Tableof Contents

 

 

 

**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 March 31, 2009**

 

**CommissionFile Number 0001366367**

 

**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)**

 

Indicate by check markwhether the registrant (1) has filed all reports required to be filed by Section 13or 15(d) of the Securities Exchange Act of 1934 during the preceding 12months (or for such shorter period that the registrant was required to filesuch reports), and (2) has been subject to such filing requirements forthe past 90 days. Yes þNo o

 

Indicate by check markwhether the registrant has submitted electronically and posted on its corporateWeb site, if any, every Interactive Data File required to be submitted andposted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter)during the preceding 12 months (or for such shorter period that the registrantwas required to submit and post such files). Yes o No o

  

Indicate by check markwhether the registrant is a large accelerated filer, an accelerated filer, anon-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 check markwhether the registrant is a shell company (as defined in Rule 12b-2 of theExchange Act).  Yes o  No þ

 

Common shares outstandingas of April 30, 2009, par value $1.00 per share, were 11,536,500.

 

 

 

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Tableof Contents

 
| **Part I.  Financial  Information**                                                                      |       |
|-------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                                                                              |       |
| Item 1. Financial Statements                                                                                            |       |
|                                                                                                                    |       |
| Condensed Consolidated Balance Sheets March 31,  2009 and December 31, 2008                                   | 3          |
|                                                                                                                    |       |
| Condensed Consolidated Statements of Income Three  Months Ended March 31, 2009 and 2008                            | 4          |
|                                                                                                                    |       |
| Condensed Consolidated Statements of Comprehensive  Income Three Months Ended March 31, 2009 and 2008              | 5          |
|                                                                                                                    |       |
| Condensed Consolidated Statements of Stockholders’  Equity for the Three Months Ended March 31, 2009 and 2008 | 6          |
|                                                                                                                    |       |
| Condensed Consolidated Statements of Cash Flows for  the Three Months Ended March 31, 2009 and 2008                | 7          |
|                                                                                                                    |       |
| Notes to Unaudited Condensed Consolidated Financial  Statements                                                         | 8-18       |
|                                                                                                                    |       |
| Item 2. Management’s Discussion and Analysis of  Financial Condition and Results of Operations                     | 18-30      |
|                                                                                                                    |       |
| Item 3. Quantitative and Qualitative Disclosures About  Market Risk                                                     | 30         |
|                                                                                                                    |       |
| Item 4. Controls and Procedures                                                                                         | 31-33      |
|                                                                                                                    |       |
| **Part II.  Other Information**                                                                                    | ** ** |
| ** **                                                                                                              | ** ** |
| Item 6. Exhibit Index                                                                                              | 33         |
|                                                                                                                    |       |
| Signatures                                                                                                              | 34         |
|                                                                                                                    |       |
| Exhibits                                                                                                                | 35-37      |

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

2

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Tableof Contents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSEDCONSOLIDATED BALANCE SHEETS (UNAUDITED)**

 
| ** **                                                                                                                                | ** ** | **March 31,** | ** **    | **December 31,** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------|------------|--------------------|---------------|-----------------------|------------|
| ** **                                                                                                                                | ** ** | **2009**           | ** **    | **2008***             | ** ** |
| **ASSETS**                                                                                                                                | ** ** | ** **         | ** **    | ** **            | ** ** |
| ** **                                                                                                                                | ** ** | ** **         | ** **    | ** **            | ** ** |
| CASH AND CASH  EQUIVALENTS                                                                                                                |       |               |          |                  |       |
| Cash and due  from banks                                                                                                                  |       | $                  | 17,669,885    |                  | $          | 22,553,561 |   |
| Federal funds  sold                                                                                                                       |       | 51,000             |          | 58,000                |       |
| Interest-bearing  deposits                                                                                                                |       | 2,734,524          |          | 3,410,977             |       |
| TOTAL CASH AND  CASH EQUIVALENTS                                                                                                          |       | 20,455,409         |          | 26,022,538            |       |
|                                                                                                                                      |       |               |          |                  |       |
| SECURITIES  AVAILABLE FOR SALE-At fair value (Amortized cost $129,805,925 in 2009 and  $134,533,342 in 2008)                              |       | 132,609,198        |          | 137,813,529           |       |
|                                                                                                                                      |       |               |          |                  |       |
| GROSS LOANS                                                                                                                               |       | 1,182,409,461      |          | 1,187,568,945         |       |
| Less: Allowance  for loan losses                                                                                                          |       | (30,903,770        | )             | (22,355,231           | )          |
| NET LOANS                                                                                                                                 |       | 1,151,505,691      |          | 1,165,213,714         |       |
|                                                                                                                                      |       |               |          |                  |       |
| LOANS HELD FOR  SALE                                                                                                                      |       | 180,064,752        |          | 49,929,375            |       |
|                                                                                                                                      |       |               |          |                  |       |
| ACCRUED INTEREST  RECEIVABLE                                                                                                              |       | 5,276,036          |          | 5,441,754             |       |
|                                                                                                                                      |       |               |          |                  |       |
| PREMISES AND  EQUIPMENT, NET                                                                                                              |       | 34,925,526         |          | 33,899,915            |       |
|                                                                                                                                      |       |               |          |                  |       |
| FORECLOSED REAL  ESTATE                                                                                                                   |       | 4,318,280          |          | 4,017,880             |       |
|                                                                                                                                      |       |               |          |                  |       |
| FEDERAL HOME  LOAN BANK STOCK, AT COST                                                                                                    |       | 8,259,600          |          | 7,876,800             |       |
|                                                                                                                                      |       |               |          |                  |       |
| INVESTMENT IN  BANK-OWNED LIFE INSURANCE                                                                                                  |       | 23,839,068         |          | 23,607,675            |       |
|                                                                                                                                      |       |               |          |                  |       |
| GOODWILL                                                                                                                                  |       | 53,502,887         |          | 53,502,887            |       |
|                                                                                                                                      |       |               |          |                  |       |
| CORE DEPOSIT  INTANGIBLE (net of accumulated amortization of $5,320,767 at March 31,  2009 and $5,095,371 at December 31, 2008) |       | 4,434,720          |          | 4,660,116             |       |
|                                                                                                                                      |       |               |          |                  |       |
| OTHER ASSETS                                                                                                                              |       | 17,891,526         |          | 12,301,838            |       |
|                                                                                                                                      |       |               |          |                  |       |
| TOTAL ASSETS                                                                                                                              |       | $                  | 1,637,082,693 |                  | $          | 1,524,288,021 |   |
|                                                                                                                                      |       |               |          |                  |       |
| **LIABILITIES  AND STOCKHOLDERS’ EQUITY**                                                                                            | ** ** | ** **         | ** **    | ** **            | ** ** |
| ** **                                                                                                                                | ** ** | ** **         | ** **    | ** **            | ** ** |
| DEPOSITS                                                                                                                                  |       |               |          |                  |       |
| Noninterest-bearing  demand deposits                                                                                                      |       | $                  | 150,662,024   |                  | $          | 153,573,487 |   |
| Interest-bearing  deposits:                                                                                                               |       |               |          |                  |       |
| NOW, savings,  and money market accounts                                                                                                  |       | 306,698,752        |          | 283,890,757           |       |
| Time  certificates:                                                                                                                       |       |               |          |                  |       |
| Over $100,000                                                                                                                             |       | 332,080,646        |          | 333,375,040           |       |
| Other                                                                                                                                     |       | 462,397,515        |          | 384,202,791           |       |
| TOTAL DEPOSITS                                                                                                                            |       | 1,251,838,937      |          | 1,155,042,075         |       |
|                                                                                                                                      |       |               |          |                  |       |
| SHORT-TERM  BORROWINGS                                                                                                                    |       | 150,309,451        |          | 169,111,959           |       |
|                                                                                                                                      |       |               |          |                  |       |
| LONG-TERM  BORROWINGS                                                                                                                     |       | 38,849,795         |          | 38,849,795            |       |
|                                                                                                                                      |       |               |          |                  |       |
| ACCRUED INTEREST  PAYABLE                                                                                                                 |       | 3,174,036          |          | 3,554,522             |       |
|                                                                                                                                      |       |               |          |                  |       |
| OTHER  LIABILITIES                                                                                                                        |       | 12,840,766         |          | 8,085,348             |       |
|                                                                                                                                      |       |               |          |                  |       |
| TOTAL  LIABILITIES                                                                                                                        |       | 1,457,012,985      |          | 1,374,643,699         |       |
|                                                                                                                                      |       |               |          |                  |       |
| STOCKHOLDERS’  EQUITY                                                                                                                |       |               |          |                  |       |
| Common stock (a)                                                                                                                          |       | 11,536,500         |          | 11,536,500            |       |
| Preferred Stock  (b)                                                                                                                      |       | 34,345,500         |          | —                |       |
| Surplus (c)                                                                                                                               |       | 89,780,595         |          | 88,030,481            |       |
|                                                                                                                                      |       |               |          |                  |       |
| Retained  earnings                                                                                                                        |       | 42,693,423         |          | 48,070,348            |       |
| Accumulated  other comprehensive income                                                                                                   |       | 1,713,690          |          | 2,006,993             |       |
| TOTAL  STOCKHOLDERS’ EQUITY                                                                                                          |       | 180,069,708        |          | 149,644,322           |       |
|                                                                                                                                      |       |               |          |                  |       |
| TOTAL  LIABILITIES AND STOCKHOLDERS’ EQUITY                                                                                          |       | $                  | 1,637,082,693 |                  | $          | 1,524,288,021 |   |

 

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| *(a)* | *$1.00  par value, authorized 20,000,000 shares; issued 11,536,500 in 2009 and 2008*                                                                                                                  |
|-------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| *(b)* | *1,000,000  shares of authorized, no par value preferred stock of which 36,000 shares are  issued and outstanding in 2009 and none in 2008.*                                                          |
| *(c)* | *Includes  a ten-year warrant with an allocated fair value of $1.7 million at issuance  to purchase up to 385,990 shares of common stock, $1.00 par value, at an  initial price of $13.99 per share.* |

 

Seenotes to condensed consolidated financial statements

 
| * | Derived from audited  consolidated financial statements |
|---|---------------------------------------------------------|

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

3

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**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSEDCONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)**

**THREE MONTHS ENDED MARCH 31, 2009 AND 2008**

 
| ** **                                                             | ** ** | **Three Months Ended** | ** ** |
|------------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                             | ** ** | **March 31,**     | ** ** |
| ** **                                                             | ** ** | **2009**               | ** ** | **2008** | ** ** |
| INTEREST INCOME                                                        |       |                   |       |   |   |
| Interest and  fees on loans                                            |       | $                      | 16,027,822 |   | $ | 16,213,686 |   |
| Interest on  federal funds sold                                        |       | 1,413                  |       | 10,646 |   |
| Interest on  securities:                                               |       |                   |       |   |   |
| Taxable                                                                |       | 1,174,441              |       | 1,305,463 |   |
| Non-taxable                                                            |       | 385,042                |       | 368,596 |   |
| Interest-bearing  deposits                                             |       | 10,829                 |       | 4,741 |   |
| Total interest  income                                                 |       | 17,599,547             |       | 17,903,132 |   |
|                                                                   |       |                   |       |   |   |
| INTEREST EXPENSE                                                       |       |                   |       |   |   |
| Time deposits of  $100,000 or more                                     |       | 3,101,455              |       | 2,955,989 |   |
| Other deposits                                                         |       | 3,959,599              |       | 4,525,502 |   |
| Borrowed funds                                                         |       | 624,864                |       | 1,064,644 |   |
| Total interest  expense                                                |       | 7,685,918              |       | 8,546,135 |   |
|                                                                   |       |                   |       |   |   |
| NET INTEREST  INCOME                                                   |       | 9,913,629              |       | 9,356,997 |   |
|                                                                   |       |                   |       |   |   |
| PROVISION FOR  LOAN LOSSES                                             |       | 10,549,505             |       | 450,000 |   |
|                                                                   |       |                   |       |   |   |
| NET INTEREST  INCOME (LOSS) AFTER PROVISION FOR LOAN LOSSES            |       | (635,876               | )          | 8,906,997 |   |
|                                                                   |       |                   |       |   |   |
| NONINTEREST  INCOME                                                    |       |                   |       |   |   |
| Service charges  on deposit accounts                                   |       | 1,047,319              |       | 1,009,167 |   |
| Other service  fees                                                    |       | 1,064,798              |       | 863,867 |   |
| Net gain on  sales of mortgage loans                                   |       | 3,199,087              |       | 1,772,295 |   |
| Income on  investment in bank owned life insurance                     |       | 231,393                |       | 233,000 |   |
| Mortgage banking  income (loss)                                        |       | (306,963               | )          | 9,757 |   |
| Other income  (loss)                                                   |       | 35,573                 |       | 41,356 |   |
| Total  noninterest income                                              |       | 5,271,207              |       | 3,929,442 |   |
|                                                                   |       |                   |       |   |   |
| NONINTEREST  EXPENSE                                                   |       |                   |       |   |   |
| Salaries and  employee benefits                                        |       | 5,626,664              |       | 4,867,976 |   |
| Occupancy and  equipment expenses                                      |       | 1,327,074              |       | 976,449 |   |
| Printing and  supplies                                                 |       | 232,067                |       | 184,977 |   |
| Data processing                                                        |       | 132,849                |       | 112,420 |   |
| Communication  expense                                                 |       | 322,586                |       | 208,471 |   |
| Advertising and  marketing expense                                     |       | 376,256                |       | 181,900 |   |
| Amortization of  core deposit intangible                               |       | 225,396                |       | 187,508 |   |
| FDIC assessment  expense                                               |       | 662,088                |       | 52,398 |   |
| Other                                                                  |       | 2,887,855              |       | 1,870,582 |   |
| Total  noninterest expense                                             |       | 11,792,835             |       | 8,642,681 |   |
|                                                                   |       |                   |       |   |   |
| INCOME (LOSS) BEFORE  INCOME TAXES                                     |       | (7,157,504             | )          | 4,193,758 |   |
|                                                                   |       |                   |       |   |   |
| INCOME TAX  EXPENSE (BENEFIT)                                          |       | (2,994,269             | )          | 1,279,445 |   |
|                                                                   |       |                   |       |   |   |
| NET INCOME  (LOSS)                                                     |       | (4,163,235             | )          | 2,914,313 |   |
|                                                                   |       |                   |       |   |   |
| Preferred stock  dividend and amortization of preferred stock discount |       | 445,000                |       | — |   |
|                                                                   |       |                   |       |   |   |
| NET INCOME  (LOSS) AVAILABLE TO COMMON SHAREHOLDERS                    |       | $                      | (4,608,235 | ) | $ | 2,914,313 |   |
|                                                                   |       |                   |       |   |   |
| NET INCOME  (LOSS) PER COMMON SHARE:                                   |       |                   |       |   |   |
| Basic                                                                  |       | $                      | (0.40      | ) | $ | 0.28 |   |
|                                                                   |       |                   |       |   |   |
| Diluted                                                                |       | $                      | (0.40      | ) | $ | 0.27 |   |
|                                                                   |       |                   |       |   |   |
| CASH DIVIDENDS  PER COMMON SHARE                                       |       | $                      | 0.06       |   | $ | 0.13 |   |

 

Seenotes to condensed consolidated financial statements

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

4

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Table of Contents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

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

**THREE MONTHS ENDED MARCH 31, 2009 AND 2008**

 
| ** **                                                          | ** ** | **Three Months Ended** | ** ** |
|---------------------------------------------------------------------|------------|------------------------|------------|
| ** **                                                          | ** ** | **March 31,**     | ** ** |
| ** **                                                          | ** ** | **2009**               | ** ** | **2008** | ** ** |
| NET INCOME  (LOSS)                                                  |       | $                      | (4,163,235 | ) | $ | 2,914,313 |   |
|                                                                |       |                   |       |   |   |
| OTHER  COMPREHENSIVE INCOME (LOSS), BEFORE TAX:                     |       |                   |       |   |   |
|                                                                |       |                   |       |   |   |
| Unrealized  holding gains (losses) on securities available for sale |       | (476,915               | )          | 1,668,014 |   |
| Tax effect                                                          |       | 183,612                |       | (642,185 | ) |
|                                                                |       |                   |       |   |   |
| OTHER  COMPREHENSIVE INCOME (LOSS), NET OF TAX                      |       | (293,303               | )          | 1,025,829 |   |
|                                                                |       |                   |       |   |   |
| COMPREHENSIVE  INCOME (LOSS)                                        |       | $                      | (4,456,538 | ) | $ | 3,940,142 |   |

 

See notes tocondensed consolidated financial statements

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

5

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Table of Contents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

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

**FOR THE THREE MONTHS ENDED MARCH 31, 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                                           |       | —            |       | —               |       | —      |       | 2,914,313              |       | —                                        |       | 2,914,313                             |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Shares issued  under stock option plan               |       | 5,092             |       | —               |       | 24,775      |       | —                 |       | —                                        |       | 29,867                                |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Stock option  compensation                           |       | —            |       | —               |       | 11,043      |       | —                 |       | —                                        |       | 11,043                                |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Tax benefit from  exercise of stock options          |       | —            |       | —               |       | 173,189     |       | —                 |       | —                                        |       | 173,189                               |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Cumulative effect  of adoption of EITF 06-04         |       | —            |       | —               |       | —      |       | (1,966,465             | )          | —                                        |       | (1,966,465                            | )          |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Cash dividends  declared                             |       | —            |       | —               |       | —      |       | (1,490,969             | )          | —                                        |       | (1,490,969                            | )          |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Shares issued in acquisition  of Cardinal State Bank |       | 884,500           |       | —               |       | 15,921,000  |       | —                 |       | —                                        |       | 16,805,500                            |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Other  comprehensive income                          |       | —            |       | —               |       | —      |       | —                 |       | 1,025,829                                     |       | 1,025,829                             |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Balance,  March 31, 2008                        |       | $                 | 11,452,948 |                 | $          | —      |       | $                      | 87,116,691 |                                          | $          | 50,543,563                            |       | $ | 1,658,099 |   | $ | 150,771,301 |   |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Balance,  December 31, 2008*                    |       | $                 | 11,536,500 |                 | $          | —      |       | $                      | 88,030,481 |                                          | $          | 48,070,348                            |       | $ | 2,006,993 |   | $ | 149,644,322 |   |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Net income                                           |       | —            |       | —               |       | —      |       | (4,163,235             | )          | —                                        |       | (4,163,235                            | )          |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| 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      |       | —            |       | 76,500               |       | —      |       | (76,500                | )          | —                                        |       | —                                |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Stock option  compensation                           |       | —            |       | —               |       | 19,114      |       | —                 |       | —                                        |       | 19,114                                |       |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Preferred stock  dividends accrued                   |       | —            |       | —               |       | —      |       | (445,000               | )          | —                                        |       | (445,000                              | )          |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Cash dividends  declared                             |       | —            |       | —               |       | —      |       | (692,190               | )          | —                                        |       | (692,190                              | )          |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Other  comprehensive loss                            |       | —            |       | —               |       | —      |       | —                 |       | (293,303                                      | )          | (293,303                              | )          |
|                                                 |       |              |       |                 |       |        |       |                   |       |                                          |       |                                  |       |
| Balance,  March 31, 2009                        |       | $                 | 11,536,500 |                 | $          | 34,345,500  |       | $                      | 89,780,595 |                                          | $          | 42,693,423                            |       | $ | 1,713,690 |   | $ | 180,069,708 |   |

 

Seenotes to condensed consolidated financial statements

 

----

| * | Derived from audited consolidated financial  statements |
|---|---------------------------------------------------------|

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

6

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Table of Contents

 

**YADKIN VALLEY FINANCIAL CORPORATION**

**CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS(UNAUDITED)**

**THREE MONTHS ENDED MARCH 31, 2009 AND 2008**

 
| ** **                                                                                          | ** ** | **2009**     | ** ** | **2008**     | ** ** |
|-----------------------------------------------------------------------------------------------------|------------|--------------|------------|--------------|------------|
| ** **                                                                                          | ** ** | ** **   | ** ** | ** **   | ** ** |
| CASH FLOWS FROM  OPERATING ACTIVITIES:                                                              |       |         |       |         |       |
| Net income  (loss)                                                                                  |       | $            | (4,163,235 | )            | $          | 2,914,313 |   |
| Adjustments to  reconcile net income(loss) to net cash provided by (used in) operating  activities: |       |         |       |         |       |
| Net amortization  (accretion) of premiums (discounts) on investment securities                      |       | (6,325       | )          | (6,792       | )          |
| Provision for  loan losses                                                                          |       | 10,549,505   |       | 450,000      |       |
| Net gain on  sales of mortgage loans held for sale                                                  |       | (3,199,087   | )          | (1,772,295   | )          |
| Increase in  investment in Bank owned life insurance                                                |       | (231,393     | )          | (233,000     | )          |
| Depreciation and  amortization                                                                      |       | 548,466      |       | 421,584      |       |
| Net gain on sale  of premises and equipment                                                         |       | —       |       | (800         | )          |
| Net gain on sale  of other real estate owned                                                        |       | (6,425       | )          | —       |       |
| Amortization of  core deposit intangible                                                            |       | 225,396      |       | 187,508      |       |
| Deferred tax  (benefit) provision                                                                   |       | 216,051      |       | (1,187,476   | )          |
| Stock based  compensation expense                                                                   |       | 19,114       |       | 11,043       |       |
| Originations of  mortgage loans held-for-sale                                                       |       | (563,540,262 | )          | (258,770,800 | )          |
| Proceeds from  sales of mortgage loans                                                              |       | 436,603,972  |       | 261,607,970  |       |
| Decrease in  accrued interest receivable                                                            |       | 165,718      |       | 496,706      |       |
| (Increase)  decrease in other assets                                                                |       | (5,622,127   | )          | 27,154       |       |
| (Decrease) in  accrued interest payable                                                             |       | (380,486     | )          | (511,842     | )          |
| Increase in  other liabilities                                                                      |       | 5,262,557    |       | 24,419,102   |       |
|                                                                                                |       |         |       |         |       |
| Net cash  provided by (used in) operating activities                                                |       | (123,558,561 | )          | 28,052,375   |       |
|                                                                                                |       |         |       |         |       |
| CASH FLOWS FROM  INVESTING ACTIVITIES:                                                              |       |         |       |         |       |
| Purchases of  available for sale securities                                                         |       | (8,726,523   | )          | (11,896,221  | )          |
| Proceeds from  sales of available for sale securities                                               |       | 10,885,045   |       | 3,751,714    |       |
| Proceeds from  maturities of available for sale securities                                          |       | 2,575,219    |       | 8,345,000    |       |
| Net change in  loans                                                                                |       | 2,320,332    |       | 8,864,648    |       |
| Acquisition of  Cardinal State Bank, net of cash                                                    |       | —       |       | 12,619,714   |       |
| Purchases of  premises and equipment                                                                |       | (1,574,078   | )          | (243,832     | )          |
| Proceeds from  redemption of Federal Home Loan Bank stock                                           |       | 1,642,600    |       | 283,500      |       |
| Purchases of  Federal Home Loan Bank stock                                                          |       | (2,025,400   | )          | (1,444,900   | )          |
| Proceeds from  sale of premises and equipment                                                       |       | —       |       | 800          |       |
| Proceeds from  sale of other real estate owned                                                      |       | 544,211      |       | —       |       |
|                                                                                                |       |         |       |         |       |
| Net cash  provided by investing activities                                                          |       | 5,641,406    |       | 20,280,423   |       |
|                                                                                                |       |         |       |         |       |
| CASH FLOWS FROM  FINANCING ACTIVITIES:                                                              |       |         |       |         |       |
| Net increase  (decrease) in checking, NOW, money market and savings accounts                        |       | 19,896,532   |       | (787,249     | )          |
| Net increase  (decrease) in time certificates                                                       |       | 76,900,331   |       | (21,801,060  | )          |
| Net increase  (decrease) in borrowed funds                                                          |       | (18,802,508  | )          | 15,711,609   |       |
| Proceeds from  issuance of preferred stock and warrant                                              |       | 36,000,000   |       | —       |       |
| Dividends paid                                                                                      |       | (1,644,329   | )          | (1,490,969   | )          |
| Tax benefit from  exercise of stock options                                                         |       | —       |       | 173,189      |       |
| Proceeds from  exercise of stock options                                                            |       | —       |       | 29,867       |       |
|                                                                                                |       |         |       |         |       |
| Net cash  provided by (used in) financing activities                                                |       | 112,350,026  |       | (8,164,613   | )          |
|                                                                                                |       |         |       |         |       |
| NET INCREASE  (DECREASE) IN CASH AND CASH EQUIVALENTS                                               |       | (5,567,129   | )          | 40,168,185   |       |
|                                                                                                |       |         |       |         |       |
| CASH AND CASH  EQUIVALENTS:                                                                         |       |         |       |         |       |
| Beginning of  period                                                                                |       | 26,022,538   |       | 26,325,875   |       |
|                                                                                                |       |         |       |         |       |
| End of period                                                                                       |       | $            | 20,455,409 |         | $          | 66,494,060 |   |

 

See notes tocondensed consolidated financial statements

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

7

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Tableof Contents

 

**Notes toUnaudited Condensed Consolidated Financial Statements**

 

***1.  SignificantAccounting Policies***

 

**Basis ofPresentation**

 

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 andfootnotes required 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, as amended on April 30,2009.  Operating results, for the threemonths ended March 31, 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 March 31,2009 and December 31, 2008, and the results of its operations and cashflows for the three months ended March 31, 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.

 

***Reclassifications —***FDIC assessmentexpenses have been reclassified to conform to the 2009presentation.  The reclassifications hadno effect on net income or stockholders’ equity, as previously reported.

 

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

 

On January 16, 2009,Yadkin Valley Financial Corporation issued 36,000 shares of senior preferredstock, each with a liquidation preference of $1.00 per share, to the U.S.Treasury for $36 million pursuant to the Capital Purchase Program (“CPP”).Additionally, the Company issued a warrant to purchase up to 385,990 shares ofcommon stock to the U.S. Treasury as a condition to its participation in theCPP. The warrant has an exercise price of $13.99 for each share and isimmediately exercisable and expires 10 years from the date of issuance.Proceeds from this sale of the preferred stock are expected to be used for generalcorporate purposes, including supporting the continued growth and lending inthe communities served by the Bank. The CPP 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%thereafter. The preferred shares are redeemable at the option of the Companyunder certain restrictions during the first three years and are redeemablethereafter without restriction.

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

8

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Table of Contents

 

In order to determine therelative value of the preferred stock, the present value of the preferred stockcash flows, using a discount rate of 14%, was calculated as $18.2 million.  The following table shows the determinationof the value attributed to the proceeds of $36 million received for the preferredstock and warrant based on the relative values of each.

 
| ** **                              | ** ** | **Fair Value (in millions)** | ** ** | **Relative Value (%)** | ** ** | **Relative Value (in millions)** | ** ** |
|-----------------------------------------|------------|------------------------------|------------|------------------------|------------|----------------------------------|------------|
| **Relative  Value Calculation**         |       |                         |       |                   |       |                             |       |
| 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 stock warrantshave 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 allocationapproach, $1.7 million was recorded as a discount on the preferred stock andwill be accreted as a reduction in the net income available for commonshareholders over the next five years, the duration of the effect of thediscounted rate, at $300,000 to $400,000 per year.

 

***3.   Stock-basedCompensation***

 

On May 22,2008 the shareholders approved the 2008 Omnibus Stock Ownership and Long TermIncentive Plan (the “Omnibus Plan”). An aggregate of 700,000 shares has beenreserved for issuance by the Company under the terms of the Omnibus Planpursuant to the grant of incentive stock options (not to exceed 200,000shares), non-statutory stock options, restricted stock and restricted stockunits, long-term incentive compensation units and stock appreciation rights.

 

Duringthe three months ended March 31, 2009 and March 31, 2008, 21,200 and11,342 options were vested, respectively. At March 31, 2009 there were 95,600 options unvested and 10,854shares available for future grants of options in addition to the sharesavailable under the abovementioned Omnibus Plan.

 

Duringthe first quarter of 2009, there were no options granted. During the firstquarter 2008, there were 62,500 options granted at a weighted average fairvalue of $2.07 per option, a weighted average exercise price of $14.07, and afive year vesting period.  The fair valueof each option grant is estimated on the date of grant using the Black-Scholesoption pricing model with the following weighted-average assumptions used forgrants in 2008:  dividend yield of 3.70%,expected volatility of 22.74%, risk-free interest rate of 2.50%, and expectedlife of five years.

 

Thecompensation expense related to options was $19,114 for the three-month periodending March 31, 2009. As of March 31, 2009 there was $233,355 oftotal unrecognized compensation costs related to nonvested share-basedcompensation arrangements granted under all of the Company’s stock benefitplans.  This cost is expected to berecognized over an average vesting period of 1.41 years.

 

Yadkin Valley Financial Corporation

Form 10-Q QuarterlyReport March 31, 2009

 

9

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Tableof Contents

 

***3.   Stock-basedCompensation (continued)***

 

There were no optionsexercised during the three months ended March 31, 2009. Cash received fromthe options exercised during the three months ended March 31, 2008 was$29,867.  Of the 5,092 shares exercisedin 2008, there were no director options exercised.

 

***4. Business Combinations***

 

OnSeptember 10, 2008, the Company announced that it had entered into adefinitive agreement whereby the Company would acquire 100% of AmericanCommunity Bancshares, Inc. (“ACBA”), and its subsidiary, AmericanCommunity Bank, in a transaction with a total value of approximately $48million based on the Company’s closing stock price on April 17, 2009. AmericanCommunity Bancshares shareholders have the right to receive either $12.35 incash or .8517 of the Company’s shares of common stock for each AmericanCommunity share, subject to the limitations that 19.5% of total considerationis to be paid in cash and 80.5% in Yadkin Valley Financial shares. ThoseAmerican Community shares exchanged for stock will convert to Yadkin ValleyFinancial shares in a tax-free exchange. Cash will also be paid in lieu offractional shares. The acquisition of ACBA will extend the Company’s market tothe southern portion of North Carolina and into South Carolina for the firsttime, adding 16 branches and over $500 million in assets. Closing of thetransaction occurred on April 17, 2009. The initial accounting for thebusiness combination is still in process and disclosures relevant to theacquisition are not readily determinable at this time.

 

***5. InvestmentSecurities***

 

The following tableprovides 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 continuous unrealizedloss position at March 31, 2009. The unrealized losses relate to securitiesthat have incurred fair value reductions due to increases in market interestrates since the securities were purchased, and are considered by management tobe temporary. The unrealized losses are not likely to reverse unless and untilinvestment market interest rates decline to the levels that existed when thesecurities were purchased. Since none of the unrealized losses relate to themarketability of the securities or the issuer’s ability to honor redemptionobligations, none of the securities are deemed to be other than temporarilyimpaired. Management has the intent and ability to hold these securities untilmaturity or a recovery in fair value.

 
| ** **                             | ** ** | **Less Than 12 Months** | ** ** | **12 Months or More** | ** ** | **Total**                                                                 | ** ** |
|----------------------------------------|------------|----------------------------------------|------------|--------------------------------------|------------|---------------------------------------------------------------------------|------------|
| ** **                             | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**                                                                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **March 31, 2009**           | ** ** | **value**                              | ** ** | **losses**                           | ** ** | **value**                                                                 | ** ** | **losses** | ** ** | **value** | ** ** | **losses** | ** ** |
| Securities  available for sale:        |       |                                   |       |                                 |       |                                                                      |       |   |   |   |   |   |   |
| U.S. government  agencies              |       | $  1,983,120                 |       | $  16,880                  |       | $           — |       | $        — |   | $  1,983,120 |   | $     16,880 |   |
| Mortgage backed  securities            |       | 1,693,565                              |       | 120,325                              |       | 1,978,769                                                                 |       | 706,340 |   | 3,672,334 |   | 826,665 |   |
| State and  municipal securities        |       | 12,125,157                             |       | 439,865                              |       | 633,448                                                                   |       | 66,553 |   | 12,758,605 |   | 506,418 |   |
| Common and  preferred stocks           |       | 5,300                                  |       | 2,700                                |       | 6,000                                                                     |       | 13,200 |   | 11,300 |   | 15,900 |   |
|                                   |       |                                   |       |                                 |       |                                                                      |       |   |   |   |   |   |   |
| Total  temporarily impaired securities |       | $15,807,142                            |       | $579,770                             |       | $2,618,217                                                                |       | $786,093 |   | $18,425,359 |   | $1,365,863 |   |
| ** **                             |       |                                   |       |                                 |       |                                                                      |       |   |   |   |   |   |   |
| ** **                             | ** ** | **Fair**                               | ** ** | **Unrealized**                       | ** ** | **Fair**                                                                  | ** ** | **Unrealized** | ** ** | **Fair** | ** ** | **Unrealized** | ** ** |
| **March 31, 2008**           | ** ** | **value**                              | ** ** | **losses**                           | ** ** | **value**                                                                 | ** ** | **losses** | ** ** | **value** | ** ** | **losses** | ** ** |
| Securities  available for sale:        |       |                                   |       |                                 |       |                                                                      |       |   |   |   |   |   |   |
| Mortgage backed  securities            |       | $  1,527,014                 |       | $    6,353       |       | $2,608,532                                                                |       | $  45,862 |   | $  4,135,546 |   | $     52,215 |   |
| State and  municipal securities        |       | 8,770,317                              |       | 304,402                              |       | 585,707                                                                   |       | 2,001 |   | 9,356,024 |   | 306,403 |   |
| Other securities                       |       | 397,420                                |       | 102,580                              |       | —                                                                    |       | — |   | 397,420 |   | 102,580 |   |
|                                   |       |                                   |       |                                 |       |                                                                      |       |   |   |   |   |   |   |
| Total  temporarily impaired securities |       | $10,694,751                            |       | $413,335                             |       | $3,194,239                                                                |       | $  47,863 |   | $13,888,990 |   | $   461,198 |   |

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report March 31, 2009

 

10

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Tableof Contents

 

***5. InvestmentSecurities (continued)***

 

Ifmanagement determines that an investment experienced an OTTI, the loss isrecognized in the income statement.

 

The aggregate cost of the Company’s cost method investments at March 31,2009 totaled $10,238,311 of which $8,259,600 is Federal Home Loan Bank ofAtlanta (“FHLB”) stock and the rest is in included in other assets.  All equity investments were evaluated forimpairment at March 31, 2009. The Company estimated that the fair valueequaled or exceeded the cost of each of these investments (that is, theinvestments were not impaired) on the basis of the redemption provisions of theissuing entities with two exceptions.  Duringthe first quarter of 2009, the Company wrote off its investment of $151,722 inSilverton Financial Services, Inc. (“SFS”) based on events occurring afterthe financial statement date but prior to the issuance of the statements. On May 1,2009 the Office of the Comptroller of the Currency (“OCC”) closed SilvertonBank, National Association, a wholly owned subsidiary of SFS.  The OCC appointed the FDIC as receiver, andthe FDIC createda bridge bank, Silverton Bridge Bank, National Association, to take over theoperations and allow customers to transfer their account relationships in anorderly fashion. The Company’s investment in a trust company was written down by$27,771 in the first quarter because it was considered to be other thantemporarily impaired.

 

***6.  Commitments and Contingencies***

 

In the normal course ofbusiness, there are various outstanding commitments and contingent liabilities,such as commitments to extend credit, which are not reflected in theaccompanying financial statements.  At March 31,2009, the Company, had commitments outstanding of $274.7 million for additionalloan amounts.  Commitments of Sidus, theBank’s mortgage lending subsidiary, are excluded from this amount and discussedin the next paragraph.  Additionalcommitments totaling $7.2 million were outstanding under standby letters ofcredit.  Management does not expect anysignificant losses to result from these commitments.

 

At March 31, 2009, Sidus had $373.4 million ofcommitments outstanding to originate mortgage loans held for sale at fixedprices and $373.4 million of mortgage interest rate lock commitmentsoutstanding under best efforts contracts to sell mortgages to agencies andother investors.

 

The Company is a party to legal proceedings andpotential claims arising in the normal conduct of business.  The Companyhas been sued for damages in excess of $850,000 for 3.99 years of severance,continued benefits and fringe benefits by two former employees who allegebreach of contract.  In addition, the plaintiffs seek liquidated damagesand costs (including reimbursement for reasonable attorney fees) under theirwage and hour claims.  They also asserted that non-compete provisions ofthe employment agreements do not apply to their separation.  Bothplaintiffs filed for judgment on the pleadings in state court andprevailed.  The Company appealed the orders before the trial court haddetermined damages.  The North Carolina Court of Appeals affirmed thetrial court’s decision. The Company’s petition to the NC Supreme Count wasdenied and the case was remanded to the trial court for a determination ofdamages.  The Company maintains a reservefor these claims that it considers to be adequate and therefore does notbelieve that the outcome will have a material adverse effect on our financialposition or results of operations.  However the Company cannot make anyassurances regarding the final amount of damages.

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

11

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Table of Contents

 

***7.    Earnings pershare***

 

Basic net income pershare is computed by dividing net income by the weighted average number ofshares of common stock outstanding for the reporting periods.  Diluted net income per share reflects thepotential dilution that could occur if the Company’s stock options, whichrepresent potential additional common shares, 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:

 
| ** **                                                      | ** ** | **March 31,** | ** ** |
|-----------------------------------------------------------------|------------|--------------------|------------|
| ** **                                                      | ** ** | **2009**           | ** ** | **2008** | ** ** |
| Basic EPS  denominator:                                         |       |               |       |   |   |
|                                                            |       |               |       |   |   |
| Weighted average  number of common shares outstanding           |       | 11,536,500         |       | 10,573,889 |   |
|                                                            |       |               |       |   |   |
| Dilutive effect  arising from assumed exercise of stock options |       | -0-                |       | 60,364 |   |
|                                                            |       |               |       |   |   |
| Diluted EPS  denominator                                        |       | 11,536,500         |       | 10,634,253 |   |

 

During the quarterended March 31, 2009, 389,023 stock options were not considered dilutivebecause the exercise prices exceeded the average market price of $8.17 pershare. These non-dilutive shares had exercise prices ranging from $8.66 to$19.07 per share and had a weighted average price of $14.44 per share.  No dilutive shares were considered incalculating diluted earnings per share in 2009 because the Company reported anet loss. The common stock warrant, issued to the U.S. Treasury, for thepurchase of 385,990 shares of stock valued at $13.99 per share was not includedin dilutive shares because the price exceeded the average market price.

 

***8.   Stockholders’Equity***

 

On March 19, 2009,the Board of Directors of the Company declared a quarterly cash dividend of$0.06 per share to all stockholders of record on April 3, 2009, andpayable April 24, 2009. The dividend reduced stockholders’ equity by$692,190.

 

On May 24, 2007, theBoard approved a plan to repurchase up to 100,000 shares of the Company’soutstanding shares (“2007 plan”), The Company did not repurchase any sharesduring the first three months of 2009. There was no 2008 purchase plan orrepurchases in 2008.  Under the 2007plan, the Company has repurchased a total of 71,281 shares at an average priceof $17.10 per share.  There are 28,719shares available to purchase under the 2007 plan at March 31, 2009.

 

***9.  Business Segment Information***

 

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 firstthree months of 2009 and 2008 for the Bank, Sidus, and Other (eliminations andHolding Company).

 

Yadkin Valley FinancialCorporation

Form 10-Q Quarterly Report March 31, 2009

 

12

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***9.  Business Segment Information (continued)***

 
| **March 31, 2009**                                        | ** ** | **Bank**                                             | ** ** | **Sidus**                                          | ** ** | **Other**                                                                                                     | ** ** | **Total**                                            | ** ** |
|----------------------------------------------------------------|------------|------------------------------------------------------|------------|----------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------|------------|
| Interest income                                                |       | $     16,560,585            |       | $    1,038,962                 |       | $                 — |       | $     17,599,547            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Interest expense                                               |       | 7,347,947                                            |       | 131,551                                            |       | 206,420                                                                                                       |       | 7,685,918                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Net interest  income (expense)                                 |       | 9,212,638                                            |       | 907,411                                            |       | (206,420                                                                                                      | )          | 9,913,629                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Provision for  loan losses                                     |       | 10,538,740                                           |       | 10,765                                             |       | —                                                                                                        |       | 10,549,505                                           |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Net interest  income (expense) after provision for loan losses |       | (1,326,102                                           | )          | 896,646                                            |       | (206,420                                                                                                      | )          | (635,876                                             | )          |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Other income                                                   |       | 1,801,057                                            |       | 3,199,087                                          |       | 271,063                                                                                                       |       | 5,271,207                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Other expense                                                  |       | 9,502,797                                            |       | 2,133,285                                          |       | 156,753                                                                                                       |       | 11,792,835                                           |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Income (loss)  before income taxes                             |       | (9,027,842                                           | )          | 1,962,448                                          |       | (92,110                                                                                                       | )          | (7,157,504                                           | )          |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Income taxes (1)                                               |       | (3,759,624                                           | )          | 765,355                                            |       | —                                                                                                        |       | (2,994,269                                           | )          |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Net income  (loss)                                             |       | $     (5,268,218            | )          | $    1,197,093                 |       | $         (92,110                                                | )          | $      (4,163,235      | )          |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Total assets  (2)                                         |       | $1,622,324,848                                       |       | $190,984,577                                       |       | $(176,226,732                                                                                                 | )          | $1,637,082,693                                       |       |
| Net loans                                                      |       | 1,151,505,691                                        |       | —                                             |       | —                                                                                                        |       | 1,151,505,691                                        |       |
| Loans held for  sale                                           |       | 444,000                                              |       | 179,620,752                                        |       | —                                                                                                        |       | 180,064,752                                          |       |
| Goodwill                                                       |       | 48,559,015                                           |       | 4,943,872                                          |       | —                                                                                                        |       | 53,502,887                                           |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| **March 31, 2008**                                        | ** ** | **Bank**                                             | ** ** | **Sidus**                                          | ** ** | **Other**                                                                                                     | ** ** | **Total**                                            | ** ** |
| Interest income                                                |       | $     17,282,737            |       | $       620,395 |       | $                 — |       | $     17,903,132            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Interest expense                                               |       | 8,144,622                                            |       | 317,978                                            |       | 83,535                                                                                                        |       | 8,546,135                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Net interest  income (expense)                                 |       | 9,138,115                                            |       | 302,417                                            |       | (83,535                                                                                                       | )          | 9,356,997                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Provision for  loan losses                                     |       | 450,000                                              |       | —                                             |       | —                                                                                                        |       | 450,000                                              |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Net interest  income (expense) after provision for loan losses |       | 8,688,115                                            |       | 302,417                                            |       | (83,535                                                                                                       | )          | 8,906,997                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Other income                                                   |       | 2,144,403                                            |       | 1,772,295                                          |       | 12,744                                                                                                        |       | 3,929,442                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Other expense                                                  |       | 7,193,651                                            |       | 1,411,243                                          |       | 37,787                                                                                                        |       | 8,642,681                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Income (loss)  before income taxes                             |       | 3,638,867                                            |       | 663,469                                            |       | (108,578                                                                                                      | )          | 4,193,758                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Income taxes (1)                                               |       | 1,020,692                                            |       | 258,753                                            |       | —                                                                                                        |       | 1,279,445                                            |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Net income                                                     |       | $       2,618,175 |       | $       404,716 |       | $       (108,578                                                           | )          | $       2,914,313 |       |
|                                                           |       |                                                 |       |                                               |       |                                                                                                          |       |                                                 |       |
| Total assets  (2)                                         |       | $1,453,599,675                                       |       | $ 58,229,229                                  |       | $ (86,617,169                                                                                            | )          | $1,425,211,735                                       |       |
| Net loans                                                      |       | 1,026,912,730                                        |       | —                                             |       | —                                                                                                        |       | 1,026,912,730                                        |       |
| Loans held for  sale                                           |       | 910,700                                              |       | 50,778,332                                         |       | —                                                                                                        |       | 51,689,032                                           |       |
| Goodwill                                                       |       | 47,624,104                                           |       | 4,943,872                                          |       | —                                                                                                        |       | 52,567,976                                           |       |

 

----

(1)               Note: Income tax expense has been allocated to the Sidus business segment forcomparative purposes.  As an LLC, Siduspasses its pre-tax income through to its single member, the Bank, which istaxed 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 in 2009and 2008), and the Bank’s A/R from Sidus ($119,344 in 2009 and $172,277 in2008).  Also included in this column areHolding Company assets and income and expenses ($1,892,612 in 2009 and$1,555,108 in 2008).

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

13

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Tableof Contents

 

***10. Allowancefor Loan Losses***

 

Changesin the allowance for loan losses for the first quarters of 2009 and 2008 are asfollows (in thousands):

 
| ** **                                | ** ** | **March 31,2009** | ** ** | **March 31,2008** | ** ** |
|-------------------------------------------|------------|------------------------|------------|------------------------|------------|
|                                      |       |                   |       |                   |       |
| Balance,  beginning of period             |       | $                      | 22,355     |                   | $          | 12,445 |   |
| Charge-offs                               |       | (2,023                 | )          | (239                   | )          |
| Recoveries                                |       | 22                     |       | 254                    |       |
| Provision for  loan losses                |       | 10,550                 |       | 450                    |       |
| Acquisition of  Cardinal                  |       | —                 |       | 1,658                  |       |
| Allowance for  Loan Losses, end of period |       | $                      | 30,904     |                   | $          | 14,568 |   |

 

Thefollowing table presents the Bank’s investment in loans considered to beimpaired and related information on those impaired loans:

 
| ** **                                                  | ** ** | **March 31,** | ** ** | **December 31,** | ** ** |
|-------------------------------------------------------------|------------|--------------------|------------|-----------------------|------------|
| ** **                                                  | ** ** | **2009**           | ** ** | **2008**              | ** ** |
|                                                        |       |               |       |                  |       |
| Impaired loans  without a related allowance for loan losses |       | $                  | 5,915,007  |                  | $          | 6,942,036 |   |
| Impaired loans  with a related allowance for loan losses    |       | 16,094,472         |       | 7,496,309             |       |
| Total impaired  loans                                       |       | $                  | 22,009,479 |                  | $          | 14,438,345 |   |
| Allowance for  loan losses related to impaired loans        |       | $                  | 6,506,898  |                  | $          | 3,663,409 |   |

 

Nonperforming assets aresummarized as follows:

 
| ** **                           | ** ** | **March 31, 2009** | ** ** | **December 31, 2008** | ** ** |
|--------------------------------------|------------|------------------------------|------------|---------------------------------|------------|
|                                 |       |                         |       |                            |       |
| Impaired loans:                      |       |                         |       |                            |       |
| Nonaccrual                           |       | $                            | 17,419,612 |                            | $          | 13,647,312 |   |
| Restructured                         |       | 2,656,852                    |       | —                          |       |
| Potential  problem loans             |       | 1,933,015                    |       | 791,033                         |       |
| Total  Impaired loans                |       | $                            | 22,009,479 |                            | $          | 14,438,345 |   |
|                                 |       |                         |       |                            |       |
| Nonaccrual loans                     |       | $                            | 17,419,612 |                            | $          | 13,647,312 |   |
| Loans past due  90 days and accruing |       | —                       |       | —                          |       |
| Foreclosed real  estate              |       | 4,318,280                    |       | 4,017,880                       |       |
| Total  Nonperforming Assets          |       | $                            | 21,737,892 |                            | $          | 17,665,192 |   |

 

Potential problem loansare loans that are in currently compliance with payment terms but due toexisting circumstances it is considered possible that the Bank will be unableto collect all amounts due according to the existing loan repayment terms andhave insufficient collateral values.

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

14

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*** ***

***11. New Accounting Standards***

 

**RecentlyAdopted Accounting Standards**

 

EffectiveJanuary 1, 2009, the Company adopted SFAS No. 161, “Disclosures aboutDerivative Instruments and Hedging Activities’ (“Statement 161”). Statement 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 enhanceddisclosures which are in the following paragraph.

 

TheCompany is exposed to certain risks relating to its ongoing mortgageorigination business.  The primary risksmanaged by derivative instruments are interest rate lock commitments and forwardloan sale commitments.  Interest ratelock commitments are entered into to manage interest rate risk associated withthe Company’s fixed rate loan commitments. The period of time between the issuance of a loan commitment and theclosing and sale of the loan generally ranges from 10 to 60 days. Suchinterest rate lock commitments represent derivative instruments which arerequired to be carried at fair value. These derivative instruments do notqualify as hedges under SFAS No. 133. The fair value of the Company’sinterest rate lock commitments is based on current secondary market pricing andis included on the balance sheet in loans held for sale.  The gain and losses from the fair value ofthe derivatives 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.

 

Asof March 31, 2009, the total amount of the Company’s outstanding interestrate lock commitments was approximately $1.7 million and the forward salescommitments totaled $927,000.

 

On February 12, 2008, theFASB issued FASB Staff Position No. FAS 157-2, *EffectiveDate of FASB Statement No. 157* which deferred the application ofSFAS 157. *Fair Value Measurements* to nonfinancialassets and liabilities measured on a nonrecurring basis until interim andannual periods beginning after November 15, 2008. The Company applied the fullprovisions of SFAS 157, *Fair Value Measurements*to its nonfinancial assets measured on a nonrecurring basis during the firstquarter of 2009. The adoption FSP FAS 157-2 did not have a material effect onthe Company’s financial position or results of operations however it did resultin additional disclosure regarding foreclosed real estate in Note 12 to theconsolidated financial.

 

**RecentlyIssued but not yet Effective Accounting Pronouncements:**

 

OnApril 9, 2009, the FASB issued FASB Staff Position (FSP) FAS 157-4, “Determining Fair Value When the Volume andLevel of Activity for the Asset or Liability Have Significantly Decreased andIdentifying Transactions That Are Not Orderly.” The FSP providesadditional guidance for estimating fair value in accordance with FASB StatementNo. 157, “Fair Value Measurements”,when the volume and level of activity for the asset or liability havesignificantly decreased. The FSP also includes guidance on identifyingcircumstances that indicate a transaction is not orderly. Further, the FSPemphasizes that even if there has been a significant decrease in the volume andlevel of activity for the asset or liability and regardless of the valuationtechnique(s) used, the objective of a fair value measurement remains thesame. Fair value is the price that would be received to sell an asset or paidto transfer a liability in an orderly transaction (that is, not a forcedliquidation or distressed sale) between market participants at the measurementdate under current market conditions. The FSP amends Statement 157 to requirecertain additional disclosures in interim and annual periods to discuss theinputs and valuation technique(s) used to measure fair value. This FSP iseffective 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 Company plans to adopt this newaccounting pronouncement in the second quarter of 2009. Management is stillevaluating the impact of FSP 157-4.

 

OnApril 9, 2009, the FASB issued FASB FSP No. FAS 107-1 and APB 28-1, “Interim Disclosures about Fair Value ofFinancial Instruments.” This FSP amends FASB Statement No. 107, “Disclosures about Fair Value of FinancialInstruments”, to require disclosures about fair value of financialinstruments for interim reporting periods of publicly traded companies as wellas in annual financial statements. This FSP also amends APB Opinion No. 28,“Interim Financial Reporting”, torequire those disclosures in summarized financial information at interimreporting periods. This FSP is effective for interim reporting periods endingafter June 15, 2009, with early adoption permitted for periods endingafter March 15, 2009. The Companu will adopt this new accountingpronouncement in the second quarter of 2009. Management is still evaluating theimpact of FSP FAS 107-1 and APB 28-1.

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

15

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Table of Contents

 

***11. New Accounting Standards(continued)***

 

OnApril 9, 2009, the FASB issued FSP FAS 115-2 and FAS 124-2, “Recognition and Presentation ofOther-Than-Temporary Impairments.” This FSP amends theother-than-temporary impairment guidance in GAAP for debt securities to makethe guidance more operational and to improve the presentation and disclosure ofother-than-temporary impairments on debt and equity securities in the financialstatements. This FSP does not amend existing recognition and measurement guidancerelated to other-than-temporary impairments of equity securities. The FSP iseffective for interim and annual reporting periods ending after June 15,2009, with early adoption permitted for periods ending after March 15,2009. The Company plans to adopt this new accounting pronouncement in thesecond quarter of 2009. Management is still evaluating the impact of FSP FAS115-2 and FAS 124-2.

 

***12. Fair Value***

 

TheCompany utilizes fair value measurements to record fair value adjustments forcertain assets and liabilities and to determine fair value disclosures.Available-for-sale securities, mortgage servicing rights, interest rate lockcommitments and forward sale loan commitments are recorded at fair value on amonthly basis. Additionally, from time to time, the Company may be required torecord other assets at fair value, such as loans held for investment andcertain other assets. These nonrecurring fair value adjustments usually involvewriting the asset down to lower of cost or market.

 

**FairValue Hierarchy**

 

UnderSFAS 157, the Company groups assets and liabilities at fair value in threelevels, based on the markets in which the assets and liabilities are traded andthe reliability of the assumptions used to determine fair value. These levelsare:

 
| 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. |

 

Followingis a description of valuation methodologies used for assets and liabilitiesrecorded at fair value.

 

**Assets and liabilities subjectedto recurring fair value adjustments**

 

**Available-for-SaleInvestment 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 asthe present value of future cash flows, adjusted for the security’s creditrating, prepayment assumptions and other factors such as credit lossassumptions. Level 1 securities include those traded on an active exchange,such as the New York Stock Exchange, U.S. Treasury securities that are tradedby dealers or brokers in active over-the-counter markets and money marketfunds. Level 2 securities include mortgage-backed securities issued bygovernment sponsored entities, municipal bonds and corporate debt securities.

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

16

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***12. Fair Value(continued)***

 

**InterestRate Locks and Forward Sale Loan Commitments**

 

Sidus,the Company’s mortgage lending subsidiary, enters into interest rate lockcommitments and commitments to sell mortgages. At December 31, 2008, theamount of fair value was considered immaterial for reporting purposes underSFAS 157. At March 31, 2009, the amount of fair value associated withthese interest rate lock commitments and forward sale commitments was $1,670,721and ($927,507), respectively.

 

**MortgageServicing Rights**

 

Avaluation 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.

 

Assetsand (liabilities) subjected to recurring fair value adjustments:

 
| **March 31, 2009**         | ** ** | **Fair Value**                     | ** ** | **Level 1**                           | ** ** | **Level 2**                                                                                             | ** ** | **Level 3**                                                                     | ** ** |
|---------------------------------|------------|------------------------------------|------------|---------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| Available for  sale securities  |       | $132,609,198                       |       | $7,509                                |       | $132,601,689                                                                                            |       | $            — |       |
| Interest rate  lock commitments |       | 1,670,721                          |       | —                                |       | 1,670,721                                                                                               |       | —                                                                          |       |
| Forward loan  sale commitments  |       | (927,507)                          |       | —                                |       | (927,507)                                                                                               |       | —                                                                          |       |
| Mortgage  servicing rights      |       | $    1,594,711 |       | $     — |       | $                — |       | $1,594,711                                                                      |       |

 
| **December 31, 2008** | ** ** | **Fair Value**                | ** ** | **Level 1**                                  | ** ** | **Level 2**                                                                                        | ** ** | **Level 3**                                                                | ** ** |
|---------------------------------|------------|------------------------------------|------------|---------------------------------------------------|------------|---------------------------------------------------------------------------------------------------------|------------|---------------------------------------------------------------------------------|------------|
| Available for  sale securities  |       | $137,813,529                       |       | $22,596                                           |       | $137,813,529                                                                                            |       | $            — |       |
| Mortgage  servicing rights      |       | $    1,745,466 |       | $       — |       | $                — |       | $1,745,466                                                                      |       |

 

The following tablepresents a rollforward of mortgage servicing rights from December 31, 2008to March 31, 2009 and December 31, 2007 to March 31, 2008 andshows that the mortgage servicing rights are classified as Level 3 as discussedabove.

 
| ** **                       | ** ** | **Fair Value** | ** ** | **Level 3** | ** ** |
|----------------------------------|------------|----------------|------------|-------------|------------|
| Balance,  December 31, 2008 |       | $1,745,466     |       | $1,745,466  |       |
| Capitalized                      |       | 286,821        |       | 286,821     |       |
| Change in fair  value            |       | (437,576       | )          | (437,576    | )          |
| Balance,  March 31, 2009    |       | $1,594,711     |       | $1,594,711  |       |

 
| ** **                       | ** ** | **Fair Value** | ** ** | **Level 3** | ** ** |
|----------------------------------|------------|----------------|------------|-------------|------------|
| Balance,  December 31, 2007 |       | $2,000,770     |       | $2,000,770  |       |
| Capitalized                      |       | 16,407         |       | 16,407      |       |
| Change in fair  value            |       | (113,573       | )          | (113,573    | )          |
| Balance,  March 31, 2008    |       | $1,903,604     |       | $1,903,604  |       |

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

17

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***12. Fair Value(continued)***

 

**MortgageLoans Held for Sale**

 

Loansheld for sale are carried at lower of cost or market value. The fair value ofloans held for sale is based on what secondary markets are currently offeringfor portfolios with similar characteristics. As such, the Company classifiesloans subjected to nonrecurring fair value adjustments as Level 2.  At March 31, 2009 the cost of theCompany’s mortgage loans held for sale was less than the market value.  Accordingly, at quarter end the Company’sloans held for sale were carried at cost.

 

**ImpairedLoans**

 

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 an allowance for loan losses is established.Loans for which it is probable that payment of interest and principal will notbe made in accordance with the contractual terms of the loan agreement are consideredimpaired. Once a loan is identified as individually impaired, managementmeasures impairment in accordance with SFAS 114, “Accounting by Creditors forImpairment of a Loan,” (SFAS114). The fair value of impaired loans is estimated using one of severalmethods, including collateral value, market value of similar debt, enterprisevalue, liquidation value and discounted cash flows. Those impaired loans notrequiring an allowance represent loans for which the fair value of the expectedrepayments or collateral exceed the recorded investments in such loans. At March 31,2009, 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 based on the fair value of collateral requireclassification in the fair value hierarchy. When the fair value of thecollateral is based on an observable market price or a current appraised value,the Company records the impaired loan as nonrecurring Level 2. When anappraised value is not available or management determines the fair value of thecollateral is further impaired below the appraised value and there is noobservable market price, the Company records the impaired loan as nonrecurringLevel 3.

 

**Foreclosed Property**

 

Foreclosed property isadjusted to fair value upon transfer of the loans to Foreclosed property.Subsequently, foreclosed property is carried at the lower of carrying value orfair value. Fair value is based upon independent market prices, appraisedvalues of the collateral or management’s estimation of the value of thecollateral. When the fair value of the collateral is based on an observablemarket price or a current appraised value, the Company records the foreclosedasset as nonrecurring Level 2. When an appraised value is not available ormanagement determines the fair value of the collateral is further impairedbelow the appraised value and there is no observable market price, the Companyrecords the foreclosed property as nonrecurring Level 3. The current value of foreclosedproperty at March 31, 2009 is $4,318,280.

 

Assetsubjected to nonrecurring fair value adjustments:

 
| ** **                                | ** ** | **Fair Value**         | ** ** | **Level 1**   | ** ** | **Level 2** | ** ** | **Level 3**            | ** ** |
|-------------------------------------------|------------|------------------------|------------|---------------|------------|-------------|------------|------------------------|------------|
| Foreclosed  property at March 31, 2009    |       | $  4,318,280 |       | $—  |       | $—     |       | $  4,318,280 |       |
| Impaired loans  at March 31, 2009    |       | 16,094,472             |       | —        |       | —      |       | 16,094,472             |       |
| Impaired loans  at December 31, 2008 |       | $  7,864,055 |       | —        |       | —      |       | $  7,864,055 |       |

 

**Item2.**  **Management’s Discussion and Analysis of FinancialCondition and Results of Operations**

 

**CAUTIONARYSTATEMENT REGARDING FORWARD-LOOKING STATEMENTS**

 

Thefollowing is our discussion and analysis of certain significant factors thathave affected our financial position and operating results during the periodsincluded 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.

 

The discussions presented in this report containstatements that could be deemed forward looking statements within the meaningof the Securities Exchange Act of 1934 and the Private Securities LitigationReform Act of 1995, which statements are inherently subject to risks anduncertainties.  Forward looking statementsare statements that include projections, predictions, expectations or beliefsabout future events or results or otherwise are not statements of historicalfact.  Such statements are oftencharacterized by the use of qualifying words (and their derivatives) such as“expect,” “believe,” “estimate,” “plan,” “project,” or other statementsconcerning opinions or judgments about future 

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

18

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events. Factors that could influence the accuracy of such forward-lookingstatements include, but are not limited to, the financial success or changingstrategies of the Bank’s customers or vendors, actions of governmentregulators, the level of market interest rates, and general economicconditions.

 

Potential risks and uncertainties that could cause our actual resultsto differ from those anticipated in any forward-looking statements include, butare not limited to, those described below under Item 1A- Risk Factors of ourAnnual Report on 10-K (as amended) and the following:

 

·                  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;

 

·                  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 ofcharge-offs;

 

·                  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;

 

·                  changes in the securities markets; and

 

·                  other risks and uncertainties detailed fromtime to time in our filings with the Securities and Exchange Commission.

 

Wehave based our forward-looking statements on our current expectations aboutfuture events. Although we believe that the expectations reflected in ourforward-looking statements are reasonable, we cannot guarantee you that theseexpectations will be achieved. We undertake no obligation to publicly update orotherwise revise any forward-looking statements, whether as a result of newinformation, future events, or otherwise.

 

Theserisks are exacerbated by the recent developments in national and internationalfinancial markets, and we are unable to predict what effect these uncertainmarket conditions will have on us. During 2008 and the first quarter of 2009, the capital and creditmarkets have experienced extended volatility and disruption.  In recent months, the volatility anddisruption have reached unprecedented levels. There can be no assurance that these unprecedented recent developmentswill not continue to materially and adversely affect our business, financialcondition and results of operations.

 

**RecentGovernment Actions**

 

OnOctober 14, 2008, under authority granted by the Emergency EconomicStabilization Act of 2008 (the “EESA”), the United States Department of theTreasury adopted the Troubled Asset Relief Program and the Capital

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

19

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PurchaseProgram (the “Capital Purchase Program”) pursuant to which the Treasury intendsto make senior preferred stock investments in participating financialinstitutions. The terms and conditions of the Capital Purchase Program aregenerally described in the Treasury’s term sheet available on the Treasury’swebsite at http://www.ustreas.gov. The Company applied for and receivedapproval to participate in the Treasury’s Capital Purchase Program and received$36 million in additional capital.

 

Anotheraspect of EESA (in addition to the Capital Purchase Plan) which becameeffective on October 3, 2008 is a temporary increase of the basic limit onfederal deposit insurance coverage from $100,000 to $250,000 perdepositor.  The basic deposit insurancelimit will return to $100,000 after December 31, 2009.

 

Followinga systemic risk determination, the FDIC established the Temporary LiquidityGuarantee 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 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 50 to 100 basis points (annualized) forcovered debt outstanding until the earlier of maturity or June 30, 2012and a surcharge of 25 basis points (annualized) for covered debt outstandinguntil after June 30, 2012.  The TAGPand DGP are in effect for all eligible entities, unless the entity opted out onor before December 5, 2008.  TheBank is 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 following discussiondescribes our results of operations for the quarter ended March 31, 2009as compared to the quarter ended March 31, 2008, and also analyzes ourfinancial condition as of March 31, 2009 as compared to December 31,2008.  Like most community banks, wederive most of our income from interest we receive on our loans andinvestments.  Our primary source of fundsfor making these loans and investments is our deposits, on which we

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

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pay interest.  Consequently, one of the key measures of oursuccess is the amount of net interest income, or the difference between theincome on interest-earning assets, such as loans and investments, and theexpense on 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 oninterest-bearing liabilities.

 

Of course, there arerisks 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 to earninginterest on our loans and investments, we earn income through fees and otherexpenses we charge to our customers.  Wedescribe the various components of this noninterest income, as well as ournoninterest 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 March 31, 2009 were $1,637.1 million,an increase of $112.8 million or 7.4% compared to assets of $1,524.3 million atDecember 31, 2008.  The increase intotal assets was primarily in mortgage loans held for sale, offset by decreasesin net loans held for investment.  Theloan portfolio, net of allowance for losses, was $1,151.5 million at March 31,2009, compared to $1,165.2 million at December 31, 2008.  Gross loans held for investment decreased by$5.2 million, or 0.4%. The allowance for loan losses increased by $8.5 millionto $30.9 million for the period ended March 31, 2009 due to the generalallowance increase which was driven primarily by increased charge-offs for therolling eight quarters ended March 31, 2009 as compared to the eightquarter period ending December 31, 2008 and rising trends in the Bank’spast due and nonaccrual loans and the state’s increasing unemployment rates.

 

Loan growth concentrationwas divided within the following categories. Commercial real estate loans increased by $9.1 million, or 2.2%;construction and land development loans increased by $5.6 million, or 2.5%; andhome equity lines of credit increased $3.4 million, or 2.5%.  Commercial and industrial loans decreased$26.5 million or 11.8% which is a normal recurring seasonal fluctuation.  Loans were funded by certificates of deposit(“CODs”), negotiable orders of withdrawal (“NOW”), money market deposits, andborrowings.  The Bank promoted one ormore special COD rates throughout the period.

 

Mortgage loansheld for sale increased by $130.1 million (261%) as the Bank continued itsstrategy of selling mortgage loans mostly to various investors with servicingrights released and to a lesser extent to the Federal National MortgageAssociation with servicing rights retained. These loans are normally held for a period of two to three weeks before beingsold to investors.  The timing of theloans closed within each month allowed the Bank to sell more of its outstandingloans at the end of December 2008 than at quarter end March 2009.  Mortgage loans closed in the first quarter of2009, ranged from a low of $150.7 million in January to a high of $225.4million in March and totaled $563.5 million.  In first quarter of 2008 total loans closedwere $258.8 million.  Mortgage loans soldduring the three months ended March 31, 2009 totaled $433.7 millioncompared to $260.6 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.

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

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The securities portfoliodecreased 3.78% from $137.8 million at December 31, 2008, to $132.6 million at March31, 2009.  The portfolio is comprised ofsecurities of federal agencies (30.6%), mortgage-backed securities (37.9%),tax-exempt municipal securities (31.5%), and publicly traded common andpreferred stocks (.01%).  Temporaryinvestments, including deposits at the Federal Home Loan Bank and federal fundssold, decreased from approximately $58,000 at December 31, 2008 to $51,000 at March31, 2009.

 

Other assets increased $5.6 million during thethree-month period ended March 31, 2009, due largely to an increase in currenttax benefit of $3.5 million, other current assets of the Sidus segment of $1.4million and a $500,000 receivable for a trade settlement. Other real estateowned (OREO) increased $300,000, with additional investments made in the amountof $0.8 million less dispositions of $0.5 million.  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 evaluation management determined that noimpairment existed in the banking segment.  However, no assurance can be made that theCompany will not have impairment in the banking or Sidus reporting units in thefuture.

 

Deposits increased $96.8 million or 8.4% comparing March 31,2009 to December 31, 2008.  Overall, noninterest-bearing demand depositsdecreased $2.9 million or 1.9% during the three-month period ended March 31,2009; NOW, savings, and money market accounts increased $22.8 million or 8.0%;CODs over $100,000 decreased $1.3 million or 0.4%; and other COD’s increased$78.2 million or 20.4% primarily in brokered deposits.  The interest-bearing deposit growth wasconcentrated in money market accounts which increased $20.5 million. NOWaccounts and savings increased $2.3 million.

 

Borrowed funds decreased $18.8 million or 9.0%comparing March 31, 2009 to December 31, 2008. Both advances from the FHLB (down $21 million) and overnight borrowings(down $4 million) decreased, while repurchase agreements increased by $6million. The increase in deposits, discussed above, allowed the Company to paydown short-term borrowings. As of March 31, 2009, long term borrowingsconsisted of $25.8 million of trust preferred securities, advances from theFHLB of $8.1 million and a structured wholesale repurchase agreement of $5.0million. Yadkin Valley Statutory Trust I (“the Trust”) issued the trustpreferred securities on November 1, 2007, at a rate equal to the three-monthLIBOR rate plus 1.32%.  The trustpreferred securities mature in 30 years, and can be called by the Trust withoutpenalty after five years.

 

Other liabilitiesincreased by $4.8 million or 58.8% from December 31, 2008 to March 31, 2009primarily due to an increase in accounts payable of $3.0 million due to normaltiming fluctuations.  Additional accrualswere also recorded for increased FDIC expenses, security trades initiated butnot settled prior to quarter end, and for the settlement of lawsuits due to theuncertainties concerning the outcome.

 

At March 31, 2009, totalstockholders’ equity was $180.1 million or a book value of $12.63 per common sharecompared to $149.6 million or a book value of $12.97 per share at year-end December31, 2008.  The tangible book values percommon share at March 31, 2009 and December 31, 2008 were $7.61 and $7.93,respectively.  At March 31, 2009, theCompany was in compliance with all existing regulatory capital requirements tomaintain its status as a well-capitalized bank. During the three-month periodended March 31, 2009, the Company did not purchase any shares of its commonstock.

 

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

 

The Bank derives themajority 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 20.0% at March 31, 2009 compared to11.9% at December 31, 2008.  Additionalliquidity is provided by $99.4 million in unused credit including federal fundspurchased lines provided by correspondent banks as well as credit availabilityfrom the FHLB. In addition, the Bank has unpledged marketable securities of$61.6 million available for use as a

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

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source ofcollateral.  At March 31, 2009, brokereddeposits totaled $100.9 million, or 8.1% of total deposits, and consisted ofcertificates of deposit totaling $97.9 million and NOW public funds totaling$3.0 million.  Certificates of depositare primarily short-term with maturities of three months or less.

 

The Bank contracted withPromontory Interfinancial Network in 2008 for various services includingwholesale CD funding. Promontory’s CDARS® product, One-Way BuySM, enables the Bank to bid on a weekly basis through anprivate auction for CD terms ranging from four weeks to 260 weeks(approximately five years) with settlement available each Thursday. At March 31,2009, the balance of funds acquired through the One-Way Buy product totaled$20,000,000. The Bank obtained funding from out of market customers throughother deposit brokers totaling $77.9 million.

 

Promontory also providesa product, CDARS® Reciprocal, which allows the Bank’s customers to place fundsin excess of the FDIC insurance limit with Promontory’s network ofparticipating Bank’s so that the customer is fully insured for the amountdeposited. Promontory provides reciprocating funds to the Bank from fundsplaced at other banks by their customers. The Bank sets its customers interestrates when they place deposits through the network and pays/receives the ratedifference to/from the other banks whose reciprocal funds are held by the Bank.The overall impact of this process is that the Bank effectively pays the rateoffered to its relationship customer. Therefore, the Bank does not considerthese 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 March 31, 2009,CDARS® reciprocal deposits totaled $14.1 million.

 

Managementcontinues to assess interest rate risk internally and by utilizing outsidesources.  Following a period of stablerates, the Company’s balance sheet is asset sensitive over a three-monthperiod.  Net cumulative repricing assets(i.e. the amount of repricing assets less repricing liabilities) over thatperiod represent about 16% of total assets. Over a period of twelve months, thebalance sheet becomes liability sensitive. Net cumulative repricing liabilities over that period represent about 2%of total assets.  Although the balancesheet is slightly liability sensitive after twelve months, net interest incomeover that period would have a positive correlation to rate changes because netassets will reprice early in the period. We generally would benefit from increasing market interest rates when wehave an asset-sensitive, or a positive, interest rate gap, and we wouldgenerally benefit from decreasing market interest rates when we haveliability-sensitive, or a negative, interest rate 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 net interestincome between these points is positive unless the yield curve is inverted, adecrease in the slope of the yield curve will result in a decrease in the netinterest margin for Sidus.  Conversely,an increase in the slope will result in an increase in Sidus’ net interestmargin.  The yield curve for the firstthree months of 2009 was generally steeper than it was for the first threemonths of 2008, and as expected, Sidus’ net interest margin increased by 84basis points from the first quarter of 2008 to the first quarter of 2009.

 

The Company hasnot used derivative financial instruments such as futures, swaps and optionshistorically; 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.

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

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**Resultsof Operations**

 

Net loss availableto common shareholders for the three-month period ended March 31, 2009 was($4,163,235), compared to net income of $2,914,313 in the same period of 2008,a decrease of 242.9%. Basic and diluted earnings (loss) available to common shareholdersper common share were ($0.40) for the three-month period ended March 31,2009.  Basic and diluted earnings percommon share were $0.28 and $0.27 for the three-month period ended March 31,2008, respectively.  On an annualizedbasis, results of operations represent returns on average assets of (1.07%), (0.69%),and 0.98% for the quarters ended March 31, 2009, December 31, 2008, and March 31,2008, respectively.  Returns on averageequity for the same periods were (9.25%), (6.64%), and 8.55%.

 

The Companycalculates tangible equity by subtracting goodwill and core deposit intangiblefrom total equity.  Return on averagetangible equity (annualized) was (13.62%) for the quarter ended March 31, 2009,as compared to 11.75% for the quarter ended March 31, 2008 mainly due to thedecline of the quarterly net income.

 

Totalinterest income was $17.6 million for the three months ended March 31, 2009 andincluded $2.1 million from the Cardinal region, which the Company acquired on March31, 2008.  This represents 12.0% of thetotal interest income for the Bank. The Sidus segment had interest income of$1.0 million. Total interest income was $17.9 million for the three monthsended March 31, 2008. The Sidus segment had interest income of $0.6 million Totalinterest expense of the Bank for the three months ended March 31, 2009 was $7.7million and included $1.2 million from the Cardinal region, 16.0% of the Bank’stotal interest expense. The Sidus segment had interest expense of $132,000.Cardinal’s noninterest income for the quarter ended March 31, 2009 was $75,000which represented 1.4% of the Bank’s $5.3 million in total noninterest incomefor the period. The Sidus segment had noninterest income of $3.2 million andnoninterest expense of $2.1 million. Cardinal’s noninterest expense for the quarter ended March 31, 2009 was$985,000 which represented 8.5% of the Bank’s total noninterest expense of$11.8 million for the period. Total interest expense of the Bank for the threemonths ended March 31, 2008 was $8.5 million. The Sidus segment had interestexpense of $0.3 million and noninterest expense of $1.4 million. Cardinal’s netloss for the period of $31,000 represented 0.7% of net loss for the Bank.

 

###### **Net InterestIncome**

###### ** **

Net interestincome, the largest contributor to earnings, increased slightly to $9.9 millionin the first quarter of 2009, compared with $9.4 million in the same period of2008. The decrease in the prime interest rate was offset by the additional netinterest income earned by the recently acquired Cardinal region. The netinterest margin declined to 2.87% in the first quarter of 2009 from 3.56% inthe first quarter of 2008.

 

Thequarter-to-date margin decline was driven by the Bank’s short term assetsensitivity to changing interest rates. A comparison of the first quarters of 2009 and 2008 shows that yield onearning assets decreased by 168 basis points which was partially offset by adecrease of 127 basis points in the yield on interest bearing liabilities.  The decline in yield on earning assets wasattributable to the yield on loans which declined by 192 basis points in thefirst quarter of 2009 as compared to the first quarter of 2008.  The sum of variable rate loans that canreprice in three months and fixed rate loans that mature within 3 monthscomprised 41.9% of total loans held for investment at March 31, 2009 down from44.1% at March 31, 2008.

 

The Companymaintains an asset-sensitive position with respect to the impact of changingrates on net interest income.  The primerate decreased by 200 basis points from April 1, 2008 to March 31, 2009,including a steep decline of 175 basis points during the fourth quarter of2008.  After a 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.Comparing the linked first quarter of 2009 and fourth quarter of 2008, the netinterest margin declined by seven basis points as a result of the prime ratedecreasing by 75 basis points in mid-December 2008.

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

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**AverageBalance Sheets and Net Interest Income Analysis(Dollars in Thousands)**

(Unaudited)

**ThreeMonths Ended:**

 
| ** **                                              | ** ** | **March 31, 2009** | ** ** | **March 31, 2008** | ** ** |
|---------------------------------------------------------|------------|-------------------------|------------|-------------------------|------------|
| ** **                                              | ** ** | **Average****Balance**  | ** ** | **Interest**            | ** ** | **Yield/****Rate** | ** ** | **Average****Balance** | ** ** | **Interest** | ** ** | **Yield/****Rate** | ** ** |
| INTEREST EARNING  ASSETS                                |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Federal funds  sold                                     |       | $                       | 4,709      |                    | $          | 1 |   | 0.09 | % | $ | 1,365 |   | $ | 11 |   | 3.23 | % |
| Interest bearing  deposits                              |       | 1,971                   |       | 11                      |       | 2.26 | % | 2,303 |   | 5 |   | 0.87 | % |
| Investment  securities (1)                              |       | 133,439                 |       | 1,685                   |       | 5.12 | % | 142,310 |   | 1,836 |   | 5.17 | % |
| Total loans  (1,2)                                      |       | 1,283,418               |       | 16,063                  |       | 5.08 | % | 931,869 |   | 16,254 |   | 7.00 | % |
| Total average  earning assets (1)                       |       | 1,423,537               |       | 17,760                  |       | 5.06 | % | 1,077,847 |   | 18,106 |   | 6.74 | % |
| Noninterest  earning assets                             |       | 147,593                 |       |                    |       |   |   | 113,911 |   |   |   |   |   |
| Total average  assets                                   |       | $                       | 1,571,130  |                    |       |   |   |   | $ | 1,191,758 |   |   |   |   |   |
|                                                    |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| INTEREST BEARING  LIABILITIES                           |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| NOW and money  market                                   |       | $                       | 260,257    |                    | $          | 703 |   | 1.10 | % | $ | 198,273 |   | $ | 995 |   | 2.01 | % |
| Savings                                                 |       | 36,962                  |       | 24                      |       | 0.26 | % | 35,563 |   | 61 |   | 0.69 | % |
| Time  certificates                                      |       | 748,478                 |       | 6,334                   |       | 3.43 | % | 560,585 |   | 6,425 |   | 4.60 | % |
| Total interest  bearing deposits                        |       | 1,045,697               |       | 7,061                   |       | 2.74 | % | 794,421 |   | 7,481 |   | 3.78 | % |
| Repurchase  agreements sold                             |       | 54,763                  |       | 158                     |       | 1.17 | % | 47,651 |   | 365 |   | 3.07 | % |
| Borrowed funds                                          |       | 130,734                 |       | 467                     |       | 1.45 | % | 59,683 |   | 700 |   | 4.70 | % |
| Total interest  bearing liabilities                     |       | 1,231,194               |       | 7,686                   |       | 2.53 | % | 901,755 |   | 8,546 |   | 3.80 | % |
|                                                    |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| Noninterest  bearing deposits                           |       | 148,720                 |       |                    |       |   |   | 144,838 |   |   |   |   |   |
| Stockholders’  equity                              |       | 182,448                 |       |                    |       |   |   | 136,637 |   |   |   |   |   |
| Other  liabilities                                      |       | 8,768                   |       |                    |       |   |   | 8,528 |   |   |   |   |   |
| Total average  liabilities andstockholders’ equity |       | $                       | 1,571,130  |                    |       |   |   |   | $ | 1,191,758 |   |   |   |   |   |
| NET INTEREST  INCOME/YIELD  (3,4)                       |       |                    |       | $                       | 10,074     |   | 2.87 | % |   |   | $ | 9,560 |   | 3.56 | % |
|                                                    |       |                    |       |                    |       |   |   |   |   |   |   |   |   |
| INTEREST SPREAD  (5)                                    |       |                    |       |                    |       | 2.53 | % |   |   |   |   | 2.94 | % |

 

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| 1. |   | Interest income and yields related to securities and  loans exempt from Federal income taxes are stated on a fully tax equivalent basis,  assuming a Federal income tax rate of 34%, reduced by the nondeductible  portion of interest expense |
|----|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 2. |   | The loan average includes loans on which accrual of  interest has been discontinued.                                                                                                                                                           |
| 3. |   | Net interest income is the difference between income  from earning assets and interest expense.                                                                                                                                                |
| 4. |   | Net interest yield is net interest income divided by  total average earning assets.                                                                                                                                                            |
| 5. |   | Interest spread is the difference between the  average interest rate received on earning assets and the average rate paid on  interest bearing liabilities.                                                                                    |

 

Yadkin Valley FinancialCorporation

Form 10-Q QuarterlyReport March 31, 2009

 

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**Provisionsand Allowance for Loan Losses**

 

Adequacy of the allowance orreserve for loan losses of the Bank is a significant estimate that is based onmanagement’s assumptions regarding, among other factors, general and localeconomic conditions, which are difficult to predict and are beyond the Bank’scontrol.  In estimating these lossreserve levels, management also considers the financial conditions of specificborrowers and credit concentrations with specific borrowers, groups ofborrowers, and industries.

 

Theloan loss provision is determined by management’s assessment of the amount ofallowance for loan losses to absorb losses inherent in the loan portfolio dueto 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.

 

TheBank calculated an allowance for loan losses of $30.9 million at March 31,2009 as compared to $22.4 million at December 31, 2008 based on applicationof its model for the allowance calculation applied to the loan portfolio ateach balance sheet date.  The combinationof this increase in the estimated allowance and $2.0 million in charge-offsresulted in provision expense of $10.5 million for the quarter ended March 31,2009 as compared to $450,000 for the same period in the prior year. Theallowance model is applied to the loan portfolio quarterly to determine thespecific allowance balance for impaired loans and the general allowance balancefor unimpaired loans grouped by loan type. Out of the $30.9 million in total allowance for loans losses at March 31,2009, the specific allowance for impaired loans accounted for $6.6 million, upfrom $3.7 million at year end.  Theremaining general allowance, $24.3 million, was attributed to unimpaired loansand was up from $18.7 million at year end. This increase in the general allowance was driven primarily by increasedcharge-offs for the rolling eight quarters ended March 31, 2009 ascompared to the eight quarter period ending December 31, 2008 .  Other model factors that added to theallowance included rising trends in Bank’s past due and nonaccrual loans andrising unemployment rates.  Usually, weexpect the general allowance on unimpaired loans to increase when periods ofeconomic weakness are coupled with look-back periods of increasingcharged-offs.  Conversely, we expect thegeneral allowance to decrease as a percentage of loans when a stronger economyis combined with a decrease in rolling eight-quarter average of the Bank’scharged off loans.

 

Generally,all loans with outstanding balances of $100,000 or greater, that have beenidentified as impaired, are reviewed periodically in order to determine if aspecific allowance is required.  Chargeoff history, credit administration’s determination of loan impairment and riskgrades, and other internal and external qualitative factors are primaryconsiderations 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.

 

Managementuses several measures to assess and monitor the credit risks in the loanportfolio, including a loan grading system that begins upon loan originationand continues for the entire life of the loan. Upon loan origination, the Bank’s originating loan officer evaluates thequality of the loan and assigns one of eight risk levels.  The loan officer monitors the loan’sperformance and credit quality and makes changes to the risk grade asconditions warrant.  The Chief CreditOfficer coordinates the loan approval process for loans not involving the Boardby delegating authority to certain lenders with Board approval. The 

 

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Bank Loan Committee is comprised of senior bankmanagement and approves new loans and relationship exposures over certaindollar amounts. Officer loan approval limits are reviewed and approved by theBoard of Directors.  The Chief CreditOfficer is responsible for the credit policy which includes underwritingguidelines and procedures.  The ChiefCredit Officer is a voting member of the Bank Loan Committee.

 

Managementuses the information developed from the procedures above in evaluating andgrading the loan portfolio.  Thiscontinual grading process is used to monitor the credit quality of the loanportfolio and to assist management in determining the appropriate levels of theallowance for loan losses.

 

Asa part of the continual grading process, loans over $20,000 are assigned acredit risk grade based on their credit quality, which is subject to change asconditions warrant.  Any changes in riskassessments as determined by loan officers, credit administrators, regulatoryexaminers and management are also considered. Management considers certain loans graded “doubtful” or “loss” to beindividually impaired and may consider “substandard” loans individually impaireddepending on the borrower’s payment history. The Bank measures impairment based upon probable cash flows and thevalue of the collateral.  Impaired loansare identified and evaluated for specific reserves in a periodic analysis ofthe adequacy of the reserve.  Inestimating reserve levels, the Bank aggregates the remaining loans not deemedto be impaired and reviews the historical loss experience as well asenvironmental factors by type of loan as additional criteria to allocate theallowance.  The historical lossexperience factors applied to “watch list” and “substandard” loans that are notindividually impaired are adjusted for other factors that are not necessarilycaptured in the historical loss ratios. Internal environmental factors applied to non-impaired loan poolsinclude past-due and nonaccrual trends, risk grade migration trends and theassessment of underwriting and servicing. External environmental factors include interest rate trends,unemployment rate trends, and real estate loan concentrations.

 

Managementconsiders the allowance for loan losses adequate to cover the estimated lossesinherent in the Bank’s loan portfolio as of March 31, 2009. No assurancecan be given in this regard, however, especially considering the overallweakness in the commercial real estate market and the Bank’s market areas.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 economictrends greatly affect loan losses. The recent downturn in the real estatemarket has resulted in increased loan delinquencies, defaults and foreclosures,and we believe that these trends are likely to continue. In some cases, thisdownturn has resulted in a significant impairment to the value of ourcollateral and our ability to sell the collateral upon foreclosure. The realestate collateral in each case provides an alternate source of repayment in theevent of default by the borrower and may deteriorate in value during the timethe credit is extended. If real estate values continue to decline, it is alsomore likely that we would be required to increase our allowance for loan lossesand our net charge-offs which could have a material adverse effect on ourfinancial condition and results of operations. Assurances cannot be made either(1) that further charges to the allowance account will not be significantin relation to the normal activity or (2) that further evaluation of theloan portfolio based on prevailing conditions may not require sizable additionsto the allowance and charges to provision expense. Net loan charge offs(recoveries) were $2,000,967 or 0.69% (annualized) of average loans held forinvestment, for the three months ending March 31, 2009 compared to($14,574) or (0.01%) (annualized) of average loans held for investment, for thethree months ending March 31, 2008. The 

 

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Bank’sdelinquent loans and nonperforming loans remained lower than the peer groupaverages at March 31, 2009, while our net charge-offs as a percentage ofaverage loans were higher than the peer group for the first quarter.  The increase over last year was caused bysome weakening in the economy resulting in an uptick in charge-offs across allcategories of loans.

 

Asof March 31, 2009, the allowance for loan losses was $30.9 million or2.61% of gross loans held for investment. This allowance level compares with $22.4 million or 1.88% of loans heldfor investment at December 31, 2008 and $12.4 million or 1.38% at December 31,2007.

 

**NonperformingAssets**

 

Totalnon-performing assets increased from $17.7 million to $21.7 million and from1.16% to 1.33% of total assets as of December 31, 2008 and March 31,2009, respectively. Total foreclosed property increased from approximately $4.0million at December 31, 2008 to $4.3 million at March 31, 2009.  Added during the first quarter were three 1-4family homes valued at $260,500 and one land development property valued at$558,000.  Total nonaccrual loansincreased from $13.6 million at December 31, 2008 to $17.4 million at March 31,2009.  The increases in nonaccrual loans,impaired loans, and foreclosed property are the result of some economicsoftening in our markets during the past three months.   Each non-performing loan has been analyzedto determine what we believe is the amount needed to reserve in the allowancefor loan losses based on an assessment of the collateral value.  We have downgraded loans for which theprobability of collection is more uncertain and written down foreclosedproperty values where net realizable values have declined.

 

The largest amountof nonaccrual loans for one customer totaled $2.5 million for a commercial andindustrial loan relationship, for which $2.3 million was specifically assignedto the allowance.  These loans wereplaced in nonaccrual status because of the customer’s inability to pay,collateral deterioration and dismal future industry outlook.  Three other relationships in the residentialconstruction and land development category amounted to $2.6 million and $0.4million was specifically assigned to the allowance for these loans. Two of therelationships include loans that were past due 90 days or more, and the otherrelationship with a balance of $1.5 million was in current standing.

 

Allloans over 90 days are put on nonaccrual and stop accruing interest.  Inaddition, loans are placed in nonaccrual status if, based on currentinformation, circumstances, or events, it is probable that the Bank will notcollect the scheduled payments of principal and interest when due according tothe contractual terms of the loan agreement. Nonaccrual loan relationships withbalances of at least $100,000 will be considered impaired and evaluated forspecific allowances needed. Occasionally, accruing loan relationships may be determined to beimpaired under certain circumstances such as declines in collateral values thatindicate a probable loss if, at a later date, the borrower is unable to makepayments on time.  When a nonaccrual loanhas paid according to the schedule for at least six months and the customerdemonstrates the intent and ability to continue to pay in a timely manner, theBank will begin accruing interest, and it will no longer be consideredimpaired.

 

OnApril 17, 2009 the merger closed with American Community Bancshares Inc.and its subsidiary, American Community Bank. The Company’s second quarterperformance and results of operations will include American Community Bank adivision of Yadkin Valley Bank since April 17, 2009.  During the first quarter of 2009, AmericanCommunity’s nonperforming loans as a percentage of total loans were 2.53%,nonperforming assets as a percentage of total assets were 2.11%, annualized netcharge-off ratio was 0.31%, loan loss reserves as a percentage of total loanswere 2.56%, and reserves covered nonperforming loans by 101%.

 

**NoninterestIncome**

 

Noninterest incomeconsists of all revenues that are not included in interest and fee incomerelated to earning assets.  Totalnoninterest income increased approximately $1.3 million or 34.2% comparing thefirst quarters of 2009 and 2008. The quarterly fluctuations in the incomecategories that make up noninterest income are as follows:

 

·                  Service charges on deposit accounts increased $38,000or 3.78% due mainly to income from the Cardinal region of $76,000. As notedabove, Cardinal closed on March 31, 2008. Excluding charges from theCardinal region, services charges decreased $38,000 or 3.2%.   Aggregate not sufficient funds (“NSF”) feesincome increased $59,000. NSF fees excluding Cardinal increased $7,000.  Automated Teller Machine (“ATM”) fee incomedecreased $46,000, and without Cardinal the decrease was $49,000.  A change in service providers during 2008resulted in changes in billings and revenues, as a result both income andexpenses related to ATMs have decreased in the current quarter.

 

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·                  Other service fee income increased by approximately$201,000 or 23.3%, due primarily from an increase in commission income earnedfrom mortgage originations of $108,000; an increase in investment fees earnedby the brokerage division, Main Street Investment Services, Inc. of$26,000, and an increase in merchant fee income and credit card user fees of$67,000.

 

·                  Gain on sale of mortgage loans increased byapproximately $1.4 million or 80.5%. Total loans originated increased by $304.7million and total loans sold increased by $173.1 million. The adjustmentresulting from earlier implementation of SAB 109 accounted for a $453,145 increasein income as mortgage interest rate lock commitments increased from $246.2million at December 31, 2008 to $373.4 million at March 31, 2009. Asdiscussed in Note 6 to the financial statements, mortgage interest rate lockcommitments are under best efforts contracts to sell mortgages to agencies andother investors. The increase in loans sold and originated is due in part tothe expansion into the New England states as discussed earlier.

 

·                  Mortgage banking income decreased approximately$317,000 for the quarter due in part to the valuation adjustment to mortgageservicing rights (“MSR”) as the MSR was marked to fair value. The reduction infair value was due mainly to a steady decline in the average serviced mortgagebalances. In addition, there was a decrease in the servicing feesreceived.  Average year-to-date servicedmortgage loans fell from $203.2 million to $187.4 million from March 2008to March 2009.

 

·                  Income on investment in bank-owned life insurance (“BOLI”)decreased by $1,600 for the quarter as the interest earned on the investmentdecreased.

 

·                  Other income decreased by approximately $6,000 for thequarter mainly due to a decrease in dividend income received from the FHLB of$17,000, offset by decreases in losses incurred on the sale of OREO of $12,000.

 

**NoninterestExpense**

 

Total noninterestexpenses were $11.8 million for the first quarter of 2009, compared to $8.6million in the same period of 2008, an increase of $3.2 million, or 36.5%.  The following is a summary of thefluctuations for the quarter ended March 31, 2009 as compared to March 31,2008.

 

·                  Salaries and employee benefits expenses increased by$759,000 or 15.6%.  Cardinal’s expenses,included in that amount, were $519,000. The major components of the $759,000 increase are summarized asfollows.  Salaries and wages increased by$1.2 million, with $494,000 related to the Cardinal acquisition.  Salaries and benefit costs directly relatedto loan originations, which are expensed over the life of the loan, increased$683,000, directly offsetting the increase in wages. These increased costdeferrals were a product of increases in (1) loan volume and (2) costper loan (held for investment) that was deferred.  Accruals for the bonus incentive plandecreased $102,000 based on performance measures.  Other personnel expenses increased by$77,000, primarily for (1) post-retirement benefit accruals fromsplit-dollar policies and for (2) expenses associated with operating theCardinal division after its acquisition. In the aggregate, employee group insurance expense increased by$106,000, payroll taxes by $94,000, and 401(k) matching contributions by$25,000.  Most of the increases in thesecategories were associated with the addition of previous Cardinalemployees.  Commission expenses increasedby $68,000 as mortgage origination production at the Bank increased.

 

·                  Occupancy and equipment expenses increased by $351,000or 35.9%.  The increase attributable to the addition of the Cardinal branches was$290,000, with the remaining increase attributable to normal recurringincreases in costs and additional maintenance.

 

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·                  Printing and supplies increased by $47,000, or25.5%,with the Cardinal region contributing $9,000 of the increase. Suppliesfor the new offices opened or expanded after the first quarter of 2008 createdadditional expenses along with the normal increase in the price of supplies.

 

·                  Data processing expense increased $20,000 or18.2%.  Additional in-house processingdue to the acquisition of Cardinal’s accounts and increases in users accountfor the majority of the increase.

 

·                  Communication expense increased by $114,000 or54.7% with additional expenses contributed by the Cardinal region of $52,000,as compared to the first quarter of 2008.

 

·                  Advertising and marketingexpense increased $194,000 or 107% due to the implementation of a new loyaltyprogram in the second half of 2008.

 

·                  Amortization of the core deposit intangible recognizedwith the purchases of Main Street BankShares, Inc. in 2002, High CountryFinancial Corporation in 2004, and Cardinal State Bank in 2008 increased$38,000, or 20.2%, for the quarter due to the intangible acquired in thepurchase of Cardinal on March 31, 2008. The CDI amortization is intended to match the expected life of therelated deposits.  The amortizationrelated to the acquisition of Cardinal is $191,000 for the first twelve monthsand declines annually to $128,000 per year in the fourth year. Thereafter theexpense remains constant until the amortization is completed in the secondmonth of the tenth year.

 

·                  Other operating expenses increased approximately $1.4million or 92.1% with the Cardinal region contributing $157,000 of theincrease. The largest increases were in the following categories:  attorney fees due to additional servicesprovided (up $71,000); postage (up $77,000), write down of investment inSilverton Bank (up $152,000) conversion and merger costs (up $110,000) andother miscellaneous expenses (up $516,000) due to increased accruals forlawsuits. Decreases in this category include: ATM service fees (down $72,000) due to change in service provider asexplained in the noninterest income above and accounting expenses (down$89,000).

 

**Income Tax Expense**

 

Incometax (benefit) expense for the first quarter of 2009 was ($2,994,269) comparedto $1,279,445 in the first quarter of 2008, a decrease of 334.0%.  Theeffective tax rate for the first quarter of 2009 was (41.8%) compared to 30.5%in the same period of 2008.  The decreaseis attributable to the net loss incurred in the first quarter compared to thenet income earned in the first quarter of 2008.

 

**Item3.  Quantitative and QualitativeDisclosures About Market Risk**

 

Market risk is the riskof 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 primary objective ofasset and liability management is to manage interest rate risk and achievereasonable 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 

 

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Form 10-Q Quarterly Report March 31, 2009

 

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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.

 

**Item4.  Controls and Procedures**

 

Asof the end of the period covered by this report, we carried out an evealuation,under the supervision and with the participation of our management, includingour Chief Executive Officer and Chief Financial Officer, of the effectivenessof our disclosure controls and procedures as defined in Exchange Act Rule 13a-15(e).Our disclosure controls and procedures are designed to ensure that informationrequired to be disclosed by us in the reports that we file or submit under theExchange Act is (i) recorded, processed, summarized and reported withinthe time periods specified in the Securities and Exchange Commission’s rules andforms, and (ii) accumulated and communicated to our management, includingour Chief Executive Officer and Chief Financial Officer, as appropriate toallow timely decisions regarding required disclosures.

 

Basedupon that evaluation, the Chief Executive Officer and the Chief FinancialOfficer concluded that the Company’s disclosure controls and procedures werenot effective as of March 31, 2009, because of the existence of materialweaknesses in internal control over financial reporting.  A material weakness is a deficiency, or a combinationof deficiencies, in internal control over financial reporting, such that thereis a reasonable possibility that a material misstatement of the company’sannual or interim financial statements will not be prevented or detected on a timelybasis. As disclosed in Item 9A of our 2008 Annual Report on Form 10-K, wehave identified the following material weaknesses as of December 31, 2008:

 

*Control Environment*

 

A control environmentsets the tone of an organization, influences the control consciousness of itspeople, and is the foundation of all other components of internal control overfinancial reporting. The Company’s control environment did not sufficientlypromote effective internal control over financial reporting throughout the organization.

 

Specifically, thefollowing material weaknesses were identified in the Company’s controlenvironment at December 31, 2008:

 

· Although management has taken steps toremediate deficiencies identified in the Annual Report on Form 10-K forthe year ended December 31, 2007, management still needs to place greateremphasis on supporting effective application of policies, execution ofprocedures, and remediation of the deficiencies identified in previous periods.

 

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

 

These deficiencies in thecontrol environment contributed to the material weaknesses described below, andresulted in a reasonable possibility that a material error in the Company’sinterim or annual financial statements would not be prevented or detected.

 

*Accounting for SignjficantEstimates*

 

The Company did notmaintain sufficient internal controls over the preparation and review of itsallowance for loan losses model, including obtaining approval and documentedsupport 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, *Accounting by Creditorsfor Impairment of a Loan* (as amended), are made timely andaccurately, 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.

 

*Credit Administration*

 

While management hascommitted substantial additional resources to credit administration in 2008,the Company needs to make further improvement to its internal control overcertain areas involving credit administration, in order to reduce thepossibility of material errors in the estimation of the allowance for loanlosses. 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.

 

*Preparation of Financial Reports*

 

The Company did notmaintain sufficient internal controls over the preparation and review of itsfinancial reports for use in Company filings. In addition, the lack of adequatefinancial reporting resources prevented the Company from being able to properlyprepare financial reports on a timely basis in accordance with generallyaccepted accounting principles. As a result, material errors and inadequatedisclosures were made in the Company’s preliminary financial statements thatrequired adjustments prior to completion of the Form 10-K.

 

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Form 10-Q Quarterly Report March 31, 2009

 

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**RemediationPlan**

 

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.

 

·                  We continue toemphasize the importance of following existing procedures for underwriting,lien perfection, and documentation for new and existing loan.

 

·                  We continue toemphasize the importance of accurate risk grades on loans and will continue todevelop our Credit Risk Review with our Regional Credit Officer staff to ensureproper grading of loans at origination, as well as throughout the life of theloan.  Lenders and loan operationspersonnel have been informed of the requirement to assign risk grades to loansupon origination.  The importance ofperiodic review of risk grades has been emphasized to ensure that changes aremade as warranted due to the changes in the condition of the borrower, thecollateral, or general economic conditions. The controls over pre-and post-origination review of loans in loanoperations have been strengthened to ensure the accuracy and completeness ofloan data, including assignment of risk grades. Our Credit Risk Review staffwill perform periodic risk grades reviews on selected loans to ensure riskgrading accuracy.

 

·                  We will developa formal procedure for recommending and approving any changes to the allowancefor loan loss model to ensure that such changes are appropriate. Procedures andcontrols over accuracy and completeness of impaired loan date including the allowancesfor probable losses will be documented and implemented during the first quarterof 2009.

 

·                  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 expect toenhance financial reporting resources by adding personnel from the merger withAmerican Community Bancshares, Inc. In addition, a review of the staffingand technology resources that are needed to support accurate, complete, andtimely financial reporting according to generally accepted accountingprinciples is underway. A proposal for remediation is expected to be completedand submitted to the Audit 

 

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Form 10-Q Quarterly Report March 31, 2009

 

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Committee in June 2009. This proposal will include documentationof the process enhancements and personnel responsible for both preparation andreview. Implementation will begin immediately thereafter, and is expected to becompleted during the second quarter of 2009.

 

OurBoard of Directors is actively monitoring these remediation efforts and maydirect additional measures as deemed appropriate from time to time.  We cannot be certain how long it will take tofully implement the remediation plan, whether the remediation plan will beeffective to maintain adequate controls over our financial reporting process inthe future, or whether the remediation plan will be sufficient to address andeliminate the material weaknesses.

 

**Changes in Internal Control over Financial Reporting**

 

Theonly changes in our internal control over financial reporting that occurredduring the quarter ended March 31, 2009 that have materially affected, orare reasonably likely to materially affect, our internal control over financialreporting, are summarized above in the description of our material weaknessesin internal control over financial reporting, as well as the ongoingremediation efforts described above.

 

**Part II.Other Information**

 

**Item6.  Exhibits**

 
| **Exhibit #** | ** ** | **Description**                                                                                                                                                                                                                                              |
|--------------------|------------|--------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
| 3.1                |       | Amended and Restated Articles of Incorporation (incorporated by  reference to Exhibit 3(i) to the Current Report on Form 8K  dated July 1, 2006)                                                                                         |
|               |       |                                                                                                                                                                                                                                                         |
| 3.2                |       | Amended and Restated Bylaws (incorporated by reference to  Exhibit 3.1 of the Form 8-K filed by December 19, 2008)                                                                                                                            |
|               |       |                                                                                                                                                                                                                                                         |
| 3.3                |       | Articles of Amendment to the Company’s Restated Articles of  Incorporation establishing the terms of the Series T Preferred Stock  (incorporated by reference to the Company’s Form 8-K filed  January 20, 2009 as Exhibit 3.1 |
|               |       |                                                                                                                                                                                                                                                         |
| 31.1               |       | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                             |
|               |       |                                                                                                                                                                                                                                                         |
| 31.2               |       | Rule 13a-14(a)/15d-14(a) Certification                                                                                                                                                                                                             |
|               |       |                                                                                                                                                                                                                                                         |
| 32                 |       | Section 1350  Certification                                                                                                                                                                                                                             |

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

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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*              |                |
| *[Principal  Executive Officer]*                                       |                |
|                                                                   |                |
| BY:                                                                    | /s/ Edwin E. Laws   |   |
| *Edwin  E. Laws, Executive Vice President and Chief Financial Officer* |
| *[Principal Financial Officer]*                                        |                |
|                                                                   |                |
| May 12, 2009                                                      |                |

 

Yadkin Valley Financial Corporation

Form 10-Q Quarterly Report March 31, 2009

 

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