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Section 1: 10-K (FORM 10-K)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2017
or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from          to         
Commission file number: 001-33037
SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
(Exact name of registrant as specified in its charter)
VIRGINIA
20-1417448
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
6830 Old Dominion Drive
McLean, Virginia 22101
(Address or principal executive offices) (Zip code)
(703) 893-7400
(Registrant’s telephone number including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Name of each exchange on which registered
Common Stock, $0.01 par value
Nasdaq Global Market
Securities registered pursuant to Section 12(g) of the Act: None
Indicate by check mark if the registrant is a well-known seasoned issuer as defined in Rule 405 of the Securities Act.  Yes ☐ No ☒
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.  Yes ☐ No ☒
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes ☒ No ☐
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§229.405 of this chapter) is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of  “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer   ☐ Accelerated filer   ☒ Smaller reporting company   ☐ Emerging growth company   ☐
Non-accelerated filer   ☐   (Do not check if a smaller reporting company)
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ☐ No ☒
The aggregate market value of voting stock held by non-affiliates of the registrant as of June 30, 2017 was approximately $395.6 million based on the closing price of the common stock on such date.
The number of shares of common stock outstanding as of March 6, 2018 was 23,984,853.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement pursuant to Regulation 14A of the Securities Exchange Act of 1934 in conjunction with the registrant’s 2018 Annual Meeting of Shareholders are incorporated into Part III, Items 10-14 of this Annual Report on Form 10-K.

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SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.
FORM 10-K
INDEX
Page
PART I
1
23
38
38
42
42
PART II
43
46
47
74
75
132
132
132
PART III
133
133
133
133
133
PART IV
134
137
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains statements about future expectations, activities and events that constitute forward-looking statements within the meaning of, and subject to the protection of, Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act and are intended to be covered by the safe harbor provided by the same. Forward-looking statements are based on our beliefs, assumptions and expectations of our future financial and operating performance and growth plans, taking into account the information currently available to us. These statements are not statements of historical fact. The words “believe,” “may,” “forecast,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” or similar words, or the negatives of these words, identify forward-looking statements.
Forward-looking statements involve risks and uncertainties that may cause our actual results to differ materially from the expectations of future results we express or imply in any forward-looking statements. In addition to the other factors discussed in the “Risk Factors” section of this Annual Report on Form 10-K, factors that could contribute to those differences include, but are not limited to:

the effects of future economic, business and market conditions and disruptions in the credit and financial markets, domestic and foreign;

changes in the local economies in our market areas which adversely affect our customers and their ability to transact profitable business with us, including the ability of our borrowers to repay their loans according to their terms or a change in the value of the related collateral;

changes in the availability of funds resulting in increased costs or reduced liquidity, as well as the adequacy of our cash flow from operations and borrowings to meet our short-term liquidity needs;

a deterioration or downgrade in the credit quality and credit agency ratings of the investment securities in our investment securities portfolio;

impairment concerns and risks related to our investment securities portfolio of collateralized mortgage obligations, agency mortgage-backed securities, obligations of states and political subdivisions and pooled trust preferred securities;

the incurrence and possible impairment of goodwill associated with current or future acquisitions and possible adverse short-term effects on our results of operations;

increased credit risk in our assets and increased operating risk caused by a material change in commercial, consumer and/or real estate loans as a percentage of our total loan portfolio;

the concentration of our loan portfolio in loans collateralized by real estate;

our level of construction and land development and commercial real estate loans;

failure to prevent a breach to our Internet-based system and online commerce security;

changes in the levels of loan prepayments and the resulting effects on the value of our loan portfolio;

the failure of assumptions and estimates underlying the establishment of and provisions made to the allowance for loan losses;

our ability to expand and grow our business and operations, including the establishment of additional branches and acquisition of additional branches and banks, and our ability to realize the cost savings and revenue enhancements we expect from such activities;

government intervention in the U.S. financial system, including the effects of recent legislative, tax, accounting and regulatory actions and reforms, including the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), the Jumpstart Our Business Startups Act, the Consumer Financial Protection Bureau, the capital ratios of Basel III as adopted by the federal banking authorities and the Tax Cuts and Jobs Act;

increased competition for deposits and loans adversely affecting rates and terms;
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the continued service of key management personnel;

the potential payment of interest on demand deposit accounts to effectively compete for customers;

potential environmental liability risk associated with properties that we assume upon foreclosure;

increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;

risks of current or future mergers and acquisitions, including the related time and cost of implementing transactions and the potential failure to achieve expected gains, revenue growth or expense savings;

increases in regulatory capital requirements for banking organizations generally, which may adversely affect our ability to expand our business or could cause us to shrink our business;

acts of God or of war or other conflicts, acts of terrorism or other catastrophic events that may affect general economic conditions;

changes in accounting policies, rules and practices and applications or determinations made thereunder;

fraudulent and negligent acts by loan applicants, mortgage brokers and our employees;

failure to maintain effective internal controls and procedures;

the risk that our deferred tax assets could be reduced if future taxable income is less than currently estimated, if corporate tax rates in the future are less than current rates, or if sales of our capital stock trigger limitations on the amount of net operating loss carryforwards that we may utilize for income tax purposes;

our ability to attract and retain qualified employees; and

other factors and risks described under “Risk Factors” herein and in any of our subsequent reports that we file with the Securities and Exchange Commission (the “Commission” or “SEC”) under the Exchange Act.
Forward-looking statements are not guarantees of performance or results and should not be relied upon as representing management’s views as of any subsequent date. A forward-looking statement may include a statement of the assumptions or bases underlying the forward-looking statement. We believe we have chosen these assumptions or bases in good faith and that they are reasonable. We caution you, however, that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. When considering forward-looking statements, you should refer to the risk factors and other cautionary statements in this Annual Report on Form 10-K and in our periodic and current reports filed with the SEC for specific factors that could cause our actual results to be different from those expressed or implied by our forward-looking statements. These statements speak only as of the date of this Annual Report on Form 10-K (or an earlier date to the extent applicable). Except as required by applicable law, we undertake no obligation to update publicly these statements in light of new information or future events.
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PART I
Item 1.   Business
Overview
Southern National Bancorp of Virginia, Inc. (“Southern National”, “SNBV”, “we” or “our”) is the bank holding company for Sonabank (“Sonabank” or the “Bank”), a Virginia state chartered bank which commenced operations on April 14, 2005. Sonabank provides a range of financial services to individuals and small and medium sized businesses. As of December 31, 2017, Southern National had $2.06 billion in total loans, $2.61 billion in total assets, $1.87 billion in total deposits and $322.8 million in total stockholders’ equity. At December 31, 2017, Sonabank had thirty-eight full-service retail branches in Virginia, located in the counties of Chesterfield (2), Essex (2), Fairfax (Reston, McLean and Fairfax), Gloucester (2), Hanover (3), King William, Lancaster, Middlesex (3), New Kent, Northumberland (3), Southampton, Surry, Sussex, and in Charlottesville, Clifton Forge, Colonial Heights, Front Royal, Hampton, Haymarket, Leesburg, Middleburg, New Market, Newport News, Richmond, South Riding, Warrenton, and Williamsburg, and seven full-service retail branches in Maryland, in Rockville, Shady Grove, Bethesda, Upper Marlboro, Brandywine, Owings and Huntingtown.
While we offer a wide range of commercial banking services, we focus on making loans secured primarily by commercial real estate and other types of secured and unsecured commercial loans to small and medium-sized businesses in a number of industries, as well as loans to individuals for a variety of purposes, including 1-4 family residential loans. We are a leading Small Business Administration (“SBA”) lender among Virginia community banks. We also invest in real estate-related securities, including collateralized mortgage obligations and agency mortgage backed securities. Our principal sources of funds for loans and investing in securities are deposits and, to a lesser extent, borrowings. We offer a broad range of deposit products, including checking (NOW), savings, money market accounts and certificates of deposit. We actively pursue business relationships by utilizing the business contacts of our senior management, other bank officers and our directors, thereby capitalizing on our knowledge of our local market areas.
Effective December 4, 2009, Sonabank assumed certain deposits and liabilities and acquired certain assets of Greater Atlantic Bank (“GAB”) from the Federal Deposit Insurance Corporation (“FDIC”), as receiver for GAB, pursuant to the terms of a purchase and assumption agreement entered into by the Bank and the FDIC on December 4, 2009. On December 5, 2009, the former GAB offices, located in Reston, New Market, Front Royal and South Riding, Virginia and Rockville, Maryland opened as Sonabank branches.
Covered loan losses are reimbursed in accordance with our FDIC loss sharing agreements. There are two agreements with the FDIC, one for single family assets which is a 10 year agreement expiring in December 2019, and one for non-single family (commercial) assets which was a 5 year agreement that expired in December 2014. Our FDIC indemnification asset, the estimate of the expected loss amounts to be reimbursed by the FDIC has a current carrying value of  $1.4 million and an estimated fair value of $309 thousand reflecting an overstated FDIC indemnification asset. This current overstatement, which is due to improvements in the loss estimates in the single family covered loans, is being amortized down in accordance with accounting rules over the life of the contract (10 years for single family covered assets) or the life of the loans, whichever is shorter.
On October 1, 2011, Sonabank completed the acquisition of the Midlothian branch of the Bank of Hampton Roads in Richmond, Virginia. We assumed deposits in the amount of  $42.2 million.
Effective April 27, 2012, Sonabank assumed substantially all of the deposits and liabilities and acquired substantially all of the assets of the HarVest Bank of Maryland from the FDIC as receiver. The acquisition included HarVest Bank’s branches in Bethesda, North Rockville, Germantown and Frederick, Maryland. Adding these new branches to our existing branch in Rockville, Maryland brought Sonabank’s total number of branches in Maryland to five, four of which are in Montgomery County, Maryland. This was a strategic acquisition for Sonabank in order to expand into an affluent market.
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The merger with Prince George’s Federal Savings Bank (“PGFSB”) was completed on August 1, 2014. Southern National acquired PGFSB in a cash and stock transaction. Sonabank acquired PGFSB’s four offices in Maryland, including a main office in Upper Marlboro and three branch offices in Dunkirk, Brandywine and Huntingtown.
On May 15, 2014, SNBV purchased a 44% equity investment and preferred stock of Southern Trust Mortgage, LLC (“STM”), a regional mortgage banking company headquartered in Virginia Beach, Virginia. On June 23, 2017, in connection with the Eastern Virginia Bankshares, Inc. (“EVBS”) acquisition, we added 4.9% of additional equity investment and preferred stock in STM, bringing our total equity investment to 48.9%. As of December 31, 2017, our equity investment in STM totaled $4.7 million and our preferred stock investment in STM totaled $3.3 million. STM has mortgage banking originators in Delaware, Virginia, Maryland, North Carolina and South Carolina. STM only originates retail mortgages.
On January 20, 2017, Southern National completed the sale of  $27.0 million of its fixed-to-floating rate Subordinated Notes due 2027 (the “SNBV Senior Subordinated Notes”). The SNBV Senior Subordinated Notes will initially bear interest at 5.875% per annum until January 31, 2022; thereafter, the SNBV Senior Subordinated Notes will be payable at an annual floating rate equal to three-month LIBOR plus a spread of 3.95% until maturity or early redemption. Immediately following the completion of the sale of the SNBV Senior Subordinated Notes, Southern National injected $22.0 million of the proceeds into its subsidiary, Sonabank.
On June 23, 2017, SNBV completed its acquisition of EVBS, headquartered in Glen Allen, Virginia, and its subsidiaries, EVB Statutory Trust I (the “Trust”) and EVB, a Virginia state-charted bank. Pursuant to the Agreement and Plan of Merger, dated December 13, 2016, as amended, holders of EVBS common stock received 0.6313 shares of SNBV common stock for each outstanding share of EVBS common stock held immediately prior to the effective time of the merger and holders of Non-Voting Mandatorily Convertible Non-Cumulative Preferred Stock, Series B of EVBS (“EVBS Series B Preferred Stock”) received 0.6313 shares of SNBV common stock for each share of EVBS Series B Preferred Stock held immediately prior to the effective time of the merger, which totaled approximately $198.9 million based on SNBV’s closing common stock price on June 23, 2017 of  $17.21 per share. EVBS operated twenty-four retail branches in Virginia.
We primarily market our products and services to small and medium-sized businesses and to retail consumers. Our strategy is to provide superior service through our employees, who are relationship-oriented and committed to their respective customers. Through this strategy, we intend to grow our business, expand our customer base and improve our profitability. The key elements of our strategy are to:

Utilize the Strength of our Management Team.   The experience and market knowledge of our management team is one of our greatest strengths and competitive advantages. Our executive chairman of the board, Georgia S. Derrico, served as chairman of the board and chief executive officer of Southern National until our merger with EVBS on June 23, 2017. Our executive vice chairman of the board, R. Roderick Porter, served as president of Southern National until our merger with EVBS on June 23, 2017. Before joining Southern National, Ms. Derrico was the founder, chairman of the board and chief executive officer, and Mr. Porter was the president and chief operating officer of Southern Financial Bancorp, Inc. (“Southern Financial”), a publicly traded bank holding company. At the time of its sale to Provident Bankshares, Inc. in April of 2004, Southern Financial had $1.5 billion in assets and operated 34 full-service banking offices of Southern Financial Bank, which was founded in Fairfax County, Virginia and subsequently expanded into Central and Southern Virginia. As part of the merger with EVBS on June 23, 2017, legacy EVBS president and chief executive officer, Joe A. Shearin, assumed the same role with Southern National. Mr. Shearin has nearly 40 years of bank management experience. These three individuals comprise our newly created office of the chairman, which serves as the senior executive leadership of Southern National.

Leverage Our Existing Foundation for Additional Growth.    Based on our management’s depth of experience and certain infrastructure investments, we believe that we will be able to take advantage of certain economies of scale typically enjoyed by larger organizations to expand our operations both organically and through strategic cost-effective branch or bank acquisitions. We believe that
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the investments we have made in our data processing, risk management infrastructure, staff and branch network will be able to support a much larger asset base. We are committed, however, to control any additional growth in a manner designed to minimize the risk and to maintain strong capital ratios.

Continue to Pursue Selective Acquisition Opportunities.   Historically, acquisitions have been a key part of our growth. In addition to the transactions previously highlighted, we completed the acquisition of a branch of Millennium Bank in Warrenton, Virginia on September 28, 2009, the acquisition of the Leesburg, Virginia branch location from Founders Corporation which opened on February 11, 2008, the acquisition of 1st Service Bank in December of 2006 and the acquisition of the Clifton Forge branch of First Community Bancorp, Inc. in December of 2005. We intend to continue to review branch and whole bank acquisition opportunities, including possible acquisitions of failed financial institutions in FDIC-assisted transactions, and will pursue these opportunities if they represent the most efficient use of our capital under the circumstances. We believe that we have demonstrated the skill sets and experience necessary to acquire and integrate successfully both bank and branch acquisitions, and that with our strong capital position, we are well-positioned to take advantage of acquisition opportunities as they may arise. We intend to focus on targets in our market areas or other attractive areas with significant core deposits and/or a potential customer base compatible with our growth strategy.

De novo Branch Expansion.   In addition to our acquisition strategy, we plan to open de novo branches from time to time to fill in our existing footprint. Most recently, we opened our newest full-service branch in the River’s Bend market located in Chesterfield County, Virginia in October 2017. This branch, which was part of the EVBS merger, is located in a dynamic growth area with new businesses and consumers entering the market every day. Additionally, this market compliments our focus on the south of Richmond market which includes Colonial Heights, Tri-Cities and Midlothian.

Focus on the Business Owner.   It is our goal to be the bank that business owners in our markets turn to first for commercial banking needs as a result of our superior personal service and the tailored products and services that we provide. To help achieve this goal, we:

have a standing credit committee that meets as often as necessary on a “when needed” basis to review completed loan applications, making extensive use of technology to facilitate our internal communications and thereby enabling us to respond to our customers promptly;

are an SBA approved “Preferred” lender, which permits us to make SBA loan decisions at Sonabank rather than waiting for SBA processing. We offer a number of different types of SBA loans designed for the small and medium-sized business owner and many of our SBA loan customers also have other relationships with Sonabank. This product group is complex and “paper intensive” and not well utilized by some of our competitors;

provide Internet business banking at www.sonabank.com which allows our business customers 24-hour web-based access to their accounts so they can confirm or transfer balances, pay bills, download statements and use our “Web Lockbox” or “Sona Cash Manager;”

provide our business customers with “Sona In-House,” a service that utilizes Check 21 technology to allow customers to make remote deposits from their business locations and gives them access to those funds within 24 to 48 hours; and

provide our business customers with access to SABL, our state-of-the-art asset-based lending system. Unlike most asset-based lending systems, which are based on manual processes or software that certifies a company’s borrowing base periodically, SABL provides a real time capability to analyze and adjust borrowing availability based on actual collateral levels. SABL is predicated on a link between any kind of accounting software used by the customer and Sonabank’s server.
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Maintain Local Decision-Making and Accountability.   We believe that we have a competitive advantage over larger national and regional financial institutions by providing superior customer service with experienced, knowledgeable management, localized decision-making capabilities and prompt credit decisions. We believe that our customers want to deal directly with the people who make the credit decisions.

Focus on Asset Quality and Strong Underwriting.   We consider asset quality to be of primary importance and have taken measures in an effort to ensure that, despite the growth in our loan portfolio, we maintain strong asset quality through strong underwriting standards.

Build a Stable Core Deposit Base.   We intend to continue to grow a stable core deposit base of business and retail customers. To the extent that our asset growth outpaces this local deposit funding source, we plan to continue to borrow and raise deposits in the national market using deposit intermediaries. We intend to continue our practice of developing a deposit relationship with each of our loan customers.
General
Our principal business is the acquisition of deposits from the general public through our branch offices and deposit intermediaries and the use of these deposits to fund our loan and investment security portfolios. We seek to be a full service community bank that provides a wide variety of financial services to our middle market corporate clients as well as to our retail clients. We are an active commercial lender, have been designated as a “Preferred SBA Lender” and participate in the Virginia Small Business Financing Authority lending program. In addition, we are an active commercial real estate lender. We also invest funds in mortgage-backed securities, collateralized mortgage obligations, securities issued by agencies of the federal government, obligations of states and political subdivisions and pooled trust preferred securities.
The principal sources of funds for our lending and investment activities are deposits, repayment of loans, prepayments from mortgage-backed securities, repayments of maturing investment securities, Federal Home Loan Bank (“FHLB”) advances and other borrowed money.
Principal sources of revenue are interest and fees on loans and investment securities, as well as fee income derived from the maintenance of deposit accounts and income from bank-owned life insurance policies. Our principal expenses include interest paid on deposits, advances from the FHLB of Atlanta, junior subordinated debt, senior subordinated notes and other borrowings, and operating expenses.
Available Information
Southern National files annual, quarterly, periodic and other reports under the Securities Exchange Act of 1934, as amended, with the SEC. These reports are posted and are available at no cost on our website, www.sonabank.com, through the Investor Relations link, as soon as reasonably practicable after we file such documents with the SEC. Our filings are also available through the SEC’s website at www.sec.gov.
Lending Activities
Our primary strategic objective is to serve small to medium-sized businesses in our market with a variety of unique and useful services, including a full array of commercial mortgage and non-mortgage loans. These loans include commercial real estate loans, construction to permanent loans, development and builder loans, accounts receivable financing, lines of credit, equipment and vehicle loans, leasing, and commercial overdraft protection. We strive to do business in the areas served by our branches, which is also where our marketing is focused, and the vast majority of our loan customers are located in existing market areas. Virtually all of our loans are with borrowers in Virginia, Maryland, West Virginia, or Washington, D.C. The SBA may from time to time come to us because of our reputation and expertise as an SBA lender and ask us to review a loan outside of our core counties but within our market area. Prior to making a loan, we obtain loan applications to determine a borrower’s ability to repay, and the more significant items on these applications are verified through the use of credit reports, financial statements and confirmations.
The following is a discussion of each of the major types of lending. For more information on our lending activities, see “Item 7. Management’s Discussion and Analysis of Financial Condition.”
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Commercial Real Estate Lending
Permanent.    Commercial real estate lending includes loans for permanent financing. Commercial real estate lending typically involves higher loan principal amounts and the repayment of loans is dependent, in large part, on sufficient income from the properties securing the loans to cover operating expenses and debt service. As a general practice, we require our commercial real estate loans to be secured by well-managed income producing properties with adequate margins and to be guaranteed by responsible parties. We look for opportunities where cash flow from the collateral properties provides adequate debt service coverage and the guarantor’s net worth is strong. At December 31, 2017, our commercial real estate loans for permanent financing, including multi-family residential loans and loans secured by farmland, totaled $936.5 million. Owner occupied commercial real estate loans totaled $401.8 million.
Our underwriting guidelines for commercial real estate loans reflect all relevant credit factors, including, among other things, the income generated from the underlying property to adequately service the debt, the availability of secondary sources of repayment and the overall creditworthiness of the borrower. In addition, we look to the value of the collateral, while maintaining the level of equity invested by the borrower.
All valuations on property which will secure loans over $250 thousand are performed by independent outside appraisers who are reviewed by our executive vice president of credit risk management and/or our appraisal reviewer. We retain a valid lien on real estate and obtain a title insurance policy (on first trust loans only) that insures the property is free of encumbrances. In addition, we do title searches on all loans secured by real estate.
Construction.    We recognize that construction loans for commercial, multifamily and other non-residential properties can involve risk due to the length of time it may take to bring a finished real estate product to market. As a result, we will only make these types of loans when pre-leasing or pre-sales or other credit factors suggest that the borrower can carry the debt if the anticipated market and property cash flow projections change during the construction phase.
Income producing property loans are supported by evidence of the borrower’s capacity to service the debt. All of our commercial construction loans are guaranteed by the principals or general partners. At December 31, 2017, we had $198.0 million of construction and land development loans.
Construction loan borrowers are generally pre-qualified for the permanent loan by us or a third party. We obtain a copy of the contract with the general contractor who must be acceptable to us. All plans, specifications and surveys must include proposed improvements. We review feasibility studies and risk analyses showing sensitivity of the project to variables such as interest rates, vacancy rates, lease rates and operating expenses.
Commercial Business Lending
These loans consist of lines of credit, revolving credit facilities, demand loans, term loans, equipment loans, SBA loans, stand-by letters of credit and unsecured loans. Commercial business loans are generally secured by accounts receivable, equipment, inventory and other collateral, such as readily marketable stocks and bonds with adequate margins, cash value in life insurance policies and savings and time deposits at Sonabank. At December 31, 2017, our commercial business loans totaled $253.3 million.
In general, commercial business loans involve more credit risk than residential mortgage loans and real estate-backed commercial loans and, therefore, usually yield a higher return to us. The increased risk for commercial business loans is due to the type of collateral securing these loans. The increased risk also derives from the expectation that commercial loans will be serviced principally from the operations of the business, which may not be successful. Historical trends have shown that these types of loans have higher delinquencies than mortgage loans. Because of this, we often utilize the SBA 7(a) program (which guarantees the repayment of up to 90% of the principal and accrued interest to us) to reduce the inherent risk associated with commercial business lending.
Another way that we reduce risk in the commercial loan portfolio is by taking accounts receivable as collateral using our SABL system. Our accounts receivable financing facilities, which provide a relatively high yield with considerable collateral control, are lines of credit under which a company can borrow up to
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the amount of a borrowing base which covers a certain percentage of the company’s receivables. From our customer’s point of view, accounts receivable financing is an efficient way to finance expanding operations because borrowing capacity expands as sales increase. Customers can borrow from 75% to 90% of qualified receivables. In most cases, the borrower’s customers pay us directly. For borrowers with a good track record for earnings and quality receivables, we will consider pricing based on an increment above the prime rate for transactions in which we lend up to a percentage of qualified outstanding receivables based on reported aging of the receivables portfolio.
We also actively pursue for our customers equipment lease financing opportunities. We provide financing and use a third party to service the leases. Payment is derived from the cash flow of the borrower, so credit quality may not be any lower than it would be in the case of an unsecured loan for a similar amount and term.
SBA Lending
We have developed an expertise in the federally guaranteed SBA program. The SBA program is an economic development program which finances the expansion of small businesses. We are a Preferred Lender in the Washington, D.C. and Richmond, Virginia Districts of the SBA. As an SBA Preferred Lender, our pre-approved status allows us to quickly respond to customers’ needs. Under the SBA program, we originate and fund SBA 7(a) loans which qualify for guarantees up to 90% of principal and accrued interest. We also originate 504 chapter loans in which we generally provide 50% of the financing, taking a first lien on the real property as collateral.
We provide SBA loans to potential borrowers who are proposing a business venture, often with existing cash flow and a reasonable chance of success. We do not treat the SBA guarantee as a substitute for a borrower meeting our credit standards, and, except for minimum capital levels or maximum loan terms, the borrower must meet our other credit standards as applicable to loans outside the SBA process.
Residential Mortgage Lending
Permanent.   Our business model generally does not include originating permanent residential mortgage loans. We originate such loans solely on a case-by-case basis. In the case of conventional loans, we typically lend up to 80% of the appraised value of single-family residences and require mortgage insurance for loans exceeding that amount. We have no sub-prime loans.
On May 15, 2014, we purchased a 44% equity investment and preferred stock of STM, a regional mortgage banking company headquartered in Virginia Beach, Virginia. On June 23, 2017, in connection with the EVBS acquisition, we added 4.9% of additional equity investment and preferred stock in STM, bringing our total equity investment to 48.9%. STM has mortgage banking originators in Virginia, Maryland, North Carolina, South Carolina, and Delaware. STM only originates retail mortgages.
Sonabank has established with STM underwriting guidelines under which it will purchase residential construction only, construction loans that convert to permanent, and permanent loans primarily in its Virginia and Maryland footprint from STM. These are largely loans that do not conform to FNMA or FHLMC standards because of size or acreage. We purchased loans in an aggregate amount of $102.1 million from STM during 2017.
We retain a valid lien on real estate and obtain a title insurance policy that ensures that the property is free of encumbrances. We also require hazard insurance and flood insurance for all loans secured by real property if the real property is in a flood plain as designated by the Department of Housing and Urban Development. We also require most borrowers to advance funds on a monthly basis from which we make disbursements for items such as real estate taxes, private mortgage insurance and hazard insurance.
Home Equity Lines of Credit (“HELOC”).   Sonabank rarely originated HELOCs prior to our merger with EVBS. Since our merger with EVBS, HELOC’s are now a regular part of our business model. At December 31, 2017, we had outstanding HELOC balances totaling $152.8 million.
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Consumer Lending
We offer various types of secured and unsecured consumer loans. We make consumer loans primarily for personal, family or household purposes as a convenience to our customer base since these loans are not the focus of our lending activities. As a general guideline, a consumer’s debt service should not exceed 40% of his gross income or 45% of net income. For purposes of this calculation, debt includes house payment or rent, fixed installment payments, the estimated payment for the loan being requested and the minimum required payment on any revolving debt. At December 31, 2017, we had $39.4 million of consumer loans outstanding.
Credit Approval and Collection Policies
Because future loan losses are so closely intertwined with our underwriting policy, we have instituted what management believes is a stringent loan underwriting policy. Our underwriting guidelines are tailored for particular credit types, including lines of credit, revolving credit facilities, demand loans, term loans, equipment loans, real estate loans, SBA loans, stand-by letters of credit and unsecured loans. We will make extensions of credit based, among other factors, on the potential borrower’s creditworthiness, likelihood of repayment and proximity to market areas served.
We have a standing Credit Committee comprised of certain officers, each of whom has a defined lending authority in combination with other officers. These individual lending authorities are determined by our Chief Executive Officer and certain directors and are based on the individual’s technical ability and experience. These lending authorities must be approved by our board of directors and our Credit Committee. Our Credit Committee is comprised of four levels of members, based on experience: junior, regular, senior, and executive. Our Senior Executive members are Ms. Derrico, Mr. Porter and Mr. Shearin. Our Junior Executive members are Messrs. Baker and Brockwell. Mr. Stevens, Chief Credit Risk Officer, must approve risk ratings for loans over $1.5 million, as well as exceptions to the Credit Policy. Ms. Milne, Senior Credit Risk Officer must approve exceptions to Credit Policy for loans less than $1.5 million. Loans over a certain size must be approved by the full Board of Directors or the Credit Committee plus two outside directors. Under our loan approval process, the sponsoring loan officer’s approval is required on all credit submissions. This approval must be included in or added to the individual and joining authorities outlined below. The sponsoring loan officer is primarily responsible for the customer’s relationship with us, including, among other things, obtaining and maintaining adequate credit file information. We require each loan officer to maintain loan files in an order and detail that would enable a disinterested third party to review the file and determine the current status and quality of the credit.
In addition to the approval of the sponsoring loan officer, we require approvals from one or more members of the Credit Committee on all loans. The approvals required differ based on the size of the borrowing relationship. At least one regular and one senior or executive member must approve loans up to $500 thousand. One regular, one senior and one executive member of the committee must approve all loans between $500 thousand and $1.0 million. One regular, one senior and two executive members must approve loans between $1.0 million and $6.0 million. All five executive members must approve loans over $6.0 million. Regardless of the number of approvals needed, we encourage each member not to rely on another member’s approval as a basis for approval and to treat his approval as if it were the only approval necessary to approve the loan. Our legal lending limit to one borrower is 15% of our unimpaired capital and surplus plus the allowance for loan losses. As of December 31, 2017, our legal lending limit was approximately $56.9 million. Our largest group credit as of December 31, 2017, was approximately $25.8 million.
The following collection actions are the minimal procedures which management believes are necessary to properly monitor past due loans and leases. When a borrower fails to make a payment, we contact the borrower in person, in writing or on the telephone. At a minimum, all borrowers are notified by mail when payments of principal and/or interest are 10 days past due. Real estate and commercial loan borrowers are assessed a late charge when payments are 10 – 15 days past due. Customers are contacted by a loan officer before the loan becomes 60 days delinquent. After 90 days, if the loan has not been brought current or an acceptable arrangement is not worked out with the borrower, we will institute measures to remedy the default, including commencing foreclosure action with respect to mortgage loans and repossessions of collateral in the case of consumer loans.
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If foreclosure is effected, the property is sold at a public auction in which we may participate as a bidder. If we are the successful bidder, we include the acquired real estate property in our real estate owned (“OREO”) account until it is sold. These assets are initially recorded at fair value net of estimated selling costs. To the extent there is a subsequent decline in fair value, that amount is charged to operating expense. At December 31, 2017, we had OREO totaling $7.6 million.
Special Products and Services
To complement our array of loans, we also provide the following special products and services to our commercial customers:
Cash Management Services
Cash Management services are offered that enable the Bank’s business customers to maximize the efficiency of their cash management. Specific products offered in our Cash Management services program include the following:

Investment/sweep accounts

Wire Transfer services

Employer Services/Payroll processing services

Zero balance accounts

Night depository services

Lockbox services

Depository transfers

Merchant services (third party)

ACH originations

Business debit cards

Controlled disbursement accounts

SONA 24/7 (Check 21 processing)

Sonabank asset based lending (SABL)

Mobiliti, a mobile banking application for personal and business accounts
Some of the products listed above are described in-depth below.

SONA 24/7/Check 21:   SONA 24/7 is ideal for landlords, property managers, medical professionals, and any other businesses that accept checks. SONA 24/7 allows customers of Sonabank to have total control over how, when, and where their checks will be deposited. SONA 24/7 uses the Check Truncation technology outlined by the “Check Clearing for the 21st Century Act”, passed in October 2004 (“Check 21”). With Check Truncation, paper checks can now be converted to electronic images and processed between participating banks, vastly speeding up the check clearing process. SONA In-House passes on the benefits of Check Truncation directly to Sonabank’s business customers.

Lockbox Services:   Sonabank will open a lockbox, retrieve and scan incoming checks, and deposit them directly into the customer’s account. The images of the checks will then be available to view online. This makes bookkeeping for the customer fast and easy, and because Sonabank is checking the lockbox daily, funds will often be available sooner. Big businesses have been using lockboxes for decades as a cash management tool. Sonabank makes this service cost effective for all small and medium sized businesses as well.

Employer Services:   Sonabank will provide its business clients with software that allows them to generate ACH payroll transactions to their employees’ accounts.
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SABL:   Asset Based Lending is a form of  “collateral-based” lending. It is a combination of secured lending and short-term business lending. It is a specialized form of financing that allows a bank’s commercial customers to pledge their working assets, typically accounts receivable and, to a lesser extent, inventory, as collateral to secure financing. Asset Based Lending borrowers are typically in the service, manufacturing or distribution fields.
SABL is an Asset Based Lending software system built by Sonabank that allows the Bank to monitor the collateral of its commercial borrowers who have pledged their working assets (accounts receivables and other qualifying assets such as inventory) as collateral. SABL has the ability to track other offsets (liabilities, e.g. other loans the customer has with the Bank) to the line of credit. SABL serves to provide the more stringent controls and supervision that this type of lending requires.
One control that is typical of Asset Based Lending is that the commercial borrower is required to have its customers remit invoice payments to a bank controlled lockbox. The bank retrieves these payments and the bank applies them directly to any outstanding balance on the line. SABL allows for this and can combine that service with remote capture (Check 21) if warranted.
Most Asset Based Lending systems are manual processes or software that certifies the borrowing base periodically. These certifications are usually provided in the form of manually created borrowing bases backed up with field exams. SABL provides a real time capability to analyze and adjust borrowing availability based on the levels of collateral at the moment.
SABL also offers an automated collateral upload, taking receivable information directly from the clients accounting system. SABL also offers discretionary borrowings and pay offs, allowing clients to borrow on or pay down their line at their discretion, as long as they are compliant with the SABL system. Lastly, SABL offers superior reporting, offering reports to bank officers that provide all the information they need to monitor risk. Customized reports can also be built for clients.

Mobiliti:   Sona Mobile is perfect for customers on the go, as it is available on a large variety of devices and networks. Sona Mobile offers easy access to account balances, transactions and internal transfers. Mobile Deposit allows customers to save time by eliminating the need to visit a branch. The customer can deposit a check through Sona Mobile by using their certified device (up to $2,000).
Sona Business Mobile can help business customers manage their finances faster than ever. Customers have access to their information via a wide range of devices and networks. The shared user credentials and security settings between online and mobile banking make access more efficient for the business customer. Sona Business Mobile offers standard online banking features, along with enhanced features such as ACH & Wire transfer processing, including granting approvals to users to complete those processes. Mobile deposit is a time saving tool that allows business customers to deposit checks through Sona Business Mobile from their certified device (up to $5,000).

Other Consumer/Retail Products and Services.   Other products and services that are offered by the Bank are primarily directed toward the individual customer and include the following:

Debit cards

ATM services

Travelers Checks

Notary service in some branches

Wire transfers

Online banking with bill payment services

Credit Cards

Kasasa
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Competition
The banking business is highly competitive, and our profitability depends principally on our ability to compete in the market areas in which our banking operations are located. We experience substantial competition in attracting and retaining savings deposits and in lending funds. The primary factors we encounter in competing for savings deposits are convenient office locations and rates offered. Direct competition for savings deposits comes from other commercial bank and thrift institutions, money market mutual funds and corporate and government securities which may offer more attractive rates than insured depository institutions are willing to pay. The primary factors we encounter in competing for loans include, among others, interest rate and loan origination fees and the range of services offered. Competition for origination of loans normally comes from other commercial banks, thrift institutions, mortgage bankers, mortgage brokers and insurance companies. We have been able to compete effectively with other financial institutions by:

emphasizing customer service and technology;

establishing long-term customer relationships and building customer loyalty; and

providing products and services designed to address the specific needs of our customers.
Employees
At December 31, 2017, we had 393 full-time equivalent employees. Management of Southern National and Sonabank considers its relations with its employees to be good. Neither Southern National nor Sonabank are a party to any collective bargaining agreement.
SUPERVISION AND REGULATION
The business of Southern National and the Bank are subject to extensive regulation and supervision under federal and state banking laws and other federal and state laws and regulations, including primary oversight by the Board of Governors of the Federal Reserve System and secondary oversight by the Bureau of Financial Institutions (“VBFI”), a regulatory division of the Virginia State Corporation Commission, and possibly other authorities. In general, legislative changes and regulations are intended for the protection of the customers and depositors of the Bank and not for the protection of Southern National or its shareholders. Set forth below are brief descriptions of selected laws and regulations applicable to Southern National and the Bank. These descriptions are not intended to be a comprehensive description of all laws and regulations to which Southern National and the Bank are subject or to be complete descriptions of the laws and regulations discussed. The descriptions of statutory and regulatory provisions are qualified in their entirety by reference to the particular statutes and regulations.
The earnings of the Bank and therefore of Southern National are affected by general economic conditions, changes in federal and state laws and regulations and actions of various regulatory authorities, including those referenced above. Additional changes to the laws and regulations applicable to us are frequently proposed at both the federal and state levels. Changes in applicable statutes, regulations or regulatory policy may have a material effect on Southern National, the Bank and their business.
Federal Reserve Board Oversight, including the Bank Holding Company Act of 1956.   Under the Bank Holding Company Act of 1956, as amended (“BHCA”), we are subject to periodic examination by the Federal Reserve Board (“FRB”) and required to file periodic reports regarding our operations and any additional information that the FRB may require. Our activities at the bank holding company level are limited to:

banking, managing or controlling banks;

furnishing services to or performing services for our bank subsidiary; and

engaging in other activities that the FRB has determined by regulation or order to be so closely related to banking as to be a proper incident thereto.
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Some of the activities that the FRB has determined by regulation to be permissible include making or servicing loans and specific types of leases, performing specific data processing services and acting in some circumstances as a fiduciary or investment or financial adviser. Southern National does not currently plan to perform any of these activities, but may do so in the future.
With some limited exceptions, the BHCA requires every bank holding company to obtain the prior approval of the FRB before: (i) acquiring substantially all the assets of any bank; (ii) acquiring direct or indirect ownership or control of any voting shares of any bank if after such acquisition it would own or control more than 5% of the voting shares of such bank (unless it already owns or controls the majority of such shares); or (iii) merging or consolidating with another bank holding company. In approving bank acquisitions by bank holding companies, the FRB is required to consider, among other things, the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors.
In addition, and subject to some exceptions, the BHCA and the Change in Bank Control Act, together with their regulations, require FRB approval prior to any person or company acquiring “control” of a bank holding company. Control is conclusively presumed to exist if an individual or company acquires 25% (5% in the case of an acquirer that is a bank holding company) or more of any class of voting securities of the bank or bank holding company. Control is rebuttably presumed to exist under the Change in Bank Control Act if a person acquires 10% or more, of any class of voting securities and has registered securities under Section 12 of the Exchange Act. On September 22, 2008, the FRB issued a policy statement on equity investments in bank holding companies and banks, which allows the FRB to generally be able to conclude that an entity’s investment is not “controlling” for purposes of the BHCA if the entity does not own in excess of 15% of the voting power and 33% of the total equity of the bank holding company or bank.
In November 1999, Congress enacted the Gramm-Leach-Bliley Act (“GLBA”), which made substantial revisions to the statutory restrictions separating banking activities from other financial activities. Under the GLBA, as amended, bank holding companies, together with their bank subsidiaries, that are well-capitalized under the prompt-corrective-action provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) and well-managed under applicable FRB regulations and meet other conditions can elect to become “financial holding companies” and engage in certain activities that are not permissible for a bank holding company. As financial holding companies, they and their subsidiaries are permitted to acquire or engage in previously impermissible activities such as insurance underwriting, securities underwriting and distribution, insurance agency activities, merchant banking and other activities that the FRB determines to be financial in nature or complementary to these activities. Although Southern National has not elected to become a financial holding company in order to exercise the broader activity powers provided by the GLBA, we may elect to do so in the future.
In addition, as a member of the Federal Reserve System, the Bank is also subject to primary federal oversight by the FRB, as well as oversight by the VBFI, and on a secondary basis, the Consumer Financial Protection Bureau (the “Bureau”) and the FDIC. Notably, the discussions below are relevant to both Southern National and the Bank.
Bank Permitted Activities and Investments.   The activities and investments of state member banks are generally limited to those permissible under applicable state law. In addition, under the Federal Deposit Insurance Act (“FDIA”), a state member bank may not engage in any activity that is not permissible for a national bank unless the appropriate bank regulator determines that the activity does not pose a significant risk to the Deposit Insurance Fund (“DIF”) and that the bank meets its minimum capital requirements.
Dodd-Frank Wall Street Reform and Consumer Protection Act.   In July 2010, Congress enacted the Dodd-Frank Act regulatory reform legislation, which the President signed into law on July 21, 2010. The regulatory framework under which we operate has and may continue to change substantially as the result of the enactment of the Dodd-Frank Act or other legislative changes. The Dodd-Frank Act represented a significant overhaul of many aspects of the regulation of the financial services industry, addressing, among other things, systemic risk, capital adequacy, deposit insurance assessments, consumer financial protection, interchange fees, derivatives, lending limits, mortgage lending practices, registration of investment advisors and changes among the bank regulatory agencies. The Dodd-Frank Act broadly affects the financial services industry by implementing changes to the financial regulatory landscape aimed at strengthening the sound operation of the financial services sector, including provisions that, among other things:
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Created a new regulatory authority, the Bureau, responsible for implementing, examining and enforcing compliance with federal consumer financial laws;

Established new regulatory capital requirements, including changes to leverage and risk-based capital standards and changes to the components of permissible tiered capital;

Broadened the base for FDIC insurance assessments from the amount of insured deposits to average total consolidated assets less average tangible equity during the assessment period;

Permanently increased FDIC deposit insurance to $250,000;

Permitted banks to engage in de novo interstate branching if the laws of the state where the new branch is to be established would permit the establishment of the branch if it were chartered by such state;

Repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts;

Required financial holding companies to be well capitalized and well managed as of July 21, 2011. Bank holding companies and banks must also be both well capitalized and well managed in order to acquire banks located outside their home state;

Eliminated the ceiling on the size of and increased the floor of the size of the FDIC’s DIF;

Added new limitations on federal preemption;

Imposed new prohibitions and restrictions on the ability of a banking entity to engage in proprietary trading for its own account and to have certain interests in, or relationships with, certain unregistered hedge funds, private equity funds and commodity pools (together, “covered funds”);

Required that sponsors of asset-backed securities retain a percentage of the credit risk underlying the securities;

Required banking regulators to remove references to and requirements of reliance upon credit ratings from their regulations and replace them with appropriate alternatives for evaluating creditworthiness;

Implemented corporate governance revisions, including with regard to executive compensation and proxy access by shareholders, that apply to all public companies, not just financial institutions;

Amended the Electronic Fund Transfer Act which, among other things, gave the FRB the authority to establish rules regarding interchange fees charged for electronic debit transactions by payment card issuers having assets over $10 billion and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer; and

Increased the authority of the FRB to examine us and our non-bank subsidiaries.
As stated above, the Dodd-Frank Act created the Bureau, a new federal regulatory body with broad authority to regulate the offering and provision of consumer financial products. The authority of the Bureau to supervise and examine depository institutions with $10 billion or less in assets for compliance with federal consumer laws remains largely with those institutions’ primary regulators. However, the Bureau may participate in examinations of institutions with $10 billion or less in assets on a “sampling basis” and may refer potential enforcement actions against such institutions to their primary regulators. Accordingly, the Bureau may participate in examinations of the Bank, and could supervise and examine other direct or indirect subsidiaries of Southern National that offer consumer financial products.
Some of these and other major changes could materially impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices, or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk. While many of the requirements called for in the Dodd-Frank Act have been implemented, others will continue to be implemented over time. In light of these significant changes and the
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discretion afforded to federal regulators, we cannot fully predict the effect that compliance with the Dodd-Frank Act or any implementing regulations will have on our businesses or ability to pursue future business opportunities. Additional regulations resulting from the Dodd-Frank Act may materially adversely affect our business, financial condition or results of operations.
Deposit Insurance.   Deposits at Sonabank are insured by the DIF, as administered by the FDIC, up to the applicable limits established by law. The Dodd-Frank Act amended the statutory regime governing the DIF. Among other things, the Dodd-Frank Act established a minimum designated reserve ratio of 1.35% of estimated insured deposits (which the FDIC has set at 2.0% each year since 2010), required that the fund reserve ratio reach 1.35% by September 30, 2020, and directed the FDIC to amend its regulations to redefine the assessment base used for calculating deposit insurance assessments. Specifically, the Dodd-Frank Act requires the assessment base to be an amount equal to the average consolidated total assets of the insured depository institution during the assessment period, minus the sum of the average tangible equity of the insured depository institution during the assessment period and an amount the FDIC determines is necessary to establish assessments consistent with the risk-based assessment system found in the FDIA.
Under the FDIC’s risk-based assessment system, insured institutions are assigned to risk categories based on supervisory evaluations, regulatory capital levels and certain other factors. As of July 1, 2016, minimum and maximum assessment rates (inclusive of possible adjustments) for institutions the size of Sonabank range from 1.5 to 30 basis points of total assets less tangible capital. The FDIC’s current system represents a change, required by the Dodd-Frank Act, from its prior practice of basing the assessment on an institution’s aggregate deposits.
In addition, the FDIC collects quarterly FICO deposit assessments, which are calculated off of the assessment base described above. Sonabank pays the deposit insurance assessment and pays the quarterly FICO assessments.
Safety and Soundness.   There are a number of obligations and restrictions imposed on bank holding companies and their depository institution subsidiaries by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the DIF in the event that the depository institution is insolvent or is in danger of becoming insolvent. These obligations and restrictions are not for the benefit of investors. The FRB’s Regulation Y, for example, requires a holding company that is not well-capitalized to give the FRB prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the net consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the holding company’s consolidated net worth. The FRB may oppose such transaction if it believes that the transaction would constitute an unsafe or unsound practice or would violate any law or regulation.
Regulators may pursue an administrative action against any bank holding company or state member bank which violates the law, engages in an unsafe or unsound banking practice or which is about to engage in an unsafe and unsound banking practice. The administrative action could take the form of a cease and desist proceeding, a removal action against the responsible individuals or, in the case of a violation of law or unsafe and unsound banking practice, a civil penalty action. A cease and desist order, in addition to prohibiting certain action, could also require that certain action be undertaken. Under the policies of the FRB, Southern National is required to serve as a source of financial strength to the Bank and to commit resources to support the Bank in circumstances where Southern National might not do so otherwise. Notably, the Dodd-Frank Act codified the FRB’s “source of strength” doctrine. In addition to the foregoing requirements, the Dodd-Frank Act authorizes the FRB to require a company that directly or indirectly controls a bank to submit reports that are designed both to assess the ability of such company to comply with its “source of strength” obligations and to enforce the company’s compliance with these obligations. The FRB and other federal banking regulators have not yet issued rules implementing this requirement.
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Capital Adequacy Requirements.   The regulatory capital framework has recently changed as a result of the Dodd-Frank Act and a separate, international capital initiative known as “Basel III.” Regulators issued rules implementing these requirements effective for us and Sonabank as of January 1, 2015 (“Revised Capital Rules”). Among other things, the Revised Capital Rules raised the minimum thresholds for required capital and revise certain aspects of the definitions and elements of the capital that can be used to satisfy these required minimum thresholds.
The Revised Capital Rules, among other things, (i) introduced a new capital measure called “Common Equity Tier 1” (“CET1”), (ii) specify that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting specified requirements, (iii) define CET1 narrowly by requiring that most adjustments to regulatory capital measures be made to CET1 and not to the other components of capital and (iv) expand the scope of the adjustments as compared to existing regulations. Further, the Revised Capital Rules set forth the following minimum capital ratios, which took effect in for certain banking organizations, including Southern National and the Bank, on January 1, 2015:

4.5 percent CET1 to risk-weighted assets.

6.0 percent Tier 1 Capital to risk-weighted assets.

8.0 percent Total Capital to risk-weighted assets.

4.0 percent Tier 1 Capital to average consolidated assets as reported on consolidated financial statements (known as the “leverage ratio”).
The Revised Capital Rules also introduce a minimum “capital conservation buffer” equal to 2.5% of an organization’s total risk-weighted assets, which exists in addition to the required minimum asset ratios identified above. The “capital conservation buffer” must consist entirely of CET1 and is designed to absorb losses during periods of economic stress. Thus, when fully phased in on January 1, 2019, the Revised Capital Rules will require us to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (resulting in an effective minimum ratio of CET1 to risk-weighted assets of at least 7.0%), (ii) a minimum ratio of Tier 1 Capital to risk-weighted assets of at least 6.0%, plus the “capital conservation buffer” (resulting in an effective minimum Tier 1 Capital ratio of 8.5%), (iii) a minimum ratio of Total (that is, Tier 1 plus Tier 2) Capital to risk-weighted assets of at least 8.0%, plus the “capital conservation buffer” (resulting in an effective minimum Total Capital ratio of 10.5%) and (iv) a minimum leverage ratio of 4.0%, calculated as the ratio of Tier 1 Capital to average consolidated assets.
Under the Revised Capital Rules, for most banking organizations, the most common form of Additional Tier 1 Capital will be non-cumulative perpetual preferred stock, and the most common form of Tier 2 Capital will be subordinated notes and a portion of the allowance for loan losses, in each case, subject to certain specific requirements set forth in the regulation. The Revised Capital Rules permanently grandfather in Tier 1 capital non-qualifying capital instruments, including trust preferred securities (“TruPS”) and cumulative perpetual preferred stock, issued prior to May 19, 2010 by depository institution holding companies with < $15 billion in total assets as of year-end 2009, subject to a limit of 25% of Tier 1 capital (excluding any non-qualifying capital instruments and after applying all regulatory capital deductions and adjustments to Tier 1 capital). Under the capital standards that applied prior to January 1, 2015, the effects of accumulated other comprehensive income items included in shareholders’ equity under U.S. generally accepted accounting principles (“U.S. GAAP”) are excluded for the purposes of determining capital ratios. Under the Revised Capital Rules, the effects of certain accumulated other comprehensive income items are not excluded. However, the Revised Capital Rules permit most banking organizations to make a one-time election to continue to exclude these items. This election was made when we filed the first of certain periodic regulatory reports after January 1, 2015.
In addition, under the Revised Capital Rules, certain hybrid securities, such as trust preferred securities, generally do not qualify as Tier 1 Capital. However, for bank holding companies that had assets of less than $15 billion as of December 31, 2009, trust preferred securities issued prior to May 19, 2010 can be treated as Tier 1 Capital to the extent that they do not exceed 25% of Tier 1 Capital after the application of capital deductions and adjustments.
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Prompt Corrective Action.   Under Section 38 of the FDIA, each federal banking agency is required to implement a system of prompt corrective action for institutions that it regulates. The federal banking agencies (including the FRB) have adopted substantially similar regulations to implement Section 38 of the FDIA. Section 38 of the FDIA and the regulations promulgated thereunder also specify circumstances under which the FRB may reclassify a well-capitalized bank as adequately capitalized and may require an adequately capitalized bank or an undercapitalized bank to comply with supervisory actions as if it were in the next lower category (except that the FRB may not reclassify a significantly undercapitalized bank as critically undercapitalized). The thresholds for each of these categories were revised pursuant to the Revised Capital Rules, which are discussed above. These revised categories began to apply to the Bank on January 1, 2015.
Under these regulations, insured depository institutions are assigned to one of the following capital categories:

“well capitalized” — A well-capitalized depository institution is one that (i) has a total risk-based capital ratio of 10 percent or greater, (ii) has a Tier 1 risk-based capital ratio of 8 percent or greater, (iii) has a CET1 risk-based capital ratio of 6.5 percent or greater, (iv) has a leverage capital ratio of 5 percent or greater and (v) is not subject to any order or written directive to meet and maintain a specific capital level for any capital measure.

“adequately capitalized” — An adequately capitalized depository institution is one that has (i) a total risk-based capital ratio of 8 percent or greater, (ii) a Tier 1 risk-based capital ratio of 6 percent or greater, (iii) a CET1 risk-based capital ratio of 4.5 percent or greater, and (iv) a leverage capital ratio of 4 percent or greater.

“undercapitalized” — An undercapitalized depository institution is one that has (i) a total risk-based capital ratio of less than 8 percent, (ii) a Tier 1 risk-based capital ratio of less than 6 percent, (iii) a CET1 risk-based capital ratio of less than 4.5 percent, or (iv) a leverage capital ratio of less than 4 percent.

“significantly undercapitalized” — A significantly undercapitalized institution is one that has (i) a total risk-based capital ratio of less than 6 percent, (ii) a Tier 1 risk-based capital ratio of less than 4 percent, (iii) a CET1 risk-based capital ratio of less than 3 percent, or (iv) a leverage capital ratio of less than 3 percent.

“critically undercapitalized” — An insured depository institution is critically undercapitalized if its tangible equity is equal to or less than 2% of tangible assets. The Revised Capital Rules made certain changes to the framework for calculating an insured depository institution’s ratio of tangible equity to total assets.
The FRB may take various corrective actions against the Bank if it becomes undercapitalized or fails to submit an acceptable capital restoration plan or fails to implement a plan accepted by the FRB. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring a new election of directors, and requiring the dismissal of directors and officers.
If certain criteria are met, the aggregate guarantee of the holding company of an undercapitalized bank for its capital restoration plan is limited to the lesser of 5% of the institution’s total assets at the time it became undercapitalized or the amount necessary to cause the institution to be “adequately capitalized.” The bank regulators have greater power in situations where an institution becomes “significantly” or “critically” undercapitalized or fails to submit a capital restoration plan. For example, a bank holding company controlling such an institution can be required to obtain prior FRB approval of proposed dividends, or might be required to consent to a consolidation or to divest the troubled institution or other affiliates.
Brokered Deposit Restrictions.   Adequately capitalized institutions (as defined for purposes of the prompt corrective action rules described above) cannot accept, renew or roll over brokered deposits except with a waiver from the FDIC, and are subject to restrictions on the interest rates that can be paid on such deposits. Undercapitalized institutions may not accept, renew, or roll over brokered deposits.
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Volcker Rule.   In December 2013, federal regulators, including the FRB, issued final rules to implement Section 619 of the Dodd-Frank Act, known as the “Volcker Rule.” The Volcker Rule generally prohibits insured depository institutions, such as the Bank, and their holding companies and affiliates, such as Southern National, from engaging in proprietary trading for their own accounts and acquiring or retaining an ownership interest in or having certain relationships with “covered funds,” subject to certain exceptions. Southern National and the Bank were required to conform most of their activities and investments to the requirements of the Volcker Rule by July 21, 2015. The FRB extended the conformance deadline to July 21, 2017 for certain legacy “covered funds” activities and investments in place before December 31, 2013. Further, the FRB has permitted limited exemptions, upon application, for divestiture of certain “illiquid” covered funds, for an additional period of up to 5 years beyond that date.
Payment of Dividends.   Southern National is a legal entity separate and distinct from the Bank. The principal sources of our cash flow, including cash flow to pay dividends to Southern National’s stockholders, are dividends that the Bank pays to its sole shareholder, Southern National. Statutory and regulatory limitations apply to the Bank’s payment of dividends to us as well as to Southern National’s payment of dividends to its stockholders.
It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
Under FRB policy, a bank holding company has historically been required to act as a source of financial strength to each of its banking subsidiaries. As described above in the discussion of  “Safety and Soundness” requirements, the Dodd-Frank Act codifies this policy as a statutory requirement. Under this requirement, Southern National is expected to commit resources to support the Bank, including at times when we may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. As discussed below, a bank holding company, in certain circumstances, could be required to guarantee the capital plan of an undercapitalized banking subsidiary.
Capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. The bank regulatory agencies may declare a dividend payment to be unsafe and unsound even though the Bank would continue to meet its capital requirements after the dividend.
The ability of Southern National to pay dividends is also subject to the provisions of Virginia law. The payment of dividends by Southern National and the Bank may also be affected by other factors, such as the requirement to maintain adequate capital above regulatory guidelines. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s capital base to an inadequate level would be an unsafe and unsound banking practice. Under the FDICIA, a depository institution may not pay any dividend if payment would cause it to become undercapitalized or if it already is undercapitalized.
In the event of a bank holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, the trustee will be deemed to have assumed and to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution. Any claim for breach of such obligation will generally have priority over most other unsecured claims.
Because Southern National is a legal entity separate and distinct from our subsidiary Sonabank, our right to participate in the distribution of assets of any subsidiary upon the subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its shareholders, arising as a result of their status as shareholders, including any depository institution holding company (such as us) or any shareholder or creditor thereof.
Privacy.   Under the GLBA, financial institutions are required to disclose their policies for collecting and protecting nonpublic personal information. Customers generally may prevent financial institutions from sharing nonpublic personal information with nonaffiliated third parties except under narrow
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circumstances, such as the processing of transactions requested by the consumer or when the financial institution is jointly sponsoring a product or service with a nonaffiliated third party. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing to consumers. Financial institutions are further required to disclose their privacy policies to customers annually. Financial institutions, however, will be required to comply with state law if it is more protective of customer privacy than the GLBA. The Bank has established policies and procedures to assure our compliance with all privacy provisions of the GLBA.
Audit Reports.   Insured institutions with total assets of  $500 million or more must submit annual audit reports prepared by independent auditors to federal and state regulators. In some instances, the audit report of the institution’s holding company can be used to satisfy this requirement. Independent auditors must receive examination reports, supervisory agreements and reports of enforcement actions. For insured institutions with total assets of  $1 billion or more, financial statements prepared in accordance with U.S. GAAP, management’s certifications concerning responsibility for the financial statements, internal controls and compliance with legal requirements designated by the FDIC, and an attestation by the independent auditor regarding the statements of management relating to the internal controls must be submitted. For insured institutions with total assets of more than $3 billion, independent auditors may be required to review quarterly financial statements. The FDICIA requires that institutions with total assets of $1.0 billion or more have independent audit committees consisting of outside directors only. The committees of insured institutions with total assets of  $3.0 billion or more must include members with experience in banking or financial management, must have access to outside counsel, and must not include representatives of large customers.
Anti-Terrorism and Anti-Money Laundering Legislation.   A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA PATRIOT Act of 2001 (the “USA Patriot Act”) substantially broadened the scope of United States anti-money laundering laws and regulations by imposing significant new compliance and due diligence obligations, creating new crimes and penalties and expanding the extra-territorial jurisdiction of the United States. The Financial Crimes Enforcement Network (“FinCEN”), a bureau of the U.S. Department of the Treasury, has issued a number of regulations that apply various requirements of the USA Patriot Act to financial institutions. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Certain of those regulations impose specific due diligence requirements on financial institutions that maintain correspondent or private banking relationships with non-U.S. financial institutions or persons. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the financial institution. Bank regulators routinely examine institutions for compliance with these anti-money laundering obligations and recently have been active in imposing “cease and desist” and other regulatory orders and money penalty sanctions against financial institutions found to be in violation of these requirements.
Office of Foreign Assets Control Regulation.   The United States has imposed economic sanctions that affect transactions with designated foreign countries, nationals and others. These are typically known as the “OFAC” rules based on their administration by the U.S. Department of the Treasury’s Office of Foreign Assets Control (“OFAC”). The OFAC-administered sanctions targeting countries take many different forms. Generally, however, they contain one or more of the following elements: (i) restrictions on trade with or investment in a sanctioned country, including prohibitions against direct or indirect imports from and exports to a sanctioned country and prohibitions on “U.S. persons” engaging in financial transactions relating to making investments in, or providing investment-related advice or assistance to, a sanctioned country; and (ii) a blocking of assets in which the government or specially designated nationals of the sanctioned country have an interest, by prohibiting transfers of property subject to U.S. jurisdiction (including property in the possession or control of U.S. persons). Blocked assets (e.g., property and bank deposits) cannot be paid out, withdrawn, set off or transferred in any manner without a license from OFAC. Failure to comply with these sanctions could have serious legal and reputational consequences.
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Virginia Law.   Certain state corporation laws may have an anti-takeover affect. Virginia law restricts transactions between a Virginia corporation and its affiliates and potential acquirers. The following discussion summarizes the two Virginia statutes that may discourage an attempt to acquire control of Southern National.
Virginia Code Sections 13.1-725 – 727.1 govern “Affiliated Transactions.” These provisions, with several exceptions discussed below, require approval by the holders of at least two-thirds of the remaining voting shares of material acquisition transactions between a Virginia corporation and any holder of more than 10% of any class of its outstanding voting shares. Affiliated Transactions include mergers, share exchanges, material dispositions of corporate assets not in the ordinary course of business, any dissolution of the corporation proposed by or on behalf of an interested shareholder, or any reclassification, including a reverse stock split, recapitalization, or merger of the corporation with its subsidiaries which increases the percentage of voting shares owned beneficially by any 10% shareholder by more than 5%.
These provisions were designed to deter certain takeovers of Virginia corporations. In addition, the statute provides that, by affirmative vote of a majority of the voting shares other than shares owned by any 10% shareholder, a corporation can adopt an amendment to its articles of incorporation or bylaws providing that the Affiliated Transactions provisions shall not apply to the corporation. Southern National “opted out” of the Affiliated Transactions provisions when it incorporated.
Virginia law also provides that shares acquired in a transaction that would cause the acquiring person’s voting strength to meet or exceed any of the three thresholds (20%, 3313% or 50%) have no voting rights for those shares exceeding that threshold, unless granted by a majority vote of shares not owned by the acquiring person. This provision empowers an acquiring person to require the Virginia corporation to hold a special meeting of shareholders to consider the matter within 50 days of the request. Southern National also “opted out” of this provision at the time of its incorporation.
Federal Reserve Monetary Policy.   The Bank will be directly affected by government monetary and fiscal policy and by regulatory measures affecting the banking industry and the economy in general. The actions of the FRB as the nation’s central bank can directly affect the money supply and, in general, affect the lending activities of banks by increasing or decreasing the cost and availability of funds. An important function of the FRB is to regulate the national supply of bank credit. Among the instruments of monetary policy used by the FRB to implement this objective are open market operations in United States government securities, changes in the discount rate on member bank borrowings and changes in reserve requirements against bank deposits. These means are used in varying combinations to influence overall growth of bank loans, investments and deposits, and interest rates charged on loans or paid on deposits. The monetary policies of the FRB have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future; however, the effects of the various FRB policies on our future business and earnings cannot be predicted.
Reserve Requirements.   In 1980, Congress enacted legislation that imposed reserve requirements on all depository institutions that maintain transaction accounts or nonpersonal time deposits. NOW accounts, money market deposit accounts and other types of accounts that permit payments or transfers to third parties fall within the definition of transaction accounts and are subject to these reserve requirements, as are any nonpersonal time deposits at a depository institution. For net transaction accounts in 2018, the first $16.0 million will be exempt from reserve requirements. A 3.0% reserve ratio will be assessed on net transaction accounts over $16.0 million to and including $122.3 million. A 10.0% reserve ratio will be applied to net transaction accounts in excess of  $122.3 million. These percentages are subject to adjustment by the FRB.
Restrictions on Transactions with Affiliates and Insiders.   Transactions between banks and their affiliates are governed by Sections 23A and 23B of the Federal Reserve Act (“FRA”) and the corresponding provisions of the FRB’s Regulation W thereunder. An affiliate of a bank for purposes of Sections 23A and 23B of the FRA and Regulation W is generally any entity that controls, is controlled by or is under common control with such bank, with certain exceptions. In general, Section 23A and the corresponding provisions of Regulation W limit the amount of  “covered transactions” between Sonabank and an affiliate (including a financial subsidiary of Sonabank) to 10% of Sonabank’s capital stock and surplus and limits the aggregate amount of Sonabank’s “covered transactions” with all affiliates to 20% of Sonabank’s capital
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stock and surplus. Section 23A also requires that certain “covered transactions” be secured by designated amounts of specified collateral. It also limits the amount of advances to third parties which are collateralized by the securities or obligations of Southern National or its subsidiaries. “Covered transactions” are defined by statute to include a loan or extension of credit, as well as a purchase of securities issued by an affiliate, a purchase of assets (unless otherwise exempted by the FRB) from the affiliate, the acceptance of securities issued by the affiliate as collateral for a loan, and the issuance of a guarantee, acceptance or letter of credit on behalf of an affiliate.
Affiliate transactions are also subject to Section 23B of the FRA and the corresponding provisions of Regulation W, which generally require that certain “covered transactions” and other transactions between Sonabank and its affiliates be on terms substantially the same, or at least as favorable to Sonabank, as those prevailing at the time for comparable transactions with or involving other nonaffiliated persons.
The restrictions on loans to directors, executive officers, principal shareholders and their related interests (collectively referred to herein as “insiders”) contained in the FRA and the FRB’s Regulation O apply to all insured institutions, their holding companies and all other subsidiaries of the holding company. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to “insiders” and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the FRB may determine that a lesser amount is appropriate. “Insiders” are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.
Commercial Real Estate Lending Concentrations.   In 2006, the federal banking agencies, including the FRB, promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance sets forth parameters for risk management practices that are consistent with the level and nature of a financial institution’s commercial real estate lending portfolio. The guidance provides that a bank has a concentration in commercial real estate lending if  (i) total reported loans for construction, land development, and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm non-residential properties and loans for construction, land development, and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. Owner occupied loans are excluded from this second category. If a concentration is present, management must employ heightened risk management practices that address the following key elements: including board and management oversight and strategic planning, portfolio management, development of underwriting standards, risk assessment, review and monitoring through market analysis and stress testing, and maintenance of increased capital levels as needed to support the level of commercial real estate lending.
In October 2009, the federal banking agencies issued additional guidance on commercial real estate lending that emphasizes these considerations and also supports prudent loan workouts for financial institutions working with commercial real estate borrowers who are experiencing diminished operating cash flows, depreciated collateral values, or prolonged delays in selling or renting commercial properties.
In addition, the Dodd-Frank Act contains provisions that may impact the Bank’s business by reducing the amount of our commercial real estate lending and increasing the cost of borrowing, including rules relating to risk retention of securitized assets. Section 941 of the Dodd-Frank Act requires, among other things, that a loan originator or a securitizer of asset-backed securities retain a percentage of the credit risk of securitized assets. The banking agencies have jointly issued a final rule to implement these requirements, which became effective on December 24, 2016.
Cross-Guarantee Provisions.   The Financial Institutions Reform, Recovery and Enforcement Act of 1989 contains a “cross-guarantee” provision which generally makes commonly controlled insured depository institutions liable to the FDIC for any losses incurred in connection with the failure of a commonly controlled insured depository institution.
Community Reinvestment Act.   Under the Community Reinvestment Act (“CRA”) and related regulations, depository institutions have a continuing and affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice. The CRA requires the adoption by each institution of a CRA statement for each
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of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with the CRA and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s CRA rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries.
CRA agreements with private parties must be disclosed and annual reports must be made to a bank’s primary federal regulator. A bank holding company will not be permitted to become a financial holding company and no new activities authorized under the GLBA may be commenced by a holding company or by a financial subsidiary if any of its bank subsidiaries received less than a “satisfactory” rating in its latest CRA examination. The Bank received a “satisfactory” rating in the most recent examination for CRA compliance in July 2015.
Fair Lending; Consumer Laws.   In addition to the CRA, other federal and state laws regulate various lending and consumer aspects of the banking business. Governmental agencies, including the Department of Housing and Urban Development, the Federal Trade Commission and the Department of Justice, have become concerned that prospective borrowers experience discrimination in their efforts to obtain loans from depository and other lending institutions. These agencies have brought litigation against depository institutions alleging discrimination against borrowers. Many of these suits have been settled, in some cases for material sums, short of a full trial.
These governmental agencies have clarified what they consider to be lending discrimination and have specified various factors that they will use to determine the existence of lending discrimination under the Equal Credit Opportunity Act and the Fair Housing Act, including evidence that a lender discriminated on a prohibited basis, evidence that a lender treated applicants differently based on prohibited factors in the absence of evidence that the treatment was the result of prejudice or a conscious intention to discriminate, and evidence that a lender applied an otherwise neutral non-discriminatory policy uniformly to all applicants, but the practice had a discriminatory effect, unless the practice could be justified as a business necessity.
Banks and other depository institutions also are subject to numerous consumer-oriented laws and regulations. These laws, which include the Truth in Lending Act, the Truth in Savings Act, the Real Estate Settlement Procedures Act, the Electronic Fund Transfer Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Fair Credit Reporting Act and the Expedited Funds Availability Act require compliance by depository institutions with various disclosure requirements and requirements regulating the availability of funds after deposit or the making of some loans to customers.
The Bureau issued rules that have impacted our residential mortgage lending practices, and the residential mortgage market generally, including rules that implement the “ability-to-repay” requirement and provide protection from liability for “qualified mortgages,” as required by the Dodd-Frank Act. The “ability-to-repay” rule, which took effect on January 10, 2014, requires lenders to consider, among other things, income, employment status, assets, employment, payment amounts, and credit history before approving a mortgage, and provides a compliance “safe harbor” for lenders that issue certain “qualified mortgages.” The “ability-to-repay” rule defines a “qualified mortgage” to have certain specified characteristics, and generally prohibit loans with negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years from being “qualified mortgages”. The rule also establishes general underwriting criteria for “qualified mortgages”, including that monthly payments be calculated based on the highest payment that will apply in the first five years of the loan and that the borrower have a total debt-to-income ratio that is less than or equal to 43 percent. While “qualified mortgages” will generally be afforded “safe harbor” status, a rebuttable presumption of compliance with the “ability-to-repay” requirements will attach to “qualified mortgages” that are “higher priced mortgages” (which are generally subprime loans). In addition, under rules that became effective December 24, 2015, and December 24, 2016, the securitizer of certain asset-backed securities must retain not less than 5 percent of the credit risk of the assets collateralizing the asset-backed securities, unless subject to an exemption for asset-backed securities that are collateralized exclusively by residential mortgages that qualify as “qualified residential mortgages.” These definitions are expected to significantly shape the parameters for the majority of consumer mortgage lending in the U.S.
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Reflecting the Bureau’s focus on the residential mortgage lending market, the Bureau has also issued rules to implement requirements of the Dodd-Frank Act pertaining to mortgage loan origination (including with respect to loan originator compensation and loan originator qualifications) and has finalized integrated mortgage disclosure rules that replace and combine certain requirements under the Truth in Lending Act and the Real Estate Settlement Procedures Act. In addition, the Bureau has issued rules that require servicers to comply with new standards and practices with regard to: error correction; information disclosure; force-placement of insurance; information management policies and procedures; requiring information about mortgage loss mitigation options be provided to delinquent borrowers; providing delinquent borrowers access to servicer personnel with continuity of contact about the borrower’s mortgage loan account; and evaluating borrowers’ applications for available loss mitigation options. These rules also address initial rate adjustment notices for adjustable-rate mortgages (“ARMs”), periodic statements for residential mortgage loans, and prompt crediting of mortgage payments and response to requests for payoff amounts. The Bureau has indicated that it expects to issue additional mortgage-related rules in the future.
In addition, it is anticipated that the Bureau will engage in other rulemakings in the near term that may impact our business, as the Bureau has indicated that, in addition to specific statutory mandates, it is working on a wide range of initiatives to address issues in markets for consumer financial products and services. The Bureau also has broad authority to prohibit unfair, deceptive and abusive acts and practices (“UDAAP”) and to investigate and penalize financial institutions that violate this prohibition. While the statutory language of the Dodd-Frank Act sets forth the standards for acts and practices that violate this prohibition, certain aspects of these standards are untested, which has created some uncertainty regarding how the Bureau will exercise this authority. The Bureau has, however, brought enforcement actions against certain financial institutions for UDAAP violations and issued some guidance on the topic, which provides insight into the agency’s expectations regarding these standards. Among other things, Bureau guidance and its UDAAP-related enforcement actions have emphasized that management of third-party service providers is essential to effective UDAAP compliance and that the Bureau is particularly focused on marketing and sales practices.
We cannot fully predict the effect that being regulated by a regulatory authority focused on consumer financial protection, or any new implementing regulations or revisions to existing regulations that may result from the establishment of this new authority, will have on our businesses.
Legislative Initiatives.   From time to time, various legislative and regulatory initiatives are introduced in Congress and State Legislatures. Such initiatives may change banking statutes and the operating environment for us and Sonabank in substantial and unpredictable ways. We cannot determine the ultimate effect that any potential legislation, if enacted, or implementing regulations with respect thereto, would have, upon the financial condition or results of our operations or the operations of Sonabank. A change in statutes, regulations or regulatory policies applicable to us or Sonabank could have a material effect on the financial condition, results of operations or business of us and Sonabank.
Incentive Compensation.   The Dodd-Frank Act requires the federal bank regulatory agencies and the SEC to establish joint regulations or guidelines prohibiting incentive-based payment arrangements at specified regulated entities having at least $1 billion in total assets, such as Southern National and Sonabank, that encourage inappropriate risks by providing an executive officer, employee, director or principal shareholder with excessive compensation, fees, or benefits or that could lead to material financial loss to the entity. In addition, these regulators must establish regulations or guidelines requiring enhanced disclosure to regulators of incentive-based compensation arrangements. The agencies proposed such regulations in April 2011, but the regulations have not been finalized. In 2016, the FRB and the OCC have also proposed rules that would, depending upon the assets of the institution, directly regulate incentive compensation arrangements and would require enhanced oversight and recordkeeping. As of December 31, 2017, these rules have not been implemented.
In June 2010, the FRB, the Office of the Comptroller of the Currency (“OCC”), and the FDIC issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The guidance, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is
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based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.
The FRB will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of banking organizations, such as us, that are not “large, complex banking organizations.” These reviews will be tailored to each organization based on the scope and complexity of the organization’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the organization’s supervisory ratings, which can affect the organization’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a banking organization if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.
Enforcement Powers of Federal and State Banking Agencies.   The federal banking agencies have broad enforcement powers, including the power to terminate deposit insurance, impose substantial fines and other civil and criminal penalties, and appoint a conservator or receiver. Failure to comply with applicable laws, regulations, and supervisory agreements could subject Southern National or the Bank and their subsidiaries, as well as officers, directors, and other institution-affiliated parties of these organizations, to administrative sanctions and potentially substantial civil money penalties. In addition to the grounds discussed above, the appropriate federal banking agency may appoint the FDIC as conservator or receiver for a banking institution (or the FDIC may appoint itself, under certain circumstances) if any one or more of a number of circumstances exist, including, without limitation, the fact that the banking institution is undercapitalized and has no reasonable prospect of becoming adequately capitalized; fails to become adequately capitalized when required to do so; fails to submit a timely and acceptable capital restoration plan; or materially fails to implement an accepted capital restoration plan. The VBFI also has broad enforcement powers over the Bank, including the power to impose orders, remove officers and directors and impose fines.
The foregoing is only a brief summary of certain statutes, rules, and regulations that may affect Southern National and the Bank. Numerous other statutes and regulations also will have an impact on the operations of Southern National and the Bank. Supervision, regulation and examination of banks by the regulatory agencies are intended primarily for the protection of depositors, not shareholders.
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Item 1A.
Risk Factors
An investment in our common stock involves risks. The following is a description of the material risks and uncertainties that Southern National believes affect its business and should be considered before making an investment in our common stock. Additional risks and uncertainties that we are unaware of, or that we currently deem immaterial, also may become important factors that affect us and our business. If any of the risks described in this Annual Report on Form 10-K were to actually occur, our financial condition, results of operations and cash flows could be materially and adversely affected. If this were to happen, the value of our common stock could decline significantly and you could lose part or all of your investment.
General market conditions and economic trends could have a material adverse effect on our business, financial condition and results of operations.
The state of the economy and various economic factors, including inflation, recession, unemployment, interest rates, declining oil prices and the level of U.S. debt, as well as governmental action and uncertainty resulting from U.S. and global political trends, may directly or indirectly, have a destabilizing effect on our financial condition and results of operations. An unfavorable or uncertain national or regional political or economic environment could drive losses beyond those which are provided for in our allowance for loan losses and result in the following consequences:

increases in loan delinquencies;

increases in nonperforming assets and foreclosures;

decreases in demand for our products and services, which could adversely affect our liquidity position; and

decreases in the value of the collateral securing our loans, especially real estate, which could reduce customers’ borrowing power.
Any of the foregoing could adversely affect our financial condition and results of operations. While economic conditions in the Commonwealth of Virginia and the U.S. are strong, there can be no assurance that the economy will continue to grow.
Liquidity risk could impair our ability to fund operations and jeopardize our financial condition, results of operations and cash flows.
Liquidity is essential to our business. Our ability to implement our business strategy will depend on our ability to obtain funding for loan originations, working capital, possible acquisitions and other general corporate purposes. An inability to raise funds through deposits, borrowings, securities sold under agreements to repurchase, the sale of loans and other sources could have a substantial negative effect on our liquidity. We do not anticipate that our retail and commercial deposits will be sufficient to meet our funding needs in the foreseeable future. We therefore rely on deposits obtained through intermediaries, FHLB advances, and other wholesale funding sources to obtain the funds necessary to implement our growth strategy.
Our access to funding sources in amounts adequate to finance our activities or on terms which are acceptable to us could be impaired by factors that affect us specifically or the financial services industry or economy in general, including a decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated or adverse regulatory action against us. Our ability to borrow could also be impaired by factors that are not specific to us, such as a disruption in the financial markets or negative views and expectations about the prospects for the financial services industry. To the extent we are not successful in obtaining such funding, we will be unable to implement our strategy as planned which could have a material adverse effect on our financial condition, results of operations and cash flows.
Declines in asset values may result in impairment charges and adversely affect the value of our investment securities, financial performance and capital.
We maintain an investment securities portfolio that includes, but is not limited to, collateralized mortgage obligations, agency mortgage-backed securities and pooled trust preferred securities. The market
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value of investment securities may be affected by factors other than the underlying performance of the issuer or composition of the bonds themselves, such as ratings downgrades, adverse changes in the business climate and a lack of liquidity for resales of certain investment securities. At each reporting period, we evaluate investment securities and other assets for impairment indicators. We may be required to record additional impairment charges if our investment securities suffer a decline in value that is considered other-than-temporary. During the years ended December 31, 2017, 2016 and 2015, we incurred no other-than-temporary impairment charges. If in future periods we determine that a significant impairment has occurred, we would be required to charge against earnings the credit-related portion of the other-than-temporary impairment, which could have a material adverse effect on our results of operations in the periods in which the write-offs occur.
Our pooled trust preferred securities are particularly vulnerable to the performance of the issuer of the subordinated debentures that are collateral for the trust preferred securities. Deterioration of these trust preferred securities can occur because of defaults by the issuer of the collateral or because of deferrals of dividend payments on the securities. Numerous financial institutions have failed subsequent to their issuance of trust preferred securities, and their parent bank holding companies have filed for bankruptcy, which has led to defaults in the subordinated debentures that collateralize the trust preferred securities. Further, increased regulatory pressure has been placed on financial institutions to maintain capital ratios above the required minimum to be well-capitalized, which often results in restrictions on dividends, and leads to deferrals of dividend payments on the trust preferred securities. More specifically, the FRB has stated that a bank holding company should eliminate, defer or significantly reduce dividends if  (i) its net income available to shareholders for the past four quarters, net of dividends paid, is not sufficient to fully fund the dividends, (ii) its prospective rate of earnings retention is not consistent with its capital needs or (iii) it is in danger of not meeting its minimum regulatory capital adequacy ratios. In addition, although interest deferrals are permitted under the terms of the instruments governing the trust preferred securities, such deferrals are typically limited to 20 consecutive quarterly periods. As a result, many financial institutions that commenced deferral periods in 2009 are no longer permitted to defer interest payments, which could result in increased defaults on trust preferred securities. Additional defaults in the underlying collateral or deferrals of dividend payments for these securities could lead to additional charges on these securities and/or other-than-temporary impairment charges on other trust preferred securities we own. Finally, proposed or future changes in the regulatory treatment of both issuers and holders of trust preferred securities could have a negative impact on the value of the pooled trust preferred securities held in our portfolio.
The soundness of other financial institutions could adversely affect us.
Financial institutions are interrelated as a result of trading, clearing, counterparty and other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with a variety of counterparties in the financial services industry. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated if the collateral we hold cannot be sold at prices that are sufficient for us to recover the full amount of our exposure. Any such losses could materially and adversely affect our financial condition and results of operations.
If the goodwill that we record in connection with business acquisitions becomes impaired, it could have a negative impact on our profitability.
Goodwill represents the amount of acquisition cost over the fair value of net assets we acquire in the purchase of another entity. We review goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate the carrying value of the asset might be impaired. Examples of those events or circumstances include the following:

significant adverse changes in business climate;

significant changes in credit quality;

significant unanticipated loss of customers;
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significant loss of deposits or loans; or

significant reductions in profitability.
As of December 31, 2017, our goodwill totaled $100.6 million and is primarily related to the 2017 acquisition of EVBS, which increased goodwill by $90.1 million. While we have recorded no such impairment charges since we initially recorded the goodwill, there can be no assurance that our future evaluations of goodwill will not result in findings of impairment and related write-downs, which may have a material adverse effect on our financial condition and results of operations.
If our nonperforming assets increase, our earnings will suffer.
At December 31, 2017, our non-covered nonperforming assets (which consist of non-covered nonaccrual loans, loans past due 90 days and accruing and OREO) totaled $24.5 million, or 1.20% of total non-covered loans and OREO, which is an increase of  $12.1 million, or 97.5%, compared with non-covered nonperforming assets of  $12.4 million, or 1.36% of total non-covered loans and OREO at December 31, 2016. At December 31, 2015, our non-covered nonperforming assets were $14.3 million, or 1.77% of total non-covered loans and OREO.
Although economic and market conditions are stable, and our non-covered nonperforming assets as a percentage of total non-covered loans and OREO has improved, we may incur losses if there is a continued increase in non-covered nonperforming assets in the future. Our nonperforming assets adversely affect our net income in various ways. We do not record interest income on nonaccrual loans or OREO, thereby adversely affecting our net interest income, and increasing loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related loan to the then fair value of the collateral, which may ultimately result in a loss. We must reserve for probable losses, which is established through a current period charge to the provision for loan losses as well as from time to time, as appropriate, a write down of the value of properties in our OREO portfolio to reflect changing market values. Additionally, there are legal fees associated with the resolution of problem assets as well as carrying costs such as taxes, insurance and maintenance related to our OREO. Further, the resolution of nonperforming assets requires the active involvement of management, which can distract them from more profitable activity. Finally, an increase in the level of nonperforming assets increases our regulatory risk profile. There can be no assurance that we will not experience future increases in nonperforming assets.
A significant amount of our loans are secured by real estate and any declines in real estate values in our primary markets could be detrimental to our financial condition and results of operations.
Real estate lending (including commercial, construction, land development, and residential loans) is a large portion of our loan portfolio, constituting $1.77 billion, or approximately 85.8% of our total loan portfolio, as of December 31, 2017. Although residential and commercial real estate values have improved in our market area, such improved values may not continue or may slow down. If loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the full value of the collateral that we anticipated at the time of originating the loan, which could require us to increase our provision for loan losses and adversely affect our financial condition and results of operations.
As of December 31, 2017, $635.8 million, or approximately 30.8% of our total loans, were secured by single-family residential real estate. This includes $483.0 million in residential 1-4 family loans and $152.8 million in home equity lines of credit. Total single-family residential real estate loans covered under the FDIC loss sharing agreement amount to $23.3 million as of December 31, 2017. If housing markets in our market areas do not continue to steadily improve or deteriorate, we may experience an increase in nonperforming loans, provision for loan losses and charge-offs.
If the value of real estate in our market areas were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which could have a material adverse effect on our asset quality, capital structure and profitability.
As of December 31, 2017, a significant portion of our loan portfolio was comprised of loans secured by commercial real estate. In the majority of these loans, real estate was the primary collateral component. In some cases we take real estate as security for a loan even when it is not the primary component of
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collateral. The real estate collateral that provides the primary or an alternate source of repayment in the event of default may deteriorate in value during the term of the loan as a result of changes in economic conditions, fluctuations in interest rates and the availability of loans to potential purchasers, changes in tax and other laws and acts of nature. If we are required to liquidate the collateral securing a loan to satisfy the debt during a period of reduced real estate values, our earnings and capital could be adversely affected. We are subject to increased lending risks in the form of loan defaults as a result of the high concentration of real estate lending in our loan portfolio. A weak real estate market in our primary market areas could have an adverse effect on the demand for new loans, the ability of borrowers to repay outstanding loans, the value of real estate and other collateral securing the loans and the value of real estate owned by us. If real estate values do not continue to improve or decline, it is also more likely that we would be required to increase our allowance for loan losses, which could adversely affect our financial condition and results of operations.
We are subject to risks related to our concentration of construction and land development and commercial real estate loans.
As of December 31, 2017, we had $198.0 million of construction and land development loans. Construction and land development loans are subject to risks during the construction phase that are not present in standard residential real estate and commercial real estate loans. These risks include:

the viability of the contractor;

the contractor’s ability to successfully complete the project, to meet deadlines and time schedules and to stay within cost estimates; and

concentrations of such loans with a single contractor and its affiliates.
Real estate construction and land development loans may involve the disbursement of substantial funds with repayment dependent, in part, on the success of the ultimate project rather than the ability of a borrower or guarantor to repay the loan and also present risks of default in the event of declines in property values or volatility in the real estate market during the construction phase. Our practice, in the majority of instances, is to secure the personal guaranty of individuals in support of our real estate construction and land development loans which provides us with an additional source of repayment. As of December 31, 2017, we had $10.0 million of nonperforming construction and land development loans and $3.2 million of assets that have been foreclosed. If one or more of our larger borrowers were to default on their construction and land development loans, and we did not have alternative sources of repayment through personal guarantees or other sources, or if any of the aforementioned risks were to occur, we could incur significant losses.
As of December 31, 2017, we had $936.5 million of commercial real estate loans, including multi-family residential loans and loans secured by farmland, none of which is covered by the FDIC loss sharing agreement. Commercial real estate lending typically involves higher loan principal amounts and the repayment is dependent, in large part, on sufficient income from the properties securing the loan to cover operating expenses and debt service.
In addition, the Dodd-Frank Act contains provisions that may impact the Bank’s business by reducing the amount of our commercial real estate lending and increasing the cost of borrowing, including rules relating to risk retention of securitized assets. Section 941 of the Dodd-Frank Act requires, among other things, that a loan originator or a securitizer of asset-backed securities retain a percentage of the credit risk of securitized assets. The banking agencies have jointly issued a final rule to implement these requirements, which became effective on December 24, 2015 for residential mortgage-backed securitizations and became effective on December 24, 2016 for classes of asset-backed securities other than residential mortgage-backed securitizations. Banks with higher levels of commercial real estate loans are expected to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as higher levels of allowances for loan losses and capital levels as a result of commercial real estate lending growth and exposures. The Bank’s commercial real estate loans are below the thresholds identified as significant by the regulatory guidance. If there is deterioration in our commercial real estate portfolio or if regulatory authorities conclude that we have not implemented appropriate risk management policies and practices, it could adversely affect our business and result in a requirement of increased capital levels, and such capital may not be available at that time.
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A new accounting standard will result in a significant change in how we recognize credit losses and may have a material impact on our financial condition or results of operations.
In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, Financial Instruments — Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, which replaces the current “incurred loss” model for recognizing credit losses with an “expected loss” model referred to as the Current Expected Credit Loss (“CECL”) model. Under the CECL model, we will be required to present certain financial assets carried at amortized cost, such as loans held for investment and held-to-maturity debt securities, at the net amount expected to be collected. The measurement of expected credit losses is to be based on information about past events, including historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount. This measurement will take place at the time the financial asset is first added to the balance sheet and periodically thereafter. This differs significantly from the “incurred loss” model required under current U.S. GAAP, which delays recognition until it is probable a loss has been incurred. Accordingly, we expect that the adoption of the CECL model will materially affect how we determine our allowance for loan losses and could require us to significantly increase our allowance. Moreover, the CECL model may create more volatility in the level of our allowance for loan losses. If we are required to materially increase our level of allowance for loan losses for any reason, such increase could adversely affect our business, financial condition and results of operations.
The new CECL standard will become effective for us for fiscal years beginning after December 15, 2019 and for interim periods within those fiscal years. We are currently evaluating the impact the CECL model will have on our accounting, but we expect to recognize a one-time cumulative-effect adjustment to our allowance for loan losses as of the beginning of the first reporting period in which the new standard is effective, consistent with regulatory expectations set forth in interagency guidance issued at the end of 2016. We cannot yet determine the magnitude of any such one-time cumulative adjustment or of the overall impact of the new standard on our business, financial condition and results of operations.
Changes to government guaranteed loan programs could affect our SBA business.
The Bank relies on originating government guaranteed loans, in particular those guaranteed by the SBA. As of December 31, 2017, the Bank had $70.5 million of SBA loans, $43.4 million of which were guaranteed and $27.1 million were non-guaranteed. We can provide no assurance that the Bank will be able to continue originating these loans, that it will be able to sell the loans in the secondary market if market conditions are favorable, or that it will continue to realize premiums upon any sale of SBA loans.
SBA lending is a federal government created and administered program. As such, legislative and regulatory developments can affect the availability and funding of the program. This dependence on legislative funding and regulatory restrictions from time to time causes limitations and uncertainties with regard to the continued funding of such loans, with a resulting potential adverse financial impact on our business. Currently, the maximum limit on individual 7(a) loans which the SBA will permit is $5.0 million. Any reduction in this level could adversely affect the volume of our business. The periodic uncertainty of the SBA program relative to availability, amounts of funding and the waiver of associated fees creates greater risk for our business than do more stable aspects of our business.
The federal government presently guarantees up to 75% of the principal amount of loans above $150,000 and up to 90% of the principal amount for certain programs under the 7(a) program. SBA Express loans can be guaranteed by the federal government up to 50%. We can provide no assurance that the federal government will maintain the SBA program, or if it does, that such guaranteed portion will remain at its current funding level. Furthermore, it is possible that the Bank could lose its preferred lender status which, subject to certain limitations, allows it to approve and fund SBA loans without the necessity of having the loan approved in advance by the SBA. It is also possible the federal government could reduce the amount of loans which it guarantees. In addition, we are dependent on the expertise of our personnel who make SBA loans in order to continue to originate and service SBA loans. If we are unable to retain qualified employees in the future, our income from the origination of SBA loans could be substantially reduced.
We are subject to credit quality risks and our credit policies may not be sufficient to avoid losses.
We are subject to the risk of losses resulting from the failure of borrowers, guarantors and related parties to pay interest and principal amounts on their loans. Although we maintain credit policies and credit
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underwriting, monitoring and collection procedures, these policies and procedures may not prevent losses, particularly during periods in which the local, regional or national economy suffers a general decline. If borrowers fail to repay their loans, our financial condition and results of operations would be adversely affected.
We depend on the accuracy and completeness of information from customers and counterparties.
In deciding whether to extend credit or enter into other transactions, we rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business, financial condition and results of operations.
Failure to maintain an effective system of disclosure controls and procedures could have a material adverse effect on our business, results of operations and financial condition and could impact the price of our common stock.
Failure to maintain an effective internal control environment could result in us not being able to accurately report our financial results, prevent or detect fraud, or provide timely and reliable financial information pursuant to our reporting obligations, which could have a material adverse effect on our business, financial condition, and results of operations. Further, it could cause our investors to lose confidence in the financial information we report, which could affect the trading price of our common stock.
Management regularly reviews and updates our disclosure controls and procedures, including our internal control over financial reporting. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
If our allowance for loan losses is not adequate to cover actual loan losses, our earnings will decrease.
As a lender, we are exposed to the risk that our borrowers may not repay their loans according to the terms of these loans, and the collateral securing the payment of these loans may be insufficient to ensure repayment. We make various assumptions and judgments about the collectability of our loan portfolio, including the creditworthiness of the borrowers and the value of the real estate and other assets serving as collateral for the repayment of many of our loans. We maintain an allowance for loan losses to cover any probable inherent loan losses in the loan portfolio. In determining the size of the allowance, we rely on a periodic analysis of our loan portfolio, our historical loss experience and our evaluation of general economic conditions. If our assumptions prove to be incorrect or if we experience significant loan losses, our current allowance may not be sufficient to cover actual loan losses and adjustments may be necessary to allow for different economic conditions or adverse developments in our loan portfolio. A material addition to the allowance for loan losses could cause our earnings to decrease. Due to the relatively unseasoned nature of our loan portfolio, we may experience an increase in delinquencies and losses as these loans continue to mature.
In addition, federal regulators periodically review our allowance for loan losses and may require us to increase our provision for loan losses or recognize further charge-offs, based on judgments different than those of our management. Any significant increase in our allowance for loan losses or charge-offs required by these regulatory agencies could have a material adverse effect on our results of operations and financial condition.
Our business strategy includes strategic growth, and our financial condition and results of operations could be negatively affected if we fail to grow or fail to manage our growth effectively.
We completed the merger with EVBS on June 23, 2017, the acquisition of PGFSB on August 1, 2014, the acquisition of the HarVest Bank of Maryland on April 27, 2012, the acquisition of the Midlothian
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Branch in Richmond, Virginia on October 1, 2011, the acquisition and assumption of certain assets and liabilities of GAB from the FDIC on December 4, 2009, the acquisition of a branch of Millennium Bank in Warrenton, Virginia on September 28, 2009, the acquisition of the Leesburg, Virginia branch location from Founders Corporation which opened on February 11, 2008, the acquisition of 1st Service Bank in December of 2006 and the acquisition of the Clifton Forge, Virginia branch of First Community Bancorp, Inc. in December of 2005.
We intend to continue pursuing a growth strategy for our business. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by growing companies such as the continuing need for infrastructure and personnel, the time and costs inherent in integrating a series of different operations and the ongoing expense of acquiring and staffing new banks or branches. We may not be able to expand our presence in our existing markets or successfully enter new markets and any expansion could adversely affect our results of operations. Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy. Our ability to grow successfully will depend on a variety of factors, including the continued availability of desirable business opportunities, the competitive responses from other financial institutions in our market areas and our ability to manage our growth. There can be no assurance of success or the availability of branch or bank acquisitions in the future.
It may be difficult to fully integrate the business of EVBS and we may fail to realize all of the anticipated benefits of the acquisition of EVBS.
If our costs to fully integrate the business of EVBS into our existing operations are greater than anticipated, or we are not able to achieve the anticipated benefits of the acquisition, including cost savings and other synergies, our business could be negatively affected. In addition, it is possible that we could lose key employees from EVBS’s legacy operations, and that fully integrating EVBS’s legacy operations could result in loss of customers, the disruption of our ongoing businesses or inconsistencies in standards, controls, procedures and policies that adversely affect our ability to maintain relationships with customers and employees or to achieve the anticipated benefits of the acquisition. Integration efforts also may divert management attention and resources, which could adversely affect our ability to service our existing business and generate new business, which in turn could adversely affect our business and financial results.
Federal income tax reform could have unforeseen effects on our financial condition and results of operations.
On December 22, 2017, the President of the United States signed into law H.R. 1, originally known as the “Tax Cuts and Jobs Act.” We are still in the process of analyzing the Tax Cuts and Jobs Act and its possible effects on us. The Tax Cuts and Jobs Act includes a number of provisions, including the lowering of the U.S. corporate income tax rate from 35 percent to 21 percent, effective January 1, 2018. There are also provisions that may partially offset the benefit of such rate reduction. Financial statement impacts include adjustments for, among other things, the re-measurement of deferred tax assets and liabilities. While there are benefits, there is also substantial uncertainty regarding the details of U.S. Tax Reform. The intended and unintended consequences of Tax Cuts and Jobs Act on our business and on holders of our common stock is uncertain and could be adverse. We anticipate that the impact of the Tax Cuts and Jobs Act may be material to our business, financial condition and results of operations.
Future growth or operating results may require us to raise additional capital, but that capital may not be available, be available on unfavorable terms or may be dilutive.
We and the Bank are each required by the FRB to maintain adequate levels of capital to support our operations. In the event that our future operating results erode capital, if the Bank is required to maintain capital in excess of well-capitalized standards, or if we elect to expand through loan growth or acquisitions, we may be required to raise additional capital. Our ability to raise capital will depend on conditions in the capital markets, which are outside our control, and on our financial performance. Accordingly, we cannot be assured of our ability to raise capital on favorable terms when needed, or at all. If we cannot raise additional capital when needed, we will be subject to increased regulatory supervision and the imposition of restrictions on our growth and business. These outcomes could negatively impact our ability to operate or
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further expand our operations through acquisitions or the establishment of additional branches and may result in increases in operating expenses and reductions in revenues that could have a material adverse effect on our financial condition and results of operations. In addition, in order to raise additional capital, we may need to issue shares of our common stock that would dilute the book value of our common stock and reduce our current shareholders’ percentage ownership interest to the extent they do not participate in future offerings.
An investment in our common stock is not an insured deposit.
Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.
Our stock price can be volatile.
Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:

actual or anticipated variations in quarterly results of operations;

recommendations by securities analysts;

operating and stock price performance of other companies that investors deem comparable to us;

news reports relating to trends, concerns and other issues in the financial services industry;

perceptions in the marketplace regarding us and/or our competitors;

new technology used, or services offered, by competitors;

significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors;

failure to integrate acquisitions or realize anticipated benefits from acquisitions;

changes in government regulations; and

geopolitical conditions such as acts or threats of terrorism or military conflicts.
General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.
We may issue a new series of preferred stock or debt securities, which would be senior to our common stock and may cause the market price of our common stock to decline.
We have issued $27.0 million in aggregate principal amount of 5.875% Fixed-to-Floating Rate Subordinated Notes due January 31, 2027. In the future, we may increase our capital resources by making additional offerings of debt or equity securities, which may include senior or additional subordinated notes, classes of preferred shares and/or common shares. Holders of our common stock are not entitled to preemptive rights or other protections against dilution. Preferred shares and debt, if issued, have a preference on liquidating distributions or a preference on dividend or interest payments that could limit our ability to make a distribution to the holders of our common stock. Future issuances and sales of parity preferred stock, or the perception that such issuances and sales could occur, may also cause prevailing market price for our common stock to decline and may adversely affect our ability to raise additional capital in the financial markets at times and prices favorable to us. Further issuances of our common stock could be dilutive to holders of our common stock.
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Our business is subject to interest rate risk and variations in interest rates may negatively affect our financial performance.
The majority of our assets and liabilities are monetary in nature and subject us to significant risk from changes in interest rates. Fluctuations in interest rates are not predictable or controllable. Like most financial institutions, changes in interest rates can impact our net interest income as well as the valuation of our assets and liabilities, which is the difference between interest earned from interest-earning assets, such as loans and investment securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will negatively impact our earnings. Many factors impact interest rates, including governmental monetary policies, inflation, recession, changes in unemployment, the money supply, and international disorder and instability in domestic and foreign financial markets.
Based on our analysis of the interest rate sensitivity of our assets, an increase in the general level of interest rates may negatively affect the market value of the portfolio equity, but will positively affect our net interest income since most of our assets have floating rates of interest that adjust fairly quickly to changes in market rates of interest. Additionally, an increase in interest rates may, among other things, reduce the demand for loans and our ability to originate loans. A decrease in the general level of interest rates may affect us through, among other things, increased prepayments on our loan and mortgage-backed securities portfolios and increased competition for deposits. Accordingly, changes in the level of market interest rates affect our net yield on interest-earning assets, loan origination volume, loan and mortgage-backed securities portfolios, and our overall results. Although our asset liability management strategy is designed to control our risk from changes in market interest rates, it may not be able to prevent changes in interest rates from having a material adverse effect on our results of operations and financial condition.
We are dependent on key personnel and the loss of one or more of those key personnel could impair our relationship with our customers and adversely affect our business.
Many community banks attract customers based on the personal relationships that the banks’ officers and customers establish with each other and the confidence that the customers have in the officers. We significantly depend on the continued service and performance of our key management personnel. We also believe our management team’s depth and breadth of experience in the banking industry is integral to executing our business plan. The loss of the services of members of our senior management team or other key employees or the inability to attract additional qualified personnel as needed could have a material adverse effect on our business.
Our profitability depends significantly on local economic conditions in the areas where our operations and loans are concentrated.
We operate in a mixed market environment with influences from both rural and urban areas. Our profitability depends on the general economic conditions in our market areas of Northern Virginia, Maryland, Washington, D.C., Charlottesville and Clifton Forge (Alleghany County), Front Royal, New Market, Northern Neck, Middle Peninsula, Richmond, Hampton Roads and the surrounding areas. Unlike larger banks that are more geographically diversified, we provide banking and financial services to clients primarily in these market areas. As of December 31, 2017, substantially all of our commercial real estate, real estate construction and residential real estate loans were made to borrowers in our market area. The local economic conditions in this area have a significant impact on our commercial, real estate and construction and consumer loans, the ability of the borrowers to repay these loans and the value of the collateral securing these loans. In addition, if the population or income growth in these market areas slows, stops or declines, income levels, deposits and housing starts could be adversely affected and could result in the curtailment of our expansion, growth and profitability.
Additionally, political conditions could impact our earnings. For example, political debate over the budget, taxes and the potential for reduced government spending may adversely impact the economy, and more specifically local economic conditions given the concentration of Federal workers and government
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contractors in our market. Acts or threats of war, terrorism, an outbreak of hostilities or other international or domestic calamities, or other factors beyond our control could impact these local economic conditions and could negatively affect the financial results of our banking operations.
The properties that we own and our foreclosed real estate assets could subject us to environmental risks and associated costs.
There is a risk that hazardous substances or wastes, contaminants, pollutants or other environmentally restricted substances could be discovered on our properties or our foreclosed assets (particularly in the case of real estate loans). In this event, we might be required to remove the substances from the affected properties or to engage in abatement procedures at our sole cost and expense. Besides being liable under applicable federal and state statutes for our own conduct, we may also be held liable under certain circumstances for actions of borrowers or other third parties on property that collateralizes one or more of our loans or on property that we own. Potential environmental liability could include the cost of remediation and also damages for any injuries caused to third-parties. We cannot assure you that the cost of removal or abatement would not substantially exceed the value of the affected properties or the loans secured by those properties, that we would have adequate remedies against prior owners or other responsible parties or that we would be able to resell the affected properties either prior to or following completion of any such removal or abatement procedures. Any environmental damages on a property would substantially reduce the value of such property as collateral and, as a result, we may suffer a loss upon collection of the loan.
The small to medium-sized businesses we lend to may have fewer resources to weather a downturn in the economy, which may impair a borrower’s ability to repay a loan to us that could materially harm our operating results.
We make loans to professional firms and privately owned businesses that are considered to be small to medium-sized businesses. Small to medium-sized businesses frequently have smaller market shares than their competition, may be more vulnerable to economic downturns, often need substantial additional capital to expand or compete and may experience substantial volatility in operating results, any of which may impair a borrower’s ability to repay a loan. In addition, the success of a small and medium-sized business often depends on the management talents and efforts of one or two persons or a small group of persons, and the death, disability or resignation of one or more of these persons could have a material adverse impact on the business and its ability to repay our loan. Economic downturns in our target markets could cause us to incur substantial loan losses that could materially harm our operating results.
We are heavily regulated by federal and state agencies; changes in laws and regulations or failures to comply with such laws and regulations may adversely affect our operations and our financial results.
We and the Bank are subject to extensive regulation, supervision and examination by federal and state banking authorities. Any change in applicable regulations or federal or state legislation could have a substantial impact on us and the Bank, and our respective operations. Additional legislation and regulations may be enacted or adopted in the future that could significantly affect our powers, authority and operations or the powers, authority and operations of the Bank, which could have a material adverse effect on our financial condition and results of operations.
Further, bank regulatory authorities have the authority to bring enforcement actions against banks and their holding companies for unsafe or unsound practices in the conduct of their businesses or for violations of any law, rule or regulation, any condition imposed in writing by the appropriate bank regulatory agency or any written agreement with the agency. Possible enforcement actions against us could include the issuance of a cease-and-desist order that could be judicially enforced, the imposition of civil monetary penalties, the issuance of directives to increase capital or enter into a strategic transaction, whether by merger or otherwise, with a third party, the appointment of a conservator or receiver, the termination of insurance on deposits, the issuance of removal and prohibition orders against institution-affiliated parties, and the enforcement of such actions through injunctions or restraining orders. The exercise of this regulatory discretion and power may have a negative impact on us.
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As a regulated entity, we and Sonabank must each maintain certain required levels of regulatory capital that may limit our operations and potential growth.
We and the Bank are subject to various regulatory capital requirements administered by the FRB. The capital requirements applicable to us and the Bank changed as a result of the Dodd-Frank Act and the international regulatory capital initiative known as Basel III, and could be subject to further change as a result of additional government actions or regulatory interpretations. We are required to comply with the Revised Capital Rules. Among other things, the Revised Capital Rules raised the minimum thresholds for required capital and revised certain aspects of the definitions and elements of the capital that can be used to satisfy these required minimum thresholds. The Revised Capital Rules also introduce a minimum “capital conservation buffer” equal to 2.5% of an organization’s total risk-weighted assets once fully phased-in, which exists in addition to the required minimum CET1, Tier 1, and Total Capital ratios that are discussed above. Complying with these capital requirements may affect our operations, including our asset portfolios and financial performance.
Failure to meet minimum capital requirements can initiate certain mandatory, and possibly additional, discretionary actions by regulators that, if undertaken, could have a direct material effect on the Bank’s and our consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities and certain off-balance sheet commitments as calculated under these regulations.
The Revised Capital Rules require us and the Bank to maintain minimum amounts and defined ratios of Total, CET1 and Tier 1 capital to risk-weighted assets and of Tier 1 capital to average total consolidated assets, also known as the leverage ratio.
As of December 31, 2017, the Bank exceeded the amounts required to be well capitalized with respect to all four required capital ratios. As of December 31, 2017, the Bank’s leverage, CET1 risk-based capital, Tier 1 risk-based capital and Total risk-based capital ratios were 10.26%, 12.79%, 12.79% and 13.26%, respectively.
Many factors affect the calculation of the Bank’s risk-based assets and its ability to maintain the level of capital required to achieve acceptable capital ratios. For example, changes in risk weightings of assets relative to capital and other factors may combine to increase the amount of risk-weighted assets in the Tier 1 risk-based capital ratio and the Total risk-based capital ratio. Any increases in its risk-weighted assets will require a corresponding increase in its capital to maintain the applicable ratios. In addition, recognized loan losses in excess of amounts reserved for such losses, loan impairments, impairment losses on investment securities and other factors will decrease the Bank’s capital, thereby reducing the level of the applicable ratios.
The Bank’s failure to remain well capitalized for bank regulatory purposes could affect customer confidence, our ability to grow, our costs of funds and FDIC insurance costs, our ability to pay dividends on our capital stock, our ability to make acquisitions, and on our business, results of operations and financial condition. Under FRB rules, if the Bank ceases to be a well capitalized institution for bank regulatory purposes, the interest rates that it pays on deposits and its ability to accept, renew or rollover brokered deposits may be restricted. As of December 31, 2017, we had $109.9 million of brokered deposits, which represented 5.9% of our total deposits.
We may not be able to successfully compete with others for business.
The metropolitan statistical areas in which we operate are considered highly attractive from an economic and demographic viewpoint, and are highly competitive banking markets. We compete for loans, deposits and investment dollars with numerous regional and national banks, online divisions of out-of-market banks and other community banking institutions, as well as other kinds of financial institutions and enterprises, such as securities firms, insurance companies, savings associations, credit unions, mortgage brokers and private lenders. Many competitors have substantially greater resources than us, and operate under less stringent regulatory environments. The differences in resources and regulations may make it harder for us to compete profitably, reduce the rates that we can earn on loans and investments, increase the rates we must offer on deposits and other funds and adversely affect our overall financial condition and earnings.
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Consumers may decide not to use banks to complete their financial transactions.
Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our financial condition and results of operations.
Further, clients may choose to conduct business with other market participants who engage in business or offer products in areas we deem speculative or risky, such as cryptocurrencies. Increased competition may negatively affect our earnings by creating pressure to lower prices or credit standards on our products and services requiring additional investment to improve the quality and delivery of our technology and/or reducing our market share, or affecting the willingness of our clients to do business with us.
In addition, the widespread adoption of new technologies, including internet services, cryptocurrencies and payment systems, could require substantial expenditures to modify or adapt our existing products and services as we grow and develop our internet banking and mobile banking channel strategies in addition to remote connectivity solutions. We might not be successful in developing or introducing new products and services, integrating new products or services into our existing offerings, responding or adapting to changes in consumer behavior, preferences, spending, investing and/or saving habits, achieving market acceptance of our products and services, reducing costs in response to pressures to deliver products and services at lower prices or sufficiently developing and maintaining loyal customers.
Our information systems may experience an interruption or breach in security.
We rely heavily on communications and information systems provided both internally and externally to conduct our business. Any failure, interruption or breach in security of these systems (such as a spike in transaction volume, a cyber-attack or other unforeseen events) could result in failures or disruptions in our customer relationship management, general ledger, deposit, loan and other systems. While we have policies and procedures and service level agreements designed to prevent or limit the effect of the failure, interruption or security breach of our information systems, there can be no assurance that any such failures, interruptions or security breaches will not occur or, if they do occur, that they will be adequately addressed. While we maintain an insurance policy which we believe provides sufficient coverage at a manageable expense for an institution of our size and scope with similar technological systems, we cannot assure shareholders that this policy would be sufficient to cover all related financial losses and damages should we experience any one or more of our or a third party’s systems failing or experiencing a cyber-attack. The occurrence of any failures, interruptions or security breaches of our information systems could damage our reputation, result in a loss of customer business, subject us to additional regulatory scrutiny, or expose us to civil litigation and possible financial liability, including remediation costs and increased protection costs, any of which could have a material adverse effect on our financial condition and results of operations.
We face significant cyber and data security risk that could result in the disclosure of confidential information, adversely affect our business or reputation and expose us to significant liabilities.
As a financial institution, we are under threat of loss due to hacking and cyber-attacks. This risk has increased in recent years, and continues to increase, as we continue to expand customer capabilities to utilize internet and other remote channels to transact business. Two of the most significant cyber-attack risks that we face are e-fraud and loss of sensitive customer data. Loss from e-fraud occurs when cybercriminals breach and extract funds directly from customer or our accounts. The attempts to breach sensitive customer data, such as account numbers and social security numbers, are less frequent but would present significant reputational, legal and/or regulatory costs to us if successful. Our risk and exposure to these matters remains heightened because of the evolving nature and complexity of these threats from cybercriminals and hackers, our plans to continue to provide internet banking and mobile banking channels, and our plans to develop additional remote connectivity solutions to serve our customers. In July 2017, we incurred a loss of approximately $172 thousand due to fraudulent wire transactions. These
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fraudulent wire transactions were the result of an email phishing scheme that targeted various employees of the Bank and led to an internal email compromise, affording the perpetrators access to personal information of a number of the Bank’s customers. We took immediate action to contain and eradicate the email compromise, including the implementation of control enhancements to prevent a similar situation from occurring again. We believe this was an isolated event and do not believe our technology systems have been compromised. While we have not experienced any material losses relating to cyber-attacks or other information security breaches such as the one that occurred in July 2017, we have been the subject of a successful hacking and cyber-attack and there can be no assurance that we will not suffer additional losses in the future related to this event or others.
The occurrence of any cyber-attack or information security breach, such as the one that occurred in July 2017, could result in material adverse consequences to us including damage to our reputation and the loss of customers. We also could face litigation or additional regulatory scrutiny. Litigation or regulatory actions in turn could lead to significant liability or other sanctions, including fines and penalties or reimbursement of customers adversely affected by this security breach. Even if we do not suffer any material adverse consequences as a result of the event that occurred in July 2017 or as a result of other future events, successful attacks or systems failures at the Bank or at other financial institutions could lead to a general loss of customer confidence in financial institutions including the Bank.
Our ability to mitigate the adverse consequences of occurrences (such as the one in July 2017) is in part dependent on the quality of our information security procedures and contracts and our ability to anticipate the timing and nature of any such event that occurs. In recent years, we have incurred significant expense towards improving the reliability of our systems and their security from attack. Nonetheless, there remains the risk that we may be materially harmed by this cyber-attack and information security breach or others in the future. Methods used to attack information systems change frequently (with generally increasing sophistication), often are not recognized until launched against a target, may be supported by foreign governments or other well-financed entities, and may originate from less regulated and remote areas around the world. As a result, we may be unable to address these methods in advance of attacks, including by implementing adequate preventive measures. If such an attack or breach does occur again, we might not be able to fix it timely or adequately. To the extent that such an attack or breach relates to products or services provided by others, we seek to engage in due diligence and monitoring to limit the risk.
We rely on third-party vendors to provide key components of our business infrastructure.
Third-party vendors provide key components of our business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, Internet connections and network access. We have selected these third-party vendors carefully and have conducted the due diligence consistent with regulatory guidance and best practices. While we have ongoing programs to review third-party vendors and assess risk, we do not control their actions. Any problems caused by these third parties, including those resulting from disruptions in communication services provided by a vendor, failure of a vendor to handle current or higher volumes, cyber-attacks and security breaches at a vendor, failure of a vendor to provide services for any reason or poor performance of services, could adversely affect our ability to deliver products and services to our customers and otherwise conduct our business. Financial or operational difficulties of a third-party vendor could also hurt our operations if those difficulties interfere with the vendor’s ability to serve us. Furthermore, our vendors could also be sources of operational and information security risk to us, including from breakdowns or failures of their own systems or capacity constraints. Replacing these third-party vendors could also create significant delay and expense. Accordingly, use of such third parties creates an unavoidable inherent risk to our business operations.
Provisions of our articles of incorporation and bylaws, as well as state and federal banking regulations, could delay or prevent a takeover of us by a third party.
Our articles of incorporation and bylaws could delay, defer or prevent a third party from acquiring us, despite the possible benefit to our shareholders, or otherwise adversely affect the price of our common stock.
Any individual, acting alone or with other individuals, who are seeking to acquire, directly or indirectly, 10.0% or more of our outstanding common stock must comply with the Change in Bank Control Act, which requires prior notice to the FRB for any acquisition. Additionally, any entity that wants to acquire
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5.0% or more of our outstanding common stock, or otherwise control us, may need to obtain the prior approval of the FRB under the BHCA of 1956, as amended. As a result, prospective investors in our common stock need to be aware of and comply with those requirements, to the extent applicable.
We are subject to transaction risk, which could adversely affect our business, financial condition and results of operations.
We, like all businesses, are subject to transaction risk, which is the risk of loss resulting from human error, fraud or unauthorized transactions due to inadequate or failed internal processes and systems, and external events that are wholly or partially beyond our control (including, for example, computer viruses or electrical or telecommunications outages). Transaction risk also encompasses compliance risk, which is the risk of loss from violations of, or noncompliance with, laws, rules, regulations, prescribed practices or ethical standards. Although we seek to mitigate transaction risk through a system of internal controls, there can be no assurance that we will not suffer losses from transaction risks in the future that may be material in amount. Any losses resulting from transaction risk could take the form of explicit charges, increased operational costs, litigation costs, harm to reputation or forgone opportunities, any and all of which could have a material adverse effect on business, financial condition and results of operations.
We must respond to rapid technological changes and these changes may be more difficult or expensive than anticipated.
If competitors introduce new products and services embodying new technologies, or if new industry standards and practices emerge, our existing product and service offerings, technology and systems may become obsolete. Further, if we fail to adopt or develop new technologies or to adapt our products and services to emerging industry standards, we may lose current and future customers, which could have a material adverse effect on our business, financial condition and results of operations. The financial services industry is changing rapidly and in order to remain competitive, we must continue to enhance and improve the functionality and features of our products, services and technologies. These changes may be more difficult or expensive than we anticipate.
The impact of financial reform legislation is uncertain.
The Dodd-Frank Act, enacted in 2010, instituted a wide range of regulatory, supervisory, and compliance reforms that have had and will continue to have an impact on all financial institutions, including the creation of the Bureau with centralized authority, including examination and enforcement authority, for consumer protection in the banking industry. The Dodd-Frank Act also included, among other things, changes to the deposit insurance and financial regulatory systems, enhanced bank capital requirements and requirements designed to protect consumers in financial transactions. While many of the requirements called for in the Dodd-Frank Act have been implemented, others will continue to be implemented over time. In light of these significant changes and the discretion afforded to federal regulators, we cannot fully predict the effect that compliance with the Dodd-Frank Act or any implementing regulations will have on our businesses or ability to pursue future business opportunities. Regulations implementing the Dodd-Frank Act, or any other aspects of current proposed regulatory or legislative changes to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities or change certain of our business practices, including our ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. Other changes to statutes, regulations, or regulatory policies or supervisory guidance, including changes in their interpretation or implementation, may affect us in substantial ways that we cannot predict. These changes also may require us to invest significant management attention and resources to make any necessary changes to our operations in order to comply, and could therefore also materially adversely affect our business, financial condition, and results of operations.
The “ability-to-repay” and “qualified mortgage” rules may have a negative impact on our loan origination process and foreclosure proceedings, which could adversely affect our business, operating results and financial condition.
As described above in Supervision and Regulation — Fair Lending; Consumer Laws, the Bureau adopted a rule that implements the “ability-to-repay” and “qualified mortgage” provisions of the
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Dodd-Frank Act. The “ability-to-repay” rule, which took effect on January 10, 2014, has impacted our residential mortgage lending practices, and the residential mortgage market generally.
Reflecting the Bureau’s focus on the residential mortgage lending market, the Bureau has also issued rules to implement requirements of the Dodd-Frank Act pertaining to mortgage loan origination (including with respect to loan originator compensation and loan originator qualifications) and has issued integrated mortgage disclosure rules that replaced and combined certain existing requirements under the Truth in Lending Act and the Real Estate Settlement Procedures Act. The Bureau has indicated that it expects to issue additional mortgage-related rules in the future.
The “qualified mortgage” rules may increase our compliance burden and reduce our lending flexibility and discretion, which could negatively impact our ability to originate new loans and the cost of originating new loans. Any loans that we make outside of the “qualified mortgage” criteria could expose us to an increased risk of liability and reduce or delay our ability to foreclose on the underlying property. Additionally, qualified “higher priced mortgages” only provide a rebuttable presumption of compliance and thus may be more susceptible to challenges from borrowers. It is difficult to predict the impact of the Bureau’s “qualified mortgage” rules, but any decreases in loan origination volume or increases in compliance and foreclosure costs could negatively affect our business, operating results and financial condition.
We currently intend to pay dividends on our common stock; however, our future ability to pay dividends is subject to restrictions.
We declared the first cash dividend on our common stock in February 2012, and each quarter thereafter through 2017. We also declared a special dividend in the fourth quarters of 2014 and 2015. There are a number of restrictions on our ability to pay dividends. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of strength to its banking subsidiaries.
Our principal source of funds to pay dividends on our common stock is cash dividends that we receive from the Bank. The payment of dividends by the Bank to us is subject to certain restrictions imposed by federal banking laws, regulations and authorities. The federal banking statutes prohibit federally insured banks from making any capital distributions (including a dividend payment) if, after making the distribution, the institution would be “under capitalized” as defined by statute. In addition, the relevant federal regulatory agencies have authority to prohibit an insured bank from engaging in an unsafe or unsound practice, as determined by the agency, in conducting an activity. The payment of dividends could be deemed to constitute such an unsafe or unsound practice, depending on the financial condition of the Bank. Regulatory authorities could impose administratively stricter limitations on the ability of the Bank to pay dividends to us if such limits were deemed appropriate to preserve certain capital adequacy requirements.
The trading volume in our common stock is less than that of other larger financial services companies.
Although our common stock is listed for trading on the NASDAQ Global Market, the trading volume is low, and you are not assured liquidity with respect to transactions in our common stock. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause our stock price to fall.
Severe weather, natural disasters, climate change, acts of war or terrorism and other adverse external events could significantly impact our business.
Severe weather, natural disasters, climate change, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the
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stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. Although management has established disaster recovery policies and procedures, there can be no assurance of the effectiveness of such policies and procedures, and the occurrence of any such event could have a material adverse effect on our business, financial condition and results of operations.
The benefits of our FDIC loss-sharing agreements may be reduced or eliminated.
In connection with the Bank’s assumption of the banking operations of GAB, the Bank entered into the Agreement, which contains loss-sharing provisions. Our decisions regarding the fair value of assets acquired, including the FDIC loss-sharing assets (referred to herein as the “covered assets”), could be inaccurate which could materially and adversely affect our business, financial condition, results of operations, and future prospects. Management makes various assumptions and judgments about the collectability of the acquired loans, including the creditworthiness of borrowers and the value of the real estate and other assets serving as collateral for the repayment of secured loans. In the GAB acquisition, we recorded a loss-sharing asset that reflects our estimate of the timing and amount of future losses we anticipate occurring in the acquired loan portfolio. In determining the size of the loss-sharing asset, we analyzed the loan portfolio based on historical loss experience, volume and classification of loans, volume and trends in delinquencies and nonaccruals, local economic conditions, and other pertinent information.
If our assumptions related to the timing or amount of expected losses are incorrect, there could be a negative impact on our operating results. Increases in the amount of future losses in response to different economic conditions or adverse developments in the acquired loan portfolio may result in increased credit loss provisions. Changes in our estimate of the timing of those losses, specifically if those losses are to occur beyond the applicable loss-sharing periods, may result in impairments of the FDIC indemnification asset.
Our ability to obtain reimbursement under the loss-sharing agreements on covered assets depends on our compliance with the terms of the loss-sharing agreements.
Management must certify to the FDIC on a quarterly basis our compliance with the terms of the FDIC loss-sharing agreements as a prerequisite to obtaining reimbursement from the FDIC for realized losses on covered assets. The agreements contain specific, detailed and cumbersome compliance, servicing, notification and reporting requirements, and failure to comply with any of the requirements and guidelines could result in a specific asset or group of assets permanently losing their loss-sharing coverage. Additionally, management may decide to forgo loss-share coverage on certain assets to allow greater flexibility over the management of such assets. As of December 31, 2017, $23.3 million, or 0.9%, of our assets were covered by the FDIC loss-sharing agreements.
Under the terms of the FDIC loss-sharing agreements, the assignment or transfer of a loss-sharing agreement to another entity generally requires the written consent of the FDIC. Our failure to comply with the terms of the loss-sharing agreements or to manage the covered assets in such a way as to maintain loss-share coverage on all such assets may cause individual loans or large pools of loans to lose eligibility for loss share payments from the FDIC, which could result in material losses.
Item 1B.
Unresolved Staff Comments
Southern National does not have any unresolved staff comments from the SEC to report for the year ended December 31, 2017.
Item 2.   Properties
Southern National’s principal office is located at 6830 Old Dominion Drive, McLean, Virginia. Southern National and Sonabank also have executive offices located at 1002 Wisconsin Avenue, N.W. Washington, DC and 10900 Nuckols Road, Suite 325, Glen Allen, Virginia. At December 31, 2017, Sonabank had 38 full-service retail branches in Virginia and seven full-service retail branches in Maryland. Impacting the number of Sonabank’s full-service retail branches in 2017 was the acquisition of EVBS resulting in 24 additional full-service retail branches at the time of the merger. As part of an overall
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restructuring of the combined institutions retail branch network, it was decided that we would close two full-service branches and one drive-thru facility in the Sonabank retail network. The Leesburg, Virginia drive-thru location was closed in July 2017, while the Broadview Avenue branch in Warrenton, Virginia and the Frederick, Maryland branch were both closed in September 2017 immediately prior to the core processing system conversion. Additionally, in October 2017, Sonabank opened a new full-service branch in the River’s Bend market located in Chesterfield County, Virginia. This branch, which was part of the EVBS merger, is in a dynamic growth area with new businesses and consumers entering the market every day. This market compliments our focus on the south of Richmond market which includes Colonial Heights, Tri-Cities and Midlothian.
Southern National believes its facilities are in good operating condition, are suitable and adequate for its operational needs and are adequately insured.
The following table sets forth the date opened or acquired, ownership status and the total deposits, not including brokered deposits, for each of our banking locations, as of December 31, 2017:
Location
Date Opened
or Acquired
Owned or
Leased
Deposits
(in thousands)
Full Service Branch Offices:
511 Main Street
Clifton Forge, Virginia 24442
December 2005
Owned
$ 41,606
1770 Timberwood Boulevard
Charlottesville, Virginia 22911
April 2005
Leased
30,499
6830 Old Dominion Drive
McLean, Virginia 22101
December 2006
Leased
61,090
11527 Sunrise Valley Drive
Reston, Virginia 20191
December 2006
Leased
28,291
10855 Fairfax Boulevard
Fairfax, Virginia 22030
December 2006
Leased
40,364
1 East Market Street
Leesburg, Virginia 20176
April 2008
Leased
46,347
11 Main Street
Warrenton, Virginia 20186
September 2009
Leased
$ 47,349
11200 Rockville Pike
Rockville, Maryland 20852
December 2009
Leased
80,126
1 South Front Royal Avenue
Front Royal, Virginia 22630
December 2009
Owned
36,174
9484 Congress Street
New Market, Virginia 22844
December 2009
Owned
40,647
43086 Peacock Market Plaza
South Riding, Virginia 20152
December 2009
Leased
18,632
10 West Washington Street
Middleburg, Virginia 20117
May 2011
Leased
17,597
13804 Hull Street Road
Midlothian, Virginia 23112
October 2011
Owned
28,856
9707 Medical Center Drive, Suite 150
Rockville, Maryland 20850
April 2012
Leased
40,231
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Location
Date Opened
or Acquired
Owned or
Leased
Deposits
(in thousands)
6719 Leaberry Way
Haymarket, Virginia 20169
August 2012
Leased
10,640
7700 Wisconsin Avenue
Bethesda, Maryland 22101
October 2012
Leased
27,740
4009 Old Town Road
Huntingtown, Maryland 20639
August 2014
Leased
15,154
137 E. Chesapeake Beach Road
Owings, Maryland 20736
August 2014
Owned
13,489
14804 Pratt Street
Upper Marlboro, Maryland 20772
August 2014
Owned
59,690
14118 Brandywine Road
Brandywine, Maryland 20613
August 2014
Owned
13,777
307 Church Lane(1)
Tappahannock, Virginia 22560
June 2017
Owned
43,103
1665 Tappahannock Boulevard
Tappahannock, Virginia 22560
June 2017
Owned
22,468
11290 General Puller Highway
Hartfield, Virginia 23071
June 2017
Leased
43,492
291 Virginia Street
Urbanna, Virginia 23175
June 2017
Owned
33,953
16273 General Puller Highway
Deltaville, Virginia 23043
June 2017
Leased
21,623
7132 George Washington Memorial Highway
Gloucester, Virginia 23061
June 2017
Owned
35,776
1953 George Washington Memorial Highway
Gloucester Point, Virginia 23062
June 2017
Owned
$ 29,057
20 Commerce Lane
King William, Virginia 23086
June 2017
Owned
54,049
22241 Main Steet
Courtland, Virginia 23837
June 2017
Owned
31,354
176 Colonial Trail, East
Surry, Virginia 23883
June 2017
Owned
24,697
209 West Main Street
Waverly, Virginia 23890
June 2017
Owned
40,083
2599 New Kent Highway
Quinton, Virginia 23141
June 2017
Owned
23,726
3012 Boulevard
Colonial Heights, Virginia 23834
June 2017
Owned
83,606
8821 West Broad Street
Richmond, Virginia 23294
June 2017
Leased
43,530
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Location
Date Opened
or Acquired
Owned or
Leased
Deposits
(in thousands)
6941 Northumberland Highway
Heathsville, Virginia 22473
June 2017
Owned
69,469
110 Northumberland Highway
Callao, Virginia 22435
June 2017
Owned
43,920
14954 Northumberland Highway
Burgess, Virginia 22432
June 2017
Owned
34,164
437 North Main Street
Kilmarnock, Virginia 22482
June 2017
Owned
24,925
11801 Merchants Walk(2)
Newport News, Virginia 23606
June 2017
Owned
48,428
1430 Building 12 High Street
Williamsburg, Virginia 23185
June 2017
Leased
22,565
2198 Coliseum Drive
Hampton, Virginia 23666
June 2017
Leased
19,294
8123 Mechanicsville Turnpike
Mechanicsville, Virginia 23111
June 2017
Owned
83,381
9495 Charter Gate Drive
Mechanicsville, Virginia 23116
June 2017
Owned
60,528
201 North Washington Highway
Ashland, Virginia 23005
June 2017
Leased
55,808
350 East Hundred Road
Chester, Virginia 23836
October 2017
Owned
10,995
Drive-In/ATM Only Locations:
22510 Linden Street
Courtland, Virginia 23837
June 2017
Owned
N/A
233 South County Drive
Waverly, Virginia 23890
June 2017
Owned
N/A
Loan Production Offices:
230 Court Square
Charlottesville, Virginia 22902
March 2005
Leased
N/A
2217 Princess Anne Street
Fredericksburg, Virginia 22401
April 2005
Leased
N/A
550 Broadview Avenue
Warrenton, Virginia 20186
September 2005
Leased
N/A
5601 Ironbridge Parkway, Suite 101
Chester, Virginia 23831
June 2017
Leased
N/A
Administrative Offices:
70 Main Street, Suite 34
Warrenton, Virginia 20186
December 2014
Leased
N/A
9702 Atlee Commons Drive
Ashland, Virginia 23005
June 2017
Owned
N/A
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Location
Date Opened
or Acquired
Owned or
Leased
Deposits
(in thousands)
9706 Atlee Commons Drive
Ashland, Virginia 23005
June 2017
Owned
N/A
9718 Atlee Commons Drive
Ashland, Virginia 23005
June 2017
Owned
N/A
Executive Offices:
1002 Wisconsin Avenue, N.W.
Washington, D.C. 20007
April 2005
Leased
N/A
10900 Nuckols Road, Suite 325(2)(3)
Glen Allen, Virginia 23060
June 2017
Leased
$ 162,864
(1)
Serves as the main banking office of Sonabank.
(2)
Also serves as an administrative office.
(3)
This location is not a retail banking location. Deposits reported at this location consist of internal accounts, brokered accounts and listed CDs.
Item 3.   Legal Proceedings
Southern National and Sonabank may, from time to time, be a party to various legal proceedings arising in the ordinary course of business. There are no other proceedings pending, or to management’s knowledge, threatened, against Southern National or Sonabank as of December 31, 2017.
Item 4.   Mine Safety Disclosures.
Not applicable.
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PART II
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock Market Prices
On November 6, 2006, Southern National closed on the initial public offering of its common stock, $0.01 par value. The shares of common stock sold in the offering were registered under the Securities Act of 1933, as amended, on a Registration Statement (Registration No. 333-136285) that was declared effective by the SEC on October 31, 2006. The shares of common stock were sold at a price to the public of  $14.00 per share (equivalent to $12.73 after the stock dividend declared in May 2007).
Southern National completed a follow-on public offering of its common stock in an underwritten public offering on November 4, 2009, selling 4,791,665 shares of common stock, including 624,999 shares sold pursuant to an over-allotment option granted to the underwriter, at a price of  $6.00 per share. The gross proceeds from the shares sold were $28.7 million. The net proceeds to Southern National from the offering were approximately $26.9 million after deducting $1.3 million in underwriting commission and an estimated $486 thousand in other expenses incurred in connection with the offering.
In connection with its acquisition of EVBS, Southern National issued 11,557,760 shares of its common stock on June 23, 2017, which had a value of approximately $198.9 million based on Southern National’s common stock’s closing price of  $17.21 per share on June 23, 2017.
Southern National’s common stock is traded on the Nasdaq Global Market under the symbol “SONA”. Our common stock began trading on the Nasdaq Capital Market in November 2006, and the exchange listing was upgraded to the Nasdaq Global Market at the open of trading on December 18, 2007.
There were 23,984,853 shares of our common stock outstanding at the close of business on March 6, 2018, which were held by 1,917 shareholders of record. As of that date, the closing price of our common stock on the NASDAQ Global Market was $15.84.
The following table presents the high and low intra-day sales prices and dividends declared for quarterly periods during 2017 and 2016:
Market Values
Dividends Declared
2017
2016
2017
2016
High
Low
High
Low
First Quarter
$ 17.50 $ 15.51 $ 13.40 $ 11.92 $ 0.08 $ 0.08
Second Quarter
18.48 15.99 12.77 11.60 0.08 0.08
Third Quarter
18.00 15.26 13.59 11.95 0.08 0.08
Fourth Quarter
17.49 15.12 16.78 12.74 0.08 0.08
Dividend Policy
Dividends are paid at the discretion of our board of directors. While we paid a nonrecurring 10% stock dividend to our holders of common stock in 2007, we declared the first cash dividend on our common stock in February 2012 and each quarter thereafter through 2017. The amount and frequency of dividends, if any, will be determined by our board of directors after consideration of our earnings, capital requirements, our financial condition and our ability to service any equity or debt obligations senior to our common stock, and will depend on cash dividends paid to us by the Bank. As a result, our ability to pay future dividends will depend on the earnings of the Bank, its financial condition and its need for funds.
There are a number of restrictions on our ability to pay cash dividends. It is the policy of the FRB that bank holding companies should pay cash dividends on common stock only out of net income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company’s ability to serve as a source of financial
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strength to its banking subsidiary. For a foreseeable period of time, our principal source of cash will be dividends paid by the Bank with respect to its capital stock. There are certain restrictions on the payment of these dividends imposed by federal and state banking laws, regulations and authorities.
Regulatory authorities could administratively impose limitations on the ability of the Bank to pay dividends to us if such limits were deemed appropriate to preserve certain capital adequacy requirements or in the interests of  “safety and soundness.”
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance under Equity Compensation Plans
As of December 31, 2017, Southern National had outstanding stock options granted under the 2010 Stock Awards and Incentive Plan (the “2010 Plan”) and the 2017 Equity Compensation Plan (the “2017 Plan”), which were approved by its shareholders. The following table provides information as of December 31, 2017 regarding Southern National’s equity compensation plans under which our equity securities are authorized for issuance:
Plan category
Number of securities
to be issued upon exercise
of outstanding options,
warrants and rights
A
Weighted average
exercise price of
outstanding options,
warrants and rights
B
Number of securities
remaining available for
future issuance under
equity compensation plans
(excluding securities reflected
in column A)
C
Equity compensation plans approved by
security holders
714,967 $ 9.83 724,641
Equity compensation plans not approved by security holders
Total
714,967 $ 9.83 724,641
Issuer Purchases of Equity Securities
None.
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Performance Graph
The following chart compares the cumulative total shareholder return on Southern National common stock during the five years ended December 31, 2017, with the cumulative total return of the Russell 2000 Index and the SNL Bank and Thrift Index for the same period. Dividend reinvestment has been assumed. This comparison assumes $100 invested on December 31, 2012 in Southern National common stock, the Russell 2000 Index and the SNL Bank and Thrift Index. The historical stock price performance for Southern National common stock shown on the graph below is not necessarily indicative of future stock performance.
[MISSING IMAGE: 392635520_tv483777_chrt-line.jpg]
2012
2013
2014
2015
2016
2017
Southern National Bancorp of Virginia, Inc.
100.00 126.22 150.84 181.68 233.10 233.15
Russell 2000 Index
100.00 138.82 145.62 139.19 168.85 193.58
SNL Bank and Thrift Index
100.00 136.92 152.85 155.94 196.86 231.49
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Item 6.   Selected Financial Data
The following table sets forth selected financial data for Southern National as of and for the years ended December 31, 2017, 2016, 2015, 2014 and 2013:
2017
2016
2015
2014
2013
(in thousands, except per share amounts)
Results of Operations:
Interest income
$ 83,570 $ 48,947 $ 43,701 $ 38,091 $ 35,116
Interest expense
15,653 8,633 7,077 4,673 4,668
Net interest income
67,917 40,314 36,624 33,418 30,448
Provision for loan losses
8,625 4,912 3,171 3,444 3,615
Net interest income after provision for loan
losses
59,292 35,402 33,453 29,974 26,833
Noninterest income
5,429 2,820 3,781 2,364 1,753
Noninterest expenses
49,149 22,815 23,278 21,101 19,292
Income before income taxes
15,572 15,407 13,956 11,237 9,294
Income tax expense
13,147 5,095 4,667 3,754 3,036
Net income
$ 2,425 $ 10,312 $ 9,289 $ 7,483 $ 6,258
Per Share Data:
Earnings per share – Basic
$ 0.13 $ 0.84 $ 0.76 $ 0.63 $ 0.54
Earnings per share – Diluted
$ 0.13 $ 0.83 $ 0.75 $ 0.63 $ 0.54
Cash dividends paid per share
$ 0.32 $ 0.32 $ 0.52 $ 0.60 $ 0.25
Book value per share
$ 13.48 $ 10.30 $ 9.78 $ 9.33 $ 9.20
Tangible book value per share(1)
$ 8.86 $ 9.37 $ 8.83 $ 8.36 $ 8.34
Dividend payout ratio
246.15% 38.10% 68.42% 95.24% 46.30%
Weighted average shares outstanding –  Basic
18,390,810 12,251,804 12,224,494 11,846,126 11,590,333
Weighted average shares outstanding –  Diluted
18,671,392 12,426,783 12,330,431 11,927,083 11,627,445
Shares outstanding at end of period
23,936,453 12,263,643 12,234,443 12,216,669 11,590,612
Selected Performance Ratios and Other Data:
Return on average assets
0.13% 0.95% 0.95% 0.94% 0.89%
Return on average equity
1.02% 8.37% 7.87% 6.76% 5.95%
Yield on earning assets
4.76% 4.84% 4.85% 5.24% 5.48%
Cost of funds
0.94% 0.91% 0.91% 0.75% 0.85%
Net interest margin
3.87% 3.99% 4.07% 4.60% 4.75%
Efficiency ratio(2)
54.20% 51.50% 57.64% 60.45% 60.78%
Net charge-offs to average loans
0.51% 0.53% 0.28% 0.51% 0.69%
Allowance for loan losses to total non-covered loans
0.46% 0.95% 1.06% 1.11% 1.42%
Stockholders’ equity to total assets
12.35% 11.06% 11.55% 12.43% 14.89%
Financial Condition:
Total assets
$ 2,614,252 $ 1,142,443 $ 1,036,107 $ 916,645 $ 716,185
Total loans, net of deferred fees
2,062,328 930,415 829,425 703,472 546,058
Total deposits
1,865,156 912,982 825,294 742,425 540,359
Stockholders’ equity
322,772 126,344 119,636 113,979 106,614
(1)
Tangible book value per share is calculated by dividing stockholders’ equity less intangible assets by the number of outstanding shares of common stock.
(2)
Efficiency ratio is a non-GAAP measure calculated by dividing noninterest expenses by the sum of net interest income plus noninterest income, excluding any gains/losses on sales of investment securities, gains/losses and write-downs on OREO, gains on acquisitions, recoveries related to acquired charged-off loans and investment securities that are recognized in other noninterest income, merger expenses and gains/losses on sales of loans.
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Item 7.   Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of Southern National. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are in accordance with U.S. GAAP and with general practices within the banking industry. Management makes a number of estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during periods presented. Different assumptions in the application of these methods or policies could result in material changes in our financial statements. As such, the following policies are considered “critical accounting policies” for us.
Allowance for Loan and Lease Losses (“ALLL”)
The allowance for loan and lease losses is a valuation allowance for probable incurred credit losses. Loan losses are charged against the allowance when management believes the collection of the principal is unlikely. Recoveries of amounts previously charged-off are credited to the allowance. Management’s determination of the adequacy of the allowance is based on a three year historical average net loss experience for each portfolio segment adjusted for current industry and economic conditions (referred to as “current factors”) and estimates of their effect on loan collectability. While management uses available information to estimate losses on loans, future additions to the allowance may be necessary based on changes in economic conditions, particularly those affecting real estate values.
The allowance consists of specific and general components. The specific component relates to loans that are individually classified as impaired. The general component provides for estimated losses in unimpaired loans and is based on historical loss experience adjusted for current factors.
A loan is considered impaired when, based on current information and events, it is probable that Southern National will be unable to collect the scheduled payments of principal or interest when due according to the terms of the loan documentation. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due, among other considerations. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan-by-loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Individual consumer and residential loans are evaluated for impairment based on the aforementioned criteria as well as regulatory guidelines.
The general component covers non-impaired loans and is based on historical loss experience adjusted for current factors. The historical loss experience is determined by portfolio segment and is based on the actual net loss history experienced by Southern National over the most recent three years. This actual loss experience is adjusted for current factors based on the risks present for each portfolio segment. These current factors include consideration of the following: levels of and trends in delinquencies and impaired loans; levels of and trends in charge-offs and recoveries; trends in volume and terms of loans; effects of any changes in risk selection and underwriting standards; other changes in lending policies, procedures, and practices; experience, ability, and depth of lending management and other relevant staff; national and local economic trends and conditions; industry conditions; and effects of changes in credit concentrations. The following portfolio segments have been identified: owner occupied commercial real estate, non-owner occupied commercial real estate, construction and land development, commercial loans, residential 1-4 family, multi-family residential, loans secured by farmland, HELOC and consumer. While underwriting
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practices in this environment are more stringent, the Bank estimates the effect of internal factors on future net loss experience to be negligible. Management’s estimate of the effect of current external economic environmental conditions on future net loss experience is significant in all loan segments and particularly on loans secured by real estate including single family 1-4, non-owner occupied commercial real estate and construction and land development loans. These factors include excess inventory, generally less demand driven in part by fewer qualified borrowers and buyers. These considerations have played a significant role in management’s estimate of the adequacy of the allowance for loan and lease losses.
Accounting for the FDIC Indemnification Asset and Acquired Loans
Southern National acquired loan portfolios through its acquisitions of EVBS in 2017, GAB in 2009, HarVest Bank of Maryland in 2012, and PGFSB in 2014. The single family residential loans acquired in the GAB transaction are referred to as “covered loans” because of loss protection provided by the FDIC pursuant to a loss sharing agreement which expires in December 2019. The loss sharing agreement with the FDIC related to non-single family (commercial) loans expired in December 2014. The loans acquired in the EVBS, HarVest Bank of Maryland, and PGFSB transactions are not covered by an FDIC loss sharing agreement.
The accounting for the covered loans requires Southern National to estimate the timing and amount of cash flows to be collected from these loans at acquisition, and to periodically update our estimates of the cash flows expected to be collected over the life of the covered loans. Similarly, the accounting for the FDIC indemnification asset requires us to estimate the timing and amount of cash flows to be received from the FDIC in reimbursement for losses and expenses related to the covered loans; these estimates are directly related to estimates of cash flows to be received from the covered loans. The estimated cash flows from the FDIC indemnification asset are sensitive to changes in the same assumptions that impact expected cash flows on covered loans. If the amount of expected cash flows to be recovered from the FDIC changes, the difference between the carrying amount of the FDIC indemnification asset and the revised recoverable amount is accreted or amortized over the remaining term of the FDIC agreement or the life of the loans, whichever is shorter. These estimates are considered to be critical accounting estimates because they involve significant judgment and assumptions as to the amount and timing of cash flows to be collected.
Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual payments will not be received are accounted for under Accounting Standards Codification (“ASC”) Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality (“ASC 310-30”). These loans are recorded at fair value at the time of acquisition, with no carryover of the related allowance for loan losses. Fair value of acquired loans is determined using a discounted cash flow methodology based on assumptions about the amount and timing of principal and interest payments, principal prepayments and principal defaults and losses, and current market rates. In recording the acquisition date fair values of acquired impaired loans, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans).
Over the life of the acquired loans, we continue to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques. We evaluate at each balance sheet date whether the present value of our pools of loans determined using the effective interest rates has decreased significantly and if so, recognize a provision for loan losses in our consolidated statement of income. For any significant increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the pool’s remaining life.
These cash flow evaluations are inherently subjective as they require management to make estimates about expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. Changes in these factors, as well as changing economic conditions will likely impact the carrying value of these acquired loans.
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Business Combinations, Goodwill and Other Intangible Assets
Southern National accounts for all business combinations under the purchase method of accounting. Tangible and intangible assets and liabilities of the acquired entity are recorded at fair value. The determination of fair values is based on valuations using management’s assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors. Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying values of goodwill or intangible assets and could result in impairment losses affecting our financials as a whole and our banking subsidiary in which the goodwill or intangibles resides.
Intangible assets with finite useful lives represent the future benefit associated with the acquisition of the core deposits and are amortized over their estimated useful lives utilizing a method that approximates the expected attrition of the deposits. Under FASB ASC 350, Intangibles — Goodwill and Other, goodwill with an indefinite life is not amortized, but rather tested annually for impairment. Southern National evaluates goodwill for impairment each year as of September 30. Goodwill totaled $100.6 million at December 31, 2017. There was no impairment recorded for the years ended December 31, 2017, 2016 and 2015.
Other-Than-Temporary-Impairment (“OTTI”) of Investment Securities
Management evaluates investment securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, an investment security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt investment securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity investment securities, the entire amount of impairment is recognized through earnings.
In order to determine OTTI for purchased beneficial interests that, on the purchase date, were not highly rated, Southern National compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.
Other Real Estate Owned (“OREO”)
Real estate acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the fair value of the collateral at the date of foreclosure based on estimates, including some obtained from third parties, less estimated costs to sell, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of cost or fair value, less estimated costs to sell. Significant property improvements that enhance the salability of the property are capitalized to the extent that the carrying value does not exceed the estimated realizable value. Legal fees, maintenance and other direct costs of foreclosed properties are expensed as incurred.
Due to the judgment involved in estimating fair value of the properties, accounting for OREO is regarded as a critical accounting policy. Estimates of value of OREO properties at the date of foreclosure are typically based on real estate appraisals performed by independent appraisers. These values are generally updated as appraisals become available.
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Valuation of Deferred Tax Asset
The provision for income taxes reflects the tax effects of the transactions reported in the consolidated financial statements, including taxes currently due as well as changes in deferred taxes. Deferred tax assets and liabilities represent estimates of the future tax return consequences of temporary differences between carrying amounts and tax bases of assets and liabilities. Deferred tax assets and liabilities are computed by using currently enacted income tax rates and applying those rates to the periods in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. As of December 31, 2017 and 2016, management concluded that it is more likely than not that Southern National will generate sufficient taxable income to fully utilize our deferred tax assets.
OVERVIEW
Southern National is a corporation that was formed on July 28, 2004 under the laws of the Commonwealth of Virginia and is the holding company for Sonabank, a Virginia state-chartered bank which commenced operations on April 14, 2005. Sonabank provides a range of financial services to individuals and small and medium sized businesses.
On June 23, 2017, SNBV completed its merger with EVBS and the merger of EVBS’s wholly-owned subsidiary, EVB, with and into SNBV’s wholly-owned subsidiary, Sonabank (see Note 2 — Business Combinations). This combination has brought together two banking companies with complementary business lines, creating one of the premier banking institutions headquartered in the Commonwealth of Virginia. EVBS was the holding company for EVB, a Virginia state-chartered bank which traced its beginnings to 1910.
Southern National acquired PGFSB in a cash and stock transaction on August 1, 2014. PGFSB was founded in 1931 and was headquartered in Upper Marlboro, which is the County Seat of Prince George’s County, Maryland. PGFSB had four offices in Maryland, including a main office in Upper Marlboro and three branch offices in Dunkirk, Brandywine and Huntingtown.
We completed the acquisition of the HarVest Bank of Maryland on April 27, 2012, the Midlothian branch in Richmond, Virginia on October 1, 2011 and the acquisition and assumption of certain assets and liabilities of GAB from the FDIC on December 4, 2009. As part of the GAB acquisition, the Bank and the FDIC entered into a loss sharing agreement (the “loss sharing agreement”) on approximately $143.4 million (cost basis) of GAB’s assets. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreement; we refer to these assets collectively as “covered assets.”
At December 31, 2017, Sonabank had thirty-eight full-service retail branches in Virginia, located in the counties of Chesterfield (2), Essex (2), Fairfax (Reston, McLean and Fairfax), Gloucester (2), Hanover (3), King William, Lancaster, Middlesex (3), New Kent, Northumberland (3), Southampton, Surry, Sussex, and in Charlottesville, Clifton Forge, Colonial Heights, Front Royal, Hampton, Haymarket, Leesburg, Middleburg, New Market, Newport News, Richmond, South Riding, Warrenton, and Williamsburg, and seven full-service retail branches in Maryland, in Rockville, Shady Grove, Bethesda, Upper Marlboro, Brandywine, Owings and Huntingtown.
While we offer a wide range of commercial banking services, we focus on making loans secured primarily by commercial real estate and other types of secured and unsecured commercial loans to small and medium-sized businesses in a number of industries, as well as loans to individuals for a variety of purposes. We are a leading SBA lender among Virginia community banks. We also invest in real estate-related investment securities, including collateralized mortgage obligations and agency mortgage backed securities. Our principal sources of funds for loans and investing in securities are deposits and, to a lesser extent, borrowings. We offer a broad range of deposit products, including checking (“NOW”), savings, money market accounts and certificates of deposit. We actively pursue business relationships by utilizing the business contacts of our senior management, other bank officers and our directors, thereby capitalizing on our knowledge of our local market areas.
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RESULTS OF OPERATIONS
Net Income
Net income for the year ended December 31, 2017 was $2.4 million, compared to $10.3 million for the year ended December 31, 2016 and $9.3 million for the year ended December 31, 2015. Southern National’s results for the year ended December 31, 2017 were significantly impacted by the inclusion of a provisional $7.2 million in additional estimated income tax expense from the revaluation of its net deferred tax asset (“DTA”) as a result of the reduction in the corporate income tax rate going forward under the recently enacted Tax Cuts and Jobs Act. Due to the new law being enacted on December 22, 2017, this revaluation of the DTA was accounted for in the fourth quarter of 2017 through adjustments to Income Tax Expense on the Consolidated Statements of Income. Southern National’s DTA position is attributable primarily to the net operating losses acquired in the merger with EVBS and the timing difference created by the allowance for loan losses, which will be deductible at the lower U.S. corporate income tax rate beginning in 2018, as opposed to the higher rates in effect through December 31, 2017. Although directly affecting its current period results, Southern National expects that its earnings beginning in 2018 will benefit from the lower U.S. corporate income tax rate going forward which will result in a reduction of income tax expense. Southern National’s results for the year ended December 31, 2017 were also directly impacted by the merger with EVBS including expenses related to the merger of  $9.4 million, compared to $429 thousand in merger expenses during 2016.
Net Interest Income
Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings.
Net interest income was $67.9 million during the year ended December 31, 2017, compared to $40.3 million during the prior year. Average loans during the year ended December 31, 2017 were $1.53 billion compared to $889.6 million during 2016, with the increase mostly attributable to the acquisition of EVBS in June of 2017. Southern National’s net interest margin was 3.87% during the year ended December 31, 2017 compared to 3.99% during the year ended December 31, 2016. The yield on average interest-earning assets decreased 8 basis points to 4.76% during the year ended December 31, 2017 when comparing to the 4.84% yield on average interest-earning assets during 2016. The cost of average interest-bearing liabilities increased 8 basis points to 1.08% during the year ended December 31, 2017 when comparing to the 1.00% cost on average interest-bearing liabilities during 2016. The loan discount accretion on our acquisitions were $4.5 million in the year ended December 31, 2017 compared to $2.1 million in 2016.
Net interest income was $40.3 million during the year ended December 31, 2016, compared to $36.6 million during the previous year. Average loans during the year ended December 31, 2016 were $889.6 million compared to $761.6 million during 2015. Southern National’s net interest margin was 3.99% during the year ended December 31, 2016 compared to 4.07% during the year ended December 31, 2015. The loan discount accretion on our acquisitions were $2.1 million in the year ended December 31, 2016 compared to $2.6 million in 2015.
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The following table details average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:
Average Balance Sheets and Net Interest Analysis
For the Years Ended
December 31,
2017
2016
2015
Average
Balance
Interest
Income/​
Expense
Yield/​
Rate
Average
Balance
Interest
Income/​
Expense
Yield/​
Rate
Average
Balance
Interest
Income/​
Expense
Yield/​
Rate
(Dollar amounts in thousands)
Assets
Interest-earning assets:
Loans, net of deferred fees(1)(2)
$ 1,528,081 $ 77,764 5.09% $ 889,600 $ 45,348 5.10% $ 761,550 $ 40,104 5.27%
Investment securities
182,464 4,569 2.50% 96,836 2,955 3.05% 97,580 2,806 2.88%
Other earning assets
44,546 1,237 2.78% 24,208 644 2.66% 41,245 791 1.92%
Total earning assets
1,755,091 83,570 4.76% 1,010,644 48,947 4.84% 900,375 43,701 4.85%
Allowance for loan losses
(9,831) (8,634) (8,139)
Intangible assets
61,969 11,499 11,991
Other non-earning assets
115,388 66,850 70,800
Total assets
$ 1,922,617 $ 1,080,359 $ 975,027
Liabilities and stockholders’ equity
Interest-bearing liabilities:
NOW and other demand accounts
$ 192,789 704 0.36% $ 36,470 60 0.16% $ 24,306 25 0.10%
Money market accounts
256,746 1,582 0.62% 127,121 453 0.36% 138,559 483 0.35%
Savings accounts
112,868 442 0.39% 51,670 333 0.64% 44,661 282 0.63%
Time deposits
668,566 8,265 1.24% 579,157 7,255 1.25% 509,900 5,643 1.11%
Total interest-bearing deposits
1,230,969 10,993 0.89% 794,418 8,101 1.02% 717,426 6,433 0.90%
Borrowings
218,581 4,660 2.13% 66,230 532 0.80% 58,358 644 1.10%
Total interest-bearing liabilities
1,449,550 15,653 1.08% 860,648 8,633 1.00% 775,784 7,077 0.91%
Noninterest-bearing liabilities:
Demand deposits
219,107 88,413 75,129
Other liabilities
15,694 8,140 6,120
Total liabilities
1,684,351 957,201 857,033
Stockholders’ equity
238,266 123,158 117,994
Total liabilities and stockholders’
equity
$ 1,922,617 $ 1,080,359 $ 975,027
Net interest income
$ 67,917 $ 40,314 $ 36,624
Interest rate spread
3.68% 3.84% 3.94%
Net interest margin
3.87% 3.99% 4.07%
(1)
Includes loan fees in both interest income and the calculation of the yield on loans.
(2)
Calculations include non-accruing loans in average loan amounts outstanding.
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The following table summarizes changes in net interest income attributable to changes in the volume of interest-earning assets and interest-bearing liabilities compared to changes in interest rates. The change in interest, due to both rate and volume, has been proportionately allocated between rate and volume.
Year Ended December 31, 2017 vs. 2016
Year Ended December 31, 2016 vs. 2015
Increase (Decrease)
Due to Change in:
Increase (Decrease)
Due to Change in:
Volume
Rate
Net Change
Volume
Rate
Net Change
(in thousands)
Interest-earning assets:
Loans, net of deferred fees
$ 32,505 $ (89) $ 32,416 $ 6,477 $ (1,233) $ 5,244
Investment securities
2,267 (653) 1,614 (21) 170 149
Other earning assets
563 30 593 596 (743) (147)
Total interest-earning assets
35,335 (712) 34,623 7,052 (1,806) 5,246
Interest-bearing liabilities:
NOW and other demand accounts
500 144 644 16 19 35
Money market accounts
659 470 1,129 (41) 11 (30)
Savings accounts
163 (54) 109 45 6 51
Time deposits
1,067 (57) 1,010 818 794 1,612
Total interest-bearing deposits
2,389 503 2,892 838 830 1,668
Borrowings
2,397 1,731 4,128 110 (222) (112)
Total interest-bearing liabilities
4,786 2,234 7,020 948 608 1,556
Change in net interest income
$ 30,549 $ (2,946) $ 27,603 $ 6,104 $ (2,414) $ 3,690
Provision for Loan Losses
The provision for loan losses is a current charge to earnings made in order to increase or decrease the allowance for loan losses to a level for inherent probable losses in the loan portfolio based on an evaluation of the loan portfolio, current economic conditions, changes in the nature and volume of lending, historical loan experience and other known internal and external factors affecting loan collectability. Our loan loss allowance is calculated by segmenting the loan portfolio by loan type and applying risk factors to each segment. The risk factors are determined by considering historical loss data, peer data, as well as applying management’s judgment.
The provision for loan losses for the years ended December 31, 2017, 2016 and 2015 was $8.6 million, $4.9 million, and $3.2 million, respectively. We had charge-offs totaling $8.8 million during 2017, $5.0 million during 2016, and $2.7 million during 2015. There were recoveries totaling $991 thousand during 2017, $239 thousand during 2016 and $526 thousand during 2015. The primary driver of the elevated provision for loan losses and the increased level of charge-offs during the year ended December 31, 2017, as compared to 2016, was the $7.1 million in charge-offs taken on loans that were related to the deteriorating financial condition of one long-time borrower of the Bank, a government contractor, who is experiencing cash flow problems. Management is closely monitoring this situation.
The Financial Condition Section of Management’s Discussion and Analysis provides information on our loan portfolio, past due loans, nonperforming assets and the allowance for loan losses.
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Noninterest Income
The following tables present the major categories of noninterest income for the years ended December 31, 2017, 2016 and 2015 (in thousands):
2017
2016
Change
Account maintenance and deposit service fees
$ 3,564 $ 896 $ 2,668
Income from bank-owned life insurance
929 700 229
Equity (loss) income from mortgage affiliate
(345) 1,109 (1,454)
Gain on sales of investment securities
255 255
Other
1,026 115 911
Total noninterest income
$ 5,429 $ 2,820 $ 2,609
2016
2015
Change
Account maintenance and deposit service fees
$ 896 $ 953 $ (57)
Income from bank-owned life insurance
700 636 64
Equity income from mortgage affiliate
1,109 1,459 (350)
Net gain on other assets
7 (7)
Gain on sales of investment securities
520 (520)
Other
115 206 (91)
Total noninterest income
$ 2,820 $ 3,781 $ (961)
Noninterest income increased to $5.4 million in the year ended December 31, 2017 from $2.8 million in 2016. The increase was mainly due to the $2.7 million increase in account maintenance and deposit service fees primarily driven by the increased retail deposits acquired in the merger with EVBS. Income from bank-owned life insurance, which totaled $929 thousand for the year ended December 31, 2017, increased $229 thousand when compared to 2016, primarily driven by additional income earned from the increase in bank-owned life insurance policies acquired in the merger with EVBS. Southern National also recognized increases of  $255 thousand and $911 thousand on gains on sales of investment securities and in other noninterest income, respectively. The main driver of the $911 thousand increase in other noninterest income was recoveries of  $757 thousand from acquired loan and investment security balances from the EVBS acquisition. These loan and investment security balances were fully charged-off by EVBS prior to its acquisition by Southern National. Partially offsetting these increases was a $1.5 million decline in income from the investment in STM, which resulted in a loss of  $345 thousand for the year ended December 31, 2017. The decline in income from the investment in STM is mainly attributable to the overall decrease in STM’s revenue due to a lower volume of mortgage loan closings.
Noninterest income decreased to $2.8 million in the year ended December 31, 2016 from $3.8 million in 2015. Much of the noninterest income in 2015 resulted from the fact that we transferred from our held-to-maturity portfolio all of the trust preferred securities and a non-government sponsored residential collateralized mortgage obligation (“CMO”) that had previously been classified as other than temporarily impaired to the available for sale classification. We sold five of these trust preferred securities and the CMO, recognizing a net gain of $520 thousand in the year ended December 31, 2015. We recognized income from our investment in STM in the amount of $1.1 million during the year ended December 31, 2016, compared to $1.5 million during 2015. STM showed volume growth in the fourth quarter of 2016 with originations of  $212 million, up from $179 million in the same quarter of 2015. However, they experienced a fourth quarter loss of   $556 thousand attributable to the operating costs related to the opening of new offices in Innsbrook, Virginia; Raleigh, North Carolina; New Castle, Delaware and the cost of installing a new delivery channel. In addition, STM experienced some margin compression. Our share of the fourth quarter 2016 loss was $272 thousand.
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Noninterest Expense
The following tables present the major categories of noninterest expense for the years ended December 31, 2017, 2016 and 2015 (in thousands):
2017
2016
Change
Salaries and benefits
$ 20,285 $ 11,675 $ 8,610
Occupancy expenses
4,809 3,155 1,654
Furniture and equipment expenses
2,228 975 1,253
Amortization of core deposit intangible
845 219 626
Virginia franchise tax expense
969 387 582
FDIC assessment
802 543 259
Data processing expense
1,140 744 396
Telephone and communication expense
1,422 745 677
Amortization of FDIC indemnification asset
712 793 (81)
Net loss on other real estate owned
520 174 346
Merger expenses
9,426 429 8,997
Other operating expenses
5,991 2,976 3,015
Total noninterest expenses
$ 49,149 $ 22,815 $ 26,334
2016
2015
Change
Salaries and benefits
$ 11,675 $ 11,860 $ (185)
Occupancy expenses
3,155 3,269 (114)
Furniture and equipment expenses
975 815 160
Amortization of core deposit intangible
219 261 (42)
Virginia franchise tax expense
387 352 35
FDIC assessment
543 664 (121)
Data processing expense
744 668 76
Telephone and communication expense
745 786 (41)
Amortization of FDIC indemnification asset
793 630 163
Net loss on other real estate owned
174 291 (117)
Merger expenses
429 429
Other operating expenses
2,976 3,682 (706)
Total noninterest expenses
$ 22,815 $ 23,278 $ (463)
Noninterest expenses were $49.1 million during the year ended December 31, 2017, compared to $22.8 million during the year ended December 31, 2016. The year-over-year increase of 115.4% in noninterest expenses was mainly driven by the additional acquisition and post-acquisition expenses associated with the EVBS merger on June 23, 2017. Salaries and benefits increased $8.6 million in 2017 when compared to 2016. Additional staff added in the EVBS acquisition was the main factor in the increase. Southern National anticipates salaries and benefits expense to normalize starting in the first quarter of 2018 as the last of the merger-related full-time equivalent employee (“FTE”) reductions took place in the fourth quarter of 2017. Occupancy expenses and furniture and equipment expenses increased $1.7 million and $1.3 million, respectively, year-over-year to $4.8 million and $2.2 million, respectively, for the year ended December 31, 2017. The main factor in the $1.7 million and $1.3 million year-over-year increases in occupancy expenses and furniture and equipment expenses, respectively, was the added expenses associated with the EVBS merger, which are in line with expectations. Merger expenses associated with the EVBS acquisition increased $9.0 million to $9.4 million for the year ended December 31, 2017, compared to the $429 thousand of merger expenses during 2016. Only nominal merger expenses associated with the EVBS merger are anticipated going forward. Other operating expenses increased $3.0 million for
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the year ended December 31, 2017, when compared to the year ended December 31, 2016. The $3.0 million increase in other operating expenses is in line with the anticipated added expenses associated with the EVBS merger and was driven by a $500 thousand and a $477 thousand increase in professional services and marketing and advertising, respectively, in 2017. Professional services includes consulting fees, legal services, and audit and accounting fees.
Noninterest expenses were $22.8 million during the year ended December 31, 2016, compared to $23.3 million during the year ended December 31, 2015. During the year ended December 31, 2016 we had losses of  $375 thousand because of impairment recognized on four OREO properties. This was partially offset by gains on the sale of four OREO properties in the amount of  $201 thousand, resulting in a net loss of  $174 thousand on OREO. During 2015, we had losses on OREO of  $740 thousand as we charged down five OREO properties which proved challenging to sell. This was partially offset by gains on the sale of six OREO properties in the amount of  $449 thousand, resulting in a net loss on OREO of  $291 thousand. We had merger expenses of  $429 thousand in 2016 related to the merger with EVBS, and there were no merger expenses in 2015. Salaries and benefits decreased by $185 thousand in 2016 compared to the year ended December 31, 2015.
The majority of the merger and merger related expenses have been incurred as the result of the merger with EVBS. The following table shows a breakdown of those merger and merger related expenses:
For the Year Ended
December 31,
2017
December 31,
2016
(dollars in thousands)
Salaries and benefits(1)
$ 4,927 $
Consulting and investment banking fees
2,234 250
Data processing(2)
609
Legal fees
637 161
Occupancy expenses
628
Filing fees
165 18
Appraisals
95
Lodging, travel and meals
33
Training
17
Other
81
Total merger expenses
$ 9,426 $ 429
(1)
Includes change-in-control contract payouts, severance and pay-to-stay bonuses.
(2)
Fee incurred to cancel core system platform contract.
FINANCIAL CONDITION
Total assets were $2.61 billion as of December 31, 2017, compared to $1.14 billion as of December 31, 2016. The $1.47 billion increase in total assets from the end of 2016 to the end of 2017 was primarily due to the $1.37 billion in assets acquired, inclusive of fair value adjustments, in the merger with EVBS on June 23, 2017.
Loans
Total loans, net of deferred fees were $2.06 billion and $930.4 million at December 31, 2017 and 2016, respectively. The $1.13 billion increase in total loans, net of deferred fees during 2017 was mainly due to the $1.03 billion of loans, inclusive of fair value adjustments, acquired in the merger with EVBS on June 23, 2017. The loans acquired in the merger with EVBS totaled $942.8 million at December 31, 2017. Loan growth during the year ended December 31, 2017 was offset by the sale of approximately $29.0 million of EVB’s classified and residential TDR loans during the third quarter of 2017 as well as net charge-offs of $7.8 million.
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As of December 31, 2017 and 2016, substantially all of our loans were to customers located in Virginia and Maryland. We are not dependent on any single customer or group of customers whose insolvency would have a material adverse effect on operations.
The following table summarizes the composition of our loans, net of unearned income, at December 31 for the years indicated:
2017
2016
2015
2014
2013
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Amount
Percent
Loans secured by real estate:
Commercial real estate – owner occupied
$ 401,847 19.5%