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Section 1: 10-Q (10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE

SECURITIES EXCHANGE ACT OF 1934

 

For the Quarterly Period Ended June 30, 2018

 

Commission File No. 001-33037

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

 

Virginia   20-1417448
(State or other jurisdiction   (I.R.S. Employer Identification No.)
of incorporation or organization)    

 

6830 Old Dominion Drive

McLean, Virginia 22101

(Address of principal executive offices) (zip code)

 

(703) 893-7400

(Registrant’s telephone number, including area code)

 

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 x             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 x             NO ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definition of “large accelerated filer”, “accelerated filer”, “smaller reporting company”, and “emerging growth company.” in Rule 12b–2 of the Exchange Act:

 

Large accelerated filer ¨ Accelerated filer x Smaller reporting company ¨
     
Non-accelerated filer    ¨ An emerging growth company ¨  
     
  (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 Exchange Act).

 

Yes ¨              No x

 

As of August 2, 2018, there were 24,048,453 shares of common stock outstanding.

 

 

 

 

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

FORM 10-Q

June 30, 2018

 

INDEX

 

    PAGE
     
PART I - FINANCIAL INFORMATION  
     
Item 1 - Financial Statements  
  Consolidated Balance Sheets as of June 30, 2018 and December 31, 2017 2
  Consolidated Statements of Income and Comprehensive Income for the three and six months ended June 30, 2018 and 2017 3
  Consolidated Statement of Changes in Stockholders’ Equity for the six months ended June 30, 2018 4
  Consolidated Statements of Cash Flows for the six months ended June 30, 2018 and 2017 5
  Notes to Consolidated Financial Statements 6-35
     
Item 2 - Management’s Discussion and Analysis of Financial Condition and Results of Operations 36-47
     
Item 3 – Quantitative and Qualitative Disclosures about Market Risk 48-49
     
Item 4 – Controls and Procedures 50
     
PART II - OTHER INFORMATION  
     
Item 1 – Legal Proceedings 50
     
Item 1A – Risk Factors 50
     
Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds 50
     
Item 3 – Defaults Upon Senior Securities 50
     
Item 4 – Mine Safety Disclosures 50
     
Item 5 – Other Information 50
     
Item 6 - Exhibits 51
     
Signatures 52
   
Certifications  

 

 

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED BALANCE SHEETS

(dollars in thousands, except per share amounts)

 

   June 30,   December 31, 
   2018   2017 
   (unaudited)   (audited) 
ASSETS          
Cash and cash equivalents:          
Cash and due from financial institutions  $7,534   $7,937 
Interest-bearing deposits in other financial institutions   40,834    15,815 
Federal funds sold   3,795    1,711 
Total cash and cash equivalents   52,163    25,463 
           
Securities available for sale, at fair value   149,836    160,673 
           
Securities held to maturity, at amortized cost (fair value of $92,492 and $97,597, respectively)   96,175    98,912 
           
Total loans   2,154,892    2,062,328 
Less allowance for loan losses   (11,000)   (9,397)
Net loans   2,143,892    2,052,931 
           
Stock in Federal Reserve Bank and Federal Home Loan Bank   26,019    26,775 
Equity investment in mortgage affiliate   4,597    4,723 
Preferred investment in mortgage affiliate   3,305    3,305 
Bank premises and equipment, net   33,808    35,788 
Goodwill   101,954    100,606 
Core deposit intangibles, net   9,331    10,054 
FDIC indemnification asset   1,003    1,353 
Bank-owned life insurance   63,183    50,790 
Other real estate owned   5,560    7,577 
Deferred tax assets, net   17,471    16,903 
Other assets   17,438    18,399 
           
Total assets  $2,725,735   $2,614,252 
           
LIABILITIES AND STOCKHOLDERS' EQUITY          
           
Noninterest-bearing demand deposits  $337,151   $319,189 
Interest-bearing deposits:          
NOW accounts   322,184    329,878 
Money market accounts   314,570    355,084 
Savings accounts   162,511    161,947 
Time deposits   844,287    699,058 
Total interest-bearing deposits   1,643,552    1,545,967 
Total deposits   1,980,703    1,865,156 
           
Securities sold under agreements to repurchase - short term   20,289    15,468 
Federal Home Loan Bank (FHLB) advances - short term   316,215    335,615 
Junior subordinated debt - long term   9,559    9,534 
Senior subordinated notes - long term   47,109    47,128 
Other liabilities   17,410    18,579 
Total liabilities   2,391,285    2,291,480 
           
Commitments and contingencies (See Note 6)   -    - 
           
Stockholders' equity:          
Preferred stock, $0.01 par value. Authorized 5,000,000 shares; no shares issued and outstanding   -    - 
Common stock, $0.01 par value. Authorized 45,000,000 shares; 24,046,453 and 23,936,453  shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively   240    239 
Additional paid in capital   305,460    304,932 
Retained earnings   32,269    18,753 
Accumulated other comprehensive loss   (3,519)   (1,152)
Total stockholders' equity   334,450    322,772 
           
Total liabilities and stockholders' equity  $2,725,735   $2,614,252 

 

See accompanying notes to unaudited consolidated financial statements.

 

 2 

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(dollars in thousands, except per share amounts) (Unaudited)

 

   For the Three Months Ended   For the Six Months Ended 
   June 30,   June 30, 
   2018   2017   2018   2017 
Interest and dividend income:                    
Interest and fees on loans  $27,697   $13,332   $53,602   $25,093 
Interest and dividends on taxable securities   1,400    618    2,882    1,156 
Interest and dividends on tax exempt securities   160    90    319    174 
Interest and dividends on other earning assets   412    209    879    371 
Interest on federal funds sold   14    -    21    - 
Total interest and dividend income   29,683    14,249    57,703    26,794 
                     
Interest expense:                    
Interest on deposits   3,810    2,258    7,080    4,418 
Interest on repurchase agreements   24    1    46    1 
Interest on junior subordinated debt   147    9    275    9 
Interest on senior subordinated notes   712    442    1,423    771 
Interest on other borrowings   1,816    334    3,205    499 
Total interest expense   6,509    3,044    12,029    5,698 
                     
Net interest income   23,174    11,205    45,674    21,096 
                     
Provision for loan losses   1,050    1,050    2,650    1,600 
Net interest income after provision for loan losses   22,124    10,155    43,024    19,496 
                     
Noninterest income:                    
Account maintenance and deposit service fees   1,375    367    2,783    580 
Income from bank-owned life insurance   563    163    870    326 
Equity income (loss) from mortgage affiliate   191    112    (126)   (367)
Gain on sales of investment securities   -    257    -    257 
Other   424    (17)   2,105    19 
Total noninterest income   2,553    882    5,632    815 
                     
Noninterest expenses:                    
Salaries and benefits   7,007    3,106    13,779    6,004 
Occupancy expenses   1,656    844    3,306    1,635 
Furniture and equipment expenses   712    247    1,509    494 
Amortization of core deposit intangible   361    75    723    123 
Virginia franchise tax expense   492    130    856    241 
FDIC assessment   320    68    655    205 
Data processing expense   464    210    930    418 
Telephone and communication expense   501    183    1,095    345 
Amortization of FDIC indemnification asset   177    176    350    367 
Net (gain) loss on other real estate owned   (40)   266    160    319 
Merger expenses   -    8,603    -    8,926 
Other operating expenses   1,967    933    3,873    1,817 
Total noninterest expenses   13,617    14,841    27,236    20,894 
Income (loss) before income taxes   11,060    (3,804)   21,420    (583)
Income tax expense (benefit)   2,193    (962)   4,294    205 
Net income (loss)  $8,867   $(2,842)  $17,126   $(788)
                     
Other comprehensive loss:                    
Unrealized loss on available for sale securities  $(837)  $(241)  $(2,713)  $81 
Realized amounts on securities sold, net   -    (257)   -    (257)
Accretion of amounts previously recorded upon transfer to held to maturity from available for sale   2    3    6    6 
Net unrealized loss   (835)   (495)   (2,707)   (170)
Tax effect   175    168    569    58 
Other comprehensive loss   (660)   (327)   (2,138)   (112)
Comprehensive income (loss)  $8,207   $(3,169)   14,988    (900)
                     
Earnings (loss) per share, basic  $0.37   $(0.21)  $0.71   $(0.06)
Earnings (loss) per share, diluted  $0.37   $(0.21)  $0.71   $(0.06)

 

See accompanying notes to unaudited consolidated financial statements.

 

 3 

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY

FOR THE SIX MONTHS ENDED JUNE 30, 2018

(dollars in thousands, except per share amounts) (Unaudited)

 

               Accumulated     
       Additional       Other     
   Common   Paid in   Retained   Comphrensive     
   Stock   Capital   Earnings   Loss   Total 
Balance - December 31, 2017  $239   $304,932   $18,753   $(1,152)  $322,772 
Comprehensive income:                         
Net income   -    -    17,126    -    17,126 
Changes in other comprehensive loss on Investment securities (net of tax, $569, and accretion of $6)   -    -    -    (2,138)   (2,138)
Dividends on common stock ($0.16 per share)   -    -    (3,839)   -    (3,839)
Issuance of common stock under Stock Incentive Plan (110,000 shares, net)   1    359    -    -    360 
Reclassification adjustment from accumulated other comprehensive income to retained earnings   -    -    229    (229)   - 
Stock-based compensation expense   -    169    -    -    169 
Balance - June 30, 2018  $240   $305,460   $32,269   $(3,519)  $334,450 

 

See accompanying notes to unaudited consolidated financial statements.

 

 4 

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

FOR THE SIX MONTHS ENDED JUNE 30, 2018 AND 2017

(dollars in thousands) (Unaudited)

 

   2018   2017 
         
Operating activities:          
Net income (loss)  $17,126   $(788)
Adjustments to reconcile net income (loss) to net cash and cash equivalents provided by operating activities:          
Depreciation   1,649    426 
Amortization of core deposit intangible   723    123 
Other amortization, net   1,360    110 
Accretion of loan discount   (2,453)   (848)
Amortization of FDIC indemnification asset   350    367 
Provision for loan losses   2,650    1,600 
Earnings on bank-owned life insurance   (706)   (326)
Equity loss on mortgage affiliate   126    367 
Stock-based compensation expense   169    101 
Gain on sales of investment securities   -    (257)
Gain on bank-owned life insurance death benefit   (164)   - 
Net loss on other real estate owned   160    319 
Net decrease (increase) in other assets   1,230    (290)
Net decrease in other liabilities   (2,169)   (490)
Net cash and cash equivalents provided by operating activities   20,051    414 
Investing activities:          
Proceeds from sales of investment securities   -    4,767 
Purchases of held to maturity investment securities   -    (9,950)
Proceeds from paydowns, maturities and calls of available for sale investment securities   7,363    - 
Proceeds from paydowns, maturities and calls of held to maturity investment securities   2,498    7,141 
Loan originations and payments, net   (91,728)   (63,223)
Net decrease in stock in Federal Reserve Bank and Federal Home Loan Bank   756    855 
Purchase of bank-owned life insurance   (12,000)   - 
Proceeds from bank-owned life insurance death benefit   477    - 
Improvements on other real estate owned   52    - 
Proceeds from sales of other real estate owned   1,805    383 
Proceeds from sales of bank premise and equipment and assets held for sale   2,136    - 
Purchases of bank premises and equipment   (1,805)   (339)
Acquisition of Eastern Virginia Bankshares, Inc.   -    (10)
Cash acquired in acquisition of Eastern Virginia Bankshares, Inc.   -    24,025 
Net cash and cash equivalents used in investing activities   (90,446)   (36,351)
Financing activities:          
Net  increase (decrease) in deposits   115,153    (40,742)
Cash dividends paid on common stock   (3,839)   (1,972)
Issuance of common stock for warrants exercised   -    449 
Issuance of common stock under Stock Incentive Plan   360    335 
Issuance of subordinated notes, net of cost   -    26,075 
Net (decrease) increase in short-term borrowings   (14,579)   49,000 
Net cash and cash equivalents provided by financing activities   97,095    33,145 
Increase (decrease) in cash and cash equivalents   26,700    (2,792)
Cash and cash equivalents at beginning of period   25,463    47,392 
Cash and cash equivalents at end of period  $52,163   $44,600 
           
Supplemental disclosure of cash flow information          
Cash payments for:          
Interest  $11,663   $4,633 
Income taxes   4,516    2,390 
Supplemental schedule of noncash investing and financing activities          
Assets acquired, excluding cash and cash equivalents of $24,025  $-   $1,343,767 
Liabilities assumed   -    1,257,533 

 

See accompanying notes to unaudited consolidated financial statements.

 

 5 

 

 

SOUTHERN NATIONAL BANCORP OF VIRGINIA, INC.

Notes to Consolidated Financial Statements (Unaudited)

June 30, 2018

 

1.ACCOUNTING POLICIES

 

Southern National Bancorp of Virginia, Inc. (“Southern National” or “SNBV” or the “Company”) 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 (“Sonabank” or the “Bank”) a Virginia state-chartered bank which commenced operations on April 14, 2005. As of the close of business on June 23, 2017, SNBV completed its previously announced merger of Eastern Virginia Bankshares, Inc. (“EVBS”) with and into SNBV and the completion of 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. Sonabank provides a range of financial services to individuals and small and medium sized businesses. At June 30, 2018, 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, located in Rockville, Shady Grove, Bethesda, Upper Marlboro, Brandywine, Owings and Huntingtown.

 

The consolidated financial statements include the accounts of Southern National and its subsidiaries Sonabank and EVB Statutory Trust I (the “Trust”). Significant inter-company accounts and transactions have been eliminated in consolidation. Southern National consolidates subsidiaries in which it holds, directly or indirectly, more than 50 percent of the voting rights or where it exercises control. Entities where Southern National holds 20 to 50 percent of the voting rights, or has the ability to exercise significant influence, or both, are accounted for under the equity method. Southern National has an interest in one affiliate, Southern Trust Mortgage, LLC (“STM”), which it accounts for as an equity method investment. In addition, Southern National owns the Trust which is an unconsolidated subsidiary. The junior subordinated debt owed to the Trust is reported as a liability of Southern National.

 

The unaudited consolidated financial statements have been prepared in accordance with U.S. generally accepted accounting principles (“U.S. GAAP”) for interim financial information and instructions for Form 10-Q and follow general practice within the banking industry. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by U.S. GAAP for complete financial statements. However, in the opinion of management, all adjustments (consisting only of normal recurring accruals) necessary for a fair presentation of the results of the interim periods presented have been made. The results of operations for the interim periods are not necessarily indicative of the results that may be expected for the full year. For further information, refer to the consolidated financial statements and footnotes thereto included in Southern National’s Form 10-K for the year ended December 31, 2017.

 

Revenue from Contracts with Customers

 

Southern National records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, we must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) we satisfy a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.

 

Our primary sources of revenue are derived from financial instruments, namely loans, investment securities, and other financial instruments that are not within the scope of Topic 606. We have evaluated the nature of the Company’s contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Consolidated Statements of Income was not necessary. Southern National generally fully satisfies its performance obligations on its contracts with customers as services are rendered and the transaction prices are typically fixed; charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.

 

 6 

 

 

Use of Estimates

 

The preparation of the consolidated financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from these estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, the carrying value of investment securities, other than temporary impairment of investment securities, the valuation of goodwill and intangible assets, the FDIC indemnification asset, other real estate owned (“OREO”), deferred tax assets, and fair value measurements related to assets acquired and liabilities assumed from business combinations.

 

Recent Accounting Pronouncements

 

Adoption of New Accounting Standards:

 

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue From Contracts With Customers (Topic 606). These amendments affect any entity that either enters into contracts with customers to transfer goods or services or enters into contracts for the transfer of nonfinancial assets unless those contracts are within the scope of other standards (e.g. insurance contracts or lease contracts). This ASU will supersede the revenue recognition requirements in Topic 605, Revenue Recognition, and most industry-specific guidance, and creates a Topic 606, Revenue from Contracts with Customers. The core principle of the guidance is that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. The ASU allows for either full retrospective or modified retrospective adoption. The new guidance became effective for interim and annual reporting periods beginning after December 15, 2017. Our revenue is balanced between net interest income on financial assets and liabilities, which is explicitly excluded from the scope of the new standard, and noninterest income. The Company’s revenue recognition pattern for revenue streams within the scope of ASU 2014-09, include service charges on deposit accounts, investment services income and card interchange fees, which did not materially change from its prior practice. The Company adopted ASU No. 2014-09 on January 1, 2018 utilizing the modified retrospective approach.

 

In January 2016, the FASB issued ASU 2016-1, Financial Instruments Overall (Topic 825): Recognition and Measurement of Financial Assets and Financial Liabilities. The amendments in ASU 2016-01: (a) require equity investments (except for those accounted for under the equity method of accounting or those that result in consolidation of the investee) to be measured at fair value with changes in fair value recognized in net income; (b) simplify the impairment assessment of equity securities without readily determinable fair values by requiring a qualitative assessment to identify impairment; (c) eliminate the requirement for public business entities to disclose the method and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet; (d) require public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes; (e) require an entity to present separately in other comprehensive income, the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments; (f) require separate presentation of financial assets and financial liabilities by measurement category and form of financial assets on the balance sheet or the notes to the financial statements; and (g) clarify that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available for sale securities in combination with the entity’s other deferred tax assets. The amendments in this ASU became effective for public companies for fiscal years beginning after December 15, 2017, including interim periods within those fiscal years. The adoption of ASU 2016-01 on January 1, 2018 did not have a material impact on the Company's consolidated financial statements. In accordance with (d) above, the Company measured fair value of its net loans, certificates of deposits, junior subordinated debt, and senior subordinated notes as of June 30, 2018 using an exit price notion (see Note 8 Fair Value).

 

 7 

 

 

In August 2016, the FASB issued ASU 2016-15, Classification of Certain Cash Receipts and Cash Payments. Before ASU 2016-15 GAAP was unclear or did not include specific guidance on how to classify certain transactions in the statement of cash flows. This ASU reduced diversity in practice in how eight particular transactions are classified in the statement of cash flows. ASU No. 2016-15 became effective for interim and annual reporting periods beginning after December 15, 2017. Entities are required to apply the guidance retrospectively. If it is impracticable to apply the guidance retrospectively for an issue, the amendments related to that issue would be applied prospectively. The Company adopted ASU 2016-15 on January 1, 2018. ASU 2016-15 did not have a material impact on the Company’s consolidated financial statements.

 

In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718), Scope of Modification Accounting. These amendments provide guidance on determining which changes to the terms and conditions of share-based payment awards require an entity to apply modification accounting under Topic 718. The guidance is effective for all entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2017. The Company adopted ASU 2017-09 on January 1, 2018 and it did not have a material impact of the Company’s consolidated financial statements.

 

In February 2018, the FASB issued ASU 2018-02, Income Statement — Reporting Comprehensive Income (Topic 220); Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The amendments in this ASU require a reclassification from/to accumulated other comprehensive income and to/from retained earnings for stranded tax effects resulting from the change in the newly enacted federal corporate income tax rate. Consequently, the amendments in this ASU eliminates the stranded tax effects associated with the change in the federal corporate income tax rate in the Tax Cuts and Jobs Act of 2017. The amendments in this ASU are effective for all entities for fiscal years beginning after December 15, 2018 with early adoption allowed. Southern National adopted this ASU 2018-02 during the first quarter of 2018. The effect of the adoption of this ASU increased accumulated other comprehensive loss by $229 thousand with the offset to retained earnings as recorded in the statement of changes in stockholders’ equity. This represents the difference between the historical federal corporate income tax rate and the newly enacted 21 percent federal corporate income tax rate.

 

New Accounting Standards Not Yet Adopted:

 

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). The FASB issued this ASU to increase transparency and comparability among organizations by recognizing lease assets and lease liabilities on the balance sheet by lessees for those leases classified as operating leases under current U.S. GAAP and disclosing key information about leasing arrangements. In July 2018, the FASB issued ASU 2018-10, Codification Improvements to Topic 842, Leases, which updates narrow aspects of the guidance issued in ASU 2016-02. The amendments in this ASU are effective for public business entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2018. Early application of this ASU is permitted for all entities. Management currently anticipates recognizing a right-of-use asset and a lease liability associated with its long-term operating leases and is in the process of inventorying and categorizing its lease agreements.

 

In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments ("ASU 2016-13"), which sets forth a “current expected credit loss” ("CECL") model requiring the Company to measure all expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable supportable forecasts. This replaces the existing incurred loss model and is applicable to the measurement of credit losses on financial assets measured at amortized cost and applies to some off-balance sheet credit exposures. For public business entities that are U.S. Securities and Exchange Commission filers, the amendments in this update are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. Southern National is currently assessing the impact of the adoption of this ASU on its consolidated financial statements and is collecting data that will be needed to produce historical inputs into any models created as a result of adopting this ASU.

 

 8 

 

 

In January 2017, the FASB issued ASU 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which is intended to provide guidance in evaluating whether transactions should be accounted for as acquisitions (or disposals) of assets or businesses in order to provide stakeholders with more detailed reporting and less cost to analyze transactions. This ASU provides a screen to determine when a set of assets is not a business. It requires that when substantially all fair value of gross assets acquired (or disposed of) is concentrated in a single identifiable asset or group of similar identifiable assets, the set of assets is not a business. If the screen is not met, the amendments in this update provide a framework to assist entities in evaluating whether both an input and a substantive process are present for the set to be a business. ASU 2017-01 is effective for annual periods beginning after December 15, 2017, including interim periods within those annual periods. No disclosures are required at transition and early adoption is permitted. The Company is evaluating the impact of adopting the new guidance on the Company’s consolidated financial statements.

 

In January 2017, the FASB issued ASU 2017-04, Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment ("ASU 2017-04"), which eliminates the second step of the previous FASB guidance for testing goodwill for impairment and is intended to reduce cost and complexity of goodwill impairment testing. The amendments in this ASU modify the concept of impairment from the condition that exists when the carrying amount of goodwill exceeds its implied fair value to the condition that exists when the carrying amount of a reporting unit exceeds its fair value. After determining if the carrying amount of a reporting unit exceeds its fair value, the entity should take an impairment charge of the same amount to the goodwill for that reporting unit, not to exceed the total goodwill amount for that reporting unit. ASU 2017-04 is effective for annual periods beginning after December 15, 2019, including interim periods within those annual periods. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. Southern National is currently evaluating the impact of adopting the new guidance on its consolidated financial statements.

 

In March 2017, the FASB issued ASU 2017-08, Receivables – Nonrefundable Fees and Other Costs (Subtopic 310-20), Premium Amortization on Purchased Callable Debt Securities, which shorten the amortization period for certain callable debt securities held at a premium. Specifically, the amendments require the premium to be amortized to the earliest call date.  The amendments do not require an accounting change for securities held at a discount; the discount continues to be amortized to maturity.  ASU 2017-08 is effective for public entities for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2018.  Southern National is currently reviewing its portfolio of debt securities to determine the impact that this ASU will have on its consolidated financial statements.

 

In July 2018, the FASB issued ASU 2018-09, Codification Improvements. This ASU makes changes to a variety of topics to clarify, correct errors in, or make minor improvements to the Accounting Standards Codification. The majority of the amendments in ASU 2018-09 will be effective for the Company for fiscal years beginning after December 15, 2018. Southern National expects to adopt ASU 2018-09 in the first quarter of 2019 and is evaluating the impact of the standard, but does not expect the guidance to have a material effect on its financial statements.

 

2.BUSINESS COMBINATIONS

 

On June 23, 2017, SNBV completed its acquisition of EVBS and its subsidiaries, the Trust and EVB. 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 was a bank holding company organized and chartered under the laws of the Commonwealth of Virginia on September 5, 1997, commenced operations on December 29, 1997 and was headquartered in Glen Allen, Virginia. EVBS operated twenty-four retail branches, which served diverse markets that primarily are in the counties of Essex, Gloucester, Hanover, Henrico, King and Queen, King William, Lancaster, Middlesex, New Kent, Northumberland, Southampton, Surry, Sussex and the cities of Colonial Heights, Hampton, Newport News, Richmond and Williamsburg.

 

 9 

 

 

SNBV accounted for the acquisition using the acquisition method of accounting in accordance with FASB Accounting Standards Codification (“ASC”) 805, “Business Combinations.” Under the acquisition method of accounting, the assets and liabilities of EVBS were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is a complicated process involving significant judgment regarding methods and assumptions used to calculate the estimated fair values. After recognition of all measurement period adjustments, SNBV recognized goodwill of $91.5 million in connection with the acquisition, none of which is deductible for income tax purposes.

 

The following table details the total consideration paid by SNBV on June 23, 2017 in connection with the acquisition of EVBS, the fair values of the assets acquired and liabilities assumed, and the resulting goodwill.

 

   As Recorded   Fair Value   As Recorded 
(dollars in thousands) (unaudited)  by EVBS   Adjustments   by the Company 
Consideration paid:               
Cash            $10 
SNBV common stock             198,909 
Total consideration paid            $198,919 
                
Identifiable assets acquired:               
Cash and due from banks  $4,350   $-   $4,350 
Interest bearing deposits with banks   18,993    -    18,993 
Federal funds sold   682    -    682 
Securities available for sale, at fair value   163,029    (150)   162,879 
Securities held to maturity, at carrying value   19,036    508    19,544 
Restricted securities, at cost   6,734    -    6,734 
Loans   1,045,600    (14,188)   1,031,412 
Loans held for sale   19,689    -    19,689 
Deferred income taxes   15,735    4,912    20,647 
Bank premises and equipment   24,242    4,158    28,400 
Assets held for sale   2,970    (884)   2,086 
Accrued interest receivable   4,272    -    4,272 
Other real estate owned   563    (1)   562 
Core deposit intangible   435    9,590    10,025 
Bank owned life insurance   26,035    -    26,035 
Other assets   10,004    -    10,004 
Total identifiable assets acquired   1,362,369    3,945    1,366,314 
                
Identifiable liabilities assumed:               
Noninterest-bearing demand accounts   226,637    -    226,637 
Interest-bearing deposits   920,743    1,182    921,925 
Federal funds purchased and repurchase agreements   7,598    -    7,598 
Federal Home Loan Bank advances   57,475    -    57,475 
Junior subordinated debt   10,310    (801)   9,509 
Senior subordinated notes   19,175    1,876    21,051 
Accrued interest payable   902    -    902 
Other liabilities   12,748    1,000    13,748 
Total identifiable liabilities assumed   1,255,588    3,257    1,258,845 
                
Net identifiable assets acquired  $106,781   $688   $107,469 
                
Goodwill resulting from acquisition            $91,450 

 

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The net effect of the amortization and accretion of premiums and discounts associated with the Company’s acquisition accounting adjustments to assets acquired and liabilities assumed from EVBS had the following impact on the consolidating statements of income during the six months ended June 30, 2018:

 

   For the Six Months Ended 
(dollars in thousands)  June 30, 2018 
Loans (1)  $1,707 
Time deposits (2)   394 
Junior and senior subordinated debt (3)   42 
Core deposit intangible (4)   (627)
Net impact to income before income taxes  $1,516 

 

(1)Loan discount accretion is included in the “Interest and fees on loans” section of “Interest and dividend income” in the Consolidated Statements of Income.
(2)Time deposit premium amortization is included in the "Interest on deposits" section of "Interest expense" in the Consolidated Statements of Income.
(3)The junior subordinated debt discount accretion and senior subordinated notes premium amortization are included in the “Interest on junior subordinated debt” and “Interest on senior subordinated notes” section of “Interest expense”, respectively, in the Consolidated Statements of Income.
(4)Core deposit intangible premium amortization is included in the "Amortization of core deposit intangible" section of "Noninterest expenses" in the Consolidated Statements of Income.

 

Fair values of the major categories of assets acquired and liabilities assumed were determined as follows:

 

Loans: The acquired loans were recorded at fair value at the acquisition date of $1.03 billion without carryover of EVBS’s allowance for loan losses. The unpaid principal balance and discount at the merger date were $1.05 billion and $21.4 million, respectively. Where loans exhibited characteristics of performance, fair value was determined based on a discounted cash flow analysis which included default estimates; loans without such characteristics, fair value was determined based on the estimated values of the underlying collateral. While estimating the amount and timing of both principal and interest cash flows expected to be collected, a market-based discount rate was applied.  In this regard, the acquired loans were segregated into pools based on loan type and credit risk.  Loan type was determined based on collateral type and purpose, industry segment and loan structure.  Credit risk characteristics included risk rating groups pass, special mention and substandard and lien position. For valuation purposes, these pools were further disaggregated by maturity and pricing characteristics (e.g., fixed-rate, adjustable-rate, balloon maturities).

 

Included in the $1.05 billion of acquired loans were certain loans acquired with deteriorating credit quality, or purchased credit impaired loans. The table below summarizes the purchased credit impaired loans acquired in the EVBS acquisition on June 23, 2017 (in thousands):

 

   Purchased Credit 
   Impaired Loans 
Contractually required principal and interest at acquisition  $17,970 
Contractual cash flows not expected to be collected (nonaccretable difference)   (6,243)
Expected cash flows at acquisition   11,727 
Accretable difference   398 
Basis in acquired loans at acquisition - estimated fair value  $11,329 

 

Loans Held for Sale: The $19.7 million of acquired loans held for sale were recorded at fair value at the acquisition date. Acquired loans held for sale represent the potentially credit-impaired loans that were moved out of the held for investment portfolio and marked to fair value by EVBS just prior to the closing of the merger. Fair value was determined using quoted prices from an independent, third party buyer. Subsequent to the acquisition date, acquired loans held for sale were sold to an independent third party.

 

Premises and Equipment and Assets Held for Sale: The fair value of EVBS’s premises, including land, buildings and improvements, was determined based upon appraisal by licensed appraisers or sales contracts. These appraisals were based upon the best and highest use of the property with final values determined based upon an analysis of the cost, sales comparison and income capitalization approaches for each property appraised. The fair value of bank-owned real estate resulted in a net premium of $3.3 million.  Land is not depreciated.

 

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Core Deposit Intangible: The fair value of the core deposit intangible (“CDI”) was determined based on a combined discounted economic benefit and market approach.  The economic benefit was calculated as the cost savings between maintaining the core deposit base and using an alternate funding source, such as FHLB advances.  The life of the deposit base and projected deposit attrition rates was determined using EVBS's historical deposit data.  The CDI was estimated at $10.0 million or 0.9% of total deposits.  The CDI is being amortized over a weighted average life of 96 months using the straight-line method.

 

Time Deposits: The fair value of time deposits was determined based on the discounted value of contractual cash flows. The discount rate is estimated using the rates currently offered for deposits of similar remaining maturities. The resulting estimated fair value adjustment of time deposits is a $1.2 million premium and is being amortized over the weighted average remaining life of approximately 18 months using the straight-line method.

 

FHLB Advances: The fair value of FHLB advances was considered to be equivalent to EVBS’s recorded book balance as the advances mature in 90 days or less.

 

Junior Subordinated Debt and Senior Subordinated Notes: The fair value of the junior subordinated debt and senior subordinated notes were based on discounted cash flows using rates for securities with similar terms. The resulting estimated fair value adjustment of junior subordinated debt is a $801 thousand discount and is being accreted over the remaining life of approximately 195 months using the straight-line method. The resulting estimated fair value adjustment of senior subordinated notes is a $1.1 million premium and is being amortized over the remaining life of approximately 95 months using the straight-line method.

 

Deferred Income Taxes: Certain deferred tax assets and liabilities were carried over to SNBV from EVBS based on the Company’s ability to utilize them in the future. Additionally, deferred tax assets and liabilities were established for acquisition accounting fair value adjustments as the future amortization/accretion of these adjustments represent temporary differences between book income and taxable income.

 

3.STOCK-BASED COMPENSATION

 

In 2004, the Board of Directors adopted a stock option plan that authorized the reservation of up to 302,500 shares of common stock and provided for the granting of stock options to certain directors, officers and employees. The 2010 Stock Awards and Incentive Plan (the “2010 Plan”) was approved by the Board of Directors in January 2010 and approved by the stockholders at the Annual Meeting in April 2010. The 2010 Plan authorized the reservation of an additional 700,000 shares of common stock for the granting of stock awards. The options granted to officers and employees are incentive stock options and the options granted to non-employee directors are non-qualified stock options. The purpose of the plan is to afford key employees an incentive to remain in the employ of Southern National and to assist in the attracting and retaining of non-employee directors by affording them an opportunity to share in Southern National’s future success. Under the plan, the option’s price cannot be less than the fair market value of the stock on the grant date. The maximum term of the options is ten years and options granted may be subject to a graded vesting schedule. At the June 21, 2017 Annual Meeting of Stockholders of Southern National, the 2017 Equity Compensation Plan (the “2017 Plan”) was approved as recommended by the Board of Directors. The 2017 Plan replaces the 2010 Plan and has a maximum number of 750,000 shares reserved for issuance. The purpose of the 2017 Plan is to promote the success of the Company by providing greater incentive to employees, non-employee directors, consultants and advisors to associate their personal interests with the long-term financial success of the Company, including its subsidiaries, and with growth in stockholder value, consistent with the Company’s risk management practices. Because the 2017 Plan was approved, shares under the 2004 stock-option plan or 2010 Plan will no longer be awarded.

 

A total of 52,700 stock options were exercised during the first six months of 2018. Southern National granted 58,000 shares of restricted stock during the first six months of 2018. A total of 700 shares of restricted stock issued in 2017 were forfeited during the first quarter of 2018 due to the employee who was granted the restricted shares leaving the Company before the shares had vested.

 

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For the three and six months ended June 30, 2018, stock-based compensation expense was $94 thousand and $169 thousand, respectively. That compares to $41 thousand and $101 thousand for the same periods in 2017, respectively. As of June 30, 2018, unrecognized compensation expense associated with the stock options was $136 thousand, which is expected to be recognized over a weighted average period of 1.9 years.

 

A summary of the activity in the stock option plan during the six months ended June 30, 2018 follows:

 

           Weighted     
       Weighted   Average   Aggregate 
       Average   Remaining   Intrinsic 
       Exercise   Contractual   Value 
   Shares   Price   Term   (in thousands) 
Options outstanding, beginning of period   714,967   $9.83           
Granted   -    -           
Forfeited   -    -           
Exercised   (52,700)   7.37           
Options outstanding, end of period   662,267   $10.03    5.4   $5,280 
                     
Exercisable at end of period   431,567   $9.05    4.3   $3,167 

 

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4.INVESTMENT SECURITIES

 

The amortized cost and fair value of available for sale investment securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows (in thousands):

 

   Amortized   Gross Unrealized   Fair 
June 30, 2018  Cost   Gains   Losses   Value 
Residential government-sponsored mortgage-backed securities  $29,498   $-   $(919)  $28,579 
Obligations of states and political subdivisions   18,443    29    (357)   18,115 
Corporate securities   2,010    -    (4)   2,006 
Trust preferred securities   2,590    208    (64)   2,734 
Residential government-sponsored collateralized mortgage obligations   47,729    1    (1,617)   46,113 
Government-sponsored agency securities   3,247    -    (141)   3,106 
Agency commercial mortgage-backed securities   28,178    -    (1,029)   27,149 
SBA pool securities   22,372    5    (343)   22,034 
Total  $154,067   $243   $(4,474)  $149,836 
             
   Amortized   Gross Unrealized   Fair 
December 31, 2017  Cost   Gains   Losses   Value 
Residential government-sponsored mortgage-backed securities  $31,145   $3   $(284)  $30,864 
Obligations of states and political subdivisions   18,581    187    (41)   18,727 
Corporate securities   2,013    2    -    2,015 
Trust preferred securities   2,590    -    (202)   2,388 
Residential government-sponsored collateralized mortgage obligations   51,521    1    (756)   50,766 
Government-sponsored agency securities   3,247    -    (21)   3,226 
Agency commercial mortgage-backed securities   28,263    -    (365)   27,898 
SBA pool securities   24,829    68    (108)   24,789 
Total  $162,189   $261   $(1,777)  $160,673 

 

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The amortized cost, unrecognized gains and losses, and fair value of investment securities held to maturity were as follows (in thousands):

 

   Amortized   Gross Unrecognized   Fair 
June 30, 2018  Cost   Gains   Losses   Value 
Residential government-sponsored mortgage-backed securities  $10,459   $3   $(294)  $10,168 
Obligations of states and political subdivisions   22,656    95    (192)   22,559 
Trust preferred securities   3,054    172    (15)   3,211 
Residential government-sponsored collateralized mortgage obligations   7,353    -    (136)   7,217 
Government-sponsored agency securities   52,653    -    (3,316)   49,337 
Total  $96,175   $270   $(3,953)  $92,492 
                     
   Amortized   Gross Unrecognized   Fair 
December 31, 2017  Cost   Gains   Losses   Value 
Residential government-sponsored mortgage-backed securities  $11,500   $23   $(77)  $11,446 
Obligations of states and political subdivisions   22,830    169    (56)   22,943 
Trust preferred securities   3,205    165    (17)   3,353 
Residential government-sponsored collateralized mortgage obligations   8,727    -    (99)   8,628 
Government-sponsored agency securities   52,650    25    (1,448)   51,227 
Total  $98,912   $382   $(1,697)  $97,597 

 

The amortized cost amounts are net of recognized other than temporary impairment.

 

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The fair value and carrying amount, if different, of debt investment securities as of June 30, 2018, by contractual maturity were as follows (in thousands). Investment securities not due at a single maturity date are shown separately.

 

   Held to Maturity   Available for Sale 
   Amortized       Amortized     
   Cost   Fair Value   Cost   Fair Value 
Due in one to five years  $5,367   $5,348   $3,402   $3,317 
Due in five to ten years   20,096    19,165    5,365    5,314 
Due after ten years   52,900    50,594    17,523    17,330 
Residential government-sponsored mortgage-backed securities   10,459    10,168    29,498    28,579 
Residential government-sponsored collateralized mortgage obligations   7,353    7,217    47,729    46,113 
Agency commercial mortgage-backed securities   -    -    28,178    27,149 
SBA pool securities   -    -    22,372    22,034 
Total  $96,175   $92,492   $154,067   $149,836 

 

Investment securities with a carrying amount of approximately $163.9 million and $173.4 million at June 30, 2018 and December 31, 2017, respectively, were pledged to secure public deposits, certain other deposits, a line of credit for advances from the Federal Home Loan Bank of Atlanta (“FHLB”), and repurchase agreements.

 

Southern National monitors the portfolio for indicators of other than temporary impairment. At June 30, 2018 and December 31, 2017, certain investment securities’ fair values were below cost. As outlined in the table below, there were investment securities with fair values totaling approximately $222.3 million in the portfolio with the carrying value exceeding the estimated fair value that are considered temporarily impaired at June 30, 2018. Because the decline in fair value is attributable to changes in interest rates and market illiquidity, and not credit quality, and because we do not have the intent to sell these investment securities and it is likely that we will not be required to sell the investment securities before their anticipated recovery, management does not consider these investment securities to be other than temporarily impaired as of June 30, 2018.

 

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The following tables present information regarding investment securities in a continuous unrealized loss position as of June 30, 2018 and December 31, 2017 by duration of time in a loss position (in thousands):

 

June 30, 2018  Less than 12 months   12 Months or More   Total 
Available for Sale  Fair value   Unrealized
Losses
   Fair value   Unrealized
Losses
   Fair value   Unrealized
Losses
 
Residential government-sponsored mortgage-backed securities  $21,281   $(793)  $7,136   $(126)  $28,417   $(919)
Obligations of states and political subdivisions   16,264    (357)   -    -    16,264    (357)
Corporate securities   1,006    (4)   -    -    1,006    (4)
Trust preferred securities   -    -    1,035    (64)   1,035    (64)
Residential government-sponsored collateralized mortgage obligations   41,339    (1,486)   4,444    (131)   45,783    (1,617)
Government-sponsored agency securities   3,106    (141)   -    -    3,106    (141)
Agency commercial mortgage-backed securities   27,149    (1,029)   -    -    27,149    (1,029)
SBA pool securities   13,254    (247)   5,608    (96)   18,862    (343)
Total  $123,399   $(4,057)  $18,223   $(417)  $141,622   $(4,474)
                               
   Less than 12 months   12 Months or More   Total 
Held to Maturity  Fair value   Unrecognized
Losses
   Fair value   Unrecognized
Losses
   Fair value   Unrecognized
Losses
 
Residential government-sponsored mortgage-backed securities  $7,021   $(178)  $2,599   $(116)  $9,620   $(294)
Obligations of states and political subdivisions   10,965    (99)   3,311    (93)   14,276    (192)
Trust preferred securities   -    -    238    (15)   238    (15)
Residential government-sponsored collateralized mortgage obligations   1,076    (26)   6,141    (110)   7,217    (136)
Government-sponsored agency securities   13,253    (422)   36,085    (2,894)   49,338    (3,316)
Total  $32,315   $(725)  $48,374   $(3,228)  $80,689   $(3,953)
                               
December 31, 2017                        
   Less than 12 months   12 Months or More   Total 
Available for Sale  Fair value   Unrealized
Losses
   Fair value   Unrealized
Losses
   Fair value   Unrealized
Losses
 
Residential government-sponsored mortgage-backed securities  $30,336   $(284)  $-   $-   $30,336   $(284)
Obligations of states and political subdivisions   4,642    (41)   -    -    4,642    (41)
Trust preferred securities   1,473    (18)   915    (184)   2,388    (202)
Residential government-sponsored collateralized mortgage obligations   50,555    (756)   -    -    50,555    (756)
Government-sponsored agency securities   1,726    (21)   -    -    1,726    (21)
Agency commercial mortgage-backed securities   27,898    (365)   -    -    27,898    (365)
SBA pool securities   15,156    (108)   -    -    15,156    (108)
Total  $131,786   $(1,593)  $915   $(184)  $132,701   $(1,777)
                               
   Less than 12 months   12 Months or More   Total 
Held to Maturity  Fair value   Unrecognized
Losses
   Fair value   Unrecognized
Losses
   Fair value   Unrecognized
Losses
 
Residential government-sponsored mortgage-backed securities  $3,409   $(26)  $2,986   $(51)  $6,395   $(77)
Obligations of states and political subdivisions   7,918    (34)   1,782    (22)   9,700    (56)
Trust preferred securities   -    -    240    (17)   240    (17)
Residential government-sponsored collateralized mortgage obligations   7,112    (46)   1,516    (53)   8,628    (99)
Government-sponsored agency securities   1,719    (2)   37,532    (1,446)   39,251    (1,448)
Total  $20,158   $(108)  $44,056   $(1,589)  $64,214   $(1,697)

 

 17 

 

 

As of June 30, 2018, we owned pooled trust preferred securities as follows:

 

                                  Previously 
                              % of Current   Recognized 
                              Defaults and   Cumulative 
      Ratings                Estimated   Deferrals to   Other 
   Tranche  When Purchased  Current Ratings  Par   Book   Fair   Total   Comprehensive 
Security  Level  Moody's  Fitch  Moody's  Fitch  Value   Value   Value   Collateral   Loss (1) 
                  (in thousands)         
Held to Maturity                                        
ALESCO VII A1B  Senior  Aaa  AAA  Aa2  AA  $3,026   $2,801    $2,973    18%  $219 
MMCF III B  Senior Sub  A3  A-  Ba1  BBB   257    253    238    32%   4 
                   3,283    3,054    3,211        $223 
                                         
                                      Cumulative OTTI 
                                      Related to  
                                      Credit Loss (2) 
Available for Sale                                        
Other Than Temporarily Impaired:                                        
TPREF FUNDING II  Mezzanine  A1  A-  Caa3  C   1,500    1,099    1,035    26%  $400 
ALESCO V C1  Mezzanine  A2  A  Caa1  C   2,150    1,491    1,699    14%   660 
                   3,650    2,590    2,734        $1,060 
                                         
Total                 $6,933   $5,644   $5,945           

 

(1) Pre-tax, and represents unrealized losses at date of transfer from available-for-sale to held-to-maturity, net of accretion

(2) Pre-tax

 

Each of these investment securities has been evaluated for other than temporary impairment. In performing a detailed cash flow analysis of each investment security, Sonabank works with independent third parties to estimate expected cash flows and assist with the evaluation of other than temporary impairment. The cash flow analyses performed included the following assumptions:

 

·0.5% of the remaining performing collateral will default or defer per annum.
·Recoveries of 9% with a two year lag on all defaults and deferrals.
·No prepayments for 10 years and then 1% per annum for the remaining life of the investment security.
·Our investment securities have been modeled using the above assumptions by independent third parties using the forward LIBOR curve to discount projected cash flows to present values.

 

We recognized no other than temporary impairment charges during the six months ended June 30, 2018 and 2017, respectively.

 

 18 

 

 

Changes in accumulated other comprehensive loss by component for the three and six months ended June 30, 2018 and 2017 are shown in the tables below. All amounts are net of tax (in thousands).

 

   Unrealized Holding         
   Losses on
Available for Sale
   Held to Maturity     
For the three months ended June 30, 2018  Securities   Securities   Total 
Beginning balance  $(2,680)  $(179)  $(2,859)
Other comprehensive (loss) income before reclassifications   (662)   2    (660)
Ending balance  $(3,342)  $(177)  $(3,519)
             
   Unrealized Holding         
   Losses on
Available for Sale
   Held to Maturity     
For the three months ended June 30, 2017  Securities   Securities   Total 
Beginning balance  $(414)  $(160)  $(574)
Other comprehensive (loss) income before reclassifications   (331)   4    (327)
Ending balance  $(745)  $(156)  $(901)
             
   Unrealized Holding         
   Losses on
Available for Sale
   Held to Maturity     
For the six months ended June 30, 2018  Securities   Securities   Total 
Beginning balance  $(999)  $(153)  $(1,152)
Other comprehensive (loss) income before reclassifications   (2,144)   6    (2,138)
Reclassification adjustment   (199)   (30)   (229)
Ending balance  $(3,342)  $(177)  $(3,519)
                
   Unrealized Holding         
   Losses on
Available for Sale
   Held to Maturity     
For the six months ended June 30, 2017  Securities   Securities   Total 
Beginning balance  $(627)  $(162)  $(789)
Other comprehensive (loss) income before reclassifications   (118)   6    (112)
Ending balance  $(745)  $(156)  $(901)

 

 19 

 

 

5.LOANS AND ALLOWANCE FOR LOAN LOSSES

 

The following table summarizes the composition of our loan portfolio as of June 30, 2018 and December 31, 2017 (in thousands):

 

   June 30, 2018   December 31, 2017 
Loans secured by real estate:          
Commercial real estate - owner occupied  $402,839   $401,847 
Commercial real estate - non-owner occupied   477,032    440,700 
Secured by farmland   21,347    23,038 
Construction and land loans   190,399    197,972 
Residential 1-4 family   546,648    483,006 
Multi- family residential   83,471    70,892 
Home equity lines of credit   136,820    152,829 
Total real estate loans   1,858,556    1,770,284 
           
Commercial loans   261,487    253,258 
Consumer loans   35,000    39,374 
Gross loans   2,155,043    2,062,916 
           
Less deferred fees on loans   (151)   (588)
Loans, net of deferred fees  $2,154,892   $2,062,328 

 

Accounting policy related to the allowance for loan losses is considered a critical policy given the level of estimation, judgment, and uncertainty in the levels of the allowance required to account for the inherent probable losses in the loan portfolio and the material effect such estimation, judgment, and uncertainty can have on the consolidated financial results.

 

On June 23, 2017, in connection with the merger with EVBS, SNBV acquired loans held for sale with a fair value, after recognition of certain measurement period adjustments, of $19.7 million and loans held for investment with an unpaid principal balance of $1.05 billion and an estimated fair value, after recognition of certain measurement period adjustments, of $1.03 billion, which created an accretable discount of $14.2 million at acquisition. As of June 30, 2018, outstanding loans acquired in the merger with EVBS totaled $819 million.

 

As part of the Greater Atlantic Bank acquisition, the Bank and the FDIC entered into loss sharing agreements on approximately $143.4 million (contractual basis) of Greater Atlantic Bank’s assets.  There were two agreements with the FDIC: one for single family loans which is a 10-year agreement expiring in December 2019, and one for non-single family (commercial) assets which was a 5-year agreement which expired in December 2014. The Bank will share in the losses on the loans and foreclosed loan collateral with the FDIC as specified in the loss sharing agreements; we refer to these assets collectively as “covered assets.”  Loans that are not covered in the loss sharing agreement are referred to as “non-covered loans”. Covered loans totaled $19.9 million and $23.3 million at June 30, 2018 and December 31, 2017, respectively.

 

Accretable discount on the acquired EVBS, Greater Atlantic Bank (“GAB”), Prince George’s Federal Savings Bank (“PGFSB”), and the HarVest Bank (“HarVest”) loans totaled $15.5 million and $17.5 million at June 30, 2018 and December 31, 2017, respectively.

 

For the three acquisitions subsequent to the Greater Atlantic Bank acquisition noted above, management sold the majority of the purchased credit impaired loans immediately after closing of the acquisition.

 

 20 

 

 

Impaired loans for the covered and non-covered portfolios were as follows (in thousands):

 

   Total Loans 
       Unpaid     
   Recorded   Principal   Related 
June 30, 2018  Investment (1)   Balance   Allowance 
With no related allowance recorded               
Commercial real estate - owner occupied  $665   $665   $- 
Commercial real estate - non-owner occupied (2)   191    296    - 
Construction and land development   -    -    - 
Commercial loans   4,044    11,388    - 
Residential 1-4 family (3)   2,665    2,719    - 
Other consumer loans   22    22    - 
                
Total  $7,587   $15,090   $- 
                
With an allowance recorded               
Commercial real estate - owner occupied  $-   $-   $- 
Commercial real estate - non-owner occupied (2)   -    -    - 
Construction and land development   -    -    - 
Commercial loans   -    -    - 
Residential 1-4 family (3)   -    -    - 
Other consumer loans   -    -    - 
                
Total  $-   $-   $- 
Grand total  $7,587   $15,090   $- 

 

(1)Includes $4.0 million in SBA guarantees.
(2)Includes loans secured by farmland and multi-family loans.
(3)Includes home equity lines of credit.

 

   Total Loans 
       Unpaid     
   Recorded   Principal   Related 
December 31, 2017  Investment (1)   Balance   Allowance 
With no related allowance recorded               
Commercial real estate - owner occupied  $767   $781   $- 
Commercial real estate - non-owner occupied (2)   766    830    - 
Construction and land development   9,969    9,984    - 
Commercial loans   6,035    12,847    - 
Residential 1-4 family (3)   3,160    3,430    - 
Other consumer loans   -    -    - 
                
Total  $20,697   $27,872   $- 
                
With an allowance recorded               
Commercial real estate - owner occupied  $-   $-   $- 
Commercial real estate - non-owner occupied (2)   -    -    - 
Construction and land development   -    -    - 
Commercial loans   -    -    - 
Residential 1-4 family (3)   -    -    - 
Other consumer loans   -    -    - 
                
Total  $-   $-   $- 
Grand total  $20,697   $27,872   $- 

 

(1)Includes $5.0 million in SBA guarantees.
(2)Includes loans secured by farmland and multi-family loans.
(3)Includes home equity lines of credit.

 

 21 

 

 

The following tables present the average recorded investment and interest income for impaired loans recognized by class of loans for the three and six months ended June 30, 2018 and 2017 (in thousands):

 

   Total Loans 
   Average   Interest 
   Recorded   Income 
Three Months Ended June 30, 2018  Investment   Recognized 
With no related allowance recorded          
Commercial real estate - owner occupied  $668   $9 
Commercial real estate - non-owner occupied (1)   193    5 
Construction and land development   -    - 
Commercial loans   5,109    10 
Residential 1-4 family (2)   2,894    14 
Other consumer loans   21    - 
           
Total  $8,885   $38 
           
With an allowance recorded          
Commercial real estate - owner occupied  $-   $- 
Commercial real estate - non-owner occupied (1)   -    - 
Construction and land development   -    - 
Commercial loans   -    - 
Residential 1-4 family (2)   -    - 
Other consumer loans   -    - 
           
Total  $-   $- 
Grand total  $8,885   $38 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

   Total Loans 
   Average   Interest 
   Recorded   Income 
Three Months Ended June 30, 2017  Investment   Recognized 
With no related allowance recorded          
Commercial real estate - owner occupied  $-   $- 
Commercial real estate - non-owner occupied (1)   -    - 
Construction and land development   -    - 
Commercial loans   2,052    - 
Residential 1-4 family (2)   1,287    9 
Other consumer loans   -    - 
           
Total  $3,339   $9 
           
With an allowance recorded          
Commercial real estate - owner occupied  $1,271   $8 
Commercial real estate - non-owner occupied (1)   -    - 
Construction and land development   -    - 
Commercial loans   -    - 
Residential 1-4 family (2)   430    - 
Other consumer loans   -    - 
           
Total  $1,701   $8 
Grand total  $5,040   $17 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

 22 

 

 

   Total Loans 
   Average   Interest 
   Recorded   Income 
Six Months Ended June 30, 2018  Investment   Recognized 
With no related allowance recorded          
Commercial real estate - owner occupied  $670   $17 
Commercial real estate - non-owner occupied (1)   194    10 
Construction and land development   -    - 
Commercial loans   5,032    25 
Residential 1-4 family (2)   2,733    49 
Other consumer loans   21    - 
           
Total  $8,650   $101 
           
With an allowance recorded          
Commercial real estate - owner occupied  $-   $- 
Commercial real estate - non-owner occupied (1)   -    - 
Construction and land development   -    - 
Commercial loans   -    - 
Residential 1-4 family (2)   -    - 
Other consumer loans   -    - 
           
Total  $-   $- 
Grand total  $8,650   $101 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

   Total Loans 
   Average   Interest 
   Recorded   Income 
Six Months Ended June 30, 2017  Investment   Recognized 
With no related allowance recorded          
Commercial real estate - owner occupied  $-   $- 
Commercial real estate - non-owner occupied (1)   -    - 
Construction and land development   -    - 
Commercial loans   2,085    - 
Residential 1-4 family (2)   1,288    17 
Other consumer loans   -    - 
           
Total  $3,373   $17 
           
With an allowance recorded          
Commercial real estate - owner occupied  $1,297   $16 
Commercial real estate - non-owner occupied (1)   -    - 
Construction and land development   -    - 
Commercial loans   -    - 
Residential 1-4 family (2)   336    - 
Other consumer loans   -    - 
           
Total  $1,633   $16 
Grand total  $5,006   $33 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

 23 

 

 

The following tables present the aging of the recorded investment in past due loans by class of loans as of June 30, 2018 and December 31, 2017 (in thousands):

 

   30 - 59   60 - 89                     
   Days   Days   90 Days   Total   Nonaccrual   Loans Not   Total 
June 30, 2018  Past Due   Past Due   or More   Past Due   Loans   Past Due   Loans 
Total loans:                                   
Commercial real estate - owner occupied  $954   $-   $-   $954   $-   $401,885   $402,839 
Commercial real estate - non-owner occupied (1)   44    -    -    44    -    581,806    581,850 
Construction and land development   44    114    -    158    -    190,241    190,399 
Commercial loans   296    22    -    318    3,699    257,470    261,487 
Residential 1-4 family (2)   2,836    1,192    -    4,028    2,061    677,379    683,468 
Other consumer loans   25    54    -    79    21    34,900    35,000 
                                    
Total  $4,199   $1,382   $-   $5,581   $5,781   $2,143,681   $2,155,043 
                             
   30 - 59   60 - 89                     
   Days   Days   90 Days   Total   Nonaccrual   Loans Not   Total 
December 31, 2017  Past Due   Past Due   or More   Past Due   Loans   Past Due   Loans 
Total loans:                                   
Commercial real estate - owner occupied  $687   $-   $-   $687   $-   $401,160   $401,847 
Commercial real estate - non-owner occupied (1)   138    50    -    188    -    534,442    534,630 
Construction and land development   1,134    44    -    1,178    9,969    186,825    197,972 
Commercial loans   496    -    -    496    5,664    247,098    253,258 
Residential 1-4 family (2)   2,926    361    -    3,287    2,392    630,156    635,835 
Other consumer loans   57    1    -    58    -    39,316    39,374 
                                    
Total  $5,438   $456   $-   $5,894   $18,025   $2,038,997   $2,062,916 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

 24 

 

 

Activity in the allowance for non-covered loan and lease losses for the three and six months ended June 30, 2018 and 2017 is summarized below (in thousands):

 

       Commercial                         
   Commercial   Real Estate                         
   Real Estate   Non-owner   Construction       1-4 Family   Other         
   Owner   Occupied   and Land   Commercial   Residential   Consumer   Un-     
   Occupied   (1)   Development   Loans   (2)   Loans   allocated   Total 
Three Months Ended June 30, 2018                                        
Allowance for loan losses:                                        
Beginning balance  $859   $1,550   $804   $5,272   $1,450   $820   $-   $10,755 
Charge offs   -    -    -    (707)   (95)   (91)   -    (893)
Recoveries   4    -    -    32    25    27    -    88 
Provision   (113)   (257)   69    1,709    199    (557)   -    1,050 
                                         
Ending balance  $750   $1,293   $873   $6,306   $1,579   $199   $-   $11,000 
                                         
Three Months Ended June 30, 2017                                        
Allowance for loan losses:                                        
Beginning balance  $1,188   $1,546   $801   $3,007   $1,254   $74   $808   $8,678 
Charge offs   -    (100)   -    (467)   (307)   (5)   -    (879)
Recoveries   11    299    -    36    2    -    -    348 
Provision   (261)   45    295    115    474    15    367    1,050 
                                         
Ending balance  $938   $1,790   $1,096   $2,691   $1,423   $84   $1,175   $9,197 

 

(1)Includes loans secured by farmland and multi-family loans.

(2)Includes home equity lines of credit.

 

       Commercial                         
   Commercial   Real Estate                         
   Real Estate   Non-owner   Construction       1-4 Family   Other         
   Owner   Occupied   and Land   Commercial   Residential   Consumer   Un-     
   Occupied   (1)   Development   Loans   (2)   Loans   allocated   Total 
Six Months Ended June 30, 2018                                        
Allowance for loan losses:                                        
Beginning balance  $690   $1,321   $692   $4,496   $1,586   $612   $-   $9,397 
Charge offs   -    -    -    (937)   (261)   (182)   -    (1,380)
Recoveries   7    -    -    207    89    30    -    333 
Provision   53    (28)   181    2,540    165    (261)   -    2,650 
                                         
Ending balance  $750   $1,293   $873   $6,306   $1,579   $199   $-   $11,000 
                                         
Six Months Ended June 30, 2017                                        
Allowance for loan losses:                                        
Beginning balance  $905   $1,484   $752   $3,366   $1,279   $78   $746   $8,610 
Charge offs   -    (100)   -    (967)   (319)   (5)   -    (1,391)
Recoveries   21    299    -    51    5    2    -    378 
Provision   12    107    344    241    458    9    429    1,600 
                                         
Ending balance  $938   $1,790   $1,096   $2,691   $1,423   $84   $1,175   $9,197 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

 25 

 

 

The following tables present the balance in the allowance for loan losses and the recorded investment in non-covered loans by portfolio segment and based on impairment method as of June 30, 2018 and December 31, 2017 (in thousands):

 

       Commercial                         
   Commercial   Real Estate                         
   Real Estate   Non-owner   Construction       1-4 Family   Other         
   Owner   Occupied   and Land   Commercial   Residential   Consumer   Un-     
   Occupied   (1)   Development   Loans   (2)   Loans   allocated   Total 
June 30, 2018                                        
Ending allowance balance attributable to loans:                                        
Individually evaluated for impairment  $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment   750    1,293    873    6,306    1,579    199    -    11,000 
Total ending allowance  $750   $1,293   $873   $6,306   $1,579   $199   $-   $11,000 
                                         
Loans:                                        
Individually evaluated for impairment  $665   $191   $-   $4,044   $2,665   $22   $-   $7,587 
Collectively evaluated for impairment   402,174    581,659    190,399    257,443    680,803    34,978    -    2,147,456 
Total ending loan balances  $402,839   $581,850   $190,399   $261,487   $683,468   $35,000   $-   $2,155,043 
                                         
December 31, 2017                                        
Ending allowance balance attributable to loans:                                        
Individually evaluated for impairment  $-   $-   $-   $-   $-   $-   $-   $- 
Collectively evaluated for impairment   690    1,321    692    4,496    1,586    612    -    9,397 
Total ending allowance  $690   $1,321   $692   $4,496   $1,586   $612   $-   $9,397 
                                         
Loans:                                        
Individually evaluated for impairment  $767   $766   $9,969   $6,035   $3,160   $-   $-   $20,697 
Collectively evaluated for impairment   401,080    533,864    188,003    247,223    632,675    39,374    -    2,042,219 
Total ending loan balances  $401,847   $534,630   $197,972   $253,258   $635,835   $39,374   $-   $2,062,916 

 

(1)Includes loans secured by farmland and multi-family loans.
(2)Includes home equity lines of credit.

 

Troubled Debt Restructurings

 

A modification is classified as a troubled debt restructuring (“TDR”) if both of the following exist: (1) the borrower is experiencing financial difficulty and (2) the Bank has granted a concession to the borrower. The Bank determines that a borrower may be experiencing financial difficulty if the borrower is currently delinquent on any of its debt, or if the Bank is concerned that the borrower may not be able to perform in accordance with the current terms of the loan agreement in the foreseeable future. Many aspects of the borrower’s financial situation are assessed when determining whether they are experiencing financial difficulty, particularly as it relates to commercial borrowers due to the complex nature of the loan structure, business/industry risk and borrower/guarantor structures. Concessions may include the reduction of an interest rate at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, or principal forgiveness. When evaluating whether a concession has been granted, the Bank also considers whether the borrower has provided additional collateral or guarantors and whether such additions adequately compensate the Bank for the restructured terms, or if the revised terms are consistent with those currently being offered to new loan customers. The assessments of whether a borrower is experiencing (or is likely to experience) financial difficulty and whether a concession has been granted is subjective in nature and management’s judgment is required when determining whether a modification is a TDR.

 

Although each occurrence is unique to the borrower and is evaluated separately, for all portfolio segments, TDRs are typically modified through reduction in interest rates, reductions in payments, changing the payment terms from principal and interest to interest only, and/or extensions in term maturity.

 

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During the six months ending June 30, 2018 and June 30, 2017, there were no loans modified in TDRs. One TDR which had been modified in 2013 defaulted during the second quarter of 2015. This loan, in the amount of $665 thousand, was current as of June 30, 2018.

 

Credit Quality Indicator

 

Through its system of internal controls, Southern National evaluates and segments loan portfolio credit quality on a quarterly basis using regulatory definitions for Special Mention, Substandard and Doubtful. Special Mention loans are considered to be criticized. Substandard and Doubtful loans are considered to be classified.

 

Special Mention loans are loans that have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position.

 

Substandard loans may be inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged if any. Loans so classified have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected.

 

Doubtful loans have all the weaknesses inherent in those classified as substandard, with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions, and values, highly questionable and improbable. Southern National had no loans classified as Doubtful at June 30, 2018 or December 31, 2017.

 

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As of June 30, 2018 and December 31, 2017, and based on the most recent analysis performed, the risk category of loans by class of loans is as follows (in thousands):

 

   Total Loans 
   Special             
June 30, 2018  Mention   Substandard (3)   Pass   Total 
Commercial real estate - owner occupied  $6,775   $1,551   $394,513   $402,839 
Commercial real estate - non-owner occupied (1)   5,280    191    576,379    581,850 
Construction and land development   83    -    190,316    190,399 
Commercial loans   6,678    4,044    250,765    261,487 
Residential 1-4 family (2)   1,017    3,379    679,072    683,468 
Other consumer loans   152    22    34,826    35,000 
Total  $19,985   $9,187   $2,125,871   $2,155,043 
     
   Total Loans 
   Special             
December 31, 2017  Mention   Substandard (3)   Pass   Total 
Commercial real estate - owner occupied  $4,178   $1,678   $395,991   $401,847 
Commercial real estate - non-owner occupied (1)   5,705    830    528,095    534,630 
Construction and land development   128    9,969    187,875    197,972 
Commercial loans   5,936    6,035    241,287    253,258 
Residential 1-4 family (2)   1,323    3,935    630,577    635,835 
Other consumer loans   162    -    39,212    39,374 
Total  $17,432   $22,447   $2,023,037   $2,062,916 

 

(1) Includes loans secured by farmland and multi-family residential loans.

(2) Includes home equity lines of credit.

(3) Includes SBA guarantees of $4.0 million and $5.0 million as of June 30, 2018 and December 31, 2017, respectively.

 

The amount of foreclosed residential real estate property held at June 30, 2018 and December 31, 2017 was $1.4 million and $3.3 million, respectively. The recorded investment in consumer mortgage loans collateralized by residential real estate property that are in the process of foreclosure was $83 thousand and $939 thousand at June 30, 2018 and December 31, 2017, respectively.

 

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6.FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK

 

Southern National is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and guarantees of credit card accounts sold by EVBS premerger. These instruments involve elements of credit and funding risk in excess of the amount recognized in the consolidated balance sheet. Letters of credit are written conditional commitments issued by Southern National to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling $15.7 million and $15.2 million as of June 30, 2018 and December 31, 2017, respectively.

 

Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Unless noted otherwise, we do not require collateral or other security to support financial instruments with credit risk.

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer's creditworthiness on a case-by-case basis.

 

At June 30, 2018 and December 31, 2017, we had unfunded lines of credit and undisbursed construction loan funds totaling $326.8 million and $361.7 million, respectively. Virtually all of our unfunded lines of credit and undisbursed construction loan funds are variable rate.

 

Pre-merger, EVBS sold its credit card portfolio. With that sale, EVBS guaranteed the credit card accounts of certain customers to the bank that issues the cards. In connection with the merger with EVBS, Southern National now is the guarantor. The fair value of guarantees of credit card accounts previously sold is based on the estimated cost to settle the obligations with the counterparty and are not considered significant as of June 30, 2018.

 

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7.Earnings Per Share

 

The following is a reconciliation of the denominators of the basic and diluted earnings per share (“EPS”) computations (dollars in thousands, except per share data):

 

       Weighted     
       Average     
   Income   Shares   Per Share 
   (Numerator)   (Denominator)   Amount 
For the three months ended June 30, 2018               
Basic EPS  $8,867   $24,038   $0.37 
Effect of dilutive stock options and warrants   -    292    - 
Diluted EPS  $8,867   $24,330   $0.37 
                
For the three months ended June 30, 2017               
Basic EPS  $(2,842)  $13,231   $(0.21)
Effect of dilutive stock options and warrants   -    -    - 
Diluted EPS  $(2,842)  $13,231   $(0.21)
                
For the six months ended June 30, 2018               
Basic EPS  $17,126   $24,000   $0.71 
Effect of dilutive stock options and warrants   -    282    - 
Diluted EPS  $17,126   $24,282   $0.71 
                
For the six months ended June 30, 2017               
Basic EPS  $(788)  $12,772   $(0.06)
Effect of dilutive stock options and warrants   -    -    - 
Diluted EPS  $(788)  $12,772   $(0.06)

 

There were 422,789 and 432,713 anti-dilutive options outstanding for the three and six months ended June 30, 2018. There were 466,655 and 172,819 anti-dilutive options and warrants outstanding for the three and six months ended June 30, 2017, respectively.

 

8.FAIR VALUE

 

ASC 820-10 establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:

 

Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date

 

Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data

 

Level 3: Significant unobservable inputs that reflect a reporting entity’s own assumptions about the assumptions that market participants would use in pricing an asset or liability

 

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The following is a description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy:

 

Investment Securities Available for Sale

 

Where quoted prices are available in an active market, investment securities are classified within Level 1 of the valuation hierarchy. Level 1 investment securities would include highly liquid government bonds, mortgage products and exchange traded equities. If quoted market prices are not available, then fair values are estimated by using pricing models, quoted prices of investment securities with similar characteristics or discounted cash flow. Level 2 investment securities would include U.S. agency securities, mortgage-backed securities, obligations of states and political subdivisions and certain corporate, asset-backed and other securities. In certain cases where there is limited activity or less transparency around inputs to the valuation, investment securities are classified within Level 3 of the valuation hierarchy. Currently, all of Southern National’s available for sale debt investment securities are considered to be Level 2 investment securities.

 

Assets measured at fair value on a recurring basis are summarized below:

 

       Fair Value Measurements Using 
           Significant     
       Quoted Prices in   Other   Significant 
       Active Markets for   Observable   Unobservable 
   Total at   Identical Assets   Inputs   Inputs 
(dollars in thousands)  June 30, 2018   (Level 1)   (Level 2)   (Level 3) 
Financial assets:                    
Available for sale securities                    
Residential government-sponsored mortgage-backed securities  $28,579   $-   $28,579   $- 
Obligations of states and political subdivisions   18,115    -    18,115    - 
Corporate securities   2,006    -    2,006    - 
Trust preferred securities   2,734    -    2,734    - 
Residential government-sponsored collateralized mortgage obligations   46,113    -    46,113    - 
Government-sponsored agency securities   3,106    -    3,106    - 
Agency commercial mortgage-backed securities   27,149    -    27,149    - 
SBA pool securities   22,034    -    22,034    - 
Total  $149,836   $-   $149,836   $- 
         
       Fair Value Measurements Using 
           Significant     
       Quoted Prices in   Other   Significant 
       Active Markets for   Observable   Unobservable 
   Total at   Identical Assets   Inputs   Inputs 
(dollars in thousands)  December 31, 2017   (Level 1)   (Level 2)   (Level 3) 
Financial assets:                    
Available for sale securities                    
Residential government-sponsored mortgage-backed securities  $30,864   $-   $30,864   $- 
Obligations of states and political subdivisions   18,727    -    18,727    - 
Corporate securities   2,015    -    2,015    - 
Trust preferred securities   2,388    -    2,388    - 
Residential government-sponsored collateralized mortgage obligations   50,766    -    50,766    - 
Government-sponsored agency securities   3,226    -    3,226    - 
Agency commercial mortgage-backed securities   27,898    -    27,898    - 
SBA pool securities   24,789    -    24,789    - 
Total  $160,673   $-   $160,673   $- 

 

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Assets and Liabilities Measured on a Non-recurring Basis:

 

Impaired Loans

 

Generally, we measure the impairment for impaired loans considering the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral is determined by an independent appraisal or evaluation less estimated costs related to selling the collateral. In some cases appraised value is net of costs to sell. Estimated selling costs range from 6% to 10% of collateral valuation at June 30, 2018 and December 31, 2017. For loans who fair values are not measured based on the fair value of the collateral, impairment is measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate. Fair value is classified as Level 3 in the fair value hierarchy. Loans identified as impaired totaled $7.6 million (including SBA guarantees of $4.0 million) as of June 30, 2018 with no allocation made to the allowance for loan losses compared to a carrying amount of $20.7 million (including SBA guarantees of $5.0 million) with $0 allocated allowance for loan losses at December 31, 2017.

 

Assets held for sale

 

In connection with the merger with EVBS, SNBV acquired four properties that were either former EVBS administrative locations or previously anticipated to be future EVBS administrative locations. Assets held for sale are measured at fair value less cost to sell, based on appraisals conducted by an independent, licensed appraiser outside of the Company using observable market data. If the fair value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. Assets held for sale are measured at fair value on a non-recurring basis. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the consolidated statements of income.

 

Other Real Estate Owned (“OREO”)

 

OREO is evaluated at the time of acquisition and recorded at fair value as determined by independent appraisal or evaluation less cost to sell. In some cases appraised value is net of costs to sell. Selling costs have been in the range from 5.0% to 7.6% of collateral valuation at June 30, 2018 and December 31, 2017. Fair value is classified as Level 3 in the fair value hierarchy. OREO is further evaluated quarterly for any additional impairment. At June 30, 2018 and December 31, 2017 total OREO was $5.6 million and $7.6 million, respectively.

 

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Assets measured at fair value on a non-recurring basis are summarized below:

 

       Fair Value Measurements Using 
           Significant     
       Quoted Prices in   Other   Significant 
       Active Markets for   Observable   Unobservable 
   Total at   Identical Assets   Inputs   Inputs 
(dollars in thousands)  June 30, 2018   (Level 1)   (Level 2)   (Level 3) 
Impaired loans:                    
Commercial real estate - owner occupied  $665   $-   $-   $665 
Commercial real estate - non-owner occupied (1)   191    -    -    191 
Commercial loans   4,044    -    -    4,044 
Residential 1-4 family (2)   2,665    -    -    2,665 
Consumer   22    -    -    22 
Assets held for sale   600    -    -    600 
Other real estate owned:                    
Commercial real estate - owner occupied (1)   1,008    -    -    1,008 
Construction and land development   3,185    -    -    3,185 
Residential 1-4 family (2)   1,367    -    -    1,367 
                     
       Fair Value Measurements Using 
           Significant     
       Quoted Prices in   Other   Significant 
       Active Markets for   Observable   Unobservable 
   Total at   Identical Assets   Inputs   Inputs 
(dollars in thousands)  December 31, 2017   (Level 1)   (Level 2)   (Level 3) 
Impaired loans:                    
Commercial real estate - owner occupied  $767   $-   $-   $767 
Commercial real estate - non-owner occupied (1)   766    -    -    766 
Construction and land development   9,969    -    -    9,969 
Commercial loans   6,035    -    -    6,035 
Residential 1-4 family (2)   3,160    -    -    3,160 
Assets held for sale   1,927    -    -    1,927 
Other real estate owned:                    
Commercial real estate - owner occupied (1)   1,060    -    -    1,060 
Construction and land development   3,229    -    -    3,229 
Residential 1-4 family (2)   3,288    -    -    3,288 

 

(1) Includes loans secured by farmland and multi-family residential loans.

(2) Includes home equity lines of credit.

 

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Fair Value of Financial Instruments

 

The carrying amount, estimated fair values and fair value hierarchy levels (previously defined) of financial instruments were as follows (in thousands):

 

      June 30, 2018   December 31, 2017 
   Fair Value  Carrying   Fair   Carrying   Fair 
   Hierarchy Level  Amount   Value   Amount   Value 
Financial assets:                       
Cash and cash equivalents  Level 1  $52,163   $52,163   $25,463   $25,463 
Securities available for sale  Level 2   149,836    149,836    160,673    160,673 
Securities held to maturity  Level 2   96,175    92,492    98,912    97,597 
Stock in Federal Reserve Bank and Federal  Home Loan Bank  n/a   26,019    n/a    26,775    n/a 
Equity investment in mortgage affiliate  Level 3   4,597    4,597    4,723    4,723 
Preferred investment in mortgage affiliate  Level 3   3,305    3,305    3,305    3,305 
Net loans  Level 3   2,143,892    2,141,499    2,052,931    2,058,779 
Accrued interest receivable  Level 2 & Level 3   8,162    8,162    8,073    8,073 
FDIC indemnification asset  Level 3   1,003    309    1,353    309 
Financial liabilities:                       
Demand deposits  Level 1  $659,335    659,335   $649,067   $649,067 
Money market and savings accounts  Level 1   477,081    477,081    517,031    517,031 
Certificates of deposit  Level 3   844,287    841,742    699,058    694,368 
Securities sold under agreements to repurchase  Level 1   20,289    20,289    15,468    15,468 
FHLB short term advances  Level 1   316,215    316,215    335,615    335,615 
Junior subordinated debt  Level 2   9,559    9,854    9,534    12,043 
Senior subordinated notes  Level 2   47,109    47,065    47,128    58,163 
Accrued interest payable  Level 1 & Level 3   2,639    2,639    2,273    2,273 

 

Carrying amount is the estimated fair value for cash and cash equivalents, equity investment in mortgage affiliate, preferred investment in mortgage affiliate, accrued interest receivable and payable, demand deposits, savings accounts, money market accounts, securities sold under agreements to repurchase, and short-term debt (FHLB short-term advances and securities sold under agreements to repurchase). Fair value of long-term debt is based on current rates for similar financing. It was not practicable to determine the fair value of Federal Reserve Bank and Federal Home Loan Bank stock due to restrictions placed on its transferability. The fair value of the FDIC indemnification asset was determined by discounting estimated future cash flows using the long-term risk free rate plus a premium and represents the present value of our current expectation for recoveries from the FDIC on covered loans. The fair value of off-balance-sheet items is not considered material.

 

At June 30, 2018 fair value of net loans, certificates of deposits, junior subordinated debt, and senior subordinated notes are measured using the exit-price notion in accordance with the adoption of ASU 2016-01. At December 31, 2017 the fair value of net loans and certificates of deposits are based on discounted cash flows using current market rates applied to the estimated life of the asset.

 

9.SECURITIES SOLD UNDER AGREEMENTS TO REPURCHASE AND OTHER SHORT-TERM BORROWINGS

 

Other short-term borrowings can consist of Federal Home Loan Bank (“FHLB”) overnight advances, other FHLB advances maturing within one year, federal funds purchased and securities sold under agreements to repurchase (“repo”) that mature within one year, which are secured transactions with customers.

 

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In the second quarter of 2016, the Company discontinued offering repo accounts. However, repo accounts totaling $7.6 million were assumed on June 23, 2017 in the merger with EVBS. During the third quarter of 2017 the Company determined that it will continue to offer repo accounts and the balance at June 30, 2018 and December 31, 2017 was $20.3 million and $15.5 million, respectively.

 

10.JUNIOR SUBORDINATED DEBT AND SENIOR SUBORDINATED NOTES

 

In connection with our merger with EVBS, the Company assumed $10.3 million of trust preferred securities that were issued on September 17, 2003 and placed through the Trust in a pooled underwriting totaling approximately $650 million. The trust issuer has invested the total proceeds from the sale of the trust preferred securities in Floating Rate Junior Subordinated Deferrable Interest Debentures (“Junior Subordinated Debt”) issued by EVBS. The trust preferred securities pay cumulative cash distributions quarterly at a variable rate per annum, reset quarterly, equal to the three-month LIBOR plus 2.95%. As of June 30, 2018 and December 31, 2017, the interest rate was 5.28% and 4.55%, respectively. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. The trust preferred securities have a mandatory redemption date of September 17, 2033, and became subject to varying call provisions beginning September 17, 2008. The Company has fully and unconditionally guaranteed the trust preferred securities through the combined operation of the Junior Subordinated Debt and other related documents. The Company’s obligation under the guarantee is unsecured and subordinate to senior and subordinated indebtedness of the Company.

 

The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. At June 30, 2018, all of the trust preferred securities qualified as Tier 1 capital.

 

Subject to certain exceptions and limitations, the Company is permitted to elect from time to time to defer regularly scheduled interest payments on its outstanding Junior Subordinated Debt relating to its trust preferred securities. If the Company defers interest payments on the Junior Subordinated Debt for more than 20 consecutive quarters, the Company would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable.

 

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. At June 30, 2018, all of the SNBV Senior Subordinated Notes qualified as Tier 2 capital. At June 30, 2018, the remaining unamortized debt issuance costs related to the SNBV Senior Subordinated Notes totaled $807 thousand.

 

Also in connection with our merger with EVBS, the Company assumed the Senior Subordinated Note Purchase Agreement previously entered into by EVBS on April 22, 2015 with certain institutional accredited investors pursuant to which EVBS sold $20.0 million in aggregate principal amount of its 6.50% Fixed-to-Floating Rate Subordinated Notes due 2025 (the “EVBS Senior Subordinated Notes”) to the investors at a price equal to 100% of the aggregate principal amount of the EVBS Senior Subordinated Notes. The EVBS Senior Subordinated Notes bear interest at an annual rate of 6.50%, payable semi-annually in arrears on May 1 and November 1 of each year ending on May 1, 2020. From and including May 1, 2020 to, but excluding, the maturity date, the EVBS Senior Subordinated Notes will bear interest at an annual rate, reset quarterly, equal to LIBOR determined on the determination date of the applicable interest period plus 502 basis points, payable quarterly in arrears on February 1, May 1, August 1 and November 1 of each year, beginning on August 1, 2020. The Company may, at its option, redeem, in whole or in part, the EVBS Senior Subordinated Notes as early as May 1, 2020, and any partial redemption would be made pro rata among all of the holders. At June 30, 2018 all of the EVBS Senior Subordinated Notes qualified as Tier 2 capital.

 

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ITEM 2 - 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 SNBV. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report and in our annual report on Form 10-K for the year ended December 31, 2017. Results of operations for the three and six months ended June 30, 2018 are not necessarily indicative of results that may be attained for any other period.

 

FORWARD-LOOKING STATEMENTS

 

Statements and financial discussion and analysis contained in this Quarterly Report on Form 10-Q that are not statements of historical fact constitute forward-looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on assumptions and involve a number of risks and uncertainties, many of which are beyond our control. The words “believe,” “may,” “should,” “anticipate,” “estimate,” “expect,” “intend,” “continue,” “would,” “could,” “hope,” “might,” “assume,” “objective,” “seek,” “plan,” “strive” and similar words, or the negatives of these words, are intended to identify forward-looking statements.

 

Many possible events or factors could affect our future financial results and performance and could 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 Risk Factor contained in this Quarterly Report on Form 10-Q, as well as the Risk Factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017, factors that could contribute to those differences include, but are not limited to:

 

the effects of future economic, business and market conditions and changes, domestic and foreign;
changes in the local economies in our market areas 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;
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 an acquisition 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;
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;
changes in governmental monetary and fiscal policies, including interest rate policies of the Board of Governors of the Federal Reserve System, or changes in interest rates and market prices, which could reduce our net interest margins, asset valuations and expense expectations;
increased competition for deposits and loans adversely affecting rates and terms;
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 lending activities;

 

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increased asset levels and changes in the composition of assets and the resulting impact on our capital levels and regulatory capital ratios;
risks of 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;
legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, including those associated with the Dodd Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) and changes in the scope and cost of Federal Deposit Insurance Corporation (“FDIC”) insurance and other coverage;
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;
the effects 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;
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;
unanticipated effects from the Tax Act may limit its benefits or adversely impact our business, which could include decreased demand for borrowing by our middle market customers or increased price competition that offsets the benefits of decreased federal income tax expense.
factors that adversely affect our business initiatives, including, without limitation, changes in the economic or business conditions in SNBV’s markets; and
other factors and risks described under “Risk Factors” herein and in any of our subsequent reports that we make with the Securities and Exchange Commission (the “Commission” or “SEC”) under the Exchange Act.

 

Forward-looking statements are not guarantees of performance or results. 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 keep in mind the risk factors and other cautionary statements in this Quarterly Report on Form 10-Q. These statements speak only as of the date of this Quarterly Report on Form 10-Q. Except as required by applicable law, we undertake no obligation to update publicly these statements in light of new information or future events.

 

OVERVIEW

 

SNBV 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. As of the close of business on June 23, 2017, SNBV completed its previously announced merger of EVBS with and into SNBV and the completion of the merger of EVBS’s wholly-owned subsidiary, EVB, with and into SNBV’s wholly-owned subsidiary, Sonabank.  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. Sonabank provides a range of financial services to individuals and small and medium sized businesses. At June 30,2018, 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.

 

We have administrative offices in Warrenton and Glen Allen, Virginia, and executive offices in Georgetown, Washington, D.C. and Glen Allen, Virginia where senior management is located. During 2018 and forward, we plan to continue to focus our efforts on realizing cost savings, maximizing revenue enhancement opportunities from the merger of EVBS, while conservatively and prudently growing the balance sheet. 

 

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RESULTS OF OPERATIONS

 

Net Income

 

Net income for the three months ended June 30, 2018 was $8.9 million or $0.37 per basic and diluted earnings per share and $17.1 million or $0.71 per basic and diluted earnings per share or the first half of 2018. That compares to a net loss of ($2.8) million, or ($0.21) basic and diluted earnings per share for the three months ended June 30, 2017 and a loss of ($788) thousand for the six months ended June 30, 2017. When comparing SNBV’s results for the six months ended June 30, 2018 to the same six months in 2017, note that most categories increased due to the merger with EVBS on June 23, 2017.

 

During the second quarter of 2018, the following affected net income positively:

 

·$1.2 million of accretion income from the acquired loan discounts;
·$732 thousand of interest income recognized on the payout of a $9.9 million nonaccrual loan; and
·$250 thousand of other noninterest income from recoveries of legacy investment securities and loans charged off by EVBS before Southern National merged with EVBS in June of 2017.

 

For the first six months of 2018, the following affected net income positively:

 

·$2.5 million of accretion income from the acquired loan discounts;
·$1.7 million of other noninterest income from recoveries of legacy investment securities and loans charged off by EVBS before Southern National merged with EVBS in June of 2017; and
·the reduced effective income tax rate of 21% from 34% due to the enactment of the Tax Cuts and Jobs Act of 2017, which became effective on January 1, 2018.

 

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.

 

Three-Month Comparison. Net interest income was $23.2 million for the quarter ended June 30, 2018 compared to $11.2 million during the same period last year. Southern National’s net interest margin was 3.79% in the second quarter of 2018 compared to 3.72% during the second quarter of 2017. Total income on interest-earning assets was $30.0 million and $14.2 million for the three months ended June 30, 2018 and 2017, respectively. The yield on average interest-earning assets was 4.86% and 4.73% for the second quarters of 2018 and 2017, respectively. Interest and fees on loans totaled $27.7 million and $13.3 million for the second quarters of 2018 and 2017, respectively. The accretion of the discount on loans acquired in the acquisitions of EVBS, Greater Atlantic Bank, HarVest and Prince Georges Federal Savings Bank contributed $1.2 million to interest income on loans for the quarter ended June 30, 2018 compared to $630 thousand during the second quarter of 2017. Average loans during the second quarter of 2018 were $2.14 billion compared to $1.07 billion during the same period last year. The increase in average loans was mainly attributable to the acquisition of EVBS in June of 2017.

 

Total interest expense was $6.5 million and $3.0 million for the three months ended June 30, 2018 and 2017, respectively. Interest on deposits were $3.8 million and $2.3 million for the three months ended June 30, 2018 and 2017, respectively. Total average interest-bearing deposits for the second quarters of 2018 and 2017 were $1.56 billion and $865.6 million, respectively. The increase in total average interest-bearing deposits was mainly attributable to the acquisition of EVBS in June of 2017. The yield on total average interest-bearing deposits was 0.98% and 1.05% for the quarters ended June 30, 2018 and 2017, respectively. Interest expense on total average borrowings, which include securities sold under agreements to repurchase, FHLB advances, junior subordinated debt, and senior subordinated notes, was $2.7 million and $786 thousand for the three months ended June 30, 2018 and 2017, respectively. Total average borrowings were $451.9 million and $113.8 million for the three months ended June 30, 2018 and 2017, respectively.

 

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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 Three Months Ended 
   June 30, 2018   June 30, 2017 
       Interest           Interest     
   Average   Income/   Yield/   Average   Income/   Yield/ 
   Balance   Expense   Rate   Balance   Expense   Rate 
   (Dollar amounts in thousands) 
Assets                              
Interest-earning assets:                              
Loans, net  of deferred fees (1) (2)  $2,141,966   $27,697    5.19%  $1,071,508   $13,332    4.99%
Investment securities   250,573    1,560    2.50%   107,079    708    2.65%
Other earning assets   58,517    426    2.92%   29,241    209    2.87%
Total earning assets   2,451,056    29,683    4.86%   1,207,828    14,249    4.73%
Allowance for loan losses   (11,172)             (8,966)          
Total non-earning assets   262,974              94,757           
Total assets  $2,702,858             $1,293,619           
                               
Liabilities and stockholders' equity                              
Interest-bearing liabilities:                              
NOW and other demand accounts  $327,459    336    0.41%  $64,579    44    0.27%
Money market accounts   330,214    619    0.75%   152,517    183    0.48%
Savings accounts   164,421    132    0.32%   65,526    89    0.54%
Time deposits   739,673    2,722    1.48%   582,878    1,942    1.34%
Total interest-bearing deposits   1,561,767    3,810    0.98%   865,500    2,258    1.05%
Borrowings   451,919    2,699    2.40%   113,784    786    2.77%
Total interest-bearing liabilities   2,013,686    6,509    1.30%   979,284    3,044    1.25%
Noninterest-bearing liabilities:                              
Demand deposits   336,849              129,311           
Other liabilities   19,248              10,379           
Total liabilities   2,369,783              1,118,974           
Stockholders' equity   333,075              174,645           
Total liabilities and stockholders' equity  $2,702,858             $1,293,619           
Net interest income       $23,174             $11,205      
Interest rate spread             3.56%             3.48%
Net interest margin             3.79%             3.72%

 

(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.

 

Six-Month Comparison. Net interest income was $45.7 million for the six months ended June 30, 2018 compared to $21.1 million during the same period last year. Southern National’s net interest margin was 3.80% for the first six months of 2018 compared to 3.72% during the same period of 2017. Total income on interest-earning assets was $57.7 million and $26.8 million for the six months ended June 30, 2018 and 2017, respectively. The yield on average interest-earning assets was 4.81% and 4.73% for the first six months of 2018 and 2017, respectively. Interest and fees on loans totaled $53.6 million and $25.1 million for the six months ended June 30, 2018 and 2017, respectively. The accretion of the discount on loans acquired in the acquisitions of EVBS, Greater Atlantic Bank, HarVest and Prince Georges Federal Savings Bank contributed $2.5 million to interest income on loans for the six months ended June 30, 2018 compared to $1.1 million for the six months ended June 30, 2017. Average loans during the first half of 2018 were $2.11 billion compared to $1.01 billion during the same period last year. The increase in average loans was mainly attributable to the acquisition of EVBS in June of 2017. Total interest expense was $12.0 million and $5.7 million for the six months ended June 30, 2018 and 2017, respectively. Interest on deposits were $7.1 million and $4.4 million for the six months ended June 30, 2018 and 2017, respectively. Total average interest-bearing deposits for the first halves of 2018 and 2017 were $1.55 billion and $840.2 million, respectively. The increase in total average interest-bearing deposits was mainly attributable to the acquisition of EVBS in June of 2017. The yield on total average interest-bearing deposits was 0.92% and 1.06% for the six months ended June 30, 2018 and 2017, respectively. Interest expense on total average borrowings, which include securities sold under agreements to repurchase, FHLB advances, junior subordinated debt, and senior subordinated notes, was $4.9 million and $1.3 million for the six months ended June 30, 2018 and 2017, respectively. Total average borrowings were $439.0 million and $94.5 million for the three months ended June 30, 2018 and 2017, respectively.

 

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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 Six Months Ended 
   June 30, 2018   June 30, 2017 
       Interest           Interest     
   Average   Income/   Yield/   Average   Income/   Yield/ 
   Balance   Expense   Rate   Balance   Expense   Rate 
   (Dollar amounts in thousands) 
Assets                              
Interest-earning assets:                              
Loans, net  of deferred fees (1) (2)  $2,109,109    53,602    5.13%  $1,014,829    25,093    4.99%
Investment securities   254,083    3,201    2.54%   99,022    1,330    2.71%
Other earning assets   58,401    900    3.11%   29,517    371    2.53%
Total earning assets   2,421,593    57,703    4.81%   1,143,368    26,794    4.73%
Allowance for loan losses   (10,781)             (8,934)          
Total non-earning assets   259,038              82,778           
Total assets  $2,669,850             $1,217,212           
                               
Liabilities and stockholders' equity                              
Interest-bearing liabilities:                              
NOW and other demand accounts  $327,427    652    0.40%  $50,719    61    0.24%
Money market accounts   336,425    1,179    0.71%   140,743    315    0.45%
Savings accounts   163,786    260