ITEM 1.
BUSINESS
General
Citizens Bancorp of Virginia, Inc. (the Company) is a one-bank holding company formed on December 18, 2003 headquartered in Blackstone, Virginia. The Company is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (the Bank). The Bank conducts and transacts the general business of a commercial bank as authorized by the banking laws of the Commonwealth of Virginia and the rules and regulations of the Federal Reserve System. The Bank was incorporated in 1873 under the laws of Virginia. Deposits are insured by the Federal Deposit Insurance Corporation. In September 1995, the Bank became a member of the Federal Home Loan Bank of Atlanta. Although the Company is a corporate entity, legally separate and distinct from the Bank, bank holding companies such as Citizens Bancorp of Virginia, Inc. are generally required to act as a source of financial strength for their subsidiary bank. The principal source of the Company’s income is dividends from the Bank. There are certain regulatory restrictions on the extent to which subsidiary banks can pay dividends or otherwise supply funds to the parent holding company. See the section captioned “Supervision and Regulation of Banking Activities” for further discussion of these matters.
The Bank’s primary activity is retail and commercial banking that includes commercial and consumer demand and time deposit accounts, real estate, commercial and consumer loans, online internet banking, 24-hour ATM network, brokerage services, safe deposit boxes, wire transfer services and other miscellaneous services incidental to the operation of a commercial bank. The Bank also acts as an agent for Visa. The Bank is authorized to have a trust department, but does not offer trust services. The Bank’s primary trade areas are served by its 11 banking offices located in the counties of Nottoway, Amelia, Prince Edward, Chesterfield, the City of Colonial Heights, and the Town of South Hill, Virginia.
The Bank’s primary revenue comes from retail banking in the form of interest income received on loans and investments. This income is partially offset by the Bank’s interest expense on deposits and borrowed funds, resulting in net interest income. The Bank’s earnings also come from noninterest income in the form of deposit fees, gains on the sale of loans and investments, ATM fees, Bank-owned Life Insurance, and other financial services. The Bank’s combined noninterest income and net interest income are offset by the Bank’s noninterest expense which includes employee compensation and benefits, occupancy, equipment and other operating expenses.
The Bank holds a 0.356% ownership in Infinex Investments, Inc., which delivers investment services to customers through the use of a dual-employee broker. The Bank also holds an 8.20% ownership interest in Bankers Title, LLC, which is a provider of title insurance. The Bank has an ownership interest of 1.53% in CBB Financial Corp. whose sole subsidiary is Community Bankers’ Bank, a provider of correspondent banking services exclusively to financial institutions. The financial position and operating results of these investments are not significant to the Bank as a whole and are not considered principal activities of the Bank.
The Company maintains an internet website at www.cbtva.com which contains information relating to the business. The Company makes available free of charge through its website its Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on Form 8-K as soon as possible after such forms have been filed with the Securities and Exchange Commission. Copies of the Company’s Audit Committee Charter, Nominating Committee Charter and Code of Conduct are available upon written request to: Corporate Secretary, Citizens Bancorp of Virginia, Inc., 126 South Main Street, Blackstone, Virginia, 23824.
Competition
The Bank competes for business with numerous other financial institutions including large national and regional banks, credit unions, other community banks, mutual funds, brokerage firms and insurance companies offering deposit products. Some of these firms do not have a physical presence in our
markets, but offer their products through local third party representatives or via the Internet. Factors such as interest rates offered for loan and deposit products, the number and location of branches, and the reputation of the Bank affect the competition for deposits and loans. The Bank’s marketing and business development efforts are concentrated on developing long-term customer relationships, and building customer loyalty by providing loan and deposit products and financial services that meet our customers’ needs. The Bank targets individual retail and small-to-medium size commercial customers.
The Bank’s trade areas include the counties of Amelia, Brunswick, Buckingham, Charlotte, Chesterfield, Cumberland, Dinwiddie, Lunenburg, Mecklenburg, Nottoway, Prince Edward, the cities of Colonial Heights and Petersburg, and the Town of South Hill. The following data reflects the Bank’s market share in its primary market places at June 30, 2010, according to information obtained from the FDIC website. In Amelia County, the Bank held 33.54% of the market share, in Nottoway County, 59.87%, in Prince Edward County, 14.37%, in the City of Colonial Heights, 2.33%, in Mecklenburg County, 1.53% and in Chesterfield County, 0.12%.
Supervision and Regulation of Banking Activities
General
The supervision and regulation of bank holding companies and their subsidiaries is intended primarily for the protection of depositors, the FDIC’s deposit insurance fund and the banking system as a whole, and not necessarily for the protection of shareholders or creditors of bank holding companies. Bank regulatory agencies have broad enforcement power over bank holding companies and banks, including the power to impose substantial fines, operational restrictions and other penalties for violations of laws and regulations. Management believes the Company is in compliance in all material respects with these laws and regulations. Changes in the laws, regulations or policies that impact the Company cannot necessarily be predicted, but they may have a material effect on the business and earnings of the Company.
The following summary briefly describes the more significant provisions of applicable federal and state laws and certain regulations and the potential impact of such provisions on the Company and the Bank. This summary is not complete, and we refer you to the particular statutory or regulatory provisions or proposals for more information.
The Dodd-Frank Act
On July 21, 2010, financial regulatory reform legislation entitled the “Dodd-Frank Wall Street Reform and Consumer Protection Act” (the “Dodd-Frank Act”) was signed into law. The Dodd-Frank Act implements far-reaching changes across the financial regulatory landscape, including the following:
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FDIC Assessments. The Dodd-Frank Act changes the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less its average tangible equity. In addition, it increases the minimum size of the Deposit Insurance Fund (“DIF”) and eliminates its ceiling, with the burden of the increase in the minimum size on institutions with more than $10 billion in assets.
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Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 limit for federal deposit insurance and provides unlimited federal deposit insurance until December 31, 2012 for non-interest-bearing demand transaction accounts at all insured depository institutions.
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Interest on Demand Deposits. The Dodd-Frank Act also provides that, effective one year after the date of enactment, depository institutions may pay interest on demand deposits, including business transaction and other accounts.
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Interchange Fees. The Dodd-Frank Act requires the Federal Reserve to set a cap on debit card interchange fees charged to retailers. While banks with less than $10 billion in assets, such as the Bank, are exempted from this measure, it is likely that, if this measure is implemented, all banks could be forced by market pressures to lower their interchange fees or face potential
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rejection of their cards by retailers. As a result, our debit card revenue could be adversely impacted if the interchange cap is implemented.
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Consumer Financial Protection Bureau. The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
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Mortgage Lending. New requirements are imposed on mortgage lending, including new minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various new mandated disclosures to mortgage borrowers.
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Holding Company Capital Levels. Bank regulators are required to establish minimum capital levels for holding companies that are at least as stringent as those currently applicable to banks. See a further discussion of this issue, below, under “Regulations affecting the Company” and “Capital Adequacy Requirements”.
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De Novo Interstate Branching. National and state banks are permitted to establish de novo interstate branches outside of their home state, and bank holding companies and banks must be well-capitalized and well managed in order to acquire banks located outside their home state.
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Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and increasing the amount of time for which collateral requirements regarding covered transactions must be maintained.
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Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.
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Corporate Governance. The Dodd-Frank Act includes corporate governance revisions that apply to all public companies, not just financial institutions, including with regard to executive compensation and proxy access to shareholders.
Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, and their impact on the Company or the financial industry is difficult to predict before such regulations are adopted. Provisions in the legislation that affect the payment of interest on demand deposits and interchange fees are likely to increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate. Some of the rules that have been proposed and, in some cases, adopted to comply with the Dodd-Frank Act’s mandates are discussed further below.
Securities and Exchange Commission
The Company must file annual, quarterly and other periodic reports with the Securities and Exchange Commission (the SEC).
The Company is affected by the corporate responsibility and accounting reform legislation signed into law on July 30, 2002, known as the Sarbanes-Oxley Act of 2002 (the SOA), and the related rules and regulations. The SOA includes provisions that, among other things: (1) require that periodic reports containing financial statements that are filed with the SEC be accompanied by chief executive officer and
chief financial officer certifications as to their accuracy and compliance with law; (2) prohibit public companies, with certain limited exceptions, from making personal loans to their directors or executive officers; (3) require chief executive officers and chief financial officers to forfeit bonuses and profits if company financial statements are restated due to misconduct; (4) require audit committees to pre-approve all audit and non-audit services provided by an issuer’s outside auditors, except for de minimis non-audit services; (5) protect employees of public companies who assist in investigations relating to violations of the federal securities laws from job discrimination, otherwise known as “whistleblower” policy and provisions; (6) require companies to disclose in plain English on a “rapid and current basis” material changes in their financial condition or operations, as well as certain other specified information; (7) require a public company’s Section 16 insiders to make Form 4 filings with the SEC within two business days following the day on which purchases or sales of the company’s equity securities were made; and (8) increased penalties for existing crimes and created new criminal offenses. The Company has incurred additional expenses and we expect to continue to incur additional expenses in complying with the requirements of the SOA and related regulations adopted by the SEC and the Public Company Accounting Oversight Board. We anticipate that those expenses will not have a material effect on the Company’s results of operations or financial condition.
On September 15, 2010, the SEC issued Release No. 33-9142, “Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers.” This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act. SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010. As a result, the Company is not required to have an independent auditor attestation of the Company’s internal controls over financial reporting, however management’s attestation is maintained and provided.
Regulations affecting the Company
Citizens Bancorp of Virginia, Inc. is incorporated under the laws of the Commonwealth of Virginia as a bank holding company, the Company is subject to the Bank Holding Company Act of 1956, as amended (the "BHC Act"), and is required to file annual reports and such additional information as may be required by the Federal Reserve Board (the "FRB") pursuant to the BHC Act. The FRB has the authority to examine the Company and the Bank. The BHC Act and other federal laws, of which some are discussed below, subject bank holding companies to restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.
Regulatory Restrictions on Dividends. It is the policy of the Federal Reserve Board that bank holding companies should pay cash dividends on common stock only out of income available over the past year, and only if prospective earnings retention is consistent with the holding company's expected future needs and financial condition. The policy provides that bank holding companies should not maintain a level of cash dividends that undermines the bank holding company's ability to serve as a source of strength to its banking subsidiary. Moreover, the Federal Reserve Board has stated that bank holding companies should inform the Federal Reserve Board reasonably in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid. Under Federal Reserve Board policy and the Dodd-Frank Act, a bank holding company is expected to act as a source of financial strength to its banking subsidiary and commit resources to its support.
The Company is currently considered to be “well capitalized” and does not expect that these laws, regulations or policies will materially affect its ability to pay dividends. Payment of dividends is at the discretion of the Company’s Board of Directors. The Company’s cash dividend policy limits cash dividend payments to 60% or less of the trailing 12-month net consolidated earnings. For the year ended December 31, 2010, the Company declared $1,606,028 in dividends payable to shareholders or 54.5% of trailing earnings.
Source of Strength Doctrine. The Federal Reserve Board policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Act codifies this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.
Capital Adequacy Requirements. The Federal Reserve Board has adopted a system using risk-based capital guidelines to evaluate the capital adequacy of bank holding companies. Under the guidelines, specific categories of assets are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a "risk-weighted" asset base. In addition to the risk-based capital guidelines, the Federal Reserve Board uses a leverage ratio as an additional tool to evaluate the capital adequacy of bank holding companies.
Federal Reserve Board guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. The Federal regulatory agencies may take various corrective actions against any undercapitalized bank holding company or bank, and any bank that fails to submit a capital restoration plan or fails to implement a plan accepted by the regulators. These powers include, but are not limited to, requiring the institution to be recapitalized, prohibiting asset growth, restricting interest rates paid, requiring prior approval of capital distributions by any bank holding company that controls the institution, requiring divestiture by the institution of its subsidiaries or by the holding company of the institution itself, requiring new election of directors, and requiring the dismissal of directors and officers. The Company and the Bank presently maintain sufficient capital to remain in compliance with these capital requirements. See Note 14 to the Consolidated Financial Statements, which is incorporated as part of this report.
The Dodd-Frank Act contains a number of provisions dealing with capital adequacy of insured depository institutions and their holding companies, which may result in more stringent capital requirements. Under the Collins Amendment to the Dodd-Frank Act, federal regulators have been directed to establish minimum leverage and risk-based capital requirements for, among other entities, banks and bank holding companies on a consolidated basis. These minimum requirements can’t be less than the generally applicable leverage and risk-based capital requirements established for insured depository institutions nor quantitatively lower than the leverage and risk-based capital requirements established for insured depository institutions that were in effect as of July 21, 2010. These requirements in effect create capital level floors for bank holding companies similar to those in place currently for insured depository institutions. The Collins Amendment also excludes trust preferred securities issued after May 19, 2010 from being included in Tier 1 capital unless the issuing company is a bank holding company with less than $500 million in total assets. Trust preferred securities issued prior to that date will continue to count as Tier 1 capital for bank holding companies with less than $15 billion in total assets, and such securities will be phased out of Tier 1 capital treatment for bank holding companies with over $15 billion in total assets over a three-year period beginning in 2013. The Company does not currently have any trust preferred securities issued or outstanding.
The Board of Directors of the Company approved a stock repurchase program for the common stock of the Company on July 18, 2007. Further information on the stock repurchase program is found in Part 2, Item 5 of this report.
Safe and Sound Banking Practices. Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The Federal Reserve Board's regulations, for example, generally require a holding company to give the Federal Reserve Board prior notice of any redemption or repurchase of its own equity securities, if the consideration to be paid, together with the consideration paid for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company's consolidated net worth. The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution.
for any repurchases or redemptions in the preceding year, is equal to 10% or more of the company's consolidated net worth. The Federal Reserve Board has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries which represent unsafe and unsound banking practices or which constitute violations of laws or regulations, and can assess civil money penalties for certain activities conducted on a knowing and reckless basis, if those activities caused a substantial loss to a depository institution.
The FDIC is authorized to prohibit any DIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the deposit insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC. It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance, if the institution has no tangible capital. If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC. Management is not aware of any existing circumstances that could result in termination of any of the Bank’s deposit insurance.
Acquisitions by Bank Holding Companies. The Bank Holding Company Act requires every bank holding company to obtain the prior approval of the Federal Reserve Board before it may acquire all or substantially all of the assets of any bank, or ownership or control of any voting shares of any bank, if after such acquisition it would own or control, directly or indirectly, more than 5% of the voting shares of such bank. In approving bank acquisitions by bank holding companies, the Federal Reserve Board is required to consider the financial and managerial resources and future prospects of the bank holding company and the banks concerned, the convenience and needs of the communities to be served, and various competitive factors.
Control Acquisitions. The Change in Bank Control Act prohibits a person or group of persons from acquiring "control" of a bank holding company unless the Federal Reserve Board has been notified and has not objected to the transaction. Under a rebuttable presumption established by the Federal Reserve Board, the acquisition of 10% or more of a class of voting stock of a bank holding company with a class of securities registered under Section 12 of the Exchange Act, would, under the circumstances set forth in the presumption, constitute acquisition of control of the Company. In addition, under the Bank Holding Company Act, any entity is required to obtain the approval of the Federal Reserve Board before acquiring 25% (5% in the case of an acquirer that is a bank holding company) or more of the Company's outstanding common stock, or otherwise obtaining control or a "controlling influence" over the Company.
Regulations affecting the Bank
Citizens Bank and Trust Company is incorporated under the laws of the Commonwealth of Virginia as a state-chartered commercial bank. The Bank is a wholly owned subsidiary of Citizens Bancorp of Virginia, Inc. and has been in continuous operation since August 23, 1873.
Insider Loans. Restrictions on loans to directors, executive officers, principal shareholders and their related interests ("insiders") contained in the Federal Reserve Act and Regulation O applies to the Bank and the Company. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution's total unimpaired capital and surplus, and the Federal Reserve may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.
Restrictions on Distribution of Subsidiary Bank Dividends and Assets. Dividends paid by the Bank have been the Company's primary source of funds utilized to pay shareholder cash dividends and are expected to be for the foreseeable future. Capital adequacy requirements serve to limit the amount of dividends that may be paid by the Bank. Under Federal law, the Bank cannot pay a dividend if, after paying the dividend, it will be "undercapitalized." The Federal Reserve may declare a dividend payment to be unsafe and unsound even though the Bank would continue to meet its capital requirements after the dividend. Because the Company is a legal entity separate and distinct from the Bank, the Company's right to participate in the distribution of assets of the Bank in the event of the Bank's liquidation or reorganization would be subject to the prior claims of the Bank's creditors. In the event of a liquidation or other resolution of an insured depository institution, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its shareholders, including any depository bank holding company (such as the Company) or any shareholder or creditor thereof.
Deposit Insurance. Substantially all of the deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating (“CAMELS rating”). The risk matrix utilizes four risk categories which are distinguished by capital levels and supervisory ratings.
In May 2009, the FDIC issued a final rule which levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution’s total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits. The special assessment was part of the FDIC’s efforts to rebuild the DIF. Deposit insurance expense during 2009 included $137.5 thousand related to the special assessment.
In November 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011 and 2012. The FDIC also adopted a uniform three-basis point increase in assessment rates effective on January 1, 2011; however, as further discussed below, the FDIC has elected to forgo this increase under a new DIF restoration plan adopted in October 2010. As of December 31, 2010, $1.032 million in pre-paid deposit insurance assessments is included in other assets in the accompanying consolidated balance sheet.
In October 2010, the FDIC adopted a new DIF restoration plan to ensure that the fund reserve ratio reaches 1.35% by September 30, 2020, as required by the Dodd-Frank Act. Under the new restoration plan, the FDIC will forego the uniform three-basis point increase in initial assessment rates scheduled to take place on January 1, 2011 and maintain the current schedule of assessment rates for all depository institutions. At least semi-annually, the FDIC will update its loss and income projections for the fund and, if needed, will increase or decrease assessment rates, following notice-and-comment rulemaking if required.
In November 2010, the FDIC issued a final rule to implement provisions of the Dodd-Frank Act that provide for temporary unlimited coverage for non-interest-bearing transaction accounts. The separate coverage for non-interest-bearing transaction accounts became effective on December 31, 2010 and terminates on December 31, 2012.
In November 2010, the FDIC issued a notice of proposed rulemaking to change the deposit insurance assessment base from total domestic deposits to average total assets minus average tangible equity, as required by the Dodd-Frank Act, effective April 1, 2011. The initial base assessment rate would range from 5 to 35 basis points on an annualized basis (basis points representing cents per $100 of assessable assets). After the effect of potential base-rate adjustments, the total base assessment rate could range from 2.5 to 45 basis points on an annualized basis. The potential adjustments to an institution’s initial base assessment rate include (i) a potential decrease of up to 5 basis points for certain long-term unsecured debt (“unsecured debt adjustment”) and (ii) a potential increase of up to 10 basis points for brokered deposits in excess of 10% of domestic deposits (“brokered deposit adjustment”). As
the DIF reserve ratio grows, the rate schedule will be adjusted downward. Additionally, the proposed rule includes a new adjustment for depository institution debt whereby an institution would pay an additional premium equal to 50 basis points on every dollar of long-term, unsecured debt held that was issued by another insured depository institution (excluding debt guaranteed under the TLGP). The final rule related to this proposal is expected to
be effective April 1, 2011. The Company cannot provide any assurance as to the effect of any proposed change in its deposit insurance premium
rate, should such a change occur, as such changes are dependent upon a variety of factors, some of which are beyond the Company’s control.
FDIC insurance expense totaled $506.7 thousand, $340.2 thousand, and $33.5 thousand in 2010, 2009 and 2008, respectively.
Examinations and Audits. The Federal Reserve Board and the Virginia State Corporation Commission’s Bureau of Financial Institutions periodically examine and evaluate the Bank. Based upon such examinations, the appropriate regulator may revalue the assets of the institution and require that it establish specific reserves to compensate for the difference between what the regulator determines the value to be and the carrying value of such assets.
Capital Adequacy Requirements. Refer to “Capital Adequacy Requirements” under “Regulations affecting the Company”, above.
Community Reinvestment Act. Under the Community Reinvestment Act and related regulations, depository institutions have an affirmative obligation to assist in meeting the credit needs of their market areas, including low and moderate-income areas, consistent with safe and sound banking practice. The Community Reinvestment Act requires the adoption by each institution of a Community Reinvestment Act statement for each of its market areas describing the depository institution’s efforts to assist in its community’s credit needs. Depository institutions are periodically examined for compliance with the Community Reinvestment Act and are periodically assigned ratings in this regard. Banking regulators consider a depository institution’s Community Reinvestment Act rating when reviewing applications to establish new branches, undertake new lines of business, and/or acquire part or all of another depository institution. An unsatisfactory rating can significantly delay or even prohibit regulatory approval of a proposed transaction by a bank holding company or its depository institution subsidiaries.
The Currency and Foreign Transactions Reporting Act. Also known as the Bank Secrecy Act (BSA), and its implementing regulation, 31 CFR 103, is a tool the U.S. government uses to fight drug trafficking, money laundering, and other crimes. Congress enacted the BSA to prevent banks and other financial service providers from being used as intermediaries for, or to hide the transfer or deposit of money derived from, criminal activity. The Federal Reserve Board monitors state member banks’ compliance with the BSA and 31 CFR 103.
Since its passage, Congress has amended the BSA a number of times to enhance law enforcement effectiveness. The Anti-Drug Abuse Act of 1986, which included the Money Laundering Control Act of 1986 (MLCA), strengthened the government's ability to fight money laundering by making it a criminal activity. The Money Laundering Suppression Act of 1994 (Title IV of the Riegle-Neal Community Development and Regulatory Improvement Act of 1994) required regulators to develop enhanced examination procedures and increase examiner training to improve the identification of money laundering schemes in financial institutions.
Today more than 170 crimes are listed in the federal money laundering statutes. They range from drug trafficking, gunrunning, murder for hire, fraud, acts of terrorism, and the illegal use of a wetland. The list also includes certain foreign crimes. A financial institution must educate its employees, understand its customers and their businesses, and have systems and procedures in place to distinguish routine transactions from ones that rise to the level of suspicious activity. The reporting and record keeping requirements of the BSA regulations create a paper trail for law enforcement to investigate money
laundering schemes and other illegal activities. This paper trail operates to deter illegal activity and provides a means to trace movements of money through the financial system.
USA PATRIOT Act of 2001. This regulation was enacted in response to the terrorist attacks, which occurred on September 11, 2001. The USA PATRIOT Act is intended to strengthen U.S. law enforcement's and the intelligence communities' abilities to work cohesively to combat terrorism on a variety of fronts. The impact of the PATRIOT Act on financial institutions of all kinds is significant and wide ranging. The PATRIOT Act contains sweeping anti-money laundering and financial transparency laws and requires various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators, and law enforcement entities in identifying parties that may be involved in terrorism or money laundering.
Financial Services Modernization Legislation. In November 1999, the Gramm-Leach-Bliley (GLB) Act of 1999 was enacted. The GLB Act repealed provisions of the Glass-Steagall Act which restricted the affiliation of Federal Reserve member banks with firms "engaged principally" in specified securities activities, and which restricted officer, director, or employee interlocks between a member bank and any company or person primarily engaged in specified securities activities. In addition, the GLB Act contained provisions that expressly preempt any state law restricting the establishment of financial affiliations, primarily related to insurance. The general effect of the law was to establish a comprehensive framework to permit affiliations among commercial banks, insurance companies, securities firms, and other financial service providers by revising and expanding the Bank Holding Company Act framework to permit a holding company to engage in a full range of financial activities through a new entity known as a financial holding company.
The GLB Act contains extensive customer privacy protection provisions. Under these provisions, a financial institution must provide to its customers, both at the inception of the customer relationship and on an annual basis, the institution’s policies and procedures regarding the handling of customers’ nonpublic personal financial information. The law provides that, except for specific limited exceptions, an institution may not provide such personal information to unaffiliated third parties unless the institution discloses to the customer that such information may be so provided and the customer is given the opportunity to opt out of such disclosure. An institution may not disclose to a non-affiliated third party, other than to a consumer reporting agency, customer account numbers or other similar account identifiers for marketing purposes. The GLB Act also provides that the states may adopt customer privacy protections that are stricter than those contained in the Act.
Fair and Accurate Credit Transactions Act ("FACT Act"). The FACT Act includes many provisions concerning national credit reporting standards, and permits consumers, including the customers of the Company, to opt out of information sharing among affiliated companies for marketing purposes. The FACT Act also requires financial institutions, including banks, to notify their customers if they report negative information about them to credit bureaus or if the credit that is granted to them is on less favorable terms than generally available. Banks also must comply with guidelines established by their federal banking regulators to help detect identity theft.
Check Clearing for the 21st Century Act ("Check 21 Act"). This Act became effective in October 2004. The Check 21 Act creates a new negotiable instrument, called a "substitute check," which banks are required to accept as the legal equivalent of a paper check if it meets the requirements of the Check 21 Act. The Check 21 Act is designed to facilitate check truncation, to foster innovation in the check payment systems and to improve the payment system by shortening processing times and reducing the volume of paper.
Consumer Laws and Regulations. In addition to the laws and regulations discussed herein, the Bank is also subject to certain consumer laws and regulations that are designed to protect consumers in transactions with banks. These laws and regulations include, but are not limited to, the Truth in Lending Act, the Truth in Savings Act, the Electronic Funds Transfer Act, the Expedited Funds Availability Act, the Equal Credit Opportunity Act, the Fair Housing Act, the Home Mortgage Disclosure Act, the Real Estate
Settlement Procedures Act, Federal Financial Privacy Laws, Interagency Guidelines Establishing Information Security Standards, and the Right to Financial Privacy Act. These laws and regulations regulate the manner in which financial institutions must deal with customers when taking deposits or making loans to such customers.
Future Regulatory Uncertainty
Federal regulation of financial institutions changes regularly and is the subject of constant legislative debate the Company cannot forecast how Federal regulation of financial institutions may change in the future and the potential impact to its operations. As a result of the global economic recession, Congress and the Administration have enacted and are considering enacting laws that incorporate significant regulatory changes upon the financial services industry. The Company fully expects that the financial institution industry will remain heavily regulated in the foreseeable future and those additional laws or regulations may be adopted further regulating specific banking practices.
Employees
As of December 31, 2010, the Company and the Bank employed 111 full-time equivalent employees. The Company’s success is highly dependent on its ability to attract and retain qualified employees. Competition in the industry is intense for qualified employees; however, the Company believes it has been successful in recruiting qualified employees and believes relations with its employees are excellent. None of the Company’s employees are represented by collective bargaining agreements.
Executive Officers of the Registrant
The names, ages as of December 31, 2010, recent business experience and positions or offices held by each of the executive officers of the Company and the Bank are as follows:
Name and Position Held
Age
Recent Business Experience
Joseph D. Borgerding
President, Chief Executive Officer and
Director
Officer of the Bank since 2003. Elected as President, Chief Executive Officer and Director of the Company and the Bank September 2005 to present.
Ronald E. Baron
Senior Vice President, Chief Financial Officer
Senior Vice President and Chief Financial Officer of the Company and the Bank from May 2005 to present.
Lynn K. Shekleton
Senior Vice President, Secretary
Officer of the Bank since 1994. Senior Vice President and Secretary of the Company from May 2006 to present. Senior Vice President, Branch Administration and Human Resources of the Bank from May 2006 to present.
Availability of Information
The Company electronically files quarterly (Form 10-Q) and annual (Form 10-K) reports and proxy statements with the Securities and Exchange Commission (SEC) on a regular basis. Other reports are filed when necessary in accordance with the Securities Exchange Act of 1934.
The public may read and print any materials the Company files with the SEC at the SEC’s web site at http://www.sec.gov. In addition, any document filed by the Company with the SEC can be read and copied at the SEC’s public reference facilities at 100 F Street, N.E., Room 1580, Washington, D.C. 20549. Copies of documents can be obtained at prescribed rates by writing to the Public Reference Section of the SEC at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330.
ITEM 1A.
ITEM 1A.
RISK FACTORS
An investment in our common stock involves risks and you should not invest in our common stock unless you understand these risk factors and how it could impact the value of your investment. The risks and uncertainties described below are not the only ones facing the Company. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial may also impair the Company’s business operations. This report is qualified in its entirety by these risk factors. You should read this section together with the other information, including our consolidated financial statements and related notes to the consolidated financial statements.
If any of the following risks actually occur, the Company’s financial condition and results of operations could be materially and adversely affected. If this were to happen, the market price of the Company’s common stock could decline significantly, and you could lose all or part of your investment.
Risks Related to the Company’s Business
The Corporation’s Business May Be Adversely Affected by Economic Conditions Generally
The Company's operations are principally located in the counties of Amelia, Nottoway, Prince Edward, Chesterfield, the City of Colonial Heights, the Town of South Hill and adjoining counties. Given the geographic concentration of its operations, the Company's results depend largely upon the general economic conditions in this market. Changes in the suburban and rural markets we serve may influence the growth rate of our loans and deposits, the quality of the loan portfolio and the loan and deposit pricing that we may obtain. Significant decline in general economic conditions caused by inflation, recession, unemployment or other factors beyond our control would impact these local economic conditions and the demand for banking products and services generally, which could negatively affect our financial condition and performance.
A continuation of the recent economic turbulence could impact the Company’s performance, both directly by affecting our revenues and the value of our assets and liabilities, and indirectly by affecting our counterparties and the economy generally. Dramatic declines in the housing market in the past year have resulted in significant write-downs of asset values by financial institutions. The Company’s average level of nonperforming and delinquent loans remained at higher-than-historical levels during 2010. Concerns about the stability of the financial markets generally have reduced the availability of funding to certain financial institutions, leading to a tightening of credit, reduction of business activity and increased market volatility. The extreme levels of volatility and limited credit availability currently being experienced could continue to affect the U.S. banking industry and the broader U.S. and global economies, which would have an effect on all financial institutions, including the Company.
The Company Operates In A Highly Competitive Industry
The Company and the Bank face vigorous competition from other banks and other financial institutions, including savings and loan associations, savings banks, finance companies and credit unions for deposits, loans, and other financial services in our market area. Many of these banks and other financial institutions are significantly larger than we are and have greater access to capital and other resources, as well as larger lending limits and branch systems, and offer a wider array of banking services. To a limited extent, we also compete with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies, insurance companies and governmental organizations which may offer more favorable financing than we are able to offer. Many of our non-bank competitors have advantages over us in providing certain services. This competition may reduce or limit our margins and our market share and may adversely affect our results of operations and financial condition.
The Company Is Subject To Lending Risk
There are inherent risks associated with the Company’s lending activities. These risks include, among other things, the impact of changes in interest rates and changes in the economic conditions in the markets where the Company operates as well as those across the Commonwealth of Virginia and the United States. Increases in interest rates and/or weakening economic conditions could adversely impact the ability of borrowers to repay outstanding loans or the value of the collateral securing these loans. The Company is also subject to various laws and regulations that affect its lending activities. Failure to comply with applicable laws and regulations could subject the Company to regulatory enforcement action that could result in the assessment of significant civil money penalties against the Company.
As of December 31, 2010, approximately 39.4% of the Company’s loan portfolio consisted of commercial and industrial, construction and commercial real estate mortgage loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans. These types of loans are also typically carrying larger balances than residential real estate loans and consumer loans. The deterioration of one or a few of these loans could cause a significant increase in non-performing loans. An increase in non-performing loans could result in a net loss of earnings from these loans, an increase in the provision for possible loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations. See the section captioned “Asset Quality” in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” located elsewhere in this report for further discussion related to the asset quality of loans.
The Company Is Subject To Interest Rate Risk
The Company's earnings depend largely on the relationship between the yield on earning assets, primarily loans and investments, and the cost of funds, primarily deposits and borrowings. This relationship, known as the interest rate spread, is subject to fluctuation and is affected by economic and competitive factors which influence interest rates, the volume and mix of interest-earning assets and interest-bearing liabilities, and the level of non-performing assets. The Company is subject to interest rate risk to the degree that its interest-bearing liabilities reprice or mature more slowly or more rapidly or on a different basis than its interest-earning assets. Community banks are often at a competitive disadvantage in managing their cost of funds compared to the large regional, super-regional or national banks that have access to the national and international capital markets. These factors influence our ability to maintain a stable net interest margin. We seek to maintain a neutral position in terms of the volume of assets and liabilities that mature or re-price during any period so that we may reasonably predict our net interest margin; however, interest rate fluctuations, loan prepayments, loan production and deposit flows are constantly changing and influence our ability to maintain this neutral position and affect the demand of customers for the Company's products and services. Significant fluctuations in interest rates could have a material adverse effect on the Company's business, financial condition, results of operations or liquidity. For additional information regarding interest rate risk, see Part II, Item 7A, "Quantitative and Qualitative Disclosures About Market Risk" locate elsewhere in this report.
The Company’s Allowance for Loan Losses May Be Insufficient
The allowance for loan losses is determined by analyzing historical loan losses, current trends in delinquencies and charge-offs, plans for problem loan resolution, the opinions of our regulators, changes in the size and composition of the loan portfolio and industry information. Also included in our estimates for loan losses are considerations with respect to the impact of economic events, the outcome of which are uncertain. Because any estimate of loan losses is necessarily subjective and the accuracy of any estimate depends on the outcome of future events, we face the risk that charge-offs in future periods will exceed our allowance for loan losses and that additional increases in the allowance for loan losses will be required. Additions to the allowance for loan losses would result in a decrease of our net income. Although we believe our allowance for loan losses is adequate to absorb probable losses in our loan portfolio, we cannot predict such losses or that our allowance will be adequate in the future. For a
complete discussion on asset quality and the allowance for loan losses, see Part II, Item 7, “Critical Accounting Policies - Allowance for Loan Losses” and "Asset Quality" later in this report.
The Company Is Subject to Extensive Government Regulation and Supervision
The Company and the banking industry are subject to extensive regulation and supervision under federal and state laws and regulations. The restrictions imposed by such laws and regulations limit the manner in which the Company conducts its business, undertakes new investments and activities, and obtains financing. These regulations are designed primarily for the protection of the deposit insurance funds and consumers and not to benefit the Company's shareholders. The burden imposed by these federal and state regulations may place banks in general, and specifically Citizens Bancorp of Virginia, Inc. and Citizens Bank & Trust Company, at a competitive disadvantage compared to less regulated competitors. Financial institution regulation has been the subject of significant legislation in recent years and may be the subject of further significant legislation in the future. The Dodd-Frank Act, enacted in July 2010, instituted major changes to the banking and financial institutions regulatory regimes in light of the recent performance of and government intervention in the financial services sector. Significant new laws or changes in, or repeals of, existing laws could have a material adverse effect on the Company's business, financial condition, results of operations, or liquidity. Further, Federal monetary policy, particularly as implemented through the Federal Reserve System, significantly affects credit conditions for the Company and any unfavorable change in these conditions could have a material adverse effect on the Company's business, financial condition, results of operations or liquidity. See the sections captioned “Supervision and Regulation of Banking Activities” included in Item 1, “Business” and Note 14, “Regulatory Matters” in the notes to consolidated financial statements included in Item 8. Financial Statements and Supplementary Data, which are located elsewhere in this report.
The Recent Repeal of Federal Prohibitions on Payment of Interest on Demand Deposits Could Increase the Company’s Interest Expense
All federal prohibitions on the ability of financial institutions to pay interest on demand deposit accounts were repealed as part of the Dodd-Frank Act. As a result, beginning on July 21, 2011, financial institutions could commence offering interest on demand deposits to compete for clients. The Company does not yet know what interest rates other institutions may offer. The Company’s interest expense will increase and its net interest margin will decrease if it begins offering interest on demand deposits to attract additional customers or maintain current customers, which could have a material adverse effect on the Company’s business, financial condition and results of operations.
The Company’s Controls and Procedures May Fail or Be Circumvented
Management regularly reviews and updates the Company’s internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of the Company’s controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on the Company’s business, results of operations and financial condition.
The Company Relies On Dividends From Its Subsidiaries For Most Of Its Revenue
Citizens Bancorp of Virginia, Inc., is a separate and distinct legal entity from its subsidiary. It receives substantially all of its revenue from dividends from the Bank. These dividends are the principal source of funds to pay dividends on the Company’s common stock. Various federal and/or state laws and regulations limit the amount of dividends that the Bank may pay to its parent. Also, the Company’s right to participate in a distribution of assets upon the Bank’s liquidation or reorganization is subject to the prior claims of the Bank’s creditors. In the event the Bank is unable to pay dividends to the Company, Citizens Bancorp of Virginia, Inc. may not be able to pay dividends on the Company’s common stock. The inability
to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations. See the section captioned “Supervision and Regulation of Banking Activities” in Item 1, “Business” and Note 14 “Regulatory Matters” in the notes to consolidated financial statements included in Item 8, “Financial Statements and Supplementary Data”, which are located elsewhere in this report.
The Company Is Subject To Liquidity Risk
Liquidity risk is the risk that the Company will have insufficient cash or access to cash to satisfy current and future financial obligations, including demands for loans and deposit withdrawals, funding operating costs, and for other corporate purposes. Liquidity risk arises whenever the maturities of financial instruments included in assets and liabilities differ. The Company is subject to liquidity risk, which it mitigates by establishing and accessing lines of credit with various financial institutions and accessing the brokered CD markets. Results of operations could be affected if the Company were unable to satisfy current or future financial obligations. See Part II, Item 7, "Liquidity" found later in this Report.
The Company May Not Be Able To Attract and Retain Skilled People
The Company and the Bank represent a customer-focused, relationship-driven, and community-oriented financial services organization. The Company expects our future growth to be driven in a large part by the relationships maintained with our customers by Joseph D. Borgerding, President and Chief Executive Officer, the rest of our executive management team, and our lending officers. Neither the Company nor the Bank has employment agreements with Mr. Borgerding, executive management or our lending officers. The unexpected loss of Mr. Borgerding or other key employees could have a material adverse effect on our business and possibly result in reduced revenues and earnings. The Bank has invested in bank-owned life insurance that covers Mr. Borgerding and certain other members of executive management and the lending officers.
Our business strategy will require us to continue to attract, hire, motivate and retain skilled personnel to develop new customer relationships as well as new financial products and services. Many experienced banking professionals employed by our competitors are covered by agreements not to compete or solicit their existing customers if they were to leave their current employment. These agreements make the recruitment of these professionals more difficult. Meanwhile, the market for these people is competitive, and we cannot assure you that we will be successful in attracting or hiring skilled personnel or be successful in retaining existing personnel.
The Company’s Information Systems May Experience An Interruption Or Breach In Security
The Company depends upon data processing, software, communication, and information exchange on a variety of computing platforms and networks, including the Internet. Despite instituted safeguards, the Company cannot be certain that all of its systems are entirely free from vulnerability to attack or other technological difficulties or failures. The Company relies on the services of a variety of vendors to meet its data processing and communication needs. If information security is breached or other technology difficulties or failures occur, information may be lost or misappropriated, services and operations may be interrupted, and the Company could be exposed to claims from customers. Any of these results could have a material adverse effect on the Company's business, financial condition, results of operations or liquidity.
The Company Continually Encounters Technological Change
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. The Company’s future success depends, in part, upon its ability to address the needs of its customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional
efficiencies in the Company’s operations. Many of the Company’s competitors have substantially greater resources to invest in technological improvements. The Company may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to its customers. Failure to successfully keep pace with technological change affecting the financial services industry could have a material adverse impact on the Company’s business and, in turn, the Company’s financial condition and results of operations.
The Company’s Operations Rely on Certain External Vendors
The Company is reliant upon certain external vendors to provide products and services necessary to maintain day-to-day operations of the Company. Accordingly, the Company’s operations are exposed to risk that these vendors will not perform in accordance with the contracted arrangements under service level agreements. The Company maintains a system of comprehensive policies and a control framework designed to monitor vendor risks including, among other things, (i) changes in the vendor’s organizational structure, (ii) changes in the vendor’s financial condition, (iii) changes in the vendor’s support for existing products and services and (iv) changes in the vendor’s strategic focus. While the Company believes these policies and procedures help to mitigate risk, the failure of an external vendor to perform in accordance with the contracted arrangements under service level agreements could be disruptive to the Company’s operations, which could have a material adverse impact on the Company’s business and, in turn, the Company’s financial condition and results of operations.
Risks Associated With The Company’s Common Stock
Citizens Bancorp of Virginia, Inc. May Reduce or Eliminate Dividends on its Common Stock in the Future
Holders of the Company’s common stock are only entitled to receive such dividends as its board of directors may declare out of funds legally available for such payments. Although the Company has historically declared cash dividends on its common stock, it is not required to do so and may reduce or eliminate its common stock dividend in the future. This could adversely affect the market price of the Company’s common stock. Also, Citizens Bancorp of Virginia, Inc. is a bank holding company, and its ability to declare and pay dividends is dependent on certain federal regulatory considerations, including the guidelines of the Federal Reserve regarding capital adequacy and dividends.
ITEM 1B.
ITEM 1B.
UNRESOLVED STAFF COMMENTS
The Company has no unresolved comments from the SEC staff.
ITEM 2.
ITEM 2.
PROPERTIES
The corporate headquarters of Citizens Bancorp of Virginia, Inc, and the main office of the Bank are located at 126 South Main Street, Blackstone, Virginia. The location consists of a full service banking office as well as administrative, operational and electronic data processing offices. Additional banking offices are located within Nottoway County at 101 North Main Street, Blackstone, Virginia; 1575 South Main Street, Blackstone, Virginia; 210 Carter Street, Crewe, Virginia; and 102 Second Street, Northeast, Burkeville, Virginia. In Amelia County, the banking office is located at 9060 North Five Forks Road. Banking offices in Prince Edward County are located at 1517 West Third Street (Route 460 West), Farmville, 712 South Main Street, Farmville and a remote ATM location at 200 North Main Street, Farmville, Virginia. The Chesterfield County banking office is located at 10001 Courtview Commons Lane, Chesterfield, Virginia. In the City of Colonial Heights the banking office is located at 946 Southpark Boulevard. In Mecklenburg County the banking office is located at 622 East Atlantic Street, South Hill, Virginia. All real estate and improvements at these locations are owned by the Bank except for the real estate at the Chesterfield branch, which is under a lease agreement for five years renewable for five additional terms of five years each. The current lease term is scheduled to end April 30, 2014.
All of the Company’s properties are in good operating condition and are adequate for the Company’s present and anticipated future needs.
ITEM 3.
ITEM 3.
LEGAL PROCEEDINGS
There are no material pending legal proceedings to which the Company is a party or of which the property of the Company is subject.
ITEM 4.
ITEM 4.
RESERVED
(Remainder of this page is left blank, intentionally.)
PART II
ITEM 5.
ITEM 5.
MARKET FOR THE REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Performance and Dividends
The Company’s common stock is not listed on a national securities exchange, nor is it actively traded; only 3.8% of the average number of outstanding shares traded during 2010. Due to the extremely limited number of transactions, the average sale price of the Company’s common stock may not be indicative of its actual value.
Shares of the Company’s common stock trade through the OTC BULLETIN BOARD® (OTCBB) under the stock symbol “CZBT.” The OTCBB is a regulated quotation service that displays real-time quotes, last sale prices, and volume information in over-the-counter (OTC) equity securities. The OTCBB is a quotation medium for subscribing members, not an issuer listing service, and should not be confused with the NASDAQ Stock MarketSM. Investors must contact a broker/dealer to trade OTCBB securities. Investors do not have direct access to the OTCBB service. The Securities and Exchange Commission’s order-handling rules, which apply to NASDAQ-listed securities, do not apply to OTCBB securities.
As of March 15, 2011, the Company had approximately 769 shareholders of record. As of that date, the closing price of the common stock was $13.75. The chart below illustrates the high and low bid prices of common stock as reported on the OTCBB and the dividends declared during the last two years.
Market Price and Dividends
Dividend Policy
The Company historically has paid cash dividends on a quarterly basis. The final determination of the timing, amount and payment of dividends on the Common Stock is at the discretion of the Company’s Board of Directors and will depend upon the earnings of the Company and the Bank, the financial condition of the Company and other factors, including general economic conditions and applicable governmental regulations and policies as discussed in Item 1., “Business - Supervision and Regulation,” above, the section captioned “Capital” included in Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Note 14 - Regulatory Matters” contained in the notes to consolidated financial statements filed as part of this report, after Item 15.
The Company is organized under the Virginia Stock Corporation Act, which prohibits the payment of a dividend if, after giving it effect, the corporation would not be able to pay its debts as they become due in the usual course of business or if the corporation’s total assets would be less than the sum of its total liabilities plus the amount that would be needed, if the corporation were to be dissolved, to satisfy the preferential rights upon dissolution of any preferred shareholders.
The Company is a legal entity separate and distinct from its subsidiary. Its ability to distribute cash dividends will depend primarily on the ability of the Bank to pay dividends to it, and the Bank is subject to laws and regulations that limit the amount of dividends that it can pay. As a state member
bank, the Bank is subject to certain restrictions imposed by the reserve and capital requirements of federal and Virginia banking statutes and regulations. Under Virginia law, a bank may not declare a dividend in excess of its undivided profits. Additionally, the Bank may not declare a dividend if the total amount of all dividends, including the proposed dividend, declared by it in any calendar year exceeds the total of its retained net income of that year to date, combined with its retained net income of the two preceding years, unless the dividend is approved by the Federal Reserve. In addition, the Company is subject to certain regulatory capital requirements to maintain capital at or above regulatory minimums. These regulatory capital requirements affect its dividend policies.
Stock Repurchases
The Board of Directors of the Company approved the establishment of the current Stock Repurchase Plan July 18, 2007. The Stock Repurchase Plan is structured under the Securities and Exchange Commission’s Rule 10b5-1. The Plan went into effect on September 1, 2007, and is renewable every six months, at the recommendation of management and approval by the Board of Directors. The Company has an agreement with Scott & Stringfellow, Inc. to act as the Company’s agent in facilitating the repurchase of the Company’s common stock. The Plan calls for the repurchase of up to 40,000 shares of stock for each six month term. The Board of Directors reviews the results of the Plan, monthly. The Plan has been continuously reapproved since its inception.
The table below represents the record of when shares of common stock were repurchased during the most recent fiscal quarter.
Repurchase Plan Table
The six-month terms for the Stock Repurchase Plan do not coincide with calendar quarters. A new term for the Plan began on December 1, 2010, which brought the maximum number of shares yet to be purchased under the Plan back to 40,000 shares as of December 1, 2010.
ITEM 6.
ITEM 6.
SELECTED FINANCIAL DATA
Not applicable.
ITEM 7.
ITEM 7.
MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATION
General
Management’s discussion and analysis is intended to assist the reader in evaluating and understanding the consolidated results of operations and financial condition of the Company and should be read in conjunction with the Company’s Consolidated Financial Statements and Notes to Consolidated Financial Statements. The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of the Company.
Forward Looking Statements
The Company makes forward looking statements in this annual report that are subject to risks and uncertainties. These forward looking statements include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy, and financial and other goals. The words “believes,” “expects,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends,” or other similar words or terms are intended to identify forward looking statements.
These forward looking statements are subject to significant uncertainties because they are based upon or are affected by factors including:
·
Local, regional, and national economic conditions and the impact they may have on the Company and its customers and the Company’s assessment of that impact;
·
Government intervention in the U.S. financial system;
·
Level of market interest rates;
·
The successful management of interest rate risk; including changes in interest rates and interest rate policies;
·
The effect of changes in laws and regulations (including laws and regulations concerning taxes, banking, and securities) with which the Company and the Bank must comply;
·
Risks inherent in making loans such as repayment risks and fluctuating collateral values;
·
The value of securities held in the Company’s investment portfolio;
·
The ability to successfully manage growth or to implement growth strategies if the Company is unable to identify attractive markets, locations or opportunities to expand in the future;
·
Reliance on an experienced management team, including ability to attract and retain key personnel;
·
Competition with other banks, financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
·
Demand, development and acceptance of new products and services;
·
Changes in consumer spending, borrowings and savings habits;
·
Changes in the Company’s liquidity position;
·
The ability to rely on third party vendors that perform critical services for the Company;
·
Technology utilized by the Company;
·
Maintaining expense controls and asset qualities as new branches are opened or acquired;
·
Maintaining capital levels adequate to support growth;
·
The effect of changes in accounting policies and practices, as may be adopted by the regulatory agencies, as well as the Public Company Accounting Oversight Board, the Financial Accounting Standards Board and other accounting standard setters;
·
Changes in the Company’s organization, compensation and benefit plan;
·
The Company’s success at managing the risks involved in the foregoing items.
Because of these uncertainties, actual future results may be materially different from the results indicated by these forward looking statements. In addition, past results of operations do not necessarily indicate future results.
Application of Critical Accounting Polices and Accounting Estimates
The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States and to general practices within the financial services industry. The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s financial statements.
Accounting policies related to the allowance for possible loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. The allowance for possible loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for possible loan loss methodology includes allowance allocations calculated in accordance with Accounting Standards Codification (ASC) Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio, as well as trends in the foregoing. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. See the section captioned “Allowance and Provision for Possible Loan Losses” elsewhere in this discussion and Note 4 - Allowance for Loan Losses in the notes to consolidated financial statements which follows Item 15, later in this report, for further details of the risk factors considered by management in estimating the necessary level of the allowance for possible loan losses.
Executive Overview
The Company conducts the general business of a commercial bank, offering traditional lending and deposit products to businesses and individuals. Revenue is generated primarily from interest income received on loans, investments combined with fee income and other miscellaneous revenue sources. This income is primarily offset by interest paid on deposits and borrowed funds, provision for loan losses and other noninterest expenses such as salaries and employee benefits, occupancy expense and other miscellaneous expenses.
The Company reported net income of $2,948,000 in 2010, an increase of 4.1% or $116,000 from 2009 net income of $2,832,000. Net income on a basic and diluted per share basis was reported as $1.25 and $1.19 in 2009 and 2008, respectively. Core earnings of the Company in 2010 were strong despite the overall level of interest rates, higher than normal loan loss provision, and higher deposit insurance expenses. The loan loss provision decreased by $150,000 from the amount recorded for 2009, and the Company paid $166,000 in additional FDIC deposit insurance costs as compared to 2009.
As part of this report and its discussion of the results of operations, management refers to “taxable-equivalent adjustments”. Taxable-equivalent adjustments are the result of increasing income from tax-free investments by an amount equal to the taxes that would be paid if the income were fully taxable based on a 34% federal tax rate, thus making tax-exempt yields comparable to taxable asset yields. Refer to the reconciliation of taxable-equivalent income to US GAAP income in the footnote to the Average Balance Sheet and Income Data, found later in this report.
Results of Operations
The table below lists the Company’s quarterly performance for the years ended December 31, 2010 and 2009.
Summary of Financial Results by Quarter
Summary
Total assets increased $9.5 million during 2010 from $321 million in 2009 to $330.5 million, or a 2.9% increase. The growth in deposit account balances enabled the growth in total assets. Net loans decreased $14.4 million during 2010 from $214.9 million in 2009 to $200.5 million, or a 6.7% decrease and this was a reflection of the weak economy and lowered demand for business and consumer loans. Investment securities available for sale increased $15.9 million to $82.7 million at December 31, 2010 from $66.8 million at December 31, 2009. The investment portfolio increase was a response to the liquidity provided by higher deposit account balances and anemic loan demand. Average earning assets for 2010 were $302.9 million, an increase of $15.1 million or 5.2% as compared to the annual average for 2009 of $287.8 million. Year-over-year average balances by earning asset category, included: loan balances decreasing $4.9 million, securities balances increasing $28.8 million and Federal funds sold decreasing $8.7 million over the prior year.
Total deposits were $278.0 million at December 31, 2010, an increase of $9.2 million or 3.4% compared to $268.8 million at the end of 2009. On average, deposit account balances were $275.2 million for 2010 as compared to $255.8 million for 2009; an increase of $19.4 million or 7.6%. The deposit
category that saw the highest average balance increase over 2009 was savings deposits, up $21.3 million; with $20.4 million of the increase coming in money market accounts. Interest-bearing checking account balances averaged $39.3 million for 2010 as compared to $36.1 million for 2009. Average balances for time deposits were $133.2 million at December 31, 2010, a decrease of $4.7 million from $137.9 million at December 31, 2009.
Other borrowings consisted of term advances from the Federal Home Loan Bank of Atlanta and overnight commercial repurchase agreements known as the Investment Sweeps product, which are non-deposit accounts, not insured by FDIC, collateralized by the Bank with US Government or Federal Agency securities sufficient to cover average account balances. During 2010 the Investment Sweeps product balances averaged $5.3 million; or an increase of $200 thousand over the average balance for 2009 of $5.1 million. The advance from the Federal Home Loan Bank of Atlanta remained unchanged at $5.0 million for the periods ended December 31, 2010 and December 31, 2009.
Stockholders' equity balance at December 31, 2010 was $39.638 million, an increase of $648 thousand from the year earlier ending balance of $38.990 million. Retained earnings, net of dividends and repurchased common stock grew $1.130 million from December 31, 2009 to December 31, 2010. The decrease in accumulated other comprehensive loss of $474 thousand from December 31, 2009 to December 31, 2010 was attributed to an increase of $222 thousand in the unfunded pension liability and a decrease of $253 thousand in the mark-to-market value of the investment securities portfolio. Book value per common share at December 31, 2010 was $16.84, an increase of 2.4% or $.40 from the book value per share of $16.44 at December 31, 2009. The stock closed at $13.10 on December 31, 2010 or 78% of book value as compared to a December 31, 2009 closing stock price of $12.75 or 78% of book value.
The Company’s return on average assets (ROAA) for 2010 was 0.90% compared to 0.91% in 2009 while the return on average equity (ROAE) was 7.29% for 2010 compared to 7.49% in 2009. The Company’s 2010 earnings reflected the effects of the economic recession that was responsible for anemic economic activity leading to business failures, high unemployment, consumers and businesses postponing purchases in favor of paying off outstanding loans and historically-low levels of interest rates. These incidences resulted in an overall decline in loan balances, any new loans came on at lower rates and adjustable-rate loans, scheduled to reprice, repriced at lower rates. The liquidity from the overall decline in loans was generally invested in securities at significantly lower yields. On the deposit side, volume was strong in lower cost deposit accounts as compared to the previous year; however the interest margin benefited most from the 38 basis-point decline in certificate of deposit account rates. The ROAE for the Company has historically been lower than peer financial institutions due to the higher amount of capital held by the Bank and the Company.
The provision for loan losses amounted to $750 thousand for 2010, a decrease of $150 thousand as compared to the $900 thousand provision for 2009. Adversely classified loans totaled $11.9 million as of December 31, 2010, which is $1.0 million lower than the $12.9 million at December 31, 2009. The allowance-to-total-loans ratio decreased from 1.23% at December 31, 2009 to 1.07% at December 31, 2010, primarily as a result of criticized loans being charged off during the year and the reduced amount of criticized loans at December 31, 2010. Management believes that the allowance was appropriate to cover any foreseeable loan losses as of December 31, 2010.
Non-interest income and non-interest expense for 2010 continue to be impacted by several factors which can be attributed back to the economic recession. Non-interest income totaled $2.341 million or $149.0 thousand less than the $2.490 million reported for 2009. Deposit customers managed their accounts more closely to avoid overdraft or services charges, when possible, and some moved to the Bank’s “free checking” product. This resulted in a decline in deposit account service charges of $205 thousand to $1.036 million for 2010 as compared to $1.241 million for 2009. In addition, the Bank recorded an impairment charge of $76 thousand on other real estate owned properties as property values continued to decline in 2010. Areas where non-interest income increased in 2010 from the prior year included net gains from securities calls which increased $11 thousand, the cash surrender value of bank-owned life insurance increased to $291.9 thousand in 2010 or $10.2 thousand more than in 2009, and ATM fee income increased $97.6 thousand when compared to 2009. Non-interest expense totaled $9.525 million for 2010, which is an increase of $556 thousand, or 6.20%, from the $8.969 recorded for 2009.
Higher costs were seen in a few areas including: other expenses, up $297 thousand in 2010 over 2009, FDIC deposit insurance expense, up $166.5 thousand, and compensation-related costs increased $105 thousand over the previous year.
The effective income tax rate for the Company decreased for 2010 to 24.59% as compared to 26.43% for 2009 due to an increase in tax exempt ninterest income.
The following table summarizes the net changes in the income statement as discussed above:
Net Interest Income
Net interest income, the amount by which interest income on interest earning assets exceeds interest expense on interest bearing liabilities, is the most significant component of the Company’s earnings. Net interest income is the function of several factors consisting of changes in the volume and composition (mix) of interest earning assets, funding sources, and market interest rates. While management’s policies influence these factors, external forces such as customer needs and demands, competition and economic and monetary policies of the Federal Reserve Board are also contributing forces.
The Federal Reserve Board influences the general market rates of interest, including the deposit and loan rates offered by many financial institutions. The Company’s loan portfolio is significantly affected by changes in the prime interest rate. The prime interest rate, which is the rate offered on loans to borrowers with strong credit, began 2008 at 7.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 3.25%. During 2009 and 2010, the prime interest rate remained at 3.25%. The intended federal funds rate, which is the cost of immediately available overnight funds, fluctuated in a similar manner to the prime interest rate. It began 2008 at 4.25% and decreased 200 basis points in the first quarter, 25 basis points in the second quarter and 175 basis points in the fourth quarter to end the year at 0.25%. During 2009 and 2010, the intended federal funds rate remained at zero to 0.25%.
The Company’s balance sheet has historically been asset sensitive, meaning that earning assets generally reprice more quickly than interest-bearing liabilities. Therefore, the Company’s net interest margin was likely to increase in sustained periods of rising interest rates and decrease in sustained periods of declining interest rates. In an effort to mitigate the effects of declining interest rates, the Bank began in 2008 to implement interest rate floors on newly originated commercial loans, home equity lines of credit and adjustable rate residential mortgages. An “interest rate floor” is part of the contractual terms of a loan note when the loan’s interest rate is subject to change during the life of the loan on either a variable or adjustable basis and the interest rate is pegged to a certain market index; such as the prime
rate or LIBOR. The terms of an interest rate floor state a specific minimum interest rate that will be charged even if the base index results in a lower interest rate.
The Company is primarily funded by interest-bearing liabilities consisting of deposit account products and other borrowings. Other borrowings include the overnight investment product offered to commercial customers which is known as the Investment Sweeps product and advances from the Federal Home Loan Bank of Atlanta. Other borrowings represented 4.1% of total average interest bearing liabilities for 2010. The majority of interest-bearing deposit account balances are in time deposits. During 2010, time deposits averaged 55.2% of total interest-bearing deposit account balances and low-cost deposit account balances for savings, interest checking and money-market accounts averaged 44.8% of total interest-bearing deposit account balance in 2010. The lower-cost funding base is expected to have a positive impact on the Company’s net interest income and net interest margin in a rising interest rate environment. As stated previously in the section captioned “Supervision and Regulation of Banking Activities” included in Item 1, Business, elsewhere in this report, the Dodd-Frank Act repealed the federal prohibitions on the payment of interest on demand deposits, thereby permitting depository institutions to pay interest on business transaction and other accounts beginning July 21, 2011. Although the ultimate impact of this legislation on the Company has not yet been determined, the Company expects interest costs associated with demand deposits to increase. Additional analysis of the components of the Company’s net interest margin is presented below.
Rate and Volume Analysis(1)
The following table depicts the changes in interest income and interest expense caused by variations in the volume and mix of these assets and liabilities, as well as changes in interest rates when compared to the previous period. Interest income on securities is shown in this table on a tax-equivalent basis. This rate/volume table is intended to be used in conjunction with the Average Balance Sheet Data, shown on the following page.
Notes:
(1) Changes caused by the combination of rate and volume are allocated based on the percentage caused by each.
(2) Income is reported on a tax-equivalent basis, assuming a federal income tax rate of 34%.
Net Interest Income Analysis
Net interest income, on a tax equivalent basis, increased $744 thousand in 2010 as compared to 2009 and increased $589 thousand in 2009 as compared to 2008. The net interest margin, which is net income expressed as a percentage of earning assets, was 4.05% for 2010, 4.00% for 2009 and 4.10% for 2008. The decline of the net interest margin in 2009 from 2008, when net interest income in 2009 was actually higher than in 2008, was the result of significant growth in average earning assets in 2009 of 7.85%, the majority of the asset growth went into lower yielding securities and overnight funds sold.
The greatest contribution to the improvement of net interest income in 2010 and in 2009 was the significant decrease in interest expense for time deposit accounts in each of the prior years. Interest costs on time deposits declined from $4.391 million or 3.18% for 2009 to $3.728 million or 2.80% in 2010; a decrease of $663 thousand or 17.8%. In 2009, the interest expense for time deposits dropped by $1.158 million to $4.391 million from 2008 when the cost was $5.549 million.
The average earning assets yield for 2010 was 5.54% as compared to 5.80% for 2009; a decrease of 26 basis points for 2010 when compared to 2009 and the yield decreased 59 basis points in 2009 from a yield of 6.39% for 2008. The decrease in earning assets yields over the last 3 years is a direct result of declining interest rates discussed earlier in this section and the decrease of loans as a percentage of total earning assets. In 2008, loans accounted for 80% of average earning assets, this decreased to 75.3% in 2009 and to 69.9% in 2010. Loans generally have significantly higher yields compared to securities and Federal funds sold, as such, have a more positive effect on the net interest margin. Average earning assets for the three- year period were $302.9 million during 2010, $287.8 million during 2009; an increase of $15.1 million or 5.25% from 2009 which was an increase of $20.9 million from 2008 when average earning assets were $266.9 million.
Loans averaged $211.7 million in 2010 this was a decrease of $4.9 million from the $216.6 million in average loans for 2009. During 2009, average loan balances were $3.3 million greater than the average loan balances of $213.3 million in 2008. The average loan yield was 6.40% in 2010 compared to 6.49% in 2009 and 6.82% in 2008. The decline in 2010 of loan interest income of $510 thousand or 9 basis points was attributable to new loans being originated at lower market rates and existing loans repricing to lower rates and a higher level of non-accrual loans for 2010. The $484 thousand decline in loan interest income in 2009 from 2008 was chiefly the result of a rapidly decreasing interest rate environment and the effect of one less day’s interest in 2009 since 2008 was a leap year with 366 days.
Securities averaged 27.0% of earning assets in 2010 or a 45.9% increase as compared to the 18.5% average share in 2009 and 17.5% of average earning assets for 2008. The increase in securities as a percentage of earning assets was the direct result of a combined growth of total assets and ebb and flow of loan demand over the 3-year period. The decline of market interest rates from 2008 to 2010 is evident by the decline of the yield on securities from 5.05% in 2008 to 4.55% in 2009 and to 3.90% for 2010. The average duration of the securities portfolio is generally from 3 to 5 years, which helps to sustain the liquidity position of the balance sheet. This level of duration will react more quickly to changes in interest rates, either up or down. The securities portfolio is structured in a manner that will provide funding for loan demand in the future.
Federal funds sold and other interest bearing account balances comprise the smallest portion of earning assets and it is intended to serve immediate liquidity needs of the Company. During 2010, the average balance was $9.3 million or 3.1% of total earning assets as compared to $18.1 million or 6.2% of earning assets for 2009 and $6.8 million or 2.5% of earning assets for 2008. The yield for 2010 was 0.44% as compared to 1.16% for 2009 and 2.03% for 2008. The decline in yield from 2009 to 2010 was attributable not only to the decline in overnight rates, but also to the fact that CDs the Bank held during 2009 had matured at the end of that year.
Total average interest-bearing liabilities increased $14.3 million to $251.5 million during 2010 as compared to $237.2 million for 2009, which was an increase of $20.1 million over the average interest- bearing liabilities of $217.1 million for 2008. The yield on average interest-bearing liabilities was 1.80% or
38 basis points less than the yield of 2.18% for 2009, which is 64 basis points less than the 2.82% yield for 2008. Total interest expense for 2010 was $4.527 million or $642 thousand less than the $5.169 million reported for 2009 and a decrease of $945 thousand from the interest expense of $6.114 million for 2008. Average deposits increased $19.4 million or 7.6% for 2010 compared to 2009 and $15.2 million or 6.3% in 2009 as compared to 2008. Average interest-bearing deposits increased $19.8 million in 2010 as compared to 2009 and $16.2 million in 2009 as compared to 2008. Average interest-bearing deposits as a percentage of average deposits were 87.6% and compared to 86.6% for 2009 and 85.3% as a percentage for 2008. The average cost of interest-bearing deposits was 1.81% in 2010 compared to 2.23% in 2009 and 2.87% in 2008. The decrease in the average cost of interest-bearing deposits during the comparable periods was primarily the result of the decrease in interest rates offered on time deposit accounts due to decreases in average market interest rates and decreases in renewal interest rates on maturing time deposits given the current low interest rate environment.
The Company’s net interest spread, which represents the difference between the average rate earned on earning assets and the average rate paid on interest-bearing liabilities, was 3.74% in 2010 compared to 3.62% in 2009 and 3.57% in 2008. The net interest spread, as well as the net interest margin, will be impacted by future changes in short-term and long-term interest rate levels, as well as the impact from the competitive environment. A discussion of the effects of changing interest rates on net interest income is set forth in Item 7A.
ITEM 7A.
QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The disclosures set forth in this item are qualified by Item 1A. Risk Factors and the section captioned “Forward-Looking Statements” included in Item 7 - Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this report.
Market risk refers to the risk of loss arising from adverse changes in interest rates, foreign currency exchange rates, commodity prices, and other relevant market rates and prices, such as equity prices. The risk of loss can be assessed from the perspective of adverse changes in fair values, cash flows, and future earnings. Due to the nature of its operations, the Company is primarily exposed to interest rate risk (IRR) and, to a lesser extent, liquidity risk.
Interest rate risk on the Company’s balance sheets consists of reprice, option, and basis risks. Reprice risk results from differences in the maturity, or repricing, of asset and liability portfolios. Option risk arises from “embedded options” present in many financial instruments such as loan prepayment options, deposit early withdrawal options and interest rate options. These options allow customers opportunities to benefit when market interest rates change, which typically results in higher costs or lower revenue for the Company. Basis risk refers to the potential for changes in the underlying relationship between market rates and indices, which subsequently result in a narrowing of the profit spread on an earning asset or liability. Basis risk is also present in administered rate liabilities, such as savings accounts, negotiable order of withdrawal accounts, and money market accounts where historical pricing relationships to market rates may change due to the level or directional change in market interest rates.
The Company seeks to avoid fluctuations in its net interest margin and to maximize net interest income within acceptable levels of risk through periods of changing interest rates. Accordingly, the Company’s interest rate sensitivity and liquidity are monitored on an ongoing basis by its Asset and Liability Committee (ALCO), which oversees market risk management and establishes risk measures, limits and policy guidelines for managing the amount of interest rate risk and its effect on net interest income and capital. The Company uses a simulation model on a quarterly basis to measure IRR. This model utilizes the Company’s financial data and various management assumptions and projections as they relate to growth, interest rates, noninterest income and noninterest expenses in order to forecast the interest sensitivity of the Company and its potential impact on net interest income, earnings and equity. The model projects a “most likely” forecast which is then “shocked” with various interest rate increases and decreases in order to project the short term effects on net interest income and net income. The model also projects the effects on the economic value of equity (EVE) of the Company using the same interest rate increases and decreases. The EVE sensitivity measure is a measure of the long-term risk of the Bank. Other interest rate-related risks such as prepayment, basis and option risk are also considered.
ALCO continuously monitors and manages the balance between interest rate-sensitive assets and liabilities. The objective is to manage the impact of fluctuating market rates on net interest income within acceptable levels. In order to meet this objective, management may lengthen or shorten the duration of assets or liabilities. The "gap analysis" is the difference between the amounts of such assets and liabilities that are subject to such repricing. An "asset sensitive" gap for a given period means that the amount of interest-earning assets maturing or otherwise repricing within that period exceeds the amount of interest-bearing liabilities maturing or otherwise repricing during that same period. In a rising interest rate environment, an institution with an asset sensitive gap would generally be expected, absent the effects of other factors, to experience a greater increase in the yield of its assets relative to the cost of its liabilities. Conversely, the cost of funds for an institution with an asset sensitive gap would generally be expected to decline less quickly than the yield on its assets in a falling interest rate environment. Changes in interest rates generally have the opposite effect on an institution with a "liability sensitive" gap.
The Company’s balance sheet has historically been asset sensitive. At December 31, 2010, the Company’s asset/liability model analysis indicated that the Company remains asset sensitive for 2011 and 2012, on a cumulative gap basis. The static gap analysis table, shown below, indicates that the Company is asset sensitive for the first 90 days of 2011 and becomes liability sensitive for the remainder of 2011 when $76.7 million in interest-bearing liabilities will mature or reprice as compared to $54.9 million of interest earning assets that will mature or reprice over the same period. The majority of the effect from interest-bearing liabilities will be from time deposits or CDs. It is expected that the maturity of CDs and
their renewal at current rates should have a positive effect on net interest income by decreasing interest expense.
The ALCO adopted an interest rate forecast that called for interest rates to remain at generally the same level they were at December 2010 for all of 2011, through the third quarter of 2012. It is expected that at the start of the fourth quarter of 2012 interest rates, especially short-term rates will rise by approximately 25 basis points. Therefore, being asset sensitive in a steady or slightly rising rate environment would have a positive impact on net interest income. Interest rate consensus forecasts are updated quarterly by ALCO.
Since the earnings model uses numerous assumptions regarding the effect of changes in interest rates, on the timing and extent of re-pricing characteristics, future cash flows and customer behavior, the model cannot precisely estimate net interest income and the effect on net income from sudden changes in interest rates. Actual results will differ from simulated results due to the timing, magnitude and frequency of interest rate changes and changes in market conditions and management strategies, among other factors. The model simulation results presented below are based upon the instantaneous increase or decrease (shock) of current interest rates at December 31, 2010. This method meets regulatory requirements. The Company’s management does recognize that rate shocks represent the most severe of interest rate change scenarios. The model utilizes current market interest rates to measure against the Company’s portfolio rates for earning assets, deposits and other interest sensitive liabilities in order to compute the economic value of equity.
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The following static gap table illustrates the Company’s interest rate sensitivity between interest earnings assets and interest-bearing liabilities over time:
ITEM 8.
ITEM 8.
FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
The following financial statements are filed as a part of this report following Item 15 below:
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets as of December 31, 2010 and 2009
Consolidated Statements of Income for the Years Ended December 31, 2010, 2009 and 2008
Consolidated Statements of Changes in Stockholders’ Equity for the Years Ended December 31, 2010, 2009 and 2008
Consolidated Statements of Cash Flows for the Years Ended December 31, 2010, 2009 and 2008
Notes to Consolidated Financial Statements
ITEM 9.
ITEM 9.
CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
The Company does not have any changes or disagreements with respect to accounting or financial disclosure with its external accountants.
ITEM 9A.
ITEM 9A.
CONTROLS AND PROCEDURES
As of December 31, 2010, the Company carried out an evaluation, under the supervision and with the participation of the Chief Executive Officer and the Chief Financial Officer, of the design and operation of the disclosure controls and procedures. Based on this evaluation, the Chief Executive Officer and the Chief Financial Officer concluded that the disclosure controls and procedures are effective.
Management’s Report on Internal Control over Financial Reporting
Management is responsible for establishing and maintaining adequate internal control over financial reporting for the Company.
Internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records which accurately and fairly reflect, in reasonable detail, the transactions of the Company; (2) provide reasonable assurance that transactions are recorded as necessary to permit the preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the Company are made in accordance with authorizations of management and directors of the Company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the Company’s assets that could have a material effect on the financial statements.
Any system of internal control, no matter how well designed, will have inherent limitations, such as the possibility of unintentional human error or intentional circumvention of overriding control. Therefore, any system of internal control can provide only a reasonable assurance as to the effectiveness of the internal control over financial reporting. Further, because of changes in conditions, internal control effectiveness may vary over time.
The Company’s management conducted an evaluation of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2010. This assessment was based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that the Company’s internal control over financial reporting was effective as of December 31, 2010. There were no changes in internal controls during the fourth quarter of 2010 that materially affected, or are reasonably likely to materially affect, internal controls over financial reporting.
Effective September 21, 2010, the Securities and Exchange Commission enacted a final rule voted to permanently exempt non-accelerated filers from the requirement in Section 404(b) of the
Sarbanes-Oxley Act of 2002 to obtain an external audit on the effectiveness of internal controls over financial reporting. The Company is considered a non-accelerated filer and is therefore exempt.
ITEM 9B.
ITEM 9B.
OTHER INFORMATION
None to report.
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PART III
ITEM 10.
ITEM 10.
DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.
ITEM 11.
ITEM 11.
EXECUTIVE COMPENSATION
Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.
ITEM 12.
ITEM 12.
SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.
ITEM 13.
ITEM 13.
CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPEDENCE
Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.
ITEM 14.
ITEM 14.
PRINCIPAL ACCOUNTING FEES AND SERVICES
Pursuant to General Instruction G(3) of Form 10-K, the information required by this Item is incorporated by reference to the Company’s definitive Proxy Statement for the 2011 Annual Meeting of Shareholders to be filed within 120 days of the end of the fiscal year.
PART IV
ITEM 15.
ITEM 15.
EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a)
(1) and (2). The response to this portion of Item 15 is submitted as a separate section of this report.
(a)
(3) Exhibits.
Exhibit No. Description
3.1
Restated Articles of Incorporation of the Company (restated in electronic format only through June 10, 2004) (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-K, filed April 1, 2005).
3.2
Amended and Restated Bylaws of the Company, (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K, filed June 30, 2009).
10.1
Form of Management Continuity Agreement, amended and restated as of December 31, 2008, entered into by the Company and each of Joseph D. Borgerding, Ronald E. Baron, Lynn K. Shekleton, and Rhonda W. Kincer (incorporated by reference to Exhibit 10.4 to the Company’s Form 10-K, filed March 31, 2009).
10.2
Form of Management Continuity Agreement, amended and restated as of March 26, 2009, entered into by the Company and each of Joseph D. Borgerding, Ronald E. Baron, Lynn K. Shekleton, and Rhonda W. Kincer (incorporated by reference to Exhibit 10.5 to the Company’s Form 10-K, filed March 31, 2009).
21.1
Subsidiary of the Company (filed herewith).
31.1
Certification of Principal Executive Officer Pursuant to Rule 13a-14(a) (filed herewith).
31.2
Certification of Principal Financial Officer Pursuant to Rule 13a-14(a) (filed herewith).
32.1
Statement of Principal Executive Officer Pursuant to 18 U.S.C. § 1350 (filed herewith).
32.2
Statement of Principal Executive Officer Pursuant to 18 U.S.C. § 1350 (filed herewith).
(b) Exhibits - - See Item 15(a)(3) above.
(c) Financial Statement Schedules - - See Item 15(a)(2) above.
Blackstone, Virginia
CONSOLIDATED FINANCIAL REPORT
DECEMBER 31, 2010
C O N T E N T S
Page
REPORT OF INDEPENDENT REGISTERED
PUBLIC ACCOUNTING FIRM
CONSOLIDATED FINANCIAL STATEMENTS
Consolidated balance sheets
Consolidated statements of income
Consolidated statements of changes in stockholders’ equity
Consolidated statements of cash flows
Notes to consolidated financial statements
Certified Public Accountants
and Consultants
To the Shareholders and Board of Directors
Citizens Bancorp of Virginia, Inc.
Blackstone, VA
REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We have audited the accompanying consolidated balance sheets of Citizens Bancorp of Virginia, Inc. and Subsidiary (the “Company”) as of December 31, 2010 and 2009, and the related consolidated statements of income, changes in stockholders’ equity, and cash flows for the years then ended. These 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 financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform an audit of its internal control over financial reporting. Our audit included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, 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 Citizens Bancorp of Virginia, Inc. and Subsidiary as of December 31, 2010 and 2009, and the results of its operations and its cash flows for the years then ended in conformity with U.S. generally accepted accounting principles.
Winchester, Virginia
March 31, 2011
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies
Business
Citizens Bancorp of Virginia, Inc. (the Company) is a one-bank holding company and is the sole shareholder of its only subsidiary, Citizens Bank and Trust Company (the Bank). The Bank conducts the general business of a commercial bank. The Company is chartered under the laws of the Commonwealth of Virginia and is a member of the Federal Reserve System. The Bank’s primary trade areas are in the Virginia counties of Nottoway, Amelia, Prince Edward, Brunswick, Buckingham, Charlotte, Chesterfield, Cumberland, Dinwiddie, Lunenburg, Mecklenburg, the cities of Colonial Heights and Petersburg and the town of South Hill. The Bank offers traditional lending and deposit products to businesses and individuals.
Basis of Presentation
The consolidated financial statements include the accounts of Citizens Bancorp of Virginia, Inc. and its wholly-owned subsidiary, Citizens Bank and Trust Company. All significant intercompany balances and transactions have been eliminated in consolidation. The Consolidated Financial Statements have been prepared in conformity with U.S. Generally Accepted Accounting Principles and conform to predominant practices within the financial services industry.
In preparing financial statements in conformity with accounting principles generally accepted in the United States of America, management is required to make estimates and assumptions that affect the reported amounts of assets and liabilities as of the date of the balance sheet and the reported amounts of revenues and expenses during the reported period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, securities with other than temporary impairment, deferred income taxes, other real estate owned, and fair value measurements.
Amounts in prior years’ Consolidated Financial Statements are reclassified whenever necessary to conform to the current year’s presentation.
Management has evaluated the impact of subsequent events on these financial statements through the date these financial statements were available to be issued.
Cash and Due from Banks, Interest-bearing Deposits in Banks, and Federal Funds Sold
Cash and due from banks include cash and balances due from correspondent banks which are deposited in both non-interest bearing and interest-bearing accounts and federal funds sold. With the exception of certain FDIC-insured time deposits, all balances are readily available for use by the Company and its subsidiary.
The Company maintains deposits with correspondent banks in amounts that exceed federal deposit insurance coverage. Furthermore, federal funds sold are essentially uncollateralized loans to other financial institutions. Management regularly evaluates the credit risk associated with the counterparties to these transactions and believes that the Company is not exposed to any significant credit risks on cash and cash equivalents.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
The Company was required to have $139,000 and $146,000 of cash on hand or on deposit with the Federal Reserve Bank to meet regulatory reserve and clearing requirements at December 31, 2010 and 2009. These deposits with the Federal Reserve Bank do not earn interest.
Securities
The Company classifies all investment securities as available for sale as of December 31, 2010 and 2009. Securities classified as available for sale are recorded at fair value, with unrealized gains and losses excluded from earnings and reported in other comprehensive income, net of taxes. Other-than-temporary-impairment, deemed to be credit-related, is charged to earnings as realized losses.
Impairment of securities occurs when the fair value of a security is less than its amortized cost. For debt securities, impairment is considered other-than-temporary and recognized in its entirety in net income if either (1) the Company intends to sell the security or (2) it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis. If, however the Company does not intend to sell the security and it is not more-than-likely that the Company will be required to sell the security before recovery, management must determine what portion of the impairment is attributable to a credit loss, which occurs when the amortized cost of the security exceeds the present value of the cash flows expected to be collected from the security. If there is no credit loss, there is no other-than-temporary impairment. If there is a credit loss, other-than-temporary impairment exists, and the credit loss must be recognized in net income and the remaining portion of impairment must be recognized in other comprehensive income.
Management evaluates securities for other-than-temporary impairment at least on a quarterly basis. Consideration is given to: (1) the length of time and the extent to which the fair value has been less than cost; (2) the financial condition and near-term prospects of the issuer; (3) the ability of the issuer to make principal and interest payments, and (4) changes in the regulatory, economic, or technological environment of the issuer. A decline in fair value of any security below cost that is deemed other than temporary and related to the credit-worthiness of the issuer is charged to earnings, resulting in the establishment of a new cost basis for the security.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
Restricted Securities
The Company is required to maintain an investment in the capital stock of the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta. No ready market exists for this stock, and it has no quoted market value. The Company’s investment in these stocks is recorded at cost.
Loans
The recorded investment in loans represents the principal amount outstanding net of deferred origination costs. The deferred origination costs together with loan origination fees are recognized as an adjustment of the related loan yield using the interest method. Interest on loans is credited to operations based on the principal amount outstanding. Management has the intent and ability to hold the loans for the foreseeable future or until maturity or pay-off.
A loan’s past due status is based on the contractual due date of the most delinquent payment due. Loans are generally placed on nonaccrual status when the collection of principal or interest is 90 days or more past due, or earlier, if collection is uncertain based on an evaluation of the net realizable value
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
of the collateral and the financial strength of the borrower. Loans greater than 90 days past due may remain on accrual status if management determines it has adequate collateral to cover the principal and interest. For those loans that are carried on nonaccrual status, payments are first applied to principal outstanding. A loan may be returned to accrual status if the borrower has demonstrated a sustained period of repayment performance in accordance with the contractual terms of the loan and there is reasonable assurance the borrower will continue to make payments as agreed. These policies are applied consistently across our loan portfolio.
Loans are considered impaired when, based on current information and events, it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans and homogeneous loans: residential mortgage loans, home equity loans, and all consumer loans, unless such loans were restructured in a troubled debt restructuring. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
Troubled Debt Restructurings (TDRs)
Troubled Debt Restructurings occur when the Company agrees to significantly modify the original terms of a loan due to the deterioration in the financial condition of the borrower. TDRs are considered impaired loans. Upon designation as a TDR, the Company evaluates the borrower’s payment history, past due status and ability to make payments based on the revised terms of the loan. If a loan was accruing prior to being modified as a TDR and if the Company concludes that the borrower is able to make such payments, and there are no other factors or circumstances that would cause it to conclude otherwise, the loan will remain on an accruing status. If a loan was on nonaccrual status at the time of the TDR, the loan will remain on nonaccrual status following the modification and may be returned to accrual status based on the policy for returning loans to accrual status. As of December 31, 2010, the Company had $1.7 million in loans which had been modified as TDRs and the Company did not report any TDRs at December 31, 2009.
Loans Held for Sale
Loans originated and intended for sale in the secondary market are carried at the lower of aggregate cost or fair value. Mortgage loans held for sale are sold with the mortgage servicing rights released by the Company.
The Company enters into commitments to originate certain mortgage loans whereby the interest rate on the loans is determined prior to funding (rate lock commitments). Rate lock commitments on mortgage loans that are intended to be sold are considered to be derivatives. The period of time between issuance of a loan commitment, loan closing and the sale of the loan generally ranges from thirty to ninety days. The Company protects itself from changes in interest rates through the use of best efforts forward delivery commitments, whereby the Company commits to sell a loan at the time the borrower commits to an interest rate with the intent that the buyer has assumed interest rate risk on the loan. As a result, the Company is not exposed to losses nor will it realize significant gains related to its rate lock commitments due to changes in interest rates. The correlation between the rate lock commitments and the best efforts contracts is very high due to their similarity. Because of this high correlation, no gain or loss occurs on the rate lock commitments.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
Allowance for Loan Losses
The allowance for loan losses is a valuation reserve for probable and inherent losses in the loan portfolio. Credit losses arise primarily from the loan portfolio, but may also be derived from other credit-related sources, when drawn upon, such as commitments and standby letters of credit. Additions are made to the allowance through periodic provisions, which are charged to expense.
All losses of principal are charged against the allowance when incurred or when it is determined that the loan principal will either be entirely or partially uncollectable as a result of either cash payments and/or the liquidation of the loan's collateral. This methodology applies to all loan segments that are secured by collateral property. For commercial unsecured loans, the financial strength of the loan guarantors will be evaluated to determine what portion of the outstanding loan balance can be repaid. Any unrecoverable amount is charged-oft. Unsecured consumer loans are charged-off after 60 days of non-payment. Subsequent recoveries, if any, are credited to the allowance.
The Company has established a process to assess the adequacy of the allowance for loan losses and to identify the risks in the loan portfolio. The allowance for possible loan losses includes allowance allocations calculated in accordance with Accounting Standards Codification (“ASC”) Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” This process consists of the identification of specific reserves for identified problem commercial loans. The specific component relates to loans that are classified as either doubtful or substandard. For such loans that are also classified as impaired, 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 calculation of the general reserve involves several steps and covers non-classified loans and special mention loans. A historical loss factor is applied to each loan classification. The historical loss factor is referred to as the Historical Net Charge-off Ratio (HNCR). The HNCR is calculated by using an average of the net charge-offs, by loan segment, for a rolling 36-month period and also includes any specific reserves that are assigned to any individual, impaired loans as though these amounts were charged-off. An unallocated component is maintained to cover uncertainties that could affect management’s estimate of probable losses. The unallocated component of the allowance reflects subjective elements (economic conditions, portfolio growth rate, portfolio management, credit policy, and others). This methodology is applied to the commercial, residential mortgage, and consumer portfolios and represents the margin of imprecision inherent in the underlying assumptions used in the methodologies for estimating specific and general losses in the portfolio.
While management uses the best information available to make its evaluation, future adjustments to the allowance may be necessary if there are significant changes in economic conditions. In addition, regulatory agencies, as an integral part of their examination process, periodically review the Company’s allowance for loan losses and may require the Company to make additions to the allowance based on their judgment about information available to them at the time of their examinations. Additional information regarding the Company’s policies and methodology used to estimate the allowance for possible loan losses is presented in Note 4 - Allowance for Loan Losses.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
Premises and Equipment
Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization expense is computed by the straight-line method over the estimated useful lives of the assets. Estimated useful lives of the assets range from 3 to 39 years. Leasehold improvements are generally depreciated over the lesser of the lease term or the estimated useful lives of the improvements. Major improvements are capitalized while maintenance and repairs are charged to expense as incurred.
Other Real Estate Owned
Real estate acquired through, or in lieu of, foreclosure is held for sale and is initially recorded at the lower of carrying value or fair value less cost to sell at the date of foreclosure. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell. Adjustments to carrying value, revenue and expenses related to holding foreclosed assets are recorded in earnings as they occur.
Income Taxes
Deferred income tax assets and liabilities are determined using the balance sheet method. Under this method, the net deferred tax asset or liability is determined based on the tax effects of the temporary differences between the book and tax bases of the various balance sheet assets and liabilities and gives current recognition to changes in tax rates and laws. Realization of deferred tax assets is dependent upon the generation of a sufficient level of future taxable income and recoverable taxes paid in prior years. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized.
When tax returns are filed, it is highly certain that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax benefits in the accompanying balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
The Company files a consolidated Federal income tax return with the Bank. Federal income tax expense or benefit has been allocated to each on a separate return basis. The Commonwealth of Virginia has a Bank Franchise Tax in lieu of a state income tax. The Bank files a Bank Franchise Tax and the expense is recorded as non-interest expense.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
Defined Benefit Pension Plan
The Company provides a noncontributory pension plan covering substantially all of the Company’s employees who are eligible based on age and length of service. The Company funds pension costs in accordance with the funding provisions of the Employee Retirement Income Security Act.
Comprehensive Income
Besides net income, other components of the Company’s comprehensive income include the after tax effect of changes in the net unrealized gain/loss on securities available for sale and changes in the net actuarial gain/loss on defined benefit pension plan. Accumulated other comprehensive income is reported in the accompanying consolidated statements of changes in shareholders’ equity.
Transfer of Assets
Transfers of loans are accounted for as sales when control over the loans has been surrendered. Control over transferred loans is deemed to be surrendered when (1) the loans have been isolated from the Company, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred loans and (3) the Company does not maintain effective control over the transferred loans through an agreement to repurchase them before their maturity.
Advertising
Advertising costs are expensed as incurred.
Earnings Per Share
Earnings per share are calculated based on the weighted-average number of common shares and common stock equivalents outstanding. The Company has no dilutive or potentially dilutive common stock equivalents. For the years ending December 31, 2010, 2009 and 2008, the weighted-average common shares outstanding were 2,363,947, 2,380,366, and 2,412,954 respectively.
Fair Value Measurements
ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and requires certain disclosures about fair value measurements. See Note 15 - Fair Value Measurements. In general, fair values of financial instruments are based upon quoted market prices, where available. If such quoted market prices are not available, fair value is based upon internally developed models that primarily use, as inputs, observable market-based parameters. Any such valuation adjustments are applied consistently over time.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
Recent Accounting Pronouncements
In June 2009, the Financial Accounting Standards Board (FASB) issued new guidance relating to the accounting for transfers of financial assets. The new guidance, which was issued as SFAS No. 166, “Accounting for Transfers of Financial Assets, an amendment to SFAS No. 140,” was adopted into the Accounting Standards Codification (Codification) in December 2009 through the issuance of Accounting Standards Update (ASU) 2009-16. The new standard provides guidance to improve the relevance, representational faithfulness, and comparability of the information that an entity provides in its financial statements about a transfer of financial assets; the effects of a transfer on its financial position, financial performance, and cash flows; and a transferor’s continuing involvement, if any, in transferred financial assets. ASU 2009-16 was effective for transfers on or after January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In June 2009, the FASB issued new guidance relating to variable interest entities. The new guidance, which was issued as SFAS No. 167, “Amendments to FASB Interpretation No. 46(R),” was adopted into the Codification in December 2009. The objective of the guidance is to improve financial reporting by enterprises involved with variable interest entities and to provide more relevant and reliable information to users of financial statements. SFAS No. 167 was effective as of January 1, 2010. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements as the Company does not have any variable interest entities or conduits.
In October 2009, the FASB issued ASU 2009-15, “Accounting for Own-Share Lending Arrangements in Contemplation of Convertible Debt Issuance or Other Financing.” ASU 2009-15 amends Subtopic 470-20 to expand accounting and reporting guidance for own-share lending arrangements issued in contemplation of convertible debt issuance. ASU 2009-15 is effective for fiscal years beginning on or after December 15, 2009 and interim periods within those fiscal years for arrangements outstanding as of the beginning of those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU 2010-04, “Accounting for Various Topics - Technical Corrections to SEC Paragraphs”. ASU 2010-04 makes technical corrections to existing Securities and Exchange Commission (SEC) guidance including the following topics: accounting for subsequent investments, termination of an interest rate swap, issuance of financial statements - subsequent events, use of residential method to value acquired assets other than goodwill, adjustments in assets and liabilities for holding gains and losses, and selections of discount rate used for measuring defined benefit obligation. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In January 2010, the FASB issued ASU 2010-06, “Fair Value Measurements and Disclosures (Topic 820): Improving Disclosures about Fair Value Measurements.” ASU 2010-06 amends Subtopic 820-10 to clarify existing disclosures, require new disclosures, and includes conforming amendments to guidance on employers’ disclosures about postretirement benefit plan assets. ASU 2010-06 is effective for interim and annual periods beginning after December 15, 2009, except for disclosures about purchases, sales, issuances, and settlements in the roll forward of activity in Level 3 fair value measurements. Those disclosures are effective for fiscal years beginning after December 15, 2010 and for interim periods within those fiscal years. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
In February 2010, the FASB issued ASU 2010-09, “Subsequent Events (Topic 855): Amendments to Certain Recognition and Disclosure Requirements.” ASU 2010-09 addresses both the interaction of the requirements of Topic 855 with the SEC’s reporting requirements and the intended breadth of the reissuance disclosures provisions related to subsequent events. An entity that is an SEC filer is not required to disclose the date through which subsequent events have been evaluated. ASU 2010-09 was effective immediately. The adoption of the new guidance did not have a material impact on the Company’s consolidated financial statements.
In July 2010, the FASB issued ASU 2010-20, “Disclosures about the Credit Quality of Financing Receivables and the Allowance for Credit Losses.” The new disclosure guidance significantly expands the existing requirements and will lead to greater transparency into a company’s exposure to credit losses from lending arrangements. The extensive new disclosures of information as of the end of a reporting period will become effective for both interim and annual reporting periods ending on or after December 15, 2010. Specific disclosures regarding activity that occurred before the issuance of the ASU, such as the allowance roll forward and modification disclosures, will be required for periods beginning on or after December 15, 2010. The Company has included the required disclosures in its consolidated financial statements.
On September 15, 2010, the SEC issued Release No. 33-9142, “Internal Control Over Financial Reporting In Exchange Act Periodic Reports of Non-Accelerated Filers.” This release issued a final rule adopting amendments to its rules and forms to conform them to Section 404(c) of the Sarbanes-Oxley Act of 2002 (SOX), as added by Section 989G of the Dodd-Frank Wall Street Reform and Consumer Protection Act. SOX Section 404(c) provides that Section 404(b) shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer as defined in Rule 12b-2 under the Securities Exchange Act of 1934. Release No. 33-9142 was effective September 21, 2010.
On September 17, 2010, the SEC issued Release No. 33-9144, “Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in Management’s Discussion and Analysis.” This interpretive release is intended to improve discussion of liquidity and capital resources in Management’s Discussion and Analysis of Financial Condition and Results of Operations in order to facilitate understanding by investors of the liquidity and funding risks facing the registrant. This release was issued in conjunction with a proposed rule, “Short-Term Borrowings Disclosures,” that would require public companies to disclose additional information to investors about their short-term borrowing arrangements. Release No. 33-9144 was effective on September 28, 2010.
Accounting Standards Not Yet Effective
In January 2011, the FASB issued ASU 2011-01, “Deferral of the Effective Date of Disclosures about Troubled Debt Restructurings in Update No. 2010-20.” The amendments in this ASU temporarily delay the effective date of the disclosures about troubled debt restructurings in ASU 2010-20 for public entities. The delay is intended to allow the FASB time to complete its deliberations on what constitutes a troubled debt restructuring. The effective date of the new disclosures about troubled debt restructurings for public entities and the guidance for determining what constitutes a troubled debt restructuring will then be coordinated. Currently, that guidance is anticipated to be effective for interim and annual periods ending after June 15, 2011.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 1. Summary of Significant Accounting Policies (continued)
In December 2010, the FASB issued ASU 2010-29, “Disclosure of Supplementary Pro Forma Information for Business Combinations.” The guidance requires pro forma disclosure for business combinations that occurred in the current reporting period as though the acquisition date for all business combinations that occurred during the year had been as of the beginning of the annual reporting period. If comparative financial statements are presented, the pro forma information should be reported as though the acquisition date for all business combinations that occurred during the current year had been as of the beginning of the comparable prior annual reporting period. ASU 2010-29 is effective for business combinations for which the acquisition date is on or after the beginning of the first annual reporting period beginning on or after December 15, 2010. Early adoption is permitted. The adoption of the new guidance is not expected to have a material impact on the Company’s consolidated financial statements.
In December 2010, the FASB issued ASU 2010-28, “When to Perform Step 2 of the Goodwill Impairment Test for Reporting Units with Zero or Negative Carrying Amounts.” The amendments in this ASU modify Step 1 of the goodwill impairment test for reporting units with zero or negative carrying amounts. For those reporting units, an entity is required to perform Step 2 of the goodwill impairment test if it is more likely than not that a goodwill impairment exists. For public entities, the amendments in this Update are effective for fiscal years, and interim periods within those years, beginning after December 15, 2010. Early adoption is not permitted. The adoption of the new guidance is not expected to have any impact on the Company’s consolidated financial statements since the Company did not have any goodwill reported on its balance sheet at December 31, 2010.
The SEC has issued Final Rule No. 33-9002, “Interactive Data to Improve Financial Reporting”, which requires companies to submit financial statements in XBRL (extensible business reporting language) format with their SEC filings on a phased-in schedule. Large accelerated filers and foreign large accelerated filers using U.S. GAAP were required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2010. All remaining filers are required to provide interactive data reports starting with their first quarterly report for fiscal periods ending on or after June 15, 2011.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 2. Securities
The amortized cost and fair value of securities available for sale, with gross unrealized gains and losses, follows:
Securities having carrying values of $27,828,340 and $24,873,948 at December 31, 2010 and 2009, respectively, were pledged to secure public deposits and for other purposes required by law.
U.S. Government and Federal Agency securities consist of debt obligations of the U.S. Government or of its designated agencies including Federal Farm Credit Bank, Federal Home Loan Bank, Federal Home Loan Mortgage Corporation (FHLMC), and the Federal National Mortgage Association (FNMA). At December 31, 2010, the Company held debt securities for the Federal Farm Credit Bank, Federal Home Loan Bank, and the Federal Home Loan Mortgage Corporation.
State and municipal bonds consist of debt obligations of states, municipalities, and school districts throughout the United States. Management’s evaluation of state and municipal debt securities, prior to the purchase, includes a review of the governmental entity’s credit rating. A security purchase is made based on the entity’s credit rating without any consideration to the rating enhancement which may come from the bond insurer. Management strives to purchase general obligation debt securities which can offer a reduced risk of default.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 2. Securities (continued)
Mortgage-backed securities consist of mortgage-backed pass-through securities that are issued by the Federal Agencies: Government National Mortgage Association, FHLMC and FNMA. This category also includes collateralized mortgage obligations, otherwise known as CMOs, which are issued by Federal Agencies such as FNMA and FHLMC and by private issuers, referred to above as “non-agency” issuers.
Maturities may differ from contractual maturities in mortgage-backed securities because the mortgages underlying the securities may be called or prepaid without any penalties.
Corporate securities consist of debt obligations issued by large, national corporations. This category while providing diversity for the investment portfolio, is the smallest of the four securities categories in terms of total dollars invested.
Information pertaining to securities with gross unrealized losses at December 31, 2010 and 2009 aggregated by investment category and length of time that individual securities have been in a continuous loss position, follows:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 2. Securities (continued)
The unrealized losses in the investment portfolio as of December 31, 2010 are considered temporary and are a result of general market fluctuations. The unrealized losses are from 74 securities, of which 70 securities are rated as investment grade and are backed by insurance, U.S. government agency guarantees, or the full faith and credit of local municipalities throughout the United States. The Company’s investment policy requires that a below investment grade security be monitored by Management but the investment policy does not require that the security be sold simply because it has fallen to below investment grade.
Impaired Securities
The Company and the Bank own five non-agency collateralized mortgage obligation (CMO) securities in the investment portfolio. At December 31, 2010, four of the five CMOs were rated below investment grade, with three of the securities downgraded to below investment grade prior to December 31, 2009. The Company’s investment policy does not regard a post-purchase credit rating downgrade as the sole determining factor whether or not the Company or the Bank should sell a downgraded security. The policy requires that management perform quarterly, credit profile reviews on a below investment-grade security and the results reported to the board of directors.
The credit profile review process includes an analysis of the performance of the loans that collateralize the securities from the inception of the security to a present date. Based upon the delinquency and default performance of each security’s mortgages, this data is used in a stress-testing model to project the likelihood of possible credit losses occurring in the future. If the results of the stress test indicate that a loss is imminent, within the next 12 months or less, then management is likely to recommend that a loss be recorded for the permanent impairment of the security. Due to the large number of factors incorporated in the stress test model and the likelihood that these factors could vary significantly from where they are today, projections of loss beyond a 12-month period could be misleading. The recording of an impairment loss would result in a charge to current earnings in the period when the impairment is determined. There was a $60 thousand impairment recorded during the year ended December 31, 2009 and no additional impairment allowance was required during 2010.
The analysis performed in the fourth quarter of 2010 indicated no further impairment loss from the non-agency CMO securities. At December 31, 2010, the fair value of the non-agency CMOs were $2.3 million and this total represented 2.78% of the total $82.7 million investment portfolio, exclusive of restricted securities. Management has reported that all five non-agency securities made monthly principal and interest payments during all of 2010.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 2. Securities (continued)
A roll-forward of the OTTI amount related to credit losses on debt securities for the year ended December 31, 2010 is as follows:
Market prices change daily and are affected by conditions beyond the control of the Company. Investment decisions are made by the management group of the Company and reflect the overall liquidity and strategic asset/liability objectives of the Company. Management analyzes the securities portfolio frequently and manages the portfolio to provide an overall positive impact to the Company’s income statement and balance sheet.
Management has positioned the investment portfolio to take advantage of not only the current investment environment but also the investment opportunities that will exist as market interest rates rise. As a result of this strategy, it is possible to see an increase in the number of securities that are called by the issuer, prior to maturity. For the years ended December 31, 2010, 2009 and 2008, proceeds from the sales and calls of securities amounted to $47,045,378 $22,815,000 and $15,793,135 respectively. Gross realized gains for the years ended December 31, 2010, 2009 and 2008 were $32,419, $21,409 and $19,821, respectively.
Restricted securities consist of required investments in Federal Home Loan Bank stock, Federal Reserve Bank stock and Community Banker’s Bank stock. No ready market exists for these stocks, and there is no quoted market value. Therefore the stock is carried at cost.
The Bank’s investment in Federal Home Loan Bank (“FHLB”) stock totaled $922,800 at December 31, 2010. FHLB stock is generally viewed as a long term investment and as a restricted investment security which is carried at cost, because there is no market for the stock other than the FHLB or member institutions. Therefore, when evaluating FHLB stock for impairment, its value is based on ultimate recoverability of the par value rather than by recognizing temporary declines in value.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans
A summary of the year-end loan balances by class:
Loan Origination
The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and the Board of Directors approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management and the Board with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans. Diversification in the loan portfolio is a means of managing risk associated with fluctuations in economic conditions.
The Company has six loan portfolio level segments and eight loan class levels for reporting
purposes. The six loan portfolio level segments include:
·
Residential real estate loans are loans made to borrowers for the purchase of residential dwellings.
·
Commercial real estate loans are loans made to business entities for the purchase of real estate and buildings that will be used in the business.
·
Farmland loans are loans made to farming entities to acquire land used for agricultural purposes such as in the cultivation of crops or livestock.
·
Construction and land development loans are loans made to individuals or developers in
order to construct homes, develop raw land into buildable acreage, or for commercial
construction purposes.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
·
Commercial and industrial loans are loans made to small and medium-sized businesses for
any number of reasons especially working capital. Loans are typically secured by inventory,
business equipment, furniture or receivables and they are frequently guaranteed by
principals of the business.
·
Consumer loans are loans made to individuals and the loans may be secured by personal
property or be unsecured.
Residential real estate loans, including home equity loans and lines of credit, are subject to underwriting standards that are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage of 80%, debt-to-income ratios, credit history, collection remedies, the number of such loans a borrower can have at one time and documentation requirements. While many of the statutory requirements are for the protection of the consumer, underwriting standards aid at mitigating the risks to the Company by setting acceptable loan-approval standards that marginal borrowers may not meet. Additional risk mitigating factors include: residential real estate typically serves as a borrower’s primary residence which encourages timely payments and the avoidance of foreclosure, the average dollar amount of a loan is typically less than that of a commercial real estate loan, and there are a large number of loans which help to diversify the risk potential.
Commercial real estate loans are subject to underwriting standards and processes similar to commercial and industrial loans, in addition to those of real estate loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts and the repayment of these loans is generally largely dependent on the successful operation of the property securing the loan or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. This diversity helps reduce the Company’s exposure to adverse economic events that affect any single market or industry.
Management monitors and evaluates commercial real estate loans based on collateral, geography and risk grade criteria. Management tracks the level of owner-occupied commercial real estate loans versus non-owner occupied loans. At December 31, 2010, approximately 45.51% of the outstanding principal balance of the Company’s commercial real estate loans was secured by owner-occupied properties.
Farmland loans are subject to underwriting standards and processes similar to commercial real estate loans. The loans are considered primarily on the borrower’s ability to make payments originating primarily from the cash flow of the business and secondarily as loans secured by real estate.
With respect to construction, land and land development loans that are secured by non-owner occupied properties that the Company may originate from time to time, the Company generally requires the borrower to have had an existing relationship with the Company and have a proven record of success. Construction loans are underwritten with independent appraisal reviews, lease rates and financial analysis of the borrowers. Construction loans are generally based upon estimates of costs and value associated with the complete project. Construction loans often involve the disbursement of substantial funds with repayment substantially dependent on the success of the ultimate project. Sources of repayment for these types of loans may be pre-committed permanent loans from approved long-term lenders, sales of developed property or an interim loan commitment from the Company until permanent financing is obtained. These loans are closely monitored by on-site inspections and are considered to have higher risks than other real estate
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
loans due to their ultimate repayment being sensitive to interest rate changes, governmental regulation of real property, general economic conditions and the availability of long-term financing.
Commercial and industrial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. Underwriting standards are designed to promote relationship banking rather than transactional banking. Once it is determined that the borrower’s management possesses sound ethics and solid business acumen, the Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial and industrial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. The cash flows of borrowers, however, may not be as expected and the collateral securing these loans may fluctuate in value. Most commercial and industrial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short-term loans may be made on an unsecured basis. In the case of loans secured by accounts receivable, the availability of funds for the repayment of these loans may be substantially dependent on the ability of the borrower to collect amounts due from its customers.
To monitor and manage consumer loan risk, policies and procedures are developed and modified by credit administration and senior management. This activity, coupled with relatively small loan amounts that are spread across many individual borrowers, minimizes risk. Underwriting standards for home equity loans are heavily influenced by statutory requirements, which include, but are not limited to, a maximum loan-to-value percentage, debt-to-income ratios, credit history, and the number of such loans a borrower can have at one time.
The Company maintains an independent loan review department that reviews and validates the credit risk program on a periodic basis. Results of these reviews are presented to management, the Audit and Risk Management Committee and the Board of Directors. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel, as well as the Company’s policies and procedures.
Concentrations of Credits
Most of the Company’s lending activity occurs within the Commonwealth of Virginia, more specifically within the South-Central Virginia markets that include Richmond. The majority of the Company’s loan portfolio consists of residential and commercial real estate loans. A substantial portion of its debtors’ ability to honor their contracts and the Company’s ability to realize the value of any underlying collateral, if needed, is influenced by the economic conditions in this market. As of December 31, 2010, there were no concentrations of commercial loans related to any individual purpose that was in excess of 5.98% of total loans.
Related Party Loans
In the ordinary course of business, the Company has granted loans to certain directors, executiveofficers and their affiliates (collectively referred to as “related parties”). These loans were made onsubstantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other unaffiliated persons and do not involve more than normal risk of collectability.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
Activity in related party loans during 2010 is presented in the following table:
Non-accrual and Past Due Loans
All loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due in accordance with the contractual terms of the underlying loan agreement. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed against interest income. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Aging and nonaccrual loans, by individual loan class, as of December 31, 2010 and 2009 was as follows:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
Impaired Loans
Loans are considered impaired when, based on current information and events, it is probable the Corporation will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, which represents either the present value of estimated future cash flows using the loan’s existing rate or the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.
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CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
Impaired loans, by class, as of December 31, 2010 are shown in the table below:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
A summary of information pertaining to impaired loans for 2009 and 2008 follows:
The Company utilizes a risk grading matrix to assign a risk grade to each of its commercial loans. Loans are graded on a scale of 1 to 9. A description of the general characteristics of the 9 risk grades is as follows:
Grade 1 - “Excellent” This grade includes loans to borrowers with superior capacity to pay interest and principal. Foreseeable economic changes are unlikely to impair the borrowers’ strength. Typically, borrowers have an excellent organizational structure in place with highly regarded and experienced management. Stable business, relatively unaffected by business, credit, or product cycles, business is significant in its market and has a well-defined market share. Borrower will have ready access to both public debt and equity markets under most conditions. Collateral is highly liquid, substantial margins are maintained, and primary/secondary sources of repayment are excellent. Loans secured by cash.
Grade 2 - “Good” This grade includes loans to borrowers that represent a solid, demonstrated capacity to pay interest and principal, but material downturns in economic conditions may impact the borrowers’ financial condition. Typically, borrowers exhibit low levels of leverage and the overall capitalization of the company is deemed satisfactory. Trends for revenue, core profitability and financial ratios are consistently above average with industry peers. Cash flow adequately covers dividends/withdrawals, and historic debt service in excess of 1.5 times. Collateral coverage is greater than 2.0 times or less than 50% loan-to-value ratio. Borrower has a stable, well-regarded and qualified management team in place, along with strong financial controls being evident. Normal industry stability, sales and profits are affected by business, credit or product cycles. Market share is stable. Borrower has the capability to refinance with another institution.
Grade 3 - “Standard” This grade includes loans to borrowers which have historically demonstrated an above adequate capacity to repay forecasted principal and interest charges; with debt service coverage of 1.20 times based on at least two years of historical earnings. Borrowers have inherent, definable weaknesses; however the weaknesses are not necessarily uncommon to a particular business, loan type or industry. Changes in economic circumstances could have non-material immediate repercussions on
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
the borrowers’ financial condition. Collateral support is deemed to be satisfactory based on appropriate discount factoring to allow a recovery sufficient to pay-off the debt. Collateral could be reasonably collected and/or liquidated in the general market. Additional collateral may be deemed an abundance of caution. Earnings are generally positive, subject to influences of current market conditions and distributions are reasonable in relation to the overall financial picture of the company. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full, if needed.
Grade 4 - “Acceptable” This grade includes loans to borrowers that will have inherent, definable weaknesses, however these weaknesses are not necessarily uncommon to a particular business, loan type, or industry. Economic changes could have negative repercussions on the financial condition. Borrowers overall financial position would indicate financing in the market is feasible, at rates and terms typical of current market conditions. Debt service coverage is deemed acceptable at 1.00 to 1.19 times on a combined basis for at least two years of historical earnings. Borrowers exhibit moderately high to high levels of leverage as noted against policy and Risk Management Association industry averages. Tangible net worth is marginally positive or even showing signs of a deficit net worth. Collateral support is deemed to be acceptable or even marginal, but not strong based on appropriate discounting, asset quality may be questionable given specific nature of assets, often secondary non-business assets are required. Earnings are marginally positive or a trend of negative earnings is identified and distributions are considered to be in excess of reasonableness. Guarantor support is deemed to be marginal as evidenced by personal assets, which probably could not support the business in full if needed. Repayment history also shows a discernable level of delinquent payments.
Grade 5 - This grade includes loans on management’s “watch list” and is intended to be utilized on a temporary basis for pass grade borrowers where a significant risk-modifying action is anticipated in the near term.
Grades 6 - This grade is for “Other Assets Especially Mentioned” in accordance with regulatory guidelines. This grade is intended to be temporary and includes loans to borrowers whose credit quality has clearly deteriorated and are at risk of further decline unless active measures are taken to correct the situation.
Grade 7 - This grade includes “Substandard” loans, in accordance with regulatory guidelines, for which the accrual of interest may or may not have been stopped. This grade also includes loans where interest is more than 120 days past due and not fully secured and loans where a specific valuation allowance may be necessary, but does not exceed 30% of the principal balance.
Grade 8 - This grade includes “Doubtful” loans in accordance with regulatory guidelines. Such loans are placed on non-accrual status and may be dependent upon collateral having a value that is difficult to determine or upon some near-term event which lacks certainty. Additionally, these loans generally have a specific valuation allowance in excess of 30% of the principal balance.
Grade 9 - This grade includes “Loss” loans in accordance with regulatory guidelines. Such loans are to be charged-off or charged-down when payment is acknowledged to be uncertain or when the timing or value of payments cannot be determined. “Loss” is not intended to imply that the loan or some portion of it will never be repaid, nor does it in any way imply that there has been a forgiveness of debt.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 3. Loans (continued)
The following table presents credit quality by loan class.
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CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 4. Allowance for Loan Losses
The allowance for possible loan losses is a reserve established through a provision for possible loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio. The Company’s allowance for possible loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” Accordingly, the methodology is based on historical loss experience by loan segment and internal risk grade, specific homogeneous risk pools and specific loss allocations, with adjustments for current events and conditions. The Company’s process for determining the appropriate level of the allowance for possible loan losses is designed to account for credit deterioration as it occurs. The provision for possible loan losses reflects loan quality trends, including the levels of and trends related to non-accrual loans, past due loans, potential problem loans, criticized loans and net charge-offs or recoveries, among other factors. The provision for possible loan losses also reflects the totality of actions taken on all loans for a particular period. In other words, the amount of the provision reflects not only the necessary increases in the allowance for possible loan losses related to newly identified criticized loans, but it also reflects actions taken related to other loans including, among other things, any necessary increases or decreases in required allowances for specific loans or loan pools.
The level of the allowance reflects management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including, among other things, the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
The Company's allowance for possible loan losses consists of three elements: (i) specific valuation allowances determined in accordance with ASC Topic 310 based on probable losses on specific loans; (ii) historical valuation allowances determined in accordance with ASC Topic 450 based on historical loan loss experience for similar loans with similar characteristics and trends, adjusted, as necessary, to reflect the impact of current conditions; and (iii) general valuation allowances determined in accordance with ASC Topic 450 based on general economic conditions and other qualitative risk factors both internal and external to the Company. Provisions for loan losses increase the amount of the allowance based upon the above considerations. Amounts computed to produce an appropriate allowance amount in one period can subsequently be affected by any recoveries of previously charged-off amounts, which are credited to the allowance, and by the reduction of overall loan balances from one period to another. These events, as well as others, can result in producing an "unallocated reserve component" at the end of any period, which is not attributable to any specific loan segment.
The allowance established for probable losses on specific loans is based on a regular analysis and evaluation of problem loans. Commercial loans are classified based on an internal credit risk grading process that evaluates, among other things: (i) the obligor’s ability to repay; (ii) the underlying collateral, if any; and (iii) the economic environment and industry in which the borrower operates. This analysis is performed at the relationship manager level for all commercial loans. When a loan has a calculated grade of 7 or higher, the loan is analyzed to determine whether the loan is impaired and, if impaired, the need to specifically allocate a portion of the allowance for possible loan losses to the loan. Specific valuation allowances are determined by analyzing the borrower’s ability to repay amounts owed, collateral deficiencies, the relative risk grade of the loan and economic conditions affecting the borrower’s industry, among other things.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 4. Allowance for Loan Losses (continued)
The historical component is calculated based on the historical charge-off experience of loan segments. The Company calculates historical loss ratios for pools of similar loans with similar characteristics based on the proportion of actual charge-offs experienced to the total population of loans in the pool. The historical loss ratios are periodically updated based on actual charge-off experience. A historical valuation allowance is established for each pool of similar loans based upon the product of the historical loss ratio and the total dollar amount of the loans in the pool. The Company’s pools of similar loans include similar groups of residential real estate loans, commercial real estate loans, commercial and industrial loans, and consumer loans. During the fourth quarter of 2010, management modified the methodology for calculating the historical component. Previously, management used a 60-month historical average of net charge-offs, by loan segment, to determine this portion of the allowance for loan losses. The methodology employed currently takes into consideration the net charge-offs for the most recent 36-months and adds in any specific reserve that has been placed against individually impaired loans, by loan segment.
The general reserve component is based on general economic conditions and other qualitative risk factors both internal and external to the Company. In general, such valuation allowances are determined by evaluating, among other things: (i) the experience, ability and effectiveness of the Company’s lending management and staff; (ii) the effectiveness of the Company’s loan policies, procedures and internal controls; (iii) changes in asset quality; (iv) changes in loan portfolio volume; (v) the composition and concentrations of credit; (vi) the impact of competition on loan pricing; (vii) the effectiveness of the internal loan review function; (viii) the impact of environmental risks on portfolio risks; and (ix) the impact of rising interest rates on portfolio risk. Management evaluates the degree of risk that each one of these components has on the quality of the loan portfolio on a quarterly basis. Each component will have a certain percentage assigned to it and this percent will be applied against the specific loan segments that are impacted by the various factors, mentioned above. The results of the general component are then included to determine an appropriate valuation allowance.
Loans that are either partially or totally identified as losses by management, internal loan review and/or bank examiners are charged-off. Certain unsecured consumer loan accounts are charged-off automatically based on regulatory requirements.
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CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 4. Allowance for Loan Losses (continued)
The following table details activity in the allowance for possible loan losses by portfolio segment for the year ended December 31, 2010. Allocation of a portion of the allowance to one category of loans does not preclude its availability to absorb losses in other categories.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 4. Allowance for Loan Losses (continued)
An analysis of the allowance for loan losses for 2009 and 2008 follows:
Note 5. Other Real Estate Owned
An analysis of other real estate owned follows:
Expenses applicable to other real estate owned include the following:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 6. Premises and Equipment
A summary of the cost and accumulated depreciation of premises and equipment follows:
Depreciation expense for the years ended December 31, 2010, 2009 and 2008 totaled $592,302, $612,667, and $633,906, respectively.
All branch locations are owned by the Bank except the Chesterfield branch and one location where the Bank has a remote ATM machine.
The Chesterfield branch is under a lease agreement for five years renewable for five additional terms of five years each. The current lease term is scheduled to end April 30, 2014.
The Bank installed one remote ATM in 2008 located at 200 North Main Street in Farmville, Virginia. The lease is a five year lease with option for automatic renewal for another five-year term.
All leases are classified as operating leases. Pursuant to the terms of the lease agreements, future minimum rent commitments are as follows:
Note 7. Deposits
The aggregate amounts of time deposits in denominations of $100,000 or more at December 31, 2010 and 2009 were $55,119,932 and $48,749,455, respectively.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 7. Deposits (continued)
At December 31, 2010, the scheduled maturities of time deposits are as follows:
At December 31, 2010 and 2009, overdraft demand deposits reclassified to loans totaled $53,309 and $45,084, respectively.
At December 31, 2010 and 2009, total deposits for related parties amounted to $4,221,000 and $7,902,000, respectively.
Note 8. FHLB Advances
At December 31, 2010 and 2009 the Bank had outstanding advances totaling $5,000,000 with the Federal Home Loan Bank of Atlanta, detailed below.
Note 9. Other Borrowings
Other borrowings include commercial customer deposit balances that are invested overnight into an investment sweeps product. The balances held in this deposit-alternative investment vehicle are not insured by the FDIC; however, the Bank pledges U.S. government securities sufficient to cover the balances held in these accounts.
The Bank also has available credit facilities with several correspondent banks totaling $76,949,123 at December 31, 2010.
Note 10. Off-Balance Sheet Arrangements, Commitments, Guarantees and Contingencies
Financial Instruments with Off-Balance Sheet Risk
The Company is a party to credit related financial instruments with off-balance-sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit, standby letters of credit and commercial letters of credit. Such commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheets.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 10. Off-Balance Sheet Arrangements, Commitments, Guarantees and Contingencies (continued)
The Company’s exposure to credit loss is represented by the contractual amount of these commitments. The Company follows the same credit policies in making commitments as it does for on-balance-sheet instruments.
At December 31, 2010 and 2009, the following financial instruments were outstanding:
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. The commitments for equity lines of credit may expire without being drawn upon. Therefore, the total commitment amounts do not necessarily represent future cash requirements. The amount of collateral obtained, if it is deemed necessary by the Company, is based on management’s credit evaluation of the customer.
Unfunded commitments under commercial lines of credit, revolving credit lines and overdraft protection agreements are commitments for possible future extensions of credit to existing customers. These lines of credit are uncollateralized and usually do not contain a specified maturity date and may not be drawn upon to the total extent to which the Company is committed.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Those letters of credit are primarily issued to support public and private borrowing arrangements. All letters of credit issued have expiration dates within one year. The credit risk involved in issuing letters of credit is the same as that involved in extending loan facilities to customers. The Company generally holds collateral supporting these commitments, if deemed necessary.
Credit Card Guarantees
The Company guarantees the credit card debt of certain customers to the merchant bank that issues the cards. At December 31, 2010, the guarantees totaled $3.8 thousand.
Change of Control Agreements
The Company has change-in-control agreements with certain executive officers. The agreements provide for the continuity of base salary and entitle each named executive officer to participate in the incentive, savings, and retirement benefits and payments in the event of the termination of employment following a change-in-control. If employment terminates without “cause’, for “good reason”, or during the “window period” (as these terms are defined in the agreements), the executive will be entitled to receive a lump sum payment of one and one-half times base salary and the continuation of employee welfare benefits for 24 months following the date of termination.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 11. Income Taxes
The Company files income tax returns with the U.S. Federal government and the Commonwealth of Virginia. With few exceptions, the Company is no longer subject to U.S. Federal income and state tax examinations by tax authorities for years prior to 2007.
Allocation of income tax expense between current and deferred portions is as follows:
The reasons for the differences between the statutory Federal income tax rate and the effective tax rates are summarized as follows:
The Bank is subject to a Bank Franchise Tax that is imposed by the Commonwealth of Virginia. The Bank Franchise Tax is not an income tax and as such the tax cost is included in other non-interest expense.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 11. Income Taxes (continued)
The components of the net deferred tax asset, included in other assets, are as follows:
Note 12. Employee Benefit Plans
The Company offers a number of benefit plans to its employees. Among them are a 401(k) plan and a defined benefit plan, which are described below:
401(k) Plan
The Company offers a 401(k) plan for the benefit of all employees who have attained the age of 18 and completed three months of continuous service. The plan allows participating employees to contribute amounts up to the limits set by the Internal Revenue Service and permits the Company to make discretionary contributions to the plan in such amounts as the Board of Directors may determine to be appropriate. The Company presently makes matching contributions equal to 50% of the first six percent of an employee’s compensation contributed to the plan. Contributions made to the plan by the Company for the years ended December 31, 2010, 2009, and 2008 were $83,255, $81,940, and $73,728, respectively.
Defined Benefit Pension Plan
The Company has a defined benefit pension plan covering all employees who meet eligibility requirements. To be eligible, an employee must be 20.5 years of age and have completed six months of eligibility service. The plan provides benefits based on the participant’s years of service and five year average final compensation. At a minimum, our funding policy is to make annual contributions as permitted or required by regulations. For the year ended December 31, 2010, the Company made a cash contribution totaling $202,283. Contributions for the years ended December 31, 2009 and 2008 were $100,000 and $253,411, respectively.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 12. Employee Benefit Plans (continued)
Additional information regarding the Company’s pension plan is presented below in accordance with ASC 715-30-25 for all years. The measurement date used for the pension disclosure is December 31.
The accumulated benefit obligation for the defined benefit pension plan was $4,398,057, $3,838,055 and $3,470,359 at December 31, 2010, 2009 and 2008, respectively.
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CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 12. Employee Benefit Plans (continued)
The weighted-average assumptions used in the measurement of the Company’s benefit obligation are shown in the following table:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 12. Employee Benefit Plans (continued)
The weighted-average assumptions used in the measurement of the Company’s net periodic benefit cost are shown in the following table:
Long-Term Rate of Return
The plan sponsor selects the expected long-term rate-of-return-on-assets assumption in consultation with its investment advisors and actuary. This rate is intended to reflect the average rate of earnings expected to be earned on the funds invested or to be invested to provide plan benefits. Historical performance is reviewed, especially with respect to real rates of return (net of inflation), for the major asset classes held or anticipated to be held by the trust and for the trust itself. Undue weight is not given to recent experience that may not continue over the measurement period with higher significance placed on current forecasts of future long-term economic conditions.
Because assets are held in a qualified trust, anticipated returns are not reduced for taxes. Further, solely for this purpose, the plan is assumed to continue in force and not terminate during the period in which assets are invested. However, consideration is given to the potential impact of current and future investment policy, cash flow into and out of the trust, and expenses (both investment and non-investment) typically paid from plan assets (to the extent such expenses are not explicitly estimated within periodic cost).
Asset Allocation
The pension plan’s weighted-average asset allocations as December 31, 2010 and 2009, by asset category are as follows:
The trust fund is sufficiently diversified to maintain a reasonable level of risk without imprudently sacrificing return with a targeted asset allocation of 50% fixed income and 50% equities. The investment manager selects investment fund managers with demonstrated experience and expertise and funds with demonstrated historical performance for the implementation of the plan’s investment strategy. The investment manager will consider both
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 12. Employee Benefit Plans (continued)
actively and passively managed investment strategies and will allocate funds across the asset classes to develop an efficient investment structure.
The following table sets forth by level, within the fair value hierarchy, the plan’s assets at fair value as of December 31, 2010 and 2009:
It is the responsibility of the trustee to administer the investments of the trust within reasonable costs, being careful to avoid sacrificing quality. These costs include, but are not limited to, management and custodial fees, consulting fees, transaction costs and other administrative costs chargeable to the trust.
The Company expects to contribute $250,000 to its pension plan in 2011.
Estimated future benefit payments, which reflect expected future service as appropriate, are as follows:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 13. Other Expenses
The principal components of other expenses in the statements of income are:
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CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 14. Regulatory Matters
Regulatory Capital Requirements
The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The capital amounts and classifications are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors. Prompt corrective action provisions are not applicable to bank holding companies.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, that as of December 31, 2010 and 2009, the Company and the Bank met all capital adequacy requirements to which they are subject.
As of December 31, 2010, the most recent notification from the Federal Reserve Bank categorized the Bank as well capitalized under the framework for prompt corrective action. To be categorized as well capitalized, an institution must maintain minimum total risk-based, Tier 1 risk-based, and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s categorization.
(Capital ratio tables continued on next page.)
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 14. Regulatory Matters (continued)
The Company’s and the Bank’s actual capital amounts and ratios as of December 31, 2010 and 2009 are presented in the table below:
Restriction on Dividends
The Bank is subject to certain restrictions on the amount of dividends it may pay without prior regulatory approval. The Bank normally restricts dividends to a lesser amount. At December 31, 2010, retained earnings of approximately $4,305,635 were available for the payment of dividends without prior regulatory approval.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 15. Fair Value Measurements
Current accounting pronouncements require disclosure of the estimated fair value of financial instruments. Fair value is generally defined as the price that would be received to sell an asset or paid to transfer a liability in an orderly, non-distressed sale between market participants at the measurement date. With the exception of certain marketable securities and one-to-four-family residential mortgage loans originated for sale, the Company’s financial instruments are not readily marketable and market prices do not exist. The Company, in attempting to comply with accounting disclosure pronouncements, has not attempted to market its financial instruments to potential buyers, if any exist. Since negotiated prices in illiquid markets depend upon the then present motivations of the buyer and seller, it is reasonable to assume that actual sales prices could vary widely from any estimate of fair value made without the benefit of negotiations. Additionally, changes in market interest rates can dramatically impact the value of financial instruments in a short period of time. Finally, the Company expects to retain substantially all assets and liabilities measured at fair value to their maturity or call date. Accordingly, the fair values disclosed herein are unlikely to represent the instruments’ liquidation values, and do not, with the exception of securities, consider exit costs, since they cannot be reasonably estimated by us.
The Company in estimating fair value disclosures for financial instruments used the following methods and assumptions:
Cash and cash equivalents: The carrying amounts of cash and short-term instruments approximate fair values.
Securities: Fair values for investment 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.
Loans: For variable-rate loans that reprice frequently and with no significant change in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (e.g., one-to-four family residential) and other consumer loans are based on quoted market prices of similar loans sold in conjunction with securitization transactions, adjusted for differences in loan characteristics. Fair values for other loans (e.g., commercial real estate and investment property mortgage loans, commercial and industrial loans) are estimated using discounted cash flow analyses based upon interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.
Deposits: The fair values disclosed for demand deposits (e.g., interest and non-interest checking, passbook savings, and certain types of money market accounts) are, by definition, equal to the amounts payable on demand at the reporting date (i.e., their carrying amounts). The carrying amounts of variable-rate, fixed-term money market accounts and certificates of deposit approximate their fair values at the reporting date. Fair values for fixed-rate 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 expected monthly maturities on time deposits.
Borrowings: The carrying amounts of federal funds purchased and other short term borrowings maturing within 90 days approximate their fair values. Fair values for Federal Home Loan Bank advances are estimated based upon current advance rates for the remaining term of the advance.
Accrued interest: The carrying amounts of accrued interest approximate fair value.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 15. Fair Value Measurements (continued)
Off-balance-sheet instruments: Fair values for off-balance-sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. At December 31, 2010 and 2009, the fair value of loan commitments and standby letters of credit was deemed to be immaterial.
The estimated fair values, and related carrying or notional amounts, of the Company’s financial instruments are as follows:
The Company assumes interest rate risk as part of its normal operations. As a result, the fair values of the Company’s financial instruments will change when interest rate levels change and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent possible to minimize interest rate risk. However, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
Some of the financial instruments disclosed in the previous table are measured at fair value in the consolidated financial statements. Accounting principles establish a three-level valuation hierarchy for fair value measurements. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. A financial instrument’s categorization within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement. The three levels are defined as follows:
● Level 1 Inputs to the valuation methodology are quoted prices for similar assets andliabilities in active markets.
● Level 2 Inputs to the valuation methodology included quoted prices for similar assets andliabilities in active markets, and inputs that are observable for the asset or liability,either directly or indirectly, for substantially the full term of the financial instrument.
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 15. Fair Value Measurements (continued)
● Level 3 Inputs to the valuation methodology are unobservable and significant to the fair value measurement.
The following tables present the balances of financial assets measured at fair value on a recurring basis as of December 31, 2010 and 2009:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 15. Fair Value Measurements (continued)
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the financial statements:
Securities available for sale: Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).
Accounting principles permit the measurement of certain assets at fair value on a nonrecurring basis. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write-downs of individual assets.
The following table summarizes the Company’s assets that were measured at fair value on a nonrecurring basis during the period:
CITIZENS BANCORP OF VIRGINIA, INC. AND SUBSIDIARY
Notes to Consolidated Financial Statements for December 31, 2010, 2009, and 2008
Note 15. Fair Value Measurements (continued)
The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the financial statements:
Impaired Loans: Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral. Fair value is measured based on the value of the collateral securing the loans. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data (Level 2).
However, if the collateral is a house or building in the process of construction or if an appraisal of the real estate property is over two years old, then the fair value is considered Level 3. The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant using observable market data. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3). Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.
Other Real Estate Owned: The fair values are estimated based upon recent appraisal values of the property less costs to sell the property. Certain inputs used in appraisals are not always observable, and therefore Other Real Estate Owned may be categorized as Level 3. When inputs in appraisals are observable, they are classified as Level 2.
Note 16. Condensed Parent Company Financial Statements
The following parent company accounting policies should be read in conjunction with the related condensed balance sheets, statements of income, and statements of cash flows.
The investment in subsidiary is accounted for using the equity method of accounting. The parent company and its subsidiary file a consolidated federal income tax return. The subsidiary’s individual tax provision and liability are stated as if it filed a separate return and any benefits or detriments of filing the consolidated tax return are absorbed by the parent company.
The parent company’s principal asset is its investment in its wholly-owned subsidiary. Dividends from the subsidiary and from the parent company’s investment portfolio are the sources of cash flow for the parent company. The payment of dividends by the subsidiary is restricted by various statutory limitations. Banking regulations also prohibit extensions of credit by the Bank to the parent company unless appropriately secured by assets.
(Statements shown on next two pages)
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, as amended, the Registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated.
Signature
Title
Date
/s/ Joseph D. Borgerding
President and Chief Executive Offi­c­er
March 31, 2011
Joseph D. Borgerding
and Di­rec­tor
(principal executive officer)
/s/ Ronald E. Baron
Senior Vice President and
March 31, 2011
Ronald E. Baron
Chief Financial Offi­c­er
(principal financial and accounting officer)
/s/ Frank P. Beale
Director
March 31, 2011
Frank P. Beale
/s/ William D. Coleburn
Director
March 31, 2011
William D. Coleburn
/s/ Roy C. Jenkins, Jr.
Director
March 31, 2011
Roy C. Jenkins, Jr.
Signature
Title
Date
/s/ Joseph F. Morissette
Director
March 31, 2011
Joseph F. Morrissette
/s/ E. Walter Newman
Director
March 31, 2011
E. Walter Newman
/s/ Charles F. Parker, Jr.
Director
March 31, 2011
Charles F. Parker, Jr.
/s/ JoAnne Scott Webb
Director
March 31, 2011
JoAnne Scott Webb
/s/ Samuel H. West
Director
March 31, 2011
Samuel H. West
/s/ Jerome A. Wilson, III
Director
March 31, 2011
Jerome A. Wilson, III
EXHIBIT INDEX
Exhibit No.
Description
3.1
Restated Articles of Incorporation of the Company (restated in electronic format only through June 10, 2004) (incorporated by reference to Exhibit 3.1 to the Company’s Form 10-K, filed April 1, 2005).
3.2
Amended and Restated Bylaws of the Company, (incorporated by reference to Exhibit 3.1 to the Company’s Form 8-K, filed June 30, 2009).
10.1
Form of Management Continuity Agreement, amended and restated as of December 31, 2008, entered into by the Company and each of Joseph D. Borgerding, Ronald E. Baron, Lynn K. Shekleton, and Rhonda W. Kincer (incorporated by reference to Exhibit 10.4 to the Company’s Form 10-K, filed March 31, 2009).
10.2
Form of Management Continuity Agreement, amended and restated as of March 26, 2009, entered into by the Company and each of Joseph D. Borgerding, Ronald E. Baron, Lynn K. Shekleton, and Rhonda W. Kincer (incorporated by reference to Exhibit 10.5 to the Company’s Form 10-K, filed March 31, 2009).
21.1
Subsidiary of the Company (filed herewith).
31.1
Certification of Principal Executive Officer Pursuant to Rule 13a-14(a) (filed herewith).
31.2
Certification of Principal Financial Officer Pursuant to Rule 13a-14(a) (filed herewith).
32.1
Statement of Principal Executive Officer Pursuant to 18 U.S.C. § 1350 (filed herewith).
32.2
Statement of Principal Executive Officer Pursuant to 18 U.S.C. § 1350 (filed herewith).