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Eagle Bancorp 10-Q 2013

Documents found in this filing:

  1. 10-Q
  2. Ex-4
  3. Ex-21
  4. Ex-31
  5. Ex-31
  6. Ex-32
  7. Ex-32
  8. Ex-32
egbn20130930_10q.htm

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

FORM 10-Q

 

(Mark One)

( X )

QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) 

 

 

OF THE SECURITIES EXCHANGE ACT OF 1934

 

      

For the Quarterly Period Ended September 30, 2013

 

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 0-25923

 

Eagle Bancorp, Inc.

(Exact name of registrant as specified in its charter)

 

Maryland

52-2061461

(State or other jurisdiction of

(I.R.S. Employer

incorporation or organization) 

 Identification No.)

 

7830 Old Georgetown Road, Third Floor, Bethesda, Maryland         

20814

(Address of principal executive offices)

(Zip Code) 

 

(301) 986-1800

(Registrant's telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes☒ No ☐

 

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

Large accelerated filer ☐

Accelerated filer ☒

Non-accelerated filer ☐ 

Smaller Reporting Company ☐

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act

Yes ☐     No ☒

 

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.

 

As of October 31, 2013, the registrant had 25,801,543 shares of Common Stock outstanding.

 

 
1

 

 

EAGLE BANCORP, INC.

TABLE OF CONTENTS

 

PART I.

FINANCIAL INFORMATION

 
     

Item 1.

Financial Statements (Unaudited) 

 3
 

Consolidated Balance Sheets

  4
 

Consolidated Statements of Operations

  5
 

Consolidated Statements of Comprehensive Income

 6
 

Consolidated Statements of Changes in Shareholders’ Equity

  7
 

Consolidated Statements of Cash Flows

 8
 

Notes to Consolidated Financial Statements

 
     

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

  36
     

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

  64
     

Item 4.

Controls and Procedures

  64
     

PART II.

OTHER INFORMATION

 
     

Item 1.

Legal Proceedings

  65
     

Item 1A.

Risk Factors

 
     

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

  65
     

Item 3.

Defaults Upon Senior Securities

  65
     

Item 4.

Mine Safety Disclosures

  65
     

Item 5.

Other Information

  65
     

Item 6.

Exhibits

  65
     

Signatures

  67

 

 

 
2

 

 

Item 1 – Financial Statements (Unaudited)


 

EAGLE BANCORP, INC.

Consolidated Balance Sheets (Unaudited)

(dollars in thousands, except per share data)

 

   

September 30, 2013

   

December 31, 2012

   

September 30, 2012

 

Assets

                       

Cash and due from banks

  $ 8,013     $ 7,439     $ 6,780  

Federal funds sold

    3,844       7,852       4,173  

Interest bearing deposits with banks and other short-term investments

    208,522       324,043       46,752  

Investment securities available for sale, at fair value

    355,830       299,820       296,363  

Federal Reserve and Federal Home Loan Bank stock

    11,246       10,694       12,031  

Loans held for sale

    39,206       226,923       171,241  

Loans

    2,796,840       2,493,095       2,397,669  

Less allowance for credit losses

    (39,687 )     (37,492 )     (35,582 )

Loans, net

    2,757,153       2,455,603       2,362,087  

Premises and equipment, net

    16,319       15,261       14,472  

Deferred income taxes

    25,982       19,128       16,413  

Bank owned life insurance

    29,555       14,135       14,036  

Intangible assets, net

    3,597       3,785       3,895  

Other real estate owned

    11,285       5,299       4,923  

Other assets

    34,376       19,459       23,022  

Total Assets

  $ 3,504,928     $ 3,409,441     $ 2,976,188  
                         

Liabilities and Shareholders' Equity

                       

Liabilities

                       

Deposits:

                       

Noninterest bearing demand

  $ 898,831     $ 881,390     $ 796,654  

Interest bearing transaction

    104,004       113,813       112,901  

Savings and money market

    1,538,630       1,374,869       1,180,894  

Time, $100,000 or more

    249,594       232,875       242,159  

Other time

    193,000       294,275       182,381  

Total deposits

    2,984,059       2,897,222       2,514,989  

Customer repurchase agreements

    82,266       101,338       75,368  

Other short-term borrowings

    -       -       10,000  

Long-term borrowings

    39,300       39,300       39,300  

Other liabilities

    17,203       21,605       12,132  

Total Liabilities

    3,122,828       3,059,465       2,651,789  
                         

Shareholders' Equity

                       

Preferred stock, par value $.01 per share, shares authorized 1,000,000, Series B, $1,000 per share liquidation preference, shares issued and outstanding 56,600 at September 30, 2013, December 31, 2012 and September 30, 2012.

    56,600       56,600       56,600  

Common stock, par value $.01 per share; shares authorized 50,000,000, shares issued and outstanding 25,799,220, 22,954,889 and 22,040,006, respectively

    252       226       217  

Warrant

    946       946       946  

Additional paid in capital

    241,131       180,593       164,522  

Retained earnings

    84,534       106,146       96,088  

Accumulated other comprehensive (loss) income

    (1,363 )     5,465       6,026  

Total Shareholders' Equity

    382,100       349,976       324,399  

Total Liabilities and Shareholders' Equity

  $ 3,504,928     $ 3,409,441     $ 2,976,188  

 

See notes to consolidated financial statements.

 

 
3

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Operations (Unaudited)

(dollars in thousands, except per share data) 

 

   

Nine Months Ended September 30,

   

Three Months Ended September 30,

 
   

2013

   

2012

   

2013

   

2012

 

Interest Income

                               

Interest and fees on loans

  $ 109,479     $ 98,161     $ 37,457     $ 34,805  

Interest and dividends on investment securities

    5,589       5,279       2,082       1,735  

Interest on balances with other banks and short-term investments

    564       298       182       83  

Interest on federal funds sold

    10       41       3       13  

Total interest income

    115,642       103,779       39,724       36,636  

Interest Expense

                               

Interest on deposits

    8,122       9,130       2,544       2,722  

Interest on customer repurchase agreements

    197       250       64       68  

Interest on short-term borrowings

    -       2       -       2  

Interest on long-term borrowings

    1,247       1,605       413       536  

Total interest expense

    9,566       10,987       3,021       3,328  

Net Interest Income

    106,076       92,792       36,703       33,308  

Provision for Credit Losses

    7,094       12,051       1,372       3,638  

Net Interest Income After Provision For Credit Losses

    98,982       80,741       35,331       29,670  
                                 

Noninterest Income

                               

Service charges on deposits

    3,351       2,902       1,115       988  

Gain on sale of loans

    13,355       9,867       2,938       3,144  

Gain on sale of investment securities

    23       765       -       464  

Loss on early extinguishment of debt

    -       (529 )     -       (529 )

Increase in the cash surrender value of bank owned life insurance

    420       294       231       100  

Other income

    3,263       2,005       952       684  

Total noninterest income

    20,412       15,304       5,236       4,851  

Noninterest Expense

                               

Salaries and employee benefits

    34,722       31,520       12,187       10,807  

Premises and equipment expenses

    8,949       7,541       3,222       2,562  

Marketing and advertising

    1,167       1,340       426       497  

Data processing

    4,456       3,273       1,386       1,066  

Legal, accounting and professional fees

    2,586       3,315       984       1,073  

FDIC insurance

    1,780       1,553       584       485  

Other expenses

    9,395       7,664       2,884       2,617  

Total noninterest expense

    63,055       56,206       21,673       19,107  

Income Before Income Tax Expense

    56,339       39,839       18,894       15,414  

Income Tax Expense

    21,335       14,748       7,137       5,739  

Net Income

    35,004       25,091       11,757       9,675  

Preferred Stock Dividends

    425       425       142       142  

Net Income Available to Common Shareholders

  $ 34,579     $ 24,666     $ 11,615     $ 9,533  
                                 

Earnings Per Common Share

                               

Basic

  $ 1.35     $ 1.09     $ 0.45     $ 0.41  

Diluted

  $ 1.31     $ 1.07     $ 0.44     $ 0.40  

 

See notes to consolidated financial statements.

 

 
4

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Comprehensive Income (Unaudited)

(dollars in thousands)

 

   

Nine Months Ended September 30,

   

Three Months Ended September 30,

 
   

2013

   

2012

   

2013

   

2012

 
                                 

Net Income

  $ 35,004     $ 25,091     $ 11,757     $ 9,675  
                                 

Other comprehensive income, net of tax:

                               

Net unrealized (loss) gain on securities available for sale

    (6,841 )     1,610       (456 )     911  

Reclassification adjustment for net gains included in net income

    (13 )     (459 )     -       (278 )

Net change in unrealized (loss) gains on securities

    (6,828 )     1,151       (456 )     633  

Comprehensive Income

  $ 28,176     $ 26,242     $ 11,301     $ 10,308  
 

See notes to consolidated financial statements.

 

 
5

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Changes in Shareholders’ Equity (Unaudited)

(dollars in thousands)

 

   

Preferred

Stock

   

Common

Stock

   

Warrant

   

Additional Paid

in Capital

   

Retained

Earnings

   

Accumulated

Other

Comprehensive

Income (Loss)

   

Total

Shareholders'

Equity

 

Balance January 1, 2013

  $ 56,600     $ 226     $ 946     $ 180,593     $ 106,146     $ 5,465     $ 349,976  

Net Income

    -       -       -       -       35,004       -       35,004  

Net change in other comprehensive income

    -       -       -       -       -       (6,828 )     (6,828 )

10% common stock dividend 2,340,518 shares

    -       23       -       56,158       (56,181 )     -       -  

Cash paid in lieu of fractional shares

    -       -       -       -       (10 )     -       (10 )

Stock-based compensation

    -       -       -       2,429       -       -       2,429  

Common stock issued 483,595 shares under equity compensation plans

    -       3       -       1,244       -       -       1,247  

Tax benefits releated to stock compensation

    -       -       -       322       -       -       322  

Employee stock purchase plan 20,218 shares

    -       -       -       385       -       -       385  

Preferred stock dividends

    -       -       -       -       (425 )     -       (425 )

Balance September 30, 2013

  $ 56,600     $ 252     $ 946     $ 241,131     $ 84,534     $ (1,363 )   $ 382,100  
                                                         

Balance January 1, 2012

  $ 56,600     $ 197     $ 946     $ 132,670     $ 71,423     $ 4,875     $ 266,711  

Net Income

    -       -       -       -       25,091       -       25,091  

Net change in other comprehensive income

    -       -       -       -       -       1,151       1,151  

Stock-based compensation

    -       -       -       2,060       (1     -       2,059  

Common stock issued 288,170 shares under equity compensation plans

    -       2       -       776       -       -       778  

Common stock issued 1,770,585 shares

    -       18       -       28,482       -       -       28,500  

Tax benefits releated to stock compensation

    -       -       -       87       -       -       87  

Employee stock purchase plan 28,407 shares

    -       -       -       447       -       -       447  

Preferred stock dividends

    -       -       -       -       (425 )     -       (425 )

Balance September 30, 2012

  $ 56,600     $ 217     $ 946     $ 164,522     $ 96,088     $ 6,026     $ 324,399  
 

See notes to consolidated financial statements.

 

 
6

 

 

EAGLE BANCORP, INC.

Consolidated Statements of Cash Flows (Unaudited)

(dollars in thousands)

 

   

Nine Months Ended September 30,

 
   

2013

   

2012

 

Cash Flows From Operating Activities:

               

Net Income

  $ 35,004     $ 25,091  

Adjustments to reconcile net income to net cash provided by operating activities:

               

Provision for credit losses

    7,094       12,051  

Depreciation and amortization

    3,161       2,392  

Gains on sale of loans

    (13,355 )     (9,867 )

Securities premium amortization (discount accretion), net

    2,306       3,662  

Origination of loans held for sale

    (853,068 )     (981,733 )

Proceeds from sale of loans held for sale

    1,054,140       997,185  

Net increase in cash surrender value of BOLI

    (420 )     (294 )

Increase in deferred income taxes

    (6,854 )     (1,740 )

Net loss (gain) on sale of other real estate owned

    781       (26 )

Net gain on sale of investment securities

    (23 )     (765 )

Loss on early extinguishment of debt

    -       529  

Stock-based compensation expense

    2,429       2,059  

Excess tax benefit from stock-based compensation

    (322 )     (87 )

(Increase) decrease in other assets

    (3,733 )     234  

Decrease in other liabilities

    (4,402 )     (7,655 )

Net cash provided by operating activities

    222,738       41,036  

Cash Flows From Investing Activities:

               

(Decrease) increase in interest bearing deposits with other banks and short-term investments

    (53 )     22  

Purchases of available for sale investment securities

    (114,259 )     (79,314 )

Proceeds from maturities of available for sale securities

    26,990       30,212  

Proceeds from sale/call of available for sale securities

    22,148       62,888  

Purchases of Federal Reserve and Federal Home Loan Bank stock

    (705 )     (2,763 )

Proceeds from redemption of federal reserve and federal home loan bank stock

    153       974  

Net increase in loans

    (318,191 )     (348,405 )

Purchases of BOLI

    (15,000 )     -  

Purchases of Annuities

    (11,184 )     -  

Proceeds from sale of other real estate owned

    3,068       901  

Bank premises and equipment acquired

    (3,944 )     (4,321 )

Net cash used in investing activities

    (410,977 )     (339,806 )

Cash Flows From Financing Activities:

               

Increase in deposits

    86,837       122,671  

Decrease in customer repurchase agreements

    (19,072 )     (27,994 )

Increase in other short-term borrowings

    -       10,000  

Decrease in long-term borrowings

    -       (10,000 )

Payment of dividends on preferred stock

    (425 )     (425 )

Issuance of common stock

    -       28,500  

Proceeds from exercise of stock options

    1,247       778  

Excess tax benefit from stock-based compensation

    322       87  

Payment in lieu of fractional shares

    (10 )     -  

Proceeds from employee stock purchase plan

    385       447  

Net cash provided by financing activities

    69,284       124,064  

Net Decrease In Cash and Cash Equivalents

    (118,955 )     (174,706 )

Cash and Cash Equivalents at Beginning of Period

    339,334       232,411  

Cash and Cash Equivalents at End of Period

  $ 220,379     $ 57,705  

Supplemental Cash Flows Information:

               

Interest paid

  $ 10,078     $ 11,752  

Income taxes paid

  $ 23,945     $ 11,951  

Non-Cash Investing Activities

               

Transfers from loans to other real estate owned

  $ 9,835     $ 3,555  

 

See notes to consolidated financial statements.

 

 
7

 

 

EAGLE BANCORP, INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

 

Note 1. Summary of Significant Accounting Policies

 

Basis of Presentation

 

The consolidated financial statements include the accounts of Eagle Bancorp, Inc. and its subsidiaries (the “Company”), EagleBank (the “Bank”), Eagle Commercial Ventures, LLC (“ECV”), Eagle Insurance Services, LLC, and Bethesda Leasing, LLC, with all significant intercompany transactions eliminated.

 

The consolidated financial statements of the Company included herein are unaudited. The consolidated financial statements reflect all adjustments, consisting of normal recurring accruals that in the opinion of management, are necessary to present fairly the results for the periods presented. The amounts as of and for the year ended December 31, 2012 were derived from audited consolidated financial statements. Certain information and note disclosures normally included in financial statements prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission. There have been no significant changes to the Company’s Accounting Policies as disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. The Company believes that the disclosures are adequate to make the information presented not misleading. Certain reclassifications have been made to amounts previously reported to conform to the current period presentation.

 

These statements should be read in conjunction with the audited consolidated financial statements and related notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012. Operating results for the three and nine months ended September 30, 2013 are not necessarily indicative of the results of operations to be expected for the remainder of the year, or for any other period.

 

Nature of Operations

 

The Company, through the Bank, conducts a full service community banking business, primarily in Montgomery County, Maryland; Washington, DC and Northern Virginia. The primary financial services offered by the Bank include real estate, commercial and consumer lending, as well as traditional deposit and repurchase agreement products. The Bank is also active in the origination and sale of residential mortgage loans and the origination of small business loans. The guaranteed portion of small business loans, guaranteed by the Small Business Administration (“SBA”), is typically sold to third party investors in a transaction apart from the loan’s origination. The Bank offers its products and services through eighteen branch offices and various electronic capabilities, including remote deposit and mobile banking services. Eagle Insurance Services, LLC, a subsidiary of the Bank, offers access to insurance products and services through a referral program with a third party insurance broker. Eagle Commercial Ventures, LLC, a direct subsidiary of the Company, provides subordinated financing for the acquisition, development and construction of real estate projects. These transactions involve higher levels of risk, together with commensurate higher returns. Refer to Higher Risk Lending – Revenue Recognition below.

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts in the financial statements and accompanying notes. Actual results may differ from those estimates and such differences could be material to the financial statements.

 

Cash Flows

 

For purposes of reporting cash flows, cash and cash equivalents include cash and due from banks, federal funds sold, and interest bearing deposits with other banks which have an original maturity of three months or less.

 

 

 
8

 

 

Loans Held for Sale

 

The Company engages in sales of residential mortgage loans and the guaranteed portion of Small Business Administration loans originated by the Bank. Loans held for sale are carried at the lower of aggregate cost or fair value. Fair value is derived from secondary market quotations for similar instruments. Gains and losses on sales of these loans are recorded as a component of noninterest income in the Consolidated Statements of Operations.

 

The Company’s current practice is to sell residential mortgage loans on a servicing released basis, and, therefore, it has no intangible asset recorded for the value of such servicing as of September 30, 2013, December 31, 2012, and September 30, 2012. The sale of the guaranteed portion of SBA loans on a servicing retained basis gives rise to an excess servicing asset, which is computed on a loan by loan basis with the unamortized amount being included in Other Assets in the Consolidated Balance Sheet. This excess servicing asset is being amortized on a straight-line basis (with adjustment for prepayments) as an offset to servicing fees collected and is included in other noninterest income in the Consolidated Statement of Operations.

 

The Company enters into commitments to originate residential mortgage loans whereby the interest rate on the loan is determined prior to funding (i.e. rate lock commitments). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives but are effectively offset by whole loan purchase commitments from various investors. The period of time between issuance of a loan commitment to the customer and closing and sale of the loan to an investor generally ranges from 30 to 90 days under current market conditions. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the investor commits to purchase a loan at a price representing a premium on the day the borrower commits to an interest rate with the intent that the buyer / investor has assumed the interest rate risk on the loan. As a result, the Company is not generally exposed to losses on loans sold nor will it realize gains, related to rate lock commitments due to changes in interest rates.

 

The market values of rate lock commitments and best efforts contracts are not readily ascertainable with precision because rate lock commitments and best efforts contracts are not actively traded. Because of the high correlation between rate lock commitments and best efforts contracts, no gain or loss should occur on the rate lock commitments.

 

In circumstances where the Company does not deliver the whole loan to an investor, but rather elects to retain the loan in its portfolio, the loan is transferred from held for sale at fair value.

 

Investment Securities

 

The Company has no securities classified as trading, nor are any investment securities classified as held to maturity. Marketable equity securities and debt securities not classified as held to maturity or trading are classified as available-for-sale. Securities available-for-sale are acquired as part of the Company’s asset/liability management strategy and may be sold in response to changes in interest rates, current market conditions, loan demand, changes in prepayment risk and other factors. Securities available-for-sale are carried at fair value, with unrealized gains or losses being reported as accumulated other comprehensive income/(loss), a separate component of shareholders’ equity, net of deferred income tax. Realized gains and losses, using the specific identification method, are included as a separate component of noninterest income in the Consolidated Statements of Operations.

 

Premiums and discounts on investment securities are amortized/accreted to the earlier of call or maturity based on expected lives, which lives are adjusted based on prepayment assumptions and call optionality if any. Declines in the fair value of individual available-for-sale securities below their cost that are other-than-temporary in nature result in write-downs of the individual securities to their fair value. Factors affecting the determination of whether other-than-temporary impairment has occurred include a downgrading of the security by a rating agency, a significant deterioration in the financial condition of the issuer, or a change in management’s intent and ability to hold a security for a period of time sufficient to allow for any anticipated recovery in fair value. Management systematically evaluates investment securities for other-than-temporary declines in fair value on a quarterly basis. This analysis requires management to consider various factors, which include (1) duration and magnitude of the decline in value, (2) the financial condition of the issuer or issuers and (3) structure of the security.

 

 

 
9

 

 

The entire amount of an impairment loss is recognized in earnings only when (1) the Company intends to sell the security, or (2) it is more likely than not that the Company will have to sell the security before recovery of its amortized cost basis, or (3) the Company does not expect to recover the entire amortized cost basis of the security. In all other situations, only the portion of the impairment loss representing the credit loss must be recognized in earnings, with the remaining portion being recognized in shareholders’ equity as comprehensive income, net of deferred taxes.

 

Loans

 

Loans are stated at the principal amount outstanding, net of unamortized deferred costs and fees. Interest income on loans is accrued at the contractual rate on the principal amount outstanding. It is the Company’s policy to discontinue the accrual of interest when circumstances indicate that collection is doubtful. Deferred fees and costs are being amortized on the interest method over the term of the loan.

 

Management considers loans impaired when, based on current information, it is probable that the Company will not collect all principal and interest payments according to contractual terms. Loans are evaluated for impairment in accordance with the Company’s portfolio monitoring and ongoing risk assessment procedures.  Management considers the financial condition of the borrower, cash flow of the borrower, payment status of the loan, and the value of the collateral, if any, securing the loan. Generally, impaired loans do not include large groups of smaller balance homogeneous loans such as residential real estate and consumer type loans which are evaluated collectively for impairment and are generally placed on nonaccrual when the loan becomes 90 days past due as to principal or interest. Loans specifically reviewed for impairment are not considered impaired during periods of “minimal delay” in payment (ninety days or less) provided eventual collection of all amounts due is expected.  The impairment of a loan is measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate, or the fair value of the collateral if repayment is expected to be provided solely by the collateral.  In appropriate circumstances, interest income on impaired loans may be recognized on the cash basis.

 

Higher Risk Lending – Revenue Recognition

 

The Company has occasionally made higher risk acquisition, development, and construction (“ADC”) loans that entail higher risks than ADC loans made following normal underwriting practices (“higher risk loan transactions”). These higher risk loan transactions are currently made through the Company’s subsidiary, ECV. This activity is limited as to individual transaction amount and total exposure amounts based on capital levels and is carefully monitored. The loans are carried on the balance sheet at amounts outstanding and meet the loan classification requirements of the Accounting Standards Executive Committee (“AcSEC”) guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No. 1). Additional interest earned on certain of these higher risk loan transactions (as defined in the individual loan agreements) is recognized as realized under the provisions contained in AcSEC’s guidance reprinted from the CPA Letter, Special Supplement, dated February 10, 1986 (also referred to as Exhibit 1 to AcSEC Practice Bulletin No.1) and Staff Accounting Bulletin No. 101 (Revenue Recognition in Financial Statements). Such additional interest may be included as a component of noninterest income. ECV recorded no additional interest on higher risk transactions during 2013 and 2012 (although normal interest income was recorded). ECV had five higher risk lending transactions with balances outstanding at September 30, 2013 and four such transactions outstanding at December 31, 2012, amounting to $7.4 million and $3.5 million, respectively.

 

Allowance for Credit Losses

 

The allowance for credit losses represents an amount which, in management’s judgment, is adequate to absorb probable losses on existing loans and other extensions of credit that may become uncollectible. The adequacy of the allowance for credit losses is determined through careful and continuous review and evaluation of the loan portfolio and involves the balancing of a number of factors to establish a prudent level of allowance. Among the factors considered in evaluating the adequacy of the allowance for credit losses are lending risks associated with growth and entry into new markets, loss allocations for specific credits, the level of the allowance to nonperforming loans, historical loss experience, economic conditions, portfolio trends and credit concentrations, changes in the size and character of the loan portfolio, and management’s judgment with respect to current and expected economic conditions and their impact on the existing loan portfolio. Allowances for impaired loans are generally determined based on collateral values. Loans or any portion thereof deemed uncollectible are charged against the allowance, while recoveries are credited to the allowance. Management adjusts the level of the allowance through the provision for credit losses, which is recorded as a current period operating expense. The allowance for credit losses consists of allocated and unallocated components.

 

 

 
10

 

 

The components of the allowance for credit losses represent an estimation done pursuant to Accounting Standards Codification (“ASC”) Topic 450, “Contingencies,” or ASC Topic 310, “Receivables.” Specific allowances are established in cases where management has identified significant conditions or circumstances related to a specific credit that management believes indicate the probability that a loss may be incurred. For potential problem credits for which specific allowance amounts have not been determined, the Company establishes allowances according to the application of credit risk factors. These factors are set by management and approved by the appropriate Board Committee to reflect its assessment of the relative level of risk inherent in each risk grade. A third component of the allowance computation, termed a nonspecific or environmental factors allowance, is based upon management’s evaluation of various environmental conditions that are not directly measured in the determination of either the specific allowance or formula allowance. Such conditions include general economic and business conditions affecting key lending areas, credit quality trends (including trends in delinquencies and nonperforming loans expected to result from existing conditions), loan volumes and concentrations, specific industry conditions within portfolio categories, recent loss experience in particular loan categories, duration of the current business cycle, bank regulatory examination results, findings of outside review consultants, and management’s judgment with respect to various other conditions including credit administration and management and the quality of risk identification systems. Executive management reviews these environmental conditions quarterly, and documents the rationale for all changes.

 

Management believes that the allowance for credit losses is adequate; however, determination of the allowance is inherently subjective and requires significant estimates. While management uses available information to recognize losses on loans, future additions to the allowance may be necessary based on changes in economic conditions. Evaluation of the potential effects of these factors on estimated losses involves a high degree of uncertainty, including the strength and timing of economic cycles and concerns over the effects of a prolonged economic downturn in the current cycle. In addition, various regulatory agencies, as an integral part of their examination process, and independent consultants engaged by the Bank periodically review the Bank’s loan portfolio and allowance for credit losses. Such review may result in recognition of adjustments to the allowance based on their judgments of information available to them at the time of their examination.

 

Premises and Equipment

 

Premises and equipment are stated at cost less accumulated depreciation and amortization computed using the straight-line method for financial reporting purposes. Premises and equipment are depreciated over the useful lives of the assets, which generally range from five to seven years for furniture, fixtures and equipment, to three to five years for computer software and hardware, and to ten to forty years for buildings and building improvements. Leasehold improvements are amortized over the terms of the respective leases, which may include renewal options where management has the positive intent to exercise such options, or the estimated useful lives of the improvements, whichever is shorter. The costs of major renewals and betterments are capitalized, while the costs of ordinary maintenance and repairs are expensed as incurred. These costs are included as a component of premises and equipment expenses on the Consolidated Statements of Operations.

 

Other Real Estate Owned (OREO)

 

Assets acquired through loan foreclosure are held for sale and are initially recorded at the lower of cost or fair value less estimated selling costs when acquired, establishing a new cost basis. The new basis is supported by recent appraisals. Costs after acquisition are generally expensed. If the fair value of the asset declines, a write-down is recorded through expense. The valuation of foreclosed assets is subjective in nature and may be adjusted in the future because of changes in market conditions or appraised values.

 

 

 
11

 

 

Goodwill and Other Intangible Assets

 

Goodwill and other intangible assets are subject to impairment testing at least annually, or when events or changes in circumstances indicate the assets might be impaired. Intangible assets (other than goodwill) are amortized to expense using accelerated or straight-line methods over their respective estimated useful lives. The Company’s testing of potential goodwill impairment (which is performed annually) at December 31, 2012, resulted in no impairment being recorded.

 

Customer Repurchase Agreements

 

The Company enters into agreements under which it sells securities subject to an obligation to repurchase the same securities. Under these arrangements, the Company may transfer legal control over the assets but still retain effective control through an agreement that both entitles and obligates the Company to repurchase the assets. As a result, securities sold under agreements to repurchase are accounted for as collateralized financing arrangements and not as a sale and subsequent repurchase of securities. The agreements are entered into primarily as accommodations for large commercial deposit customers. The obligation to repurchase the securities is reflected as a liability in the Company’s Consolidated Statement of Condition, while the securities underlying the securities sold under agreements to repurchase remain in the respective assets accounts and are delivered to and held as collateral by third party trustees.

 

Marketing and Advertising

 

Marketing and advertising costs are generally expensed as incurred.

 

Income Taxes

 

The Company employs the liability method of accounting for income taxes as required by ASC Topic 740, “Income Taxes.” Under the liability method, deferred tax assets and liabilities are determined based on differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities (i.e., temporary timing differences) and are measured at the enacted rates that will be in effect when these differences reverse. The Company utilizes statutory requirements for its income tax accounting, and avoids risks associated with potentially problematic tax positions that may incur challenge upon audit, where an adverse outcome is more likely than not. Therefore, no provisions are made for either uncertain tax positions nor accompanying potential tax penalties and interest for underpayments of income taxes in the Company’s tax reserves. In accordance with ASC Topic 740, the Company may establish a reserve against deferred tax assets in those cases where realization is less than certain, although no such reserves exist at September 30, 2013, December 31, 2012, or September 30, 2012.

 

Transfer of Financial Assets

 

Transfers of financial assets are accounted for as sales, when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. In certain cases, the recourse to the Bank to repurchase assets may exist but is deemed immaterial based on the specific facts and circumstances.

 

Earnings per Common Share

 

Basic net income per common share is derived by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured. Diluted earnings per common share is computed by dividing net income available to common shareholders by the weighted-average number of common shares outstanding during the period measured including the potential dilutive effects of common stock equivalents. Earnings per share amounts for periods ending prior to June 30, 2013 have been adjusted to reflect a 10% stock dividend paid on June 14, 2013.

 

 

 
12

 

 

Stock-Based Compensation

 

In accordance with ASC Topic 718, “Compensation,” the Company records as compensation expense an amount equal to the amortization (over the remaining service period) of the fair value computed at the date of grant. Compensation expense on variable stock option grants (i.e. performance based grants) is recorded based on the probability of achievement of the goals underlying the performance grant. Refer to Note 6 for a description of stock-based compensation awards, activity and expense.

 

New Authoritative Accounting Guidance

 

In February 2013, the FASB issued ASU 2013-02, “Comprehensive Income (Topic 220) – Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income.” ASU 2013-02 amends recent guidance related to the reporting of comprehensive income to enhance the reporting of reclassifications out of accumulated other comprehensive income. The Company adopted the provisions of ASU No. 2013-02 effective January 1, 2013. As the Company provided these required disclosures in the notes to the Consolidated Financial Statements, the adoption of ASU No. 2013-02 had no impact on the Company's consolidated statements of income and condition. See Note 7 to the consolidated financial statements for the disclosures required by ASU No. 2013-02.

 

Note 2. Cash and Due from Banks

 

Regulation D of the Federal Reserve Act requires that banks maintain noninterest reserve balances with the Federal Reserve Bank based principally on the type and amount of their deposits. During 2013, the Bank maintained balances at the Federal Reserve (in addition to vault cash) to meet the reserve requirements as well as balances to partially compensate for services. Late in 2008, the Federal Reserve in connection with the Emergency Economic Stabilization Act of 2008 began paying a nominal amount of interest on balances held, which interest on excess reserves was increased under provisions of the Dodd Frank Wall Street Reform and Consumer Protection Act passed in July 2010. Additionally, the Bank maintains interest-bearing balances with the Federal Home Loan Bank of Atlanta and noninterest bearing balances with six domestic correspondent banks as compensation for services they provide to the Bank.

 

 

Note 3. Investment Securities Available-for-Sale

 

Amortized cost and estimated fair value of securities available-for-sale are summarized as follows:

 

 

September 30, 2013

 

Amortized

   

Gross

Unrealized

   

Gross

Unrealized

   

Estimated

Fair

 

(dollars in thousands)

 

Cost

   

Gains

   

Losses

   

Value

 

U. S. Government agency securities

  $ 41,729     $ 969     $ 143     $ 42,555  

Residential mortgage backed securities

    223,216       1,423       4,649       219,990  

Municipal bonds

    92,746       2,461       2,308       92,899  

Other equity investments

    412       -       26       386  
    $ 358,103     $ 4,853     $ 7,126     $ 355,830  

 

December 31, 2012

 

Amortized

   

Gross

Unrealized

   

Gross

Unrealized

   

Estimated

Fair

 

(dollars in thousands)

 

Cost

   

Gains

   

Losses

   

Value

 

U. S. Government agency securities

  $ 47,606     $ 1,477     $ 1     $ 49,082  

Residential mortgage backed securities

    170,649       2,730       296       173,083  

Municipal bonds

    72,050       5,314       51       77,313  

Other equity investments

    407       -       65       342  
    $ 290,712     $ 9,521     $ 413     $ 299,820  

 

 
13

 

 

Gross unrealized losses and fair value by length of time that the individual available-for-sale securities have been in a continuous unrealized loss position are as follows:

 

   

Less than

12 Months

   

12 Months

or Greater

   

Total

 

September 30, 2013

 

Estimated

Fair

   

Unrealized

   

Estimated

Fair

   

Unrealized

   

Estimated

Fair

   

Unrealized

 

(dollars in thousands)

 

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

U. S. Government agency securities

  $ 4,787     $ 143     $ -     $ -     $ 4,787     $ 143  

Residential mortgage backed securities

    133,938       4,580       2,649       69       136,587       4,649  

Municipal bonds

    40,656       2,300       482       8       41,138       2,308  

Other equity investments

    -       -       151       26       151       26  
    $ 179,381     $ 7,023     $ 3,282     $ 103     $ 182,663     $ 7,126  

 

   

Less than

12 Months

   

12 Months

or Greater

   

Total

 

December 31, 2012

 

Estimated

Fair

   

Unrealized

   

Estimated

Fair

   

Unrealized

   

Estimated

Fair

   

Unrealized

 

(dollars in thousands)

 

Value

   

Losses

   

Value

   

Losses

   

Value

   

Losses

 

U. S. Government agency securities

  $ 2,999     $ 1     $ -     $ -     $ 2,999     $ 1  

Residential mortgage backed securities

    44,992       263       2,743       33       47,735       296  

Municipal bonds

    3,964       51       -       -       3,964       51  

Other equity investments

    -       -       112       65       112       65  
    $ 51,955     $ 315     $ 2,855     $ 98     $ 54,810     $ 413  

 

 

The unrealized losses that exist are generally the result of changes in market interest rates and interest spread relationships since original purchases. The weighted average duration of debt securities, which comprise 99.9% of total investment securities, is relatively short at 4.5 years. The gross unrealized loss on other equity investments represents common stock of one local banking company owned by the Company, and traded on a broker “bulletin board” exchange. The estimated fair value is determined by broker quoted prices. The unrealized loss is deemed a result of generally weak valuations for many smaller community bank stocks. The individual banking company is profitable, has good financial trends and has a satisfactory capital position. If quoted prices are not available, fair value is measured using independent pricing models or other model-based valuation techniques such as the present value of future cash flows, adjusted for the security’s credit rating, prepayment assumptions and other factors such as credit loss assumptions. The Company does not believe that the investment securities that were in an unrealized loss position as of September 30, 2013 represent an other-than-temporary impairment for the reasons noted. The Company does not intend to sell the investments and it is more likely than not that the Company will not have to sell the securities before recovery of its amortized cost basis, which may be maturity. In addition, at September 30, 2013, the Company held $11.2 million in equity securities in a combination of Federal Reserve Bank (“FRB”) and Federal Home Loan Bank (“FHLB”) stocks, which are required to be held for regulatory purposes and are not marketable.

 

The amortized cost and estimated fair value of investments available-for-sale by contractual maturity are shown in the table below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.

 

 

 
14

 

 

   

September 30, 2013

   

December 31, 2012

 

(dollars in thousands)

 

Amortized

Cost

   

Estimated

Fair Value

   

Amortized

Cost

   

Estimated

Fair Value

 

U. S. Government agency securities maturing:

                               

One year or less

  $ 14,041     $ 14,198     $ 5,038     $ 5,053  

After one year through five years

    27,688       28,357       42,568       44,029  

Residential mortgage backed securities

    223,216       219,990       170,649       173,083  

Municipal bonds maturing:

                               

After one year through five years

    21,158       21,477       11,469       11,978  

Five years through ten years

    71,588       71,422       60,581       65,335  

Other equity investments

    412       386       407       342  
    $ 358,103     $ 355,830     $ 290,712     $ 299,820  

 

 

The carrying value of securities pledged as collateral for certain government deposits, securities sold under agreements to repurchase, and certain lines of credit with correspondent banks at September 30, 2013 was $260.7 million. As of September 30, 2013 and December 31, 2012, there were no holdings of securities of any one issuer, other than the U.S. Government and U.S. Government agency securities that exceeded ten percent of shareholders’ equity.

 

 

Note 4.    Loans and Allowance for Credit Losses

 

The Bank makes loans to customers primarily in the Washington, DC metropolitan area and surrounding communities. A substantial portion of the Bank’s loan portfolio consists of loans to businesses secured by real estate and other business assets.

 

Loans, net of unamortized net deferred fees, at September 30, 2013, December 31, 2012, and September 30, 2012 are summarized by type as follows:

 

   

September 30, 2013

   

December 31, 2012

   

September 30, 2012

 

(dollars in thousands)

 

Amount

   

%

   

Amount

   

%

   

Amount

   

%

 

Commercial

  $ 682,413       25 %   $ 545,070       22 %   $ 534,133       23 %

Investment - commercial real estate

    1,039,775       37 %     914,638       37 %     942,770       39 %

Owner occupied - commercial real estate

    334,078       12 %     297,857       12 %     306,148       13 %

Real estate mortgage - residential

    79,061       3 %     61,871       3 %     57,952       2 %

Construction - commercial and residential

    507,653       18 %     533,722       21 %     437,954       18 %

Construction - C&I (owner occupied)

    35,612       1 %     28,808       1 %     14,739       1 %

Home equity

    108,889       4