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MBRG > SEC Filings for MBRG > Form 10-K on 18-Mar-2013All Recent SEC Filings

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Annual Report


The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company. This discussion and analysis should be read in conjunction with the Company's Consolidated Financial Statements and Notes to Consolidated Financial Statements. It should also be read in conjunction with the "Caution About Forward Looking Statements" section at the end of this discussion.


The Company is headquartered in Middleburg, Virginia and conducts its primary operations through two wholly owned subsidiaries, Middleburg Bank and Middleburg Investment Group, Inc. and a majority owned subsidiary, Southern Trust Mortgage,
LLC. Middleburg Bank is a community bank serving the Virginia counties of Prince William, Loudoun, Fairfax, Fauquier, the Town of Williamsburg and the City of Richmond with twelve financial service centers and one limited service facility. Middleburg Investment Group is a non-bank holding company with one wholly owned subsidiary, Middleburg Trust Company. Middleburg Trust Company is a trust company headquartered in Richmond, Virginia, and maintains offices in Williamsburg, Virginia and in several of Middleburg Bank's facilities. Southern Trust Mortgage is a regional mortgage company headquartered in Virginia Beach, Virginia and maintains offices in Virginia, Maryland, Georgia, North Carolina and South Carolina.

The Company generates a significant amount of its income from the net interest income earned by Middleburg Bank. Net interest income is the difference between interest income and interest expense. Interest income depends on the amount of interest-earning assets outstanding during the period and the interest rates earned thereon. Middleburg Bank's cost of money is

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a function of the average amount of deposits and borrowed money outstanding during the period and the interest rates paid thereon. The quality of the assets further influences the amount of interest income lost on non-accrual loans and the amount of additions to the allowance for loan losses or potential other-than-temporary impairment of securities. Middleburg Investment Group's subsidiary, Middleburg Trust Company, generates fee income by providing investment management and trust services to its clients. Investment management and trust fees are generally based upon the value of assets under management, and, therefore can be significantly affected by fluctuations in the values of securities caused by changes in the capital markets. Southern Trust Mortgage generates fees from the origination and sale of mortgages loans. Southern Trust Mortgage also maintains a real estate construction portfolio and receives interest and fee income from these loans, which, net of interest expense, is included in net interest income.

At December 31, 2012, total assets were $1.2 billion, an increase of 3.7% or $43.9 million from total assets of $1.2 billion at December 31, 2011. Total loans, including mortgages held for sale increased $27.3 million from $763.9 million at December 31, 2011 to $791.6 million at December 31, 2012. Total deposits increased by $52.0 million or 5.6% to $981.9 million at December 31, 2012 from $929.9 million at December 31, 2011. Lower cost deposits, including demand checking, interest checking and savings increased $86.0 million or 14.2% from the year ended December 31, 2011 to $689.9 million for the year ended December 31, 2012. Higher cost time deposits, excluding brokered certificates of deposit, decreased 14.4% or $38.2 million from the year ended December 31, 2011 to $226.9 million for the year ended December 31, 2012. The shift in the mix of deposits as well as lower interest rates paid on deposits and borrowings during 2012 contributed to the 26 basis point decrease in the overall cost of interest-bearing liabilities from 2011 to 2012. The net interest margin, a non-GAAP measure more fully described in the "Results of Operations" section below, decreased from 3.72% for the year ended December 31, 2011 to 3.47% for the year ended December 31, 2012. The decrease is primarily attributed to the 26 basis point decrease in the cost of total interest bearing liabilities as compared to the 49 basis point decrease, on a tax equivalent basis, in yield of total interest bearing assets. The provision for loan losses increased by $554,000 for the year ended December 31, 2012 to $3.4 million compared to $2.9 million for the same period in 2011. The Company recognized no other-than-temporary impairment for the year ended December 31, 2012 compared to $25,000 in 2011. Total non-interest income increased by $9.5 million for the year ended December 31, 2012, compared to 2011. The increase is largely due to gains on the sale of loans by the Company's mortgage banking subsidiary, Southern Trust Mortgage. Non-interest expense in 2012 increased $5.2 million, up 10.7% from 2011.

Total non-interest expenses for the years ended December 31, 2012, 2011, and 2010 include the consolidated expenses of Southern Trust Mortgage. Although the Company is focused on keeping growth in non-interest expense low in the future, because of the Company's plan to continue growth and expansion, it is expected that non-interest expense will continue to grow in the future at a rate similar to previous years. The Company remains well capitalized with risk-adjusted core capital and total capital ratios well above the regulatory minimums.

With the creation of Middleburg Investment Group, the Company has expanded the integration of Middleburg Trust Company and Middleburg Bank's investment services department into a more focused wealth management program for all of the Company's clients. The Company intends to make each of its wealth management services available within all of its financial service centers. Also, through the affiliation with Southern Trust Mortgage, Middleburg Bank plans to continue to increase its loan portfolio by purchasing high credit quality, low loan to value first deeds of trusts on residential property. Middleburg Bank plans to continue its focus on low cost deposit growth with advertising campaigns and product development.

The Company is not aware of any current recommendations by any regulatory authorities that, if they were implemented, would have a material effect on the registrant's liquidity, capital resources or results of operations.

Critical Accounting Policies


The financial condition and results of operations presented in the Consolidated Financial Statements, the accompanying Notes to the Consolidated Financial Statements and this section are, to some degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.

Presented below is discussion of those accounting policies that management believes are the most important ("Critical Accounting Policies") to the portrayal and understanding of Middleburg Financial Corporation's financial condition and results of operations. The Critical Accounting Policies require management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, the possibility of materially different financial condition or results of operations is a reasonable likelihood.

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Allowance for Loan Losses

Middleburg Bank monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. Middleburg Bank maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

Middleburg Bank evaluates various loans individually for impairment as required by applicable accounting standards. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, troubled debt restructured loans and other loans selected by management. 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 impairment. If a loan evaluated individually is not impaired, then the loan is assessed for impairment with a group of loans that have similar characteristics.

For loans without individual measures of impairment, Middleburg Bank makes estimates of losses for groups of loans as required by applicable accounting standards. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loans losses. This estimate of losses is compared to the allowance for loan losses of Middleburg Bank as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. Middleburg Bank recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the Consolidated Financial Statements.

Intangibles and Goodwill

The Company has approximately $6.0 million in intangible assets and goodwill at December 31, 2012, a decrease of $172,000 since December 31, 2011 which was attributable to regular amortization of intangible assets. On April 1, 2002, the Company acquired Middleburg Investment Advisors, a registered investment adviser, for $6.0 million. Approximately $5.9 million of the purchase price was allocated to intangible assets and goodwill. In connection with this investment, a purchase price valuation was completed to determine the appropriate allocation to identified intangibles. The valuation concluded that approximately 42% of the purchase price was related to the acquisition of customer relationships with an amortizable life of 15 years. Another 19% of the purchase price was allocated to a non-compete agreement with an amortizable life of 7 years. The remainder of the purchase price, approximately $2.4 million, was allocated to goodwill. On January 3, 2011, Middleburg Investment Advisors was merged into Middleburg Trust Company and its goodwill balance is reflected in the total goodwill balance reported for Middleburg Investment Group of $3.4 million. The remaining balance of unamortized identified intangible assets related to the acquisition of Middleburg Investment Advisors is $728,000. Approximately $1.0 million of the $6.0 million in intangible assets and goodwill at December 31, 2012 is attributable to the Company's investment in Middleburg Trust Company. With the consolidation of Southern Trust Mortgage, the Company recognized $1.9 million in goodwill as part of its equity investment.

The purchase price allocation process requires management estimates and judgment as to expectations for the life span of various customer relationships as well as the value that key members of management add to the success of the Company. For example, customer attrition rates were determined based upon assumptions that the past five years may predict the future. If the actual attrition rates, among other assumptions, differed from the estimates and judgments used in the purchase price allocation, the amounts recorded in the Consolidated Financial Statements could result in a possible impairment of the intangible assets and goodwill or require acceleration in the amortization expense.

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In addition, current accounting standards require that goodwill be tested annually using either a two-step quantitative process or a qualitative assessment followed by a two-step quantitative process if the qualitative assessment indicates that the fair value of the reporting unit may be less than its carrying value. As of December 31, 2012, the Company elected to perform a two-step quantitative process to evaluate its goodwill for any impairment. The first step is to identify a potential impairment. The second step measures the amount of the impairment loss, if any. Processes and procedures have been identified for the two-step process. The most recent evaluation was conducted as of December 31, 2012.

As of December 31, 2012, the Company recognized two consolidated subsidiaries as reporting units for the purpose of goodwill evaluation and reporting: Southern Trust Mortgage ("STM") and Middleburg Investment Group ("MIG"). MIG is the parent company of Middleburg Trust Company. The following table shows the allocation of goodwill between the two reporting units and the percentage by which the fair value of each reporting unit as of December 31, 2012 (the most recent fair value evaluation date) exceeded the carrying value as of that date:

                                  Allocation of Goodwill to Reporting Units
                                           (Dollars in Thousands)
                                                                                                  Percentage by
                                                (1)                             (1)             which Fair Value
                    Carrying Value         Carrying Value              Estimated Fair Value       of Reporting
  Reporting          of Goodwill         of Reporting Unit               of Reporting Unit        Unit Exceeds
     Unit         December 31, 2012      December 31, 2012               December 31, 2012       Carrying Value
STM              $           1,867      $            7,880            $            10,040               27.41 %
MIG                          3,422                   6,244     (2 )                 9,167               46.81 %
Total            $           5,289      $           14,124            $            19,207               35.99 %

(1) Reported amounts reflect only Middleburg Financial Corporation shareholder's ownership interests.

(2) Includes $728,000 of amortizing intangible assets.

Management estimates fair value utilizing multiple methodologies which include discounted cash flows, comparable companies, third-party sale and assets under management analysis. Determining the fair value of the Company's reporting units requires management to make judgments and assumptions related to various items, including estimates of future operating results, allocations of indirect expenses, and discount rates. Management believes its estimates and assumptions are reasonable; however, the fair value of each reporting unit could be different in the future if actual results or market conditions differ from the estimates and assumptions used.

The Company's forecasted cash flows for its reporting units assume a stable economic environment and consistent long-term growth in loan originations and assets under management over the projected periods. Additionally, expenses are assumed to be consistently correlated with projected asset and revenue growth over the time periods projected. Although we believe the key assumptions underlying the financial forecasts to be reasonable, they are inherently uncertain and involve a number of risks and uncertainties that are beyond the control of the Company. Accordingly, there can be no assurance that the forecasted results will be realized and variations from the forecast may be material. If weak economic conditions continue or worsen for a prolonged period of time, or if the reporting unit loses key personnel, the fair value of the reporting unit may be adversely affected which may result in impairment of goodwill or other intangible assets in the future. Any changes in the key management estimates or judgments could result in an impairment charge, and such a charge could have an adverse effect on the Company's financial condition and results of operations.

Other-Than-Temporary Impairment (OTTI)

No losses related to other-than-temporary impairment were recognized in 2012 compared to $25,000 of losses related to other than-temporary impairment on trust preferred securities recognized during 2011. At December 31, 2012, the Company had no trust preferred securities in its portfolio.

The Company may need to recognize additional other-than-temporary impairments related to other securities in 2013.

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Results of Operations

Net Income

The Company had net income for 2012 of $6.5 million, compared to net income of $5.0 million in 2011. For 2012, the earnings per diluted share was $0.92 compared to earnings per diluted share of $0.71 and a loss per diluted share of $0.39 for 2011 and 2010 respectively.

Return on average assets ("ROA") measures how effectively the Company employs its assets to produce net income. The ROA for the Company was 0.54% for the year ended December 31, 2012 compared to 0.44% and - 0.25% for the years ended December 31, 2011 and 2010 respectively. Return on average equity ("ROE"), another measure of earnings performance, indicates the amount of net income earned in relation to the total average equity capital invested. ROE was 5.9% for the year ended December 31, 2012. ROE was 4.9% and -2.7% for the years ended December 31, 2011 and 2010, respectively.

The following table reflects an analysis of the Company's net interest income using the daily average balances of the Company's assets and liabilities as of December 31. Non-accrual loans are included in the loan average balances.

            Average Balances, Income and Expenses, Yields and Rates
                           (Years Ended December 31)

                                        2012                                    2011                                    2010
                           Average       Income/      Yield/       Average       Income/      Yield/       Average       Income/      Yield/
                           Balance       Expense       Rate        Balance       Expense       Rate        Balance       Expense       Rate
                                                                       (Dollars in thousands)
Assets :
Taxable                  $   262,991     $  6,601       2.51 %   $   231,893     $  6,771       2.92 %   $   159,326     $  4,838       3.04 %
Tax-exempt (1)                62,363        3,642       5.84 %        56,793        3,580       6.30 %        59,654        3,810       6.39 %
Total securities         $   325,354     $ 10,243       3.15 %   $   288,686     $ 10,351       3.59 %   $   218,980     $  8,648       3.95 %

Loans                    $   755,925     $ 37,898       5.01 %   $   720,633     $ 39,392       5.47 %   $   707,135     $ 40,548       5.73 %
Interest bearing
deposits in other
financial institutions        54,237          124       0.23 %        43,469          110       0.25 %        47,836          131       0.27 %
Total earning assets     $ 1,135,516     $ 48,265       4.25 %   $ 1,052,788     $ 49,853       4.74 %   $   973,951     $ 49,327       5.06 %
Less: allowances for
credit losses                (14,830 )                               (14,835 )                               (11,119 )
Total nonearning
assets                        84,279                                  87,410                                  94,005
Total assets             $ 1,204,965                             $ 1,125,363                             $ 1,056,837
Checking                 $   322,715     $  1,271       0.39 %   $   294,660     $  1,883       0.64 %   $   283,294     $  2,294       0.81 %
Regular savings              105,768          350       0.33 %        96,725          683       0.71 %        77,864          725       0.93 %
Money market savings          64,517          204       0.32 %        59,356          353       0.59 %        53,894          427       0.79 %
Time deposits:
$100,000 and over            143,687        2,200       1.53 %       136,526        2,419       1.77 %       160,063        4,298       2.69 %
Under $100,000               165,703        2,891       1.74 %       172,815        3,529       2.04 %       161,338        4,289       2.66 %
Total interest-bearing
deposits                 $   802,390     $  6,916       0.86 %   $   760,082     $  8,867       1.17 %   $   736,453     $ 12,033       1.63 %
Short-term borrowings          8,725          392       4.49 %         9,555          318       3.33 %        10,419          393       3.77 %
Securities sold under

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to repurchase                   34,177          332       0.97 %        33,162          293       0.88 %        25,314          205       0.81 %
Long-term debt                  83,654        1,184       1.42 %        81,300        1,213       1.49 %        55,303        1,544       2.79 %
Federal funds purchased              1            -       0.00 %            42            -       0.00 %            25            -       0.00 %
Total interest-bearing
liabilities                $   928,947     $  8,824       0.95 %   $   884,141     $ 10,691       1.21 %   $   827,514     $ 14,175       1.71 %
Non-interest bearing
Demand deposits                156,057                                 130,565                                 120,475
Other liabilities                6,503                                   6,628                                   6,850
Total liabilities          $ 1,091,507                             $ 1,021,334                             $   954,839
Non-controlling interest
consolidated Subsidiary          2,828                                   2,241                                   2,876
Shareholders' equity           110,630                                 101,788                                  99,122
 Total liabilities
and Shareholders' equity   $ 1,204,965                             $ 1,125,363                             $ 1,056,837
Net interest income                        $ 39,441                                $ 39,162                                $ 35,152
Interest rate spread                                      3.30 %                                  3.53 %                                  3.35 %
Interest expense as a
percent of average
earning assets                                            0.78 %                                  1.02 %                                  1.46 %
Net interest margin                                       3.47 %                                  3.72 %                                  3.61 %

(1) Income and yields are reported on tax equivalent basis assuming a federal tax rate of 34%.

Net Interest Income

Net interest income represents the principal source of earnings of the Company. Net interest income is the amount by which interest generated from earning assets exceeds the expense of funding those assets. Changes in 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.

Net interest income was $38.2 million for the year ended December 31, 2012. This is an increase of 0.7% over the $37.9 million reported for 2011. Net interest income for 2011 increased 12.1% over the $33.8 million reported for 2010. The net interest margin decreased 25 basis points to 3.47% in 2012. The net interest margin is calculated by dividing tax equivalent net interest income by total average earning assets. Because a portion of interest income earned by the Company is nontaxable, the tax equivalent net interest income is considered in the calculation of this ratio. Tax equivalent net interest income is calculated by adding the tax benefit realized from interest income that is nontaxable to total interest income then subtracting total interest expense. The tax rate utilized in calculating the tax benefit for each of 2012, 2011 and 2010 is 34%. The reconciliation of tax equivalent net interest income, which is not a measurement under accounting principles generally accepted in the United States, to net interest income is reflected in the table below.

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Reconciliation of Net Interest Income to
                                Tax-Equivalent Income
                                                 For the Year Ended December 31,
(in thousands)                                  2012            2011          2010
GAAP measures:
Interest Income - Loans                    $    37,895       $  39,392     $  40,548
Interest Income - Investments & Other            9,128           9,244         7,483
Interest Expense - Deposits                      6,916           8,867        12,033
Interest Expense - Other Borrowings              1,908           1,824         2,142
Total Net Interest Income                  $    38,199       $  37,945     $  33,856
NON-GAAP measures:
Tax Benefit Realized on:
Non-taxable interest income - municipal
securities                                 $     1,238       $   1,217     $   1,296
Non-taxable interest income - loans                  3               -             -
Total Tax Benefit Realized on
Non-Taxable Interest Income                $     1,241       $   1,217     $   1,296
Total Tax Equivalent Net Interest Income   $    39,440       $  39,162     $  35,152

The increase in net interest income in 2012 primarily resulted from an increase in earning assets and reduced funding costs, partially offset by a decrease in yields on earning assets. Interest income and fees from loans and investments decreased 3.3% during 2012. The cost of interest bearing liabilities in 2012 . . .

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