UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

------

FORM 10-Q

------

x Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

 

For the quarterly period ended March 31, 2009

 

or

 

[ ] Transition Report Pursuant to Section 13 or 15(d)

of the Securities Exchange Act of 1934

 

For the transition period from ____________ to _____________

 

Commission File Number: 0-50576

 

CITIZENS BANCORP OF VIRGINIA, INC.

(Exact name of registrant as specified in its charter)

 

                                         

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 o

 

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 o No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

                

                

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).   Yes o No x

 

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date: 2,383,380 shares of Common Stock as of May 8, 2009.

 

---

 

 

FORM 10-Q

For the Period Ended March 31, 2009

 

INDEX

 

  Page No.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

- 2 -

 

---

Part I. Financial Information

 

Item 1. Financial Statements

 

Consolidated Balance Sheets

(Dollars in thousands, except share data)

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

- 3 -

 

---

Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

- 4 -

 

---

 

Consolidated Statements of Changes in Stockholders’ Equity

For the Nine Months Ended March 31, 2009 and 2008

(Dollars in thousands)

 

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

 

- 5 -

 

---

 

See accompanying Notes to Interim Consolidated Financial Statements

- 6 -

 

---

 

 

Notes to Interim Consolidated Financial Statements

(Unaudited)

 

 

The Consolidated Balance Sheets at March 31, 2009 and December 31, 2008, the Consolidated Statements of Income for the three months ended March 31, 2009 and March 31, 2008, and the Consolidated Changes in Stockholders’ Equity and Cash Flows for the three months ended March 31, 2009 and 2008, were prepared in accordance with instructions for Form 10-Q, and do not include all of the information and footnotes required by accounting principles generally accepted in the United States of America (GAAP) for complete financial statements. However, in the opinion of Management, the accompanying unaudited consolidated financial statements contain all adjustments (consisting of normal recurring accruals) considered necessary to present fairly the financial position at March 31, 2009 and the results of operations for the three months ended March 31, 2009 and 2008. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Citizens Bancorp of Virginia, Inc. Annual Report on Form 10-K for the year ended December 31, 2008. The results of operations for the three-month period ended March 31, 2009 are not necessarily indicative of the results to be expected for the full year.

 

Citizens Bancorp of Virginia, Inc. (the “Company”) is a one-bank holding company formed on December 18, 2003. The Company is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (the “Bank”). The Bank conducts and transacts the general business of a commercial bank as authorized by the banking laws of the Commonwealth of Virginia and the rules and regulations of the Federal Reserve System. The Bank was incorporated in 1873 under the laws of Virginia. Deposits are insured by the Federal Deposit Insurance Corporation. As of March 31, 2009 the Bank employed 114 full-time employees. The address of the principal offices for the Company and the main office of the Bank is 126 South Main Street, Blackstone, Virginia, and all banking offices are located within the Commonwealth of Virginia.

 

 

Investment decisions are made by the Management group of the Company and reflect the overall liquidity and strategic asset/liability objectives of the Company. Management analyzes the securities portfolio frequently and manages the portfolio to provide an overall positive impact to the Company’s income statement and balance sheet.

 

(Continued on following page)

 

- 7 -

 

---

Securities available for sale are summarized below:

 

 

Information pertaining to securities with gross unrealized losses at March 31, 2009 and December 31, 2008, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is summarized as follows:

 

 

 

 

- 8 -

 

---

The unrealized losses in the investment portfolio as of March 31, 2009 are considered temporary and are a result of general market fluctuations that occur daily and which have been more volatile since the current economic recession began. The unrealized losses are from 37 securities that are all of investment grade, backed by insurance, U.S. government agency guarantees, or the full faith and credit of local municipalities throughout the United States. Market prices change daily and are affected by conditions beyond the control of the Company. The unrealized losses are deemed to be temporary declines, and Management has the ability and intent to hold debt securities for the foreseeable future. The current global economic recession has reduced the number of market participants who would normally be actively trading in the securities markets. This fact is exacerbating the problem of trying to obtain fair value pricing for securities and it is exhibited in the fact that wide month-to-month pricing fluctuations have been received in the last several months.

 

In the Company’s Form 10-K report for December 31, 2008, management disclosed that two collateralized mortgage obligations also referred to as CMOs, were downgraded in the fourth quarter of 2008 to a split rating of AAA minus and BB. The two CMOs were securitized by private firms and not by Fannie Mae (FNMA) or Freddie Mac (FHLMC). The Company’s Chief Financial Officer is monitoring each security for any potential indication of impairment and he is reporting the status of each security to the Board of Directors monthly. Outside consultants continue to provide periodic stress testing of these two securities that would indicate any other than temporary impairment. Testing results provided in the first quarter of 2009 indicate that under severe and prolonged economic conditions the security tranches that are owned by the Company and the Bank do not show any permanent impairment.

 

 

The loan portfolio was composed of the following:

 

 

 

- 9 -

 

---

 

The following is a summary of transactions in the allowance for loan losses:

 

                

 

The following is a summary of impaired loans:

 

 

Non-accrual loans excluded from the above impairment disclosure under Statement of Financial Accounting Standards No. 114, “Accounting by Creditors for Impairment of a Loan-Income Recognition and Disclosures” (“SFAS No. 114”), totaled $835 thousand and $669 thousand at March 31, 2009 and December 31, 2008, respectively. Income on non-accrual and impaired loans under the original terms would have been approximately $57 thousand for the three months ended March 31, 2009 and March 31, 2008. The Company had no loans that were ninety days or more past due and still accruing at March 31, 2009. There were $241 thousand in loans that were ninety days or more past due and still accruing at December 31, 2008.

 

A further discussion of the Company’s Allowance for Loan Losses appears later in this report in the Management Discussion and Analysis segment under the section titled, “Financial Condition and Statement of Operations”.

 

 

At March 31, 2009 and December 31, 2008, the Company had outstanding advances totaling $11 million with the Federal Home Loan Bank of Atlanta, detailed below.

 

- 10 -

 

---

 

 

Other borrowings consist of $3.5 million and $5.2 million in short-term borrowings as of March 31, 2009 and December 31, 2008, respectively. These balances are from deposit balances outstanding in the Investments Sweeps Account product, which is an overnight repurchase agreement product, not insured by the FDIC, but guaranteed by the Bank with US Government and Federal Agencies. This product is offered to commercial customers only.

 

 

The weighted average number of shares used in computing earnings per share was 2,388,290 shares for the three months ended March 31, 2009 and 2,428,467 for the three months ended March 31, 2008.

 

 

The components of Net Periodic Benefit Cost for the three months ended March 31, 2009 were as follows:

 

The pension plan has a fiscal year ending September 30, providing the Company the flexibility as to the plan year in which it makes pension plan contributions. The Company made its required 2009 fiscal year contribution to the pension plan in December 2008 in the amount of $253,411. The Company anticipates making the 2010 contribution by December 31, 2009. The Company estimates this contribution to be approximately $250,000.

 

 

SFAS No. 157, Fair Value Measurements, defines fair value, establishes a framework for measuring fair value, establishes a three-level valuation hierarchy for disclosure of fair value measurement and enhances disclosure requirements for fair value measurements. The

 

- 11 -

 

---

valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The three levels are defined as follow:

 

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:

 

Securities

Where quoted prices are available in an active market, securities are classified within level 1 of the valuation hierarchy. Level 1 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 securities with similar characteristics, or discounted cash flow. Level 2 securities would include U.S. agency securities, mortgage-backed agency 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, securities are classified within level 3 of the valuation hierarchy.

 

 

Loans held for sale

 

Loans held for sale which is required to be measured in a lower of cost or fair value. Under SFAS No. 157, market value is to represent fair value. Management obtains quotes or bids on all or part of these loans directly from the purchasing financial intermediaries. Premiums received or to be received on the quotes or bids are indicative of the fact that cost is lower than fair value. At March 31, 2009, the Company had no loans held for sale.

 

Impaired loans  

 

SFAS No. 157 applies to loans measured for impairment using the practical expedients permitted by SFAS No. 114, Accounting by Creditors for Impairment of a Loan, including impaired loans measured at an observable market price (if available), or at the fair value of the loan’s collateral (if the loan is collateral dependent). Fair value of the loan’s collateral, when the loan is dependent on collateral, is determined by appraisals or independent valuation which is then adjusted for the cost related to liquidation of the collateral. See Note 4 for details.

 

- 12 -

 

---

Other Real Estate Owned  

 

Certain assets such as other real estate owned (OREO) are measured at fair value less cost to sell. We believe that the fair value component in its valuation follows the provisions of SFAS No. 157.

 

 

 

 

In September 2006, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 157, “Fair Value Measurements” (SFAS 157). SFAS 157 defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and expands disclosures about fair value measurements. SFAS 157 does not require any new fair value measurements, but rather, provides enhanced guidance to other pronouncements that require or permit assets or liabilities to be measured at fair value. The Company adopted SFAS 157 on January 1, 2008. The FASB approved a one-year deferral for the implementation of the Statement for nonfinancial assets and liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. The Company adopted the provisions of SFAS 157 for nonfinancial assets and liabilities as of January 1, 2009 without a material impact on the consolidated financial statements.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)). The Standard significantly changed the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes principles for how an acquirer recognizes and measures the identifiable assets acquired, liabilities assumed, and any non-controlling interest in the acquiree; recognizes and measures the goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. SFAS 141(R) is effective for acquisition dates on or after the beginning of an entity’s first year that begins after December 15, 2008. The Company does not expect the implementation of SFAS 141(R) to have a material impact on its consolidated financial statements, at this time, given that the Company has not been a party to any business combinations.

 

In April 2009, the FASB issued FSP FAS 141(R)-1, “Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies.” FSP FAS 141(R)-1 amends and clarifies SFAS 141(R) to address application issues on initial recognition and measurement, subsequent measurement and accounting, and disclosure of assets and liabilities arising from contingencies in a business combination. The FSP is effective for assets and liabilities arising from contingencies in business combinations for which the acquisition date

 

- 13 -

 

---

is on or after the beginning of the first annual reporting period beginning on or after December 15, 2008. The Company does not expect the adoption of FSP FAS 141(R)-1 to have a material impact on its consolidated financial statements, at this time, given that the Company has not been a party to any business combinations.

 

In April 2009, the FASB issued FSP FAS 157-4, “Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly.” FSP FAS 157-4 provides additional guidance for estimating fair value in accordance with SFAS 157 when the volume and level of activity for the asset or liability have significantly decreased. The FSP also includes guidance on identifying circumstances that indicate a transaction is not orderly. FSP FAS 157-4 is effective for interim and annual periods ending after June 15, 2009, and shall be applied prospectively. Earlier adoption is permitted for periods ending after March 15, 2009. Adoption of FSP FAS 157-4 is not expected to have a material impact on the Company’s consolidated financial statements.

 

In April 2009, the FASB issued FSP FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value of Financial Instruments.” FSP FAS 107-1 and APB 28-1 amends SFAS No. 107, “Disclosures about Fair Value of Financial Instruments,” to require disclosures about fair value of financial instruments for interim reporting periods of publicly traded companies as well as in annual financial statements. In addition, the FSP amends APB Opinion No. 28, “Interim Financial Reporting,” to require those disclosures in summarized financial information at interim reporting periods. The FSP is effective for interim periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. Adoption of FSP FAS 107-1 and APB 28-1 is not expected to have a material impact on the Company’s consolidated financial statements.

 

In April 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation of Other-Than-Temporary Impairments.” FSP FAS 115-2 and FAS 124-2 amend other-than-temporary impairment guidance for debt securities to make guidance more operational and to improve the presentation and disclosure of other-than-temporary impairments on debt and equity securities. The FSP does not amend existing recognition and measurement guidance related to other-than-temporary impairments of equity securities. FSP FAS 115-2 and FAS 124-2 are effective for interim and annual periods ending after June 15, 2009, with earlier adoption permitted for periods ending after March 15, 2009. Adoption of FSP FAS 115-2 and FAS 124-2 does not have a material impact on the Company’s consolidated financial statements.

 

In April 2009, the Securities and Exchange Commission issued Staff Accounting Bulletin No. 111 (SAB 111). SAB 111 amends and replaces SAB Topic 5.M. in the SAB Series entitled “Other Than Temporary Impairment of Certain Investments in Debt and Equity Securities.” SAB 111 maintains the SEC Staff’s previous views related to equity securities and amends Topic 5.M. to exclude debt securities from its scope. Implementation of SAB 111 is not expected to have a material impact on the Company’s consolidated financial statements.

 

 

- 14 -

 

---

 

Management’s discussion and analysis provides the reader with additional information that is helpful in gaining a greater understanding the Company’s operating results, liquidity, capital resources and financial condition. This discussion and analysis should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to the Interim Consolidated Financial Statements included in this quarterly report and the Company’s Annual Report on Form 10-K for the year ended December 31, 2008. Results of operations for the three months ended March 31, 2009 and 2008 are not necessarily indicative of results that may be attained for any future period.

 

Recent Developments

 

The Federal Government is continuing to address the current economic recession in a very aggressive and swift fashion. The newly installed executive and legislative branches in Washington have pressed for regulatory actions, deficit spending and stimulus funds that promise to help shore up the many troubled areas in the national economy. The approved Federal legislation and regulatory-induced programs such as the Capital Purchase Program have introduced opportunities for these governmental bodies to wield a significant amount of control over bank holding company boards and management, including having Federally-appointed directors to bank holding company boards and other potential actions not seen in modern US banking history.

 

As soon as details were released about these new Federal programs, the Company’s Board of Directors and Management reviewed all Federal programs to see how appropriate they were for the Company and the Bank. We deemed this approach was prudent and rational instead of merely agreeing to participate in new Federal initiatives where the terms of the programs allowed the Federal government to modify the rules, prospectively. Of all the programs announced, the Bank is currently participating in the FDIC's Transaction Account Guarantee Program which is projected to run until December 31, 2009. The program provides unlimited deposit insurance coverage by the FDIC on transaction accounts that are interest-free or pay an annual percentage yield of less than 0.50%. The Bank expects to incur additional deposit insurance premiums of 10 basis points, per year, based upon account balances in excess of $250,000.

 

The financial strength and asset quality of the Bank and the Company have served us well during this economic downturn. However, the duration and depth of this economic recession is being felt in our markets with some of the Bank’s borrowers and in the underlying borrowers whose mortgages were securitized into collateralized mortgage obligation securities, or CMOs. These areas are discussed further in this report and were also discussed in the Company’s Annual Report on Form 10-K filing for December 31, 2008.

 

CRITICAL ACCOUNTING POLICIES

 

General

 

The financial condition and results of operations presented in the Consolidated Financial Statements, accompanying Notes to Interim Consolidated Financial Statements and Management's discussion and analysis are, to a large degree, dependent upon the accounting policies of the Company. The selection and application of these accounting policies involve judgments, estimates, and uncertainties that are susceptible to change.

 

- 15 -

 

---

Presented below is a discussion of those accounting policies that Management believes are the most important to the portrayal and understanding of the Company’s financial condition and results of operations. The Critical Accounting Policies require Management's most difficult, subjective and complex judgments about matters that are inherently uncertain. In the event that different assumptions or conditions were to prevail, and depending upon the severity of such changes, materially different financial condition or results of operations is a reasonable likelihood.

 

Allowance for Loan Losses

 

The Company monitors and maintains an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. The Company maintains policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance that the systems are maintained in accordance with accounting principles generally accepted in the United States of America; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; the loan grading system; and the general economic environment.

 

The Company evaluates various loans individually for impairment as required by Statement of Financial Accounting Standards (SFAS) No. 114, Accounting by Creditors for Impairment of a Loan, and SFAS No. 118, Accounting by Creditors for Impairment of a Loan - Income Recognition and Disclosures. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by Management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

 

For loans without individual measures of impairment, the Company makes estimates of losses for groups of loans as required by SFAS No. 5. Loans are grouped by similar characteristics, including the type of loan, the assigned loan grade and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon estimates of default rates for a given loan grade, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans are adjusted for relevant environmental factors and other conditions of the portfolio of loans, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 

The amount of estimated impairment for individually evaluated loans and groups of loans is added together for a total estimate of loan losses. This estimate of losses is compared to the allowance for loan losses of the Company as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. If the estimate of losses is below the range of reasonable estimates, the allowance would be reduced by way of a credit to the provision for loan losses. The Company recognizes the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which the amount may be material to the consolidated financial statements.

 

 

- 16 -

 

---

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Balance Sheet

 

Total assets for the Company increased to $306.4 million at March 31, 2009 compared to $305.1 million at December 31, 2008, representing an increase of $1.3 million or .42%. Total net loans at March 31, 2009 were $214.7 million, an increase of $3.8 million from the December 31, 2008 amount of $210.9 million. For the three months ended March 31, 2009, $20.2 million in loans were originated as compared to $16.9 million, or 19.5% greater than the period ended March 31, 2008. The Bank continued to see loan requests from new commercial borrowers in the first quarter which is a trend that started in the second quarter of 2008. The increase of $3.3 million in originations was attributable to lending activity in a number of areas, primarily commercial real estate, residential and home equity lending, farmland and loans to governmental entities. Management recognizes that while new loan origination opportunities exist in a slower economic environment, it would be imprudent to compromise loan pricing and/or underwriting standards simply to attain loan volume targets. As a well-capitalized community bank, it is Management’s goal to continue to be a source of credit for commercial businesses, farmers, and consumers during these difficult economic times. Gross loans as a percent of total assets were 70.8% at March 31, 2009, an increase of 1.0% from December 31, 2008.

 

Investment securities increased to $49.3 million at March 31, 2009, or 16.1% of total assets, which is an increase of $5.8 million from $43.5 million at December 31, 2008. The net unrealized loss of the investment portfolio decreased to $711 thousand, net of Federal income taxes at March 31, 2009 as compared to an unrealized loss of $1.0 million at December 31, 2008. All of the Company’s investment securities at March 31, 2009 were held as “available for sale”.

 

Interest bearing deposits in other banks decreased by $4.0 million. Federal funds sold decreased $5.4 million from $9.5 million at December 31, 2008 to $4.1 million at March 31, 2009. The Company’s liquidity as represented by cash, due from banks, interest bearing deposits in banks and federal funds sold at March 31, 2009 was $21.7 million or 7.1% of total assets which is $8.2 million lower than $29.9 million or 9.8% of total assets at December 31, 2008.

 

Allowance for Loan Losses

 

The allowance for loan losses at March 31, 2009 was $2.190 million compared to $2.167 million at December 31, 2008. The allowance for loan losses, as a percentage of total outstanding loans, decreased to 1.01% at March 31, 2009 from 1.02% at December 31, 2008. The Company charged off $31 thousand in loans, recovered $9 thousand from previous write-offs, and added a provision of $45 thousand to the allowance during the three months ended March 31, 2009.

 

Management’s methodology for estimating the appropriate level of the allowance for loan losses is based upon bank regulatory guidance and generally accepted accounting principles for maintaining adequate reserves against loan losses. Periodically, management does classify certain loans and provides specific reserves for these loans when it is determined that negative conditions affecting the customer have occurred and will expose the Bank to a potential loss on a given credit customer. Classified loans with specific reserves may be accruing interest since the customer is not past due 90 days or more in their payments. The Company had $1.759 million in non-accruing loans at March 31, 2009, or 0.81% of gross loans compared to $1.115 million at December 31, 2008, or 0.52% of gross loans, an increase of $644 thousand. Of the increase in non-accruing loans of $644 thousand, $619 thousand already had specific reserves

 

- 17 -

 

---

computed in the allowance for loan losses. In this instance, the increase in non-accruing loans would not automatically translate to a higher allowance requirement for loans that already have a specific reserve attributed to them.

 

Management’s calculation of the allowance for loan losses consists of three main segments, 1- estimating future loan losses by loan category using the Bank’s historical average net losses for each category, 2- the impact of various environmental factors such as the decline in real estate value, unemployment, the volume of past due loans, etc., and 3- classified/impaired loans are individually evaluated for probable loss based upon what the Bank could recover from liquidating collateral and from individual guarantors on the loan. While the calculation methodology does provide a degree of consistency in estimating an appropriate allowance for loan losses from period to period, changes in the status of various credits between periods does result in an unavoidable variance between the computed allowance and the booked allowance. Consideration is given to managing this variance to within acceptable limits when determining the amount of provision to be booked. The decline of the allowance for loan losses from 1.02% of total loans at December 31, 2008 to 1.01% of total loans at March 31, 2009 is a result of bringing the booked allowance in line with the computed allowance requirements.

 

Management believes the allowance for loan losses is adequate to cover credit losses inherent in the loan portfolio at March 31, 2009. Loans classified as loss, doubtful, substandard or special mention are adequately reserved for at the report date and are not expected to have a material impact beyond what has been reserved. Specific reserves for impaired loans will be adjusted should material changes occur to a loan’s collateral value or if there is any further deterioration of the credit. Management is closely monitoring any potential indication of credit deterioration, beyond the classified loans currently reported. It is believed that the impact of the slowing national economy may negatively impact the economy in our local markets. Management reviewed external economic factors which are a component of the allowance calculation during the first quarter of 2009. Company policy requires an annual review of those economic factors to determine if adjustments to the calculations are needed. Due to the speed and magnitude of the slowing economy management is performing these reviews quarterly. Management continues to work at improving the status of criticized credits for which the Bank maintains significant reserves. These efforts include the addition of more collateral and/or the collection of payments which serve to improve these credits. For a more detailed discussion of Management’s analysis of the allowance for loan losses, please see the “Allowance for Loan Losses” discussion above under the section heading of “Critical Accounting Policies”.

 

Deposits

 

Total deposits of $251.2 million at March 31, 2009 represented an increase of $2.1 million from $249.1 million at December 31, 2008. Total certificates of deposit at March 31, 2009 were $144.7 million, down $2.6 million from $147.3 million at December 31, 2008. Due to the events surrounding the larger financial institutions in our market area, the Bank has found it difficult to retain non-relationship customers due to the higher-than-market interest rates being offered by the larger, liquidity-strapped banks. Management avoids competing for rate-driven time deposits since this is counter to its established asset/liability management strategies and with the goals set for the Bank’s net interest margin.

 

Non-interest bearing deposits totaled $42.7 million at March 31, 2009, which is a 5.9% increase from $40.2 million at December 31, 2008. Interest-bearing deposits accounted for 83.0% of total deposits at March 31, 2009 and 83.8% at December 31, 2008. Management continues to adhere to its deposit pricing plan that has helped minimize the negative impact of falling rates on the Bank’s net interest margin. However, as a result of this pricing strategy it is expected that volatile deposit accounts may be lost to competition paying higher-than-market rates.

 

- 18 -

 

---

Management’s goals continue to be on growing low-cost deposit account balances which is another strategy that has assisted in managing the overall interest cost of deposit accounts.

 

Borrowings

 

Borrowings include overnight repurchase agreements from commercial customers that utilize the Business Investment Sweeps product and overnight and long-term advances from the Federal Home Loan Bank of Atlanta (the “FHLB”). A secondary source of other borrowings would be overnight advances from lines of credit established with correspondent banks. For additional details on borrowing sources, see the “Liquidity” section later in this report. At March 31, 2009 the Company had total borrowings of $14.5 million that consisted of $3.5 million in overnight repurchase agreements and outstanding advances with the FHLB of $11.0 million. This is compared to $16.2 million in borrowings at December 31, 2008.

 

Stockholders’ Equity

 

Stockholders’ equity was $36.9 million at March 31, 2009 compared to $36.3 million at December 31, 2008. The book value per common share was $15.46 at March 31, 2009 compared to $15.20 at December 31, 2008. On January 9, 2009, shareholders were paid a quarterly dividend of $0.17 per share. On March 26, 2009, the Board of Directors approved a cash dividend of $0.17 per share, or $405 thousand, payable to shareholders on April 10, 2009. Total average outstanding shares for the first three months of 2009 were 2,388,290 shares as compared to the average outstanding shares of 2,412,954 shares for the year ended December 31, 2008.

 

The Board of Directors and Management recognize the intrinsic value of the Company. The banking industry as a whole has seen stock prices decline since 2007 due in part to the investment community’s concern over the overall financial strength of the banking industry, including such areas as interest margin compression, losses due to subprime lending, the decline in housing and commercial real estate values and the indications that the national economy may be impacted by an extended recession.

 

The Board reauthorized the stock repurchase plan on February 26, 2009 and appointed Scott & Stringfellow, Inc. and its affiliate BB&T Capital Markets, both of Richmond, Virginia, to oversee the plan, effective March 2, 2009 until May 29, 2009. The plan’s term is for a three month period or until 20,000 shares are purchased within a particular authorized period; whichever occurs first. The plan is renewable every three months, at the discretion of the Board of Directors.

 

The change in Accumulated Other Comprehensive Loss at March 31, 2009 versus December 31, 2008 was a result of the change in net unrealized losses on available for sale securities. At March 31, 2009, the Company had an unrealized loss on available for sale securities, net of income taxes of $711 thousand, a decrease of $297 thousand from the unrealized loss, net of income taxes of $1.008 million at December 31, 2008. At March 31, 2009 and December 31, 2008, the Accumulated Other Comprehensive Loss included $1.044 million in unfunded pension liability, net of income taxes. The unfunded pension liability is recomputed as of each December 31, only.

 

Net Income

 

For the three months ended March 31, 2008 the Company reported net income of $710 thousand as compared to $779 thousand for the same period in 2008; which is a decrease of

 

- 19 -

 

---

$69 thousand. Income per basic and diluted share was $.30 for the three months ended March 31, 2009 and March 31, 2008.

 

The Company had an annualized return on average assets of .95% and an annualized return on average equity of 7.78% for the three months ended March 31, 2009, as compared to an annualized return on average assets and average equity of 1.07% and 8.24%, respectively, for the same period in 2008.

 

The year-to-year decline in net income of $69 thousand is attributable to three factors: 1- an increase of $35 thousand in the provision for loan losses, 2- a decrease of $41 thousand in non-interest income, and 3- an increase of $61 thousand in FDIC deposit insurance premiums. These variances are discussed below within their respective segments. Additionally, the effective tax rate for the quarter ended March 31, 2009 was 26.8% as compared to 28.0% for the quarter ended March 31, 2008. When applying the effective tax rate of 26.8% to the pre-tax income for the quarter ended March 31, 2008, the result of the lower tax rate for 2009 as compared to 2008 produces tax savings variance of $30 thousand.

 

Net Interest Income

 

Net interest income is the Company’s primary source of earnings and represents the difference between interest and fees earned on loans, investments and other earning assets and the interest expense paid on deposits and other interest bearing liabilities. The cost of funds represents interest expense on deposits and other borrowings. Non-interest bearing deposit accounts and capital are other components representing funding sources. Changes in the volume and mix of earning assets and funding sources, along with the changes in yields earned and rates paid, determine changes in net interest income.

 

For the three months ended March 31, 2009 net interest income was $2.650 million, which was $52 thousand more than $2.598 million for the same period in 2008. The average loan balances for the three months ended March 31, 2009 were $213.8 million or $2.1 million greater than the three months ended March 31, 2008 when the average loan balances were $211.7 million. The loan yield decreased 52 basis points to 6.56% for the three months ended March 31, 2009 from 7.08% for the comparable period in 2008. The increase in average loan balances in the first quarter of 2009 helped to lessen the impact of the negative direction of key interest indexes used in setting loan rates. The prime rate, as an example, is used as a basis of most commercial loans and commercial mortgages; therefore, variable rate loans tied to prime adjusted to lower levels during 2009 and loan pricing for renewing or new loans was also driven lower in comparison to yields in 2008.

 

The average investment securities balance for the first three months of 2009 was $47.5 million or $1.3 million lower than the average of $48.8 million for the same period in 2008. The tax-equivalent yield on investment securities for the period in 2009 was 4.79% as compared to 4.83% for 2008, or a decrease of 4 basis points from the year-earlier period. The investment securities portfolio is experiencing the effects of the continued low interest rate environment and relatively flat yield curve which was reported to management from asset/liability modeling results. The portion of the liquidity generated by the Company’s investment securities portfolio was used to repurchase outstanding common shares under the stock repurchase plan described later in this Report under Part 2, Item 2, Unregistered Sales of Equity Securities and Use of Proceeds.

 

The yield on earning assets for the three months ended March 31, 2009 was 5.95%, a decrease of 65 basis points from the yield of 6.60% reported in the comparable period of 2008. The decrease in the earning assets yield for the three months ended March 31, 2009 as compared

 

- 20 -

---

to the same period in 2008 is primarily the result of the reduction of short-term interest rates and its impact on new and re-pricing loans.

 

Average interest bearing deposits for the three months ended March 31, 2009 was $213.8 million or $7.9 million more than the $205.9 million average balance for the three months ended March 31, 2008. The increase in interest bearing deposits is attributable to customers seeking a safe haven for funds that are being withdrawn from stock and mutual funds, as well as a greater awareness by customers for the need to have full FDIC deposit insurance coverage during these recessionary times.

 

The cost of interest bearing deposits for the three months ended March 31, 2009, expressed as a percentage, was 2.49% as compared to 3.20% for the same period of 2008, or a decrease of 71 basis points. Time deposit costs were 3.46% and 4.49% for the three months ended March 31, 2009 and 2008, respectively, or a decrease of 103 basis points. During the first quarter of 2009 there were a large number of time deposit accounts that matured or renewed at much lower rates. The competition for time deposits in our markets, during this period, began to decline largely as a result of the Federal government’s capital infusion to shore-up the national financial institutions and the deployment of the Federal government’s liquidity programs. Management maintained its disciplined pricing strategy that helped to generally retain existing relationships and attract new deposits. Average non-interest deposit balances for the three months ended March 31, 2009 was $33.9 million or $432 thousand less than the $34.3 million for the same period of 2008. While a number of factors could be attributable to this decrease, the most likely scenarios include the fact that consumers and businesses are in the process of deleveraging themselves (paying down debt) and an increasing number of households that are facing reduced incomes due to reduced work schedules or layoffs are being forced to erode their savings to cover everyday living expenses. The cost of funds for the three months ended March 31, 2009 was 2.11% or 60 basis points lower than 2.71% for the three months ended March 31, 2008.

 

The net interest margin is net interest income expressed as a percentage of average earning assets. The net interest margin decreased by 8 basis points to 3.96% for the three months ended March 31, 2009 as compared to 4.04% for the same period in 2008.

 

The table on the following page labeled “Average Balances, Interest Yields and Rates, and Net Interest Margin” presents the average balances and rates of the various categories of the Company’s assets and liabilities. Included in the table is a measurement of interest rate spread and margin. Interest rate spread is the difference (expressed as a percentage) between the interest rate earned on earning assets less the interest expense on the interest bearing liabilities. While net interest spread provides a quick comparison of earnings rates versus the cost of funds, Management believes that the interest margin provides a better measurement of performance.

 

- 21 -

 

---

Average Balances, Interest Yields and Rates, and Net Interest Margin

 

 

- 22 -

 

---

Provision for Loan Losses

 

The Company recorded provision for loan losses in the first quarter of 2009 totaling $45 thousand as compared to $10 thousand for the same period of 2008. The speed and depth of the economy’s decline into recession produced additional credit concerns in the Bank’s loan portfolio during the second half of 2008. Therefore, the provision expensed in the first quarter of 2008 was chiefly to cover loan growth. The duration of this recession is impacting commercial customers that rely on a steady flow of commerce, particularly in the real estate and timber industries, to produce the cash flow needed in repaying their loans and for working capital purposes. Management is diligent in identifying problem credits as they arise and begins to work with borrowers with the intent of mitigating credit losses, collection and legal costs. Barring any significant improvements in impaired loans during the three months ending June 30, 2009, management expects to be providing reserves to the allowance for loan losses at higher levels than in the quarter ended March 31, 2009. Preliminary estimates of provision in the upcoming quarter range from $80 thousand to $120 thousand.

 

Non-interest Income

 

Non-interest income includes deposit fees, gains on the sales of securities, OREO and loans held for sale, and ATM fees. For the three months ended March 31, 2009, non-interest income decreased 6.3% to $597 thousand compared to $637 thousand, or $40 thousand less than the same period in 2008. Revenue from the net gain on sale of securities and OREO is considered as non-recurring revenue, therefore non-interest income, excluding these items was $594 thousand for the three months ended March 31, 2009 and $637 thousand for the same period in 2008; or a decrease of $43 thousand. Below is a representation of the changes to the significant components of non-interest income.

 

 

 

 

 

- 23 -

 

---

 

Non-interest Expense

 

Non-interest expense includes employee compensation and benefits-related costs, occupancy and equipment expense, data processing and other overhead costs. For the three months ended March 31, 2009, non-interest expense increased $89 thousand to $2.232 million as compared to $2.143 million for the comparable period in 2008, or an increase of 4.2%.

 

Management has been working, over the last 4 years, to establish stricter controls over non-interest expenses, and these efforts are being realized by the very moderate increases seen in non-interest expenses over the previous year. The following table outlines the changes in significant components:

 

 

 

 

 

 

 

 

Liquidity represents an institution’s ability to meet present and future obligations through either the sale or maturity of existing assets or the acquisition of additional funds through liability management. Liquidity is also defined as the Company’s ability to meet the borrowing and deposit withdrawal requirements of the customers of the Company in addition to meeting current and planned expenditures. The Company maintains its liquidity position through cash on hand, correspondent bank balances and investment in federal funds sold, by maintaining its investment portfolio in available for sale status and through the availability of borrowing lines at the FHLB, the Federal Reserve Bank of Richmond and other correspondent banks. Federal funds lines of credit are maintained with four correspondent banks.

 

- 24 -

 

---

As of March 31, 2009 the Company has the following lines of credit available.

 

 

The Company had $14.5 million in FHLB Advances and other borrowings at March 31, 2009, which represented a $1.7 million decrease from $16.2 million at December 31, 2008. At March 31, 2009, FHLB Advances totaled $11.0 million, unchanged from year-end. Other borrowings consisted of $3.5 million in short-term borrowings from balances outstanding in the Investment Sweeps Account product, which is an overnight repurchase agreement product, not insured by FDIC, but guaranteed by the Bank with US Government and Federal Agency securities. This product is offered to commercial customers only.

 

The Company monitors its liquidity position on a regular basis and continuously adjusts its assets to maintain adequate liquidity levels. The Company has established satisfactory liquidity targets and reports its liquidity ratios to the Board of Directors on a monthly basis. The Company considers its sources of liquidity to be sufficient to meet its estimated needs.

 

Capital Resources

 

Stockholders’ equity at March 31, 2009 and December 31, 2008 was $36.9 million and $36.3 million, respectively. Total number of common shares outstanding was 2,383,380 shares at March 31, 2009 and 2,390,980 shares at December 31, 2008. The decrease of 7,600 shares represents the number of shares repurchased by the Company under the stock repurchase plan that the Board of Directors initiated in September 2007 and reauthorized on February 26, 2009. Additional information regarding the stock repurchase plan was discussed earlier in this report and is also discussed in Part 2, Item 2 entitled Unregistered Sales of Equity Securities and Use of Proceeds.

 

At March 31, 2009 the Company’s Tier 1 and total risk-based capital ratios were 19.66% and 20.77%, respectively, compared to 19.4% and 20.5% at December 31, 2008. The Company’s leverage ratio was 12.7% at March 31, 2008 compared to 13.0% at December 31, 2008. The Bank’s capital structure places it well above the regulatory capital requirements, which affords the Company the opportunity to take advantage of business opportunities while ensuring that it has the resources to protect against risk inherent in its business.

 

FORWARD LOOKING STATEMENTS

 

Certain information contained in this discussion may include “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, (the “Exchange Act”) as amended. These forward-looking statements are generally identified by phrases such as “the Company expects,” “the Company believes” or words of similar import. Such forward-looking statements involve known and unknown risks including, but not limited to, the following factors:

 

 

- 25 -

 

---

 

Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements. In addition, past results of operations do not necessarily indicate future results.

 

 

Disclosure controls and procedures are our controls and other procedures that are designed to ensure that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is accumulated and communicated to our Management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

 

Under the supervision and with the participation of our Management, including our Chief Executive Officer and Chief Financial Officer, the Company evaluated the effectiveness of the design and operation of its disclosure controls and procedures as of the end of the period covered by this quarterly report. Based on that evaluation, the Company has concluded that these controls and procedures are effective. In addition, our Management, including our Chief Executive Officer and Chief Financial Officer, is also responsible for establishing and maintaining adequate internal control over financial reporting.

 

There was no change in the Company’s internal control over financial reporting that occurred during the three months ended March 31, 2009 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

- 26 -

 

---

Part II. Other Information

 

Item 1. Legal Proceedings

 

There are no material pending legal proceedings, other than ordinary routine litigation incidental to the Company’s business, to which the Company, including its subsidiaries, is a party or of which the property of the Company is subject.

 

Item 1A. Risk Factors

 

There are no material changes from any of the risk factors previously disclosed in the Company’s 2008 Annual Report on Form 10-K.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

The Board of Directors voted to approve continuation of the common stock repurchase plan at their regularly scheduled meeting held on February 26, 2009, with an effective date of March 1, 2009. The Board appointed the firm of Scott & Stringfellow, Inc. and its affiliate BB&T Capital Markets, both of Richmond, Virginia to oversee the SEC Rule 10b5-1 plan effective March 2, 2009 until May 29, 2009. Purchases under the plan are limited to a total of 20,000 shares per term and the maximum per share price to be paid is $16.00. The stock repurchase plan was originally announced on August 20, 2007.

 

The Board of Directors reviews the results of the repurchase plan monthly. The continuation of the repurchase plan is evaluated by the Directors prior to the reauthorization of the repurchase plan for an additional 3-month period. The Company will consider whether or not it will repurchase additional shares based upon a number of factors including market conditions, the Company’s performance, and other strategic planning considerations.

 

The table below indicates the shares that were repurchased during the most recent fiscal quarter:

 

Common Stock Repurchase Plan Table

 

 

 

- 27 -

 

---

Item 3. Defaults upon Senior Securities

 

None.

 

Item 4. Submission of Matters to a Vote of Security Holders

 

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

See Exhibit Index.

 

- 28 -

 

---

 

SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

 

 

 

 

 

- 29 -

 

---

EXHIBIT INDEX

 

Exhibit Number