UNITED STATES SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

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FORM 10-Q

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

 

For the quarterly period ended June 30, 2008

 

or

 

o  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.

 

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. 2,410,980 shares of Common Stock as of August 8, 2008.

 

 

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FORM 10-Q

For the Period Ended June 30, 2008

 

INDEX

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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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.

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Consolidated Statements of Income (Unaudited)

(Dollars in thousands, except per share data)

 

See accompanying Notes to Interim Consolidated Financial Statements.

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Consolidated Statements of Changes in Stockholders’ Equity

For the Six Months Ended June 30, 2008 and 2007

 

 

See accompanying Notes to Interim Consolidated Financial Statements.

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See accompanying Notes to Interim Consolidated Financial Statements

 

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Notes to Interim Consolidated Financial Statements

(Unaudited)

 

 

The Consolidated Balance Sheets at June 30, 2008 and December 31, 2007, the Consolidated Statements of Income for the three and six months ended June 30, 2008 and June 30, 2007, and the Consolidated Changes in Stockholders’ Equity and Cash Flows for the six months ended June 30, 2008 and 2007, 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 June 30, 2008 and the results of operations for the three and six months ended June 30, 2008 and 2007. 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, 2007. The results of operations for the three-month and six-month periods ended June 30, 2008 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 June 30, 2008 the Bank employed 115 full and part-time employees, which resulted in 113 full-time equivalents. 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.

 

 

 

 

 

 

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Information pertaining to securities with gross unrealized losses at June 30, 2008 and December 31, 2007, aggregated by investment category and length of time that individual securities have been in a continuous loss position, is summarized as follows:

 

 

 

 

The unrealized losses in the investment portfolio as of June 30, 2008 are considered temporary and are a result of general market fluctuations that occur daily. The unrealized losses are from 68 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. 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

 

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portfolio to provide an overall positive impact to the Company’s income statement and balance sheet. The unrealized losses are deemed to be temporary declines, since Management has the ability and intent to hold debt securities for the foreseeable future.

 

 

The loan portfolio was composed of the following:

 

 

 

 

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

                

 

The following is a summary of impaired loans:

 

                

 

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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 $847 thousand and $598 thousand at June 30, 2008 and December 31, 2007, respectively. Income on non-accrual and impaired loans under the original terms would have been approximately $119 thousand and $92 thousand for the six months ended June 30, 2008 and June 30, 2007, respectively. The Company had $91 thousand in loans that were ninety days or more past due and still accruing at June 30, 2008. There were no loans ninety days or more past due and still accruing at December 31, 2007.

 

 

The weighted average number of shares used in computing earnings per share was 2,424,500 shares for the six months ended June 30, 2008 and 2,440,750 for the six months ended June 30, 2007.

 

 

The components of Net Periodic Benefit Cost for the six months ended June 30, 2008 and June 30, 2007 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 2008 fiscal year contribution to the pension plan in December 2007 in the amount of $224,000. The Company anticipates making the 2009 contribution by December 31, 2008. 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 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:

 

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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. Currently, all of the Company’s securities are considered to be Level 2 securities.

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 June 30, 2008, 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.

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. At June 30, 2008 the Company had $441 thousand in OREO which is included in Other Assets on the balance sheet.

 

 

In December 2007, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards No. 141(R), “Business Combinations” (SFAS 141(R)). The Standard will significantly change the financial accounting and reporting of business combination transactions. SFAS 141(R) establishes the criteria for how an acquiring entity in a business combination recognizes the assets acquired and liabilities assumed in the transaction; establishes the acquisition date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination. Acquisition related costs including finder's fees, advisory, legal, accounting valuation and other professional and consulting fees are required to be expensed as incurred. SFAS 141(R) is effective for fiscal years beginning after December 15, 2008 and early

 

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implementation is not permitted. The Company does not expect the implementation to have a material impact on its consolidated financial statements.

 

In December 2007, the FASB issued Statement of Financial Accounting Standards No.160, “Noncontrolling Interests in Consolidated Financial Statements” (SFAS 160). SFAS 160 requires the Company to establish accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. This Statement is effective for fiscal years, and interim periods within those fiscal years, beginning on or after December 15, 2008. Earlier adoption is prohibited. The Company does not expect the implementation of SFAS 160 to have a material impact on its consolidated financial statements.

 

In March 2008, the FASB issued Statement of Financial Accounting Standards No. No. 161, “Disclosures about Derivative Instruments and Hedging Activities – an amendment of FASB Statement No. 133” (SFAS 161). SFAS 161 changes the disclosure requirements for derivative instruments and hedging activities. Entities are required to provide enhanced disclosures about (a) how and why an entity uses derivative instruments, (b) how derivative instruments and related hedged items are accounted for under Statement 133 and its related interpretations, and (c) how derivative instruments and related hedged items affect an entity’s financial position, financial performance and cash flows. SFAS 161 is effective for fiscal years and interim periods beginning after November 15, 2008, with early application permitted. The Company does not expect the implementation of SFAS 161 to have a material impact on its consolidated financial statements.

 

 

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The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company. 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, 2007.

 

The Company’s primary revenue comes from retail banking in the form of interest income received on loans and investments. This income is partially offset by the Company’s interest expense on deposits and borrowed funds, resulting in net interest income. The Company’s earnings also come from noninterest income in the form of deposit fees, gains on the sale of loans and investments, ATM fees, Bank-owned Life Insurance, and other financial services. The Company’s combined noninterest income and net interest income are offset by the Company’s noninterest expense which includes employee compensation and benefits, occupancy, equipment and other operating expenses.

 

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.

 

Presented below is a discussion of those accounting policies (Critical 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. If a loan evaluated individually is not impaired, then the loan is assessed for impairment under

 

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SFAS No. 5, Accounting for Contingencies, with a group of loans that have similar characteristics.

 

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.

 

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

Balance Sheet

 

Total assets for the Company increased to $293.3 million at June 30, 2008 compared to $290.0 million at December 31, 2007, representing an increase of $3.3 million or 1.1%. Total net loans at June 30, 2008 were $213.9 million, an increase of $4.5 million from the December 31, 2007 amount of $209.4 million. For the three months ended June 30, 2008, $25.2 million in loans were originated as compared to $23.8 million, or 5.9% greater than the same period ended June 30, 2007. A greater portion of loan requests from new commercial borrowers (not current customers) was seen in the second quarter of 2008 than in the first quarter of this year or in the fourth quarter of 2007. For the first six months of 2008, loan originations totaled $42.1 million as compared to $43.9 million during the year-earlier period. The decrease of $1.8 million in originations was primarily attributable to softening economic conditions and borrowers waiting to see a bottoming out of loan rate declines. 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. Net loans as a percent of total assets were 72.9% at June 30, 2008, an increase of .70% from December 31, 2007.

 

Investment securities decreased to $45.1 million at June 30, 2008, or 15.4% of total assets, which is a decrease of $3.4 million from $48.5 million at December 31, 2007. The liquidity available from the investment portfolio was used to fund loan demand. The rise in long-term interest rates has increased the net unrealized loss of the investment portfolio to $515 thousand, net of Federal income taxes at June 30, 2008 as compared to an unrealized loss of $47 thousand at December 31, 2007. The unrealized loss position at June 30, 2008 represents

 

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an improvement over the $1.2 million unrealized loss as of June 30, 2007. All of the Company’s investment securities at June 30, 2008 were held as “available for sale”.

 

Interest bearing deposits in other banks increased by $2.7 million, due in part, to our investment in short-term certificates of deposit. The short-term liquidity that was invested into these CDs was the result of the FHLB advance taken in February 2008 and the Advance is discussed later in this report. Federal funds sold increased $613 thousand from $344 thousand at December 31, 2007 to $957 thousand at June 30, 2008. The Company’s liquidity as represented by cash, due from banks, interest bearing deposits in banks and federal funds sold at June 30, 2008 was $15.3 million or 5.2% of total assets which is $1.2 million greater than $14.1 million or 4.9% of total assets at December 31, 2007.

 

Allowance for Loan Losses

 

The allowance for loan losses at June 30, 2008 was $2.025 million compared to $1.950 million at December 31, 2007. The allowance for loan losses, as a percentage of total outstanding loans, increased to 0.94% at June 30, 2008 from 0.93% at December 31, 2007. During the six months ended June 30, 2008, the Company charged off $82 thousand in loans, recovered $122 thousand from previous write-offs, and provided an additional $35 thousand provision to the allowance.

 

Management believes the allowance for loan losses is adequate to cover credit losses inherent in the loan portfolio at June 30, 2008. Loans classified as loss, doubtful, substandard or special mention are adequately reserved for and are not expected to have a material impact beyond what has been reserved. 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 have a certain trickle-down effect that could impact the economy in our local markets. Management continues to work at improving the status of criticized credits for which the Bank maintains significant reserves. These efforts included the addition of more collateral and/or the collection of payments which served to improve these credits. The results of this improvement in credit quality allowed the previously assigned reserves for criticized loans to be reallocated to newly classified loans or to new loan growth. For a more detailed discussion of Management’s analysis of the loan portfolio, please see the “Allowance for Loan Losses” discussion, above.

 

The Company had $1.661 million in non-accruing loans at June 30, 2008, or 0.77% of gross loans compared to $1.179 million at December 31, 2007, or 0.56% of gross loans, an increase of $482 thousand or 40.88%.

 

Deposits

 

Total deposits of $241.3 million at June 30, 2008 represented a decrease of $1.7 million from $243.0 million at December 31, 2007. The decline in deposit balances has recovered during the second quarter. At March 31, 2008 deposit balances were down $4.2 million when compared to December 31, 2007, which is an increase of $2.5 million at June 30, 2008 from March 31, 2008. The Bank’s deposits declined due to the distribution of an estate account with a balance of over $5 million. The distribution was made just prior to the end of the first quarter of this year. Management was prepared for this outflow of deposits and well aware of the trustee’s distribution plan. The Bank did retain a portion of the distributed estate funds in a certificate of deposit.

 

Total certificates of deposit at June 30, 2008 were $137.4 million, down $900 thousand from $138.3 million at December 31, 2007. Due to the events surrounding the larger financial

 

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institutions in our market area, the Bank is finding it difficult to retain non-relationship customers due to the higher-than-market interest rates being offered by the larger, liquidity-strapped banks.

 

Non-interest bearing deposits totaled $42.3 million at June 30, 2008, which is a 12.8% increase from $37.5 million at December 31, 2007. Interest-bearing deposits accounted for 82.4% of total deposits at June 30, 2008 and 84.6% at December 31, 2007. 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. 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.

 

Other Borrowings

 

Other 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 June 30, 2008 the Company had total other borrowings of $12.0 million that consisted of $7.0 million in overnight repurchase agreements and a long-term advance with the FHLB of $5.0 million. This is compared to $7.3 million in other borrowings at December 31, 2007, which consisted entirely of overnight repurchase agreements.

 

Stockholders’ Equity

 

Stockholders’ equity was $37.2 million at June 30, 2008 compared to $37.3 million at December 31, 2007. The book value per common share was $15.42 at June 30, 2008 compared to $15.33 at December 31, 2007. On April 11, 2008, shareholders were paid a quarterly dividend of $0.17 per share. On June 19, 2008, the Board of Directors approved a cash dividend of $0.17 per share, or $410 thousand, payable to shareholders on July 11, 2008. Total average outstanding shares for the first six months of 2008 were 2,424,500 shares as compared to the average outstanding shares of 2,439,505 shares for the year ended December 31, 2007.

 

The Board of Directors and Management recognize the intrinsic value of the Company and they further realize that the market price of the Company’s shares during the first six months was not representative of that value. The banking industry as a whole has seen stock prices decline during 2007 and into 2008, due in part to the investment community’s concern over interest margin compression, subprime lending, the decline in housing values and the indications that the national economy is headed for a recession. The Board reauthorized the stock repurchase plan on May 22, 2008 that extends the plan until August 31, 2008. 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 June 30, 2008 versus December 31, 2007 was a result of the change in net unrealized losses on available for sale securities. At June 30, 2008, the Company had an accumulated other comprehensive loss of $772 thousand, an increase of $469 thousand from $303 thousand at December 31, 2007.

 

Net Income

 

For the six months ended June 30, 2008 the Company reported net income of $1,542 thousand as compared to $1,715 thousand for the same period in 2007; which is a decrease of $173 thousand. Income per basic and diluted share was $0.64 for the six months ended June 30, 2008 as compared to $0.70 per basic and diluted share for the period ended June 30, 2007.

 

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The Company had an annualized return on average assets of 1.06% and an annualized return on average equity of 8.17% for the six months ended June 30, 2008, as compared to an annualized return on average assets and average equity of 1.22% and 9.67%, respectively, for the same period in 2007.

 

For the three months ended June 30, 2008, the Company reported net income of $763 thousand as compared to $906 thousand for the same period in 2007, a decrease of 15.7%. Income per basic and diluted share was $0.32 for the three months ended June 30, 2008, as compared to $0.37 per basic and diluted for the period in 2007.

 

Net income for the three months ended June 30, 2008 was primarily affected by slower repricing of the time deposit accounts versus the decline in prime-based loans and costs associated with the conversion of the Bank’s network infrastructure. Both of these matters are discussed below, the first within the Net Interest Income section and the second in the Non-Interest Expense section.

 

The Company recorded provision for loan losses in the second quarter of 2008 totaling $25 thousand as compared to no provision in the same period of 2007. Management expected to be providing to build up the Allowance for Loan Losses in 2008 due to anticipated loan growth. Management is confident that it has identified problem credits and it is working with borrowers to mitigate credit losses, collection and legal costs. Signs of a weakening national economy with its potential impact on the Company’s regional economy could result in additional provisions beyond what is already anticipated.

 

Noninterest income for the first six months of 2008 was $1.338 million or $186 thousand greater than the same period in 2007. The Company continues to see increases in deposit account fees, ATM fees, and non-deposit product fee income as compared to the first six months of 2007. Management continues to work at expanding fee income through the Company’s offering of services and products to meet our customers’ needs.

 

Non-interest expenses for the first six months of 2008 were $4.378 million, or an increase of 5.2% or $215 thousand from the same period in 2007. Management continues to maintain a strict cost control attitude that includes developing greater operating efficiencies while maintaining a higher level of service to our customers.

 

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 deposits 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 six months ended June 30, 2008, net interest income was $5.205 million, which was $219 thousand less than $5.424 million for the same period in 2007. The average loan balances for the six months ended June 30, 2008 were $212.2 million or $7.8 million greater than the six months ended June 30, 2007 when the average loan balances were $204.4 million. The loan yield decreased 45 basis points to 6.93% for the six months ended June 30, 2008 from 7.38% for the comparable period in 2007. The prime rate is used as a basis of most commercial loans and commercial mortgages, therefore variable rate loans tied to prime adjusted to lower levels during the second quarter of 2008 and loan pricing for renewing or new loans was also driven lower in comparison to yields in 2007.

 

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The average investment securities balance for the first six months of 2008 was $49.6 million or $600 thousand more than the average of $49.0 million for the same period in 2007. The tax-equivalent yield on investment securities for the period in 2008 was 4.83% as compared to 4.68% for 2007, or an increase of 15 basis points from the year-earlier period. Opportunities to reinvest maturing securities into higher yielding securities occurred during the second quarter of 2008 when $5.9 million in securities were called or matured at an average tax-equivalent yield of 3.91% and these were replaced with purchases of $7.9 million with a tax-equivalent yield of 4.59% or an improvement of 68 basis points.

 

The yield on earning assets for the six months ended June 30, 2008 was 6.48%, a decrease of 36 basis points from the yield of 6.84% reported in the comparable period of 2007. The decrease in the earning assets yield for the six months ended June 30, 2008 as compared to the same period in 2007 is primarily the result of the reduction of short-term interest rates and its impact on loan yields.

 

A significant component of the Company’s decrease in net interest income is from the more rapid decline of loan income for commercial loans tied to the prime rate as compared to time deposits that reprice only upon maturity. Management expects that during the second half of 2008, the maturity level of time deposits and the current level of interest rates should result in a decline in the overall interest cost of time deposits, thus leading to an improvement in net interest income.

 

Average interest bearing deposits for the six months ended June 30, 2008 was $205.0 million or $1.2 million greater than $203.8 million for the six months ended June 30, 2007. The majority of the increase was due to higher average time deposits of $3.0 million, with the average being $137.1 million for the six months ended June 30, 2008 as compared to $134.1 for the same period in 2007. The cost of interest bearing deposits for the six months ended June 30, 2008, expressed as a percentage, was 3.06% as compared to 3.09% for the same period of 2007, or a decrease of 3 basis points. Time deposit costs were 4.31% and 4.42% for the six months ended June 30, 2008 and 2007, respectively, or an increase of 11 basis points. The competition for time deposits in our markets, during this period, remained strong with some competitors offering significantly higher rates than alternative funding sources; such as Federal Home Loan Bank advances. Despite competitive rates, Management maintained a disciplined pricing strategy that helped to generally retain existing relationships and attract new deposits. Average non-interest deposit balances for the six months ended June 30, 2008 was $34.9 million or $1.2 million less than the $36.1 million for the same period of 2007. The cost of deposits for the six months ended June 30, 2008 was 2.38% or 31 basis points lower than 2.69% for the six months ended June 30, 2007.

 

The net interest margin is net interest income expressed as a percentage of average earning assets. The net interest margin decreased by 29 basis points to 4.04% for the six months ended June 30, 2008 as compared to 4.33% for the same period in 2007.

 

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.

 

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

 

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Noninterest Income

 

Noninterest income includes deposit fees, gains on the sales of securities, OREO and Loans Held for Sale, and ATM fees. For the six months ended June 30, 2008, non-interest income increased 16.1% to $1.338 million compared to $1.152 million, or $186 thousand greater than the same period in 2007. 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 $1.318 million for the six months ended June 30, 2008 and $1.137 million for the same period in 2007; or an increase of $181 thousand. Below is a representation of the changes to the significant components.

 

 

 

 

 

 

Noninterest Expense

 

Noninterest expense includes employee-related costs, occupancy and equipment expense and other overhead costs. For the six months ended June 30, 2008, non-interest expense increased $215 thousand to $4.378 million as compared to $4.163 million for the comparable period in 2007, or an increase of 5.2%.

 

Management has been working, over the last 3 years, to establish stricter controls over noninterest expenses, and these efforts are being realized by the moderate increases in non-interest expenses over the previous year. The following table outlines the changes in significant components:

 

 

 

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Noninterest Expense (continued)

 

 

 

 

 

 

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. As of June 30, 2008 the Company has the following lines of credit available.

 

 

 

During the first quarter of 2008, the Company acquired a $5 million, five-year advance from the FHLB at a fixed interest rate of 2.47% for the first two years of the advance. The Company’s growth forecast and strategic planning anticipated the need for wholesale funding that would supplement retail deposit growth. Market rates during the first quarter offered Management with the opportunity to take the advance at this time rather than later in 2008. The rate mentioned above is 24 basis points less than the lowest annual cost for time deposit accounts in the last ten years. After the first two years, Management will have several options should the advance

 

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be converted by the FHLB, those options include: paying the advance in full, refinancing the advance into another FHLB advance product, or accept to pay a floating rate of interest based upon LIBOR for the remaining term of the advance. The initial fixed rate of 2.47% will remain in effect, beyond the first two years, if the FHLB does not exercise its quarterly convertible option.

 

The Company had $12.0 million in other borrowings at June 30, 2008, which represented a $4.7 million or 64.4% increase from $7.3 million at December 31, 2007. At June 30, 2008, other borrowings consisted of the $5.0 million long-term advance from the FHLB described above and $7.0 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, monitors its liquidity position daily, 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 June 30, 2008 and December 31, 2007 was $37.2 million and $37.3 million, respectively. Total number of common shares outstanding was 2,412,712 shares at June 30, 2008 and 2,434,550 shares at December 31, 2007. The decrease of 21,838 shares represents the number of shares repurchased by the Company under the stock repurchase plan that the Board of Directors initiated in September 2007. Additional information regarding the stock repurchase plan was discussed earlier in this report.

 

At June 30, 2008, the Company’s Tier 1 and total risk-based capital ratios were 18.9% and 20.0%, respectively, compared to 19.0% and 19.9% at December 31, 2007. The Company’s leverage ratio was 13.0% at June 30, 2008 compared to 12.9% at December 31, 2007. The Bank’s capital structure places it well above the regulatory guidelines, 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:

 

 

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Although the Company believes that its expectations with respect to the forward-looking statements are based upon reliable assumptions within the bounds of its knowledge of its business and operations, there can be no assurance that actual results, performance or achievements of the Company will not differ materially from any future results, performance or achievements expressed or implied by such forward-looking statements.

 

 

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 June 30, 2008 that has materially affected, or is reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

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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 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

On July 18, 2007, the Board of Directors of the Company voted to establish a stock repurchase plan. The Plan went into effect on September 1, 2007, for an initial three month term ending November 30, 2007. The Plan was extended for additional three month terms by the Board of Directors at its regularly scheduled meetings on November 28, 2007, February 21, 2008 and May 22, 2008. 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 repurchasing 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 since the inception of the plan on September 1, 2007 and under subsequent reauthorizations of the plan:

 

 

Item 3. Defaults upon Senior Securities

 

None.

 

 

 

 

 

 

 

 

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

 

The Annual Meeting of Shareholders was held May 22, 2008 at the Main Office of the Company, 126 South Main Street, Blackstone, Virginia. The company had 2,425,835 shares outstanding and eligible to vote at the Annual meeting. The following Directors were elected by the shareholders at the Annual meeting.

 

 

 

In addition, the shareholders ratified the selection of Yount, Hyde & Barbour, P.C. as independent public accountants for the Company for the fiscal year 2008, as follows:

 

 

Item 5. Other Information

 

None.

 

Item 6. Exhibits

 

See Exhibit Index.

 

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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.

 

 

 

 

 

 

 

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EXHIBIT INDEX

 

Exhibit Number