Primis Financial Corp. annual report, FY2012

Business context and reporting period

This is Southern National Bancorp of Virginia, Inc.’s Form 10-K for the fiscal year ended December 31, 2012, filed March 5, 2013. The filing does not identify the registrant as Primis Financial Corp.; investors should verify the entity and ticker when matching this filing to the request. Southern National was the holding company for Sonabank, a community bank focused on commercial, real-estate and SBA lending in Virginia and Maryland. The filing reports annual results and unaudited quarterly data, including fourth-quarter 2012.

Growth included the April 2012 FDIC-assisted acquisition of HarVest Bank of Maryland, which added four branches, $140.5 million in deposits and $52.0 million in loans. Unlike Greater Atlantic’s acquired assets, HarVest loans were not covered by an FDIC loss-sharing agreement.

Financial performance and condition

Fourth-quarter 2012 net income was $1.3 million, or $0.11 per diluted share, versus $1.2 million and $0.10 in the third quarter. Q4 net interest income was $8.1 million and income before tax was $1.9 million.

At year-end, total assets were $723.8 million, loans net of deferred fees were $530.2 million, deposits were $551.0 million and shareholders’ equity was $103.2 million. Versus year-end 2011, assets rose 18%, loans 8% and deposits 20%; the HarVest acquisition contributed to the increases.

Operating cash flow was $10.8 million, compared with $13.2 million in 2011. Cash and cash equivalents increased to $39.2 million from $5.0 million. Investing activities provided $77.6 million, including $47.3 million of net cash from the HarVest acquisition; financing activities used $54.3 million. Total period-end borrowings were $63.7 million: $33.4 million of short-term borrowings and $30.3 million of FHLB advances.

Liquidity considerations include $183.9 million of certificates of deposit maturing in 2013 and the company’s stated reliance on wholesale funding as local deposits have not fully funded lending activity. It reported $108.4 million of additional available FHLB borrowing capacity. Brokered certificates of deposit were nil; brokered money-market deposits were $10.2 million.

Sonabank’s year-end regulatory capital ratios remained well above “well-capitalized” thresholds: leverage 13.59%, Tier 1 risk-based 18.18% and total risk-based 19.43%. Non-covered nonperforming assets were $20.8 million, or 4.41% of non-covered loans and OREO, up from $18.2 million and 4.30% a year earlier. Total real-estate loans represented 80.5% of loans. The allowance for loan losses was $7.1 million; the reported net charge-offs-to-average-loans ratio was 1.04%.

Material changes and unusual items

• Net income improved year over year as net interest income increased and the loan-loss provision fell. Noninterest expense rose $3.9 million to $18.8 million, reflecting added branches and staff, merger costs, and $1.1 million of audit and consulting fees related to the restatement.
• Reported noninterest income included a $3.5 million HarVest bargain-purchase gain. Results also included $2.6 million of net OREO losses and $717,000 of credit-related impairment charges on trust preferred securities. The bargain-purchase gain and these credit and property items affect comparability and earnings quality.
• Management reduced its expected losses on Greater Atlantic covered loans; the resulting updated estimate reduced expected FDIC recoveries. The FDIC indemnification asset was $6.7 million at year-end, while the company estimated it would recover $5.0 million.
• In 2012, four loans totaling $4.3 million were modified as troubled debt restructurings. Management reported that they remained accruing and had not subsequently defaulted as of the filing.
• The company restated previously issued 2009 and 2010 statements and interim periods through September 2011 for errors in Greater Atlantic purchase accounting, principally an overstated FDIC indemnification asset and incorrect acquired-loan discount accretion. The 2010 net income was restated from $1.8 million to $4.1 million; the previously reported $11.2 million 2009 acquisition gain was removed.

Outlook, risks and controls

The filing provides no specific earnings, revenue or growth guidance. Management described plans for relationship-based lending, core-deposit growth, selective acquisitions and controlled expansion, while emphasizing asset quality and capital. Key risks include concentrated real-estate and construction lending, further deterioration in local property markets or borrower credit, liquidity and deposit competition, interest-rate changes, impairment of trust preferred securities or goodwill, and execution and integration risks from acquisitions. FDIC loss-share reimbursements depend on compliance with detailed servicing and reporting requirements.

KPMG issued unqualified opinions on the 2012 consolidated financial statements and internal control over financial reporting. Management stated that the previously reported material weakness in controls over non-routine transactions had been remediated; control processes included third-party valuation assistance and additional management and audit-committee review. The history of restatement makes continued control effectiveness and purchase-accounting estimates important areas to monitor.

Investor verification priorities

• Confirm the registrant identity and ticker: the filing is for Southern National Bancorp of Virginia, Inc. (Nasdaq: SONA), not under the Primis Financial Corp. name.
• Assess recurring earnings apart from the $3.5 million acquisition gain, OREO losses, securities impairment and restatement-related costs; review the quarter-by-quarter results and noninterest expense detail.
• Review nonperforming assets, criticized and classified loans, collateral values, the allowance methodology, and whether credit trends improved or worsened after year-end.
• Evaluate liquidity and funding concentrations, especially 2013 CD maturities, wholesale funding reliance, and the availability and terms of FHLB capacity.
• Track HarVest loan performance and integration separately from Greater Atlantic covered loans, including the FDIC indemnification estimate and compliance with loss-share terms.
• Verify capital, dividend capacity and actual distributions: the company declared regular and special dividends in 2012, but future dividends depend on bank earnings, capital and regulatory limits.