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OPOF > SEC Filings for OPOF > Form 10-Q on 10-May-2013All Recent SEC Filings

Show all filings for OLD POINT FINANCIAL CORP | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for OLD POINT FINANCIAL CORP


10-May-2013

Quarterly Report


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

The following discussion is intended to assist readers in understanding and evaluating the financial condition, changes in financial condition and the results of operations of the Company. The Company consists of the parent company and its wholly-owned subsidiaries, The Old Point National Bank of Phoebus (the Bank) and Old Point Trust & Financial Services, N. A. (Trust), collectively referred to as the Company. This discussion should be read in conjunction with the consolidated financial statements and other financial information contained elsewhere in this report.

Caution About Forward-Looking Statements In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include, but are not limited to, statements regarding profitability, the net interest margin, strategies for managing the net interest margin and the expected impact of such efforts, liquidity, the loan portfolio and expected trends in the quality of the loan portfolio, the allowance and provision for loan losses, the securities portfolio, interest rate sensitivity, asset quality, levels of net loan charge-offs and nonperforming assets, noninterest expense (and components of noninterest expense), lease expense, the cost of expanding a current office building, noninterest income (and components of noninterest income), income taxes, expected impact of efforts to restructure the balance sheet, expected yields on the loan and securities portfolios, expected rates on interest-bearing liabilities, market risk, expected effects of the federal government's automatic spending cuts (commonly known as sequestration), business and growth strategies, investment strategy and financial and other goals. Forward-looking statements often use words such as "believes," "expects," "plans," "may," "will," "should," "projects," "contemplates," "anticipates," "forecasts," "intends" or other words of similar meaning. These statements can also be identified by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

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There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to, changes in interest rates, general economic conditions, the effects of the sequestration on the Company's service area and the allowance for loan losses, the quality or composition of the loan or investment portfolios, the effects of management's investment strategy, the adequacy of the Company's credit quality review processes, the level of nonperforming assets and charge-offs, the local real estate market, volatility and disruption in national and international financial markets, government intervention in the U.S. financial system, FDIC premiums and/or assessments, demand for loan products, levels of noninterest income and expense, deposit flows, competition, adequacy of the allowance for loan losses and changes in accounting principles, policies and guidelines. The Company could also be adversely affected by monetary and fiscal policies of the U.S. Government, as well as any regulations or programs implemented pursuant to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act) or other legislation and policies of the Office of the Comptroller of the Currency, U.S. Treasury and the Federal Reserve Board.

The Company has experienced reduced earnings due to the recent recession and the stagnation of the current economic recovery. The current economic climate has led to a reduction in quality loan growth, which has led to a reduction in the loan portfolio and corresponding increase in the securities portfolio.

In July 2010, the President signed into law the Dodd-Frank Act, which implements far-reaching changes across the financial regulatory landscape. It is not clear what other impacts the Dodd-Frank Act, regulations promulgated thereunder and other regulatory initiatives of the Treasury and other bank regulatory agencies will have on the financial markets and the financial services industry.

These risks and uncertainties, in addition to the risks and uncertainties identified in the Company's 2012 annual report on Form 10-K, should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results.

General
The Company is the parent company of the Bank and Trust. The Bank is a locally managed community bank serving the Hampton Roads localities of Hampton, Newport News, Norfolk, Virginia Beach, Chesapeake, Williamsburg/James City County, York County and Isle of Wight County. The Bank currently has 20 branch offices. In the first quarter of 2013 the Bank completed its combination two of its branches located in Williamsburg. Trust is a wealth management services provider.

Critical Accounting Policies and Estimates As of March 31, 2013, there have been no significant changes with regard to the critical accounting policies and estimates disclosed in the Company's 2012 annual report on Form 10-K. That disclosure included a discussion of the accounting policy that requires management's most difficult, subjective or complex judgments: the allowance for loan losses. For a discussion of the Company's policies for calculating the allowance for loan losses, see Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q.

Earnings Summary
Net income for the first quarter of 2013 was $901 thousand or $0.18 per diluted share as compared to net income of $1.1 million or $0.22 per diluted share for the first quarter of 2012. Net income for the first quarter of 2013 was $177 thousand less than the first quarter of 2012. While interest and noninterest expense were lower in the first quarter of 2013 than in 2012, the reduction in expense was not sufficient to offset the lower levels of income in 2013 compared to 2012. Several categories of interest and noninterest income were lower in the first quarter of 2013 than in 2012, including net gain on sale of securities, which was $314 thousand in the first quarter of 2012 as compared to no net gain in the first quarter of 2013. This difference was primarily attributable to a restructuring of the securities portfolio during 2012. In 2013, the Company is focusing on the liabilities side of the balance sheet to reduce high-cost deposits. Management expects to continue this strategy until loan demand increases.

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Net interest income after the provision for loan losses was $537 thousand less in the first quarter of 2013 as compared to 2012, mainly due to lower total interest income on loans. In contrast, noninterest expense was $324 thousand lower in the first quarter of 2013 as compared to the first quarter of 2012. The largest decreases in noninterest expense in the first quarter of 2013 as compared to the first quarter of 2012 were in losses on sale of foreclosed assets, FDIC insurance premiums, and legal and audit expenses.

Net Interest Income
The principal source of earnings for the Company is net interest income. Net interest income is the difference between interest and fees generated by earning assets and interest expense paid to fund them. 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 is calculated by dividing tax-equivalent net interest income by average earning assets. Although both total interest and dividend income and total interest expense decreased during the three months ended March 31, 2013, as compared to the same period in 2012, total interest and dividend income decreased more than total interest expense, causing net interest income to decrease for the three months ended March 31, 2013 compared to the three months ended March 31, 2012.

Net interest income, on a fully tax-equivalent basis, was $6.5 million in the first quarter of 2013, a decrease of $462 thousand from the first quarter of 2012. The net interest margin was 3.19% in the first quarter of 2013, 40 basis points lower than the 3.59% net interest margin in the equivalent period in 2012. While the average rate on liabilities continues to decrease, the rate of change slowed over the last year as most longer-term deposits had already repriced. In addition, the average yield on loans decreased from 5.72% for the first quarter of 2012 to 5.20% for the first quarter of 2013, as higher-yielding loans paid off or were renewed at current, lower rates. More significantly, the composition of earning assets has shifted: as average total loans have decreased from a lack of quality loan demand, a larger percent of earning assets have been invested in lower-yielding investment securities. Because investment securities typically yield less than loans, this shift to lower-yielding investment securities continues to negatively impact the Company's net interest margin in 2013.

Tax-equivalent interest income decreased by $718 thousand in the first quarter of 2013 compared to the same period of 2012. Average earning assets for the first quarter of 2013 increased $40.2 million compared to the same period in 2012. Interest expense decreased $256 thousand for the first quarter of 2013 as compared to the first quarter of 2012. The decrease in interest expense is primarily a result of the 21 basis-point decrease in the average rate on interest-bearing liabilities for first three months of 2013 compared to the same period in 2012.

The yield on average earning assets and cost of average interest-bearing liabilities both decreased due to the Federal Open Market Committee (FOMC) lowering the Federal Funds Target Rate during 2008 from 4.25% to a range of 0.00% to 0.25%. The FOMC has kept the Federal Funds Target Rate unchanged through March 31, 2013. As higher-yielding earning assets and higher-cost interest-bearing liabilities that were opened prior to 2008 mature, they are being replaced with lower-yielding earning assets and lower-cost interest-bearing liabilities. Assuming that the FOMC keeps interest rates at current levels, management believes that the decrease of the average rate on interest-bearing liabilities will continue to slow as a high percentage of the Company's interest-bearing liabilities have already repriced. Management also believes that the average yield on loans will continue to decline due to increased competition for loans in the Company's markets, and as loans are renewed or refinanced at lower current market rates.

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The following table shows an analysis of average earning assets, interest-bearing liabilities and rates and yields for the periods indicated. Nonaccrual loans are included in loans outstanding.

                            AVERAGE BALANCE SHEETS, NET INTEREST INCOME* AND RATES*
                                        For the quarter ended March 31,
                                          2013                                           2012
                                       Interest                                        Interest
                         Average       Income/         Yield/           Average        Income/         Yield/
                         Balance       Expense         Rate**           Balance        Expense         Rate**
                                                        (dollars in thousands)
ASSETS
Loans*                  $ 463,268     $    6,017            5.20 %     $  495,619     $    7,090           5.72 %
Investment
securities:
Taxable                   285,236          1,324            1.86 %        230,691          1,221           2.12 %
Tax-exempt*                40,086            401            4.00 %         13,928            143           4.11 %
Total investment
securities                325,322          1,725            2.12 %        244,619          1,364           2.23 %
Interest-bearing due
from banks                 23,912             14            0.23 %         31,290             17           0.22 %
Federal funds sold          1,932              0            0.00 %          1,955              0           0.00 %
Other investments           3,574             18            2.01 %          4,373             21           1.92 %
Total earning assets      818,008     $    7,774            3.80 %        777,856     $    8,492           4.37 %
Allowance for loan
losses                     (7,412 )                                        (8,595 )
Other nonearning
assets                     82,777                                          80,808
Total assets            $ 893,373                                      $  850,069

LIABILITIES AND
STOCKHOLDERS' EQUITY
Time and savings
deposits:
Interest-bearing
transaction accounts    $  11,037     $        2            0.07 %     $   11,163     $        2           0.07 %
Money market deposit
accounts                  195,103             71            0.15 %        172,402             79           0.18 %
Savings accounts           58,018             14            0.10 %         51,096             13           0.10 %
Time deposits,
$100,000 or more          135,786            396            1.17 %        125,393            415           1.32 %
Other time deposits       168,356            466            1.11 %        170,702            561           1.31 %
Total time and
savings deposits          568,300            949            0.67 %        530,756          1,070           0.81 %
Federal funds
purchased, repurchase
agreements and other
borrowings                 32,405              4            0.05 %         32,763             16           0.20 %
Federal Home Loan
Bank advances              25,000            302            4.83 %         35,000            425           4.86 %
Total
interest-bearing
liabilities               625,705          1,255            0.80 %        598,519          1,511           1.01 %
Demand deposits           176,249                                         163,293
Other liabilities           2,889                                           1,899
Stockholders' equity       88,530                                          86,358
Total liabilities and
stockholders' equity    $ 893,373                                      $  850,069
Net interest margin                   $    6,519            3.19 %                    $    6,981           3.59 %

*Computed on a fully tax-equivalent basis using a 34% rate **Annualized

Provision for Loan Losses
The provision for loan losses is a charge against earnings necessary to maintain the allowance for loan losses at a level consistent with management's evaluation of the portfolio. This expense is based on management's estimate of credit losses that may be sustained in the loan portfolio. Management's evaluation included credit quality trends, collateral values, the findings of internal credit quality assessments and results from external bank regulatory examinations. These factors, as well as identified impaired loans, historical losses and current economic and business conditions, were used in developing estimated loss factors for determining the loan loss provision.

The provision for loan losses was $200 thousand in the first quarter of 2013 and 2012. Management concluded that the provision was appropriate based on its analysis of the adequacy of the allowance for loan losses. Due to its concerns regarding the possible negative consequences of sequestration on local economic conditions and on borrowers' ability to repay loans, management maintained the provision in the first quarter of 2013 at the same level as the first quarter of 2012. Management believed this was appropriate even though net charge-offs were $345 thousand lower and total loans were $13.6 million lower in the first quarter of 2013 as compared to the first quarter of 2012.

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Net loans charged off were $265 thousand for the first quarter of 2013 as compared to $611 thousand for the first quarter of 2012. On an annualized basis, net loan charge-offs were 0.23% of total loans for the first three months of 2013 compared with 0.50% for the same period in 2012. Net loans charged off for the first three months of 2013 were relatively low as compared to net charge-offs of the past few years. Management anticipates that net charge-offs for the second quarter of 2013 will be below the elevated level of net charge-offs that occurred in 2010 and 2011 due to stabilization of the economy and housing prices. If the sequestration has negative consequences that are more severe than those currently expected by management, borrowers may be less likely to repay loans, net charge-offs may increase, and higher contributions to the allowance for loan losses in the form of increased provisions may be necessary.

Nonperforming assets consist of nonaccrual loans, loans past due 90 days or more and accruing interest, restructured loans that are accruing interest and not performing according to their modified terms, and foreclosed assets. See Note 3 of the Notes to the Consolidated Financial Statements included in this quarterly report on Form 10-Q for an explanation of these categories. Foreclosed assets consist of real estate from foreclosures on loan collateral. The majority of the loans 90 days or more past due but still accruing interest are classified as substandard. Substandard loans are a component of the allowance for loan losses. When a loan changes from "past due 90 days or more and accruing interest" status to "nonaccrual" status, the loan is reviewed for impairment. In most cases, if the loan is considered impaired, then the difference between the value of the collateral and the principal amount outstanding on the loan is charged off. If the Company is waiting on an appraisal to determine the collateral's value or is in negotiations with the borrower or other parties that may affect the value of the collateral, management allocates funds to cover the deficiency to the allowance for loan losses based on information available to management at that time. In the case of TDRs, the restructuring may be to modify to an unsecured loan (e.g., a short sale) that the borrower can afford to repay. In these circumstances, the entire balance of the loan would be specifically allocated for, unless the present value of expected future cash flows was more than the current balance on the loan. It would not be charged off if the loan documentation supports the borrower's ability to repay the modified loan.

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The following table presents information on nonperforming assets, as of the dates indicated:

                                        NONPERFORMING ASSETS
                                                      March 31,       December 31,        Increase
                                                        2013              2012           (Decrease)
                                                                     (in thousands)
Nonaccrual loans
Commercial                                           $        21     $           97     $        (76 )
Real estate-construction                                   2,880              3,065             (185 )
Real estate-mortgage (1)                                   7,083              7,470             (387 )
Consumer loans                                                 4                  0                4
Total nonaccrual loans                               $     9,988     $       10,632     $       (644 )
Loans past due 90 days or more and accruing
interest
Commercial                                           $         0     $           25     $        (25 )
Real estate-mortgage (1)                                     126                408             (282 )
Consumer loans                                                 0                 11              (11 )
Other                                                          4                  3                1
Total loans past due 90 days or more and accruing
interest                                             $       130     $          447     $       (317 )
Restructured loans
Real estate-mortgage (1)                             $     9,350     $        8,810     $        540
Consumer loans                                                16                 16                0
Total restructured loans                             $     9,366     $        8,826     $        540
Less nonaccrual restructured loans (included
above)                                                     1,855              1,908              (53 )
Less restructured loans currently in compliance
(2)                                                        7,511              6,918              593
Net nonperforming, accruing restructured loans       $         0     $            0     $          0

Foreclosed assets
Construction, land development, and other land       $     3,765              3,804     $        (39 )
1-4 family residential properties                            431                676             (245 )
Nonfarm nonresidential properties                          1,825              2,094             (269 )
                                                     $     6,021     $        6,574     $       (553 )

Total nonperforming assets                           $    16,139     $       17,653     $     (1,514 )

(1) The real estate-mortgage segment includes residential 1 - 4 family, commercial real estate, second mortgages and equity lines of credit.
(2) As of the dates presented, all of the Company's restructured accruing loans were performing in compliance with their modified terms.

Nonperforming assets as of March 31, 2013 were $16.1 million, $1.5 million lower than nonperforming assets as of December 31, 2012. The nonperforming assets category of nonaccrual loans decreased $644 thousand and foreclosed assets decreased by $553 thousand, when comparing the balances as of March 31, 2013 to December 31, 2012.

The majority of the balance of nonaccrual loans at March 31, 2013 was related to a few large credit relationships. Of the $10.0 million of nonaccrual loans at March 31, 2013, $8.2 million or approximately 82.31% was comprised of four credit relationships: $2.9 million, $2.8 million, $1.8 million, and $721 thousand. The loans that make up the nonaccrual balance have been written down to their net realizable value. As shown in the table above, the majority of the nonaccrual loans were collateralized by real estate at March 31, 2013 and December 31, 2012. The increase in troubled debts restructured between December 31, 2012 and March 31, 2013 was due to the Company's efforts to modify problem credits to assist borrowers and return the loans to performing status.

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Management believes the Company has excellent credit quality review processes in place to identify problem loans quickly. The quality of the Company's loan portfolio has continued to improve over the past few years, with nonperforming assets generally stabilizing as troubled borrowers' finances have improved and troubled loans have been charged off or sold. Management remains cautious about the future and is well aware that if the economy does not continue to improve, nonperforming assets could increase in future periods. As was seen in prior years, the effect of a sustained increase in nonperforming assets would be lower earnings caused by larger contributions to the loan loss provision, which in turn would be driven by larger impairments in the loan portfolio and higher levels of loan charge-offs.

As of March 31, 2013, the allowance for loan losses was 44.98% of nonperforming assets and 71.74% of nonperforming loans. The allowance for loan losses as a percentage of nonperforming assets and nonperforming loans increased slightly between March 31, 2013 and December 31, 2012 due to management concerns about the possible negative consequences of sequestration on local economic conditions and on borrowers' ability to repay loans. These percentages could increase further if the effects of sequestration on the Company's loan portfolio require increases in the allowance for loan losses.

Allowance for Loan Losses
The allowance for loan losses is based on several components. Historical loss is one of these components. Historical loss is based on the Company's loss experience during the past eight quarters, which management believes reflects the risk related to each segment of loans in the current economic environment. The historical loss component of the allowance amounted to $4.4 million and $5.4 million as of March 31, 2013 and December 31, 2012, respectively. This decrease is primarily due to lower charge-offs for the first three months of 2013 as compared to the level of charge-offs in certain quarters included in past historical loss periods. The Company uses a rolling eight-quarter average to calculate the historical loss component of the allowance, so higher charge-offs in the first three months of 2011 are no longer included in the calculation as of March 31, 2013, which has caused the historical loss component to decrease.

In evaluating the adequacy of the allowance, each segment of the loan portfolio is divided into several pools of loans based on the Company's internally assigned risk grades and on whether the loans must be specifically identified for an impairment analysis:

1. Specific identification (regardless of risk rating)

2. Pool-substandard

3. Pool-other assets especially mentioned (rated just above substandard)

4. Pool-pass loans (all other loans)

Historical loss rates are applied to the above pools of loans for each segment of the loan portfolio, except for impaired loans which have losses specifically calculated on an individual loan basis. In the past, specific identification loans were always risk-rated substandard or doubtful. Recent guidance from the FASB emphasized that TDRs must be included in the impaired loans section (specific identification) of the Company's allowance. For example, a TDR that was rated substandard and was upgraded to a pass rating after sustained performance would still be included in the specific identification section of the allowance.

In addition, nonperforming loans and both performing and nonperforming TDRs are analyzed for impairment under U.S. GAAP and are allocated based on this analysis. The impairment amounts determined for the Company's TDRs and nonperforming loans are included in the specific identification pool above. Therefore, changes in TDRs and nonperforming loans affect the dollar amount of the allowance. Unless the TDR or nonperforming loan does not require a specific allocation (i.e. the present value of expected future cash flows or the collateral value is considered sufficient), increases in the impairment analysis . . .

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