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EVBS > SEC Filings for EVBS > Form 10-K on 31-Mar-2014All Recent SEC Filings




Annual Report

Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

This commentary provides an overview of the Company's financial condition as of December 31, 2013 and 2012, and changes in financial condition and results of operations for the years 2011 through 2013. This section of the Form 10-K should be read in conjunction with the Consolidated Financial Statements and related Notes thereto included under Item 8. "Financial Statements and Supplementary Data" of this Form 10-K.

Forward Looking Statements

Certain statements contained in this Annual Report on Form 10-K that are not historical facts may constitute "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. In addition, certain statements may be contained in the Company's future filings with the SEC, in press releases, and in oral and written statements made by or with the approval of the Company that are not statements of historical fact and constitute forward-looking statements within the meaning of the Act. Examples of forward-looking statements include, but are not limited to: (i) projections of revenues, expenses, income or loss, earnings or loss per share, the payment or nonpayment of dividends, capital structure and other financial items; (ii) statements of plans, objectives and expectations of the Company or its management or Board of Directors, including those relating to products or services, the performance or disposition of portions of the Company's asset portfolio, future changes to EVB's (the "Bank") branch network, the payment of dividends, and the ability to realize deferred tax assets; (iii) statements of future financial performance and economic conditions; (iv) statements regarding the impact of the MOU or the termination of the MOU among the Company, the Bank, the Reserve Bank and the Bureau on our financial condition, operations and capital strategies, including strategies related to payment of dividends on the Company's outstanding common and preferred stock, to redemption of the Company's Series A Preferred Stock, and to payment of interest on the Company's outstanding Junior Subordinated Debentures related to the Company's trust preferred debt; (v) statements regarding the adequacy of the allowance for loan losses; (vi) statements regarding the effect of future sales of investment securities or foreclosed properties; (vii) statements regarding the Company's liquidity; (viii) statements of management's expectations regarding future trends in interest rates, real estate values, and economic conditions generally and in the Company's markets; (ix) statements regarding future asset quality, including expected levels of charge-offs; (x) statements regarding potential changes to laws, regulations or administrative guidance; (xi) statements regarding business initiatives related to and the use of proceeds from the Private Placements and the Rights Offering, including expected future interest expenses and net interest margin following the prepayment of long-term FHLB advances; and (xii) statements of assumptions underlying such statements. Words such as "believes," "anticipates," "expects," "intends," "targeted," "continue," "remain," "will," "should," "may" and other similar expressions are intended to identify forward-looking statements but are not the exclusive means of identifying such statements.

Forward-looking statements involve risks and uncertainties that may cause actual results to differ materially from those in such statements. Factors that could cause actual results to differ from those discussed in the forward-looking statements include, but are not limited to:

factors that adversely affect our business initiatives related to and the use of proceeds from the Rights Offering and the Private Placements, including, without limitation, changes in market conditions that adversely affect our ability to dispose of or work out assets adversely classified by us on advantageous terms or at all;

our ability and efforts to assess, manage and improve its asset quality;

the strength of the economy in the Company's target market area, as well as general economic, market, political, or business factors;

changes in the quality or composition of our loan or investment portfolios, including adverse developments in borrower industries, decline in real estate values in its markets, or in the repayment ability of individual borrowers or issuers;

the effects of our adjustments to the composition of our investment portfolio;

the impact of government intervention in the banking business;


an insufficient allowance for loan losses;

our ability to meet the capital requirements of our regulatory agencies;

changes in laws, regulations and the policies of federal or state regulators and agencies, including rules to implement the Basel III capital framework and for calculating risk-weighted assets;

adverse reactions in financial markets related to the budget deficit of the United States government;

changes in the interest rates affecting our deposits and loans;

the loss of any of our key employees;

changes in our competitive position, competitive actions by other financial institutions and the competitive nature of the financial services industry and our ability to compete effectively against other financial institutions in its banking markets;

our potential growth, including our entrance or expansion into new markets, the opportunities that may be presented to and pursued by us and the need for sufficient capital to support that growth;

changes in government monetary policy, interest rates, deposit flow, the cost of funds, and demand for loan products and financial services;

our ability to maintain internal control over financial reporting;

our ability to raise capital as needed by our business;

our reliance on secondary sources, such as Federal Home Loan Bank advances, sales of securities and loans, federal funds lines of credit from correspondent banks and out-of-market time deposits, to meet our liquidity needs;

possible changes to our Board of Directors, including in connection with the Private Placements and deferred dividends on our Series A Preferred Stock; and

other circumstances, many of which are beyond our control.

Forward-looking statements speak only as of the date on which such statements are made. The Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which such statement is made, or to reflect the occurrence of unanticipated events. The reader should refer to risks detailed under Item 1A. "Risk Factors" included above in this Form 10-K and in our periodic and current reports filed with the Securities and Exchange Commission for specific factors that could cause our actual results to be significantly different from those expressed or implied by our forward-looking statements.

Critical Accounting Policies

The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies with the greatest uncertainty and that require our most difficult, subjective or complex judgments affecting the application of these policies, and the likelihood that materially different amounts would be reported under different conditions, or using different assumptions, are described below.

Allowance for Loan Losses

The Company establishes the allowance for loan losses through charges to earnings in the form of a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible. Our judgment in determining the level of the allowance is based on evaluations of the collectability of loans while taking into consideration such factors as trends in delinquencies and charge-offs, changes in the nature and volume of the loan portfolio, current economic conditions that may affect a borrower's ability to repay and the value of collateral, overall portfolio quality and review of specific potential losses. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. For more information see the section titled "Asset Quality" within Item 7.


Impairment of Loans

The Company considers a loan impaired when, based on current information and events, it is probable that the Company will be unable to collect the scheduled payments of principal and interest when due, according to the contractual terms of the loan agreement. The Company does not consider a loan impaired during a period of insignificant payment shortfalls if we expect the ultimate collection of all amounts due. Impairment is measured on a loan by loan basis for real estate (including multifamily residential, construction, farmland and non-farm, non-residential) and commercial loans 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. Large groups of smaller balance homogeneous loans, representing consumer, one to four family residential first and seconds and home equity lines, are collectively evaluated for impairment. The Company maintains a valuation allowance to the extent that the measure of the impaired loan is less than the recorded investment. Troubled debt restructurings ("TDRs") are also considered impaired loans. A TDR occurs when the Company, for economic or legal reasons related to the borrower's financial condition, grants a concession (including, without limitation, rate reductions to below-market rates, payment deferrals, forbearance and, in some cases, forgiveness of principal or interest) to the borrower that it would not otherwise consider. For more information see the section titled "Asset Quality" within Item 7.

Impairment of Securities

Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (i) the Company intends to sell the security or (ii) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however, the Company does not intend to sell the security and it is not more likely than not that the Company will be required to sell the security before recovery, the Company must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost basis of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income. For equity securities, impairment is considered to be other-than-temporary based on the Company's ability and intent to hold the investment until a recovery of fair value. Other-than-temporary impairment of an equity security results in a write-down that must be included in net income. The Company regularly reviews each investment security for other-than-temporary impairment based on criteria that include the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, the Company's best estimate of the present value of cash flows expected to be collected from debt securities, the Company's intention with regard to holding the security to maturity and the likelihood that the Company would be required to sell the security before recovery.

Other Real Estate Owned

Real estate acquired through, or in lieu of, foreclosure is held for sale and is stated at estimated fair market value of the property, less estimated disposal costs, if any. Any excess of cost over the estimated fair market value less costs to sell at the time of acquisition is charged to the allowance for loan losses. The estimated fair market value is reviewed periodically by management and any write-downs are charged against current earnings.


Goodwill is not amortized but is subject to impairment tests on at least an annual basis or earlier whenever an event occurs indicating that goodwill may be impaired. In assessing the recoverability of the Company's goodwill, all of which was recognized in connection with the acquisition of branches in 2003 and 2008, we must make assumptions in order to determine the fair value of the respective assets. Major assumptions used in the impairment analysis were discounted cash flows, merger and acquisition transaction values (including as compared to tangible book value), and stock market capitalization. The Company completed its annual goodwill impairment test during the fourth quarter of 2013 and determined there was no impairment to be recognized in 2013. If the underlying estimates and related assumptions change in the future, the Company may be required to record impairment charges.


Retirement Plan

The Company has historically maintained a defined benefit pension plan. Effective January 28, 2008, the Company took action to freeze the plan with no additional contributions for a majority of participants. Employees age 55 or greater or with 10 years of credited service were grandfathered in the plan. No additional participants have been added to the plan. The plan was again amended on February 28, 2011 to freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants have remained frozen in the plan since such action was taken. Effective January 1, 2012, the plan was amended and restated as a cash balance plan. Under a cash balance plan, participant benefits are stated as an account balance. An opening account balance was established for each participant based on the lump sum value of his or her accrued benefit as of December 31, 2011 in the original defined benefit pension plan. Each participant's account will be credited with an "interest" credit each year. The interest rate for each year is determined as the average annual interest rate on the 2 year U.S. Treasury securities for the month of December preceding the plan year. Plan assets, which consist primarily of mutual funds invested in marketable equity securities and corporate and government fixed income securities, are valued using market quotations. The Company's actuary determines plan obligations and annual pension expense using a number of key assumptions. Key assumptions may include the discount rate, the estimated return on plan assets and the anticipated rate of compensation increases. Changes in these assumptions in the future, if any, or in the method under which benefits are calculated may impact pension assets, liabilities or expense.

Accounting for Income Taxes

Determining the Company's effective tax rate requires judgment. In the ordinary course of business, there are transactions and calculations for which the ultimate tax outcomes are uncertain. In addition, the Company's tax returns are subject to audit by various tax authorities. Although we believe that the estimates are reasonable, no assurance can be given that the final tax outcome will not be materially different than that which is reflected in the income tax provision and accrual.

The realization of deferred income tax assets is assessed and a valuation allowance is recorded if it is "more likely than not" that all or a portion of the deferred tax asset will not be realized. "More likely than not" is defined as greater than a 50% chance. Management considers all available evidence, both positive and negative, to determine whether, based on the weight of that evidence, a valuation allowance is needed. For more information, see Item 8. "Financial Statements and Supplementary Data," under the heading "Note 10. Income Taxes."

For further information concerning accounting policies, refer to Item 8. "Financial Statements and Supplementary Data," under the heading "Note 1. Summary of Significant Accounting Policies."

Executive Overview

Eastern Virginia Bankshares, Inc. is committed to delivering strong long-term earnings using a prudent allocation of capital, in business lines where we have demonstrated the ability to compete successfully. During 2013, the national and local economies continued to show limited signs of recovery with the main challenges continuing to be persistent unemployment above historical levels and uneven economic growth. Macro-economic and political issues continue to temper the global economic outlook and as such the Company remains cautiously optimistic regarding the limited signs of improvement seen in our local markets. Despite this, the Company believes that our local markets are poised for stronger growth in the coming months and years than the economic recovery has provided in our markets in recent periods. During 2013, the Company has continued to focus on asset quality and strengthening its balance sheet as it believes these areas are critical to its success in the near term. During 2013, the Company successfully executed on several of its previously disclosed strategic initiatives, including the closing of the private placements with certain institutional investors that raised approximately $45.0 million in aggregate gross proceeds, the closing of the rights offering to existing shareholders that raised approximately $5.0 million in aggregate gross proceeds, the accelerated resolution and disposition of certain adversely classified assets, the prepayment of higher rate long-term FHLB advances, and the termination of the formal written agreement with the Reserve Bank and the Bureau. Although the Company recorded a net loss during 2013 primarily due to the prepayment penalties on the extinguished FHLB advances, this transaction immediately improved the Company's financial position by eliminating a high cost source of funding, thus improving the Company's net interest margin in future


periods, and is a critical step in the Company's strategic progression towards optimizing its balance sheet. During the fourth quarter of 2013, the Company improved its net interest margin 65 basis points and 32 basis points when compared to the second and third quarters of 2013 due to the repayment of these long-term FHLB advances. Although interest rates have increased since the second quarter of 2013, the current low interest rate environment continues to negatively impact our margins by driving lower yields on our loan portfolio. Our overall asset quality continues to improve. During 2013, the Company was able to reduce its nonperforming assets by 28.9% and its classified assets by 35.7%. As a result of the Company's focus on resolving its problem assets, loan and asset quality metrics continue to improve as evidenced by end of year nonperforming loans to total loans of 1.68% and nonperforming assets to total assets of 1.15%. In addition, the Company's allowance for loan losses continued to remain strong at the end of 2013 producing a ratio of allowance for loan losses to nonperforming loans of 134.03% and a ratio of allowance for loan losses to total loans of 2.25%. During 2014, the Company plans to continue evaluating and implementing deliberate strategies to strengthen its financial condition and further improve its asset quality, and management looks forward to future growth and opportunities to further increase the value of the Company's franchise.

2013 Capital Initiative and Strategic Initiatives

On June 12, 2013, the Company closed on its previously disclosed private placements (the "Private Placements") with certain institutional investors which raised aggregate gross proceeds of $45.0 million through Private Placements of approximately 4.6 million shares of common stock and 5.2 million shares of Series B Preferred Stock each at $4.55 per share. For more information, see Item
8. "Financial Statements and Supplementary Data," under the heading "Note 21. Preferred Stock and Warrant."

On July 5, 2013, the Company closed on its previously disclosed rights offering (the "Rights Offering") to existing shareholders which raised aggregate gross proceeds of $5.0 million through the issuance of 1.1 million shares of common stock. After issuing these newly subscribed common shares, the Company had approximately 11.8 million total common shares outstanding.

The Company has used a portion of the gross proceeds from the 2013 Capital Initiative (consisting of the Private Placements and Rights Offering) for general corporate purposes, including strengthening its balance sheet, the accelerated resolution and disposition of assets adversely classified by the Company (consisting of other real estate owned and classified loans), and improvement of the Company's balance sheet through the restructuring of FHLB advances. During the third quarter of 2013, the Company prepaid $107.5 million of its long-term FHLB advances, and also accelerated the resolution and disposition of adversely classified assets. The extinguishment of the higher rate long-term FHLB advances triggered an $11.5 million prepayment penalty that was fully recognized during the third quarter of 2013. During 2014, the Company will continue to pursue the redemption of the Series A Preferred Stock originally issued to the Treasury through TARP, and also plans to focus on online and mobile banking options offered to the Bank's customers, including by introducing or improving the Bank's portfolio of internet and mobile banking products and services. As the Company executes these business strategies, senior management and the board of directors will continue to evaluate other initiatives that they believe will best position the Company for long-term success.

Summary of 2013 Operating Results and Financial Condition

During 2013, net loss was ($2.6) million, a decrease of $6.1 million over net income of $3.5 million for the same period of 2012. The net loss for 2013 is primarily due to an $11.5 million prepayment penalty on the extinguishment of $107.5 million in higher rate long-term FHLB advances as discussed in the previous paragraphs. Although net interest margin improved following the payoff of the long-term FHLB advances during the third quarter of 2013, earnings remain constrained due to the protracted low-interest rate environment, lingering credit quality issues and a lack of loan demand resulting from the challenging economic climate, all of which contribute to compressing the Company's net interest margin. The Company had a strong year liquidating its troubled assets, reducing its classified assets and improving its overall asset quality. The Company continues to be aggressive in the liquidation of troubled assets and that approach is evident with the overall reduction as of December 31, 2013 of nonperforming assets by 28.9% compared to December 31, 2012 through a combination of successful workouts and write-downs of previously identified impaired loans. The Company's Special Assets Division, which was formed in the second quarter of 2011 and works closely with our Executive Management Asset Quality Committee, has worked tirelessly in formulating


workout strategies and conducting asset dispositions. Despite our aggressive approach in liquidating troubled assets, the Company's allowance for loan losses remains healthy, producing a ratio of allowance for loan losses to nonperforming loans of 134.03% at December 31, 2013 compared to 171.29% at December 31, 2012. Additionally, the Company was able to reduce its ratio of nonperforming loans to total loans at December 31, 2013 to 1.68%, compared to 1.73% at December 31, 2012 while also reducing its ratio of nonperforming assets to total assets at December 31, 2013 to 1.15%, compared to 1.55% at December 31, 2012. With an economic outlook consisting of modest growth, elevated unemployment and low interest rates in the near term, the Company continues to believe the primary drivers behind our continued improvement include focusing on asset quality issues, containing noninterest expenses and lowering our cost of funding while maintaining adequate levels of liquidity, reserves for credit losses and capital.

The primary drivers for the Company's results for the year ended December 31, 2013 were the $11.5 million prepayment penalty on the payoff of long-term FHLB advances, downward pressure on asset yields in the current economic and interest rate environments, the elevated levels of the provision for loan losses over historical levels, the elevated levels of FDIC insurance premiums over historical levels, professional and collection/repossession expenses related to past due loans and nonperforming assets and losses on the sale of and valuation adjustments on other real estate owned. Sales of available for sale securities to adjust the composition of the Company's investment portfolio during 2013 generated gains of $1.5 million, a significant decrease from gains of $3.9 million during 2012. The Company experienced a decrease in the amount of net charge-offs during 2013 when compared to the same period in 2012, while the provision for loan losses during 2013 was down approximately 67.3% from the same period of 2012. This was due to improvements in some of the Company's credit quality metrics, including continued decreases in nonperforming assets, and other factors, which are reflective of slowly improving economic conditions. Although the amount of provision declined, the Company's provision for loan losses remains elevated compared to historical levels as we continue to experience historically high levels of nonperforming assets and charge-offs and aim to maintain an appropriate allowance for potential future loan losses. The Company believes the investments it has made since 2010 to reduce nonperforming assets and enhance our internal monitoring systems will significantly enhance the long-term credit quality of our loan portfolio and properly position us to deliver stronger earnings as we move forward once the economic climate improves.

For the year ended December 31, 2013, the following key points were significant factors in our reported results:

Extraordinary loss of $11.5 million on the extinguishment of $107.5 million in long-term FHLB advances.

Provision for loan losses of $1.9 million compared to $5.7 million for the same period in 2012.

Net charge-offs of $7.4 million to write off uncollectible balances on nonperforming assets.

Decrease in nonperforming assets by $4.8 million during 2013.

Gain on the sale of available for sale securities of $1.5 million resulting from the sale of a portion of the Company's previously impaired agency preferred securities (FNMA & FHLMC) as well as adjustments in the composition of the investment portfolio as part of our overall asset/liability management strategy.

Increase in net interest income by $476 thousand from the same period in 2012.

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