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EVBS > SEC Filings for EVBS > Form 10-Q on 14-Nov-2011All Recent SEC Filings




Quarterly Report

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

We present management's discussion and analysis of financial information to aid the reader in understanding and evaluating our financial condition and results of operations. This discussion provides information about the major components of our results of operations, financial condition, liquidity and capital resources. This discussion should be read in conjunction with the Unaudited Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements presented elsewhere in this report and the Consolidated Financial Statements and Notes to Consolidated Financial Statements presented in the 2010 Form 10-K. Operating results include those of all our operating entities combined for all periods presented.

The Company provides a broad range of personal and commercial banking services including commercial, consumer and real estate loans. We complement our lending operations with an array of retail and commercial deposit products and fee-based services. Our services are delivered locally by well-trained and experienced bankers, whom we empower to make decisions at the local level, so they can provide timely lending decisions and respond promptly to customer inquiries. Having been in many of our markets for over 100 years, we have established relationships with and an understanding of our customers. We believe that, by offering our customers personalized service and a breadth of products, we can compete effectively as we expand within our existing markets and into new markets.

Internet Access to Corporate Documents

Information about the Company can be found on the Company's investor relations website at The Company posts its annual reports, quarterly reports, current reports, definitive proxy materials and any amendments to those documents as soon as reasonably practicable after they are electronically filed with or furnished to the SEC. All such filings are available at no charge. The information on the Company's website is not, and shall not be deemed to be, a part of this Quarterly Report on Form 10-Q or incorporated into any other filings the Company makes with the SEC.

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Forward Looking Statements

Certain statements contained in this Quarterly Report on Form 10-Q 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 payment of dividends or the ability to realize deferred tax assets; (iii) statements of future economic performance; (iv) statements regarding the impact of the Written Agreement on our financial condition, operations and capital strategies, including strategies related to payment of dividends on the Company's outstanding common and 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 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; and (ix) 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:

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

the strength of the economy in our target market area, as well as general economic, market, 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 our markets, or in the repayment ability of individual borrowers or issuers;

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;

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

changes in the interest rates affecting our deposits and our 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 our 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;

our ability to comply with the Written Agreement, which requires us to designate a significant amount of resources to complying with the agreement and may have a material adverse effect on our operations and the value of our securities;

possible changes to our Board of Directors, including in connection with deferred dividends on our Capital Purchase Program preferred stock; and

other circumstances, many of which are beyond our control.

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All of the forward-looking statements made in this report are qualified by these factors, and there can be no assurance that the actual results anticipated by us will be realized or, even if substantially realized, that they will have the expected consequences to, or effects on, us or our business or operations. You should refer to risks detailed under Item 1A. "Risk Factors" included in the 2010 Form 10-K, detailed under Part II - Other Information, Item 1A. "Risk Factors" included in the Quarterly Reports on Form 10-Q for the quarters ended March 31, 2011 and June 30, 2011, and otherwise included in our periodic and current reports filed with the SEC for specific factors that could cause our actual results to be significantly different from those expressed or implied by our forward-looking statements.

We caution you that the above list of important factors is not all inclusive. These forward-looking statements are made as of the date of this report, and we may not undertake steps to update these forward-looking statements to reflect the impact of any circumstances or events that arise after the date the forward-looking statements are made.

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 2.

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 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 2.

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) we intend to sell the security or (ii) it is more likely than not that we will be required to sell the security before recovery of its amortized cost basis. If, however, we do not intend to sell the security and it is not more likely than not that we will be required to sell the security before recovery, we 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

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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 our 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. We regularly review each investment security for other-than-temporary impairment based on criteria that includes the extent to which cost exceeds market price, the duration of that market decline, the financial health of and specific prospects for the issuer, our best estimate of the present value of cash flows expected to be collected from debt securities, our intention with regard to holding the security to maturity and the likelihood that we 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 the lower of cost or estimated fair market value of the property, less estimated disposal costs, if any. Any excess of cost over the estimated fair market value 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. The Company completed the annual goodwill impairment test during the fourth quarter of 2010 and determined there was no impairment to be recognized in 2010. 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 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. Effective February 28, 2011, the Company took action to again freeze the plan with no additional contributions for grandfathered participants. Benefits for all participants will remain frozen in the plan until such time as further action occurs. 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

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.

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" in the Company's Annual Report on Form 10-K for the year ended December 31, 2010.

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. Over the past three years, our Company has struggled with the challenging economic environment and has focused on credit quality initiatives to position our Company for growth once the economic climate improves. Although constrained by a weak economy,

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the Company was able to achieve some positive accomplishments during the first nine months of 2011, including a return to operating profitability and a 12.6% decrease in nonperforming assets. The improvements seen in some of the Company's credit metrics, and other factors, are reflective of slowly improving economic conditions. Although the results for the third quarter of 2011 represent a continuation of a positive trend which began in the first quarter of this year, our optimism continues to be tempered with caution as the current economic environment continues to negatively impact the credit quality of our loan portfolio requiring additional charge-offs and provisions for loan losses. General credit quality is not expected to show broad based improvement until the economy shows more robust growth, improved consumer confidence and stabilized real estate prices. In the near term, the Company anticipates a continuation of prolonged economic weakness, both locally and nationally, and continued credit issues in the loan portfolio.

In spite of the operating profit reported for the first nine months of 2011, earnings remained constrained due to credit quality issues and a lack of loan demand resulting from the challenging economic climate, the high level of unemployment and depressed real estate markets. While the Company experienced some improvement in the number of loans that were negatively impacted by the continued weak economic conditions within our markets, we continue to see declining real estate values in our markets and increased stress on our customers' ability to pay their loans as agreed. 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. While the elevated level of provision for loan losses expense recorded during the first nine months of 2011 negatively impacts our operating results, the Company believes these loan loss provisions are necessary as the economic growth seen in some markets has not been realized in the local markets we serve. The Company continues to proactively manage its problem assets and is aggressively charging-off loans and increasing our allowance for potential future loan losses as necessary. The Company is diligently managing through these challenging times and remains focused on profitable balance sheet growth, timely resolution of our nonperforming assets and other financial strategies the Company believes will return us to the level of profitability to which our shareholders are accustomed.

The primary drivers for the Company's results for the first nine months of 2011 continue to be the compression of our margins, the elevated levels of the provision for loan losses, FDIC insurance premiums, professional and collection/repossession expenses related to past due loans and nonperforming assets, and losses on the sale and valuation adjustments of other real estate owned. Although marginally higher quarter over quarter, the provision for loan losses during the first nine months of 2011 dropped sharply from 2010 levels primarily due to lower net charge-offs and a continued decrease in the level of past due loans and nonperforming assets. The Company believes the investments it has made during 2010 and the first nine months of 2011 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.

As we first reported in our Quarterly Report on Form 10-Q for March 31, 2011, the Company has taken actions to preserve capital including the suspension of its quarterly common stock dividend and to defer its regular quarterly cash dividend with respect to its Series A Fixed Rate Cumulative Perpetual Preferred Stock (the "Preferred Stock") which the Company issued to the United States Department of Treasury in connection with the Company's participation in the Treasury's Capital Purchase Program in January 2009.

During the second quarter of 2011, the Company began deferring its regularly scheduled interest payments on its outstanding Junior Subordinated Debentures relating to its trust preferred securities. While the interest expense associated with this source of regulatory capital continues to be reflected in the Company's earnings, the deferred payments represent a subordinated liability to other creditors of the Parent. In addition, during the second quarter of 2011 the Company took action to improve two key regulatory ratios of the Bank. This was accomplished by the Bank repaying an $11.0 million subordinated debt due to the Parent. In conjunction with this repayment, the Parent used the proceeds to reinvest a like amount of Tier 1 qualifying capital into the Bank. The net result of this transaction was to reclassify $11.0 million of the Bank's Tier 2 qualifying regulatory capital as Tier 1 qualifying regulatory capital, which in turn improved the Bank's Leverage Ratio and Tier 1 Risk-Based Capital Ratio by approximately 100 basis points and 150 basis points, respectively, and more closely aligned these regulatory ratios between the Company and the Bank.

The actions to suspend and defer dividend and interest payments to preserve capital, while difficult, are necessary to ensure the financial strength of the Company. Despite our significant challenges over the last several years, the Company has maintained its regulatory well capitalized status and we believe that maintaining this status is critically important for the long-term value of our Company. As economic conditions improve, and as the Company is able to generate earnings to support its current and future capital needs, the Company plans to restore its common and Preferred Stock dividends as well as interest payments on its Junior Subordinated Debentures.

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On February 17, 2011, the Company and Bank entered into a Written Agreement with the FRB and the SCC. The purpose of this agreement is to formally document the common goal of the Company, Bank and the regulatory agencies to maintain the financial soundness of the Company and the Bank. This agreement contains many of the steps that the Company had already initiated during 2010 and 2011 to address our deteriorating asset quality and associated challenges brought on during the economic recession. Among other things the agreement addresses improving board oversight of the management and administration of the Company's operations, including improving credit risk management processes, lending and credit administration processes, the quality of the loan and asset portfolios and processes to manage the quality of these portfolios, and the balance of and processes related to loan loss reserves. The directors of the Company and the Bank are fully committed to the common goal of improving the financial soundness of the Company. Further, the directors and executive management of the Company are fully dedicated to diligently working to comply with all requirements of the Written Agreement. The Company is pleased with the continued support of the regulatory agencies and looks forward to the successful results of our actions.

As of the filing of this Quarterly Report on Form 10-Q, the Company has met all deadlines for delivering plans, policies and reports under the Written Agreement and we are encouraged with the initial feedback we have received from the regulatory agencies. We also believe that the improvements in our nonperforming asset levels during the first nine months of 2011 are an indication that the actions we have taken are beginning to yield positive results. The Written Agreement requires us to submit quarterly progress reports to our banking regulators on our asset quality improvement initiatives and other remediation efforts. We anticipate meeting the Written Agreement's requirements and timely submitting the quarterly progress reports during the fourth quarter of 2011 as we work closely with our regulatory agencies to improve the Company's financial performance. For further information concerning the Written Agreement, refer to Item 1. "Financial Statements," under the heading "Note 14. Formal Written Agreement."

As previously disclosed in our 2011 Proxy Statement, during August 2010 the Company established a Regulatory Compliance Oversight Committee to oversee the implementation of certain corrective actions necessary to improve the operations and financial results of the Company in light of findings of a recent regulatory examination and to comply with the Written Agreement. On behalf of the Board, this committee acts to ensure that the Bank cures the noted deficiencies. The committee continues to meet at least once a month as the remediation process progresses.

The Bank continues to improve its handling of nonperforming assets and during the second quarter of 2011 established a Special Assets Division that reports directly to the Chief Risk Officer. This Division is specifically tasked with formulating workout strategies and conducting asset dispositions to minimize future losses. The establishment of this division will also allow our loan officers to focus on expanding our lending activities when loan demand and economic conditions improve. The Company continues to make progress on this key function and was successful in recruiting a seasoned special assets manager during the second quarter of 2011 to further this initiative.

For the three months ended September 30, 2011, the following key points were significant factors in our reported results:

Provision expense for the allowance for loan losses of $1.7 million to fund possible losses in the loan portfolio.

Net charge-offs of $2.7 million to write off uncollectible balances on nonperforming assets.

Gain on sale of available for sale securities of $1.4 million resulting from adjustments in the composition of the investment portfolio as part of our overall asset/liability management strategy.

Decrease in net interest income by $539 thousand over the same period in 2010.

Impairment losses of $974 thousand related to valuation adjustments on other real estate owned.

Losses of $362 thousand on the sale of other real estate owned.

Expenses related to FDIC insurance premiums of $790 thousand.

Expenses related to collection, repossession and other real estate owned of $354 thousand.

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For the three months ended September 30, 2011 and 2010, the reported net income . . .

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