|
|
 | | | |
- close
- close
- close
- close
| |||||||||
Valley Financial 10-K 2008 Documents found in this filing:Table of Contents
UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549
FORM 10-K
FOR ANNUAL AND TRANSITION REPORTS (Mark One)
For the fiscal year ended December 31, 2007 OR
For the transition period from to Commission File Number: 000-28342
VALLEY FINANCIAL CORPORATION (Exact Name of Registrant as Specified in Its Charter)
36 Church Avenue, S.W. Roanoke, Virginia 24011 (Address of principal executive offices) Registrant’s telephone number, including area code (540) 342-2265
Securities registered under Section 12(b) of the Exchange Act of 1934: None Securities registered under Section 12(g) of the Exchange Act of 1934:
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. Yes ¨ No x Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. Yes ¨ No x Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨ Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. ¨ Indicate by checkmark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer,” and “smaller reporting company” 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 Act). Yes ¨ No x The aggregate market value of Valley Financial Corporation Common Stock held by non-affiliates of Valley Financial Corporation as of June 30, 2007 (2,789,971 shares) was $29,852,690. The number of shares of Valley Financial Corporation Common Stock outstanding as of March 11, 2008 was 4,623,947.
Table of ContentsVALLEY FINANCIAL CORPORATION FORM 10-K December 31, 2007 INDEX
2
Table of ContentsCautionary Statement Regarding Forward-Looking Statements This report contains statements concerning the Company’s expectations, plans, objectives, future financial performance and other statements that are not historical facts. These statements may constitute “forward-looking statements” as defined by federal securities laws. These statements may address issues that involve estimates and assumptions made by management and risks and uncertainties. Actual results could differ materially from historical results or those anticipated by such statements. Factors that could have a material adverse effect on the operations and future prospects of the Company include, but are not limited to, changes in:
These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein. We caution readers not to place undue reliance on those statements, which speak only as of the date of this report.
3
Table of ContentsPART I.
Valley Financial Corporation (the “Company”) was incorporated as a Virginia stock corporation on March 15, 1994, primarily to own and control all of the capital stock of Valley Bank (the “Bank”). The Company posts all reports required to be filed under the Securities Exchange Act of 1934 on its web site at www.myvalleybank.com. The Bank opened for business on May 15, 1995 at its main office in the City of Roanoke, opened its second office on September 11, 1995 in the County of Roanoke, its third office on January 15, 1997 in the City of Roanoke, its fourth office in the City of Salem on April 5, 1999, its fifth office in the City of Roanoke on May 7, 2001, its sixth office in County of Roanoke on May 20, 2002, its seventh office in the City of Roanoke on December 8, 2003, and its eighth office in the City of Roanoke on May 9, 2005. Additionally, the Bank opened its wealth management subsidiary, Valley Wealth Management Services, Inc., in the City of Roanoke on June 23, 2005. The Bank operates under a state charter issued by the Commonwealth of Virginia, and engages in the business of commercial banking. Its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) and it is a member of the Federal Reserve System. Our primary purpose is to own and manage the Bank. Effective June 26, 2003, Valley Financial (VA) Statutory Trust I was established as a wholly-owned subsidiary of the Company for the purpose of issuing trust preferred securities. Effective October 16, 2002, the Bank established VB Investments, LLC as a wholly-owned subsidiary of the Bank to be a limited partner in various tax credit partnerships. The establishment of the subsidiary gives the Bank the right to utilize certain federal and state tax credits. Effective September 26, 2005, Valley Financial (VA) Statutory Trust II was established as a wholly-owned subsidiary of the Company for the purpose of issuing additional trust preferred securities. Effective December 15, 2006, Valley Financial Statutory Trust III was established as a wholly owned subsidiary of the company for the purpose of issuing additional trust preferred securities. These entities raised capital (in the case of the statutory trusts) or investment (in the case of the LLC) for the Company and the Bank. Effective July 13, 2007, VFC Properties, LLC was established as a wholly-owned subsidiary of the Company to provide credit intermediary services for the Bank. The Company has made a decision to dissolve this entity during the first quarter of 2008. The Bank will continue to provide its own credit services. Banking Services We conduct a general commercial banking business while emphasizing the needs of small-to-medium sized businesses, professional concerns and individuals. Deposit Services We offer a full range of deposit services that are typically available in most banks and savings and loan associations, including checking accounts, NOW accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer-term certificates of deposit. The transaction accounts and time certificates are tailored to the Bank’s principal market area at rates competitive to those offered in the area. In addition, we offer certain retirement account services, such as Individual Retirement Accounts. All deposit accounts are insured by the FDIC up to the maximum amount allowed by law (generally, $100,000 per depositor, subject to aggregation rules). We solicit accounts from individuals, businesses, associations and organizations and governmental authorities.
4
Table of ContentsLending Activities We offer a full range of lending services including commercial loans, residential real estate loans, construction and development loans, and consumer loans. Commercial loans include both secured and unsecured loans for working capital (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery. Loan requests are granted based upon several factors including credit history, past and present relationships with the bank, marketability of collateral and the cash flow of the borrowers. Unsecured commercial loans must be supported by a satisfactory balance sheet, income statement and cash flow statement. Collateralized business loans may be secured by a security interest in marketable equipment, accounts receivable, business equipment and/or general intangibles of the business. In addition, or as an alternative, the loan may be secured by a deed of trust lien on business real estate. The risks associated with commercial loans are related to the strength of the individual business, the value of loan collateral, and the general health of the economy. Residential real estate loans are secured by deeds of trust on 1-4 family residential properties. The Bank also serves as a broker for residential real estate loans placed in the secondary market. There are occasions when a borrower or the real estate do not qualify under secondary market criteria, but the loan request represents a reasonable credit risk. Also, an otherwise qualified borrower may choose not to have their mortgage loan sold. On these occasions, if the loan meets the Bank’s internal underwriting criteria, the loan will be closed and placed in the Bank’s portfolio. Residential real estate loans carry risk associated with the continued credit-worthiness of the borrower and changes in the value of the collateral. The Bank makes loans for the purpose of financing the construction of business and residential structures to financially responsible business entities and individuals. Additionally, the Bank makes loans for the purpose of financing the acquisition and development of commercial and residential projects. These loans are subject to additional underwriting standards as compared to our commercial and residential real estate loans, due to the following inherent risks associated with construction and development loans. Construction loans and acquisition and development loans bear the risks that the project will not be finished according to schedule, the project will not be finished according to budget and the value of the collateral may at any point in time be less than the principal amount of the loan. Construction loans and acquisition and development loans also bear the risk that the general contractor, who may or may not be the Bank’s loan customer, is unable to finish the construction project as planned because of financial pressures unrelated to the project. Loans to customers that are made as permanent financing of construction loans may likewise under certain circumstances be affected by external financial pressures. The Bank routinely makes consumer loans, both secured and unsecured for financing automobiles, home improvements, education, and personal investments. The credit history, cash flow and character of individual borrowers is evaluated as a part of the credit decision. Loans used to purchase vehicles or other specific personal property and loans associated with real estate are usually secured with a lien on the subject vehicle or property. Negative changes in a customer’s financial circumstances due to a large number of factors, such as illness or loss of employment, can place the repayment of a consumer loan at risk. In addition, deterioration in collateral value can add risk to consumer loans. We will occasionally buy or sell all or a portion of a loan. We will consider selling a loan or a participation in a loan, if: (i) the full amount of the loan will exceed our legal lending limit to a single borrower; (ii) the full amount of the loan, when combined with a borrower’s previously outstanding loans, will exceed our legal lending limit to a single borrower; (iii) the Board of Directors or an internal Loan Committee believes that a particular borrower has a sufficient level of debt with us; (iv) the borrower requests the sale; (v) the loan to deposit ratio is at or above the optimal level as determined by bank management; and/or (vi) the loan may create too great a concentration of loans in one particular location or in one particular type of loan. We will consider purchasing a loan, or a participation in a loan, from another financial institution (including from another subsidiary of the Company) if the loan meets all
5
Table of Contentsapplicable credit quality standards and (i) the Bank’s loan to deposit ratio is at a level where additional loans would be desirable; and/or (ii) a common customer requests the purchase. Our lending activities are subject to a variety of lending limits imposed by state and federal laws and regulations. In general, the Bank is subject to a loans-to-one borrower limit of an amount equal to 15% of the total of the Bank’s unimpaired capital, surplus, and allowance for loan loss. We may not make any extensions of credit to any director, executive officer, or principal shareholder of the Bank or the Company, or to any related interest of such person, unless the extension of credit is approved by the Board of Directors of the Bank and the credit is made on terms not more favorable to such person than would be available to an unaffiliated party. Additionally, we offer leasing services for our small business, private banking and business banking customers and prospects to access equipment, technology or other capital assets that they need to improve productivity and to facilitate growth without taking on debt or investing significant working capital. Leasing facilities do generally incorporate above-average risk as they generally require minimal initial equity investments on the part of the lessee and may include residual value risks at the time of lease maturity. We offer several forms of specialized asset-based lending to our commercial business customers, which include:
Asset-based loans require substantial risk management and monitoring processes which should help mitigate collateral exposures; however, these types of financing have inherently higher risk due to the ever changing status of the underlying collateral. Other Services Other Bank services include safe deposit boxes, certain cash management services including overnight repurchase agreements, merchant purchase and management programs, traveler’s checks, direct deposit of payroll and social security checks and automatic drafts for various accounts. We operate seven proprietary ATM’s and are associated with the Honor, Cirrus and The Exchange shared networks of automated teller machines that may be used by Bank customers throughout Virginia and other regions. We also offer VISA and MasterCard credit card services as well as a debit-check card. Our lockbox service provides a simple and efficient way to collect accounts receivable payments locally for businesses and non-profit organizations. Financial Services On June 23, 2005, Valley Wealth Management Services, Inc., (VWM) a wholly-owned subsidiary of the Bank, began offering non-deposit investment products and insurance products for sale to the public. VWM is working with Bankers Insurance, LLC, a joint effort of Virginia banks, in which the Company has a small interest through its membership in the Virginia Bankers Association. We have no immediate plans to obtain or exercise trust powers. We may in the future offer a full-service trust department, but cannot do so without the prior approval of its primary regulators, the Federal Reserve Bank of Richmond and the Virginia State Corporation Commission, before exercise of trust powers.
6
Table of ContentsOperating Revenue The following table sets forth, for the two fiscal years ended December 31, 2007 and 2006 the percentage of total operating revenue contributed by each class of similar services which contributed 15 percent or more of total consolidated revenues of the Company during such periods.
Location and Service Area Our primary service area is the Roanoke Metropolitan Statistical Area (the “Roanoke MSA”), which is the regional center for southwest Virginia, and is located approximately 165 miles west of Richmond, Virginia, 178 miles northwest of Charlotte, North Carolina, 178 miles east of Charleston, West Virginia and 222 miles southwest of Washington, D.C. The population in the Roanoke MSA was estimated at 295,050 in 2006 per the Weldon Cooper Center for Public Services, University of Virginia. The Roanoke MSA’s growth typically is slower than that in the Commonwealth overall and in other key Virginia markets in particular. The Virginia Employment Commission reported that the Roanoke MSA had an unemployment rate of 3.13% in November 2007, compared with 4.5% nationally and 2.99% for Virginia. The business community in the Roanoke MSA is well diversified by industry group. The principal components of the economy are retail trade, services, transportation, manufacturing and finance, insurance and real estate. The Roanoke MSA’s position as a regional center creates a strong medical, legal and business professional community. Carilion Health System, Advance Auto Parts, Lewis-Gale Hospital, and the Veterans Administration Hospital are among Roanoke’s largest employers. Other large employers include Norfolk Southern Corporation, General Electric Co., Wachovia Corporation, The Kroger Company – Mid Atlantic, and ITT Industries Night Vision.
7
Table of ContentsCompetition The banking and financial service business in Virginia and in our primary market area specifically, is highly competitive. The increasingly competitive environment is a result of changes in regulation, changes in technology and product delivery systems and new competition from non-traditional financial services. We compete for loans and deposits with other commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other nonbank financial service providers. In order to compete, we rely upon a service-based business philosophy, personal relationships with customers, specialized services tailored to meet customers’ needs and the convenience of office locations. In addition, we are generally competitive with other financial institutions in our market area with respect to interest rates paid on deposit accounts, interest rates charged on loans and other service charges on loans and deposit accounts. Our market area is a highly concentrated, highly branched banking market. Currently, the Bank, Bank of Botetourt, Bank of Fincastle, and Hometown Bank are the only locally owned and operated commercial banks. Most competitors are subsidiaries of holding companies headquartered in North Carolina, Georgia, Tennessee, and Northern Virginia. Numerous credit unions operate additional offices in the Roanoke MSA. Further, various other financial companies, ranging from local to national firms, provide financial services to residents of the Bank’s market area. We believe that the Bank will continue to be able to compete effectively in this market, and that the community reacts favorably to our community bank focus and emphasis on service to small businesses, individuals and professional concerns. Employees At December 31, 2007 the Bank had 118 full-time employees and 5 part-time employees. Supervision and Regulation The Company and the Bank are subject to state and federal banking laws and regulations which impose specific requirements or restrictions on and provide for general regulatory oversight with respect to virtually all aspects of operations. As a result of the substantial regulatory burdens on banking, financial institutions, including the Company, are disadvantaged relative to other competitors who are not as highly regulated, and our costs of doing business are much higher. The following is a brief summary of the material provisions of certain statutes, rules and regulations affecting the Company and the Bank. This summary is qualified in its entirety by reference to the particular statutory and regulatory provisions referred to below, and is not intended to be an exhaustive description of the statutes or regulations which are applicable to the business of the Company and/or the Bank. Any change in applicable laws or regulations may have a material adverse effect on the business and prospects of the Company and/or the Bank.
8
Table of ContentsThe Company The Company is a bank holding company within the meaning of the Federal Bank Holding Company Act of 1956, as amended (the “BHCA”), and Chapter 13 of the Virginia Banking Act, as amended (the “Virginia Act”). The BHCA. The BHCA is administered by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), and the Company is required to file periodic reports and such additional information as the Federal Reserve may require. The Federal Reserve Board also is authorized to examine the Company and its subsidiaries. The BHCA, with limited exceptions, requires every bank holding company to obtain prior Federal Reserve approval before the Company can acquire the assets or more than 5% of the voting shares of another bank or merge with another bank holding company. The BHCA and the Change in Bank Control Act also generally require regulatory approval before “control” of the Company can be acquired as defined in the statutes and regulations. Under the BHCA, the Company is generally limited to conducting directly or indirectly only banking activities or nonbanking activities the Federal Reserve has found to be closely related to banking. The Federal Reserve imposes certain capital requirements on the Company under the BHCA, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. The Virginia Banking Act. . The Company is a registered bank holding company with the Bureau of Financial Institutions of the State Corporation Commission of Virginia (the “Virginia Commission”) under the Virginia Act. The Company must provide the Virginia Commission with information concerning its financial condition, operations, management, intercompany relationships of the holding company and its subsidiaries and with other information required by the Virginia Commission. The Company and its subsidiaries are also examined by the Virginia Commission. The Virginia Act requires prior approval of the Virginia commission for the Company to acquire direct or indirect ownership or control of more than 5% of the voting shares of any Virginia bank or any other bank holding company. The Virginia Act generally permits bank holding companies from throughout the United States to enter the Virginia market, subject to federal and state approval. Financial Modernization Legislation/Gramm-Leach-Bliley Act. The Gramm-Leach-Bliley Act (the “GLBA”), enacted on November 12, 1999, broadly rewrote financial services legislation. The GLBA repealed affiliation and management interlock prohibitions of the Depression-era Glass-Steagall Act and added new substantive provisions to the non-banking activities permitted under the BHCA with the creation of the financial holding company. Subject to restrictions the GLBA permits financial holding companies to directly engage in a broader range of activities than are permissible for a bank holding company. These include underwriting insurance, providing investment advice and underwriting securities among others. In order for a bank holding company to qualify as a financial holding company, all of its depository subsidiaries (i.e., banks and thrifts) must be well capitalized and well managed, and must have a satisfactory Community Reinvestment Act (“CRA”) rating. The bank holding company also must declare its intention to become a financial holding company to the Federal Reserve. The Company meets all of the requirements to become a financial holding company, but currently has not made an election with the Federal Reserve to become a financial holding company.
9
Table of ContentsSarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 was signed into law on July 30, 2002. It comprehensively revised the laws affecting corporate governance, accounting obligations and corporate reporting for companies with equity or debt securities registered under the Securities Exchange Act of 1934. Compliance with this complex legislation and with subsequent Securities and Exchange Commission rules has since been a major focus of all public corporations in the United States, including the Company. Among the many significant provisions of the Sarbanes-Oxley Act, Section 404 and related Securities and Exchange Commission rules created increased scrutiny by internal and external auditors of our systems of internal controls over financial reporting. These ongoing and extensive efforts are designed to insure that our internal controls are effective in terms of both design and operation, but compliance is very costly, especially for community banking companies like ours. The Bank General. The Bank is a state-chartered commercial bank organized under the laws of the Commonwealth of Virginia, and is subject to examination by the Federal Reserve and the Virginia Commission. The regulators monitor all areas of the Bank’s operations. The Bank is required to prepare quarterly and annual reports on the Bank’s financial condition and results of operations. The Bank also is required to adopt internal control structures and procedures in order to safeguard assets and monitor and reduce risk exposure. While considered appropriate for the safety and soundness of banks, these requirements adversely impact overhead costs. The Bank Insurance Fund (the “BIF”) is maintained for commercial banks with insurance premiums from the industry, including the Bank, used to offset losses from insurance payouts when banks fail. Also, the Bank is charged a deposit-based assessment by the FDIC in connection with the so-called Financing Corporation (“FICO”) bonds issued by the federal government to finance the savings and loan industry bailout. Deposit insurance premiums vary with the strength of the banking industry, the level of the BIF insurance fund and the Bank’s individual risk rating as determined by the FDIC, and there can be no assurance that premiums will remain at their current level. Transactions with Affiliates. The Federal Reserve Act restricts the amount and prescribes conditions with respect to loans, investments, asset purchases and other transactions between the Company and the Bank. These restrictions limit the freedom of the Company and the Bank to engage in transactions between them. The Bank is subject to restrictions on the aggregate amount, terms and risks associated with extensions of credit to executive officers, directors, principal shareholders, and their related interests. Branching and Bank Acquisitions. The Bank may branch without geographic restriction in Virginia. In addition, the federal Interstate Banking and Branching Efficiency Act of 1994 allows bank holding companies to acquire banks in any state, without regard to state law, except for state laws relating to the minimum amount of time a bank must be in existence to be acquired. While giving the Bank increased expansion opportunities, these laws also increase competition in the Bank’s markets. Community Reinvestment Act. The federal Community Reinvestment Act (“CRA”) requires that the federal banking regulators evaluate the record of financial institutions in meeting the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. The regulations place substantial importance on a bank’s product delivery system, particularly branch locations and require banks to comply with significant data collection requirements. A CRA assessment is required for any bank to, among other things, establish a new or relocate a branch office or merge or acquire the assets or assume the liabilities of a federally regulated financial institution. It is likely that banks’ compliance with the CRA, as well as other fair lending laws, will face ongoing government scrutiny and that costs associated with compliance will continue to increase. The Bank received a “Satisfactory” rating pursuant to its latest CRA examination.
10
Table of ContentsOther Regulations. Laws restrict the interest and charges which the Bank may impose for certain loans. The Bank’s loan operations also are subject to certain federal laws, such as the Truth in Lending Act, the Home Mortgage Disclosure Act, the Equal Credit Opportunity Act, and the Fair Credit Reporting Act. The deposit operations of the Bank also are subject to the Truth in Savings Act, the Right to Financial Privacy Act, the Electronic Funds Transfer Act and Regulation E, the Expedited Funds Availability Act and Regulation CC, and the Bank Secrecy Act. These and other similar laws result in significant costs to financial institutions and create the potential for liability to customers and regulatory authorities. Recently regulatory authorities have imposed significant penalties for inadequate compliance. Dividends. The Bank began paying dividends to the Company in 2003 to cover the interest expense due on the guaranteed preferred beneficial interests in the Company’s junior subordinated debentures. The amount of dividends that may be paid by the Bank to the Company will depend on the Bank’s earnings and capital position and is limited by state law, regulations and policies. See “Capital Regulations” below, “Item 5. Market for Common Equity and Related Stockholder Matters” and Note 15 to the Consolidated Financial Statements. Capital Regulations. The federal bank regulatory authorities impose certain capital requirements on the Company and the Bank. In addition to minimum capital levels prescribed by regulation, the Virginia Commission and the Federal Reserve have authority to require higher capital levels on a case-by-case basis as part of their supervisory and enforcement powers, including approval of expansion programs. An institution’s qualifying total capital consists of three components—Core or Tier 1 capital, Supplementary or Tier 2 capital, and Market Risk Allocated or Tier 3 capital. Tier 1 capital is essentially equal to common stockholders’ equity, qualifying perpetual preferred stock and minority interests in equity accounts of consolidated subsidiaries, less disallowed intangibles. Tier 2 capital, generally includes certain types of preferred stock and debt securities, hybrid capital instruments and a limited amount, not to exceed 1.25% of gross risk-weighted assets, of the allowance for loan and lease losses. Tier 3 capital is only applicable to banks which are subject to the market risk capital guidelines. The amount reported in this item may only be used to satisfy the bank’s market risk capital requirement and may not be used to support credit risk. In an effort to achieve a measure of capital adequacy that is more sensitive to the individual risk profiles of financial institutions, the federal bank regulatory authorities have adopted risk-based capital adequacy guidelines that define capital ratios to take into account assessments of risks related to each balance sheet category, as well as off-balance sheet financing activities. To supplement the risk-based capital guidelines, the federal bank regulatory agencies also have imposed a leverage ratio. The principal objective of the leverage ratio is to place a constraint on the maximum degree to which a bank or bank holding company may leverage its equity capital base. Institutions receiving less than the highest composite examination ratings are required to maintain a leverage ratio of at least 100 basis points above the regulatory minimum.
11
Table of ContentsAt December 31, 2007 the Company and the Bank had the following risk-based capital and leverage ratios relative to regulatory minimums: Capital Ratios
The regulations define five categories of compliance with regulatory capital requirements, ranging from “well capitalized” to “critically undercapitalized.” To qualify as a “well capitalized” institution, a bank must have a leverage ratio of no less than 5%, a Tier 1 risk-based ratio of no less than 6%, and a total risk-based ratio of no less than 10%, and the bank must not be under any order or directive from the appropriate regulatory agency to meet and maintain a specific capital level. As of December 31, 2007, the Company and the Bank qualified as “well-capitalized” institutions (see Note 16 to the Consolidated Financial Statements). The degree of regulatory scrutiny of a financial institution increases, and the permissible activities of the institution decreases, as it moves downward through the capital categories. Institutions that fall into one of the three undercapitalized categories may be required to take certain corrective measures, including adopting a capital restoration plan. Bank holding companies can be called upon to boost their subsidiary banks’ capital and to partially guarantee the institutions’ performance under their capital restoration plans. If this occurs, capital which otherwise would be available for holding company purposes, including possible distribution to shareholders, would be required to be down streamed to one or more subsidiary banks. International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 (USA Patriot Act). The USA Patriot Act of 2001 (the “Patriot Act”) contains anti-money laundering measures affecting insured depository institutions, broker-dealers and certain other financial institutions. The Patriot Act requires such financial institutions to implement policies and procedures to combat money laundering and the financing of terrorism, including the adoption of effective customer identification programs. Federal bank regulatory agencies must consider the effectiveness of anti-money laundering activities by a financial institution when reviewing bank mergers and bank holding company acquisitions. Compliance with the Patriot Act by the Company has not had a material impact on its results of operations or financial condition. Effect of Governmental Monetary Policies The earnings of the Bank are affected by domestic economic conditions and the monetary and fiscal policies of the United States government and its agencies. The Federal Reserve’s monetary policies have had, and will likely continue to have, an important impact on the operating results of commercial banks through its power to implement national monetary policy in order, among other things, to curb inflation or combat a recession. The monetary policies of the Federal Reserve have major effects upon the levels of bank loans, investments, deposits, interest income and interest expense through its open market operations in United States government securities and through its regulation of interest rates and the reserve requirements against member bank deposits. It is not possible to predict the nature or impact of future changes in monetary and fiscal policies.
12
Table of ContentsCompany Website The Company and the Bank maintain a website at www.myvalleybank.com. The Company makes available through its website its annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and all amendments to those reports as soon as reasonably practicable after the material is electronically filed with the Securities and Exchange Commission.
Not required.
Not applicable.
Our main office is located in a seven-story office building at 36 Church Avenue, S.W., in downtown Roanoke, Virginia 24011, which we lease five floors. We will be adding a sixth floor to the leased space during the first quarter of 2008. The lease on all floors terminates on December 31, 2014 with options to renew for two additional five-year terms at the end of the December 31, 2014 extension period. Additionally, we lease our South Roanoke and our Grandin Road offices. We own our Starkey Road, Hershberger, Vinton and Lewis Gale offices. We are in the process of relocating our South Roanoke office and anticipate completion in 2008. Once complete, we will own the South Roanoke office building. In the opinion of management of the Company, its properties are adequate for its current operations and adequately covered by insurance.
Neither the Company nor the Bank is a party to, nor is any of their property the subject of, any material pending legal proceedings other than routine litigation incidental to the Bank’s business.
None. PART II.
Market information. The Company is authorized to issue up to 10,000,000 shares of Common Stock, no par value, of which 4,623,947 shares were issued and outstanding and held of record by approximately 447 shareholders at March 11, 2008. The Common Stock is quoted under the symbol VYFC on the Nasdaq Capital Market. According to information obtained by Company management and believed to be reliable, the quarterly range of closing prices per share for the Common Stock during the last two fiscal years was as follows:
13
Table of Contents
Dividends. On April 25, 2007 the Company declared a $0.07 per share cash dividend, payable July 2, 2007 to shareholders of record June 1, 2007. On November 15, 2007 the Company declared a $0.07 per share cash dividend, payable January 2, 2008 to shareholders of record December 1, 2007. The Company declared two semi-annual dividends, both at $0.07 per share during the year ended December 31, 2006. See “Supervision and Regulation” and Note 16, “Regulatory Restrictions” to the Consolidated Financial Statements for restrictions on the payment of dividends. Securities authorized for issuance under equity compensation plans. Equity Compensation Plan Information
As of December 31, 2007 there were no compensation plans, including individual compensation arrangements, under which equity securities of the Company are authorized for issuance that have not been approved by a vote of security holders.
14
Table of Contents
Selected Financial Data (000’s omitted)
15
Table of Contents
The following is management’s discussion and analysis of the financial condition and results of operations of the Company as of and for the years ended December 31, 2007 and 2006. The discussion should be read in conjunction with the Company’s Consolidated Financial Statements and Notes thereto. Critical Accounting Policies The preparation of financial statements requires us to make estimates and assumptions. Those accounting policies that require our most difficult, subjective or complex judgments and uncertainties include (1) the allowance for loan losses and (2) impaired loans. Further information about these critical policies is described below. Allowance for Loan Losses: Certain credit risks are inherent in making loans. We seek to prudently assess these risks and manage them effectively. We have internal credit policies and procedures in place to reduce repayment risks. These policies and procedures include:
We establish the allowance for loan losses through charges to earnings through a provision for loan losses. Loan losses are charged against the allowance when we believe that the collection of the principal is unlikely. Subsequent recoveries of losses previously charged against the allowance are credited to the allowance. The allowance represents an amount that, in our judgment, will be appropriate to absorb probable losses on existing loans that may become uncollectible. Some of the factors we consider in determining the appropriate level of the allowance for loan losses are as follows:
On a quarterly basis, we perform a detailed analysis of the allowance for loan losses to verify the adequacy and appropriateness of the allowance in meeting possible losses in the loan portfolio. In analyzing our current portfolio to determine the appropriate level of the allowance for loan losses, we first segregate our portfolio into loans within the scope of FAS 114 (potentially impaired loans) and FAS 5 (non-impaired loan pools). Included in our potentially impaired loan category are our current “watch list” credits plus any additional credits which have been past due three or more times within the past 12-month period. We individually review these potentially impaired loans under FAS 114 and make a determination if the loan in fact is impaired. We consider a loan impaired when it is probable that we will be unable to collect all interest and principal payments as scheduled in the loan agreement. We do not consider a loan impaired during a period of delay in payment if we expect the ultimate collection of all amounts due. If it is found to be impaired, an allowance is established when the collateral value, discounted cash flows, or observable market price of the impaired loan is lower than the carrying value of that loan. We recognize any impairment by creating a valuation allowance with a corresponding charge to the provision for loan losses or by adjusting an existing valuation allowance for the impaired loan with a corresponding charge or credit to bad-debt expense. The valuation allowance becomes our “specific reserve” for the specific loan.
16
Table of ContentsWe take the balance of our portfolio and add back to it any loans that were included in the potentially impaired loan category but that were found not to be impaired. We then segregate the remaining portfolio into specific categories based on type of loan and review the groups of loans to estimate loss under FAS 5 (accounting rules for loss contingencies). We apply a specific loss factor to each category based upon our historical loss experience for each category of loans over the previous five years. The loss factor is multiplied by the outstanding balance in the loan category to estimate potential loss for our allowance for loan losses. We then evaluate certain environmental and qualitative factors that are relevant to our portfolio and make a risk assessment of low, medium, or high for each factor. An additional loss factor is assigned to the portfolio according to the risk assessment. This evaluation is inherently subjective, because it requires estimates that may be significantly revised as more information becomes available. Bank regulators also periodically review the loan portfolio and other assets to assess their quality, and we employ independent, third party loan reviewers as well. This evaluation is inherently subjective because it requires estimates that may be significantly revised as more information becomes available. We believe the allowance for loan losses is appropriate to provide for expected losses in the loan portfolio, but there are no assurances that it will be. Overview The Company was incorporated as a Virginia stock corporation on March 15, 1994, primarily to own and control all of the capital stock of the Bank. The Bank opened for business on May 15, 1995. There are currently eight full-service branch locations, operating in various locations throughout the Cities of Roanoke and Salem, Town of Vinton, and the County of Roanoke. The Company also operates a wealth management subsidiary, Valley Wealth Management Services, Inc. which markets investment and insurance products. Net income derived from the new subsidiary is not significant at this time. The Company’s investment in the Bank was $47.6 million as of December 31, 2007, and $44.4 million as of December 31, 2006. Performance Summary The following table shows our key performance ratios for the years ended December 31, 2007 and 2006: Key Performance Ratios
All percentage calculations are on an annualized basis.
17
Table of ContentsOur performance for 2007 was impacted by the unusually high level of nonperforming assets held throughout the year. However, due to the successful resolution of all three of our large problem loan relationships subsequent to year end, we were able to reduce the specific reserves previously set aside for these credits by over $500,000 during the fourth quarter of 2007. Additionally, we took active and prudent steps by charging off in excess of $2 million in problem loan assets during 2007. We believe these events, combined with the $4.2 Million equity capital raised in the private placement offering in the fall of last year, will enable us to move forward from a position of strength despite the uncertain and unsettling economic environment. Additionally, as can be seen from the table above, our cost of funds has increased by 46 basis points year over year in comparison to an increase of only 10 basis points in our yield on earning assets, resulting in a further squeeze on our net interest margin. The increase in our cost of funds is due to the intense competition for deposits in combination with the relatively flat yield curve over the past 18 months. However, the resolution of our three large problem loan assets will reduce our non-performing assets by nearly 75%, from 1.24% of total assets to just 0.39% of total assets, as we head into 2008. This should impact our net interest margin and the overall earnings picture in a very positive manner. While we are cautiously optimistic about 2008, we continue to be concerned about the continued weakness in the residential real estate market and general slowdown in economic activity. We did not participate in the subprime, Alt-A or third-party originated mortgage programs that are now resulting in heavy loan losses at many banks throughout the country, but the net effect of these activities may weaken the economy, in general. Growth The following table shows our key growth indicators: Key Growth Indicators (000’s omitted)
Total assets at December 31, 2007 were $601.0 million, up $9.1 million or 1.5% from $591.9 million at December 31, 2006. The principal components of the Company’s assets at the end of the period were $63.5 million in securities available-for-sale, including restricted equity securities, $17.6 million in securities held-to-maturity, and $487.1 million in gross loans. Total assets at December 31, 2006 were $591.9 million, up $93.0 million or 19% from $498.9 million at December 31, 2005. The principal components of the Company’s assets at the end of 2006 were $16.6 million in federal funds sold, $53.5 million in securities available-for-sale, including restricted equity securities, $20.1 million in securities held-to-maturity, and $471.0 million in gross loans. Total liabilities at December 31, 2007 were $560.3 million, up from $558.5 million at December 31, 2006, an increase of $1.8 million or 0.3%. Deposits decreased $9.0 million or 2.0% to $432.4 million from the $441.4 million level at December 31, 2006. We allowed a piece of our higher cost of deposits to mature during the year due to a softening in loan demand. Total liabilities at December 31, 2006 were $558.5 million, up from $468.2 million at December 31, 2005, an increase of $90.3 million or 19.3%, with the increase primarily represented by a $76.1 million growth in deposits, a $5.2 million increase in short-term borrowings, an $11.0 million in crease in long-term borrowings, a $10.8 million increase in securities sold under agreements to repurchase, a $2.2 million increase in other liabilities, offset by a $17.0 million decrease in federal funds purchased.
18
Table of ContentsWe intend to continue to execute our business model by focusing on our core business and stressing personal service to satisfy customers, although we constantly evaluate the effectiveness of the model. Due to our intense focus on restoring asset quality, we intentionally slowed down our asset growth during 2007. As we head into 2008, we are focused on returning to double-digit asset growth rates. However, competition for deposits remains heightened and our ability to fund loan growth will be dependent upon our ability to grow our deposit base at a reasonable cost. During 2006, we were successful in reducing our overall reliance on certificates of deposits by raising approximately $50 million of new deposits in a new money market product, which is tied to the WSJ Prime rate. This deposit account continued to attract enthusiasm from customers as our deposit balances grew to over $73 million in this account by the end of 2007. We will be introducing a new deposit checking account during the first quarter of 2008 that we believe will strengthen our ability to further reduce our reliance on higher rate certificates of deposits going forward and will be a great complement to the Prime money market product offering. Shareholders’ Equity Total shareholders’ equity at December 31, 2007 was $40.7 million, an increase of $7.3 million or 21.9% over the $33.4 million level at December 31, 2006. The increase is attributable to net income of $2.9 million, net proceeds from the private placement offering of $4.2 million, proceeds from the exercise of stock options of $0.4 million, $0.1 million due to the expensing of stock options, an increase in accumulated other comprehensive income of $0.3 million, offset by dividends declared of $0.6 million. Total shareholders’ equity at December 31, 2006 was $33.4 million, an increase of $2.7 million or 9% over the $30.7 million level at December 31, 2005. The increase from December 31, 2005 to December 31, 2006 was attributable to an increase in retained earnings of $2.9 million, proceeds from the exercise of stock options of $0.1 million, $0.1 million due to the expensing of stock options, an increase in accumulated other comprehensive income of $0.2 million, offset by dividends declared of $0.6 million. Net Income We earned net income of $2.9 million for the year ended December 31, 2007, equivalent to the $2.9 million reported for the same period in 2006. Net income for the three months ended December 31, 2007 was $0.9 million, an increase of $0.7 million over the $0.2 million reported for the fourth quarter of 2006. We earned net income of $2.9 million for the year ended December 31, 2006, a decrease of 15% over the $3.4 million reported for the same period in 2005. Net income for the three months ended December 31, 2006 was $0.2 million, a decrease of 86% over the $1.1 million reported for the fourth quarter of 2005. Net Interest Income Net interest income is our principal source of earnings and is calculated as the amount by which loan and investment (earning assets) income exceeds the interest expense on deposits and borrowings (interest-bearing liabilities). Changes in the volume and mix of earning assets and interest-bearing liabilities, as well as their respective yields and rates, have a significant impact on the level of net interest income. Changes in the interest rate environment and the Company’s cost of funds also affect net interest income. Net interest income for the year ended December 31, 2007 was $15.6 million, a $0.1 million decrease when compared to the $15.7 million reported for December 31, 2006. Net interest income for the quarter ended December 31, 2007 was $4.0 million, equivalent to the same period last year. Net interest income for the quarter ended December 31, 2006 was $4.0 million, a 3% increase when compared to the quarter ended December 31, 2005. The yield on average loans decreased in 2007 by 1.0% to 7.14% from its level of 7.21% in 2006. The overall tax equivalent yield on earning assets was 7.03% for the year ended 2007, as compared to 6.93% for the prior year. The yield on average loans increased in 2006
19
Table of Contentsby 0.12% to 7.21% from its level of 6.42% in 2005. The overall tax equivalent yield on earning assets was 6.93% for the year ended 2006, as compared to 6.13% for the prior year. The following table presents the major categories of interest-earning assets, interest-bearing liabilities and shareholders’ equity with corresponding average balances, related interest income or expense, and resulting yields and rates for the periods indicated. Where appropriate, income categories and yields have been adjusted in the table to their fully taxable equivalent basis.
20
Table of ContentsNET INTEREST INCOME AND AVERAGE BALANCES (1) (000’s omitted)
Legends for the table are as follows:
21
Table of ContentsAs discussed above, the Company’s net interest income is affected by the change in the amount and mix of interest-earning assets and interest-bearing liabilities (referred to as “volume change”) as well as by changes in yields earned on interest-earning assets and rates paid on deposits and borrowed funds (referred to as “rate change”). The following table presents, for the periods indicated, a summary of changes in interest income and interest expense for the major categories of interest-earning assets and interest-bearing liabilities and the amounts of change attributable to variations in volumes and rates. Changes attributable to the combined impact of volume and rate have been allocated proportionately to the changes due to volume and rate, respectively. RATE/VOLUME ANALYSIS (000’s omitted)
22
Table of ContentsRATE/VOLUME ANALYSIS (000’s omitted)
Interest Rate Risk Interest rate risk is the risk to earnings or capital generated by the effects of changes in interest rates on our on- and off-balance sheet positions. This risk can take one or more of several forms:
Embedded options are complex risk positions that are difficult to predict and offset, and are a large component of our overall interest rate risk. We have established risk measures, limits, policy guidelines and internal control mechanisms for managing our overall asset/liability management position. The responsibility for interest rate risk control resides with management, with oversight by the board of directors and the Asset Liability Oversight Committee. We seek to balance the return potential of the asset/liability management position against the desire to limit volatility in earnings.
23
Table of ContentsAt least quarterly, we measure the asset/liability management position using earnings simulation modeling to estimate what assets and liabilities would re-price, and to what extent, within a one-year period in response to an immediate 200 and 100 basis point change in the Prime Rate, as well as in response to more gradual interest rate changes. Our objective is to keep the change in net interest income over twelve months at or below 5%, and to keep the change in net income at or below 10%, under an immediate 200 basis point interest rate shock scenario. The model also incorporates management’s forecasts for balance sheet growth, noninterest income and noninterest expense. The interest rate scenarios are used for analytical purposes and do not necessarily represent management’s view of future market movements. Rather, these are intended to provide a measure of the degree of volatility interest rate movements may apply to our earnings. Modeling the sensitivity of earnings to interest rate risk is highly dependent on numerous assumptions embedded in the simulation model. While the earnings sensitivity analysis incorporates management’s best estimate of interest rate and balance sheet dynamics under various market rate movements, the actual behavior and resulting earnings impact likely will differ from that projected. We also estimate interest sensitivity by calculating the net present value of the balance sheet’s cash flows or the residual value of future cash flows ultimately due to shareholders. This calculation is known as Economic Value of Equity or “EVE” and is generally considered a better measure of long-term interest sensitivity than the interest rate shock scenarios. Our objective is for the result to change 25% or less in an immediate 200 basis point interest rate shock scenario. The following table shows the sensitivity of the Company’s balance sheet at the date indicated, but is not necessarily indicative of the position on other dates.
24
Table of ContentsINTEREST RATE SENSITIVITY Maturities/Repricing (000’s omitted)
25
Table of ContentsDerivative Financial Instruments For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining rates. Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. Interest rate swaps are contracts in which a series of cash flows from interest are exchanged over a prescribed period, based upon a notional amount. The notional amount on which the interest payments are based is not exchanged. The Company entered into its first such derivative instrument in April 2006 when it entered into a forward-start interest rate swap agreement (“Agreement”) to convert a portion of its variable rate loans to a fixed rate (cash flow hedge). We entered into this agreement to protect the Bank from interest rate exposure during a period of declining rates. The effective period of the Agreement was April 19, 2007 through April 19, 2009. As of December 31, 2006, the mark-to-market adjustment, net of taxes, included in other comprehensive income for this Agreement was $70,087. During the first quarter of 2007, we terminated this interest rate swap agreement due to the shift of the Bank’s balance sheet to a more liability-sensitive position and the changing interest rate environment as compared to when the Bank entered into the Agreement. The Bank recorded a realized gain on the termination of the Agreement of $50,629. Noninterest Income Noninterest income is made up of several categories as shown in the following table:
Service charges on deposit accounts consist of a variety of charges imposed on demand deposits, interest-bearing deposits and savings deposit accounts. These include, but are not limited to, the following:
26
Table of ContentsThe principal factors that may affect current or future income for service charges on deposit accounts are:
Other income consists of several categories, primarily the following:
Levels of income derived from these categories vary. For example, general market conditions and new insurance premiums purchased affect the income earned on bank owned life insurance. Fees for the issuance of official checks and customer check sales tend to grow as new branches are added. Fee schedules, while subject to change, generally do not alone yield a significant or discernable increase in income when they change. Additionally, with changing interest rates, mortgage originations and re-financings have slowed down, which decreases the fee income earned on real estate loans. Noninterest Expense
27
Table of ContentsAs can be seen from the table above, noninterest expense increased by a total of $1.4 million or 12% from December 31, 2006 to December 31, 2007. A few items to note are as follows:
Noninterest expense for the year ended December 31, 2006 was $2.1 million over the same period ended December 31, 2005. For the year ended December 31, 2006, we experienced an increase in our advertising and marketing expenses which were primarily attributable to the television advertising costs associated with the new Prime money market account. Compensation expense continued to increase as anticipated due to the growth of the Bank. The increase in 2006 is a result of new hires as well as merit and promotional increases to all employees during the year. However, all year-end performance bonuses for 2006 for executive officers were eliminated as a result of the Company’s performance for 2006. This elimination totaled approximately $350,000. Our business manager expenses increased as compared to the prior year due to the growth of that program. Noninterest expenses are expected to continue to increase as a direct result of business growth, expansion and complexity of banking operations, and compliance with the Sarbanes–Oxley Act, which imposes additional management and reporting burdens on reporting companies such as this one.
28
Table of ContentsIncome Taxes During 2007 and 2006, the Company recorded federal income tax provision in the amounts of $1.0 million and $0.9 million, respectively. The anticipated federal income tax liability equates to an effective tax rate of 26.4% and 23.3%, respectively. Factors contributing to the difference between the effective tax rate and the statutory rate of 34 percent include historical tax credits, tax-exempt interest income on municipal securities, net of disallowance, and tax-exempt income earned on bank owned life insurance. During 2007 and 2006, we recognized three separate federal tax credits resulting in a reduction in income tax expense of $124 for 2007 and $125 for 2006. Earning Assets Average earning assets were $557.7 million at December 31, 2007, an increase of $49.8 million or 9.8% over $507.9 million at December 31, 2006. Total average earning assets were 95.2% of total average assets at December 31, 2007. Average loans represented the largest component of average earning assets and increased $36.1 million or 8.1% to $479.1 million at December 31, 2007. Average loans were 85.9% of average earning assets and 81.8% of average total assets as of December 31, 2007. Average investment securities, increased by $12.7 million or 20.0% over December 31, 2006. Average investment securities were 13% of average earning assets and 13% of average total assets as of December 31, 2007. Average earning assets were $507.9 million at December 31, 2006, an increase of $102.1 million or 25% over 2005. Total average earning assets were 95% of total average assets at December 31, 2006. Average loans represented the largest component of average earning assets and increased $103.3 million or 30% to $443.0 million at December 31, 2006. Average loans were 87% of average earning assets and 83% of average total assets as of December 31, 2006. Average investment securities, both taxable and nontaxable, remained relatively constant as compared December 31, 2005. Average investment securities were 12% of average earning assets and 12% of average total assets as of December 31, 2006. Investment Securities Our investment portfolio is used both for investment income and liquidity purposes. Unrealized gains and losses on securities available-for-sale are recognized as direct increases or decreases in net shareholders’ equity. Funds not used for capital expenditures or lending activities are invested in the following:
29
Table of Contents
Investment securities (available for sale and held to maturity), including restricted equity securities, at December 31, 2007 were $81.1 million, an increase of $7.5 million or 10.2% from their level of $73.6 million on December 31, 2006. The increase is attributable to purchases of $17.7 million offset by principal prepayments, called proceeds and sales in the amount of $10.2 million. See Note 3 to the Consolidated Financial Statements. Investment securities (available for sale and held to maturity), including restricted equity securities, at December 31, 2006 were $73.6 million, an increase of $15.6 million or 27% from their level of $58.0 million on December 31, 2005. The increase is attributable to purchases of $21.5 million, offset by principal prepayments, called proceeds and sales in the amount of $5.9 million. The following table presents the composition of securities available-for-sale, which is carried at approximate market value at December 31, 2007 and 2006. AVAILABLE FOR SALE INVESTMENT PORTFOLIO CATEGORY DISTRIBUTION (000’s omitted)
30
Table of ContentsThe following table sets forth the composition of securities held-to-maturity, which is carried at amortized cost at December 31, 2007 and 2006. HELD TO MATURITY INVESTMENT PORTFOLIO CATEGORY DISTRIBUTION (000’s omitted)
The following table presents the maturity ranges of securities available-for-sale as of December 31, 2007 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%.
31
Table of ContentsINVESTMENT PORTFOLIO – MATURITY DISTRIBUTION (000’s omitted)
32
Table of ContentsThe following table presents the maturity ranges of securities held-to-maturity as of December 31, 2007 and the weighted average yields of such securities. Maturities may differ from scheduled maturities on mortgage-backed securities and collateralized mortgage obligations because the mortgages underlying the securities may be repaid prior to the scheduled maturity date. Maturities on all other securities are based on the contractual maturity. The weighted average yields are calculated on the basis of the cost and effective yields weighted for the scheduled maturity of each security. Weighted average yields on tax-exempt obligations have been computed on a taxable equivalent basis using a tax rate of 34%. INVESTMENT PORTFOLIO – MATURITY DISTRIBUTION (000’s omitted)
33
Table of Contents
Loan Portfolio Our total gross loans were $487.2 million at December 31, 2007, an increase of $16.1 million or 3.4% from the $471.1 million reported one year earlier. Our ratio of total loans to total funding sources (customer deposits, securities sold under agreements to repurchase, federal funds purchased, Federal Home Loan Bank advances, and trust preferred securities) stood at 88.0% at December 31, 2007 and 85.2% at December 31, 2006. Management seeks to maintain the ratio of loans to funding sources at a maximum of 90%. The loan portfolio primarily consists of commercial, real estate (including real estate term loans, construction loans and other loans secured by real estate) and loans to individuals for household, family and other consumer purposes. We adjust the mix of lending and the terms of our loan programs according to economic and market conditions, asset/liability management considerations and other factors. Loans typically (in excess of 90%) are made to businesses and individuals located within our primary market area, most of whom maintain deposit accounts with the Bank. There is no concentration of loans exceeding 10% of total loans, that is not disclosed in the Consolidated Financial Statements and the Notes to the Consolidated Financial Statements or discussed below. The following table summarizes the loan portfolio by category for the five years ended December 31, 2007. LOAN PORTFOLIO SUMMARY (000’s omitted)
The following table presents maturity information (based upon interest rate repricing dates) on the loan portfolio based upon scheduled repayments at December 31, 2007. LOAN MATURITY (000’s omitted)
34
Table of ContentsThe following table presents maturity information based upon contractual terms and scheduled repayments at December 31, 2007. FIXED AND VARIABLE RATE LOANS (000’s omitted)
Loan Category Analysis Commercial Loans. Commercial loans generally are made to provide operating lines of credit, to finance the purchase of inventory or equipment, and for other business purposes. The credit worthiness of the borrower is analyzed and re-evaluated on a periodic basis. Most commercial loans are secured with business assets such as accounts receivable, inventory and equipment. Even with substantial collateral, such as all the assets of the business and personal guarantees, commercial lending involves considerable risk of loss in the event of a business downturn or failure of the business. Commercial Real Estate Loans. Commercial real estate construction and commercial real estate mortgages represent interim and permanent financing of commercial properties that are secured primarily by real estate. The Company prefers to make commercial real estate loans secured by owner-occupied properties. These borrowers are engaged in business activities other than real estate, and the primary source of repayment is not solely dependent on conditions in the real estate market. Real Estate Construction Loans. Real estate construction loans represent interim financing on residential and commercial properties under construction, and are secured by real estate. This category also includes acquisition and development financing for residential and commercial projects. Once construction is completed and the loan becomes permanent, the loans are reclassified as either commercial real estate loans, which are secured by commercial property, or residential real estate loans, which are secured by first deeds of trust. Residential Real Estate Loans. Residential real estate loans are secured by deeds of trust on 1-4 family residential properties. To mitigate interest rate risk, the Company usually limits the final maturity of residential real estate loans held for its own portfolio to 15-20 years, although exceptions are made for competitive reasons and under special programs. Residential real estate lending involves risk elements when there is lack of timely payment and/or a decline in the value of the collateral. Loans to Individuals. We offer various secured and unsecured consumer loans, including unsecured personal loans and lines of credit, automobile loans, deposit account loans, installment and demand loans, letters of credit, and home equity loans.
35
Table of ContentsAsset Quality Summary of Allowance for Loan Losses The allowance for loan losses represents an amount that, in our judgment, will be adequate to absorb any losses on existing loans that may become uncollectible, although there can be no assurance that this will be so. The provision for loan losses increases the allowance, and loans charged off (net of recoveries) reduce the allowance. A provision for loan losses of $1.3 million was made during 2007, a decrease of $1.5 million or 53.6% from the $2.8 million provided during 2006. The decrease in the loan loss provision is a result of a decrease in loan growth as well as the resolution of our three large problem credits subsequent to year-end. This allowed us to reduce our overall loan loss provision by over $500,000 as we eliminated the unneeded specific reserves that were associated with these problem credits. For the year ended December 31, 2007, our non-performing assets to total assets ratio decreased from 1.56% at December 31, 2006 to 1.24% and will be reduced further to 0.39% at the end of January 2008 as a result of the resolution of the three large problem loan assets. Additionally, our ratio of loans past due more than 90 days to total loans decreased from 0.13% at December 31, 2006 to 0.0% at December 31, 2007. Net charge-offs for the year ended December 31, 2007 amounted to $2.0 million in comparison to $1.3 million for the year ended December 31, 2006. A provision for loan losses of $2.8 million was made during 2006, an increase of $1.5 million or 115% from the $1.3 million provided during 2005. The increase in the loan loss provision was the result of an increase in non-performing loans. For the year ended December 31, 2006, our non-performing assets to total assets ratio increased from 0.72% at December 31, 2005 to 1.56%. Additionally, our loans past due more than 90 days to total loans increased from 0.10% at December 31, 2005 to 0.13% at December 31, 2006. The allowance for loan losses was $4.9 million and $5.7 million as of December 31, 2007 and 2006, respectively. The ratio of the allowance for loan losses to total loans outstanding was approximately 1.0% at December 31, 2007, which compares to approximately 1.2% of total loans at December 31, 2006 (see Note 5 to the Consolidated Financial Statements). These estimates are primarily based on our historical loss experience, portfolio concentrations, evaluation of individual loans and economic conditions. A total of $0.7 million in specific reserves was included in the balance of the allowance for loan losses as of December 31, 2007 for impaired loans, which compares to a total of $1.1 million as of December 31, 2006. We regularly review asset quality and re-evaluate the allowance for loan losses. However, no assurance can be given that unforeseen adverse economic conditions or other circumstances will not result in increased provisions in the future. Our current market environment, with a nationwide recession possible, makes this risk even higher. Additionally, regulatory examiners may require us to recognize additions or reductions to the allowance based upon their judgment about the loan portfolio and other information available to them at the time of their examinations. (See “Allowance for Loan Losses” under “Critical Accounting Policies”.)
36
Table of ContentsThe following table summarizes the loan loss experience for the five years ended December 31, 2007. ANALYSIS OF THE ALLOWANCE FOR LOAN LOSSES (000’s omitted)
The following table summarizes the allocation of the allowance for loan losses for the five years ended December 31, 2007. The percentage in the table below refers to the percent of loans in each category to total loans. ALLOCATION OF THE ALLOWANCE FOR LOAN LOSSES (000’s omitted)
Nonperforming Assets. Nonperforming assets include nonaccrual loans, loans past due 90 days or more, restructured loans and foreclosed/repossessed property. A loan will be placed on nonaccrual status when collection of all principal or interest is deemed unlikely. A loan will be placed on nonaccrual status automatically when principal or interest is past due 90 days or more, unless the loan is both well secured and in the process of being collected. In this case, the loan will continue to accrue interest despite its past due status.
37
Table of ContentsA restructured loan is a loan in which the original contract terms have been modified due to a borrower’s financial condition or there has been a transfer of assets in full or partial satisfaction of the loan. A modification of original contractual terms is generally a concession to a borrower that a lending institution would not normally consider. A loan is impaired, as defined in Statement of Financial Accounting Standards (“SFAS”) 114 (creditor accounting rules for impaired loans) when, based on current information and events, it is likely that a creditor will be unable to collect all amounts, including both principal and interest, due according to the contractual terms of the loan agreement. Nonperforming assets for the five years ended December 31, 2007 are detailed as follows: NONPERFORMING ASSETS (000’s omitted)
Each quarter, the Directors’ Loan Committee, composed of eight directors, will review all loans on our watch list to determine proper action and reporting of any loans identified as substandard by the credit quality review. We believe that the above allocated reserves are appropriate for the impaired loans in our portfolio based upon a detailed review of the quality and pledged collateral of each individual loans considered impaired at each of the above-referenced periods. (See “Impairment of Loans” under “Critical Accounting Policies”.) If the non-accrual loans disclosed above had performed in accordance with their original terms, additional interest income in the amount of $909,586 would have been recorded for the year ended December 31, 2007. Other Assets We have purchased life insurance contracts on key employees, the tax-exempt income from which is the funding vehicle for the Company’s Supplemental Executive Retirement Plan (“SERP”) and other employee benefit costs including health insurance, dental insurance, life insurance, and 401(k) employer match. Bank owned life insurance was $11.6 million at December 31, 2007, an increase of $0.5 million over the $11.1 million reported as of December 31, 2006 as a result of the increase in the cash surrender value of the life insurance contracts. Deposits The levels and mix of deposits are influenced by such factors as customer service, interest rates paid, service charges and the convenience of banking locations. Competition for deposits is intense from other depository institutions and money market funds, some of which offer interest rates higher than we
38
Table of Contentspay. We attempt to identify and implement pricing and marketing strategies designed to control the overall cost of deposits and to maintain a stable deposit mix. The following table summarizes our total deposits for the years ended December 31, 2007 and 2006:
As can be seen from the table above, while our time deposits remained relatively stable from 2006 to 2007, the percentage of time deposits to total deposits actually increased by 1.4% due to our total deposit balances decreasing from year to year. Within the certificate of deposit category, we have marketed CDs nationally to institutional depositors, primarily banks, thrift institutions and credit unions through an Internet-based rate posting service. National market CDs at December 31, 2007 were $11.3 million, a decrease of $1.6 million from the $12.9 million reported at December 31, 2006 and represents 4% of total CDs and 3% of total deposits at December 31, 2007, as compared to 5% of total CDs and 3% of total deposits at December 31, 2006. Our interest bearing and money market deposits increased by $7.4 million during 2007, due primarily to the increase in our Prime money market account balances. The following table summarizes average deposits for the years ended December 31, 2007 and 2006. AVERAGE DEPOSIT MIX (000’s omitted)
39
Table of ContentsThe following table presents the maturity schedule of certificates of deposit of $100,000 or more as of December 31, 2007. MATURITY SCHEDULE OF CERTIFICATES OF DEPOSIT OF $100,000 OR MORE (000’s omitted)
Short-Term Borrowings Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) increased by $3.0 million from their level of $46.6 million at December 31, 2006 to a total of $49.6 million as of December 31, 2007. Short-term borrowings at December 31, 2007 include federal funds purchased of $3.3 million, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings in the amount of $13.0 million, and a commercial sweep account program in the amount of $33.3 million. The FHLB borrowings include an $8 million prime based credit that matures on June 27, 2008 and reprices monthly at the prime rate less 285 basis points (rate of 4.395% on December 31, 2007) and a fixed rate credit in the amount of $5 million that matures on October 31, 2008 (rate of 4.4975% on December 31, 2007). See the liquidity section for further information on the preceding borrowings. Total short-term borrowings (including federal funds purchased and securities sold under agreements to repurchase) decreased by $4.2 million from their level of $50.8 million at December 31, 2005 to a total of $46.6 million as of December 31, 2006. Short-term borrowings at December 31, 2006 included federal funds purchased of $0 million, Federal Home Loan Bank of Atlanta (“FHLB”) borrowings in the amount of $25 million, and a commercial sweep account program in the amount of $21.6 million. The commercial sweep program involves balances subject to repurchase agreements which are reported as short term borrowings rather than deposits since they are not FDIC insured. The balance in the program increased 54.2% or $11.7 million from $21.6 million reported at December 31, 2006 to $33.3 million at December 31, 2007. The program consists of a demand deposit account from which we invest available balances daily in securities on an overnight basis subject to repurchase. On the following business day, we repurchase from the customer the securities for an amount equal to the amount of available balances invested in the securities. Interest is calculated daily at the rate applicable for each overnight period; however, it is posted to the customer accounts only once per month.
40
Table of ContentsThe following table presents information on each category of the Company’s short-term debt, which generally mature within one to seven days from the transaction date. SHORT-TERM BORROWINGS (000’s omitted)
Long-Term Borrowings Federal Home Loan Bank advances are relatively cost-effective funding sources and provide the Company with the flexibility to structure borrowings in a manner that aids in the management of interest rate risk and liquidity. The increase in advances during the year reflects the funding to support investment growth. The Company had outstanding long-term debt with the Federal Home Bank of Atlanta in the amount of $55.0 million as of December 31, 2007, an increase of $7.0 million from the $48.0 million reported as of December 31, 2006. This increase is made up of a $15 million convertible advance offset by the movement of an $8 million fixed rate advance from long-term to short-term borrowings as of December 31, 2007. See Footnote 8 of the Company’s Consolidated Financial Statements for more information on the long-term advances.
41
Table of ContentsGuaranteed Preferred Beneficial Interests in the Company’s Junior Subordinated Debentures Valley Financial (VA) Statutory Trust I, a statutory business trust (“Trust I”), was created on June 26, 2003, at which time the Trust issued $4.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature June 26, 2033. Distributions are payable on the securities at a floating rate equal to the 3-month London Interbank Offered Rate (“LIBOR”) plus 3.10%, capped at 11.75%, and the securities may be prepaid at par by Trust I at any time after June 26, 2008. The principal assets of Trust I are $4.1 million of the Company’s junior subordinated debentures which mature on June 26, 2033, and bear interest at a floating rate equal to the 3-month LIBOR plus 3.10%, capped at 11.75%, and which are callable by the Company after June 26, 2008. All $124,000 in aggregation liquidation amount of Trust I’s common securities are held by the Company. Valley Financial (VA) Statutory Trust II, a statutory business trust (“Trust II”), was created on September 26, 2005, at which time Trust II issued $7.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature December 15, 2035. Distributions are payable on the securities at a floating rate equal to 3-month LIBOR plus 1.49%, and the securities may be prepaid at par by Trust II at any time after December 15, 2010. The principal assets of Trust II are $7.2 million of the Company’s junior subordinated debentures which mature on December 15, 2035, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.49%, and which are callable by the Company after December 15, 2010. All $217,000 in aggregation liquidation amount of Trust II’s common securities are held by the Company. Valley Financial Statutory Trust III, a statutory business trust (“Trust III”) was created by the Company on December 15, 2006, at which time Trust III issued $5.0 million in aggregate liquidation amount of $1 par value preferred capital trust securities which mature January 30, 2036. Distributions are payable on the securities at a floating rate equal to the 3-month LIBOR plus 1.73%, and the securities may be prepaid at par by Trust III at any time after January 30, 2012. The principal assets of Trust III are $5,155 of the Company’s junior subordinated debentures which mature on January 30, 2037, and bear interest at a floating rate equal to the 3-month LIBOR plus 1.73%, and which are callable by the Company after January 30, 2012. All $155 in aggregation liquidation amount of Trust III’s common securities are held by the Company. These debentures are a special form of securities that, while actually long-term debt for the Company, count as “capital” for bank regulatory purposes. The debenture proceeds from Trust I, Trust II, and Trust III are included in our Tier 1 capital for regulatory capital adequacy purposes to the extent that they do not exceed 25% of our total Tier I capital including the securities. This amount totaled $13.6 million (of the $16 million outstanding) at December 31, 2007. The remaining $4.8 is included in the calculation of our total risk-based capital ratio as Tier 2 capital. Our obligations with respect to the issuance of Trust I, Trust II, and Trust III’s preferred securities and common securities constitute a full and unconditional guarantee of Trust I, Trust II, and Trust III’s obligations with respect to the preferred securities and common securities. Subject to certain exceptions and limitations, we may elect from time to time to defer interest payments on its junior subordinated debentures, which would result in a deferral of distribution payments on Trust I, Trust II, or Trust III’s preferred trust securities and common securities. As a result of the Company’s adoption of FIN 46, the Trusts’ common securities have been presented as a component of other assets.
42
Table of ContentsCapital Adequacy Our financial position at December 31, 2007 and 2006 reflects liquidity and capital levels currently adequate to fund anticipated near-term business expansion. Our capital ratios are above the required regulatory minimums for a well-capitalized institution. We review the adequacy of our capital on an ongoing basis. We seek to maintain a capital structure adequate to support anticipated asset growth and serve as a cushion to absorb potential losses and will continue to monitor the Bank capital ratios very closely due to the impact our non-accrual loans have on retained earnings and capital. For the periods indicated, we had the following risk-based capital and leverage ratios: Capital Ratios
Liquidity Asset/liability management activities are designed to ensure that adequate liquidity is available to meet loan demand or deposit outflows and, through the management of our interest sensitivity position, to manage the impact of interest rate fluctuations on net interest income. Liquidity measures our ability to meet our maturing obligations and existing commitments, to withstand fluctuations in deposit levels, to fund our operations and to provide for customers’ credit needs. Liquidity represents a financial institution’s ability to meet present and future financial obligations through either the sale or maturity of existing assets or the acquisition of additional funds from alternative funding sources. The level of deposits may fluctuate, perhaps significantly so, due to seasonal cycles of depositing customers and the promotional activities of competitor financial institutions. Similarly, the level of demand for loans may vary significantly and at any given time may increase or decrease substantially. However, unlike the level of deposits, management has more direct control over lending activities and if necessary can adjust the level of those activities according to the amounts of available funds. Liquid assets, which include cash and due from banks, interest-bearing deposits at other banks and non-pledged securities available-for-sale, at December 31, 2007, totaled $77.0 million. Our funding sources consist of an established federal funds lines with a regional correspondent bank totaling $12.0 million that had a $3.3 million balance as of December 31, 2007, three established federal funds lines with third party banks totaling $22.0 million that had outstanding balances totaling $0.0 million as of December 31, 2007, and an established line with the FHLB that had $68.0 million outstanding under a total line of $92.0 million as of December 31, 2007. We believe these arrangements will be renewed at maturity. As of December 31, 2007, we had pledged approximately $92.0 million of our loan and investment portfolio balances as collateral for borrowings from the Federal Home Loan Bank. As of that date, we had approximately $24.0 million in remaining credit availability from the Federal Home Loan Bank. As of December 31, 2006 we had pledged approximately $89.3 million of our loan and investment portfolio balances as collateral for borrowings from the Federal Home Loan Bank. As of that date, we had approximately $16.3 million in remaining credit availability from the Federal Home Loan Bank.
43
Table of ContentsWe sell excess funds as overnight federal funds sold to provide an immediate source of liquidity. We had federal funds sold of $0.0 million at December 31, 2007, as compared to $16.6 at December 31, 2006. As a result of our management of liquid assets and our ability to generate liquidity through alternative funding sources, we believe we maintain overall liquidity sufficient to meet our depositors’ requirements and satisfy our customers’ credit needs. Impact of Inflation The consolidated financial statements and notes thereto presented herein have been prepared in accordance with generally accepted accounting principles, which requires the measurement of financial position and operating results in terms of historical dollars without considering changes in the relative purchasing power of money over time due to inflation. Unlike most industrial companies, nearly all the assets and liabilities of the Company and the Bank are monetary in nature. As a result, interest rates have a greater impact on the Company’s performance than do the effects of changes in the general rate of inflation and changes in prices. In addition, interest rates do not necessarily move in the same direction or in the same magnitude as do the prices of goods and services. Management seeks to manage the relationship between interest-sensitive assets and liabilities in order to protect against wide interest rate fluctuations, including those resulting from inflation. Recent and Future Accounting Considerations In March 2007, the FASB ratified the consensus reached on EITF 06-10, “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF 06-10”). The postretirement aspect of this EITF is substantially similar to EITF 06-4 discussed above and requires that an employer recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance arrangement in accordance with either FASB Statement No. 106 or APB Opinion No. 12, as appropriate, if the employer has agreed to maintain a life insurance policy during the employee’s retirement or provide the employee with a death benefit based on the substantive agreement with the employee. In addition, a consensus was reached that an employer should recognize and measure an asset based on the nature and substance of the collateral assignment split-dollar life insurance arrangement. EITF 06-10 is effective for the Company on January 1, 2008. The Company does not believe the adoption of EITF 06-10 will have a material impact on its financial position, results of operations or cash flows. In November 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (“SAB 109”). SAB 109 expresses the current view of the SEC staff that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SEC registrants are expected to apply this guidance on a prospective basis to derivative loan commitments issued or modified in the first quarter of 2008 and thereafter. The Company is currently analyzing the impact of this guidance, which relates to the Company’s mortgage loans held for sale. In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs.
44
Table of ContentsIn December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financials statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 is effective for the Company on January 1, 2009. Earlier adoption is prohibited. The Company is currently evaluating the impact, if any, the adoption of SFAS 160 will have on its consolidated financial statements.
45
Table of Contents
Report of Independent Registered Public Accounting Firm Board of Directors and Shareholders Valley Financial Corporation Roanoke, Virginia We have audited the consolidated balance sheets of Valley Financial Corporation and subsidiary as of December 31, 2007 and 2006, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the two years in the period ended December 31, 2007. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the consolidated financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of the Valley Financial Corporation and subsidiary as of December 31, 2007 and 2006 and the results of its operations and its cash flows for each of the years then ended, in conformity with U.S. generally accepted accounting principles. We were not engaged to examine management’s assertion about the effectiveness of Valley Financial Corporation’s internal control over financial reporting as of December 31, 2007 included in the accompanying Form 10-K, item 9A, and accordingly, we do not express an opinion thereon. Elliott Davis Galax, Virginia March 11, 2008
46
Table of Contents
Valley Financial Corporation Consolidated Balance Sheets December 31, 2007 and 2006 (In thousands, except share data)
See accompanying notes to consolidated financial statements.
47
Table of Contents
Valley Financial Corporation Consolidated Statements of Income For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
See accompanying notes to consolidated financial statements.
48
Table of Contents
Valley Financial Corporation Consolidated Statements of Shareholders’ Equity For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
See accompanying notes to consolidated financial statements
49
Table of Contents
Valley Financial Corporation Consolidated Statements of Cash Flows For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
50
Table of Contents
Valley Financial Corporation Consolidated Statements of Cash Flows, continued For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
See accompanying notes to consolidated financial statements.
51
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies General The Bank provides traditional commercial banking services concentrated primarily in the Roanoke Valley of Virginia. However, the Bank does not currently offer trust services. As a state chartered, Federal Reserve member bank, the Bank is subject to regulation by the Virginia Bureau of Financial Institutions and the Federal Reserve. The Bank opened for business on May 15, 1995 at its main office in the City of Roanoke, opened its second office on September 11, 1995 in the County of Roanoke, its third office on January 15, 1997 in the City of Roanoke, its fourth office in the City of Salem on April 5, 1999, its fifth office in the City of Roanoke on May 7, 2001, its sixth office in County of Roanoke on May 20, 2002, its seventh office in the City of Roanoke on December 8, 2003, and its eighth office in the City of Roanoke on May 9, 2005. Additionally, the Bank opened its wealth management subsidiary, Valley Wealth Management Services, Inc., in the City of Roanoke on June 23, 2005. The Bank operates under a state charter issued by the Commonwealth of Virginia, and engages in the business of commercial banking. Its deposits are insured by the Federal Deposit Insurance Corporation (“FDIC”) and it is a member of the Federal Reserve System. Our primary purpose is to own and manage the Bank. Effective October 16, 2002, the Bank established VB Investments, LLC as a wholly-owned subsidiary of the Bank to be a limited partner in various tax credit partnerships. The establishment of the subsidiary gives the Bank the right to utilize certain federal and state tax credits. Effective June 26, 2003, Valley Financial (VA) Statutory Trust I was established as a wholly-owned subsidiary of the Company for the purpose of issuing trust preferred securities. Effective September 26, 2005, Valley Financial (VA) Statutory Trust II was established as a wholly-owned subsidiary of the Company for the purpose of issuing additional trust preferred securities. Effective December 15, 2006, Valley Financial Statutory Trust III was established as a wholly owned subsidiary of the company for the purpose of issuing additional trust preferred securities. These entities are for raising capital (in the case of the statutory trusts) or investments (in the case of the LLC) for the Company and the Bank. Effective July 13, 2007, VFC Properties, LLC was established as a wholly-owned subsidiary of the Company to provide credit intermediary services for the Bank. The Company has made a decision to dissolve this entity during the first quarter of 2008. The Bank will continue to provide its own credit services. Critical Accounting Policies The accounting and reporting policies of Valley Financial Corporation (“the Company”), Valley Bank (“the Bank”), and the Bank’s Statutory Trusts as discussed in Note 9, conform to generally accepted accounting principles (GAAP) and to general banking industry practices. Our policies, with respect to the methodology for determination of the allowance for loan losses, involve a high degree of complexity. Management must make difficult and subjective judgments that often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions, or estimates would cause reported results to differ materially. These critical policies and their application are reviewed periodically with our Audit Committee and Board of Directors. The following is a summary of the more significant accounting policies: Principles of Consolidation The consolidated financial statements include the accounts of the Company and the Bank, thereafter referred to collectively as the Company. All significant intercompany transactions and balances have been eliminated in consolidation. Business Segments The Company reports its activities in one business segment. In determining the appropriateness of segment definition, the Company considers the materiality of potential business segments and components of the business about which financial information is available and regularly evaluated relative to resource allocation and performance assessment. Advertising Costs The Company expenses all advertising and business promotion costs as incurred.
52
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Use of Estimates The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change relate to the determination of the allowance for loan losses and the valuation of real estate acquired in connection with foreclosures or in satisfaction of loans. In connection with the determination of the allowances for loan and foreclosed real estate losses, management obtains independent appraisals for significant properties. Substantially all of the Bank’s loan portfolio consists of loans in the Roanoke Valley. Accordingly, the ultimate collectibility of a substantial portion of the Bank’s loan portfolio and the recovery of a substantial portion of the carrying amount of foreclosed real estate are susceptible to changes in local market conditions. The regional economy is reasonably diverse. While management uses available information to recognize loan and foreclosed real estate losses, future additions to the allowances may be necessary based on changes in local economic conditions. In addition, regulatory agencies, as a part of their routine examination process, periodically review the Bank’s allowances for loan and foreclosed real estate losses. Such agencies may require the Bank to recognize additions to the allowances based on their judgments about information available to them at the time of their examinations. Because of these factors, it is reasonably possible that the allowances for loan and foreclosed real estate losses may change materially in the near term. Cash and Cash Equivalents For the purpose of presentation in the consolidated statements of cash flows, cash and cash equivalents are defined as those amounts included in the balance sheet caption “cash and due from banks.” Interest-Bearing Deposits in Banks Interest bearing deposits in banks mature within one year and are carried at cost. Trading Securities The Company does not hold securities for short-term resale and therefore does not maintain a trading securities portfolio. Securities Held-to-Maturity Bonds, notes, and debentures for which the Bank has the positive intent and ability to hold to maturity are reported at cost, adjusted for premiums and discounts that are recognized in interest income using the interest method over the period to maturity or to call dates. Securities Available-for-Sale Available-for-sale securities are reported at fair value and consist of bonds, notes, debentures, and certain equity securities not classified as trading securities or as held-to-maturity securities. Unrealized holding gains and losses, net of tax, on available-for-sale securities are reported as a net amount in a separate component of shareholders’ equity. Realized gains and losses on the sale of available-for-sale securities are determined using the specific-identification method. Premiums and discounts are recognized in interest income using the interest method over the period to maturity or to call dates.
53
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Securities Available-for-Sale, continued Declines in the fair value of individual held-to-maturity and available-for-sale securities below cost that are other than temporary are reflected as write-downs of the individual securities to fair value. Related write-downs are included in earnings as realized losses. Loans Receivable Loans receivable that management has the intent and ability to hold for the foreseeable future or until maturity or pay-off are reported at their outstanding principal amount adjusted for the allowance for loan losses, and any deferred fees or costs on originated loans and unamortized premiums or discounts on purchased loans. Loan origination fees and costs are capitalized and recognized as an adjustment to the yield on the related loan. Discounts and premiums on any purchased residential real estate loans are amortized to income using the interest method over the remaining period to contractual maturity, adjusted for anticipated prepayments. Discounts and premiums on any purchased consumer loans are recognized over the expected lives of the loans using methods that approximate the interest method. Interest is accrued and credited to income based on the principal amount outstanding. The accrual of interest on impaired loans is discontinued when, in management’s opinion, the borrower is unlikely to meet payments as they become due. When interest accrual is discontinued, all unpaid accrued interest is reversed. We apply payments received on nonaccrual loans first to outstanding principal, and the residual amount, if any, is applied to interest. When facts and circumstances indicate the borrower has regained the ability to meet required payments, the loan is returned to accrual status. Past due status of loans is determined based on contractual terms. Allowance for Loan Losses The allowance for loan losses is an estimate of the losses that may be sustained in the loan portfolio. The allowance is based on three basic principles of accounting: (i) Statement of Financial Accounting Standards (“SFAS”) No. 5, “Accounting for Contingencies”, which requires that losses be accrued when they are probable of occurring and estimable, (ii) SFAS No. 114, “Accounting by Creditors for Impairment of a Loan”, which requires that losses be accrued based on the differences between the value of collateral, present value of future cash flows or values that are observable in the secondary market, and the loan balance, and (iii) SFAS No. 118, “Accounting by Creditors for Impairment of a Loan, Income Recognition and Disclosures – an amendment of SFAS 114”, which allows a creditor to use existing methods for recognizing interest income on an impaired loan. The allowance consists of specific and general components. The specific component relates to impaired loans. For such loans an allowance is established when the discounted cash flows (or collateral value or observable market price) of the impaired loan is lower than the carrying value of that loan. The general component is based on historical loss experience adjusted for qualitative and environmental factors. The allowance for loan losses is established as losses are estimated to have occurred through a provision for loan losses charged to earnings. Loan losses are charged against the allowance when management believes the uncollectibility of a loan balance is confirmed. Subsequent recoveries, if any, are credited to the allowance. The allowance for loan losses is evaluated on a regular basis by management and is based upon management’s periodic review of the collectibility of the loans in light of historical experience, the nature and volume of the loan portfolio, adverse situations that may affect the borrower’s ability to repay, estimated value of any underlying collateral, and prevailing economic conditions. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
54
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Allowance for Loan Losses, continued A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect the scheduled payments of principal or interest when due according to the contractual terms of the loan agreement. Factors considered by management in determining impairment include payment status, collateral value, and the probability of collecting scheduled principal and interest payments when due. Loans that experience insignificant payment delays and payment shortfalls generally are not classified as impaired. Management determines the significance of payment delays and payment shortfalls on a case-by-case basis, taking into consideration all of the circumstances surrounding the loan and the borrower, including the length of the delay, the reasons for the delay, the borrower’s prior payment record, and the amount of the shortfall in relation to the principal and interest owed. Impairment is measured on a loan by loan basis for commercial and construction loans by either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Large groups of smaller balance homogeneous loans are collectively evaluated for impairment, and from time to time, we may evaluate one or more homogeneous loans as impaired. The Bank does not separately identify individual consumer and residential loans for impairment. Premises and Equipment Land is carried at cost. Bank premises, furniture and equipment, and leasehold improvements are carried at cost, less accumulated depreciation and amortization computed principally by the straight-line method over the following estimated useful lives:
Foreclosed Properties Assets acquired through, or in lieu of, loan foreclosure are to be sold and are initially recorded at fair value less anticipated cost to sell at the date of foreclosure establishing a new cost basis. After foreclosure, valuations are periodically performed by management and the asset is carried at the lower of carrying amount or fair value less cost to sell. Revenue and expenses from operations and changes in the valuation allowance are included in foreclosed asset expense. Share Based Compensation During the first quarter of fiscal 2006, we adopted the provisions of, and account for share based compensation in accordance with, the Financial Accounting Standards Board’s (“FASB”) Statement of Financial Accounting Standards No. 123 – revised 2004, “Share-Based Payment,” (“SFAS 123R”). Under the fair value recognition provisions of this statement, share based compensation cost is measured at the grant date based on the fair value of the award and is recognized as expense on a straight-line basis over the requisite service period, which is the vesting period. The valuation provisions of SFAS 123R apply to new grants and to grants that were outstanding as of the effective date and are subsequently modified. Estimated compensation cost for unvested grants that were outstanding as of the effective date will be recognized over the remaining service period.
55
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Share Based compensation, continued Policy for issuing shares upon option exercise Options shall be exercised by the delivery of a written notice to the Company in the form prescribed by the Human Resources (HR) Committee setting forth the number of shares with respect to which the option is to be exercised, accompanied by full payment for the shares. The option price shall be payable to the Company in full either in cash, by delivery of shares of stock valued at fair market value at the time of exercise, delivery of a promissory note (in the HR Committee’s sole discretion) or by a combination of the foregoing. As soon as practicable, after receipt of written notice and payment, the Company shall deliver to the participant, stock certificates (new shares) in an appropriate amount based upon the number of options exercised, issued in the participant’s name. No participant who is awarded options shall have rights as a shareholder in connection with the shares subject to such options until the date of exercise of the options. See Note 12 for further information regarding our share based compensation assumptions and expenses. Transfers 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 Bank, (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 Bank does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity. Income Taxes Provision for income taxes is based on amounts reported in the statements of income (after exclusion of non-taxable income such as interest on state and municipal securities and income earned on bank-owned life insurance) and consists of taxes currently due plus deferred taxes on temporary differences in the recognition of income and expense for tax and financial statement purposes. Deferred tax assets and liabilities are included in the financial statements at currently enacted income tax rates applicable to the period in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. Deferred income tax liability relating to unrealized appreciation (or the deferred tax asset in the case of unrealized depreciation) on investment securities available for sale is recorded in other liabilities (assets). Such unrealized appreciation or depreciation is recorded as an adjustment to equity in the financial statements and not included in income determination until realized. Accordingly, the resulting deferred income tax liability or asset is also recorded as an adjustment to equity. In 2006, the FASB issued Interpretation No. 48 (FIN 48), “Accounting for Uncertainty in Income Taxes – an Interpretation of SFAS No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 also prescribes a recognition threshold and measurement of a tax position taken or expected to be taken in an enterprise’s tax return. FIN 48 is effective for fiscal years beginning after December 15, 2006. Accordingly, the Company adopted FIN 48 effective January 1, 2007. The adoption of FIN 48 did not have any impact on the Company’s consolidated financial position. Basic Earnings per Share Basic earnings per share is computed by dividing income available to common shareholders by the weighted average number of common shares outstanding during the period, after giving retroactive effect to stock splits and dividends. Diluted Earnings per Share The computation of diluted earnings per share is similar to the computation of basic earnings per share except that the denominator is increased to include the number of additional common shares that would have been outstanding if dilutive potential common shares had been issued. These additional common shares would include employee equity share options, nonvested shares and similar equity instruments granted to employees. Diluted earnings per
56
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Diluted Earnings per Share, continued share is based upon the actual number of options or shares granted and not yet forfeited unless doing so would be antidilutive. The numerator is adjusted for any changes in income or loss that would result from the assumed conversion of those potential common shares. Comprehensive Income Annual comprehensive income reflects the change in the Company’s equity during the year arising from transactions and events other than investments by and distributions to shareholders. It consists of net income plus certain other changes in assets and liabilities that are reported as separate components of shareholders’ equity rather than as income or expense. Financial Instruments For asset/liability management purposes, we may use interest rate swap agreements to hedge interest rate risk exposure to declining rates. Such derivatives are used as part of the asset/liability management process and are linked to specific assets, and have a high correlation between the contract and the underlying item being hedged, both at inception and throughout the hedge period. In addition, forwards and option contracts must reduce an exposure’s risk, and for hedges of anticipatory transactions, the significant terms and characteristics of the transaction must be identified and the transactions must be probable of occurring. All derivative financial instruments held or issued by the Company are held or issued for purposes other than trading. In the ordinary course of business the Bank has entered into off-balance-sheet financial instruments consisting of commitments to extend credit and commercial and standby letters of credit. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. Interest Rate Swap Agreements For asset/liability management purposes, the Company may use interest rate swap agreements to hedge various exposures or to modify interest rate characteristics of various balance sheet accounts. Interest rate swaps are contracts in which a series of cash flows from interest are exchanged over a prescribed period, based upon a notional amount. The notional amount on which the interest payments are based is not exchanged. These swap agreements are derivative instruments and generally convert a portion of the Company’s variable-rate loans to a fixed rate (cash flow hedge), and convert a portion of its fixed-rate loans to a variable rate (fair value hedge). Cash flows resulting from derivative financial instruments that are accounted for as hedges of assets and liabilities are classified in the cash flow statement in the same category as the cash flows of the items being hedged. Fair Value of Financial Instruments Statement of Financial Accounting Standards No. 107, “Disclosures about Fair Value of Financial Instruments”, requires disclosure of fair value information about financial instruments, whether or not recognized in the balance sheet. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. In that regard, the derived fair value estimates cannot be substantiated by comparison to independent markets and, in many cases, could not be realized in immediate settlement of the instruments. Statement No. 107 excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented do not represent the underlying value of the Company. The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments: Cash and due from banks: The carrying amounts reported in the balance sheet for cash and due from banks approximate their fair values.
57
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Interest-bearing deposits in banks: Fair values for time deposits are estimated using a discounted cash flow analysis that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. Federal funds sold: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value. Available-for-sale and held-to-maturity securities: Fair values for securities, excluding restricted equity securities, are based on quoted market prices, where available. If quoted market prices are not available, fair values are based on quoted market prices of comparable instruments. The carrying values of restricted equity securities approximate fair values. Loans receivable: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying amounts. The fair values for other loans are estimated using discounted cash flow analysis, based on interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. Loan fair value estimates include judgments regarding future expected loss experience and risk characteristics. Fair values for impaired loans are estimated using discounted cash flow analysis or underlying collateral values, where applicable. The carrying amount of accrued interest receivable approximates its fair value. Bank owned life insurance: The carrying amount reported in the balance sheet approximate fair value as it represents the cash surrender value of the life insurance. Deposit liabilities: The fair values disclosed for demand and savings deposits are, by definition, equal to the amount payable on demand at the reporting date. The fair values for certificates of deposit are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated contractual maturities on such time deposits. The carrying amount of accrued interest payable approximates fair value. Federal funds purchased and securities sold under agreements to repurchase: Due to the short-term nature of these assets, the carrying values of these assets approximate their fair value. Short-term debt: The carrying amounts of short-term debt approximate their fair values. Other debt: The fair values of other debt is estimated using a discounted cash flow calculation that applies contracted interest rates being paid on the debt to the current market interest rate of similar debt. Guaranteed preferred beneficial interests in the Company’s junior subordinated debentures: The fair values of guaranteed preferred beneficial interests in the Company’s junior subordinated debentures is estimated using a discounted cash flow calculation that applies contracted interest rates being paid on the debt to the current market interest rate of similar debt. Other liabilities: For fixed-rate loan commitments, fair value considers the difference between current levels of interest rates and the committed rates. The carrying amount of other liabilities approximates fair value as the estimated value of loan commitments approximates the fees charged. Reclassification Certain reclassifications have been made to the financial statements of the prior year to place them on a comparable basis with the current year. Net income and shareholders’ equity previously reported were not affected by these reclassifications. During 2007, in an effort to provide more transparent information to readers of financial statements, the Company reclassified expenses associated with the purchase of the federal historical tax credits from purchased tax credit expense to income tax expense. For reporting years prior to December 31, 2007, the gross amount of the purchase of the federal historical tax credit was presented as purchased tax credit expense (as the historical tax credit was used) with an offset to income tax expense. Within this Annual Report on Form 10-K for the year ended December 31, 2007, such expenses have been reclassified, resulting in prior period reclassifications, and are reported within the income tax expense financial statement line item within the Consolidated Statements of Income.
58
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 1. Summary of Significant Accounting Policies, continued Recent Accounting Pronouncements In March 2007, the FASB ratified the consensus reached on EITF 06-10, “Accounting for Collateral Assignment Split-Dollar Life Insurance Arrangements” (“EITF 06-10”). The postretirement aspect of this EITF is substantially similar to EITF 06-4 and requires that an employer recognize a liability for the postretirement benefit related to a collateral assignment split-dollar life insurance arrangement in accordance with either FASB Statement No. 106 or APB Opinion No. 12, as appropriate, if the employer has agreed to maintain a life insurance policy during the employee’s retirement or provide the employee with a death benefit based on the substantive agreement with the employee. In addition, a consensus was reached that an employer should recognize and measure an asset based on the nature and substance of the collateral assignment split-dollar life insurance arrangement. EITF 06-10 is effective for the Company on January 1, 2008. The Company does not believe the adoption of EITF 06-10 will have a material impact on its financial position, results of operations or cash flows. In November 2007, the Securities and Exchange Commission (“SEC”) issued Staff Accounting Bulletin No. 109, “Written Loan Commitments Recorded at Fair Value Through Earnings” (“SAB 109”). SAB 109 expresses the current view of the SEC staff that the expected net future cash flows related to the associated servicing of the loan should be included in the measurement of all written loan commitments that are accounted for at fair value through earnings. SEC registrants are expected to apply this guidance on a prospective basis to derivative loan commitments issued or modified in the first quarter of 2008 and thereafter. The Company is currently analyzing the impact of this guidance, which relates to the Company’s mortgage loans held for sale. In December 2007, the FASB issued SFAS No. 141(R), “Business Combinations,” (“SFAS 141(R)”) which replaces SFAS 141. SFAS 141(R) establishes principles and requirements for how an acquirer in a business combination recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any controlling interest; recognizes and measures goodwill acquired in the business combination or a gain from a bargain purchase; and determines what information to disclose to enable users of the financial statements to evaluate the nature and financial effects of the business combination. FAS 141(R) is effective for acquisitions by the Company taking place on or after January 1, 2009. Early adoption is prohibited. Accordingly, a calendar year-end company is required to record and disclose business combinations following existing accounting guidance until January 1, 2009. The Company will assess the impact of SFAS 141(R) if and when a future acquisition occurs. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements – an amendment of ARB No. 51” (“SFAS 160”). SFAS 160 establishes new accounting and reporting standards for the noncontrolling interest in a subsidiary and for the deconsolidation of a subsidiary. Before this statement, limited guidance existed for reporting noncontrolling interests (minority interest). As a result, diversity in practice exists. In some cases minority interest is reported as a liability and in others it is reported in the mezzanine section between liabilities and equity. Specifically, SFAS 160 requires the recognition of a noncontrolling interest (minority interest) as equity in the consolidated financials statements and separate from the parent’s equity. The amount of net income attributable to the noncontrolling interest will be included in consolidated net income on the face of the income statement. SFAS 160 clarifies that changes in a parent’s ownership interest in a subsidiary that do not result in deconsolidation are equity transactions if the parent retains its controlling financial interest. In addition, this statement requires that a parent recognize gain or loss in net income when a subsidiary is deconsolidated. Such gain or loss will be measured using the fair value of the noncontrolling equity investment on the deconsolidation date. SFAS 160 also includes expanded disclosure requirements regarding the interests of the parent and its noncontrolling interests. SFAS 160 is effective for the Company on January 1, 2009. Earlier adoption is prohibited. The Company is currently evaluating the impact, if any, the adoption of SFAS 160 will have on its consolidated financial statements.
59
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 2. Restrictions on Cash To comply with Federal Reserve regulations, the Bank is required to maintain certain average reserve balances. The daily cash reserve requirement for the week including December 31, 2007 was $71, which was met by cash on hand. The daily cash reserve requirement for the week including December 31, 2006 was $65, which was met by cash on hand. As a condition of our correspondent bank agreement, the Bank is also required to maintain a target balance. The target balance as of December 31, 2007 and December 31, 2006 was $250. Note 3. Securities The amortized costs, gross unrealized gains and losses, and approximate fair values of securities available-for-sale as of December 31, 2007 and 2006 were as follows:
60
Table of Contents
Valley Financial Corporation Notes to Consolidated Financial Statements For the Years Ended December 31, 2007 and 2006 (In thousands, except share data)
Note 3. Securities, continued The amortized costs, gross unrealized gains and losses, and approximate fair values of securities held-to-maturity as of December 31, 2007 and 2006 were as follows:
The following tables detail unrealized losses and related fair values in the Bank’s available-for-sale and held-to-maturity investment securities portfolios. This information is aggregated by the length of time that individual securities have been in a continuous unrealized loss position as of December 31, 2007. Temporarily Impaired Securities in AFS Portfolio
| |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||