Table ofContents

 

 

 

**USSecurities and Exchange Commission**

**Washington,DC 20549**

 

**Form 10-Q**

** **

**QuarterlyReport Pursuant To Section 13 or 15(d)**

**Of the Securities Exchange Act of 1934**

**For the Quarterly Period Ended June 30, 2009**

 

**CommissionFile Number 000-52099**

 

**YadkinValley Financial Corporation**

**(Exact name of registrant specified in its charter)**

** **

| **North  Carolina**          | ** ** | **20-4495993**                           |
|------------------------------|------------|------------------------------------------|
| **(State of Incorporation)** | ** ** | **(I.R.S. Employer Identification No.)** |

** **

**209 NorthBridge Street, Elkin, North Carolina 28621**

**(addressof principal executive offices)**

 

**336-526-6300**

**(Registrant’stelephone number, including area code)**

 

Indicateby check mark whether the registrant (1) has filed all reports required tobe filed by Section 13 or 15(d) of the Securities Exchange Act of1934 during the preceding 12 months (or for such shorter period that theregistrant was required to file such reports), and (2) has been subject tosuch filing requirements for the past 90 days. Yes þ No o

 

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

 
| Large  accelerated filer o | Accelerated  filer þ | Non-accelerated  filer o | Smaller  reporting company o |
|----------------------------|---------------------------|--------------------------|------------------------------|

 

Indicate by checkmark whether the registrant is a shell company (as defined in Rule 12b-2of the Exchange Act).  Yes oNo þ

 

Indicate by checkmark whether the registrant has submitted electronically and posted on itscorporate Web site, if any, every Interactive Data File required to besubmitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 ofthis chapter) during the preceding 12 months (or for such shorter period thatthe registrant was required to submit and post such files).  o Yes   oNo

 

Common sharesoutstanding as of June 30, 2009, par value $1.00 per share, were16,129,640.

 

 

 

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Table of Contents

 

**Part I.     Financial Information**

 
| Item 1.  Financial Statements                                                                                            |   |
|--------------------------------------------------------------------------------------------------------------------------|--------|
|                                                                                                                     |   |
| Condensed Consolidated Balance Sheets June 30,  2009 and December 31, 2008                                     | 3      |
|                                                                                                                     |   |
| Condensed Consolidated Statements of Income (Loss)  Three and Six Months Ended June 30, 2009 and 2008               | 4      |
|                                                                                                                     |   |
| Condensed Consolidated Statements of Comprehensive  Income (Loss) Three and Six Months Ended June 30, 2009 and 2008 | 5      |
|                                                                                                                     |   |
| Condensed Consolidated Statement of Stockholders’  Equity Six Months Ended June 30, 2009                       | 6      |
|                                                                                                                     |   |
| Condensed Consolidated Statements of Cash Flows Six  Months Ended June 30, 2009 and 2008                            | 7      |
|                                                                                                                     |   |
| Notes to Unaudited Condensed Consolidated Financial  Statements                                                          | 8-29   |
|                                                                                                                     |   |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                      | 29-42  |
|                                                                                                                     |   |
| Item 3.  Quantitative and Qualitative Disclosures About Market Risk                                                      | 42     |
|                                                                                                                     |   |
| Item 4. Controls and Procedures                                                                                          | 43-45  |
|                                                                                                                     |   |
| **Part II.  Other Information**                                                                                     |   |
|                                                                                                                     |   |
| Item 2. Unregistered Sale of Equity Securities and Use  of Proceeds                                                      | 45     |
|                                                                                                                     |   |
| Item 4. Submission of Matters to Vote of Security Holders                                                                | 45     |
|                                                                                                                     |   |
| Item 6.  Exhibit Index                                                                                              | 46     |
|                                                                                                                     |   |
| Signatures                                                                                                               | 48     |
|                                                                                                                     |   |
| Exhibits                                                                                                                 | 49-51  |

 

Yadkin ValleyFinancial Corporation

Form 10-Q QuarterlyReport June 30, 2009

 

2

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Table ofContents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| ** **                                                                                                 | ** ** | **June 30,** | ** **    | **December 31,** | ** ** |
|------------------------------------------------------------------------------------------------------------|------------|-------------------|---------------|-----------------------|------------|
| ** **                                                                                                 | ** ** | **2009**          | ** **    | **2008***             | ** ** |
| **ASSETS**                                                                                                 | ** ** | ** **        | ** **    | ** **            | ** ** |
|                                                                                                       |       |              |          |                  |       |
| CASH AND CASH EQUIVALENTS                                                                                  |       |              |          |                  |       |
| Cash and due from banks                                                                                    |       | $                 | 39,586,112    |                  | $          | 22,553,561 |   |
| Federal funds sold                                                                                         |       | 362,489           |          | 58,000                |       |
| Interest-bearing deposits                                                                                  |       | 5,149,806         |          | 3,410,977             |       |
| TOTAL CASH AND CASH EQUIVALENTS                                                                            |       | 45,098,407        |          | 26,022,538            |       |
|                                                                                                       |       |              |          |                  |       |
| SECURITIES AVAILABLE FOR SALE-At fair value(Amortized cost $193,133,670 in 2009  and $134,533,342 in 2008) |       | 196,228,853       |          | 137,813,529           |       |
|                                                                                                       |       |              |          |                  |       |
| GROSS LOANS                                                                                                |       | 1,641,096,695     |          | 1,187,568,945         |       |
| Less: Allowance for loan losses                                                                            |       | (46,242,719       | )             | (22,355,231           | )          |
| NET LOANS                                                                                                  |       | 1,594,853,976     |          | 1,165,213,714         |       |
|                                                                                                       |       |              |          |                  |       |
| LOANS HELD FOR SALE                                                                                        |       | 121,141,524       |          | 49,929,375            |       |
|                                                                                                       |       |              |          |                  |       |
| ACCRUED INTEREST RECEIVABLE                                                                                |       | 7,379,959         |          | 5,441,754             |       |
|                                                                                                       |       |              |          |                  |       |
| PREMISES AND EQUIPMENT, NET                                                                                |       | 44,530,663        |          | 33,899,915            |       |
|                                                                                                       |       |              |          |                  |       |
| FORECLOSED REAL ESTATE                                                                                     |       | 7,769,159         |          | 4,017,880             |       |
|                                                                                                       |       |              |          |                  |       |
| FEDERAL HOME LOAN BANK STOCK, AT COST                                                                      |       | 10,539,400        |          | 7,876,800             |       |
|                                                                                                       |       |              |          |                  |       |
| INVESTMENT IN BANK-OWNED LIFE INSURANCE                                                                    |       | 24,073,225        |          | 23,607,675            |       |
|                                                                                                       |       |              |          |                  |       |
| GOODWILL                                                                                                   |       | 66,509,528        |          | 53,502,887            |       |
|                                                                                                       |       |              |          |                  |       |
| CORE DEPOSIT INTANGIBLE (net of accumulated  amortizationof $5,670,338 in 2009 and $5,095,371 in 2008)     |       | 6,851,523         |          | 4,660,116             |       |
|                                                                                                       |       |              |          |                  |       |
| OTHER ASSETS                                                                                               |       | 33,383,445        |          | 12,301,838            |       |
|                                                                                                       |       |              |          |                  |       |
| TOTAL ASSETS                                                                                               |       | $                 | 2,158,359,662 |                  | $          | 1,524,288,021 |   |
|                                                                                                       |       |              |          |                  |       |
| **LIABILITIES AND STOCKHOLDERS’  EQUITY**                                                             | ** ** | ** **        | ** **    | ** **            | ** ** |
| ** **                                                                                                 | ** ** | ** **        | ** **    | ** **            | ** ** |
| DEPOSITS                                                                                                   |       |              |          |                  |       |
| Noninterest-bearing demand deposits                                                                        |       | $                 | 201,846,031   |                  | $          | 153,573,487 |   |
| Interest-bearing deposits:                                                                                 |       |              |          |                  |       |
| NOW, savings, and money market accounts                                                                    |       | 396,238,405       |          | 283,890,757           |       |
| Time certificates:                                                                                         |       |              |          |                  |       |
| Over $100,000                                                                                              |       | 554,704,375       |          | 333,375,040           |       |
| Other                                                                                                      |       | 625,371,223       |          | 384,202,791           |       |
| TOTAL DEPOSITS                                                                                             |       | 1,778,160,034     |          | 1,155,042,075         |       |
|                                                                                                       |       |              |          |                  |       |
| SHORT-TERM BORROWINGS                                                                                      |       | 105,869,562       |          | 169,111,959           |       |
|                                                                                                       |       |              |          |                  |       |
| LONG-TERM BORROWINGS                                                                                       |       | 46,886,254        |          | 38,849,795            |       |
|                                                                                                       |       |              |          |                  |       |
| ACCRUED INTEREST PAYABLE                                                                                   |       | 3,534,422         |          | 3,554,522             |       |
|                                                                                                       |       |              |          |                  |       |
| OTHER LIABILITIES                                                                                          |       | 20,440,689        |          | 8,085,348             |       |
|                                                                                                       |       |              |          |                  |       |
| TOTAL LIABILITIES                                                                                          |       | 1,954,890,961     |          | 1,374,643,699         |       |
|                                                                                                       |       |              |          |                  |       |
| STOCKHOLDERS’ EQUITY                                                                                  |       |              |          |                  |       |
| Common stock *(a)*                                                                                         |       | 16,129,640        |          | 11,536,500            |       |
| Preferred Stock *(b)*                                                                                      |       | 34,422,000        |          | —                |       |
| Surplus *(c)*                                                                                              |       | 116,267,544       |          | 88,030,481            |       |
|                                                                                                       |       |              |          |                  |       |
| Retained earnings                                                                                          |       | 34,725,327        |          | 48,070,348            |       |
| Accumulated other comprehensive income                                                                     |       | 1,924,190         |          | 2,006,993             |       |
| TOTAL STOCKHOLDERS’ EQUITY                                                                            |       | 203,468,701       |          | 149,644,322           |       |
|                                                                                                       |       |              |          |                  |       |
| TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY                                                            |       | $                 | 2,158,359,662 |                  | $          | 1,524,288,021 |   |

 

----

*(a)  $1.00 par value, authorized 20,000,000 shares;issued 16,129,640 in 2009 and 11,536,500 in 2008.*

*(b)  1,000,000 shares of authorized, no par valuepreferred stock of which 36,000 shares are issued and outstanding in 2009****and none in 2008.*

*(c)   Includes a ten-year warrant with an allocatedfair value of $1.7 million at issuance to purchase**up to 385,990 shares ofcommon stock, $1.00 par value, at an initial price of $13.99 per share.*

 

See notes to condensed consolidated financialstatements

 

* Derived from audited consolidated financialstatements

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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Table ofContents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OFINCOME (LOSS) *(UNAUDITED)***

**THREEAND SIX MONTHS ENDED JUNE 30, 2009 AND 2008**

 
| ** **                                                             | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                             | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                             | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| INTEREST INCOME                                                        |       |                   |       |                 |       |   |   |   |   |
| Interest and fees on loans                                             |       | $                      | 23,935,899 |                 | $          | 17,223,085 |   | $ | 39,963,721 |   | $ | 33,436,771 |   |
| Interest on federal funds sold                                         |       | 836                    |       | 26,230               |       | 2,249 |   | 36,876 |   |
| Interest on securities:                                                |       |                   |       |                 |       |   |   |   |   |
| Taxable                                                                |       | 1,363,564              |       | 1,344,168            |       | 2,538,005 |   | 2,649,631 |   |
| Non-taxable                                                            |       | 512,566                |       | 373,136              |       | 897,608 |   | 741,732 |   |
| Interest-bearing deposits                                              |       | 10,469                 |       | 134,371              |       | 21,298 |   | 139,112 |   |
| Total interest income                                                  |       | 25,823,334             |       | 19,100,990           |       | 43,422,881 |   | 37,004,122 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| INTEREST EXPENSE                                                       |       |                   |       |                 |       |   |   |   |   |
| Time deposits of $100,000 or more                                      |       | 3,733,396              |       | 2,726,486            |       | 6,834,851 |   | 5,682,475 |   |
| Other deposits                                                         |       | 3,753,372              |       | 4,984,912            |       | 7,712,971 |   | 9,510,414 |   |
| Borrowed funds                                                         |       | 782,086                |       | 1,016,501            |       | 1,406,950 |   | 2,081,145 |   |
| Total interest expense                                                 |       | 8,268,854              |       | 8,727,899            |       | 15,954,772 |   | 17,274,034 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NET INTEREST INCOME                                                    |       | 17,554,480             |       | 10,373,091           |       | 27,468,109 |   | 19,730,088 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| PROVISION FOR LOAN LOSSES                                              |       | 16,457,802             |       | 1,708,000            |       | 27,007,307 |   | 2,158,000 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES                    |       | 1,096,678              |       | 8,665,091            |       | 460,802 |   | 17,572,088 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NONINTEREST INCOME                                                     |       |                   |       |                 |       |   |   |   |   |
| Service charges on deposit accounts                                    |       | 1,535,326              |       | 1,065,379            |       | 2,582,645 |   | 2,074,546 |   |
| Other service fees                                                     |       | 1,365,008              |       | 876,949              |       | 2,429,806 |   | 1,740,816 |   |
| Net gain on sales of mortgage loans                                    |       | 4,801,695              |       | 1,784,383            |       | 8,000,782 |   | 3,556,678 |   |
| Net loss on investment securities                                      |       | —                 |       | (6,575               | )          | — |   | (6,575 | ) |
| Income on investment in bank owned life insurance                      |       | 234,157                |       | 235,462              |       | 465,550 |   | 468,462 |   |
| Mortgage banking income (loss)                                         |       | (207,212               | )          | 68,350               |       | (514,175 | ) | 78,107 |   |
| Other income (loss)                                                    |       | (121,673               | )          | 23,135               |       | (82,270 | ) | 64,491 |   |
| Total noninterest income                                               |       | 7,607,301              |       | 4,047,083            |       | 12,882,338 |   | 7,976,525 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NONINTEREST EXPENSE                                                    |       |                   |       |                 |       |   |   |   |   |
| Salaries and employee benefits                                         |       | 8,299,605              |       | 5,047,528            |       | 13,926,269 |   | 9,915,504 |   |
| Occupancy and equipment expenses                                       |       | 1,842,493              |       | 1,294,144            |       | 3,169,567 |   | 2,270,593 |   |
| Printing and supplies                                                  |       | 272,112                |       | 195,555              |       | 504,179 |   | 380,532 |   |
| Data processing                                                        |       | 427,111                |       | 270,990              |       | 559,960 |   | 383,410 |   |
| Communication expense                                                  |       | 329,460                |       | 277,847              |       | 652,046 |   | 486,318 |   |
| Advertising and marketing expense                                      |       | 212,774                |       | 152,229              |       | 589,030 |   | 335,807 |   |
| Amortization of core deposit intangible                                |       | 349,571                |       | 235,357              |       | 574,967 |   | 422,865 |   |
| FDIC assessment expense                                                |       | 1,797,000              |       | 190,778              |       | 2,459,088 |   | 243,177 |   |
| Acquisition related costs                                              |       | 2,192,056              |       | 106,399              |       | 2,302,054 |   | 106,399 |   |
| Attorney fees                                                          |       | 408,890                |       | 86,116               |       | 523,199 |   | 129,006 |   |
| Other                                                                  |       | 2,922,678              |       | 2,295,741            |       | 5,406,733 |   | 4,121,754 |   |
| Loss on other than temporary impairment of  securities                 |       | —                 |       | —               |       | 179,493 |   | — |   |
| Total noninterest expense                                              |       | 19,053,751             |       | 10,152,684           |       | 30,846,585 |   | 18,795,365 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| INCOME (LOSS) BEFORE INCOME TAXES                                      |       | (10,349,772            | )          | 2,559,490            |       | (17,503,445 | ) | 6,753,248 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| INCOME TAX EXPENSE (BENEFIT)                                           |       | (3,795,259             | )          | 832,566              |       | (6,789,528 | ) | 2,112,011 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NET INCOME (LOSS)                                                      |       | (6,554,513             | )          | 1,726,924            |       | (10,713,917 | ) | 4,641,237 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| Preferred stock dividend and amortization of  preferred stock discount |       | 528,000                |       | —               |       | 973,000 |   | — |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NET INCOME (LOSS) TO COMMON SHAREHOLDERS                               |       | $                      | (7,028,513 | )                    | $          | 1,726,924 |   | $ | (11,686,917 | ) | $ | 4,641,237 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| NET INCOME (LOSS) TO COMMON SHAREHOLDERS PER COMMON  SHARE:            |       |                   |       |                 |       |   |   |   |   |
| Basic                                                                  |       | $                      | (0.46      | )                    | $          | 0.15 |   | $ | (0.87 | ) | $ | 0.42 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| Diluted                                                                |       | $                      | (0.46      | )                    | $          | 0.15 |   | $ | (0.87 | ) | $ | 0.42 |   |
|                                                                   |       |                   |       |                 |       |   |   |   |   |
| CASH DIVIDENDS PER COMMON SHARE                                        |       | $                      | 0.06       |                 | $          | 0.13 |   | $ | 0.12 |   | $ | 0.26 |   |

 

See notes to condensed consolidated financialstatements

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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Table ofContents

 

 

**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS) (UNAUDITED)**

**THREE AND SIX MONTHS ENDED JUNE 30, 2009 AND 2008**

 
| ** **                                                                      | ** ** | **Three Months Ended** | ** ** | **Six Months Ended** | ** ** |
|---------------------------------------------------------------------------------|------------|------------------------|------------|----------------------|------------|
| ** **                                                                      | ** ** | **June 30,**      | ** ** | **June 30,**    | ** ** |
| ** **                                                                      | ** ** | **2009**               | ** ** | **2008**             | ** ** | **2009** | ** ** | **2008** | ** ** |
| ** **                                                                      | ** ** | ** **             | ** ** | ** **           | ** ** | ** ** | ** ** | ** ** | ** ** |
| NET INCOME (LOSS)                                                               |       | $                      | (6,554,513 | )                    | $          | 1,726,924 |   | $ | (10,713,917 | ) | $ | 4,641,237 |   |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| OTHER COMPREHENSIVE INCOME  (LOSS), BEFORE TAX:                                 |       |                   |       |                 |       |   |   |   |   |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| Unrealized holding gains  (losses) on securities available for sale             |       | 291,798                |       | (3,366,383           | )          | (185,118 | ) | (1,698,370 | ) |
| Tax effect                                                                      |       | (81,298                | )          | 1,296,056            |       | 102,315 |   | 653,872 |   |
| Unrealized holding gains  (losses) on securities available for sale, net of tax |       | 210,500                |       | (2,070,327           | )          | (82,803 | ) | (1,044,498 | ) |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| Reclassification  adjustment for realized losses                                |       | —                 |       | 6,575                |       | — |   | 6,575 |   |
| Tax effect                                                                      |       | —                 |       | (2,531               | )          | — |   | (2,531 | ) |
| Reclassification  adjustment for realized (gains) losses, net of tax            |       | —                 |       | 4,044                |       | — |   | 4,044 |   |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| OTHER COMPREHENSIVE INCOME  (LOSS), NET OF TAX                                  |       | 210,500                |       | (2,066,283           | )          | (82,803 | ) | (1,040,454 | ) |
|                                                                            |       |                   |       |                 |       |   |   |   |   |
| COMPREHENSIVE INCOME  (LOSS)                                                    |       | $                      | (6,344,013 | )                    | $          | (339,359 | ) | $ | (10,796,720 | ) | $ | 3,600,783 |   |

 

See notes to condensed consolidated financialstatements

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

5

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Table ofContents

 

**YADKINVALLEY FINANCIAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (UNAUDITED)**

**FOR THESIX MONTHS ENDED JUNE 30, 2008 and 2009**

 
| ** **                                                                       | ** ** | **Common  Stock** | ** ** | **Preferred  Stock** | ** ** | **Surplus** | ** ** | **Retained  Earnings** | ** **  | **Accumulated  Other  Comprehensive  Income** | ** ** | **Total  Stockholders’  Equity** | ** ** |
|----------------------------------------------------------------------------------|------------|-------------------|------------|----------------------|------------|-------------|------------|------------------------|-------------|-----------------------------------------------|------------|---------------------------------------|------------|
| Balance, December 31, 2007*                                                 |       | $                 | 10,563,356 |                 | $          | —      |       | $                      | 70,986,684  |                                          | $          | 51,086,684                            |       | $ | 632,270 |   | $ | 133,268,994 |   |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Net income                                                                       |       | —            |       | —               |       | —      |       | 4,641,237              |        | —                                        |       | 4,641,237                             |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Shares issued under stock option plan                                            |       | 68,700            |       | —               |       | 385,252     |       | —                 |        | —                                        |       | 453,952                               |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Stock option compensation                                                        |       | —            |       | —               |       | 29,401      |       | —                 |        | —                                        |       | 29,401                                |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Tax benefit from exercise of stock options                                       |       | —            |       | —               |       | 252,250     |       | —                 |        | —                                        |       | 252,250                               |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Cumulative effect of adoption of EITF 06-04                                      |       | —            |       | —               |       | —      |       | (1,966,465             | )           | —                                        |       | (1,966,465                            | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Common cash dividends declared                                                   |       | —            |       | —               |       | —      |       | (2,985,767             | )           | —                                        |       | (2,985,767                            | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Fractional shares purchased                                                      |       | (59               | )          |                 |       | 2           |       |                   |        |                                          |       | (57                                   | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Shares issued in acquisition of Cardinal State Bank                              |       | 883,810           |       | —               |       | 16,192,580  |       | —                 |        | —                                        |       | 17,076,390                            |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Other comprehensive income                                                       |       | —            |       | —               |       | —      |       | —                 |        | (1,040,454                                    | )          | (1,040,454                            | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Balance, June 30, 2008                                                      |       | $                 | 11,515,807 |                 | $          | —      |       | $                      | 87,846,169  |                                          | $          | 50,775,689                            |       | $ | (408,184 | ) | $ | 149,729,481 |   |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Balance, December 31, 2008*                                                 |       | 11,536,500        |       | —               |       | 88,030,481  |       | 48,070,348             |        | 2,006,993                                     |       | 149,644,322                           |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Net loss                                                                         |       | —            |       | —               |       | —      |       | (10,713,917            | )           | —                                        |       | (10,713,917                           | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Shares issued under stock option plan                                            |       | 8                 |       |                 |       | 111         |       |                   |        |                                          |       | 119                                   |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Preferred stock issued                                                           |       | —            |       | 36,000,000           |       | —      |       | —                 |        | —                                        |       | 36,000,000                            |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Preferred stock discount                                                         |       | —            |       | (1,731,000           | )          | —      |       | —                 |        | —                                        |       | (1,731,000                            | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Warrant issued                                                                   |       | —            |       | —               |       | 1,731,000   |       | —                 |        | —                                        |       | 1,731,000                             |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Discount accretion of preferred stock warrants                                   |       | —            |       | 153,000              |       | —      |       | (153,000               | )           | —                                        |       | —                                |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Stock option compensation                                                        |       | —            |       | —               |       | 36,513      |       | —                 |        | —                                        |       | 36,513                                |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Preferred stock dividends accrued                                                |       | —            |       | —               |       | —      |       | (820,000               | )           | —                                        |       | (820,000                              | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Common cash dividends declared                                                   |       | —            |       | —               |       | —      |       | (1,658,104             | )           | —                                        |       | (1,658,104                            | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Common shares issued in acquisition of American  Community Bancshares, Inc. |       | 4,593,132         |       |                 |       | 26,469,439  |       |                   |        |                                          |       | 31,062,571                            |       |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Other comprehensive loss                                                         |       | —            |       | —               |       | —      |       | —                 |        | (82,803                                       | )          | (82,803                               | )          |
|                                                                             |       |              |       |                 |       |        |       |                   |        |                                          |       |                                  |       |
| Balance, June 30, 2009                                                      |       | $                 | 16,129,640 |                 | $          | 34,422,000  |       | $                      | 116,267,544 |                                          | $          | 34,725,327                            |       | $ | 1,924,190 |   | $ | 203,468,701 |   |

 

See notes to condensed consolidated financialstatements

 

----

* Derivedfrom audited consolidated financial statements

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

6

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Table of Contents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)**

**SIXMONTHS ENDED JUNE 30, 2009 AND 2008**

 
| ** **                                                                                         | ** ** | **2009**       | ** **  | **2008**     | ** ** |
|----------------------------------------------------------------------------------------------------|------------|----------------|-------------|--------------|------------|
| ** **                                                                                         | ** ** | ** **     | ** **  | ** **   | ** ** |
| CASH FLOWS FROM OPERATING  ACTIVITIES:                                                             |       |           |        |         |       |
| Net income (loss)                                                                                  |       | $              | (10,713,917 | )            | $          | 4,641,237 |   |
| Adjustments to reconcile  net income(loss) to net cash provided by (used in) operating activities: |       |           |        |         |       |
| Net amortization  (accretion) of premiums (discounts) on investment securities                     |       | 215,411        |        | (19,112      | )          |
| Provision for loan losses                                                                          |       | 27,007,307     |        | 2,158,000    |       |
| Net gain on sales of  mortgage loans held for sale                                                 |       | (8,000,782     | )           | (3,556,678   | )          |
| Increase in investment in  Bank owned life insurance                                               |       | (465,550       | )           | (465,901     | )          |
| Depreciation and  amortization                                                                     |       | 1,238,298      |        | 973,532      |       |
| Amortization of fixed  asset fair value                                                            |       | 13,279         |        | 2,059        |       |
| Net loss on sale of  premises and equipment                                                        |       | —         |        | 50,376       |       |
| Net loss on sale of other  real estate owned                                                       |       | 150,796        |        | —       |       |
| Net loss on sale of  available for sale securities                                                 |       | —         |        | 6,575        |       |
| Other than temporary  impairment of cost method investments                                        |       | 179,493        |        | —       |       |
| Amortization of core  deposit intangible                                                           |       | 574,967        |        | 422,865      |       |
| Deferred tax benefit                                                                               |       | (9,315,797     | )           | (996,511     | )          |
| Stock based compensation  expense                                                                  |       | 36,513         |        | 29,401       |       |
| Originations of mortgage  loans held-for-sale                                                      |       | (1,140,113,841 | )           | (437,320,771 | )          |
| Proceeds from sales of  mortgage loans                                                             |       | 1,076,902,474  |        | 446,488,486  |       |
| Decrease in accrued  interest receivable                                                           |       | 55,628         |        | 798,810      |       |
| (Increase) decrease in  other assets                                                               |       | (2,273,567     | )           | 514,930      |       |
| Decrease in accrued  interest payable                                                              |       | (608,432       | )           | (654,678     | )          |
| Increase (decrease) in  other liabilities                                                          |       | 8,488,996      |        | (709,387     | )          |
|                                                                                               |       |           |        |         |       |
| Net cash provided by (used  in) operating activities                                               |       | (56,628,724    | )           | 12,363,233   |       |
|                                                                                               |       |           |        |         |       |
| CASH FLOWS FROM INVESTING  ACTIVITIES:                                                             |       |           |        |         |       |
| Purchases of available for  sale securities                                                        |       | (20,723,113    | )           | (22,160,971  | )          |
| Proceeds from sales of  available for sale securities                                              |       | —         |        | 7,160,178    |       |
| Proceeds from maturities  of available for sale securities                                         |       | 32,977,968     |        | 15,114,000   |       |
| Net change in loans                                                                                |       | (44,903,939    | )           | (26,564,874  | )          |
| Acquisition of Cardinal  State Bank, net of cash acquired                                          |       | —         |        | 11,985,011   |       |
| Acquisition of American  Community Bancshares, net of cash acquired                                |       | 2,043,289      |        | —       |       |
| Purchases of premises and  equipment                                                               |       | (2,654,626     | )           | (1,219,720   | )          |
| Proceeds from redemption  of Federal Home Loan Bank stock                                          |       | 1,851,100      |        | 283,500      |       |
| Purchases of Federal Home  Loan Bank stock                                                         |       | (2,385,300     | )           | (3,942,100   | )          |
| Proceeds from sale of  premises and equipment                                                      |       | 169,989        |        | 257,391      |       |
| Proceeds from sale of  other real estate owned                                                     |       | 1,125,646      |        | —       |       |
|                                                                                               |       |           |        |         |       |
| Net cash used in investing  activities                                                             |       | (32,498,986    | )           | (19,087,585  | )          |
|                                                                                               |       |           |        |         |       |
| CASH FLOWS FROM FINANCING  ACTIVITIES:                                                             |       |           |        |         |       |
| Net increase (decrease) in  checking, NOW, money market and savings accounts                       |       | 27,856,853     |        | (5,404,718   | )          |
| Net increase (decrease) in  time certificates                                                      |       | 155,312,048    |        | (32,898,769  | )          |
| Net increase (decrease) in  borrowed funds                                                         |       | (108,873,003   | )           | 63,629,553   |       |
| Fractional shares retired                                                                          |       | —         |        | (59          | )          |
| Proceeds from issuance of  preferred stock and warrant                                             |       | 36,000,000     |        | —       |       |
| Dividends paid                                                                                     |       | (2,092,438     | )           | (2,985,767   | )          |
| Tax benefit from exercise  of stock options                                                        |       | —         |        | 252,250      |       |
| Proceeds from exercise of  stock options                                                           |       | 119            |        | 453,952      |       |
|                                                                                               |       |           |        |         |       |
| Net cash provided by  financing activities                                                         |       | 108,203,579    |        | 23,046,442   |       |
|                                                                                               |       |           |        |         |       |
| NET INCREASE IN CASH AND  CASH EQUIVALENTS                                                         |       | 19,075,869     |        | 16,322,090   |       |
|                                                                                               |       |           |        |         |       |
| CASH AND CASH EQUIVALENTS:                                                                         |       |           |        |         |       |
| Beginning of period                                                                                |       | 26,022,538     |        | 26,325,875   |       |
|                                                                                               |       |           |        |         |       |
| End of period                                                                                      |       | $              | 45,098,407  |         | $          | 42,647,965 |   |
|                                                                                               |       |           |        |         |       |
| SUPPLEMENTAL DISCLOSURE OF  NONCASH INVESTING AND FINANCIAL ACTIVITIES:                            |       |           |        |         |       |
|                                                                                               |       |           |        |         |       |
| Cash paid for interest                                                                             |       | $              | 17,327,293  |         | $          | 15,974,872 |   |
| Cash paid for income taxes                                                                         |       | 1,082,460      |        | 3,341,950    |       |
| Transfer from loans to  foreclosed real estate                                                     |       | 5,857,288      |        | 445,881      |       |

 

See notes to condensedconsolidated financial statements

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report June 30, 2009

 

7

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Table of Contents

 

**Notes to Unaudited Condensed ConsolidatedFinancial Statements**

 

***1.  SignificantAccounting Policies***

 

**Basisof Presentation**

 

The accompanyingunaudited condensed consolidated financial statements include the accounts ofYadkin Valley Financial Corporation and its subsidiary, Yadkin Valley Bank andTrust Company.  On July 1, 2006,Yadkin Valley Bank and Trust Company (the “Bank”) became a subsidiary of YadkinValley Financial Corporation (the “Company”) through a one for one shareexchange of the then outstanding 10,648,300 shares.  Sidus Financial, LLC (“Sidus”) is a singlemember LLC with the Bank as its single member. Sidus offers mortgage bankingservices and is headquartered in Greenville, NC. The Company acquired AmericanCommunity Bancshares Inc., on April 17, 2009 (See note 4). The interimfinancial statements have been prepared in conformity with accountingprinciples generally accepted in the United States of America for interimfinancial statements and with instructions to Form 10-Q and RegulationS-X.  Accordingly, they do not includeall of the information and footnotes required by Generally Accepted AccountingPrinciples (“GAAP”) for complete financial statements.  Because the accompanying condensedconsolidated financial statements do not include all of the information and footnotesrequired by GAAP, they should be read in conjunction with the auditedconsolidated financial statements and accompanying footnotes included with theCompany’s 2008 Annual Report on Form 10-K filed with the Securities andExchange Commission (“SEC”) on March 31, 2009.  Operating results, for the three and sixmonths ended June 30, 2009, do not necessarily indicate the results thatmay be expected for the year or other interim periods.

 

In the opinion ofmanagement, the accompanying condensed consolidated financial statementscontain all the adjustments, all of which are normal recurring adjustments,necessary to present fairly the financial position of the Company as of June 30,2009 and December 31, 2008, and the results of its operations and cash flowsfor the three and six months ended June 30, 2009 and 2008.  The accounting policies followed are setforth in Note 1 to the Consolidated Financial Statements in the Company’s 2008Annual Report on Form 10-K.

 

***2.  Participation inU.S. Treasury Capital Purchase Program and Private Placement of Common Stock***

 

On January 16, 2009, Yadkin Valley Financial Corporation issued36,000 shares of senior preferred stock, each with a liquidation preference of$1,000 per share, to the U.S. Treasury for $36 million pursuant to the CapitalPurchase Program (“CPP”). Additionally, the Company issued a warrant topurchase up to 385,990 shares of common stock to the U.S. Treasury as acondition to its participation in the CPP. The warrant has an exercise price of$13.99 per share, is immediately exercisable and expires 10 years from thedate of issuance. Proceeds from this sale of the preferred stock are expectedto be used for general corporate purposes, including supporting the continuedgrowth and lending in the communities served by the Bank. The CPP preferredstock is non-voting, other than having class voting rights on certain matters,and pays cumulative dividends quarterly at a rate of 5% per annum for the firstfive years and 9% thereafter. The preferred shares are redeemable at the optionof the Company under certain circumstances during the first three years andonly thereafter without restriction.

 

In order todetermine the relative value of the preferred stock, the present value of thepreferred stock cash flows, using a discount rate of 14%, was calculated as$18.2 million.  The following table showsthe determination of the value attributed to the proceeds of $36 millionreceived for the preferred stock and warrant based on the relative values ofeach.

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report June 30, 2009

 

8

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Table of Contents

 

***2.  Participation inU.S. Treasury Capital Purchase Program and Private Placement of Common Stock(continued)***

 

**Relative ValueCalculation**

 
| ** **                              | ** ** | **Fair Value**    | ** ** | ** **             | ** ** | **Relative Value** | ** ** |
|-----------------------------------------|------------|-------------------|------------|------------------------|------------|--------------------|------------|
| ** **                              | ** ** | **(in millions)** | ** ** | **Relative Value (%)** | ** ** | **(in millions)**  | ** ** |
| NPV of Preferred (14% discount)         |       | $                 | 18.2       |                   | 95.3       | %                  | $          | 34.3 |   |
| Fair Value of warrants (Black  Scholes) |       | 0.9               |       | 4.7                    | %          | 1.7                |       |
| Total                                   |       | $                 | 19.1       |                   | 100.0      | %                  | $          | 36.0 |   |

 

The common stockwarrants have been assigned a fair value of $2.38 per share, or $0.9 million inaggregate as of January 16, 2009. Using a relative fair value allocation approach, $1.7 million wasrecorded as a discount on the preferred stock and will be accreted as areduction in the net income available for common shareholders over the nextfive years at $300,000 to $400,000 per year.

 

Under the United States Treasury’s Capital Purchase Program (CPP), theCompany issued an additional $13.31 million in Cumulative Perpetual PreferredStock, Series T-ACB, on July 24, 2009.  In addition, theCompany provided warrants to the Treasury to purchase 273,534 shares of theCompany’s common stock at an exercise price of $7.30 pershare.  These warrants are immediately exercisable and expire tenyears from the date of issuance.  The preferred stock is non-voting,other than having class voting rights on certain matters, and pays cumulativedividends quarterly at a rate of 5% per annum for the first five years and 9%per annum thereafter.  The preferred shares are redeemable at theoption of the Company subject to regulatory approval.

 

As a condition of the CPP, the Company must obtain consent from theUnited States Department of the Treasury to repurchase its common stock or toincrease its cash dividend on its common stock from the June 30, 2009quarterly amount.  Furthermore, the Company has agreed to certainrestrictions on executive compensation.  Under the American Recoveryand Reinvestment Act of 2009, the Company is limited to using restricted stockas the form of payment to the top five highest compensated executives under anyincentive compensation programs.

 

***3.   Stock-basedCompensation***

 

On May 22, 2008 the shareholders approved the2008 Omnibus Stock Ownership and Long Term Incentive Plan (the “Omnibus Plan”).An aggregate of 700,000 shares have been reserved for issuance by the Companyunder the terms of the Omnibus Plan pursuant to the grant of incentive stockoptions (not to exceed 200,000 shares), non-statutory stock options, restrictedstock and restricted stock units, long-term incentive compensation units andstock appreciation rights.

 

During the three and six months ended June 30,2009, 5,400 and 26,600 options were vested, respectively.  During the three and six months ended June 30,2008, 3,000 and 14,342 options were vested, respectively. At June 30, 2009there were 92,200 options unvested and no shares available for future grants ofoptions in addition to the shares available under the abovementioned OmnibusPlan. During the second quarter 7,854 options previously available for grantsexpired.

 

On March 31, 2008, the number of outstandingoptions increased by 140,258 in conjunction with the acquisition of CardinalState Bank.  These options were fullyvested according to the merger agreement, and they have a weighted averageexercise price of $13.04 per option and a weighted average life of 6.25 years.

 

On April 16, 2009, the number of outstandingoptions increased by 149,358 in conjunction with the acquisition of AmericanCommunity Bank.  These options were fullyvested according to the merger agreement, and they have a weighted averageexercise price of $11.86 per option and a weighted average life of 5.85years.  The FMV of the replacement stockoptions resulted in additional consideration paid in the acquisition ofAmerican Community of approximately $197,000.

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report June 30, 2009

 

9

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Table of Contents

 

During the second quarter of 2009, there were 3,000options granted at a weighted average fair value of $2.79 per option. Duringthe second quarter of 2008, there were 17,000 options granted at a weightedaverage fair value of $1.90 per option, a weighted average exercise price of$14.00, and a five year vesting period. The fair value of each option grant is estimated on the date of grantusing the Black-Scholes option pricing model with the followingweighted-average assumptions used for grants in 2009:  dividend yield of 3.288%, expected volatilityof 52.315%, risk-free interest rate of 2.03%, and expected life of 5.5 years.

 

The compensation expense related to options was$17,399 for the three-month period ending June 30, 2009 and $36,513 forthe six-month period ending June 30, 2009. As of June 30, 2009 therewas $224,313 of total unrecognized compensation cost related to nonvestedshare-based compensation arrangements granted under all of the Company’s stockbenefit plans.  This cost is expected tobe recognized over an average vesting period of 1.24 years.

 

Cash received fromthe options exercised during the three and six months ended June 30, 2009was $119.  Cash received from the optionsexercised during the three and six months ended June 30, 2008 was $424,085and $453,952, respectively.

 

***4. Business Combination***

 

At the open of business on April 17,2009, the Company acquired 100% of the outstanding common stock of AmericanCommunity Bancshares, Inc. (“American Community”), and its subsidiaryAmerican Community Bank, headquartered in Charlotte, NC. American Community had$527.5 million in tangible assets, including $416.3 million in loans and $33.6million in tangible equity at the closing date. Pursuant to the agreement, foreach share of American Community common stock, American Community shareholdersreceived either $12.35 in cash or 0.8517 shares of the Company’s common stock,subject to an overall allocation of 19.5% cash and 80.5% stock.  The overall acquisition cost wasapproximately $47.2 million based on the issuance of 4.6 million shares of theCompany’s common stock at a stock price of $6.72 at the date of the merger, andcash payment of $16.1 million to American shareholders.  Further details are available in the pressrelease and Form 8-K filed April 23, 2009. Press releases are alsoavailable on our website at www.yadkinvalleybank.com.

 

The American Communitymerger is being accounted for under the acquisition method of accounting inaccordance with Statement of Financial Accounting Standards No. 141(revised 2007) Business Combinations (“SFAS 141R”).  The statement of net assets acquired as of April 17,2009 is presented in the following table. The purchased assets and assumed fair value of  liabilities were recorded at their respectiveacquisition date fair values, and identifiable intangible assets were recordedat fair value.  Fair values arepreliminary and subject to refinement for up to one year after the closing dateof the merger as information relative to closing date fair value becomesavailable. Preliminary goodwill of $13.1 million is calculated as the purchasepremium after adjusting for the fair value of net assets acquired andrepresents the value expected from the synergies created from combining theoperations of the two companies.  None ofthe goodwill is expected to be deductible for income tax purposes. The newlyacquired American Community Bank provided revenue of $5.2 million and netincome of $1.6 million for the period of April 17, 2009 to June 30,2009, and is included in the consolidated financial statements.  American Community’s results of operationsprior to the acquisition are not included in the Company’s statement of income.

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report June 30, 2009

 

10

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Table of Contents

 
| **Acquisition  of American Community Bancshares, Inc. (in thousands)** | ** ** | **April 17, 2009** | ** ** |
|-----------------------------------------------------------------------------|------------|-------------------------|------------|
|                                                                        |       |                    |       |
| Consideration:                                                              |       |                    |       |
| Cash                                                                        |       | $                       | 16,140     |   |
| Stock                                                                       |       | 31,063                  |       |
| Fair value of total  consideration paid                                     |       | 47,203                  |       |
|                                                                        |       |                    |       |
| Cash and cash equivalents                                                   |       | 16,219                  |       |
| Investments                                                                 |       | 71,736                  |       |
| Loans, net                                                                  |       | 416,339                 |       |
| Premises and equipment, net                                                 |       | 8,623                   |       |
| Core deposit intangible                                                     |       | 2,766                   |       |
| Other assets                                                                |       | 16,372                  |       |
|                                                                        |       |                    |       |
| Deposits                                                                    |       | (439,949                | )          |
| Liabilities                                                                 |       | (57,909                 | )          |
| Total identifiable net assets                                               |       | 34,197                  |       |
|                                                                        |       |                    |       |
| Goodwill                                                                    |       | 13,006                  |       |
|                                                                        |       | $                       | 47,203     |   |

 

Purchased loans acquired ina business combination are recorded at estimated fair value on their purchasedate and prohibit the carryover of the related allowance for loan losses, whichinclude loans purchased in the American Community acquisition. Purchased impairedloans are accounted for under American Institute of Certified PublicAccountants (AICPA) Statement of Position 03-3, Accounting for CertainLoans or Debt Securities Acquired in a Transfer (SOP 03-3), when the loans haveevidence of credit deterioration since origination and it is probable at thedate of acquisition that the Company will not collect all contractuallyrequired principal and interest payments. Evidence of credit qualitydeterioration as of the purchase date may include statistics such as past dueand nonaccural status. Generally, acquired loans that meet the Company’sdefinition for nonaccrual status fall within the scope of SOP 03-3. Thedifference between contractually required payments at acquisition and the cashflows expected to be collected at acquisition is referred to as thenonaccretable difference which is included in the carrying amount of the loans.Subsequent decreases to the expected cash flows will generally result in aprovision for loan losses. Subsequent increases in cash flows result in areversal of the provision for loan losses to the extent of prior charges, or areversal of the nonaccretable difference with a positive impact on interestincome. Further, any excess of cash flows expected at acquisition over theestimated fair value is referred to as the accretable yield and is recognizedinto interest income over the remaining life of the loan when there is areasonable expectation about the amount and timing of such cash flows.Purchased performing loans are recorded at fair value, including a creditdiscount. The fair value discount is accreted as an adjustment to yield over the estimatedlives of the loans. There is no allowance for loan losses established at theacquisition date for purchased performing loans. A provision for loan losses isrecorded for any deterioration in these loans subsequent to the merger.

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report June 30, 2009

 

11

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Table ofContents

 

The carrying amount of acquired loans at April 17, 2009 consisted ofloans accounted for in accordance with SOP 03-3 and loans not subject to SOP03-3 as detailed in the following table:

 
| ** **                                       | ** ** | **SOP 03-3**       | ** ** | **Non SOP 03-3** | ** ** | ** **      | ** ** |
|--------------------------------------------------|------------|--------------------|------------|------------------|------------|-----------------|------------|
| ** **                                       | ** ** | **Loans**          | ** ** | **Loans**        | ** ** | **Total Loans** | ** ** |
| ** **                                       | ** ** | **(In thousands)** | ** ** |
| Commercial,  financial, and agricultural         |       | $                  | 265        |             | $          | 58,033          |       | $ | 58,298 |   |
| Construction,  land development & other land |       | 8,362              |       | 123,496          |       | 131,858         |       |
| Real estate- 1-4  Family mortgage loans          |       | 795                |       | 41,530           |       | 42,325          |       |
| Real estate-  Commercial and other               |       | 837                |       | 98,549           |       | 99,386          |       |
| Home equity  lines of credit                     |       | 58                 |       | 47,760           |       | 47,818          |       |
| Installment  loans to individuals                |       | 63                 |       | 12,878           |       | 12,941          |       |
| Other loans                                      |       | 308                |       | 23,405           |       | 23,713          |       |
| Total                                            |       | $                  | 10,688     |             | $          | 405,651         |       | $ | 416,339 |   |

 

The following table presents the Non SOP 03-3 loans receivable at theacquisition date of April 17, 2009.  Theamounts include principal only and do not reflect accrued interest as of thedate of the acquisition or beyond:

 
| ** **                                                         | ** ** | **(In thousands)** | ** ** |
|--------------------------------------------------------------------|------------|--------------------|------------|
| Contractually  required principal payments receivable              |       | $                  | 416,833    |   |
| Fair value of  adjustment for credit, interest rate, and liquidity |       | (11,182            | )          |
| Fair value of  Non SOP 03-3 loans receivable                       |       | $                  | 405,651    |   |

 

The following table presents the SOP 03-3 loans receivable at theacquisition date of April 17, 2009.  TheCompany has initially applied the cost recovery method to all loans subject toSOP 03-3 at the acquisition date due to uncertainty as to the timing ofexpected cash flows as reflected in the following table:

 
| ** **                                            | ** ** | **(In thousands)** | ** ** |
|-------------------------------------------------------|------------|--------------------|------------|
| Contractually  required principal payments receivable |       | $                  | 14,513     |   |
| Nonaccretable  difference                             |       | (3,825             | )          |
| Present value of  cash flows expected to be collected |       | 10,688             |       |
| Accretable  difference                                |       | —             |       |
| Fair value of  SOP 03-3 loans acquired                |       | $                  | 10,688     |   |

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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During the courseof transferring the general ledger account reconciliations from AmericanCommunity to Yadkin Valley, we found that a correspondent bank accountcontained unreconciled amounts that resulted in cash acquired in the mergerbeing overstated by $4.3 million. Immediately after discovering the discrepancy, we began the process ofplanning and procuring resources required to determine the cause of thiscondition, including identification of the journal entries that resulted in theunreconciled amounts.  We determined thatthe entries occurred at American Community prior to the merger and occurredprimarily in 2006 and earlier periods. We have determined that fictitious items had been used to reconcile thegeneral ledger balance with the correspondent bank statement balance.  One of the entries that contributed to theunreconciled difference was a $2.1 million general ledger debit in 2006 with anoffsetting credit to an official check account that also had an unreconcileddifference.  This  entry, recorded in 2006, eliminated theunreconciled difference in the official check account.  Part of the official check accountunreconciled difference was found to be official checks totaling over $1.5million that cleared in 2005 and 2006. However, the funds to pay for the official checks were not procured andrecorded, resulting in official checks that were paid from bank funds withoutcollecting customer funds to pay for them. Usually funds to issue official checks are procured form either loanproceeds, customer checks, or cash. Accordingly, we have adjusted the merger journal entries to reduce nettangible assets acquired from American Community by the amount of theunreconciled difference.  The impact ofthis adjustment is an increase of goodwill of $4.3 million.  We are also continuing the process ofinvestigating whether we may be able to recover any anticipated losses.

 

The proforma consolidated condensed statements of income for YadkinValley and American Community for the six months ended June 30, 2009 and2008 are presented below as if the combination had occurred on January 1.  The unaudited proforma information presenteddoes not necessarily reflect the results of operations that would have resultedhad the acquisition been completed at the beginning of the applicable periodspresented, nor does it indicate the results of operations in future periods.

 

The proforma purchase accounting adjustments related to investments,loans and leases, deposits, and other borrowed funds are being accreted or amortizedinto income using methods that approximate a level yield over their respectiveestimated lives.  Purchase accountingadjustments related to identifiable intangibles are being amortized andrecorded as noninterest expense over their respective estimated lives usingaccelerated methods.  The proformaconsolidated condensed statements of income do not reflect any adjustments toAmerican Community’s historical provision for credit losses.

 
| **Six Months Ended June 30,  2009****dollars  except per share data in thousands** | ** ** | **Yadkin Valley** | ** ** | **American  Community** | ** ** | **Proforma  Adjustments** | ** ** | **Proforma  Combined** | ** ** |
|-----------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|---------------------------|------------|------------------------|------------|
| Interest  Income                                                                        |       | $                 | 38,756     |                    | $          | 12,131                    |       | $                      | 6,611      |   | $ | 57,498 |   |
| Interest  Expense                                                                       |       | 13,615            |       | 6,122                   |       | (3,108                    | )          | 16,629                 |       |
| Net  Interest Income                                                                    |       | 25,141            |       | 6,009                   |       | 9,719                     |       | 40,869                 |       |
| Provision  for Credit Losses                                                            |       | 19,858            |       | 2,424                   |       | 9,342                     |       | 31,624                 |       |
| Net  Interest Income after Provision for Credit Losses                                  |       | 5,283             |       | 3,585                   |       | 377                       |       | 9,245                  |       |
| Noninterest  Income                                                                     |       | 12,342            |       | 500                     |       | —                    |       | 12,842                 |       |
| Noninterest  Expense                                                                    |       | 28,210            |       | 11,652                  |       | 273                       |       | 40,135                 |       |
| Income  (Loss) Before Taxes                                                             |       | (10,585           | )          | (7,567                  | )          | 104                       |       | (18,048                | )          |
| Income  Tax Provision (Benefit)                                                         |       | (4,106            | )          | (2,935                  | )          | 40                        |       | (7,001                 | )          |
| Net  Income (Loss)                                                                      |       | (6,479            | )          | (4,632                  | )          | 64                        |       | (11,047                | )          |
| Preferred  stock dividend and amortization of preferred stock discount                  |       | 973               |       | —                  |       | —                    |       | 973                    |       |
|                                                                                    |       | $                 | (7,452     | )                       | $          | (4,632                    | )          | $                      | 64         |   | $ | (12,020 | ) |
|                                                                                    |       |              |       |                    |       |                      |       |                   |       |
| Earnings  (loss) per common share                                                       |       | $                 | (0.65      | )                       | $          | (0.69                     | )          |                   |       | $ | (0.75 | ) |
| Diluted  earnings (loss) per common share                                               |       | $                 | (0.65      | )                       | $          | (0.69                     | )          |                   |       | $ | (0.75 | ) |
|                                                                                    |       |              |       |                    |       |                      |       |                   |       |
| Average  common shares outstanding                                                      |       | 11,536,491        |       | 6,670,869               |       | (2,077,737                | )          | 16,129,623             |       |
| Diluted  average common shares outstanding                                              |       | 11,536,491        |       | 6,670,869               |       | (2,077,737                | )          | 16,129,623             |       |

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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| **Six Month Ended June 30,  2008****dollars except per share data in thousands** | ** ** | **Yadkin Valley** | ** ** | **American  Community** | ** ** | **Proforma  Adjustments** | ** ** | **Proforma  Combined** | ** ** |
|---------------------------------------------------------------------------------------|------------|-------------------|------------|-------------------------|------------|---------------------------|------------|------------------------|------------|
| Interest  Income                                                                      |       | $                 | 37,004     |                    | $          | 15,757                    |       | $                      | 6,611      |   | $ | 59,372 |   |
| Interest  Expense                                                                     |       | 17,274            |       | 7,502                   |       | (3,108                    | )          | 21,668                 |       |
| Net  Interest Income                                                                  |       | 19,730            |       | 8,255                   |       | 9,719                     |       | 37,704                 |       |
| Provision  for Credit Losses                                                          |       | 2,158             |       | 721                     |       | 9,342                     |       | 12,221                 |       |
| Net  Interest Income after Provision for Credit Losses                                |       | 17,572            |       | 7,534                   |       | 377                       |       | 25,483                 |       |
| Noninterest  Income                                                                   |       | 7,977             |       | 1,559                   |       | —                    |       | 9,536                  |       |
| Noninterest  Expense                                                                  |       | 18,795            |       | 6,814                   |       | 273                       |       | 25,882                 |       |
| Income  Before Taxes                                                                  |       | 6,754             |       | 2,279                   |       | 104                       |       | 9,137                  |       |
| Income  Tax Provision                                                                 |       | 2,112             |       | 804                     |       | 40                        |       | 2,956                  |       |
| Net  Income                                                                           |       | 4,642             |       | 1,475                   |       | 64                        |       | 6,181                  |       |
| Preferred  stock dividend and amortization of preferred stock discount                |       | —            |       | —                  |       | 973                       |       | 973                    |       |
|                                                                                  |       | $                 | 4,642      |                    | $          | 1,475                     |       | $                      | (909       | ) | $ | 5,208 |   |
|                                                                                  |       |              |       |                    |       |                      |       |                   |       |
| Earnings  per common share                                                            |       | $                 | 0.42       |                    | $          | 0.23                      |       |                   |       | $ | 0.33 |   |
| Diluted  earnings per common share                                                    |       | $                 | 0.42       |                    | $          | 0.22                      |       |                   |       | $ | 0.33 |   |
|                                                                                  |       |              |       |                    |       |                      |       |                   |       |
| Average  common shares outstanding                                                    |       | 11,033,325        |       | 6,527,809               |       | (1,934,677                | )          | 15,626,457             |       |
| Diluted  average common shares outstanding                                            |       | 11,092,981        |       | 6,618,435               |       | (2,025,303                | )          | 15,686,113             |       |

 

The proformaresults are not necessarily indicative of what actually would have occurred ifthe acquisition had been completed as of the beginning of each fiscal periodpresented, nor are they necessarily indicative of future consolidated results.

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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***5. Investment Securities***

 

Investment securities at June 30, 2009 and December 31, 2008are summarized as follows:

** **
| ** **                                         | ** ** | **June 30, 2009** | ** **  |
|----------------------------------------------------|------------|------------------------|-------------|
| ** **                                         | ** ** | ** **             | ** **  | **Unrealized** | ** ** | **Unrealized** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Amortized Cost**     | ** **  | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Available-for-sale securities:                     |       |                   |        |   |   |   |   |   |   |
|                                               |       |                   |        |   |   |   |   |   |   |
| Securities of other U.S.  government agencies due: |       |                   |        |   |   |   |   |   |   |
| Within  1 year                                     |       | $                      | 4,993,548   |   | $ | 142,702 |   |   |   | $ | 5,136,250 |   |
| After  1 but within 5 years                        |       | 19,377,967             |        | 536,981 |   | $ | 306 |   | 19,914,642 |   |
| After  5 but within 10 years                       |       | 20,016,569             |        | 401,561 |   | 113,413 |   | 20,304,717 |   |
|                                               |       | 44,388,084             |        | 1,081,244 |   | 113,719 |   | 45,355,609 |   |
|                                               |       |                   |        |   |   |   |   |   |   |
| Residential  mortgage-backed securities due:       |       |                   |        |   |   |   |   |   |   |
| Within  1 year                                     |       | 1,157,035              |        | 7,915 |   | — |   | 1,164,950 |   |
| After  1 but within 5 years                        |       | 4,772,875              |        | 33,338 |   | 7,225 |   | 4,798,988 |   |
| After  5 but within 10 years                       |       | 10,494,669             |        | 306,077 |   | — |   | 10,800,746 |   |
| After  10 years                                    |       | 71,869,673             |        | 1,756,901 |   | 520,852 |   | 73,105,722 |   |
|                                               |       | 88,294,252             |        | 2,104,231 |   | 528,077 |   | 89,870,406 |   |
|                                               |       |                   |        |   |   |   |   |   |   |
| State  and municipal securities due:               |       |                   |        |   |   |   |   |   |   |
| Within  1 year                                     |       | 4,266,387              |        | 77,057 |   |   |   | 4,343,444 |   |
| After  1 but within 5 years                        |       | 16,018,103             |        | 604,781 |   | 417 |   | 16,622,467 |   |
| After  5 but within 10 years                       |       | 13,773,485             |        | 151,863 |   | 79,022 |   | 13,846,326 |   |
| After  10 years                                    |       | 26,266,735             |        | 83,571 |   | 285,839 |   | 26,064,467 |   |
|                                               |       | 60,324,710             |        | 917,272 |   | 365,278 |   | 60,876,704 |   |
|                                               |       |                   |        |   |   |   |   |   |   |
| Other  securities due:                             |       |                   |        |   |   |   |   |   |   |
| Within  1 year                                     |       | 1,171                  |        |   |   |   |   | 1,171 |   |
| After  10 years                                    |       | 125,453                |        | 6,111 |   | 6,601 |   | 124,963 |   |
|                                               |       | 126,624                |        | 6,111 |   | 6,601 |   | 126,134 |   |
|                                               |       |                   |        |   |   |   |   |   |   |
| Total  available-for-sale securities               |       | $                      | 193,133,670 |   | $ | 4,108,858 |   | $ | 1,013,675 |   | $ | 196,228,853 |   |

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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** **
| ** **                                         | ** ** | **December 31, 2008** | ** **        |
|----------------------------------------------------|------------|----------------------------|-------------------|
| ** **                                         | ** ** | ** **                 | ** **        | **Unrealized** | ** ** | **Unrealized** | ** ** | ** ** | ** ** |
| ** **                                         | ** ** | **Amortized Cost**         | ** **        | **Gains** | ** ** | **Losses** | ** ** | **Fair Value** | ** ** |
| Available-for-sale  securities:                    |       |                       |              |   |   |   |   |   |   |
|                                               |       |                       |              |   |   |   |   |   |   |
| Securities  of other U.S. government agencies due: |       |                       |              |   |   |   |   |   |   |
| Within  1 year                                     |       | $                          | 3,998,265         |   | $ | 59,235 |   | $ | — |   | $ | 4,057,500 |   |
| After  1 but within 5 years                        |       | 26,892,399                 |              | 865,391 |   | — |   | 27,757,790 |   |
| After  5 but within 10 years                       |       | 10,976,867                 |              | 858,320 |   | — |   | 11,835,187 |   |
|                                               |       | 41,867,531                 |              | 1,782,946 |   | — |   | 43,650,477 |   |
|                                               |       |                       |              |   |   |   |   |   |   |
| Residential  mortgage-backed securities due:       |       |                       |              |   |   |   |   |   |   |
| Within  1 year                                     |       | 1,011,391                  |              | 3,825 |   | 2 |   | 1,015,214 |   |
| After  1 but within 5 years                        |       | 2,169,311                  |              | 5,814 |   | 7,597 |   | 2,167,528 |   |
| After  5 but within 10 years                       |       | 2,994,894                  |              | 105,554 |   | — |   | 3,100,448 |   |
| After  10 years                                    |       | 45,717,258                 |              | 1,449,631 |   | 386,975 |   | 46,779,914 |   |
|                                               |       | 51,892,854                 |              | 1,564,824 |   | 394,574 |   | 53,063,104 |   |
|                                               |       |                       |              |   |   |   |   |   |   |
| State  and municipal securities due:               |       |                       |              |   |   |   |   |   |   |
| Within  1 year                                     |       | 1,325,459                  |              | 7,922 |   | — |   | 1,333,381 |   |
| After  1 but within 5 years                        |       | 16,615,757                 |              | 450,157 |   | 3,427 |   | 17,062,487 |   |
| After  5 but within 10 years                       |       | 9,777,202                  |              | 201,711 |   | 42,335 |   | 9,936,578 |   |
| After  10 years                                    |       | 13,013,444                 |              | 53,169 |   | 321,722 |   | 12,744,891 |   |
|                                               |       | 40,731,862                 |              | 712,959 |   | 367,484 |   | 41,077,337 |   |
|                                               |       |                       |              |   |   |   |   |   |   |
| Other  securities due:                             |       |                       |              |   |   |   |   |   |   |
| Within  1 year                                     |       | 1,171                      |              | — |   | — |   | 1,171 |   |
| After  10 years                                    |       | 39,924                     |              | 4 |   | 18,488 |   | 21,440 |   |
|                                               |       | 41,095                     |              | 4 |   | 18,488 |   | 22,611 |   |
|                                               |       |                       |              |   |   |   |   |   |   |
| Total  available-for-sale securities               |       | $                          |  134,533,342 |   | $ | 4,060,733 |   | $ | 780,546 |   | $ | 137,813,529 |   |

 

Mortgage-backed securities are included in maturity groups based uponstated maturity date. At June 30, 2009 and December 31, 2008, theBank’s mortgage-backed securities werepass-through securities. Actual maturity will vary based on******repayment of the underlyingmortgage loans.

 

Therewere no gross realized gains or losses on sales of securities for the three andsix months ended June 30, 2009.

 

Investmentsecurities with carrying values of approximately $110,721,324 and $70,420,459at June 30, 2009 and 2008, respectively, were pledged as collateral forpublic deposits and for other purposes as required or permitted by law.

 

The followingtable provides information on the gross unrealized losses and fair value of theCompany’s investments that are not deemed to be other-than-temporarily impaired(“OTTI”) and the length of time that the securities have been in a continuousunrealized loss position at June 30, 2009. Securities that have been ina loss position for twelve months or more at June 30, 2009 include twomortgage-backed securities, three municipal securities, and one preferredstock.  Securities that were in a lossposition for twelve months or more at June 30, 2008 included twenty-four 

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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mortgage-backed securities, six federal agency bonds, two corporatesecurities and forty-nine municipal bonds. The unrealized losses relate tosecurities that have incurred fair value reductions due to increases ininvestment market interest rates since the securities were purchased, and areconsidered by management to be temporary. The unrealized losses are not likelyto reverse unless and until market interest rates decline to the levels thatexisted when the securities were purchased. Since none of the unrealized lossesrelate to the marketability of the securities or the issuer’s ability to honorredemption obligations, none of the securities are deemed to be other thantemporarily impaired. Management has the intent and ability to hold thesesecurities until maturity or a recovery in fair value.

 
| ** **                            | ** ** | **Less  Than 12 Months** | ** **       | **12  Months or More** | ** ** | **Total**       | ** ** |
|---------------------------------------|------------|--------------------------|------------------|------------------------|------------|-----------------|------------|
| **June 30, 2009**                | ** ** | **Fair  value**          | ** **       | **Unrealized  losses** | ** ** | **Fair  value** | ** ** | **Unrealized  losses** | ** ** | **Fair  value** | ** ** | **Unrealized  losses** | ** ** |
| Securities available for sale:        |       |                     |             |                   |       |            |       |   |   |   |   |   |   |
| U.S. government agencies              |       | $                        | 7,090,020        |                   | $          | 113,719         |       | $ | — |   | $ | — |   | $ | 7,090,020 |   | $ | 113,719 |   |
| Mortgage backed securities            |       | 1,737,402                |             | 63,029                 |       | 2,126,195       |       | 465,048 |   | 3,863,597 |   | 528,077 |   |
| State and municipal securities        |       | 15,946,479               |             | 295,060                |       | 1,024,478       |       | 70,218 |   | 16,970,957 |   | 365,278 |   |
| Common and preferred stocks           |       | 47,850                   |             | 3,142                  |       | 13,500          |       | 3,459 |   | 61,350 |   | 6,601 |   |
|                                  |       |                     |             |                   |       |            |       |   |   |   |   |   |   |
| Total temporarily impaired securities |       | $                        |  24,821,751 |                   | $          | 474,950         |       | $ | 3,164,173 |   | $ | 538,725 |   | $ |  27,985,924 |   | $ | 1,013,675 |   |

 
| ** **                            | ** ** | **Less  Than 12 Months** | ** ** | **12  Months or More** | ** ** | **Total**       | ** ** |
|---------------------------------------|------------|--------------------------|------------|------------------------|------------|-----------------|------------|
| ** **                            | ** ** | ** **               | ** ** | **Unrealized**         | ** ** | ** **      | ** ** | **Unrealized** | ** ** | ** ** | ** ** | **Unrealized** | ** ** |
| **December 31, 2008**            | ** ** | **Fair  value**          | ** ** | **losses**             | ** ** | **Fair  value** | ** ** | **losses** | ** ** | **Fair  value** | ** ** | **losses** | ** ** |
| Securities available for sale:        |       |                     |       |                   |       |            |       |   |   |   |   |   |   |
| Mortgage backed securities            |       | $                        | 4,671,466  |                   | $          | 381,601         |       | $ | 720,914 |   | $ | 12,973 |   | $ | 5,392,380 |   | $ | 394,574 |   |
| State and municipal securities        |       | 12,113,871               |       | 367,484                |       | —          |       | — |   | 12,113,871 |   | 367,484 |   |
| Common and preferred stocks           |       | 21,440                   |       | 18,488                 |       | —          |       | — |   | 21,440 |   | 18,488 |   |
|                                  |       |                     |       |                   |       |            |       |   |   |   |   |   |   |
| Total temporarily impaired securities |       | $                        | 16,806,777 |                   | $          | 767,573         |       | $ | 720,914 |   | $ | 12,973 |   | $ | 17,527,691 |   | $ | 780,546 |   |

 

If management determines that an investment has experienced an OTTI,the loss is recognized in the income statement.

 

The aggregate cost of the Company’s costmethod investments at June 30, 2009 totaled $11,620,833 of which$10,539,400 is Federal Home Loan Bank of Atlanta (“FHLB”) stock and the rest isincluded in other assets.  All equityinvestments were evaluated for impairment at June 30, 2009. The Companyestimated that the fair value equaled or exceeded the cost of each of theseinvestments (that is, the investments were not impaired) on the basis of theredemption provisions of the issuing entities with two exceptions.  During the first quarter of 2009 the Companywrote off its investment of $151,722 in Silverton Financial Services, Inc.(“SFS”) based on events occurring after the financial statement date but priorto the issuance of the statements. On May 1, 2009 the Office of theComptroller of the Currency (“OCC”) closed Silverton Bank, NationalAssociation, a wholly owned subsidiary of SFS. The OCC appointed the FDIC as receiver, and the FDIC created a bridge bank, Silverton BridgeBank, National Association, to take over the operations and allow customers totransfer their account relationships in an orderly fashion. Additionally, theCompany’s investment in a trust company was written down by $27,771 in thefirst quarter of 2009 because it was considered to be other than temporarilyimpaired.

 

***6.  Commitments andContingencies***

 

Inthe normal course of business, there are various outstanding commitments andcontingent liabilities, such as commitments to extend credit, which are notreflected in the accompanying financial statements.  At June 30, 2009,

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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theCompany, had commitments outstanding of $365.6 million for additional loanamounts.  Commitments of Sidus Financial,LLC (“Sidus”), the Bank’s mortgage lending subsidiary, are excluded from thisamount and discussed in the paragraph below. Additional commitments totaling $9.1 million were outstanding understandby letters of credit.  Managementdoes not expect any significant losses to result from these commitments.

 

At June 30, 2009,Sidus had $145.4 million of commitments outstanding to originate mortgage loansheld for sale at fixed prices and $145.4 million of mortgage interest rate lockcommitments outstanding under best efforts contracts to sell mortgages toagencies and other investors.

 

***7.    Earnings per share***

 

Basic net income per share is computed by dividing net income by theweighted average number of shares of common stock outstanding for the reportingperiods.  Diluted net income per sharereflects the potential dilution that could occur if the Company’s potentialcommon stock, which consists of dilutive stock options, were exercised.  The numerators of the basic net income pershare computations are the same as the numerators of the diluted net income pershare computations for all the periods presented.  A reconciliation of the denominator of thebasic net income per share computations to the denominator of the diluted netincome per share computations is as follows:

 
| ** **                                                      | ** ** | **Three Months Ended June 30,** | ** ** | **Six Months Ended June 30,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------------------------|------------|------------------------------------|------------|
| ** **                                                      | ** ** | **2009**                             | ** ** | **2008**                           | ** ** | **2009** | ** ** | **2008** | ** ** |
| Basic EPS denominator:                                          |       |                                 |       |                               |       |   |   |   |   |
|                                                            |       |                                 |       |                               |       |   |   |   |   |
| Weighted average number of common shares outstanding            |       | 15,322,043                           |       | 11,492,811                         |       | 13,439,725 |   | 11,033,325 |   |
|                                                            |       |                                 |       |                               |       |   |   |   |   |
| Dilutive effect arising from assumed exercise of  stock options |       | —                               |       | 32,929                             |       | — |   | 59,656 |   |
|                                                            |       |                                 |       |                               |       |   |   |   |   |
| Diluted EPS denominator                                         |       | 15,322,043                           |       | 11,525,740                         |       | 13,439,725 |   | 11,092,981 |   |

 

For the three monthsended June 30, 2009 and 2008, net income (loss) for determining net income (netloss) per common share was reported as net income (loss) less the dividend onpreferred stock. During the quarter ended June 30, 2009, 605,683 warrants andstock options were not considered dilutive because the exercise prices exceededthe average market price of $6.68 per share. These non-dilutive shares hadexercise prices ranging from $6.87 to $19.07 per share and had a weightedaverage price of $13.03 per share. During the first six months of 2009, 557,752warrants and stock options were not considered dilutive because the exerciseprices exceeded the average market price of $7.43 per share. These non-dilutiveshares had exercise prices ranging from $7.44 to $19.07 per share and had aweighted average price of $13.56 per share. Unvested shares of restricted stockand all other common stock equivalents were excluded from the determination ofdiluted earnings per share for the three and six months ended June 30, 2009 dueto the Company’s loss position for those periods.

 

***8.   Stockholders’Equity***

 

On June 30,2009, the Board of Directors of the Company declared a quarterly cash dividendof $0.06 per share to all common stockholders of record on July 13, 2009,and payable July 31, 2009. The dividend reduced stockholders’ equity by$967,806.

 

On May 24,2007, the Board approved a plan to repurchase up to 100,000 shares of theCompany’s outstanding common shares (“2007 plan”), The Company did notrepurchase any common shares during the first two quarters of 2009.  There was no common stock 2008 purchase planor repurchases in 2008, and future plans to repurchase stock would be subjectto the Troubled Asset Relief Program (“TARP”) limitations. Under the 2007 plan, the Company has repurchased a total

 

Yadkin Valley FinancialCorporation 

Form 10-Q QuarterlyReport June 30, 2009

 

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of 71,281 common sharesat an average price of $17.10 per share. There are 28,719 common shares available to purchase under the 2007 planat June 30, 2009.

 

***9.  Business SegmentInformation***

 

Sidus is a singlemember LLC with the Bank as the single member. Sidus is headquartered in Greenville, North Carolina and offers mortgagebanking services to its customers in Alabama, Arkansas, Connecticut, Delaware,Florida, Georgia, Kentucky, Louisiana, Maine, Maryland, Massachusetts,Mississippi, New Hampshire, North Carolina, Pennsylvania, South Carolina,Tennessee, Vermont, Virginia and West Virginia. The following table details the results of operations for the first sixmonths of 2009 and 2008 for the Company and for Sidus.

 
| ** **                                           | ** ** | **Bank**      | ** **    | **Sidus**   | ** ** | **Other**   | ** ** | **Total**     | ** **   |
|------------------------------------------------------|------------|---------------|---------------|-------------|------------|-------------|------------|---------------|--------------|
| **For Six Months Ended June 30,  2009**         |       |          |          |        |       |        |       |          |         |   |   |   |   |
| Interest income                                      |       | $             | 40,970,512    |        | $          | 2,452,369   |       | $             | —       |   | $ | 43,422,881 |   |
| Interest expense                                     |       | 15,237,202    |          | 272,389     |       | 445,181     |       | 15,954,772    |         |
| Net interest income                                  |       | 25,733,310    |          | 2,179,980   |       | (445,181    | )          | 27,468,109    |         |
|                                                 |       |          |          |        |       |        |       |          |         |
| Provision for loan losses                            |       | 26,945,650    |          | 61,657      |       | —      |       | 27,007,307    |         |
| Net interest income after  provision for loan losses |       | (1,212,340    | )             | 2,118,323   |       | (445,181    | )          | 460,802       |         |
| Other income                                         |       | 4,473,841     |          | 7,991,783   |       | 416,714     |       | 12,882,338    |         |
| Other expense                                        |       | 25,671,603    |          | 4,813,634   |       | 361,348     |       | 30,846,585    |         |
| Income before income taxes  (benefit)                |       | (22,410,102   | )             | 5,296,472   |       | (389,815    | )          | (17,503,445   | )            |
| Income taxes (benefit)                               |       | (8,855,152    | )             | 2,065,624   |       | —      |       | (6,789,528    | )            |
| Net income(loss)                                     |       | $             | (13,554,950   | )           | $          | 3,230,848   |       | $             | (389,815     | ) | $ | (10,713,917 | ) |
|                                                 |       |          |          |        |       |        |       |          |         |
| Total assets                                         |       | $             | 2,198,971,893 |        | $          | 130,286,685 |       | $             | (170,898,916 | ) | $ | 2,158,359,662 |   |
| Net loans                                            |       | 1,592,849,160 |          | 2,004,816   |       | —      |       | 1,594,853,976 |         |
| Loans held for sale                                  |       | 984,500       |          | 120,157,024 |       | —      |       | 121,141,524   |         |
| Goodwill                                             |       | 61,565,656    |          | 4,943,872   |       | —      |       | 66,509,528    |         |
|                                                 |       |          |          |        |       |        |       |          |         |
| **For Three  Months Ended June 30, 2009**       |       |          |          |        |       |        |       |          |         |
| Interest income                                      |       | $             | 24,409,927    |        | $          | 1,413,407   |       | $             | —       |   | $ | 25,823,334 |   |
| Interest expense                                     |       | 7,889,255     |          | 140,838     |       | 238,761     |       | 8,268,854     |         |
| Net interest income                                  |       | 16,520,672    |          | 1,272,569   |       | (238,761    | )          | 17,554,480    |         |
| Provision for loan losses                            |       | 16,406,910    |          | 50,892      |       | —      |       | 16,457,802    |         |
| Net interest income after  provision for loan losses |       | 113,762       |          | 1,221,677   |       | (238,761    | )          | 1,096,678     |         |
| Other income                                         |       | 2,672,785     |          | 4,792,695   |       | 141,821     |       | 7,607,301     |         |
| Other expense                                        |       | 16,168,806    |          | 2,680,349   |       | 204,596     |       | 19,053,751    |         |
| Income (loss) before  income taxes (benefit) (loss)  |       | (13,382,259   | )             | 3,334,023   |       | (301,536    | )          | (10,349,772   | )            |
|                                                 |       |          |          |        |       |        |       |          |         |
| Income taxes (benefit)                               |       | (5,095,528    | )             | 1,300,269   |       | —      |       | (3,795,259    | )            |
| Net income(loss)                                     |       | $             | (8,286,731    | )           | $          | 2,033,754   |       | $             | (301,536     | ) | $ | (6,554,513 | ) |

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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| ** **                                           | ** ** | **Bank**      | ** **    | **Sidus**  | ** ** | **Other**  | ** ** | **Total**     | ** **  |
|------------------------------------------------------|------------|---------------|---------------|------------|------------|------------|------------|---------------|-------------|
| **For the Six Months Ended  June 30, 2008**     |       |          |          |       |       |       |       |          |        |   |   |   |   |
| Interest income                                      |       | $             | 35,688,136    |       | $          | 1,315,986  |       | $             | —      |   | $ | 37,004,122 |   |
| Interest expense                                     |       | 16,060,134    |          | 557,058    |       | 656,842    |       | 17,274,034    |        |
| Net interest income                                  |       | 19,628,002    |          | 758,928    |       | (656,842   | )          | 19,730,088    |        |
| Provision for loan losses                            |       | 2,158,000     |          | —     |       | —     |       | 2,158,000     |        |
| Net interest income after  provision for loan losses |       | 17,470,002    |          | 758,928    |       | (656,842   | )          | 17,572,088    |        |
| Net gain (loss) on sale of  investment securities    |       | (6,525        | )             | —     |       | —     |       | (6,525        | )           |
| Other income                                         |       | 3,980,238     |          | 3,556,678  |       | 446,134    |       | 7,983,050     |        |
| Other expense                                        |       | 15,616,841    |          | 3,070,565  |       | 107,959    |       | 18,795,365    |        |
| Income before income taxes                           |       | 5,826,874     |          | 1,245,041  |       | (318,667   | )          | 6,753,248     |        |
| Income taxes                                         |       | 1,626,445     |          | 485,566    |       | —     |       | 2,112,011     |        |
| Net income                                           |       | $             | 4,200,429     |       | $          | 759,475    |       | $             | (318,667    | ) | $ | 4,641,237 |   |
|                                                 |       |          |          |       |       |       |       |          |        |
| Total assets                                         |       | $             | 1,463,540,796 |       | $          | 53,996,839 |       | $             | (86,436,282 | ) | $ | 1,431,101,353 |   |
| Net loans                                            |       | 1,060,634,251 |          | —     |       | —     |       | 1,060,634,251 |        |
| Loans held for sale                                  |       | 421,750       |          | 46,721,120 |       | —     |       | 47,142,870    |        |
| Goodwill                                             |       | 49,089,430    |          | 4,943,872  |       | —     |       | 54,033,302    |        |
|                                                 |       |          |          |       |       |       |       |          |        |
| **For the Three Months ended  June 30, 2008:**  |       |          |          |       |       |       |       |          |        |
| Interest income                                      |       | $             | 18,405,399    |       | $          | 695,591    |       | $             | —      |   | $ | 19,100,990 |   |
| Interest expense                                     |       | 7,915,512     |          | 239,080    |       | 573,307    |       | 8,727,899     |        |
| Net interest income                                  |       | 10,489,887    |          | 456,511    |       | (573,307   | )          | 10,373,091    |        |
| Provision for loan losses                            |       | 1,708,000     |          | —     |       | —     |       | 1,708,000     |        |
| Net interest income after  provision for loan losses |       | 8,781,887     |          | 456,511    |       | (573,307   | )          | 8,665,091     |        |
| Net gain (loss) on sale of  investment securities    |       | (6,525        | )             | —     |       | —     |       | (6,525        | )           |
| Other income                                         |       | 1,835,835     |          | 1,784,383  |       | 433,390    |       | 4,053,608     |        |
| Other expense                                        |       | 8,423,190     |          | 1,659,322  |       | 70,172     |       | 10,152,684    |        |
| Income before income taxes                           |       | 2,188,007     |          | 581,572    |       | (210,089   | )          | 2,559,490     |        |
| Income taxes                                         |       | 605,753       |          | 226,813    |       | —     |       | 832,566       |        |
| Net income                                           |       | $             | 1,582,254     |       | $          | 354,759    |       | $             | (210,089    | ) | $ | 1,726,924 |   |

 

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(1) Note:  Income tax expense has been allocated to theSidus business segment for comparative purposes.  As an LLC, Sidus passes its pre-tax incomethrough to its single member, the Bank, which is taxed on that income.

 

(2) Note:  The “Other” column includes asseteliminations representing the Bank’s Due from Sidus account ($175,000,000 in2009 and $85,000,000 in 2008), the Bank’s Investment in Sidus ($3,000,000 in2009 and 2008), and the Bank’s A/R from Sidus ($119,344 in 2009 and $93,390 in2008).  Also included in this column areHolding Company assets ($1,892,612 in 2009 and $1,657,108 in 2008) and HoldingCompany income and expenses.

 

***10. Allowance for Loan Losses***

 

The Bank calculated an allowance for loan losses of $46.2 million at June 30,2009 as compared to $22.4 million at December 31, 2008 based onapplication of its model for the allowance calculation applied to the loanportfolio at each balance sheet date. This increase in the allowance and charge-offs totaling $3.3 millionresulted in provision expense of $27.0 million for the six months ended June 30,2009 as compared to $2.2 million for the same period in the prior year. Theallowance model is applied to determine the specific allowance balance forimpaired loans and the general allowance balance for unimpaired loans groupedby loan type.  Out of the $46.2 millionin total allowance for

 

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loans losses at June 30, 2009, the specific allowance for impairedloans accounted for $12.0 million, up from $3.7 million at year end.  The remaining general allowance, $34.2million, was attributed to unimpaired loans and was up from $18.7 million atyear end.  This increase in the generalallowance was driven primarily by increased charge-offs for the rolling eightquarters ended June 30, 2009 as compared to the eight quarter period endedDecember 31, 2008.  Other modelfactors that added to the increase in allowance included rising trends in Bank’spast due and nonaccrual loans and rising unemployment rates.  Usually, we expect the general allowance forunimpaired loans to increase when periods of economic weakness are coupled withlook-back periods of increasing charged-offs. Conversely, we expect the general allowance to decrease as a percentageof loans when a stronger economy is combined with a decrease in rollingeight-quarter average of the Bank’s charged off loans.

 

Changes in the allowance for loan losses for the six months of 2009 and2008 are as follows (in thousands):

 
| ** **                                | ** ** | **June 30, 2009** | ** ** | **June 30, 2008** | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|
| Balance,  December 31, 2008 and 2007 |       | $                      | 22,355,231 |                   | $          | 12,445,555 |   |
| Charge-offs                               |       | (3,323,998             | )          | (723,611               | )          |
| Recoveries                                |       | 204,179                |       | 353,891                |       |
| Provision  for loan losses                |       | 27,007,307             |       | 2,158,000              |       |
| Acquisition  of Cardinal                  |       | —                 |       | 1,645,157              |       |
| Allowance  for Loan Losses                |       | $                      | 46,242,719 |                   | $          | 15,878,992 |   |

 

The following table presents the Bank’sinvestment in loans considered to be impaired and related information on thoseimpaired loans:

 
| ** **                                                                                  | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|---------------------------------------------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| Impaired  loans without a related allowance for loan losses                                 |       | $                      | 5,660,647  |                       | $          | 6,942,036 |   |
| Impaired  loans with a related allowance for loan losses                                    |       | 23,993,082             |       | 7,496,309                  |       |
| Impaired  loans acquired without a related allowance for loan losses                        |       | 2,848,855              |       | —                     |       |
| Impaired  loans acquired with subsequent deterioration and related allowance for loan  loss |       | 9,806,158              |       | —                     |       |
| Total  impaired loans                                                                       |       | $                      | 42,308,742 |                       | $          | 14,438,345 |   |
|                                                                                        |       |                   |       |                       |       |
| Allowance  for loan losses related to impaired loans                                        |       | $                      | 12,020,196 |                       | $          | 3,663,409 |   |

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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Impaired loans are summarized as follows:

 
| ** **                          | ** ** | **June 30,  2009** | ** ** | **December  31, 2008** | ** ** |
|-------------------------------------|------------|--------------------|------------|------------------------|------------|
| Impaired  loans:                    |       |               |       |                   |       |
| Nonaccrual                          |       | $                  | 32,007,774 |                   | $          | 13,647,312 |   |
| Restructured                        |       | 4,356,674          |       | —                 |       |
| Other impaired loans*               |       | 5,944,294          |       | 791,033                |       |
| Total impaired loans                |       | $                  | 42,308,742 |                   | $          | 14,438,345 |   |
|                                |       |               |       |                   |       |
| Nonaccrual loans                    |       | $                  | 32,007,774 |                   | $          | 13,647,312 |   |
| Loans past due 90 days and accruing |       | —             |       | —                 |       |
| Foreclosed real estate              |       | 7,769,159          |       | 4,017,880              |       |
| Total Nonperforming Assets          |       | $                  | 39,776,933 |                   | $          | 17,665,192 |   |

 

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*Other impaired loans consists ofloans in which regular payments are still received however some uncertaintyexists as to whether or not the full contractual amounts will be collected inaccordance with the terms of the loan agreement.

 

The following tablepresents information regarding all loans accounted for under SOP 03-3, whichincludes the Company’s acquisition of American Community on April 17,2009:

 
| ** **                                  | ** ** | **Contractual****Principal  R****eceivable** | ** ** | **Fair Value  Adjustment  (nonaccretable  difference)** | ** ** | **Carrying  Amount** | ** ** |
|---------------------------------------------|------------|----------------------------------------------|------------|---------------------------------------------------------|------------|----------------------|------------|
| As  of April 17, 2009 acquisition date |       | $                                            | 14,513,154 |                                                    | $          | 3,824,951            |       | $ | 10,688,203 |   |
| Change due to payment received              |       | (61,255                                      | )          | —                                                  |       | (61,255              | )          |
| Transfer to foreclosed real estate          |       | (1,470,535                                   | )          | (247,822                                                | )          | (1,222,713           | )          |
| Change due to legal discharge of debt       |       | (498,312                                     | )          | (498,312                                                | )          | —               |       |
| Balance at June 30, 2009               |       | $                                            | 12,483,052 |                                                    | $          | 3,078,817            |       | $ | 9,404,235 |   |

 

At June 30,2009, the outstanding balance of SOP 03-3 loans, which includes principal,interest and fees due, was $12,655,013. Each of the SOP 03-3 loans isconsidered to be impaired. Because of the uncertainty of the expected cashflows, the Company is accounting for each SOP 03-3 loan under the cost recoverymethod, in which all cash payments are applied to principal. Thus, there is noaccretable yield associated with the above loans.

 

***11.  Subsequent Events***

 

In accordance with SFAS 165, “SubsequentEvents”, issued in May 2009 and effective for periods ending after June 15,2009, management performed an evaluation to determine whether there have beenany subsequent events since the balance sheet date.  The evaluation was performed through August 17,2009, the date on which the Company’s 10-Q was issued as filed with theSecurities and Exchange Commission.

 

The Company was a party to legal proceedings and potential claimsarising in the normal conduct of business.  The Company was sued for damagesin excess of $850,000 for 3.99 years of severance, continued benefits andfringe benefits by two former employees who alleged breach of contract. In addition, the plaintiffs sought liquidated damages and costs (includingreimbursement for reasonable attorney fees) under their wage and hourclaims.  They also asserted that non-compete provisions of the employmentagreements did not apply to their separation.  Both plaintiffs filed forjudgment on the pleadings in state court and prevailed.  The Companyappealed the orders to the North Carolina Court of Appeals before the trialcourt had determined damages.  Plaintiffs prevailed before the Court ofAppeals and the Company’s further appeal to the North Carolina Supreme Courtwas denied.   The Supreme Court remandedthe case to the trial court for a determination of damages.  On July 9,2009, the case was settled by confidential agreement of the parties.  Thefull amount of the settlement had been reserved in prior periods and noadditional reserves are deemed necessary.

 

On July 24, 2009, the Company entered into a Letter Agreement(including the Securities Purchase Agreement—Standard Terms incorporated byreference therein, the “Purchase Agreement”) with Treasury dated July 24,2009 pursuant to which the Company issued and sold to Treasury (i) 13,312shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series T-ACB,having a liquidation preference of $1,000 per share (the “Series T-ACBPreferred Stock”), and (ii) a ten-year warrant to purchase up to 273,534shares of the Company’s common stock, par value $1.00 per share (“Common Stock”),at an initial exercise price of $7.30 per share (the “Warrant”), for anaggregate purchase price of $13,312,000 in cash.  The terms of the Series T-ACB PreferredStock are the same as the CPP preferred stock issued to Treasury on January 16,2009.  For a more detailed discussion ofthe transaction, see the Company’s Form 8-K filed with the SEC on July 27,2009.

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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***12. New Accounting Standards***

 

**Recently Adopted Accounting Standards**

 

Effective January 1, 2009, the Company adopted SFAS No. 161, “Disclosuresabout Derivative Instruments and Hedging Activities’ (“SFAS 161”). SFAS 161requires enhanced disclosures about how and why derivative instruments areused, how derivative instruments and related hedged items are accounted forunder Statement 133 and how derivative instruments and related hedged itemsaffect the balance sheet, income statement and statement of cash flows.Adoption of this standard did not result in a change to the accounting for theCompany’s derivative financial instruments but instead resulted in enhanced disclosureswhich are in the following paragraph.

 

The Company is exposed to certain risks relating to its ongoingmortgage origination business.  Theprimary risks managed by derivative instruments are interest rate lockcommitments and forward loan sale commitments. Interest rate lock commitments and forward sales committment are enteredinto to manage interest rate risk associated with the Company’s fixed rate loancommitments.  The period of time betweenthe issuance of a loan commitment and the closing and sale of the loangenerally ranges from 10 to 60 days. Such interest rate lock commitmentsand forward loans sales commitments represent derivative instruments which arerequired to be carried at fair value. These derivative instruments do not qualifyas hedges under SFAS No. 133. The fair value of the Company’s interestrate lock commitments and forward loan sales commitments are based on currentsecondary market pricing and included on the balance sheet in the loans heldfor sale and on the income statement in gain on sale of mortgages.  The gain and losses from the future sales ofthe mortgages is recognized when the Company, the borrower and the investorenter into the loan contract and the resulting gain or loss is recorded on theincome statement under gains on sale of mortgages.

 

As of June 30, 2009, the total amount of the Company’s outstandinginterest rate lock commitments was approximately $145.4 million. The fair valueof interest rate locks and forward sales were $393,296 and $24,698, respectivelyand were recorded in other assets. Recognition of gains or losses related tothe interest rate locks and forward sales are included in other income.

 

On February 12, 2008, the Financial Accounting Standards Board (“FASB”)issued FASB Staff Position No. FAS 157-2, Effective Date of FASB StatementNo. 157**which deferred the application of SFAS157, “Fair Value Measurements”**tononfinancial assets and liabilities measured on a nonrecurring basis untilinterim and annual periods beginning after November 15, 2008.  The Company applied the full provisions ofSFAS 157, “Fair Value Measurements”**to itsnonfinancial assets measured on a nonrecurring basis during the first quarterof 2009.  The adoption of FSP FAS 157-2did not have a material effect on the Company’s financial position or resultsof operations however it did result in additional disclosure regarding otherreal estate owned in Note 13 to the consolidated financial statements.

 

On April 9, 2009, the FASB issued FASB Staff Position(FSP) FAS 157-4, “DeterminingFair Value When the Volume and Level of Activity for the Asset or LiabilityHave Significantly Decreased and Identifying Transactions That Are Not Orderly.”The FSP provides additional guidance for estimating fair value in accordancewith SFAS Statement No. 157, “FairValue Measurements”, when the volume and level of activity for the assetor liability have significantly decreased. The FSP also includes guidance onidentifying circumstances that indicate a transaction is not orderly. Further,the FSP emphasizes that even if there has been a significant decrease in thevolume and level of activity for the asset or liability and regardless of thevaluation technique(s) used, the objective of a fair value measurementremains the same. Fair value is the price that would be received to sell anasset or paid to transfer a liability in an orderly transaction (that is, not aforced liquidation or distressed sale) between market participants at themeasurement date under current market conditions. The FSP amends SFAS No. 157to require certain additional disclosures in interim and annual periods todiscuss the inputs and valuation technique(s) used to measure fair value.This FSP is effective for interim and annual reporting periods ending after June 15,2009, with early adoption permitted for periods ending after March 15,2009, and shall be applied prospectively. The adoption FSP FAS 157-4 did not have a material effect on the Company’sfinancial position or results of operations however it did result in additionaldisclosures.

 

On April 9, 2009, the FASB issued FASB FSP No. FAS 107-1 andAPB 28-1, “Interim Disclosures aboutFair Value of Financial Instruments.” This FSP amends FASB Statement No. 107,“Disclosures about Fair Value ofFinancial 

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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Instruments”, to require disclosures aboutfair value of financial instruments for interim reporting periods of publiclytraded companies as well as in annual financial statements. This FSP alsoamends APB Opinion No. 28, “InterimFinancial Reporting”, to require those disclosures in summarizedfinancial information at interim reporting periods. This FSP is effective forinterim reporting periods ending after June 15, 2009, with early adoptionpermitted for periods ending after March 15, 2009. The Company adoptedthis new accounting pronouncement in the second quarter of 2009.

 

On April 9, 2009, the FASB issued FSP SFAS 115-2 and SFAS 124-2, “Recognitionand Presentation of Other-Than-Temporary Impairments,” (“FSP SFAS 115-2 andSFAS 124-2”) categorizes losses on debt securities available-for-sale orheld-to-maturity determined by management to be other-than-temporarily impairedinto losses due to credit issues and losses related to all otherfactors.  Other-than-temporary impairment exists when it is morelikely than not that the security will mature or be sold before its amortizedcost basis can be recovered.  An OTTI related to credit losses shouldbe recognized through earnings.  An OTTI related to other factorsshould be recognized in other comprehensive income.  The FSP does notamend existing recognition and measurement guidance related toother-than-temporary impairments of equity securities. Annual disclosuresrequired in SFAS 115 and FSP SFAS 115-1 and SFAS 124-1 are also required forinterim periods (including the aging of securities with unrealized losses). Theadoption of FSP SFAS 115-2 and SFAS 124-2 did not have a material effect on theCompany’s financial position or results of operations however it did result inadditional disclosures.

 

In May 2009, the FASBissued Statement of Financial Accounting Standards (“SFAS “) No. 165, “SubsequentEvents” (“SFAS 165”).  SFAS 165 sets forth the circumstances under whichan entity should recognize events occurring after the balance sheet date andthe disclosures that should be made.  Subsequent events that provideadditional evidence about conditions that existed at the date of the balancesheet should be recognized at the balance sheet date. Subsequent events thatprovide evidence about conditions that arose after the balance sheet date but beforefinancial statements are issued, or are available to be issued, are notrequired to be recognized. The date through which subsequent events have beenevaluated must be disclosed as well as whether it is the date the financialstatements were issued or the date the financial statements were available tobe issued.  For nonrecognized subsequentevents which should be disclosed to keep the financial statements from beingmisleading, the nature of the event and an estimate of its financial effect, ora statement that such an estimate cannot be made, should be disclosed.  The standard is effective for interim orannual periods ending after June 15, 2009. See Note 11 for management’sevaluation of subsequent events.

 

**Recently Issued but not yet Effective Accounting Pronouncements:**

 

In June 2009, the FASB issued SFAS No. 166,“Accounting for Transfers of Financial Assets” (“SFAS 166”).  SFAS 166,which is a revision to SFAS No. 140, eliminates the concept of aqualifying special purpose entity (QSPE), changes the requirements forderecognizing financial assets, and requires additional disclosures, includinginformation about continuing exposure to risks related to transferred financialassets.  SFAS 166 is effective for financial asset transfers occurringafter the beginning of fiscal years beginning after November 15,2009.  The disclosure requirements must be applied to transfers thatoccurred before and after the effective date. Management is still evaluating the impact of SFAS 166.

 

In June 2009, the FASB issued SFAS No. 167,“Amendments to FASB Interpretation No. 46(R)” (SFAS 167”).  SFAS 167,which is a revision to FIN 46(R), contains new criteria for determining theprimary beneficiary, eliminates the exception to consolidating QSPEs, requirescontinual reconsideration of conclusions reached in determining the primarybeneficiary, and requires additional disclosures.  This statement iseffective as of the beginning of fiscal years beginning after November 15,2009 and is applied using a cumulative effect adjustment to retained earningsfor any carrying amount adjustments (e.g., for newly-consolidated VIEs).  Management is still evaluating the impact ofSFAS 167.

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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In June 2009, the FASB issued SFAS No. 168,“*The FASB Accounting Standards Codification*and the Hierarchy of Generally Accepted Accounting Principles— a replacement ofFASB Statement No. 162,” (SFAS 168”). SFAS 168 establishes the *FASB Accounting Standards Codification* (“Codification”) asthe source of authoritative generally accepted accounting principles (“GAAP”)for nongovernmental entities. The Codification does not change GAAP.Instead, it takes the thousands of individual pronouncements that currentlycomprise GAAP and reorganizes them into approximately 90 accounting Topics, anddisplays all Topics using a consistent structure. Contents in each Topic arefurther organized first by Subtopic, then Section and finallyParagraph.  The Paragraph level is theonly level that contains substantive content. Citing particular content in theCodification involves specifying the unique numeric path to the content throughthe Topic, Subtopic, Section and Paragraph structure.  FASB suggests that all citations begin with “FASBASC,” where ASC stands for Accounting Standards Codification. SFAS 168, (FASBASC 105-10-05, 10, 15, 65, 70) is effective for interim and annual periodsending after September 15, 2009 and will not have an impact on the Company’sfinancial position but will change the referencing system for accountingstandards.

 

***13. Fair Value***

 

The Company utilizes fair value measurements to record fair valueadjustments for certain assets and liabilities and to determine fair valuedisclosures. Available-for-sale securities, mortgage servicing rights, interestrate lock commitments and forward sale loan commitments are recorded at fair valueon a monthly basis. Additionally, from time to time, the Company may berequired to record other assets at fair value, such as loans held forinvestment and certain other assets. These nonrecurring fair value adjustmentsusually involve writing the asset down to lower of cost or market value.

 

**Fair Value Hierarchy**

 

Under SFAS 157, the Company groups assets and liabilities at fair valuein three levels, based on the markets in which the assets and liabilities aretraded and the reliability of the assumptions used to determine fair value.These levels are:

 
| Level 1 |   | Valuation is based upon quoted prices for identical instruments  traded in active markets.                                                                                                                                                                                                                                                                                             |
|---------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|    |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| Level 2 |   | Valuation is based upon quoted prices for similar instruments in  active markets, quoted prices for identical or similar instruments in markets  that are not active, and model-based valuation techniques for which all  significant assumptions are observable in the market.                                                                                                        |
|    |   |                                                                                                                                                                                                                                                                                                                                                                                   |
| Level 3 |   | Valuation is generated from model-based techniques that use at least  one significant assumption not observable in the market. These unobservable  assumptions reflect estimates of assumptions that market participants would  use in pricing the asset or liability. Valuation techniques include use of  option pricing models, discounted cash flow models and similar techniques. |

 

Following is a description of valuation methodologies used for assetsand liabilities recorded at fair value.

 

**Available-for-Sale Investment Securities**

 

Available-for-sale investment securities are recorded at fair value ona recurring basis. Fair value measurement is based upon quoted prices, ifavailable. If quoted prices are not available, fair values are measured usingindependent pricing models or other model-based valuation techniques such as thepresent value of future cash flows, adjusted for the security’s credit rating,prepayment assumptions and other factors such as credit loss assumptions. Level1 securities include those traded on an active exchange, such as the New YorkStock Exchange, U.S. Treasury securities that are traded by dealers or brokers in active over-the-countermarkets and money market funds. Level 2 securities include mortgage-backedsecurities issued by government sponsored entities, municipal bonds andcorporate debt securities.

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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**Interest Rate Locks and Forward Sale Loan Commitments**

 

Sidus, the Company’s mortgage lending subsidiary, enters into interestrate lock commitments and commitments to sell mortgages.  At December 31, 2008, the amount of fairvalue was considered immaterial for reporting purposes under SFAS 157. At June 30,2009, the amount of fair value associated with these interest rate lockcommitments and sale commitments was $393,296 and $24,698, respectively.

 

**Mortgage Servicing Rights**

 

A valuation of mortgage servicing rights is performed using a poolingmethodology.  Similar loans are pooledtogether and evaluated on a discounted earnings basis to determine the presentvalue of future earnings.  The presentvalue of the future earnings is the estimated market value for the pool,calculated using consensus assumptions that a third party purchaser wouldutilize in evaluating a potential acquisition of the servicing.  As such, the Company classifies loanservicing rights as Level 3.

 

Assets (liabilities) subjected to recurring fair valueadjustments:

 
| **June 30, 2009 (in thousands)**                    | ** ** | **Fair Value**      | ** ** | **Level 1**      | ** ** | **Level 2**      | ** ** | **Level 3**      | ** ** |
|----------------------------------------------------------|------------|---------------------|------------|------------------|------------|------------------|------------|------------------|------------|
| Available  for sale securities:                          |       |                |       |             |       |             |       |             |       |
| U.S.  government agencies                                |       | $                   | 45,356     |             | $          | —           |       | $                | 45,356     |   | $ | — |   |
| Mortgage  backed securities                              |       | 89,870              |       | —           |       | 89,870           |       | —           |       |
| State  and municipal securities                          |       | 60,877              |       | —           |       | 60,877           |       | —           |       |
| Common  and preferred stocks                             |       | 126                 |       | 126              |       | —           |       | —           |       |
| Interest  rate lock commitments                          |       | 393                 |       | —           |       | 393              |       | —           |       |
| Forward  loan sale commitments                           |       | (25                 | )          | —           |       | (25              | )          | —           |       |
| Mortgage  servicing rights                               |       | 1,478               |       | —           |       | —           |       | 1,478            |       |
|                                                     |       |                |       |             |       |             |       |             |       |
| **December 31, 2008 (in thousands)** | ** ** | **Fair Value** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
| Available  for sale securities:                          |       |                |       |             |       |             |       |             |       |   |   |   |   |
| U.S.  government agencies                                |       | $                   | 43,650     |             | $          | —           |       | $                | 43,650     |   | $ | — |   |
| Mortgage  backed securities                              |       | 53,063              |       |             |       | 53,063           |       |             |       |
| State  and municipal securities                          |       | 41,077              |       |             |       | 41,077           |       |             |       |
| Common  and preferred stocks                             |       | 23                  |       | 23               |       | —           |       | —           |       |
| Mortgage  servicing rights                               |       | 1,745               |       | —           |       | —           |       | 1,745            |       |

 

The followingtable presents a rollforward of mortgage servicing rights from December 31,2008 to June 30, 2009 and December 31, 2007 to June 30, 2008 andshows that the mortgage servicing rights are classified as Level 3 as discussedabove.

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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| ** **                  | ** ** | **Fair Value** | ** ** | **Level 3** | ** ** |
|-----------------------------|------------|----------------|------------|-------------|------------|
| Balance,  December 31, 2008 |       | $              | 1,745,466  |        | $          | 1,745,466 |   |
| Capitalized                 |       | 496,538        |       | 496,538     |       |
| Change in fair  value       |       | (763,812       | )          | (763,812    | )          |
| Balance, June  30, 2009     |       | $              | 1,478,192  |        | $          | 1,478,192 |   |
|                        |       |           |       |        |       |
| ** **                  | ** ** | **Fair Value** | ** ** | **Level 3** | ** ** |
| Balance, December 31, 2007  |       | $              | 2,000,770  |        | $          | 2,000,770 |   |
| Capitalized                 |       | 196,798        |       | 196,798     |       |
| Change in fair value        |       | (719,376       | )          | (719,376    | )          |
| Balance, June 30, 2008      |       | $              | 1,478,192  |        | $          | 1,478,192 |   |

 

**Mortgage Loans Held for Sale**

 

Loans held for sale are carried at lower of cost or market value. Thefair value of loans held for sale is based on what secondary markets arecurrently offering for portfolios with similar characteristics. As such, theCompany classifies loans subjected to nonrecurring fair value adjustments asLevel 2.  At June 30, 2009 the costof the Company’s mortgage loans held for sale was less than the marketvalue.  Accordingly, at quarter end theCompany’s loans held for sale were carried at cost.

 

**Impaired Loans**

 

The Company does not record loans held forinvestment at fair value on a recurring basis. However, from time to time, aloan is  considered impaired and anallowance for loan losses is established. Loans for which it is probable that paymentof interest and principal will not be made in accordance with the contractualterms of the loan agreement are considered impaired. Once a loan is identifiedas individually impaired, management measures impairment in accordance withSFAS 114, “Accounting by Creditors for Impairment of a Loan,” (SFAS 114). The fair value ofimpaired loans is estimated using one of several methods, including collateralvalue, market value of similar debt, enterprise value, liquidation value anddiscounted cash flows. Those impaired loans not requiring an allowancerepresent loans for which the fair value of the expected repayments orcollateral exceed the recorded investments in such loans. At June 30,2009, substantially all of the total impaired loans were evaluated based on thefair value of the collateral. In accordance with SFAS 157, impaired loans wherean allowance is established require classification in the fair value hierarchy.When the fair value of the collateral is based on an observable market price ora current appraised value, the Company records the impaired loan asnonrecurring Level 2. When an appraised value is not available or managementdetermines the fair value of the collateral is further impaired below theappraised value and there is no observable market price, the Company records theimpaired loan as nonrecurring Level 3.

 

Asset subjected to nonrecurring fair value adjustments:

 
| ** **                                     | ** ** | **Fair Value** | ** ** | **Level 1** | ** ** | **Level 2** | ** ** | **Level 3** | ** ** |
|------------------------------------------------|------------|----------------|------------|-------------|------------|-------------|------------|-------------|------------|
| Other  real estate owned at June 30, 2009 |       | $              | 7,769,159  |        |       |        | $          | 7,769,159   |       |   |   |
| Impaired  loans at June 30, 2009          |       | 21,779,044     |       |        |       |        |       | 21,779,044  |       |
| Impaired  loans at December 31, 2008      |       | 7,864,055      |       |        |       |        |       | 7,864,055   |       |
|                                                |            |                |            |             |            |             |            |             |            |  |  |

 

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**Other RealEstate Owned**

 

Other real estate owned (“OREO”)is adjusted to fair value upon transfer of the loans to OREO. Subsequently,OREO is carried at the lower of carrying value or fair value. Fair value isbased upon independent market prices, appraised values of the collateral ormanagement’s estimation of the value of the collateral. When the fair value ofthe collateral is based on an observable market price or a current appraisedvalue, the Company records the foreclosed asset as nonrecurring Level 2. Whenan appraised value is not available or management determines the fair value ofthe collateral is further impaired below the appraised value and there is noobservable market price, the Company records the OREO as nonrecurring Level 3.The current value of OREO at June 30, 2009 is $7,769,159.

 

***14. Financial Instruments***

 

The following is a summary of the carrying amounts and fair values ofthe Companies financial assets and liabilities at June 30, 2009 and December 31,2008:

 
| ** **                                               | ** ** | **June 30, 2009** | ** ** | **December 31, 2008** | ** ** |
|----------------------------------------------------------|------------|------------------------|------------|----------------------------|------------|
| ** **                                               | ** ** | **Carrying**           | ** ** | **Estimated**              | ** ** | **Carrying** | ** ** | **Estimated** | ** ** |
| ** **                                               | ** ** | **amount**             | ** ** | **fair value**             | ** ** | **amount** | ** ** | **fair value** | ** ** |
| ** **                                               | ** ** | **(in  thousands)**    | ** ** |
| Financial  assets:                                       |       |                   |       |                       |       |   |   |   |   |
| Cash  and cash equivalents                               |       | $                      | 45,098     |                       | $          | 45,098 |   | $ | 26,023 |   | $ | 26,023 |   |
| Investment  securities                                   |       | 196,229                |       | 196,229                    |       | 137,814 |   | 137,814 |   |
| Loans  and loans held for sale, net                      |       | 1,715,996              |       | 1,702,799                  |       | 1,215,143 |   | 1,266,545 |   |
| Accrued  interest receivable                             |       | 7,380                  |       | 7,380                      |       | 5,442 |   | 5,442 |   |
| Federal  Home Loan Bank stock                            |       | 10,539                 |       | 10,539                     |       | 7,877 |   | 7,877 |   |
| Investment  in Bank owned life insurance                 |       | 24,073                 |       | 24,073                     |       | 23,608 |   | 23,608 |   |
| Financial  liabilities:                                  |       |                   |       |                       |       |   |   |   |   |
| Demand  deposits, NOW, savings and money market accounts |       | 598,084                |       | 598,084                    |       | 437,464 |   | 437,464 |   |
| Time  deposits                                           |       | 1,180,076              |       | 1,180,206                  |       | 717,578 |   | 734,012 |   |
| Borrowed  funds                                          |       | 152,756                |       | 152,119                    |       | 207,962 |   | 207,344 |   |
| Accrued  interest payable                                |       | 3,534                  |       | 3,534                      |       | 3,554 |   | 3,554 |   |
|                                                          |            |                        |            |                            |            |  |  |  |  |  |  |  |  |

 

The carrying amounts of cash and cash equivalents approximate theirfair value.

 

The fair value of marketable securities is based on quoted marketprices and prices obtained from independent pricing services.

 

For certain categories of loans, such as installment and commercialloans, the fair value is estimated by discounting the future cash flows usingthe current rates at which similar loans would be made to borrowers withsimilar credit ratings and for the same remaining maturities. The cost of fixedrate mortgage loans held-for-sale approximates the fair values as these loansare typically sold within 60 days of origination. Fair values foradjustable-rate mortgages are based on quoted market prices of similar loansadjusted for differences in loan characteristics.

 

The carrying value of Federal Home Loan Bank Stock approximates fairvalue based on the redemption provisions of the Federal Home Loan Bank Stock.

 

The investment in bank owned life insurance represents the cash valueof the policies at June 30, 2009 and December 31, 2008.  The rates are adjusted annually therebyminimizing market fluctuations

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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The fair value of demand deposits and savings accounts is the amountpayable on demand at June 30, 2009 and December 31, 2008,respectively. The fair value of fixed-maturity certificates of deposit andindividual retirement accounts is estimated using the present value of theprojected cash flows using rates currently offered for similar deposits withsimilar maturities.

 

The fair values of borrowings are based on discounting expected cashflows at the interest rate for debt with the same or similar remainingmaturities and collateral requirements. Short-term borrowings, includingovernight, securities sold under agreements to repurchase, federal fundspurchased and FHLB advances, are carried at approximate fair value because ofthe short maturities of those instruments.

 

The fair value of accrued interest receivable and accrued interestpayable approximates their book values because of their short-term duration.

 

**Item 2.**  **Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**CAUTIONARY STATEMENT REGARDING FORWARD LOOKINGSTATEMENTS**

 

The following is our discussion and analysis of certain significantfactors that have affected our financial position and operating results duringthe periods included in the accompanying financial statements.  This commentary should be read in conjunctionwith the financial statements and the related notes and the other statisticalinformation included in this report.

 

This report containsstatements which constitute “forward-looking statements” within the meaning of Section 27Aof the Securities Act of 1933 and Section 21E of the Securities ExchangeAct of 1934.  Forward-looking statementsrelate to the financial condition, results of operations, plans, objectives,future performance, and business of our Company.  Forward-looking statements are based on manyassumptions and estimates and are not guarantees of future performance. Ouractual results may differ materially from those anticipated in anyforward-looking statements, as they will depend on many factors about which weare unsure, including many factors which are beyond our control. The words “may,”“would,” “could,” “should,” “will,” “expect,” “anticipate,” “predict,” “project,”“potential,” “continue,” “assume,” “believe,” “intend,” “plan,” “forecast,” “goal,”and “estimate,” as well as similar expressions, are meant to identify suchforward-looking statements.  Potentialrisks and uncertainties that could cause our actual results to differmaterially from those anticipated in our forward-looking statements include,without limitation, those described under the heading “Risk Factors” in ourAnnual Report on Form 10-K (as amended) for the year ended December 31,2008 as filed with the Securities and Exchange Commission (the “SEC”) and thefollowing:

 

·                  significant increases in competitive pressurein the banking and financial services industries;

·                  changes in the interest rate environmentwhich could reduce anticipated or actual margins;

·                  expected revenue synergies and cost savingsfrom the ACB combination may not be fully realized;

·                  changes in political conditions or thelegislative or regulatory environment;

·                  general economic conditions, eithernationally or regionally and especially in our primary service area, becomingless favorable than expected resulting in, among other things, a deteriorationin credit quality;

·                  changes occurring in business conditions andinflation;

·                  changes in technology;

·                  changes in monetary and tax policies;

·                  adequacy of the level of our allowance forloan losses;

·                  construction delays and cost overruns relatedto the expansion of our branch network;

·                  changes in deposit flows;

·                  changes in accounting principles, policies orguidelines;

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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·                  Yadkin Valley’s ability to maintain internalcontrol over financial reporting;

·                  Yadkin Valley’s reliance on secondary sourcessuch as Federal Home Loan Bank advances, sales of securities and loans, federalfunds lines of credit from correspondent banks and out-of-market time deposits,to meet its liquidity needs;

·                  the rate of delinquencies and amounts ofloans charged-off;

·                  the rates of loan growth and the lack ofseasoning of our loan portfolio;

·                  adverse changes in asset quality andresulting credit risk-related losses and expenses;

·                  loss of consumer confidence and economicdisruptions resulting from terrorist activities or other military action;

·                  changes in the securities markets; and

·                  other risks and uncertainties detailed fromtime to time in our filings with the SEC.

 

We have based our forward-looking statements on our currentexpectations about future events. Although we believe that the expectationsreflected in our forward-looking statements are reasonable, we cannot guaranteeyou that these expectations will be achieved. We undertake no obligation topublicly update or otherwise revise any forward-looking statements, whether asa result of new information, future events, or otherwise.

 

These risks are exacerbated by the recent developments in national andinternational financial markets, and we are unable to predict what effect theseuncertain market conditions will have on us. During 2008 and continuing through the second quarter of 2009, thecapital and credit markets have experienced extended volatility anddisruption.  In recent months, thevolatility and disruption have reached unprecedented levels.  There can be no assurance that theseunprecedented recent developments will not continue to materially and adverselyaffect our business, financial condition and results of operations.

 

**Recent Government Actions**

 

On October 14, 2008, under authority granted by the EmergencyEconomic Stabilization Act of 2008 (the “EESA”), the United States Departmentof the Treasury adopted the Troubled Asset Relief Program and the CapitalPurchase Program (the “Capital Purchase Program”) pursuant to which theTreasury intends to make senior preferred stock investments in participatingfinancial institutions. The terms and conditions of the Capital PurchaseProgram are generally described in the Treasury’s term sheet available on theTreasury’s website at http://www.ustreas.gov. The Company applied for andreceived approval to participate in the Treasury’s Capital Purchase Program andreceived $36 million in additional capital.

 

Another aspect of EESA (in addition to the Capital Purchase Plan) whichbecame effective on October 3, 2008 is a temporary increase of the basiclimit on federal deposit insurance coverage from $100,000 to $250,000 perdepositor.  The basic deposit insurancelimit will return to $100,000 after December 31, 2013.

 

All FDIC institutions are covered for the first 30 days at nocost.  After the initial 30 day periodexpires, the institution must opt out if it no longer wishes to participate inthe program; otherwise, it will be assessed for future participation. Therewill be a 75-basis point fee to protect new debt issues and an additional10-basis point fee to fully cover non-interest bearing deposit transactionaccounts.

 

Following a systemic risk determination, the FDIC established theTemporary Liquidity Guarantee Program (“TLGP”) on October 14, 2008.  The TLGP includes the Transaction AccountGuarantee Program (“TAGP”), which provides unlimited deposit insurance coveragethrough December 31, 2009 for noninterest-bearing transaction accounts(typically business checking accounts) and certain funds swept intononinterest-bearing savings accounts. Institutions participating in the TLGP pay a 10 basis points fee(annualized) on the balance of each covered account in excess of $250,000,while the extra deposit insurance is in place. The TLGP also includes the Debt Guarantee Program (“DGP”), under whichthe FDIC guarantees certain senior unsecured debt of FDIC-insured institutionsand their 

 

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holding companies.  The unsecureddebt must be issued on or after October 14, 2008 and not later than June 30,2009, and the guarantee is effective through the earlier of the maturity dateor June 30, 2012. On March 17, 2009, the FDIC adopted an interim rule thatextends the DGP and imposes surcharges on existing rates for certain debtissuances.  This extension allows institutions that have issued guaranteeddebt before April 1, 2009 to issue guaranteed debt during the extendedissuance period that ends on October 31, 2009. For such institutions,the guarantee on debt issued on or after April 1, 2009, will expire nolater than December 31, 2012. The DGP coverage limit is generally 125% ofthe eligible entity’s eligible debt outstanding on September 30, 2008 andscheduled to mature on or before June 30, 2009 or, for certain insuredinstitutions, 2% of their liabilities as of September 30, 2008.  Depending on the term of the debt maturity,the nonrefundable DGP fee ranges from 60 to 110 basis points (annualized) forcovered debt outstanding until the earlier of maturity or June 30, 2012and 75 to 125 basis points (annualized) for covered debt outstanding untilafter June 30, 2012.  The TAGP andDGP are in effect for all eligible entities, unless the entity opted out on orbefore December 5, 2008.  The Bankis participating in the TLGP.  TheCompany and the Bank are participating in the DGP but have elected not to havethe option of issuing certain non-guaranteed senior unsecured debt beforeissuing the maximum amount of guaranteed debt. Had we selected this non-guaranteed debt option, the FDIC would haveassessed the Bank 37.5 basis points times its two percent of liabilities as of September 30,2008.

 

**Overview**

 

The followingdiscussion describes our results of operations for the three-month andsix-month periods ended June 30, 2009 as compared to the three-month andsix-month periods ended June 30, 2008, and also analyzes our financialcondition as of June 30, 2009 as compared to December 31, 2008.  Like most community banks, we derive most ofour income from interest we receive on our loans and investments.  Our primary source of funds for making theseloans and investments is our deposits, on which we pay interest.  Consequently, one of the key measures of oursuccess is our amount of net interest income, or the difference between theincome on our interest-earning assets, such as loans and investments, and theexpense on our interest-bearing liabilities, such as deposits.  Another key measure is the spread between theyield we earn on these interest-earning assets and the rate we pay on ourinterest-bearing liabilities.

 

Of course, thereare risks inherent in all loans, so we maintain an allowance for loan losses toabsorb probable losses on existing loans that may become uncollectible.  We establish and maintain this allowance bycharging a provision for loan losses against our operating earnings.  In the following section, we have included adetailed discussion of this process.

 

In addition toearning interest on our loans and investments, we earn income through fees andother expenses we charge to our customers. We describe the various components of this noninterest income, as wellas our noninterest expense, in the following discussion.

 

#### **Thefollowing discussion and analysis also identifies significant factors that haveaffected our financial position and operating results during the periodsincluded in the accompanying financial statements.  We encourage you to read this discussion andanalysis in conjunction with the financial statements and the related notes andthe other statistical information also included in this report.**

 

The Company doesnot undertake, and specifically disclaims any obligation, to publicly releasethe result of any revisions which may be made to any forward-looking statementsto reflect events or occurrences after the date of such statements or toreflect the occurrence of anticipated or unanticipated events.

 

**Changesin Financial Position**

 

Total assets at June 30, 2009 were $2,158.4 million,an increase of $634.1 million, or 41.6%, compared to assets of $1,524.3 millionat December 31, 2008.  The increaseincluded assets acquired from the American Community merger 

 

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Form 10-Q QuarterlyReport June 30, 2009

 

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totaling $544.4 million. Without the additional assets acquired in the merger, assets would haveincreased $89.3 million or 5.9%. The loan portfolio, net of allowance for losses, was$1,594.9 million including net loans at fair value from the American Communityacquisition of $416.3 million at April 17, 2009, compared to $1,165.2million at December 31, 2008.  Grossloans held for investment increased by $453.5 million, or 38.2%, of which$416.3 million came from the American Community acquisition. Excluding theimpact of the American Community acquisition, gross loans held for investmentincreased by $37.2 million, or 3.1%.  Theallowance for loan losses increased $23.9 million driven primarily byincreased charge-offs for the rolling eight quarters ended June 30, 2009as compared to the eight quarter period ending December 31, 2008, risingtrends in the Bank’s past due and nonaccrual loans, and the state’s risingunemployment rates.

 

Loan growthconcentration was divided within the following categories.  Commercial loans increased by $65.3 millionwith $58.3 million acquired at the American Community merger.  Commercial real estate loans increased by$123.1 million with $99.4 million acquired at the American Communitymerger.  Construction and land developmentloans increased by $149.9 million with $131.9 million acquired at the AmericanCommunity merger. Home equity lines of credit increased $53.4 million with$47.8 million acquired at the American Community merger. Consumer loansincreased by $11.1 million with $12.9 million acquired at the AmericanCommunity merger.  Loans were funded bycertificates of deposit (“CODs”), negotiable orders of withdrawal (“NOW”),money market deposits, and borrowings. The Bank promoted one or more special COD rates throughout the period.

 

Mortgage loansheld for sale increased by $71.2 million, or 142.6%, from December 31,2008 to June 30, 2009 as the Bank continued its strategy of sellingmortgage loans mostly to various investors with servicing rights released andto a lesser extent to the Federal National Mortgage Association with servicingrights retained.  These loans arenormally held for a period of two to three weeks before being sold toinvestors.  The timing of the loansclosed within each month allowed the Bank to sell more of its outstanding loansat December 31, 2008 than at June 30, 2009.  Mortgage loans closed in the first six monthsof 2009 ranged from a low of $150.7 million in January to a high of $225.4million in March and totaled $1,140.1 million.  In first half of 2008, total loans closedwere $525.4 million.  Mortgage loans soldduring the six months ended June 30, 2009 totaled $1,069.4 millioncompared to $531.3 million during the same period in the prior year. DuringApril, 2008, Sidus expanded its footprint along the East Coast by entering intosix new states in the New England area. This, along with the drop in mortgageinterest rates, contributed to the increase in gains on sales of mortgages andto the increased volume in mortgage loans originated and sold.

 

The securitiesportfolio increased from $137.8 million at December 31, 2008, to $196.2million at June 30, 2009, an increase of 42.4%, with $71.7 millionacquired in the American Community merger. The portfolio is comprised of securities of other US government agencies(23.1%), mortgage-backed securities (45.8%), state and municipal securities(31.0%), and publicly traded common and preferred stocks (0.1%).  Temporary investments, including deposits atthe Federal Home Loan Bank and federal funds sold, increased from approximately$469,000 at December 31, 2008 to $2.8 million at June 30, 2009.

 

Other assetsincreased $21.1 million due largely to in the purchase of American Community,of which $7.0 million was related to deferred tax assets and income taxreceivables.  Other real estate owned(OREO) increased $3.8 million with $433,000 attributable to the AmericanCommunity merger and additional investments made in the amount.  The Company evaluates the Banking and Sidussegments for impairment on an annual basis at April 30 and October 1,respectively.  The Company performed aninterim goodwill impairment test because the market price of the Company’sstock was below book value at the balance sheet date. Upon evaluationmanagement determined that no impairment existed in the banking or Sidussegment.  However, no assurance can bemade that the Company will not have an impairment in the banking or Sidusreporting units in the future.

 

Deposits increased $623.1 million, or 54.0%, comparing June 30,2009 to December 31, 2008. Deposits totaling $439.9 million wereattributable to the American Community acquisition.  Overall, noninterest-bearing demand deposits increased $48.3million, or 31.4%, which includes the $50.2 million from the American Community

 

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acquisition. NOW,savings, and money market accounts increased $112.3 million, or 39.6%, withAmerican Community contributing $82.6 million. Certificates of deposit (“CODs”)over $100,000 increased $221.3 million, or 66.4%, and other CODs increased$241.2 million, or 62.8%.  AmericanCommunity contributed $ CODs, with the remaining increase primarily due toincreases in brokered deposits. Excluding American Community, the largest increase in interest-bearingdeposits was in the money market. NOW accounts and savings.

 

Borrowed fundsdecreased $55.2 million or 26.6 % comparing June 30, 2009 to December 31,2008.  Advances from the FHLB decreased$72.6 million excluding the $26.0 million in FHLB advances acquired fromAmerican Community, for a net decrease in FHLB advances of $46.6 million.  Repurchase agreements increased $22.1million, with $16.9 million added in the American Community merger, andovernight borrowings decreased $14.5 million. Long term borrowings included $34.9 million in trust preferredsecurities and advances from the FHLB of $7.0 million.  The American Community merger added $10.3million in trust preferred securities at a rate equal to the three-month LIBORrate plus 2.80% and will mature in 2033. Yadkin Valley Statutory Trust I (“the Trust”) issued $25.8 million intrust preferred securities at a rate equal to the three-month LIBOR rate plus1.32%.  The trust preferred securities mature in 30 years, and can becalled by the Trust without penalty after five years.

 

Other liabilitiesincreased by $12.4 million, or 152.8%, from December 31, 2008 to June 30,2009. Of that increase, $5.7 million was attributable to the other liabilitiesacquired from the purchase of American Community.  An additional $3.4 million was accrued in2009 for the legal settlement discussed in the subsequent events footnote andaccruals for FDIC assessments increased $1.6 million.

 

At June 30,2009, total stockholders’ equity was $203.5 million or a book value of $10.48per common share compared to $149.6 million or a book value of $12.97 per shareat year-end December 31, 2008.  Thetangible book values per common share at June 30, 2009 and December 31,2008 were $5.93 and $7.93, respectively. At June 30, 2009, the Company was in compliance with all existingregulatory capital requirements to maintain its status as a well-capitalizedbank. The Company’s equity to assets ratio and total risk-based capital ratiowere 9.4% and 10.25%, respectively, at June 30, 2009.  These ratios have changed since December 31,2008, when the equity to assets ratio was 9.8% and the total risk based capitalratio was 10.17%. During the six-month period ended June 30, 2009, theCompany did not repurchase any shares of its common stock.

 

**Liquidity,Interest Rate Sensitivity and Market Risk**

 

The Bank derivesthe majority of its liquidity from its core deposit base and to a lesser extentfrom wholesale borrowing.  The balancesheet liquidity ratio, measured by the sum of cash (less reserve requirements),investments, and loans held for sale reduced by pledged securities, as comparedto deposits and short-term borrowings, was 14.6% at June 30, 2009 comparedto 11.9% at December 31, 2008. Additional liquidity is provided by $161.2 million in unused creditincluding federal funds purchased lines provided by correspondent banks as wellas credit availability from the FHLB. In addition, the Bank has unpledgedmarketable securities of $85.5 million available for use as a source ofcollateral.  At June 30, 2009,brokered deposits totaled $192.6 million, or 10.6% of total deposits, andconsisted of certificates of deposit totaling $99.3 million and NOW publicfunds totaling $3.2 million.  Brokeredcertificates of deposit are primarily short-term with maturities of six monthsor less.

 

The Bankcontracted with Promontory Interfinancial Network in 2008 for various servicesincluding wholesale CD funding. Promontory’s CDARS® product, One-Way BuySM, enables the Bank to bid on a weekly basis through aprivate auction for CD terms ranging from four weeks to 260 weeks(approximately five years) with settlement available each Thursday. At June 30,2009, the balance of funds acquired through the One-Way Buy product totaled$70.4 million. The Bank obtained funding from out of market customers throughother deposit brokers totaling $99.3 million.

 

Promontory alsoprovides a product, CDARS® Reciprocal, which allows the Bank’s customers toplace funds in excess of the FDIC insurance limit with Promontory’s network ofparticipating Banks so that the customer is fully 

 

Yadkin Valley FinancialCorporation 

Form 10-Q QuarterlyReport June 30, 2009

 

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insured for theamount deposited. Promontory provides reciprocating funds to the Bank fromfunds placed at other banks by their customers. The Bank sets its customersinterest rates when they place deposits through the network and pays/receivesthe rate difference to/from the other banks whose reciprocal funds are held bythe Bank. The overall impact of this process is that the Bank effectively paysthe rate offered to its relationship customer. Therefore, the Bank does notconsider these funds to be wholesale or brokered funds. In compliance with FDICreporting requirements, the Bank reports include reciprocal deposits asbrokered deposits in its quarterly Federal Financial Institutions ExaminationCouncil Call Report.  At June 30,2009, CDARS® reciprocal deposits totaled $19.7 million.

 

Management continues to assess interest rate risk internally and byutilizing outside sources.  Following aperiod of stable rates the balance sheet is asset sensitive over a three-monthperiod, meaning that there will be more assets than liabilities immediatelyrepricing as market rates change. Over a period of twelve months, the balancesheet remains slightly asset sensitive. Following a period of rate increases(or decreases) net interest income will increase (or decrease) over both athree-month and a twelve-month period. We generally would benefit fromincreasing market interest rates when we have an asset-sensitive, or apositive, interest rate gap and we would generally benefit from decreasingmarket interest rates when we have liability-sensitive, or a negative, interestrate gap.

 

The mortgage loans held for sale by Sidus are funded by short-termborrowings and brokered deposits. Although the repricing dates of the mortgage assets and borrowings areapproximately the same, the interest rate spread fluctuates because the assetsand liabilities reprice at different points on the yield curve.  The fifteen to thirty year mortgage assets,usually held for two to three weeks prior to being sold, are priced based onthe fifteen to thirty year mortgage-backed security yield curve, whereas theborrowing rates to fund Sidus loans are based on the one month point on theLIBOR yield curve.  While the netinterest income between these points is positive unless the yield curve isinverted, a decrease in the slope of the yield curve will result in a decreasein the net interest margin for Sidus. Conversely, an increase in the slope will result in an increase inSidus’ net interest margin.  The yieldcurve for the first six months of 2009 was generally steeper than it was forthe first six months of 2008, and as expected, Sidus’ net interest marginincreased by 27 basis points from the second quarter of 2008 to the secondquarter of 2009 and by 24 basis points from the first six months of 2008 to the firstsix months of 2009.

 

The Company hasnot used derivative financial instruments such as futures, forwards, swaps andoptions historically, however, such instruments are available to management ifneeded.  The Company has no market risksensitive instruments held for trading purposes.  The Company’s exposure to market risk isreviewed regularly by management.

 

**Resultsof Operations**

 

Net loss for thethree-month period ended June 30, 2009 was $6.5 million, compared to netincome of $1.7 million in the same period of 2008.  Basic and diluted earnings (loss) availableto common shareholders per common share were $(0.46) for the three-month periodended June 30, 2009.  Basic anddiluted earnings per common share were $0.15 for the three-month period ended June 30,2008.  On an annualized basis, secondquarter results represent a return on average assets of (1.27%) at June 30,2009 compared to (0.69%) at December 31, 2008 and 0.49% at June 30,2008, and a return on average equity of (12.81%) compared to (6.64%) at December 31,2008 and 4.57% at June 30, 2008.

 

Net loss for thesix-month period ended June 30, 2009 was $10.7 million, compared to netincome of $4.6 million in the same period of 2008, a decrease of 330.8%.  Basic and diluted earnings (loss) availableto common shareholders per common share were $(0.87) for the six-month periodended June 30, 2009.  Basic anddiluted earnings per common share were $0.42 for the six-month period ended June 30,2008.  On an annualized basis,year-to-date results 

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport June 30, 2009

 

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represent a returnon average assets of (1.19%) at June 30, 2009 compared to 0.72% at June 30,2008, and a return on average equity of (10.66%) compared to 6.45% at June 30,2008.

 

###### **Net Interest Income**

 

Net interestincome, the largest contributor to earnings, increased $7.2 million or 69.2% to$17.6 million in the second quarter of 2009, compared with $10.4 million in thesame period of 2008. Net interest income earned by the recently acquiredAmerican Community region was $2.3 million for April 17, through June 30, 2009,the period following the merger.  The netinterest margin increased to 3.80% in the second quarter of 2009 from 2.87% inthe first quarter of 2009 and from 3.34% in the second quarter of 2008.

 

Net interestincome for the six-month period ended June 30, 2009 increased to $27.5million from $19.7 million when compared to the same period in 2008. Thedecrease in the prime interest rate was offset by the additional net interestincome earned by the recently acquired American Community region of $2.3million for the period. The net interest margin declined to 3.37% in the firstsix months of 2009 from 3.44% in the first six months of 2008.

 

The margin declineyear over year was driven by a higher concentration of interest bearingliabilities in overall funding in the first six months of 2009 as compared to2008 which more than offset the benefit of a higher interest spread in 2009 ascompared to 2008.  A comparison of thefirst six months of 2009 and 2008 shows that yield on earning assets decreasedby 108 basis points which was offset by a decrease of 126 basis points in thecost on interest bearing liabilities. The decline in yield on earning assets was attributable to the yield onloans which declined by 118 basis points in the first half of 2009 as comparedto the first half of 2008.  Variable rateloans that reprice within three months together with fixed rate loans thatmature within three months comprised 40.1% of total loans held for investmentat June 30, 2009, down from 49.4% at June 30, 2008.  The Company maintains an asset-sensitiveposition with respect to the impact of changing rates on net interestincome.  After period of about threemonths following a rate decrease, the Company’s net interest margin shouldbegin to increase assuming a constant mix of asset and liability categories.The Company’s internal management reports indicate that the monthly netinterest margin, excluding the impact of Sidus, reached its lowest point forthe quarter during May and began to rise in June.  Comparing the linked second and firstquarters of 2009, the net interest margin increased by 89 basis points dueprimarily to the accretion of fair market valuations of loans and deposits acquiredin the merger with American Community. Excluding the impact of merger related accretion, the net interestmargin expanded by 3 basis points on linked quarter basis in the secondquarter.

 

Yadkin Valley FinancialCorporation 

Form 10-Q QuarterlyReport June 30, 2009

 

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**Average Balance Sheets and Net Interest Income Analysis**

**(Dollars inThousands)**

 

(Unaudited)

**Six MonthsEnded:**

 
| ** **                                               | ** ** | **June 30,  2009** | ** ** | **June 30,  2008** | ** ** |
|----------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                               | ** ** | **Average**             | ** ** | ** **              | ** ** | **Yield/** | ** ** | **Average** | ** ** | ** ** | ** ** | **Yield/** | ** ** |
| ** **                                               | ** ** | **Balance**             | ** ** | **Interest**            | ** ** | **Rate** | ** ** | **Balance** | ** ** | **Interest** | ** ** | **Rate** | ** ** |
| INTEREST EARNING ASSETS                                  |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Federal funds sold                                       |       | $                       | 4,309      |                    | $          | 2 |   | 0.09 | % | $ | 3,394 |   | $ | 37 |   | 2.19 | % |
| Interest bearing deposits                                |       | 6,199                   |       | 21                      |       | 0.68 | % | 9,800 |   | 139 |   | 2.84 | % |
| Investment securities (1)                                |       | 172,262                 |       | 3,832                   |       | 4.49 | % | 144,036 |   | 3,736 |   | 5.15 | % |
| Total loans (1,2)                                        |       | 1,488,518               |       | 40,037                  |       | 5.42 | % | 1,017,687 |   | 33,515 |   | 6.60 | % |
| Total average earning  assets (1)                        |       | 1,671,288               |       | 43,892                  |       | 5.30 | % | 1,174,917 |   | 37,427 |   | 6.38 | % |
| Noninterest earning assets                               |       | 149,294                 |       |                    |       |   |   | 126,125 |   |   |   |   |   |
| Total average assets                                     |       | $                       | 1,820,582  |                    |       |   |   |   | $ | 1,301,042 |   |   |   |   |   |
|                                                     |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| INTEREST BEARING  LIABILITIES                            |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| NOW and money market                                     |       | $                       | 295,754    |                    | $          | 1,515 |   | 1.03 | % | $ | 223,633 |   | $ | 2,013 |   | 1.81 | % |
| Savings                                                  |       | 43,236                  |       | 57                      |       | 0.27 | % | 36,597 |   | 109 |   | 0.60 | % |
| Time certificates                                        |       | 912,012                 |       | 12,976                  |       | 2.87 | % | 603,561 |   | 13,071 |   | 4.34 | % |
| Total interest bearing  deposits                         |       | 1,251,002               |       | 14,548                  |       | 2.35 | % | 863,791 |   | 15,193 |   | 3.53 | % |
| Repurchase agreements sold                               |       | 55,715                  |       | 341                     |       | 1.23 | % | 47,681 |   | 628 |   | 2.64 | % |
| Borrowed funds                                           |       | 130,039                 |       | 1,066                   |       | 1.65 | % | 78,556 |   | 1,453 |   | 3.71 | % |
| Total interest bearing  liabilities                      |       | 1,436,756               |       | 15,955                  |       | 2.24 | % | 990,028 |   | 17,274 |   | 3.50 | % |
|                                                     |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Noninterest bearing  deposits                            |       | 168,093                 |       |                    |       |   |   | 152,462 |   |   |   |   |   |
| Stockholders’ equity                                |       | 202,766                 |       |                    |       |   |   | 144 234 |   |   |   |   |   |
| Other liabilities                                        |       | 12,967                  |       |                    |       |   |   | 14 ,318 |   |   |   |   |   |
| Total average liabilities  andstockholders’  equity |       | $                       | 1,820,582  |                    |       |   |   |   | $ | 1,301 042 |   |   |   |   |   |
| NET INTEREST INCOME/YIELD  (3,4)                         |       |                    |       | $                       | 27.884     |   | 3.37 | % |   |   | $ | 20,153 |   | 3.44 | % |
|                                                     |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| INTEREST SPREAD (5)                                      |       |                    |       |                    |       | 3.05 | % |   |   |   |   | 2.89 | % |

 

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1. Interest income and yields related to securities and loans exemptfrom Federal income taxes are stated on a fully tax equivalent basis,assuming a Federal income tax rate of 34%, reduced by the nondeductible portionof interest expense

2.The loan average includes loans on which accrual of interest has beendiscontinued.

3. Net interest income is thedifference between interest income from earning assets and interest expense.

4.Net interest margin is net interest income divided by total average earningassets.

5. Interest spread is the difference between the average interest ratereceived on earning assets and the average rate paid on interest bearingliabilities.

 

**Provisionsand Allowance for Loan Losses**

 

Adequacy ofthe allowance or reserve for loan losses of the Bank is a significant estimatethat is based on 

 

Yadkin Valley FinancialCorporation 

Form 10-Q QuarterlyReport June 30, 2009

 

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management’sassumptions regarding, among other factors, general and local economicconditions,which are difficult to predict and are beyond the Bank’s control.  In estimating these loss reserve levels,management also considers the financial conditions of specific borrowers andcredit concentrations with specific borrowers, groups of borrowers, andindustries.

 

The loan loss provision is determined by management’s assessment of theamount of allowance for loan losses to absorb losses inherent in the loanportfolio due to credit deterioration or changes in the risk profile.  The allowance for loan losses is created bydirect charges to provision expense. Losses on loans are charged against the allowance for loan losses in theaccounting period in which they are determined by management to beuncollectible.  Recoveries during theperiod are credited to the allowance for loan losses.

 

The Bank calculated an allowance for loan losses of $46.2 million at June 30,2009 as compared to $22.4 million at December 31, 2008 based on theapplication of its model for the allowance calculation applied to the loanportfolio at each balance sheet date. The combination of this increase in the estimated allowance and $3.3million in charge-offs resulted in provision expense of $27.0 million for thesix months ended June 30, 2009 as compared to $2.2 million for the sameperiod in the prior year. The allowance model is applied to the loan portfolioquarterly to determine the specific allowance balance for impaired loans andthe general allowance balance for unimpaired loans grouped by loan type.  Out of the $46.2 million in total allowancefor loan losses at June 30, 2009, the specific allowance for impairedloans accounted for $12.0 million, up from $3.7 million at year end.  The remaining general allowance, $34.2million, was attributed to unimpaired loans and was up from $18.7 million atyear end.  This increase in the generalallowance was driven primarily by increased charge-offs for the rolling eightquarters ended June 30, 2009 as compared to the eight quarter periodending December 31, 2008.  Othermodel factors that added to the allowance included rising trends in the Bank’spast due and nonaccrual loans and rising unemployment rates.  Usually, we expect the general allowance onunimpaired loans to increase when periods of economic weakness are coupled withlook-back periods of increasing charged-offs. Conversely, we expect the general allowance to decrease as a percentageof loans when a stronger economy is combined with a decrease in the rollingeight-quarter average of the Bank’s charged off loans.

 

Generally, all loans with outstanding balances of $100,000 or greater,that have been identified as impaired, are reviewed periodically in order todetermine if a specific allowance is required. Charge off history, credit administration’s determination of loanimpairment and risk grades, and other internal and external qualitative factorsare primary considerations in calculating the allowance for loan losses.  The risk grades are based on several factorsincluding historical data, current economic factors, and assessments ofindividual credits within specific loan types. Because these factors are dynamic, the provision for loan losses canfluctuate.  Periodic credit qualityreviews performed on a sample basis are based primarily on analysis ofborrowers’ cash flows, with asset values considered only as a second source ofpayment.

 

Management uses several measures toassess and monitor the credit risks in the loan portfolio, including a loangrading system that begins upon loan origination and continues for the entirelife of the loan.  Upon loan origination,the Bank’s originating loan officer evaluates the quality of the loan andassigns one of eight risk levels.  Theloan officer monitors the loan’s performance and credit quality and makeschanges to the risk grade as conditions warrant.  The Chief Credit Officer coordinates the loanapproval process for loans not involving the Board by delegating authority tocertain lenders with Board approval. The Bank Loan Committee is comprised ofsenior bank management and approves new loans and relationship exposures overcertain dollar amounts. Officer loan approval limits are reviewed and approvedby the Board of Directors.  The ChiefCredit Officer is responsible for the credit policy which includes underwritingguidelines and procedures.  The ChiefCredit Officer is a voting member of the Bank Loan Committee.

 

Yadkin Valley FinancialCorporation 

Form 10-Q QuarterlyReport June 30, 2009

 

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Management uses the information developed from the procedures above inevaluating and grading the loan portfolio. This continual grading process is used to monitor the credit quality ofthe loan portfolio and to assist management in determining the appropriatelevels of the allowance for loan losses.

 

As a part of the continual grading process, loans over $20,000 areassigned a credit risk grade based on their credit quality, which is subject tochange as conditions warrant.  Anychanges in risk assessments as determined by loan officers, creditadministrators, regulatory examiners and management are also considered.  Management considers certain loans graded “doubtful”or “loss” to be individually impaired and may consider “substandard” loansindividually impaired depending on the borrower’s payment history.  The Bank measures impairment based uponprobable cash flows and the value of the collateral.  Impaired loans are identified and evaluatedfor specific reserves in a periodic analysis of the adequacy of thereserve.  In estimating reserve levels,the Bank aggregates the remaining loans not deemed to be impaired and reviewsthe historical loss experience as well as environmental factors by type of loanas additional criteria to allocate the allowance.  The historical loss experience factorsapplied to “watch list” and “substandard” loans that are not individuallyimpaired are adjusted for other factors that are not necessarily captured inthe historical loss ratios.  Internalenvironmental factors applied to non-impaired loan pools include past-due andnonaccrual trends, risk grade migration trends and the assessment of underwritingand servicing.  External environmentalfactors include interest rate trends, unemployment rate trends, and real estateloan concentrations.

 

Management considers the allowance for loan losses adequate to coverthe estimated losses inherent in the Bank’s loan portfolio as of June 30,2009. No assurance can be given in this regard, however, especially consideringthe overall weakness in the commercial real estate market and the Bank’s marketareas. Management believes it has established the allowance in accordance withaccounting principles generally accepted in the United States of America andwill consider future additions to the allowance that may be necessary based onchanges in economic and other conditions. Additionally, various regulatory agencies, as an integral part of theirexamination process, periodically review the Bank’s allowance for loanlosses.  Such agencies may require therecognition of adjustments to the allowances based on their judgments ofinformation available to them at the time of their examinations.

 

Management realizes that general economic trends greatly affect loanlosses. The recent downturn in the real estate market has resulted in increasedloan delinquencies, defaults and foreclosures, and we believe that these trendsare likely to continue. In some cases, this downturn has resulted in asignificant impairment to the value of our collateral and our ability to sellthe collateral upon foreclosure. The real estate collateral in each caseprovides an alternate source of repayment in the event of default by the borrowerand may deteriorate in value during the time the credit is extended. If realestate values continue to decline, it is also more likely that we would berequired to increase our allowance for loan losses and our net charge-offswhich could have a material adverse effect on our financial condition andresults of operations. Assurances cannot be made either (1) that furthercharges to the allowance account will not be significant in relation to thenormal activity or (2) that further evaluation of the loan portfolio basedon prevailing conditions may not require sizable additions to the allowance andcharges to provision expense. Net loan charge offs (recoveries) were$3,119,819, or 0.46% (annualized), of average loans held for investment, forthe six months ending June 30, 2009 compared to $369,720, or 0.07%(annualized), of average loans held for investment, for the six months ending June 30,2008.  We believe the Bank’s delinquencyratio was higher than our peer group averages at June 30, 2009, while ournet charge-offs as a percentage of average loans were lower than the peer groupfor the first half of the year.  Theincrease over last year was caused by some weakening in the economy resultingin an uptick in charge-offs across all categories of loans.

 

As of June 30, 2009, the allowance for loan losses was $46.2million, or 2.82%, of gross loans held for investment.  This allowance level compares with $22.4million, or 1.88%, of loans held for investment at December 31, 2008, and$15.9 million, or 1.48%, at June 30, 2008.

 

Yadkin ValleyFinancial Corporation

Form 10-QQuarterly Report June 30, 2009

 

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**NonperformingAssets**

 

Totalnon-performing assets increased from $17.7 million to $39.8 million and from1.16% to 1.84% of total assets as of December 31, 2008 and June 30,2009, respectively, with $13.1 million related to the acquisition of AmericanCommunity. Total other real estate owned (“OREO”) increased from approximately$4.0 million at December 31, 2008 to $7.8 million at June 30,2009.  Total nonaccrual loans increasedfrom $13.6 million at December 31, 2008 to $32.0 million at June 30,2009.  The increases in nonaccrual loans,impaired loans, and OREO are the result of some economic softening in ourmarkets during the past three months.  We have analyzed our non-performing loans to determine what we believeis the amount needed to reserve in the allowance for loan losses based on anassessment of the collateral value or discounted cash flows of the loan.  We have downgraded loans for which theprobability of collection is more uncertain and written down OREO propertyvalues where net realizable values have declined.

 

The largest amountof nonaccrual loans for one customer totaled $2.1 million for a commercial,non-real estate loan for which $1.9 million was specifically assigned to theallowance. Nonaccrual loans also included two other relationships totaling $1.8million and $1.9 million for commercial real estate and construction loans withspecific allowances of $320,000 and $110,000, respectively.  These loans were placed in nonaccrual statusbecause of the customers’ inability to pay, collateral deterioration and dismalfuture industry outlook.  The followingtable is a breakdown of all nonaccrual loans by type:

 
| ** **                              | ** ** | **June 30, 2009** | ** ** | **December 31, 2008**       | ** ** |
|-----------------------------------------|------------|------------------------|------------|----------------------------------|------------|
| **Loan  Type**                          | ** ** | **Balance**            | ** ** | **% of Total  Nonaccrual Loans** | ** ** | **Balance** | ** ** | **% of Total  Nonaccrual Loans** | ** ** |
| Construction                            |       | $                      | 15,982,233 |                             | 49.9       | % | $ | 4,681,054 |   | 32.4 | % |
| Commercial,  financial and agricultural |       | 3,583,293              |       | 11.2                             | %          | 4,425,514 |   | 30.6 | % |
| Mortgage                                |       | 3,983,520              |       | 12.4                             | %          | 2,955,854 |   | 20.5 | % |
| Commercial  real estate                 |       | 8,176,995              |       | 25.5                             | %          | 2,194,317 |   | 15.2 | % |
| Installment  loans                      |       | 253,395                |       | 0.8                              | %          | 166,570 |   | 1.2 | % |
| Open  end, unsecured                    |       | 28,337                 |       | 0.1                              | %          | 15,036 |   | 0.1 | % |
| Total                                   |       | $                      | 32,007,773 |                             | 100.0      | % | $ | 14,438,345 |   | 100.0 | % |

 

All loans over 90 days are put on nonaccrual and stop accruinginterest.  In addition, loans are placed on nonaccrual status if, based oncurrent information, circumstances, or events, we believe it is probable thatthe Bank will not collect the scheduled payments of principal and interest whendue according to the contractual terms of the loan agreement. Nonaccrual loanrelationships with balances of at least $100,000 will be considered impairedand evaluated for specific allowances as needed.  Occasionally, accruing loan relationships maybe determined to be impaired under certain circumstances such as declines incollateral values that indicate a probable loss if, at a later date, theborrower is unable to make payments on time. When a nonaccrual loan has paid according to the schedule for at leastsix months and the customer demonstrates the intent and ability to continue topay in a timely manner, the Bank will begin accruing interest, and it will nolonger be considered impaired.

 

**NoninterestIncome**

 

Noninterest incomeconsists of all revenues that are not included in interest and fee incomerelated to earning assets.  Total noninterestincome increased approximately $3.6 million, or 87.3%, comparing the secondquarters of 2009 and 2008. Total noninterest income increased approximately$4.9 million, or 61.5%, at June 30, 2009 compared to noninterest income atJune 30, 2008. The fluctuations in the income categories that make upnoninterest income are as follows:

 

Yadkin ValleyFinancial Corporation

Form 10-Q Quarterly Report June 30, 2009

 

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·  Quarter to date service charges ondeposit accounts increased $470,000 due mainly to income from AmericanCommunity of $461,000. Service charges, excluding American Community, increased$42,000.  A decrease in NSF fee income of$33,000 offset the increases.

 

Year to dateincreases in service charges on deposit accounts of $508,000 included incomefrom American Community of $461,000 and an increase in service charges,excluding American Community, of $24,000 and increases in NSF fees of $23,000.

 

·  Quarter to date other service fee incomeincreased by approximately $488,000 due to increases in the commission incomefor mortgage originations and investment fee income of $379,000 and increasesin merchant fee income and credit card user fees of $29,000.

 

Year to date otherservice fee income increased approximately $689,000. Commission income formortgage originations increased $437,000 and investment fee income, earned bythe brokerage division, Main Street Investment Services, Inc., increasedby approximately $64,000.   Merchant feeincome also increased $92,000.

 

·  Quarter to date results show an increasein net gain in the sale of mortgages of approximately $3,017,000 or 169.1% astotal loans originated and sold increased. The decline in conventional mortgagerates during the quarter resulted in a significant increase in mortgage loansoriginated from $267 million in the second quarter of 2008 to $577 million inthe second quarter of 2009.

 

Year to date, gainon sale of mortgage loans increased by approximately $4,444,000 or 125.0%.

 

·  Income on investment in bank-owned lifeinsurance (“BOLI”) increased only slightly by 0.55% for the quarter to date anddecreased slightly by 0.62% for the year to date.

 

·  Mortgage banking income decreasedapproximately $276,000 or 403.2% to a loss for the quarter of $207,212 due inpart to the valuation adjustment to mortgage servicing rights (“MSR”) toreflect a steady decline in the average serviced mortgage balances and a dropin the servicing fees received. The decline in serviced mortgage balances wasattributed to the market rate decreases that resulted in serviced mortgagecustomers refinancing.

 

·  Other income decreased by approximately $145,000 or625.9% for the quarter and $147,000 or 227.6% for the year mainly due to losseson the sale of other real estate owned of $80,000 and $68,000, respectively,and the reduction in dividend income from the FHLB.

 

**NoninterestExpense**

 

Total noninterestexpenses were $19.0 million for the second quarter of 2009, compared to $10.1million in the same period of 2008, an increase of $8.9 million, or 87.7%.Total noninterest expenses were $30.8 million for the six months ended June 30,2009, compared to $18.8 million for the same period of 2008, an increase of$12.1 million, or 64.1%.

 

The following is asummary of the fluctuations for the quarter and six months ended June 30,2009 as compared to June 30, 2008.

 

·           Quarter-to-datesalaries and employee benefit expenses increased by $3.3 million or 64.4%.  The major components of the $3.3 millionincrease are summarized as follows.  Salaries and wages increased by $2.3million, with $1.7 million related to the American Community acquisition.  The increase in Sidus’ salaries of $0.4million was attributable to the additional staff necessary to process theincreased mortgage loan volume.  Salaries and benefit costs directlyrelated to loan originations, which are expensed over the life of the loan,increased $176,000, directly offsetting the increase in wages. These increasedcost deferrals were a product of 

 

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increases in (1) loan volume and (2) cost per loan (held forinvestment) that was deferred.  Accruals for the mortgage lendingsubsidiary’s bonus incentive plan increased $412,000 based on performancemeasures.  Other personnel expenses increased by $115,000, primarily for (1) post-retirementbenefit accruals from split-dollar policies and for (2) expensesassociated with operating the American Community division after itsacquisition.  In the aggregate, employee group insurance expense increasedby $109,000, payroll taxes by $173,000, and 401(k) matching contributionsby $61,000.  Most of the increases in these categories were associatedwith the addition of previous American Community employees.  Commissionexpenses increased by $207,000 as mortgage origination production at the Bankincreased.

 

Year-to-date increases in salaries and employee benefits were $4.0million or 40.5% for same reasons as discussed above.

 

·           Quarter-to-dateoccupancy and equipment expenses increased by $548,000 or 42.4%.  Theincrease attributable to the addition of the American Community branches was$446,000, with the remaining 7.9% increase attributable to normal recurringincreases in costs.

 

Year-to-date increases in occupancy andequipment expenses increased by $899,000, or 39.6%, for the same reasons asdiscussed above.

 

·           Printingand supplies increased by $77,000, or 39.2%, comparing second quarter 2009 withsecond quarter 2008. The increase attributable to the addition of the AmericanCommunity branches was $19,000.  Certaintraining and merger supplies required for the June 2009 conversion ofAmerican Community files increased the printing and supplies cost also.

 

Year-to-date increases in printing and supplies increased $124,000, or32.5%, for reasons discussed above.

 

·           Quarter-to-datedata processing expense increased $156,000, or 57.6%, with $193,000attributable to American Community processing expenses.  Excluding American Community, data processingexpense decreased by $37,000 due to the residual data processing costs for theCardinal branches in 2008.

 

Year—to-date data processing expense increased $177,000, or 46.1%, forsame reasons as discussed above.

 

·           Quarter-to-datecommunication expense increased $52,000, or 18.6%, with $56,000 attributable toAmerican Community expenses.

 

Year—to-date communication expense increased $166,000, or 34.1%, with$56,000 attributable to American Community expenses.  Excluding American Community, communicationexpense increased $110,000 partially due to the installation of a new communicationsystem and training provided. Additional expenses related to the Cardinalacquisition of $52,000 which occurred after the first quarter of 2008 alsoattributed to the increase.

 

·           Amortizationof the core deposit intangible, recognized with the purchases of Main StreetBankShares, Inc. in 2002, High Country Financial Corporation in 2004,Cardinal State Bank in 2008, and American Community Bancshares, Inc in 2009,increased $114,000, or 48.5%, for the quarter and $152,000, or 36.0%, for theyear due to the purchase of American Community on April 17, 2009.

 

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·           Quarter-to-dateand year-to-date FDIC assessment expenses increased $1.6 million and $2.2million, respectively, due to additional assessments imposed by the FDICincluding a one-time assessment of $1.0 million.

 

·           Quarterto date, other operating expenses increased approximately $3.0 million or122.0% with American Community contributing $262,000 of the increase. Thelargest increases were in the following categories:  merger expenses incurred in the acquisitionof American Community of $2.1 million, attorney fees (up $529,000), accountingfees due to additional services (up $146,000); outside professional servicefees, including transfer agent fees, (up $142,000); loan collection expense (up$115,000); and advertising (up $59,000) for special promotions and projects.

 

Year to date, other operating expenses increased $4.0 million or 93.0%with American Community contributing $262,000. The largest increases were inthe following categories:  mergerexpenses incurred in the acquisition of American Community of $2.2 million,attorney fees (up $600,000), accounting fees (up $57,000); advertising (up$253,000); outside professional service fees, including transfer agent fees,(up $298,000); loan collection expense (up $163,000); and contributions (up$99,000).

 

**Income Tax Expense**

 

Income tax benefit for the second quarter of 2009 was $3.8 millioncompared to income tax expense of $833,000 in the second quarter of 2008, adecrease of 555.9%.  The effective tax rate for the second quarter of 2009was (36.7%) compared to 32.5% for the same period of 2008.

 

Income tax benefit for the six month period ended June 30, 2009was $6.8 million compared to income tax expense of $2.1 million for the sameperiod of 2008, a decrease of 421.5%.  The effective tax rate for the sixmonths ended June 30, 2009 was (38.8%) compared to 31.3% in the sameperiod of 2008.  The effective tax rate decrease was attributable toincreased nontaxable investment income and reduced annualized net income.

 

**Item 3.  Quantitative and Qualitative DisclosuresAbout Market Risk**

 

Market risk is therisk of loss from adverse changes in market prices and rates.  Our market risk arises principally frominterest rate risk inherent in our lending, deposit, and borrowing activities.  Management actively monitors and manages itsinterest rate risk exposure.  In additionto other risks that we manage in the normal course of business, such as creditquality and liquidity, management considers interest rate risk to be a significantmarket risk that could potentially have a material effect on our financialcondition and results of operations.  Theinformation contained in Item 2 in the section captioned “Liquidity, InterestRate Sensitivity and Market Risk” is incorporated herein by reference.  Other types of market risks, such as foreigncurrency risk and commodity price risk, do not arise in the normal course ofour business activities. The auquisition of American Community and expansioninto new market areas in North and South Carolina have marketing risks that aremitigated by retaining the American Community brand name in these markets.Credit risk associated with loans acquired in the merger are part of theoverall discussion of credit risk in the sections captioned “Provision andAllowance for Loan Losses” and “Non-Performing Assets.”

 

The primaryobjective of asset and liability management is to manage interest rate risk andachieve reasonable stability in net interest income throughout interest ratecycles.  This is achieved by maintainingthe proper balance of rate-sensitive earning assets and rate-sensitiveinterest-bearing liabilities.  Therelationship of rate-sensitive earning assets to rate-sensitiveinterest-bearing liabilities is the principal factor in projecting the effectthat fluctuating interest rates will have on future net interest income.  Rate-sensitive assets and liabilities arethose that can be repriced to current market rates within a relatively shorttime period. Management monitors the rate sensitivity of earning assets andinterest-bearing liabilities over the entire life of these instruments, butplaces particular emphasis on the next twelve months.  Following a period of rateincreases (or decreases) net interest income will increase (or decrease) overboth a three-month and a twelve-month period.

 

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**Item 4.  Controls and Procedures**

 

As of the end of the period covered by this report, we carried out anevaluation, under the supervision and with the participation of our management,including our Chief Executive Officer and Chief Financial Officer, of theeffectiveness of our disclosure controls and procedures as defined in ExchangeAct Rule 13a-15(e). Our disclosure controls and procedures are designed toensure that information required to be disclosed by us in the reports that wefile or submit under the Exchange Act is (i) recorded, processed,summarized and reported within the time periods specified in the Securities andExchange Commission’s rules and forms, and (ii) accumulated andcommunicated to our management, including our Chief Executive Officer and ChiefFinancial Officer, as appropriate to allow timely decisions regarding requireddisclosures.

 

Basedupon that evaluation, the Chief Executive Officer and the Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures werenot effective as of June 30, 2009, because of the existence of materialweaknesses in internal control over financial reporting. A material weakness isa deficiency, or a combination of deficiencies, in internal control overfinancial reporting, such that there is a reasonable possibility that amaterial misstatement of the company’s annual or interim financial statementswill not be prevented or detected on a timely basis. As disclosed in Item 9A ofour 2008 Annual Report on Form 10-K, we have identified the followingmaterial weaknesses as of December 31, 2008:

 

*Control Environment*

 

Acontrol environment sets the tone of an organization, influences the controlconsciousness of its people, and is the foundation of all other components ofinternal control over financial reporting. The Company’s control environmentdid not sufficiently promote effective internal control over financialreporting throughout the organization. Specifically, the following materialweaknesses were identified in the Company’s control environment at December 31,2008:

 

· Although management has taken steps to remediatedeficiencies identified in the Annual Report on Form 10-K for the yearended December 31, 2007, management still needs to place greater emphasison supporting effective application of policies, execution of procedures, andremediation of the deficiencies identified in previous periods.

 

· Management needs additional financial reportingresources to ensure appropriate accounting, presentation, and disclosure inCompany filings.

 

Thesedeficiencies in the control environment contributed to the material weaknessesdescribed below, and resulted in a reasonable possibility that a material errorin the Company’s interim or annual financial statements would not be preventedor detected.

 

*Accounting for Significant Estimates*

 

TheCompany did not maintain sufficient internal controls over the preparation andreview of its allowance for loan losses model, including obtaining approval anddocumented support for changes in the underlying assumptions being used for theestimation. In addition, the Company did not maintain policies and proceduresto ensure that identification of impaired loans and estimates of valuationallowances required under SFAS 114, *Accountingby Creditors for Impairment of a Loan*(as amended), are made timelyand accurately, and are subject to a detailed supervisory review. Thesedeficiencies contributed to various mathematical errors and inappropriateassumptions being made in the estimation of the allowance for loan losses.Material adjustments were subsequently made to the Company’s preliminaryconsolidated financial statements.

 

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*Credit Administration*

 

Whilemanagement has committed substantial additional resources to creditadministration in 2008, the Company needs to make further improvement to itsinternal control over certain areas involving credit administration, in orderto reduce the possibility of material errors in the estimation of the allowancefor loan losses. Specifically, the Company needs further internal controls overdocumentation of underwriting practices over renewals and extensions,collateral inspection on construction loans before approval of advances,monitoring of interest reserves on certain acquisition and development loans,and independent review of appraisals.

 

*Preparationof Financial Reports*

 

TheCompany did not maintain sufficient internal controls over the preparation andreview of its financial reports for use in Company filings. In addition, thelack of adequate financial reporting resources prevented the Company from beingable to properly prepare financial reports on a timely basis in accordance withgenerally accepted accounting principles. As a result, material errors andinadequate disclosures were made in the Company’s preliminary financialstatements that required adjustments prior to completion of the Form 10-K.

 

**Remediation Plan**

 

In response to the material weaknesses identified, we have developedthe following remediation plan to address the material weaknesses, and we areproceeding expeditiously with the following measures to enhance internalcontrols.

 

·      Wecontinue to emphasize the importance of following existing procedures forunderwriting, lien perfection, and documentation for new and existing loans.

·      Wecontinue to emphasize the importance of accurate risk grades on loans and willcontinue to develop our Credit Risk Review with our Regional Credit Officerstaff to ensure proper grading of loans at origination, as well as throughoutthe life of the loan.  Lenders and loanoperations personnel have been informed of the requirement to assign risk gradesto loans upon origination.  Theimportance of periodic review of risk grades has been emphasized to ensure thatchanges are made as warranted due to the changes in the condition of theborrower, the collateral, or general economic conditions.  The controls over pre-and post-originationreview of loans in loan operations have been strengthened to ensure theaccuracy and completeness of loan data, including assignment of risk grades.Our Credit Risk Review staff will perform periodic risk grades reviews onselected loans to ensure risk grading accuracy.

·      We willdevelop a formal procedure for recommending and approving any changes to theallowance for loan loss model to ensure that such changes are appropriate.Controls over completeness and accuracy of the model were strengthened duringthe quarter, especially with regard to calculation of specific allowances forimpaired loans.  In addition reviewcontrols were improved for the calculation of historical loss factors,calculation of unimpaired watch list loan amounts, and calculation of ratiosused for estimating the impact of environmental factors for the generalallowance for unimpaired loans.

·      We willcontinue to assess and strengthen current lending and credit administrationpolicies and procedures, and are revising them as necessary to develop andimplement policies and procedures that will promote a culture that expectsreliability and integrity of data.

·      We expectto enhance financial reporting resources by adding personnel from the mergerwith American Community Bancshares, Inc. In addition, a review of thestaffing resources that are needed to support accurate, complete, and timelyfinancial reporting according to generally accepted accounting principles wascompleted and approved by the audit committee. A proposal for remediation wassubmitted to the Audit Committee in June 2009. This proposal includedocumentation of the process enhancements and personnel responsible for bothpreparation and review. Implementation began immediately thereafter, and wascompleted for application during the second quarter of 2009.  Management continues to evaluate itsfinancial reporting process for possible improvements in efficiency whilemaintaining completeness and accuracy.

 

Our Board of Directors is actively monitoring these remediation effortsand may direct additional measures as deemed appropriate from time totime.  We cannot be certain how long itwill take to fully implement the remediation plan, whether the remediation planwill be effective to maintain adequate controls over our financial reportingprocess in the future, or whether the remediation plan will be sufficient toaddress and eliminate the material weaknesses.

 

**Changes in Internal Control over Financial Reporting**

 

The only changes in our internal control over financial reporting thatoccurred during the six months ended June 30, 2009 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting, are summarized above in the description of ourmaterial weaknesses in internal control over financial reporting, as well asthe ongoing remediation efforts described above.

 

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Form 10-Q Quarterly Report June 30, 2009

 

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**Changes in Internal Control over Financial Reporting**

 

The only changes in our internal control over financial reporting thatoccurred during the six months ended June 30, 2009 that have materiallyaffected, or are reasonably likely to materially affect, our internal controlover financial reporting, are summarized above in the description of ourmaterial weaknesses in internal control over financial reporting, as well asthe ongoing remediation efforts described above.

 

**Part II. Other Information**

 

**Item 1.    LegalProceedings.**

 

The Company was a party to legal proceedings andpotential claims arising in the normal conduct of business.  The Companywas sued for damages in excess of $850,000 for 3.99 years of severance,continued benefits and fringe benefits by two former employees who alleged breachof contract.  In addition, the plaintiffs sought liquidated damages andcosts (including reimbursement for reasonable attorney fees) under their wageand hour claims.  They also asserted that non-compete provisions of theemployment agreements did not apply to their separation.  Both plaintiffsfiled for judgment on the pleadings in state court and prevailed.  TheCompany appealed the orders to the North Carolina Court of Appeals before thetrial court had determined damages.  Plaintiffs prevailed before the Courtof Appeals, and the Company’s further appeal to the North Carolina SupremeCourt was denied.   The Supreme Courtremanded the case to the trial court for a determination of damages.  On July 9,2009, the case was settled by confidential agreement of the parties.  Thefull amount of the settlement had been reserved in prior periods and noadditional reserves are deemed necessary.

 

**Item 1A. Risk Factors.**

 

Other than as described elsewhere in this Form 10-Q,there were no material changes from the risk factors presented in our annualreport on Form 10-K for the year ended December 31, 2008.

 

**Item 2.  UnregisteredSales of Equity Securities and Use of Proceeds.**

 

On July 24, 2009, the Company entered into aLetter Agreement (including the Securities Purchase Agreement—Standard Termsincorporated by reference therein, the “Purchase Agreement”) with Treasurydated July 24, 2009 pursuant to which the Company issued and sold toTreasury (i) 13,312 shares of the Company’s Fixed Rate CumulativePerpetual Preferred Stock, Series T-ACB, having a liquidation preferenceof $1,000 per share (the “Series T-ACB Preferred Stock”), and (ii) aten-year warrant to purchase up to 273,534 shares of the Company’s commonstock, par value $1.00 per share (“Common Stock”), at an initial exercise priceof $7.30 per share (the “Warrant”), for an aggregate purchase price of$13,312,000 in cash.  The terms of the Series T-ACB Preferred Stockare the same as the CPP preferred stock issued to Treasury on January 16,2009.  For a more detailed discussion ofthe transaction, see the Company’s Form 8-K filed with the SEC on July 27,2009.

 

**Item 4.  Submission ofMatters to Vote of Security Holders**

 

Special Meeting of Shareholders

 

At the Company’s special meeting of shareholders held on April 16,2009, our shareholders approved the merger with American Community Bancshares, Inc.  The tabulation of votes on this matterwas:  For - 6,090,778, Against -3,248,082, and Abstained — 101,794. There were no broker non-votes.

 

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Form 10-Q Quarterly Report June 30, 2009

 

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AnnualMeeting of Shareholders

 

The Annual Meeting of the Shareholders was held on June 29,2009.  Of 16,129,620 shares entitled tovote at the meeting, 12,823,125 voted. The following matters were voted on at the meeting.

 

**Proposal 1:          **Shareholderselected J. T. Alexander, Jr., Ralph L. Bentley, Nolan G. Brown, Faye E.Cooper, Harry M. Davis, James A. Harrell, Jr., Dan W. Hill III, William A.Long, James L. Poindexter, Morris L. Shambley, James N. Smoak, Harry C. Spell,C. Kenneth Wilcox, Thomas J. Hall, Larry S. Helms, Randy P. Helton, Peter A.Papas, and Alison J. Smith to serve one-year terms on the Board of Directors oruntil their successors are elected and qualified.  Votes for each nominee were as follows:

 
| **Name**                    | ** ** | **For**    | ** ** | **Withheld** | ** ** |
|-----------------------------|------------|------------|------------|--------------|------------|
| J.  T. Alexander, Jr.  |       | 11,288,782 |       | 1,534,343    |       |
| Ralph  L Bentley            |       | 11,159,687 |       | 1,663,438    |       |
| Nolan  G. Brown             |       | 11,605,766 |       | 1,217,359    |       |
| Faye  E. Cooper             |       | 11,185,008 |       | 1,638,117    |       |
| Harry  M. Davis             |       | 11,132,517 |       | 1,690,608    |       |
| James  A. Harrell, Jr. |       | 11,516,643 |       | 1,306,482    |       |
| Dan  W. Hill III            |       | 11,687,095 |       | 1,136,030    |       |
| William  A. Long            |       | 11,450,321 |       | 1,372,804    |       |
| James  L. Poindexter        |       | 11,988,150 |       | 832,975      |       |
| Morris  L. Shambley         |       | 11,806,006 |       | 1,017,119    |       |
| James  N. Smoak             |       | 10,932,905 |       | 1,890,220    |       |
| Harry  C. Spell             |       | 11,622,027 |       | 1,201,098    |       |
| C.  Kenneth Wilcox          |       | 11,773,744 |       | 1,049,381    |       |
| Thomas  J. Hall             |       | 11,731,029 |       | 1,092,096    |       |
| Larry  S. Helms             |       | 11,724,408 |       | 1,098,717    |       |
| Randy  P. Helton            |       | 11,501,085 |       | 1,322,040    |       |
| Peter  A. Papas             |       | 11,765,186 |       | 1,057,939    |       |
| Alison J. Smith             |       | 11,726,826 |       | 1,099,299    |       |

 

**Proposal 2:          **Shareholdersapproved the compensation of the named executive officers of the Corporation asdetermined by the Nominating and Compensation Committee of the Board ofDirectors by the following votes:

 
| **For**    | ** ** | **Against** | ** ** | **Withheld** | ** ** |
|------------|------------|-------------|------------|--------------|------------|
| 10,627,669 |       | 1,855,038   |       | 340,418      |       |

 

There were no other matters voted on by the Company’sshareholders at our 2009 annual shareholder meeting.

 

**Item 6.  Exhibits**

 
| **Exhibit #** | ** ** | **Description**                                                                                                                                                                                                                                 |
|--------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|               |       |                                                                                                                                                                                                                                            |
| 3.1                |       | Amended and Restated Bylaws of Yadkin Valley Financial Corporation  dated July 16, 2009 (incorporated by reference to Exhibit 3.1 to  Form 8-K filed on July 21, 2009).                                                     |
|               |       |                                                                                                                                                                                                                                            |
| 3.2                |       | Articles of Amendment to the Company’s Restated Articles of  Incorporation establishing the terms of the Series T-ACB Preferred Stock  (incorporated by reference to Exhibit 3.1 to Form 8-K filed on  July 27, 2009). |

 

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| 4.1    |   | Warrant to Purchase up to 13,312 shares of Common Stock (incorporated  by reference to Exhibit 4.1 to Form 8-K filed on July 27,  2009).                                                                                                                                                              |
|--------|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 4.2    |   | Form of Series T-ACB Preferred Stock Certificate  (incorporated by reference to Exhibit 4.2 to Form 8-K filed on  July 27, 2009).                                                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 10.1   |   | American Community Bancshares 2000 Incentive Stock Option Plan  (incorporated by reference to Exhibit 4.5 to the Registration Statement  on Form S-8 filed April 11, 2008).                                                                                                                           |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 10.2   |   | American Community Bancshares 2000 Nonstatutory Stock Option Plan  (incorporated by reference to Exhibit 4.6 to the Registration Statement  on Form S-8 filed April 11, 2008).                                                                                                                        |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 10.3   |   | Letter Agreement, dated July 24, 2009, including Securities  Purchase Agreement — Standard Terms incorporated by reference therein,  between the Company and the United States Department of the Treasury  (incorporated by reference to Exhibit 10.1 to Form 8-K filed on  July 27, 2009). |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 10.4   |   | ARRA Side Letter Agreement, dated July 24, 2009, between the  Company and the United States Department of the Treasury (incorporated by  reference to Exhibit 10.2 to Form 8-K filed on July 27, 2009).                                                                                          |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 10.5   |   | Form of Waiver, executed by each of Messrs. John M. Brubaker,  Edwin E. Laws, William A. Long, John W. Mallard, and Steven S. Robinson  (incorporated by reference to Exhibit 10.3 to Form 8-K filed on  July 27, 2009).                                                                    |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 10.6   |   | Form of Letter Amendment, executed by each of Messrs. John M.  Brubaker, Edwin E. Laws, William A. Long, John W. Mallard, Jr., and  Steven S. Robinson with the Company (incorporated by reference to  Exhibit 10.4 to Form 8-K filed on July 27, 2009).                               |
|   |   |                                                                                                                                                                                                                                                                                                                 |
| 31.1   |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                     |
| 31.2   |   | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                                                                                     |
| 32.1   |   | Section 1350  Certification                                                                                                                                                                                                                                                                                     |

 

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**Signatures**

 

Pursuant to therequirements of Securities Exchange Act of 1934, the registrant has duly causedthis report to be signed on its behalf by the undersigned thereunto dulyauthorized.

 

 
| Yadkin Valley Financial  Corporation                                    |                 |
|-------------------------------------------------------------------------|----------------------|
|                                                                    |                 |
| BY:                                                                     | /s/ William A.  Long |   |
| *William  A. Long, President and Chief Executive Officer*               |                 |
|                                                                    |                 |
| BY:                                                                     | /s/ Edwin E.  Laws   |   |
| *Edwin E. Laws, Executive Vice Presidents and  Chief Financial Officer* |

 

 

August 19,2009

 

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