans and investment securities as new loans and renewed loans were originated and repriced at lower rates, faster prepayments on mortgage backed securities, and cash flows from securities investments reinvested at lower yields. The reduction in the cost of interest-bearing liabilities was primarily driven by a shift in the mix of the Company's deposit accounts as customers moved from certificates of deposits to transaction and money market accounts. The aforementioned modification of the Company's FHLB advances lowered the 2012 cost of interest-bearing liabilities by 3 bps subsequent to executing the modification during the third quarter of 2012.

The Company's fully taxable equivalent net interest margin includes the impact of acquisition accounting fair value adjustments that were recorded during 2010 and 2011. The 2012 and remaining estimated discount/premium and net accretion impact are reflected in the following table (dollars in thousands):

                                           Loan          Certificates        Investment
                                         Accretion        of Deposit         Securities       Borrowings         Total
For the year ended December 31, 2012    $     3,719      $         233      $        201      $      (489 )     $ 3,664
For the years ending:
2013                                          2,059                  7                15             (489 )       1,592
2014                                          1,459                  4                -              (489 )         974
2015                                          1,002                 -                 -              (489 )         513
2016                                            557                 -                 -              (163 )         394
2017                                            172                 -                 -                -            172
Thereafter                                      120                 -                 -                -            120

The following table shows interest income on earning assets and related average yields, as well as interest expense on interest-bearing liabilities and related average rates paid for the periods indicated (dollars in thousands):


                                                                                                For the Year Ended December 31,
. . .
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