PRIMIS FINANCIAL CORP. Management's discussion and analysis is presented to aid the reader in understanding and evaluating the financial condition and results of operations of Southern National. This discussion and analysis should be read with the consolidated financial statements, the footnotes thereto, and the other financial data included in this report.
CRITICAL ACCOUNTING POLICIES
Our accounting policies are in accordance withU.S. GAAP and with general practices within the banking industry. Management makes a number of estimates and assumptions relating to reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during periods presented. Different assumptions in the application of these methods or policies could result in material changes in our financial statements. As such, the following policies are considered "critical accounting policies" for us.
Allowance for Loan and Lease Losses ("ALLL")
The allowance for loan and lease losses is a valuation allowance for probable
incurred credit losses. Loan losses are charged against the allowance when
management believes the collection of the principal is unlikely. Recoveries of
amounts previously charged-off are credited to the allowance. Management's
determination of the adequacy of the allowance is based on a three year
historical average net loss experience for each portfolio segment, except
consumer loans that are tracked on a two year basis, adjusted for current
industry and economic conditions (referred to as "current factors") and
estimates of their effect on loan collectability. While management uses
available information to estimate losses on loans, future additions to the
allowance may be necessary based on changes in economic conditions, particularly
those affecting real estate values.
The allowance consists of specific and general components. The specific
component relates to loans that are individually classified as impaired. The
general component provides for estimated losses in unimpaired loans and is based
on historical loss experience adjusted for current factors.
A loan is considered impaired when, based on current information and events, it
is probable that Southern National will be unable to collect the scheduled
payments of principal or interest when due according to the terms of the loan
documentation. Factors considered by management in determining impairment
include payment status, collateral value, and the probability of collecting
scheduled principal and interest payments when due, among other considerations.
Loans that experience insignificant payment delays and payment shortfalls
generally are not classified as impaired. Management determines the significance
of payment delays and payment shortfalls on a case-by-case basis, taking into
consideration all of the circumstances surrounding the loan and the borrower,
including the length of the delay, the reasons for the delay, the borrower's
prior payment record, and the amount of the shortfall in relation to the
principal and interest owed. Impairment is measured on a loan-by-loan basis for
commercial and construction loans by either the present value of expected future
cash flows discounted at the loan's effective interest rate, the loan's
observable market price, or the fair value of the collateral if the loan is
collateral dependent. Individual consumer and residential loans are evaluated
for impairment based on the aforementioned criteria as well as regulatory
guidelines.
The general component covers non-impaired loans and is based on historical loss
experience adjusted for current factors. The historical loss experience is
determined by portfolio segment and is based on the actual net loss history
experienced by Southern National over the most recent three years. This actual
loss experience is adjusted for current factors based on the risks present for
each portfolio segment. These current factors include consideration of the
following: levels of and trends in delinquencies and impaired loans; levels of
and trends in charge-offs and recoveries; trends in volume and terms of loans;
effects of any changes in risk selection and underwriting standards; other
changes in lending policies, procedures, and practices; experience, ability, and
depth of lending management and other relevant staff; national and local
economic trends and conditions; industry conditions; and effects of changes in
credit concentrations. The following portfolio segments have been identified:
owner occupied commercial real estate, non-owner occupied commercial real
estate, construction and land development, commercial loans, residential 1-4
family, multi-family residential, loans secured by farmland, HELOC and consumer.
While underwriting practices in today's environment are more stringent,
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the Bank estimates the effect of internal factors on future net loss experience to be negligible. Management's estimate of the effect of current external economic environmental conditions on future net loss experience is significant in all loan segments and particularly on loans secured by real estate including single family 1-4, non-owner occupied commercial real estate and construction and land development loans. These factors include excess inventory, generally less demand driven in part by fewer qualified borrowers and buyers. These considerations have played a significant role in management's estimate of the adequacy of the allowance for loan and lease losses.
Accounting for the FDIC Indemnification Asset and Acquired Loans
Southern National acquired loan portfolios through its acquisitions of GAB in 2009,HarVest Bank of Maryland in 2012, PGFSB in 2014 and EVBS in 2017. The single family residential loans acquired in the GAB transaction are referred to as "covered loans" because of loss protection provided by theFDIC pursuant to a loss sharing agreement which expired inDecember 2019 . The loss sharing agreement with theFDIC related to non-single family (commercial) loans expired inDecember 2014 . The loans acquired in the EVBS,HarVest Bank of Maryland , and PGFSB transactions are not covered by anFDIC loss sharing agreement. Loans acquired with evidence of credit deterioration since inception and for which it is probable that all contractual payments will not be received are accounted for under Accounting Standards Codification ("ASC") Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality ("ASC 310-30"). These loans are recorded at fair value at the time of acquisition, with no carryover of the related allowance for loan losses. Fair value of acquired loans is determined using a discounted cash flow methodology based on assumptions about the amount and timing of principal and interest payments, principal prepayments and principal defaults and losses, and current market rates. In recording the acquisition date fair values of acquired impaired loans, management calculates a non-accretable difference (the credit component of the purchased loans) and an accretable difference (the yield component of the purchased loans). Over the life of the acquired loans, we continue to estimate cash flows expected to be collected on pools of loans sharing common risk characteristics, which are treated in the aggregate when applying various valuation techniques. We evaluate at each balance sheet date whether the present value of our pools of loans determined using the effective interest rates has decreased significantly and if so, recognize a provision for loan losses in our consolidated statement of income. For any significant increases in cash flows expected to be collected, we adjust the amount of accretable yield recognized on a prospective basis over the pool's remaining life. These cash flow evaluations are inherently subjective as they require management to make estimates about expected cash flows, market conditions and other future events that are highly subjective in nature and subject to change. Changes in these factors, as well as changing economic conditions will likely impact the carrying value of these acquired loans.
Business Combinations,
Southern National accounts for all business combinations under the purchase method of accounting. Tangible and intangible assets and liabilities of the acquired entity are recorded at fair value. The determination of fair values is based on valuations using management's assumptions of future growth rates, future attrition, discount rates, multiples of earnings or other relevant factors. Changes in these factors, as well as downturns in economic or business conditions, could have a significant adverse impact on the carrying values of goodwill or intangible assets and could result in impairment losses affecting our financials as a whole and our banking subsidiary in which the goodwill or intangibles resides. Intangible assets with finite useful lives represent the future benefit associated with the acquisition of the core deposits and are amortized over their estimated useful lives utilizing a method that approximates the expected attrition of the deposits. Under FASB ASC 350, Intangibles -Goodwill and Other, goodwill is not amortized, but rather tested annually for impairment. Southern National evaluates goodwill for impairment each year as ofSeptember 30 .Goodwill totaled$101.9 million atDecember 31, 2019 . There was no impairment recorded for the years endedDecember 31, 2019 , 2018 and 2017. 43
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Other-Than-Temporary-Impairment ("OTTI") of
Management evaluates investment securities for OTTI on at least a quarterly basis, and more frequently when economic or market conditions warrant such an evaluation. For investment securities in an unrealized loss position, management considers the extent and duration of the unrealized loss, and the financial condition and near-term prospects of the issuer. Management also assesses whether it intends to sell, or it is more likely than not that it will be required to sell, an investment security in an unrealized loss position before recovery of its amortized cost basis. If either of the criteria regarding intent or requirement to sell is met, the entire difference between amortized cost and fair value is recognized as impairment through earnings. For debt investment securities that do not meet the aforementioned criteria, the amount of impairment is split into two components as follows: 1) OTTI related to credit loss, which must be recognized in the income statement and 2) OTTI related to other factors, which is recognized in other comprehensive income. The credit loss is defined as the difference between the present value of the cash flows expected to be collected and the amortized cost basis. For equity investment securities, the entire amount of impairment is recognized through earnings. In order to determine OTTI for purchased beneficial interests that, on the purchase date, were not highly rated, Southern National compares the present value of the remaining cash flows as estimated at the preceding evaluation date to the current expected remaining cash flows. OTTI is deemed to have occurred if there has been an adverse change in the remaining expected future cash flows.
Other Real Estate Owned ("OREO")
Real estate acquired through, or in lieu of, loan foreclosure are held for sale and are initially recorded at the fair value of the collateral at the date of foreclosure based on estimates, including some obtained from third parties, less estimated costs to sell, establishing a new cost basis. Subsequent to foreclosure, valuations are periodically performed by management, and the assets are carried at the lower of cost or fair value, less estimated costs to sell. Significant property improvements that enhance the salability of the property are capitalized to the extent that the carrying value does not exceed the estimated realizable value. Legal fees, maintenance and other direct costs of foreclosed properties are expensed as incurred. Due to the judgment involved in estimating fair value of the properties, accounting for OREO is regarded as a critical accounting policy. Estimates of value of OREO properties at the date of foreclosure are typically based on real estate appraisals performed by independent appraisers. These values are generally updated as appraisals become available.
Valuation of Deferred Tax Asset
The provision for income taxes reflects the tax effects of the transactions reported in the consolidated financial statements, including taxes currently due as well as changes in deferred taxes. Deferred tax assets and liabilities represent estimates of the future tax return consequences of temporary differences between carrying amounts and tax bases of assets and liabilities. Deferred tax assets and liabilities are computed by using currently enacted income tax rates and applying those rates to the periods in which the deferred tax assets or liabilities are expected to be realized or settled. As changes in tax laws or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. As ofDecember 31, 2019 and 2018, management concluded that it is more likely than not that Southern National will generate sufficient taxable income to fully utilize our deferred tax assets.
OVERVIEW
Southern National is a corporation that was formed onJuly 28, 2004 under the laws of theCommonwealth of Virginia and is the holding company forSonabank , aVirginia state-chartered bank which commenced operations onApril 14, 2005 .Sonabank provides a range of financial services to individuals and small and medium sized businesses. OnJune 23, 2017 , SNBV completed its merger with EVBS and the merger of EVBS's wholly-owned subsidiary, EVB, with and into SNBV's wholly-owned subsidiary,Sonabank . This combination has brought together two banking companies with complementary business lines, creating one of the premier banking institutions headquartered in the 44 Table of Contents
Southern National acquired PGFSB in a cash and stock transaction onAugust 1, 2014 . PGFSB was founded in 1931 and was headquartered inUpper Marlboro , which is the County Seat ofPrince George's County, Maryland . We completed the acquisition of theHarVest Bank of Maryland onApril 27, 2012 and the acquisition and assumption of certain assets and liabilities of GAB from theFDIC onDecember 4, 2009 . As part of the GAB acquisition, the Bank and theFDIC entered into a loss sharing agreement (the "loss sharing agreement") on approximately$143.4 million (cost basis) of GAB's assets. The Bank shared the losses on the loans and foreclosed loan collateral with theFDIC as specified in the loss sharing agreement; we refer to these assets collectively as "covered assets." AtDecember 31, 2019 ,Sonabank had forty-five full-service branches. Thirty-eight full-service retail branches are inVirginia , located inAshland , Burgess,Callao ,Central Garage ,Charlottesville ,Chester ,Clifton Forge ,Colonial Heights ,Courtland ,Deltaville ,Fairfax ,Front Royal ,Gloucester ,Gloucester Point ,Hampton ,Hartfield ,Haymarket ,Heathsville ,Kilmarnock ,Leesburg ,McLean ,Mechanicsville (2),Middleburg ,Midlothian ,New Market ,Newport News ,Quinton ,Reston ,Richmond ,South Riding ,Surry ,Tappahannock (2),Urbanna ,Warrenton ,Waverly , andWilliamsburg , and seven full-service retail branches inMaryland , located inBethesda ,Brandywine ,Huntingtown ,Owings ,Rockville ,Shady Grove , andUpper Marlboro . We have administrative offices inWarrenton andGlen Allen, Virginia , and executive offices inGeorgetown ,Washington, D.C. andGlen Allen, Virginia where senior management is located. While we offer a wide range of commercial banking services, we focus on making loans secured primarily by commercial real estate and other types of secured and unsecured commercial loans to small and medium-sized businesses in a number of industries, as well as loans to individuals for a variety of purposes. We are a leading SBA lender amongVirginia community banks. We also invest in real estate-related investment securities, including collateralized mortgage obligations and agency mortgage backed securities. Our principal sources of funds for loans and investing in securities are deposits and, to a lesser extent, borrowings. We offer a broad range of deposit products, including checking ("NOW"), savings, money market accounts and certificates of deposit. We actively pursue business relationships by utilizing the business contacts of our senior management, other bank officers and our directors, thereby capitalizing on our knowledge of our local market areas.
RESULTS OF OPERATIONS
Net Income
Net income for the year ended
The decrease in net income during the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 was primarily driven by a nonrecurring other loss of$2.5 million and related legal expense of$397 thousand , net of taxes. The decrease was partially offset by an income tax benefit in the second quarter of 2019 due to the formal assessment and rebooking of$1.2 million deferred tax asset stemming from a$5.5 million acquired net operating loss carryforward. Net income increased$31.3 million during the year endedDecember 31, 2018 compared to the year endedDecember 31, 2017 . Southern National's results for the year endedDecember 31, 2018 was impacted by$4.5 million of acquired loan discount accretion on loans acquired in the acquisitions of EVBS,Greater Atlantic Bank ,HarVest and Prince George Federal Savings Bank . For the year endedDecember 31, 2018 , other noninterest income benefited from$2.5 million of recoveries of legacy investment securities and loans charged off by EVBS before Southern National merged with EVBS during the late second quarter of 2017. Net income was also impacted by the reduced statutory federal tax rate applicable to the Company from 34% to 21% due to the enactment of the Tax Cuts and Jobs Act of 2017, which became effective onDecember 22, 2017 . We recognized an additional income tax expense totaling$7.2 million in 2017 from the revaluation of net deferred tax asset as a result of the reduction in the corporate tax rate. For the year endedDecember 31, 2018 , there was no material net tax expense resulting from a finalization of the calculations in 2018. 45 Table of Contents Net Interest Income
Our operating results depend primarily on our net interest income, which is the difference between interest and dividend income on interest-earning assets such as loans and investments, and interest expense on interest-bearing liabilities such as deposits and borrowings. Net interest income was$83.6 million during the year endedDecember 31, 2019 , compared to$91.0 million during the year endedDecember 31, 2018 , which was a direct result of the rising interest rate environment during 2018, competition for deposits and a decreasing rate environment during the second half of 2019. Southern National's net interest margin was 3.39% during the year endedDecember 31, 2019 compared to 3.72% during the year endedDecember 31, 2018 . The yield on average interest-earning assets increased 2 basis points to 4.88% during the year endedDecember 31, 2019 when comparing to the 4.86% yield on average interest-earning assets during 2018. The cost of average interest-bearing liabilities increased 45 basis points to 1.84% during the year endedDecember 31, 2019 when comparing to the 1.39% cost on average interest-bearing liabilities during 2018. The accretion of the discount on loans acquired in the acquisitions of EVBS,Greater Atlantic Bank ,HarVest and Prince Georges Federal Savings Bank contributed$3.9 million and$4.5 million to net interest income in the years endedDecember 31, 2019 and 2018, respectively. The decrease in accretion was due to the slowdown in the volume of acquired loan prepayments and payoffs. Average loans during the year endedDecember 31, 2019 were$2.16 billion compared to$2.14 billion during 2018. Net interest income was$91.0 million during the year endedDecember 31, 2018 , compared to$67.9 million during the year endedDecember 31, 2017 . Average loans during the year endedDecember 31, 2018 were$2.14 billion compared to$1.53 billion during 2017, with the increase mostly attributable to the acquisition of EVBS in June of 2017. Southern National's net interest margin was 3.72% during the year endedDecember 31, 2018 compared to 3.87% during the year endedDecember 31, 2017 . The yield on average interest-earning assets increased 10 basis points to 4.86% during the year endedDecember 31, 2018 when comparing to the 4.76% yield on average interest-earning assets during 2017. The cost of average interest-bearing liabilities increased 31 basis points to 1.39% during the year endedDecember 31, 2018 when comparing to the 1.08% cost on average interest-bearing liabilities during 2017. The loan discount accretion on our acquisitions were$4.5 million and$3.8 million in the years ended December
31,
2018 and 2017, respectively.
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The following table details average balances of interest-earning assets and interest-bearing liabilities, the amount of interest earned/paid on such assets and liabilities, and the yield/rate for the periods indicated:
Average Balance Sheets and Net Interest
Analysis For the Year Ended
2019 2018 2017
Interest Interest Interest
Average Income/ Yield/ Average Income/ Yield/ Average Income/ Yield/
Balance Expense Rate Balance Expense Rate Balance Expense Rate
(Dollar amounts in thousands)
Assets
Interest-earning assets:
Loans, net of deferred
fees (1) (2) $ 2,159,681 $ 112,181 5.19 % $ 2,138,845 $ 110,213 5.15 % $ 1,528,081 $ 77,764 5.09 %
Investment securities 241,800 6,224 2.57 % 247,182 6,386 2.58 % 182,464 4,569 2.50 %
Other earning assets 66,582 2,119 3.18 % 59,594 2,308 3.87 % 44,546 1,237 2.78 %
Total earning assets 2,468,063 120,524 4.88 % 2,445,621 118,907 4.86 % 1,755,091 83,570 4.76 %
Allowance for loan losses (11,852) (11,292) (9,831)
Total non-earning assets 264,265 260,348 177,357
Total assets $ 2,720,475 $ 2,694,677 $ 1,922,617
Liabilities and
stockholders' equity
Interest-bearing
liabilities:
NOW and other demand
accounts $ 360,254 $ 2,989 0.83 % $ 324,797 $ 1,478 0.46 % $ 192,789 $ 704 0.36 %
Money market accounts 439,097 7,745 1.76 % 328,142 3,060 0.93 % 256,746 1,582 0.62 %
Savings accounts 145,855 461 0.32 % 159,865 512 0.32 % 112,868 442 0.39 %
Time deposits 868,420 19,407 2.23 % 808,718 13,185 1.63 % 668,566 8,265 1.24 %
Total interest-bearing
deposits 1,813,626 30,602 1.69 % 1,621,521 18,235 1.12 % 1,230,969 10,993 0.89 %
Borrowings 188,647 6,322 3.35 % 380,822 9,606 2.52 % 218,581 4,660 2.13 %
Total interest-bearing
liabilities 2,002,273 36,924 1.84 % 2,002,343 27,841 1.39 % 1,449,550 15,653 1.08 %
Noninterest-bearing
liabilities:
Demand deposits 332,924 336,380 219,107
Other liabilities 22,115 18,646 15,694
Total liabilities 2,357,312 2,357,370 1,684,351
Stockholders' equity 363,163 337,307 238,266
Total liabilities and
stockholders' equity $ 2,720,475 $ 2,694,677 $ 1,922,617
Net interest income $ 83,600 $ 91,066 $ 67,917
Interest rate spread 3.04 % 3.47 % 3.68 %
Net interest margin 3.39 % 3.72 % 3.87 %
(1) Includes loan fees in both interest income and the calculation of the yield
on loans.
(2) Calculations include non-accruing loans in average loan amounts outstanding.
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The following table summarizes changes in net interest income attributable to
changes in the volume of interest-earning assets and interest-bearing
liabilities compared to changes in interest rates. The change in interest, due
to both rate and volume, has been proportionately allocated between rate and
volume.
Year Ended Year Ended
December 31, 2019 vs. 2018 December 31, 2018 vs. 2017
Increase (Decrease) Increase (Decrease)
Due to Change in: Due to Change in:
Net Net
Volume Rate Change Volume Rate Change
(in thousands)
Interest-earning assets:
Loans, net of deferred fees $ 1,172 $ 796 $ 1,968 $ 31,476 $ 973 $ 32,449 Investment securities (129) (33) (162) 1,669 148 1,817 Other earning assets 365 (553) (188) 496 575 1,071
Total interest-earning assets 1,408 210 1,618
33,641 1,696 35,337
Interest-bearing liabilities: NOW and other demand accounts 176 1,335 1,511
556 218 775
Money market accounts 1,304 3,380 4,684 532 946 1,478
Savings accounts (50) - (50) 124 (54) 70
Time deposits 1,074 5,148 6,222 1,982 2,938 4,920Total interest-bearing deposits 2,504 9,863 12,367 3,194 4,048 7,243 Borrowings (9,391) 6,108 (3,283) 3,962 984 4,946 Total interest-bearing liabilities (6,887) 15,971 9,084
7,156 5,032 12,189
Change in net interest income
$ 26,485 $ (3,337) $ 23,148 Provision for Loan Losses
The provision for loan losses is a current charge to earnings made in order to increase or decrease the allowance for loan losses to a level for inherent probable losses in the loan portfolio based on an evaluation of the loan portfolio, current economic conditions, changes in the nature and volume of lending, historical loan experience and other known internal and external factors affecting loan collectability. Our loan loss allowance is calculated by segmenting the loan portfolio by loan type and applying risk factors to each segment. The risk factors are determined by considering historical loss data, peer data, as well as applying management's judgment. The provision for loan losses for the years endedDecember 31, 2019 , 2018 and 2017 was$350 thousand ,$4.2 million and$8.6 million , respectively. We had charge-offs totaling$3.3 million during 2019,$3.1 million during 2018 and$8.8 million during 2017. There were recoveries totaling$906 thousand during 2019,$1.8 million during 2018 and$991 thousand during 2017. The provision for loan losses decreased$3.9 million for the year endedDecember 31, 2019 compared to the year endedDecember 31, 2018 due to improved credit quality, lower loan volume, lower delinquencies and favorable loss history in 2019. The primary driver of the decreased level of recoveries during the year endedDecember 31, 2019 , as compared to 2018, was$1.3 million in recoveries on commercial loans in 2018 that did not recur. The Financial Condition Section of Management's Discussion and Analysis provides information on our loan portfolio, past due loans, nonperforming assets and
the
allowance for loan losses.
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Noninterest Income
The following tables present the major categories of noninterest income for
the years ended
(dollars in thousands) 2019 2018
Change
Account maintenance and deposit service fees
$ 1,200 Income from bank-owned life insurance 1,699 1,983
(284)
Equity income (loss) from mortgage affiliate 1,191 (894)
2,085
Recoveries related to acquired charged-off loans and investment securities 1,537 2,610 (1,073) Other 1,000 541 459 Total noninterest income$ 12,586 $ 10,199 $ 2,387 (dollars in thousands) 2018 2017 Change
Account maintenance and deposit service fees
$ 2,395 Income from bank-owned life insurance 1,983 929
1,054
Equity loss from mortgage affiliate (894) (345)
(549)
Gain on sales of investment securities - 255
(255)
Recoveries related to acquired charged-off loans and investment securities 2,610 757 1,853 Other 541 269 272 Total noninterest income$ 10,199 $ 5,429 $ 4,770 Noninterest income increased 24% to$12.6 million in the year endedDecember 31, 2019 from$10.2 million in 2018. The$2.4 million increase was primarily driven by an increase of$1.2 million increase in account maintenance and deposit fees and$2.1 million increase in equity income from mortgage affiliate, partially offset by$1.1 million decrease in recoveries related to acquired charged-off loans and investment securities. Income improved on account maintenance and deposit services fee in the current year compared to the prior year. Income from the investment in STM totaled$1.2 million during the year endedDecember 31, 2019 compared to a loss of$894 thousand during the year endedDecember 31, 2018 . The increase was primarily driven by strengthened management and operational improvements within STM. For the year endedDecember 31, 2019 , recoveries related to acquired charged-off loans and investment securities was$1.5 million compared to$2.6 million for the year endedDecember 31, 2018 . Other noninterest income benefitted from a$337 thousand gain on sale of the last remaining fixed asset premises held for sale during 2019. Noninterest income increased 89% to$10.2 million in the year endedDecember 31, 2018 from$5.4 million in 2017. The increase was mainly due to the$2.4 million increase in account maintenance and deposit service fees primarily driven by the additional fees charged on the retail deposits acquired in the merger with EVBS. The increase in noninterest income was also driven by$1.9 million of higher income from recoveries of premerger charged off loans and securities by EVBS. Income from bank-owned life insurance (BOLI), which totaled$1.9 million for the year endedDecember 31, 2018 , increased$1.0 million when compared to 2017. The increase was driven by$350 thousand of BOLI income recognized from death benefit payouts in 2018, income from the purchase of an additional$12.0 million in BOLI in 2018 as well as increases in BOLI associated with the EVBS merger. Partially offsetting these increases was a$549 thousand increase in losses from the investment in STM, mainly attributable to rising interest rates and operational changes within STM. 49 Table of Contents Noninterest Expense
The following tables present the major categories of noninterest expense for
the years ended
(dollars in thousands) 2019 2018 Change Salaries and benefits$ 26,261 $ 27,706 $ (1,445) Occupancy expenses 6,204 6,628 (424)
Furniture and equipment expenses 2,719 2,795
(76)
Amortization of core deposit intangible 1,418 1,445 (27)
2,251 1,839 412
Data processing expense 2,381 1,885
496
Telephone and communication expense 1,615 2,035
(420)
Net (gain) loss on other real estate owned (38) 360 (398) Professional fees 3,612 1,644 1,968 Other operating expenses 10,169 7,423 2,746 Total noninterest expenses$ 56,592 $ 53,760 $ 2,832 (dollars in thousands) 2018 2017 Change Salaries and benefits$ 27,706 $ 20,285 $ 7,421 Occupancy expenses 6,628 4,809 1,819
Furniture and equipment expenses 2,795 2,228
567
Amortization of core deposit intangible 1,445 845 600
1,839 969 870
Data processing expense 1,885 1,140
745
Telephone and communication expense 2,035 1,422
613
Net loss on other real estate owned 360 520 (160) Professional fees 1,644 1,798 (154) Merger expenses - 9,426 (9,426) Other operating expenses 7,423 5,707 1,716 Total noninterest expenses$ 53,760 $ 49,149 $ 4,611
Noninterest expenses were$56.6 million during the year endedDecember 31, 2019 , compared to$53.7 million during the year endedDecember 31, 2018 . The year-over-year increase of 5.3% in noninterest expenses was primarily due to an increase in other operating expenses driven by a nonrecurring loss of$3.2 million with related legal expense of$502 thousand during the first quarter of 2019. Professional fees increased$2.0 million for the year endedDecember 31, 2019 , when compared to the year endedDecember 21, 2018 mainly due to costs incurred as part of our implementation efforts for the 2020 adoption of the Current Expected Credit Losses ("CECL") accounting standard, enhancements to our compliance and Bank Secrecy Act programs, and general legal expense for corporate matters in 2019. Employee compensation and benefits expense totaled$26.3 million and$27.7 million for the year endedDecember 31, 2019 and 2018, respectively. The decrease was due to a reduction in staffing in 2019. Noninterest expenses were$53.7 million during the year endedDecember 31, 2018 , compared to$49.1 million during the year endedDecember 31, 2017 . The year-over-year increase of 9.4% in noninterest expenses was mainly driven by increased salaries and benefits of$7.4 million in 2018 compared to 2017 due to additional staff added in the EVBS acquisition. Occupancy expenses and furniture and equipment expenses increased$1.8 million and$567 thousand , respectively, year-over-year to$6.6 million and$2.8 million , respectively, for the year endedDecember 31, 2018 primarily associated with the EVBS merger. The increases in noninterest expenses associated with the EVBS merger were in-line with management's pre-merger expectations. Other operating expenses increased$1.2 million for the year endedDecember 31, 2018 , when compared to the year endedDecember 31, 2017 . Merger expenses associated with the EVBS acquisition was$9.4 million for the year endedDecember 31, 2017 , which did not recur
during 2018.
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FINANCIAL CONDITION
Balance Sheet Overview
Total assets were $2.72 billion as of December 31, 2019 and $2.70 billion as of
December 31, 2018 . Total loans increased 0.3%, from $2.18 billion at December
31, 2018 to $2.19 billion at December 31, 2019 , primarily due to loan growth of
$262.5 million during 2019, partially offset by unanticipated large loan payoffs
or paydowns of $98.2 million in 2019. Total deposits were $2.12 billion at
December 31, 2019 compared to $2.09 billion at December 31, 2018 and total
equity was $377.2 million and $348.3 million at December 31, 2019 and December
31, 2018 , respectively.
Loans
Total loans, net of deferred fees were $2.19 billion and $2.18 billion at
December 31, 2019 and 2018, respectively. The $7.2 million increase in total
loans, net of deferred fees during 2019 has primarily been the result of loan
growth, partially offset by unanticipated pay downs or payoffs of loans two
million and greater in size during the year. New loans originated in 2019
totaled $262.5 million . Loans two million and greater in size, that have been
paid off or paid down in 2019, included $52.3 million due to the sale of the
customer's property, $24.1 million in loans that refinanced elsewhere for
unacceptable rate or structure, $13.7 million were projects that transitioned to
government financing, and $8.1 million was due to cyclical fluctuation in credit
line activity. Additionally, in the first quarter of 2019, $33.9 million of
commercial loans were reclassified into loans secured by real estate, upon
review and validation of collateral and Call Report codes.
As of December 31, 2019 and 2018, substantially all of our loans were to
customers located in Virginia and Maryland . We are not dependent on any single
customer or group of customers whose insolvency would have a material adverse
effect on operations.
The following table summarizes the composition of our loans, net of unearned
income, at
2019 2018 2017 2016 2015
Amount Percent Amount Percent Amount Percent Amount Percent Amount Percent
Loans secured by real
estate:
Commercial real estate -
owner occupied $ 414,479 19.0 % $ 407,031 18.7 % $ 401,847 19.5 % $ 154,807 16.6 % $ 141,521 17.0 %
Commercial real estate -
non-owner occupied 559,195 25.6 % 540,698 24.8 % 440,700 21.4 % 279,634 29.9 % 256,513 30.8 %
Secured by farmland 17,622 0.8 % 20,966 1.0 % 23,038 1.1 % 541 0.1 % 578 0.1 %
Construction and land
development 150,750 6.9 % 146,654 6.7 % 197,972 9.6 % 91,067 9.8 % 67,832 8.2 %Residential 1-4 family (1) 604,777 27.7 % 565,083 25.9 % 483,006 23.4 % 230,810 24.8 % 178,071 21.4 % Multi- family residential 82,055 3.8 % 82,516 3.8 % 70,892 3.4 % 30,021 3.2 % 25,501 3.1 % Home equity lines of credit (1) 109,006 5.0 % 128,225 5.9 % 152,829 7.4 % 29,203 3.1 % 35,177 4.2 % Total real estate loans 1,937,884 88.7 % 1,891,173 86.8 % 1,770,284 85.8 % 816,083 87.5 % 705,193 84.8 % Commercial loans 221,447 10.1 % 255,441 11.7 % 253,258 12.3 % 115,365 12.4 % 124,985 15.0 % Consumer loans 26,304 1.2 % 32,347 1.5 % 39,374 1.9 % 856 0.1 % 1,366 0.2 % Gross loans 2,185,635 100 % 2,178,961 100 % 2,062,916 100 % 932,304 100 % 831,544 100 % Plus (less) deferred costs (fees) on loans 412 (137) (588) (1,889) (2,119) Loans, net of deferred fees$ 2,186,047 $ 2,178,824 $ 2,062,328 $ 930,415 $ 829,425 Covered loans included above in residential 1-4 family and home equity lines of credit (1)$ 13,527 $ 18,252 $ 23,339 $ 28,180 $ 34,373
(1) Includes loans acquired in the GAB transaction covered under an
loss-share agreement which expired on December 31, 2019 .
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The following table sets forth the contractual maturity ranges of the
construction and land development and commercial loan portfolios and the amount
of those loans with fixed and floating interest rates in each maturity range as
of December 31, 2019 (in thousands):
After 1 Year
Through 5 Years After 5 Years
One Year Fixed Floating Fixed Floating
or Less Rate Rate Rate Rate TotalConstruction and land development$ 99,185 $ 25,654 $ 11,057
$ 5,103 $ 9,751 $ 150,750 Commercial 110,189 54,492 14,407 6,890 35,469 221,447 Total$ 209,374 $ 80,146 $ 25,464 $ 11,993 $ 45,220 $ 372,197
Asset Quality; Past Due Loans and Nonperforming Assets
Asset quality remained high during 2019. We will generally place a loan on nonaccrual status when it becomes 90 days past due. Loans will also be placed on nonaccrual status in cases where we are uncertain whether the borrower can satisfy the contractual terms of the loan agreement. Cash payments received while a loan is categorized as nonaccrual will be recorded as a reduction of principal as long as doubt exists as to future collections. We maintain appraisals on loans secured by real estate, particularly those categorized as nonperforming loans and potential problem loans. In instances where appraisals reflect reduced collateral values, we make an evaluation of the borrower's overall financial condition to determine the need, if any, for impairment or write-down to their fair values. If foreclosure occurs, we record OREO at the lower of our recorded investment in the loan or fair value less our estimated costs to sell. Our loss and delinquency experience on our loan portfolio has been limited by a number of factors, including our underwriting standards and the relatively short period of time since the loans were originated. Whether our loss and delinquency experience in the area of our portfolio will increase significantly depends upon the value of the real estate securing loans and economic factors such as the overall economy of the region.
The following table presents a comparison of non-covered nonperforming assets as
of
2019 2018 2017 2016 2015
Nonaccrual loans $ 8,900 $ 6,709 $ 16,931 $ 3,795 $ 4,173
Loans past due 90 days and accruing
interest - - - - -
Total nonperforming loans 8,900 6,709 16,931 3,795 4,173
Other real estate owned 6,224 5,077
7,577 8,617 10,096
Total non-covered nonperforming assets
Troubled debt restructurings$ 697 $ 692 $ 672 $ 688 $ 699 SBA guaranteed amounts included in nonaccrual loans$ 4,129 $ 3,391 $
4,664
Allowance for loan losses to nonperforming loans 115.30 % 207.63 % 55.50 % 226.88 % 201.80 % Allowance for loan losses to total non-covered loans 0.47 % 0.57 % 0.46 % 0.95 % 1.06 % Nonperforming assets excluding SBA guaranteed loans to total non-covered assets 0.41 % 0.28 % 0.77 % 0.92 % 1.07 %
Covered nonperforming assets are not included in the table above because the carrying value includes a component for credit losses (the nonaccretable yield).
OREO atDecember 31, 2019 was$6.2 million compared to$5.1 million atDecember 31, 2018 . Increase in OREO was driven by foreclosure of three small commercial properties and one residential property in 2019. 52
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Non-covered nonaccrual loans were$4.8 million (excluding$4.1 million of loans fully covered by SBA guarantees) atDecember 31, 2019 compared to$3.3 million (excluding$3.4 million of loans fully covered by SBA guarantees) atDecember 31, 2018 . The ratio of non-covered nonperforming assets (excluding the SBA guaranteed loans) to total non-covered assets decreased from 0.28% atDecember 31, 2018 to 0.41% atDecember 31, 2019 .
At
As ofDecember 31, 2019 , we had three TDR loans, totaling$697 thousand . One loan was modified as a TDR during each of the years endingDecember 31, 2019 and 2018. One TDR which had been modified in 2013 defaulted in 2015. This loan, in the amount of$645 thousand , was current as ofDecember 31, 2019 . It is the Bank's practice to concurrently charge off collateral-dependent loans at the time loan impairment is recognized. We had$245 thousand charge-offs on loans individually evaluated for impairment as ofDecember 31, 2019 . We identify potential problem loans based on loan portfolio credit quality. We define our potential problem loans as our non-covered classified/criticized loans less total non-covered nonperforming loans noted above. AtDecember 31, 2019 and 2018, our potential problem loans totaled$0.7 million and$0.2 million , respectively.
Allowance for Loan and Lease Losses
We are very focused on the asset quality of our loan portfolio, both before and after the loan is made. We have established underwriting standards that we believe are effective in maintaining high credit quality in our loan portfolio. We have experienced loan officers who take personal responsibility for the loans they underwrite, a standing credit committee that reviews each loan application carefully, and a requirement that loans over$6,000,000 must be approved by all five executive members of our standing credit committee and loans over$10,000,000 must be approved by the full board of directors or two outside directors. Our allowance for loan and lease losses is established through charges to earnings in the form of a provision for loan losses. Management evaluates the allowance at least quarterly. In addition, on a quarterly basis our board of directors reviews our loan portfolio, evaluates credit quality, reviews the loan loss provision and the allowance for loan and lease losses and makes changes as may be required. In evaluating the allowance, management and the board of directors consider the growth, composition and industry diversification of the loan portfolio, historical loan loss experience, current delinquency levels and all other known factors affecting loan collectability. The allowance for loan and lease losses represents management's estimate of an amount appropriate to provide for probable incurred losses in the loan portfolio in the normal course of business. This estimate is based on average historical losses within the various loan types that compose our portfolio as well as an estimate of the effect that other known factors such as the economic environment within our market area will have on net losses. The allowance is also subject to regulatory examinations and determination by the regulatory agencies as to the appropriate level of the allowance. Our loan review program is administrated by the Chief Risk Officer who reports results directly to the Audit Committee of the Board of Directors. The Bank's credit policy specifies that "Internal Loan review is responsible for performing a full scope review and written report of loans with a total dollar commitment amount equal to 30% of commercial loans outstanding at the previous year-end including Construction and Development, Nonfarm Nonresidential (CRE) and Commercial and Industrial loans." In 2019, internal loan review performed loan reviews on loans and commitments totaling 25.3% of this loan portfolio outstanding as ofDecember 31, 2018 . External loan review is responsible for reviewing 50% of the same portfolio at previous year end. An independent third party consultant performed loan reviews on 59.1% of this portfolio. In 2019, internal and external loan reviews were performed on 84.4% of the specified portfolio of loans. In 2020 we plan to have the independent third-party consultant review loans and commitments totaling at least 50% of the loan portfolio outstanding as ofDecember 31, 2019 , and another 30% reviewed internally. Loan reviews totaling at least 80% of the specified commercial loan portfolio outstanding atDecember 31, 2019 will be 53
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performed. The purpose of loan review by a third-party is to validate
management's assessment of risk of the individual loans in the portfolio and to
determine whether the loan was approved, underwritten and is being monitored in
accordance with the Bank's credit policy and regulatory guidance. Management's
risk assessment of individual loans takes into consideration among other
factors, the estimated value of the underlying collateral, the borrower's
ability to repay, the borrower's payment history and current payment status.
The following table sets forth the allowance for loan losses allocated by loan
category and the percent of loans in each category to total loans at the dates
indicated (in thousands):
As of December 31,
2019 2018 2017 2016 2015
Percent of Percent of Percent of Percent of Percent of
Allowance Loans by Allowance Loans by Allowance Loans by Allowance Loans by Allowance Loans by
for Loan Category to for Loan Category to for Loan Category to for Loan Category to for Loan
Category to
Losses Total Loans Losses Total Loans Losses Total Loans Losses Total Loans Losses Total Loans
Commercial real
estate (1) $ 2,530 49.1 % $ 2,471 48.2 % $ 2,011 45.4 % $ 2,389 49.8 % $ 2,407 51.0 %
Construction and
land development 683 6.9 % 821 6.7 % 692 9.6 % 752 9.8 % 865 8.2 %
Residential 1-4
family (2) 1,266 32.7 % 1,106 31.8 % 1,586 30.8 % 1,279 27.9 % 1,408 25.6 %
Commercial loans 4,518 10.1 % 6,497 11.7 % 4,496 12.3 % 3,366 12.4 % 3,041 15.0 %
Consumer loans 190 1.2 % 224 1.5 % 612 1.9 % 78 0.1 % 48 0.2 %
Total 9,187 100.0 % 11,119 100.0 % 9,397 100.0 % 7,864 100.0 % 7,769 100.0 %
Allowance for
acquired loan
losses 900 600 - - -
Total allocated
allowance 10,087 11,719 9,397 7,864 7,769
Unallocated
allowance 174 564 - 746 652
Total $ 10,261 $ 12,283 $ 9,397 $ 8,610 $ 8,421 (1) Includes owner and non-owner occupied loans, loans secured by farmland and
multi-family residential loans.
(2) Includes home equity lines of credit.
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The following table presents an analysis of the allowance for loan losses for the periods indicated (in thousands):
For the Years Ended December 31,
2019 2018 2017 2016 2015
Balance, beginning of period $ 12,283 $ 9,397 $ 8,610 $ 8,421 $ 7,414
Provision charged to operations:
Provision for non-purchased loans 50 3,600 8,625 4,912 3,171
Provision for purchase credit impaired
loans 300 600 - - -
Total provisions 350 4,200 8,625 4,912 3,171
Recoveries credited to allowance:
Real estate - commercial (1) 213 15 431 8 36
Real estate - construction, land and
other - - 1 121 139
Real estate - residential 1-4 family
(2) 306 125 17 10 242
Commercial 351 1,626 538 96 91
Consumer 36 18 4 4 1
Total recoveries 906 1,784 991 239 509
Loans charged off:Real estate - commercial (1) 1,645 400 100 799 1,067 Real estate - construction, land and other - - - 449 - Real estate - residential 1-4 family (2) 742 842 369 22 413 Commercial 622 1,566 8,250 3,370 1,174 Consumer 269 290 110 322 19 Total loans charged-off 3,278 3,098 8,829 4,962 2,673 Net charge-offs 2,372 1,314 7,838 4,723 2,164 Balance, end of period$ 10,261 $ 12,283 $ 9,397 $ 8,610 $ 8,421 Net charge-offs to average loans, net of unearned income 0.11 % 0.06 % 0.51 %
0.53 % 0.28 %
(1) Includes owner and non-owner occupied loans, loans secured by farmland and
multi-family residential loans.
(2) Includes home equity lines of credit.
In 2019, we had loan charge-offs totaling
We believe that the allowance for loan losses atDecember 31, 2019 is sufficient to absorb probable incurred credit losses in our loan portfolio based on our assessment of all known factors affecting the collectability of our loan portfolio. Our assessment involves uncertainty and judgment; therefore, the adequacy of the allowance for loan losses cannot be determined with precision and may be subject to change in future periods. In addition, bank regulatory authorities, as part of their periodic examination, may require additional charges to the provision for loan losses in future periods if the results of their reviews warrant additions to the allowance for loan losses.
Our investment securities portfolio provides us with required liquidity and
investment securities to pledge as collateral to secure public deposits, certain
other deposits, a line of credit for advances from the FHLB of
Our investment securities portfolio is managed by our executive vice chairman
and our treasurer, both of whom have significant experience in this area, with
the concurrence of our Asset/Liability Committee. In addition to our executive
vice chairman (who is the chairman of the Asset/Liability Committee) and our
Controller, this committee is comprised of outside directors and other senior
officers of the Bank, including but not limited to our executive chairman, our
chief executive officer and our chief financial officer. Investment management
is performed in accordance with our investment policy, which is approved
annually by the Asset/Liability Committee and the Board of Directors. Our
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investment policy addresses our investment strategies, approval process, approved securities dealers and authorized investments. Our investment policy authorizes us to invest in:
? Association ("FNMA") and the Federal Home Loan Mortgage Corporation ("FHLMC")
mortgage-backed securities ("MBS")
? Collateralized mortgage obligations
?U.S. Treasury securities ? SBA guaranteed loan pools ? Agency securities
? Obligations of states and political subdivisions
Pooled trust preferred securities comprised of a minimum of 80% bank collateral
? with an investment grade rating or a minimum of 60% bank collateral with a
rating at purchase
? Other corporate debt securities rated Aa3/AA- or better at purchase
MBS are securities that have been developed by pooling a number of real estate
mortgages and which are principally issued by agency/government-sponsored
entities ("GSEs") such as the GNMA, FNMA and FHLMC. These securities are deemed
to have high credit ratings, and minimum regular monthly cash flows of principal
and interest are guaranteed by the issuing agencies.
Unlike U.S. Treasury and U.S. government agency securities, which have a lump
sum payment at maturity, MBS provide cash flows from regular principal and
interest payments and principal prepayments throughout the lives of the
securities. MBS which are purchased at a premium will generally suffer
decreasing net yields as interest rates drop because homeowners tend to
refinance their mortgages. Thus, the premium paid must be amortized over a
shorter period. Conversely, MBS purchased at a discount will obtain higher net
yields in a decreasing interest rate environment. As interest rates rise, the
opposite will generally be true. During a period of increasing interest rates,
fixed rate MBS do not tend to experience heavy prepayments of principal, and
consequently the average life of these securities will be lengthened. If
interest rates begin to fall, prepayments will generally increase.
Collateralized mortgage obligations ("CMOs") are bonds that are backed by pools
of mortgages. The pools can be GNMA, FNMA or FHLMC pools or they can be
private-label pools. The CMOs are designed so that the mortgage collateral will
generate a cash flow sufficient to provide for the timely repayment of the
bonds. The mortgage collateral pool can be structured to accommodate various
desired bond repayment schedules, provided that the collateral cash flow is
adequate to meet scheduled bond payments. This is accomplished by dividing the
bonds into classes to which payments on the underlying mortgage pools are
allocated. The bond's cash flow, for example, can be dedicated to one class of
bondholders at a time, thereby increasing call protection to bondholders. In
private-label CMOs, losses on underlying mortgages are directed to the most
junior of all classes and then to the classes above in order of increasing
seniority, which means that the senior classes have enough credit protection to
be given the highest credit rating by the rating agencies.
Obligations of states and political subdivisions (municipal securities) are
purchased with consideration of the current tax position of the Bank. In-state
(Virginia ) municipal bonds will be favored when they present better relative
value than comparable out-of-state municipal bonds. Both taxable and tax-exempt
municipal bonds may be purchased, but only after careful assessment of the
market risk of the security. Appropriate credit evaluation must be performed
prior to purchasing municipal bonds.
Southern National's corporate bonds consist of pooled trust preferred securities
issued by banks, thrifts and insurance companies as well as senior subordinated
notes issued by banks. The collateral pools of these trust preferred securities
must be at least 80% banks or thrifts, if the rating at the time of purchase is
A3/A- or better. If the rating is Aaa/AAA , the collateral pool must be at least
60% banks or thrifts. These securities generally have a long term (25 years or
more), allow early redemption by the issuers, make periodic variable interest
payments and mature at face value. Trust preferred securities allow the deferral
of interest payments for up to five years.
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We classify our investment securities as either held to maturity or available for sale. Debt investment securities that Southern National has the positive intent and ability to hold to maturity are classified as held to maturity and carried at amortized cost. Investment securities classified as available for sale are those debt securities that may be sold in response to changes in interest rates, liquidity needs or other similar factors. Investment securities available for sale are carried at fair value, with unrealized gains or losses net of deferred taxes, included in accumulated other comprehensive income (loss) in stockholders' equity. Investment securities totaling$72.5 million were in the held to maturity portfolio atDecember 31, 2019 , compared to$92.4 million atDecember 31, 2018 . Investment securities totaling$164.8 million were in the available for sale portfolio atDecember 31, 2019 , compared to$143.4 million atDecember 31, 2018 . During 2019,$45.1 million and$15.3 million , respectively, of available for sale investment securities and held to maturity investment securities were purchased. No investment securities were sold during 2019. No investment securities were purchased or sold during 2018. As ofDecember 31, 2019 , we owned pooled trust preferred investment securities as follows (in thousands): % of Previously Current Recognized Defaults and Cumulative Ratings Estimated Deferrals to Other Tranche When Purchased Current Ratings Par Book Fair Total Comprehensive Security Level Moody's Fitch Moody's Fitch Value Value Value Collateral Loss (1) (in thousands) Held to Maturity ALESCO VII A1B Senior Aaa AAA Aa1
AA $ 2,019 $ 1,882 $ 1,982 17 % $ 219
MMCF III B Senior Sub A3 A- Ba1 WD 57 56 53 45 % 4
$ 2,076 $ 1,938 $ 2,035 $ 223
Cumulative OTTI
Available for Sale Related to
Other Than Temporarily Impaired:
Credit Loss (2)
TPREF FUNDING II Mezzanine A1 A- Caa3 WD $ 1,500 $ 1,040 $ 795 32 % $ 400
ALESCO V C1 Mezzanine A2 A Caa1 C 2,150 1,490 1,773 15 % 660
$ 3,650 $ 2,530 $ 2,568 $ 1,060
Total $ 5,726 $ 4,468 $ 4,603 (1) Pre-tax, and represents unrealized losses at date of transfer from available
for sale to held to maturity, net of accretion
(2) Pre-tax
Each of these investment securities has been evaluated for other than temporary
impairment ("OTTI"). In performing a detailed cash flow analysis of each
investment security, Sonabank works with independent third parties to estimate
expected cash flows and assist with the evaluation of OTTI. The cash flow
analyses performed included the following assumptions:
? 0.5% of the remaining performing collateral will default or defer per annum.
? Recoveries of 9% with a two-year lag on all defaults and deferrals.
? No prepayments for 10 years and then 1% per annum for the remaining life of the
investment security.
Our investment securities have been modeled using the above assumptions by
? independent third parties using the forward LIBOR curve to discount projected
cash flows to present values.
We recognized no OTTI charges during 2019 or 2018.
Investment securities in our portfolio as of
? residential government-sponsored collateralized mortgage obligations in the
amount of
? agency residential government-sponsored mortgage-backed securities in the
amount of
? corporate bonds in the amount of
? commercial mortgage-backed securities in the amount of
? SBA loan pool securities in the amount of
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? callable agency securities in the amount of
? trust preferred securities in the amount of
is Alesco VII A1B which is rated Aaa (Moody's); and
? municipal bonds in the amount of
with a taxable equivalent yield of 2.9% and ratings as follows:
Moody's Amount
Aaa $ 6,530 AAA $ 6,100 Aa1 6,611 AA+ 6,637 Aa2 3,908 AA 9,799 Aa3 696 AA- 1,816 A1 2,344 A+ 1,008 A2 1,511 A 840 Baa1 1,013 BBB+ 1,013 NA 10,204 NA 5,604 Total$ 32,817 Total$ 32,817
For additional information regarding investment securities refer to "Item 8.
Financial Statements and Supplementary Data, Note 2-
The following table sets forth a summary of the investment securities portfolio
as of the dates indicated. Available for sale investment securities are reported
at fair value, and held to maturity investment securities are reported at
amortized cost (in thousands).
December 31,
2019 2018 2017
Available for sale securities:
Residential government-sponsored mortgage-backed
securities $ 48,979 $ 27,302 $ 30,864
Obligations of states and political subdivisions 17,582 18,055 18,727
Corporate securities 2,012 2,008 2,015
Trust preferred securities 2,568 2,641 2,388
Residential government-sponsored collateralized
mortgage obligations 36,689 43,057 50,766
Government-sponsored agency securities 14,822 3,125 3,226
Agency commercial mortgage-backed securities 27,731 27,304 27,898
SBA pool securities 14,437 19,885 24,789
Total $ 164,820 $ 143,377 $ 160,673
Held to maturity investment securities:
Residential government-sponsored mortgage-backed
securities $ 22,925 $ 9,699 $ 11,500
Obligations of states and political subdivisions 15,071 21,496 22,830
Trust preferred securities 1,938 2,610 3,205
Residential government-sponsored collateralized
mortgage obligations 3,128 6,001 8,727
Government-sponsored agency securities 29,386 52,656 52,650
Total $ 72,448 $ 92,462 $ 98,912
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The following table sets forth the amortized cost, fair value, and weighted average yield of our investment securities by contractual maturity atDecember 31, 2019 . Expected maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties (in thousands). Investment Securities Available for Sale Weighted Amortized Average Cost Fair Value Yield Obligations of states and political subdivisions Due after one year through five years $ 827 $ 840 3.14 % Due after five years through ten years 5,048
5,163 3.06 %
Due after ten years 11,166 11,579 2.71 %
17,041 17,582 2.83 %
Trust preferred securities
Due after ten years 2,530 2,568 7.97 %
Corporate securities
Due after five years through ten years 2,004 2,012 6.13 %
Government-sponsored agency securities
Due after one year through five years 1,500 1,518 2.00 %
Due after five years through ten years 5,350
5,372 3.17 %
Due after ten years 7,973 7,932 2.84 %
14,823 14,822 2.87 %
Residential government-sponsored mortgage-backed
securities
Due after one year through five years 6,708 6,813 2.45 %
Due after five years through ten years 2,947
2,972 2.27 %
Due after ten years 38,885 39,194 2.42 %
48,540 48,979 2.42 %
Residential government-sponsored collateralized
mortgage obligations
Due after five years through ten years 8,565
8,621 2.41 %
Due after ten years 27,946 28,068 2.25 %
36,511 36,689 2.29 %
Agency commercial mortgage-backed securities
Due after one year through five years 25,542 25,671 2.16 %
Due after five years through ten years 2,015 2,060 2.59 %
27,557 27,731 2.19 %
SBA pool securities
Due after one year through five years 134 133 3.99 %
Due after five years through ten years 5,124
5,126 3.31 %
Due after ten years 9,364 9,178 3.84 %
14,622 14,437 3.65 %
$ 163,628 $ 164,820 2.68 %
InvestmentSecurities Held to Maturity
Weighted
Amortized Average
Cost Fair Value Yield
Obligations of states and political subdivisions
Due after one year through five years $ 2,731 $ 2,804 2.12 %
Due after five years through ten years 2,241
2,289 2.78 %
Due after ten years 10,099 10,142 3.37 %
15,071 15,235 3.05 %
Trust preferred securities
Due after ten years 1,938 2,035 3.32 %
Government-sponsored agency securities
Due after five years through ten years 10,000
9,985 2.50 %
Due after ten years 19,386 19,347 2.83 %
29,386 29,332 2.72 %
Residential government-sponsored mortgage-backed
securities
Due after five years through ten years 2,129
2,137 2.07 %
Due after ten years 20,796 20,798 2.52 %
22,925 22,935 2.47 %
Residential government-sponsored collateralized
mortgage obligations
Due after five years through ten years 390
390 2.07 %
Due after ten years 2,738 2,739 2.20 %
3,128 3,129 2.47 %
$ 72,448 $ 72,666 2.70 %
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Deposits and Other Borrowings
The market for deposits is competitive. We offer a line of traditional deposit products that currently include noninterest-bearing and interest-bearing checking (or NOW accounts), commercial checking, money market accounts, savings accounts and certificates of deposit. We compete for deposits through our banking branches with competitive pricing, advertising and online banking. We use deposits as a principal source of funding for our lending, purchasing of investment securities and for other business purposes. Total deposits increased 1.3% to$2.12 billion atDecember 31, 2019 from$2.09 billion atDecember 31, 2018 . Noninterest-bearing demand deposits increased from a year-end 2018 level of$320.0 million to$339.2 million as ofDecember 31, 2019 . Time deposits decreased from$925.4 million to$783.0 million and savings accounts decreased from$151.0 to$144.5 million over the same period. As ofDecember 31, 2019 , we had brokered certificates of deposit in the amount of$114.1 million and brokered money market deposits of$24.4 million . AtDecember 31, 2018 , we had brokered certificates of deposit in the amount of$254.6 , and we had brokered money market deposits of$16.9 million . The following table sets forth the average balance and average rate paid on each of the deposit categories for the years endedDecember 31, 2019 , 2018 and 2017: 2019 2018 2017 Average Average Average Average Average Average Balance Rate Balance Rate Balance Rate (in thousands) Noninterest-bearing demand deposits$ 332,924 $ 336,380 $ 219,107 Interest-bearing deposits: Savings accounts 145,855 0.32 % 159,865 0.32 % 112,868 0.39 % Money market accounts 439,097 1.76 % 328,142 0.93 % 256,746 0.62 % NOW and other demand accounts 360,254 0.83 % 324,797 0.46 % 192,789 0.36 % Time deposits 868,420 2.23 % 808,718 1.63 % 668,566 1.24 % Total interest-bearing deposits 1,813,626 1.69 % 1,621,521 1.12 % 1,230,969 0.89 % Total deposits$ 2,146,550 $ 1,957,902 $ 1,450,076 The variety of deposit accounts we offer allows us to be competitive in obtaining funds and in responding to the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities). Our ability to attract and maintain deposits, and the effect of such retention on our cost of funds, has been, and will continue to be, significantly affected by the general economy and market rates of interest.
The following table sets forth the maturities of certificates of deposit of
Within 3 to 6 6 to 12 Over 12 3 Months Months Months Months Total$ 98,038 $ 95,562 $ 135,869 $ 166,467 $ 495,936 We use borrowed funds to support our liquidity needs and to temporarily satisfy our funding needs from increased loan demand and for other shorter term purposes. We are a member of the FHLB and are authorized to obtain advances from the FHLB from time to time as needed. The FHLB has a credit program for members with different maturities and interest rates, which may be fixed or variable. We are required to collateralize our borrowings from the FHLB with our FHLB stock and other collateral acceptable to the FHLB. AtDecember 31, 2019 and 2018, total FHLB borrowings were$121.6 million and$163.3 million , respectively. AtDecember 31, 2019 , we had$554.3 million of unused and available FHLB lines of credit. Other short-term borrowings can consist of FHLB overnight advances, other FHLB advances maturing within one year, federal funds purchased and securities sold under agreements to repurchase ("repo") that mature within one year, which 60
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are secured transactions with customers. Repo accounts totaling
Other short-term borrowings consist of the following (in thousands):
December 31,
2019 2018 2017
FHLB overnight advances $ 81,000 $ 5,500 $ 56,860 Other short-term FHLB advances maturing 3/10/2020 40,640 - - Other short-term FHLB advances maturing 6/27/2019 - 40,000 - Other short-term FHLB advances maturing 6/18/2019 - 27,200 - Other short-term FHLB advances maturing 6/12/2019 - 10,000 - Other short-term FHLB advances maturing 6/11/2019 - 80,640 - Other short-term FHLB advances maturing 6/27/2018 - - 10,000 Other short-term FHLB advances maturing 6/20/2018 - - 27,200 Other short-term FHLB advances maturing 6/14/2018 - - 10,000 Other short-term FHLB advances maturing 6/13/2018 - - 80,640 Other short-term FHLB advances maturing 6/12/2018 - - 10,000 Other short-term FHLB advances maturing 3/28/2018 - - 30,000 Other short-term FHLB advances maturing 3/14/2018 - - 80,640 Other short-term FHLB advances maturing 3/13/2018 - - 30,275 Total FHLB advances 121,640 163,340 335,615 Securities sold under agreements to repurchase 12,883 18,721 15,468 Total$ 134,523 $
182,061
Weighted average interest rate at year end 1.75 %
2.68 % 1.50 %
For the periods ended
$ 125,340 $ 324,155 $ 177,983 Average interest rate during the year 2.30 %
1.91 % 1.24 %
Maximum month-end outstanding balance$ 174,739 $ 411,511 $ 351,083
Junior Subordinated Debt and Senior Subordinated Notes
OnJanuary 20, 2017 , Southern National completed the sale of$27.0 million of its fixed-to-floating rate Subordinated Notes due 2027 (the "SNBV Senior Subordinated Notes"). The SNBV Senior Subordinated Notes will initially bear interest at 5.875% per annum untilJanuary 31, 2022 ; thereafter, the SNBV Senior Subordinated Notes will be payable at an annual floating rate equal to three-month LIBOR plus a spread of 3.95% until maturity or early redemption. AtDecember 31, 2019 , all of the SNBV Senior Subordinated Notes qualified as Tier 2 capital. AtDecember 31, 2019 , the remaining unamortized debt issuance costs related to the SNBV Senior Subordinated Notes totaled$666 thousand . In connection with our merger with EVBS, the Company assumed$10.3 million (fair value adjustment of$801 thousand ) of trust preferred securities that were issued onSeptember 17, 2003 and placed through the Trust in a pooled underwriting totaling approximately$650 million . The trust issuer has invested the total proceeds from the sale of the trust preferred securities in Floating Rate Junior Subordinated Deferrable Interest Debentures ("Junior Subordinated Debt") issued by EVBS. The trust preferred securities pay cumulative cash distributions quarterly at a variable rate per annum, reset quarterly, equal to the 3-month LIBOR plus 2.95%. As ofDecember 31, 2019 , the interest rate was 4.85%. The dividends paid to holders of the trust preferred securities, which are recorded as interest expense, are deductible for income tax purposes. 61
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The trust preferred securities may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. AtDecember 31, 2019 , all of the trust preferred securities qualified as Tier 1 capital. Subject to certain exceptions and limitations, Southern National is permitted to elect from time to time to defer regularly scheduled interest payments on its outstanding Junior Subordinated Debt relating to its trust preferred securities. If Southern National defers interest payments on the Junior Subordinated Debt for more than 20 consecutive quarters, Southern National would be in default under the governing agreements for such notes and the amount due under such agreements would be immediately due and payable. Also in connection with our merger with EVBS, the Company assumed the Senior Subordinated Note Purchase Agreement previously entered into by EVBS onApril 22, 2015 with certain institutional accredited investors pursuant to which EVBS sold$20.0 million (fair value adjustment of$1.9 million ) in aggregate principal amount of its 6.50% Fixed-to-Floating Rate Subordinated Notes due 2025 (the "EVBS Senior Subordinated Notes") to the investors at a price equal to 100% of the aggregate principal amount of the EVBS Senior Subordinated Notes. AtDecember 31, 2019 all of the EVBS Senior Subordinated Notes qualified as Tier 2 capital.
Interest Rate Sensitivity and Market Risk
We are engaged primarily in the business of investing funds obtained from
deposits and borrowings into interest-earning loans and investments.
Consequently, our earnings depend to a significant extent on our net interest
income, which is the difference between the interest income on loans and other
investments and the interest expense on deposits and borrowings. To the extent
that our interest-bearing liabilities do not reprice or mature at the same time
as our interest-earning assets, we are subject to interest rate risk and
corresponding fluctuations in net interest income. We have employed
asset/liability management policies that seek to manage our net interest income,
without having to incur unacceptable levels of credit or investment risk.
We use simulation modeling to manage our interest rate risk, and review
quarterly interest sensitivity. This approach uses a model which generates
estimates of the change in our economic value of equity ("EVE") over a range of
interest rate scenarios. EVE is the present value of expected cash flows from
assets, liabilities and off-balance sheet contracts using assumptions about
estimated loan prepayment rates, reinvestment rates and deposit decay rates.
The following tables are based on an analysis of our interest rate risk as
measured by the estimated change in EVE resulting from instantaneous and
sustained parallel shifts in the yield curve (plus 400 basis points or minus 100
basis points, measured in 100 basis point increments) as of December 31, 2019
and 2018. All changes are within our Asset/Liability Risk Management Policy
guidelines except for the change resulting from the 100 basis point decrease in
interest rates at December 31, 2019 and 2018.
Sensitivity of Economic Value of Equity
As of December 31, 2019
Economic Value of
Economic Value of Equity Equity as a % of
Change in Interest Rates $ Change % Change Total Equity
in Basis Points (Rate Shock) Amount From Base From Base Assets Book Value
(dollar amounts in thousands)
Up 400 $ 323,871 $ (45,102) (12.22) % 11.90 % 85.85 %
Up 300 336,822 (32,151) (8.71) % 12.37 % 89.29 %
Up 200 349,192 (19,781) (5.36) % 12.83 % 92.56 %
Up 100 363,935 (5,038) (1.37) % 13.37 % 96.47 %
Base 368,973 - - % 13.55 % 97.81 %
Down 100 353,371 (15,602) (4.23) % 12.98 % 93.67 %
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Sensitivity of Economic Value of Equity
As of December 31, 2018
Economic Value of
Economic Value of Equity Equity as a % of
Change in Interest Rates $ Change % Change Total Equity
in Basis Points (Rate Shock) Amount From Base From Base Assets Book Value
(dollar amounts in thousands)
Up 400 $ 338,853 $ (33,298) (8.95) % 12.54 % 97.03 %
Up 300 347,409 (24,742) (6.65) % 12.85 % 99.48 %
Up 200 356,429 (15,722) (4.22) % 13.19 % 102.07 %
Up 100 362,312 (9,839) (2.64) % 13.40 % 103.75 %
Base 372,151 - 0.00 % 13.77 % 106.57 %
Down 100 341,397 (30,754) (8.26) % 12.63 % 97.76 %
Our interest rate sensitivity is also monitored by management through the use of
a model that generates estimates of the change in the net interest income
("NII") over a range of interest rate scenarios. NII depends upon the relative
amounts of interest-earning assets and interest-bearing liabilities and the
interest rates earned or paid on them. In this regard, the model assumes that
the composition of our interest sensitive assets and liabilities existing at
December 31, 2019 and 2018 remains constant over the period being measured and
also assumes that a particular change in interest rates is reflected uniformly
across the yield curve regardless of the duration to maturity or repricing of
specific assets and liabilities. All changes are within our ALM Policy
guidelines at December 31, 2019 and 2018.
Sensitivity of Net Interest Income
As of December 31, 2019
Adjusted Net Interest Income Net Interest Margin
Change in Interest Rates $ Change % Change
in Basis Points (Rate Shock) Amount From Base Percent From Base
(dollar amounts in thousands)
Up 400 $ 74,096 $ (8,158) 3.00 % (0.33) %
Up 300 76,355 (5,899) 3.09 % (0.24) %
Up 200 78,458 (3,796) 3.18 % (0.15) %
Up 100 80,649 (1,605) 3.27 % (0.07) %
Base 82,254 - 3.33 % - %
Down 100 81,273
(981) 3.29 % (0.04) %
Sensitivity of Net Interest Income
As of December 31, 2018
Adjusted Net Interest IncomeNet Interest Margin
Change in Interest Rates $ Change % Change
in Basis Points (Rate Shock) Amount From Base Percent From Base
(dollar amounts in thousands)
Up 400 $ 101,121 $ 9,785 4.05 % 0.35 %
Up 300 97,784 6,448 3.97 % 0.23 %
Up 200 96,305 4,969 3.88 % 0.16 %
Up 100 93,719 2,383 3.78 % 0.07 %
Base 91,336 - 3.70 % - %
Down 100 91,719 383 3.72 % 0.04 % Certain shortcomings are inherent in the methodology used in the above interest rate risk measurements. Modeling changes in EVE requires the making of certain assumptions that may or may not reflect the manner in which actual yields and costs respond to changes in market interest rates. Accordingly, although the EVE tables and NII tables provide an indication of our interest rate risk exposure at a particular point in time, such measurements are not intended to, and do not, provide a precise forecast of the effect of changes in market interest rates on our net worth and NII. Sensitivity of EVE and NII are modeled using different assumptions and approaches.
Liquidity and Funds Management
The objective of our liquidity management is to assure the ability to meet our
financial obligations. These obligations include the payment of deposits on
demand or at maturity, the repayment of borrowings at maturity and the ability
to
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fund commitments and other new business opportunities. We obtain funding from a
variety of sources, including customer deposit accounts, customer certificates
of deposit and payments on our loans and investments. Historically, our level of
core deposits has been insufficient to fully fund our lending activities. As a
result, we have sought funding from additional sources, including institutional
certificates of deposit and the sale of available for sale investment
securities. In addition, we maintain lines of credit with the FHLB of Atlanta ,
federal funds lines of credit with three correspondent banks and utilize
securities sold under agreements to repurchase and reverse repurchase agreement
borrowings from approved securities dealers. For additional information about
borrowings and anticipated principal repayments refer to the discussion about
Contractual Obligations below and "Item 8. Financial Statements and
Supplementary Data, Note 10 - Securities Sold Under Agreements To Repurchase And
Other Short-Term Borrowings and Note 11 - Junior Subordinated Debt and Senior
Subordinated Notes."
We prepare a cash flow forecast on a 30, 60 and 90 day basis along with a one
and a two year basis. The projections incorporate expected cash flows on loans,
investment securities, and deposits based on data used to prepare our interest
rate risk analyses. To estimate loan growth, the projection incorporates the
scheduled loan closings in the Loan Pipeline Report along with other management
estimates.
We have liquidity risk software with which we can monitor our liquidity risk at
a point in time and prepare cash flow and funds availability projections over a
two year period. The projections can be run using a base case and several stress
levels.
During the year ended December 31, 2019 , we funded our financial obligations
with deposits and borrowings from the FHLB of Atlanta . At December 31, 2019 , we
had $324.8 million of unfunded lines of credit and undisbursed construction loan
funds. The amount of certificate of deposit accounts maturing in 2020 is $554.2
million as of December 31, 2019 . Management anticipates that funding
requirements for these commitments can be met from the normal sources of funds.
As of December 31, 2019 , Southern National was not aware of any other known
trends, events or uncertainties that have or are reasonably likely to have a
material impact on our liquidity. As of December 31, 2019 , Southern National has
no material commitments or long-term debt for capital expenditures.
Capital Resources
Capital management consists of providing equity to support both current and
future operations. We and the Bank are subject to risk-based capital adequacy
requirements imposed by the
See "Item 1. Business, Supervision and Regulation-Capital Adequacy Requirements."
The following table provides a comparison of the leverage and risk-weighted
capital ratios of
Minimum
Required for
Capital Actual Ratio at
Adequacy To Be Categorized December 31,
Purposes (1) as Well Capitalized (2) 2019 2018
Sonabank
Common equity tier 1 capital ratio 4.50 % 6.50 % 14.81 % 13.64 %
Tier 1 risk-based capital ratio 6.00 % 8.00 % 14.81 % 13.64 %
Total risk-based capital ratio 8.00 % 10.00 % 15.29 % 14.22 %
Leverage ratio 4.00 % 5.00 % 12.07 % 11.03 %
Once fully phased-in on
a capital conservation buffer of 2.5% that is added on top of each of the (1) minimum risk-based capital ratios noted above. Implementation began on
until it reached 2.5% on January 1, 2019 .
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(2) Prompt corrective action provisions are not applicable at the bank holding
company level.
Impact of Inflation and Changing Prices
The financial statements and related financial data presented in this Annual Report on Form 10-K concerning Southern National have been prepared in accordance withU.S. GAAP, which require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative purchasing power of money over time due to inflation. The primary impact of inflation on our operations is reflected in increased operating costs. Unlike most industrial companies, substantially all of the assets and liabilities of a financial institution are monetary in nature. As a result, changes in interest rates have a more significant impact on our performance than do the effects of changes in the general rate of inflation and changes in prices. Interest rates do not necessarily move in the same direction or in the same magnitude as the prices of goods and services. Many factors impact interest rates, including the FRB, inflation, recession, changes in unemployment, the money supply, and international disorder and instability in domestic and foreign financial markets. Like most financial institutions, changes in interest rates can impact our net interest income which is the difference between interest earned from interest-earning assets, such as loans and investment securities, and interest paid on interest-bearing liabilities, such as deposits and borrowings, as well as the valuation of our assets and liabilities. Our interest rate risk management is the responsibility of the Bank's Asset/Liability Management Committee (the "Asset/Liability Committee"). The Asset/Liability Committee has established policies and limits for management to monitor, measure and coordinate our sources, uses and pricing of funds. The Asset/Liability Committee makes reports to the board of directors on a quarterly basis. Seasonality and Cycles
We do not consider our commercial banking business to be seasonal.
Contractual Obligations
The following table reflects the contractual maturities of our term liabilities as ofDecember 31, 2019 . The amounts shown do not reflect contractual interest, early withdrawal or prepayment assumptions. Contractual Obligations Less Than One to Three to More Than One Year Three Years Five Years Five Years Total (in thousands)
Certificates of deposit (1)$ 554,168 $ 208,186 $
20,686 $ - $ 783,040
Repurchase agreements 12,883 - - - 12,883
FHLB advances-short term 121,640 - - - 121,640
Junior subordinated debt - - - 10,310 10,310
Senior subordinated notes - - - 47,000 47,000
Operating leases 2,386 3,139 2,067 1,654 9,246
Total $ 691,077 $ 211,325 $ 22,753 $ 58,964 $ 984,119 Certificates of deposit give customers rights to early withdrawal. Early (1) withdrawals may be subject to penalties. The penalty amount depends on the
remaining time to maturity at the time of early withdrawal.
Off-Balance Sheet Arrangements
Southern National is a party to 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 guarantees of credit card accounts sold by EVBS
premerger. These instruments involve elements of credit and funding risk in
excess of the amount recognized in the consolidated balance sheet. Letters of
credit are written conditional commitments issued by Southern National to
guarantee the performance of a customer to a third party. The
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credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers. We had letters of credit outstanding totaling$17.7 million and$19.2 million as ofDecember 31, 2019 and 2018, respectively. Our exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit is based on the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. Unless noted otherwise, we do not require collateral or other security to support financial instruments with credit risk. 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 are made predominately for adjustable rate loans, and generally have fixed expiration dates of up to three months or other termination clauses and usually require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements. We evaluate each customer's creditworthiness on a case-by-case basis.
At
Premerger, EVBS sold its credit card portfolio. With that sale, EVBS guaranteed the credit card accounts of certain customers to the bank that issues the cards. In connection with the merger with EVBS, Southern National now is the guarantor. The fair value of guarantees of credit card accounts previously sold is based on the estimated cost to settle the obligations with the counterparty and are not considered significant as ofDecember 31, 2019 .
Item 7A. Quantitative and Qualitative Disclosures about Market Risk
This information is incorporated herein by reference from "Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations" of this Annual Report on Form 10-K.
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