UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
(Mark One)
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2019
OR
☐
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number: 000-55117
VIRGINIA NATIONAL BANKSHARES CORPORATION
(Exact Name of Registrant as Specified in its Charter)
Virginia
46-2331578
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
404 People Place
Charlottesville, Virginia
22911
(Address of principal executive offices)
(Zip Code)
Registrant’s telephone number, including area code: (434) 817-8621
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading
Symbol(s)
Name of each exchange on which registered
Common Stock
VABK
OTCQX
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐
As of November 6, 2019, the registrant had 2,692,005 shares of common stock, $2.50 par value per share, outstanding.
TABLE OF CONTENTS
Part I. Financial Information
Item 1 Financial Statements
Page 3
Consolidated Balance Sheets (unaudited)
Consolidated Statements of Income (unaudited)
Page 4
Consolidated Statements of Comprehensive Income (unaudited)
Page 5
Consolidated Statements of Changes in Shareholders’ Equity (unaudited)
Page 6
Consolidated Statements of Cash Flows (unaudited)
Page 7
Notes to Consolidated Financial Statements (unaudited)
Page 8
Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations
Page 31
Application of Critical Accounting Policies and Estimates
Financial Condition
Page 32
Results of Operations
Page 38
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Page 46
Item 4 Controls and Procedures
Part II. Other Information
Item 1 Legal Proceedings
Item 1A Risk Factors
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds
Item 3 Defaults Upon Senior Securities
Item 4 Mine Safety Disclosures
Item 5 Other Information
Item 6 Exhibits
Page 47
Signatures
Page 48
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
September 30, 2019
December 31, 2018*
ASSETS
(Unaudited)
Cash and due from banks
$
13,870
11,741
Federal funds sold
13,985
7,133
Securities:
Available for sale, at fair value
77,930
61,392
Restricted securities, at cost
1,684
1,683
Total securities
79,614
63,075
Loans
522,104
537,190
Allowance for loan losses
(3,983
)
(4,891
Loans, net
518,121
532,299
Premises and equipment, net
6,354
7,042
Bank owned life insurance
16,301
16,790
Goodwill
372
Other intangible assets, net
424
477
Accrued interest receivable and other assets
11,749
5,871
Total assets
660,790
644,800
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits:
Noninterest-bearing
155,134
185,819
Interest-bearing
110,152
106,884
Money market and savings deposit accounts
190,568
171,299
Certificates of deposit and other time deposits
123,592
108,531
Total deposits
579,446
572,533
Accrued interest payable and other liabilities
5,790
1,525
Total liabilities
585,236
574,058
Commitments and contingent liabilities
Shareholders' equity:
Preferred stock, $2.50 par value, 2,000,000 shares authorized, no
shares outstanding
-
Common stock, $2.50 par value, 10,000,000 shares authorized;
2,692,005 (including 4,000 nonvested shares), and 2,543,452
issued and outstanding at September 30, 2019
and December 31, 2018, respectively
6,720
6,359
Capital surplus
32,160
27,013
Retained earnings
36,611
38,647
Accumulated other comprehensive income (loss)
63
(1,277
Total shareholders' equity
75,554
70,742
Total liabilities and shareholders' equity
*
Derived from audited Consolidated Financial Statements
See Notes to Consolidated Financial Statements
3
CONSOLIDATED STATEMENTS OF INCOME
For the three months ended
For the nine months ended
September 30, 2018
Interest and dividend income:
Loans, including fees
6,021
6,200
18,223
17,849
174
46
267
120
Investment securities:
Taxable
291
265
789
814
Tax exempt
64
86
221
257
Dividends
29
42
103
Total interest and dividend income
6,579
6,639
19,586
19,143
Interest expense:
Demand and savings deposits
531
277
1,375
773
Certificates and other time deposits
574
413
1,619
815
Repurchase agreements and other borrowings
—
158
89
376
Total interest expense
1,105
848
3,083
1,964
Net interest income
5,474
5,791
16,503
17,179
Provision for (recovery of) loan losses
(120
285
500
890
Net interest income after provision for (recovery of)
loan losses
5,594
5,506
16,003
16,289
Noninterest income:
Trust income
377
409
1,126
1,250
Advisory and brokerage income
159
144
451
426
Royalty income
5
17
13
569
Deposit account fees
192
210
565
693
Debit/credit card and ATM fees
191
176
537
567
Earnings/increase in value of bank owned life insurance
111
113
687
333
Fees on mortgage sales
43
73
129
155
Gains on sales of securities
7
71
Losses on sales of other assets
(33
Loan swap fee income
116
151
Other
126
128
356
331
Total noninterest income
1,327
1,270
4,086
4,291
Noninterest expense:
Salaries and employee benefits
2,268
2,049
6,800
6,022
Net occupancy
450
458
1,373
1,387
Equipment
85
316
374
Data processing
341
281
987
828
Settlement of claims
160
460
1,257
1,173
3,721
3,522
Total noninterest expense
4,561
4,089
13,657
12,133
Income before income taxes
2,360
2,687
6,432
8,447
Provision for income taxes
463
527
1,174
1,659
Net income
1,897
2,160
5,258
6,788
Net income per common share, basic *
0.71
0.81
1.96
2.55
Net income per common share, diluted *
0.80
2.52
Weighted average common shares outstanding, basic *
2,689,092
2,669,199
2,685,134
2,665,647
Weighted average common shares outstanding, diluted *
2,690,142
2,689,720
2,688,813
2,687,101
Share data has been retroactively adjusted to reflect the 5% stock dividend effective July 5, 2019.
4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Other comprehensive income (loss)
Unrealized gain (loss) on securities, net of tax
of $29 and $372 for the three and nine months
ended September 30, 2019; and net of tax of ($59)
and ($285) for the three and nine months ended
106
(222
1,396
(1,070
Reclassification adjustment for realized gains
on sales of securities, net of tax of ($1)
and ($15) for the three and nine months
ended September 30, 2019; and net of tax
of $0 and $0 for the three and nine months
ended September 30, 2018
(6
(56
Total other comprehensive income (loss)
100
1,340
Total comprehensive income
1,997
1,938
6,598
5,718
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE MONTHS ENDED MARCH 31, JUNE 30 AND SEPTEMBER 30, 2019 AND 2018
Accumulated
Common
Capital
Retained
Comprehensive
Stock
Surplus
Earnings
Income (Loss)
Total
Balance, December 31, 2017
6,027
22,038
37,923
(883
65,105
Stock options exercised
16
Stock option expense
1
Stock dividend distributable *
301
4,673
(4,974
Cash dividends declared ($0.19 per share)
(482
2,796
Other comprehensive loss
(743
Balance, March 31, 2018
6,344
26,840
35,263
(1,626
66,821
9
65
74
Cash dividends declared ($0.30 per share)
(763
1,832
(105
Balance, June 30, 2018
6,353
26,921
36,332
(1,731
67,875
6
44
50
24
Balance, September 30, 2018
26,989
37,729
(1,953
69,124
Balance, December 31, 2018
14
88
102
Stock grants
27
397
(767
1,246
Other comprehensive income
754
Balance, March 31, 2019
6,400
27,522
39,126
(523
72,525
23
Stock dividend distributable **
320
4,593
(4,913
(806
2,115
486
Balance, June 30, 2019
32,138
35,522
(37
74,343
Cash in lieu of fractional shares
(5
(808
Balance, September 30, 2019
* 5% stock dividend distributed effective April 13, 2018.
** 5% stock dividend distributed effective July 5, 2019.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses
Net amortization and accretion of securities
200
209
Net gains on sale of securities
(71
Net losses on sales of assets
33
Earnings on bank owned life insurance
(687
(333
Amortization of intangible assets
67
83
Depreciation and other amortization
812
849
41
Stock grants, unrestricted
Net change in:
(1,921
297
(58
38
Net cash provided by operating activities
4,598
8,895
CASH FLOWS FROM INVESTING ACTIVITIES:
Net (increase) decrease in restricted investments
(1
Purchases of available for sale securities
(40,608
Proceeds from maturities, calls and principal payments of available for sale securities
4,573
3,837
Proceeds from sales of available for sale securities
21,065
Net decrease (increase) in organic loans
9,654
(604
Net decrease in purchased loans
4,024
1,806
Cash payment for wealth management book of business
(50
(100
Proceeds from settlement of bank owned life insurance
1,176
Purchase of bank premises and equipment
(124
(731
Net cash (used in) provided by investing activities
(291
4,384
CASH FLOWS FROM FINANCING ACTIVITIES:
Net decrease in demand deposits, NOW accounts, and money market accounts
(8,148
(22,417
Net increase in certificates of deposit and other time deposits
15,061
17,957
Net decrease in repurchase agreements
(11,899
Net decrease in other short term borrowings
(5,000
Proceeds from stock options exercised
268
Cash payment for stock dividend fractional shares
Cash dividends paid
(2,336
(1,703
Net cash provided by (used in) financing activities
4,674
(22,794
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
8,981
(9,515
CASH AND CASH EQUIVALENTS:
Beginning of period
18,874
18,277
End of period
27,855
8,762
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest
2,963
1,800
Taxes
1,650
1,990
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Unrealized gain (loss) on available for sale securities
1,697
(1,355
Initial right-of-use assets obtained in exchange for new operating lease liabilities
4,279
VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1. Significant Accounting Policies
Basis of Presentation
The consolidated financial statements include the accounts of Virginia National Bankshares Corporation (the “Company”), and its subsidiaries Virginia National Bank (the “Bank”) and Masonry Capital Management, LLC (“Masonry Capital”), a registered investment adviser. Effective July 1, 2018, VNBTrust, National Association (“VNBTrust”), formerly a subsidiary of the Bank, was merged into Virginia National Bank, and the Bank continued to offer investment management, wealth advisory and trust and estate administration services under the name of VNB Wealth Management, also referred to herein as “VNB Wealth.” All references herein to VNB Wealth Management or VNB Wealth refer to VNBTrust for periods prior to July 1, 2018. In 2019, the services offered by VNB Wealth are provided by Masonry Capital or by the Bank under VNB Trust & Estate Services or VNB Investment Services. All significant intercompany balances and transactions have been eliminated in consolidation.
The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.
The preparation of financial statements in conformity with GAAP and the reporting guidelines prescribed by regulatory authorities requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses (including impaired loans), other-than-temporary impairment of securities, intangible assets, and fair value measurements. Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results that may be expected for the year ending December 31, 2019.
The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2018. If needed, certain previously reported amounts have been reclassified to conform to current period presentation. No such reclassifications were significant.
Recent Accounting Pronouncements
Financial Instruments – Credit Losses In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. At its October 16, 2019 meeting, FASB’s board affirmed its decision to delay the effective date of the ASU for smaller reporting companies, like the Company, until fiscal years beginning after December 15, 2022, and interim periods within those years. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. Early in 2017, the Company formed a cross-functional steering committee, including some members of senior management, to provide governance and guidance over the project plan. The steering committee meets regularly to address the compliance requirements, data requirements and sources, and analysis efforts that are required to adopt these new requirements. In addition to attending seminars and webinars on this topic with regulators and other experts, the committee is working closely with the Company’s vendor to gather additional loan data which is anticipated to be needed for this calculation and is attending training sessions on the software to be utilized to calculate the expected credit losses. The extent of the change is indeterminable at this time as it will be dependent upon portfolio composition and credit quality at the adoption date, as well as economic conditions and forecasts at that time. Upon adoption, the impact to the allowance for credit losses (currently allowance for loan losses) will have an offsetting one-time cumulative-effect adjustment to retained earnings.
8
Goodwill Impairment Testing In January 2017, the FASB issued ASU No. 2017-04, “Intangibles – Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment.” The amendments in this ASU simplify how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Step 2 measures a goodwill impairment loss by comparing the implied fair value of a reporting unit’s goodwill with the carrying amount of that goodwill. Instead, under the amendments in this ASU, an entity should perform its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. Public business entities that are SEC filers should adopt the amendments in this ASU for annual or interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company does not expect the adoption of ASU 2017-04 to have a material impact on its consolidated financial statements.
Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820): Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement.” The amendments modify the disclosure requirements in Topic 820 to add disclosures regarding changes in unrealized gains and losses, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the narrative description of measurement uncertainty. Certain disclosure requirements in Topic 820 are also removed or modified. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Certain of the amendments are to be applied prospectively while others are to be applied retrospectively. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-13 to have a material impact on its consolidated financial statements.
Financial Instruments – Credit Losses – Derivatives and Hedging In April 2019, the FASB issued ASU 2019-04, “Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments.” This ASU clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging, and recognition and measurement including improvements resulting from various Transition Resource Group meetings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-04 will have on its consolidated financial statements.
Financial Instruments – Credit Losses – Targeted Transition Relief In May 2019, the FASB issued ASU 2019-05, “Financial Instruments—Credit Losses (Topic 326): Targeted Transition Relief.” The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments, upon the adoption of Topic 326. The fair value option election does not apply to held-to-maturity debt securities. An entity that elects the fair value option should subsequently measure those instruments at fair value with changes in fair value flowing through earnings. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. The amendments should be applied on a modified-retrospective basis by means of a cumulative-effect adjustment to the opening balance of retained earnings balance in the balance sheet. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-05 will have on its consolidated financial statements.
Note 2. Securities
The amortized cost and fair values of securities available for sale as of September 30, 2019 and December 31, 2018 were as follows (dollars in thousands):
Amortized
Gross Unrealized
Fair
Cost
Gains
(Losses)
Value
U.S. Government agencies
12,000
(25
11,975
Mortgage-backed securities/CMOs
50,987
45
(261
50,771
Municipal bonds
14,863
336
(15
15,184
Total Securities Available for Sale
77,850
381
(301
December 31, 2018
19,500
(526
18,974
25,901
(839
25,063
17,608
12
(265
17,355
63,009
(1,630
As of September 30, 2019, there were $49.1 million, or 34 issues of individual securities, held in an unrealized loss position. These securities have an unrealized loss of $301 thousand and consisted of 27 mortgage-backed/CMOs, 4 municipal bonds, and 3 agency bonds.
The following table summarizes all securities with unrealized losses, segregated by length of time in a continuous unrealized loss position, at September 30, 2019, and December 31, 2018 (dollars in thousands):
Less than 12 Months
12 Months or more
Unrealized
Fair Value
Losses
7,488
(12
1,987
(13
9,475
Mortgage-backed/CMOs
26,816
(154
11,414
(107
38,230
502
1,350
35,152
(181
13,903
49,055
24,657
4,983
(34
10,722
(231
15,705
54,353
(1,596
59,336
The Company’s securities portfolio is primarily made up of fixed rate bonds, the prices of which move inversely with interest rates. Any unrealized losses are considered by management to be driven by increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline. At the end of any accounting period, the portfolio may have both unrealized gains and losses. Management does not believe any of the securities in an unrealized loss position are impaired due to credit quality. Accordingly, as of September 30, 2019, management believes the impairments detailed in the table above are temporary, and no impairment loss has been realized in the Company’s consolidated income statement.
An “other-than-temporary impairment” (“OTTI”) is considered to exist if either of the following conditions are met: it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or the Company does not expect to recover the security’s entire amortized cost basis (even if the Company does not intend to sell). In the event that a security would suffer impairment for a reason that was “other than temporary,” the Company would be expected to write down the security’s value to its new fair value, and the amount of the write down would be included in earnings as a realized loss. As of September 30, 2019, management has concluded that none of its investment securities have an OTTI based upon the information available. Additionally, management has the ability to hold any security with an unrealized loss until maturity or until such time as the value of the security has recovered from its unrealized loss position.
Securities having carrying values of $5.0 million at September 30, 2019 were pledged as collateral to secure public deposits. At December 31, 2018, securities having carrying values of $18.0 million were similarly pledged.
For the nine months ended September 30, 2019, proceeds from the sales of securities amounted to $21.1 million, and realized gain on these securities was $71 thousand. For the nine months ended September 30, 2018, there were no sales of securities.
Restricted securities are securities with limited marketability and consist of stock in the Federal Reserve Bank of Richmond (“FRB”), the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation (“CBBFC”), the holding company for Community Bankers Bank. These restricted securities, totaling $1.7 million as of both September 30, 2019 and December 31, 2018 are carried at cost.
10
Note 3. Loans
The composition of the loan portfolio by loan classification at September 30, 2019 and December 31, 2018 appears below (dollars in thousands).
September 30,
December 31,
2019
2018
Commercial
Commercial and industrial - organic
38,308
41,526
Commercial and industrial - government guaranteed
36,799
31,367
Commercial and industrial - syndicated
6,406
12,134
Total commercial and industrial
81,513
85,027
Real estate construction and land
Residential construction
1,476
1,552
Commercial construction
6,290
5,078
Land and land development
8,905
10,894
Total construction and land
16,671
17,524
Real estate mortgages
1-4 family residential, first lien, investment
42,625
40,311
1-4 family residential, first lien, owner occupied
17,916
16,775
1-4 family residential, junior lien
2,643
3,169
1-4 family residential - purchased
18,339
18,647
Home equity lines of credit, first lien
8,954
8,325
Home equity lines of credit, junior lien
10,055
10,912
Farm
10,397
Multifamily
26,968
27,328
Commercial owner occupied
94,169
93,800
Commercial non-owner occupied
116,522
123,214
Total real estate mortgage
347,086
352,878
Consumer
Consumer revolving credit
24,987
21,540
Consumer all other credit
4,329
5,530
Student loans purchased
47,518
54,691
Total consumer
76,834
81,761
Total loans
Less: Allowance for loan losses
Net loans
The balances in the table above include unamortized premiums and net deferred loan costs and fees. As of September 30, 2019, and December 31, 2018, unamortized premiums on loans purchased were $2.7 million and $2.5 million, respectively. Net deferred loan costs (fees) totaled $96 thousand and $129 thousand as of September 30, 2019 and December 31, 2018, respectively.
Accounting guidance requires certain disclosures about investments in impaired loans, the allowance for loan losses and interest income recognized on impaired loans. A loan is considered impaired when it is probable that the Company will be unable to collect all principal and interest amounts when due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition of the borrower, and current economic conditions.
Following is a breakdown by class of the loans classified as impaired loans as of September 30, 2019 and December 31, 2018. These loans are reported at their recorded investment, which is the carrying amount of the loan as reflected on the Company’s balance sheet, net of charge-offs and other amounts applied to reduce the net book balance. Average recorded investment in impaired loans is computed using an average of month-end balances for these loans for either the nine months ended September 30, 2019 or the twelve months ended December 31, 2018. Interest income recognized is for the nine months ended September 30, 2019 or the twelve months ended December 31, 2018. (Dollars below reported in thousands.)
11
Recorded
Investment
Unpaid
Principal
Balance
Associated
Allowance
Average
Income
Recognized
Impaired loans without a valuation allowance:
15
59
26
1-4 family residential mortgages, first lien, owner occupied
1-4 family residential mortgages, junior lien
123
Commercial non-owner occupied real estate
887
906
36
Total impaired loans without a valuation allowance
1,022
1,066
1,081
Impaired loans with a valuation allowance
1,603
1,599
Total impaired loans with a valuation allowance
Total impaired loans
2,625
2,669
2,680
114
32
90
37
82
127
248
923
947
51
1,164
1,267
1,322
66
1,602
2,766
2,869
2,709
152
Included in the impaired loans above are non-accrual loans. Generally, loans are placed on non-accrual when a loan is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. The recorded investment in non-accrual loans is shown below by class (dollars in thousands):
322
445
56
Total non-accrual loans
337
615
Additionally, Troubled Debt Restructurings (“TDRs”) are considered impaired loans. TDRs occur when the Company agrees to modify the original terms of a loan by granting a concession that it would not otherwise consider due to the deterioration in the financial condition of the borrower. These concessions are done in an attempt to improve the paying capacity of the borrower, and in some cases to avoid foreclosure, and are made with the intent to restore the loan to a
performing status once sufficient payment history can be demonstrated. These concessions could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions.
Based on regulatory guidance on Student Lending, the Company has classified 76 of its student loans purchased as TDRs for a total of $1.3 million as of September 30, 2019. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered restructurings. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Initially, all student loans were fully insured by a surety bond, and the Company did not expect to experience a loss on these loans. Based on the loss of insurance after July 27, 2018 due to the insolvency of the insurer, management has evaluated these loans individually for impairment and included any potential loss in the allowance for loan losses; interest continues to accrue on these TDRs during any deferment and forbearance periods.
The following provides a summary, by class, of TDRs that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing, and TDRs that have been placed in non-accrual status, which are considered to be nonperforming (dollars in thousands).
Troubled debt restructurings (TDRs)
No. of
Performing TDRs
76
1,281
1,157
Total performing TDRs
78
2,288
2,207
Nonperforming TDRs
19
Total nonperforming TDRs
Total TDRs
79
2,303
69
2,230
A summary of loans shown above that were modified under the terms of a TDR during the three and nine months ended September 30, 2019 and 2018 is shown below by class (dollars in thousands). The Post-Modification Recorded Balance reflects the period end balances, inclusive of any interest capitalized to principal, partial principal paydowns, and principal charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.
For three months ended
Number
of Loans
Pre-
Modification
Post-
Total loans modified during the period
133
135
During the nine months ended September 30, 2019, there were three loans modified as TDRs that subsequently defaulted which had been modified as TDRs during the twelve months prior to default. These student loans had a balance of $23 thousand prior to being charged off. There was one loan modified as a TDR that subsequently defaulted during the year ending December 31, 2018 which had been modified as a TDR during the twelve months prior to default. This student loan had a balance of $33 thousand prior to being charged off.
There were no loans secured by 1-4 family residential property that were in the process of foreclosure at either September 30, 2019 or December 31, 2018.
Note 4. Allowance for Loan Losses
The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s quarterly evaluation of the collectability of the loan portfolio, credit concentrations, historical loss experience, specific impaired loans, and economic conditions. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and loans analyzed on a pooled basis. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows.
For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type. Within these segments, the Company has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes.
Loan Classes by Segments
Commercial loan segment:
Real estate construction and land loan segment:
Real estate mortgage loan segment:
Consumer loan segment:
Management utilizes a loss migration model for determining the quantitative risk assigned to unimpaired loans in order to capture historical loss information at the loan level, track loss migration through risk grade deterioration, and increase efficiencies related to performing the calculations. The quantitative risk factor for each loan class primarily utilizes a migration analysis loss method based on loss history for the prior twelve quarters.
The migration analysis loss method is used for all loan classes except for the following:
•
Student loans purchased - On June 27, 2018, the Company was notified that ReliaMax Surety Company (“ReliaMax Surety”), the South Dakota insurance company which issued surety bonds for the student loan pools, was placed into liquidation due to insolvency. As such, the historical charge-off rate on this portfolio is determined
by using the Company’s own losses/charge-offs since July 1, 2018 together with prior insurance claim history. For reporting periods prior to June 30, 2018, the Company did not charge off student loans as the insurance covered the past due loans, but the Company did apply qualitative factors to calculate a reserve on these loans, net of the deposit reserve accounts held by the Company for this group of loans.
Commercial and industrial government guaranteed loans – These loans require no reserve as these are 100% guaranteed by either the Small Business Administration (“SBA”) or the United States Department of Agriculture (“USDA”).
Commercial and industrial syndicated loans - Prior to the quarter ended September 30, 2016, there was not an established loss history in the commercial and industrial syndicated loans. The S&P credit and recovery ratings on the credit facilities were utilized to calculate a three-year weighted average historical default rate. During the third quarter of 2016, there was a small loss in the commercial and industrial syndicated loans; therefore, the Company utilized a combination of the migration analysis loss method and the S&P credit and recovery ratings.
Under the migration analysis method, average loss rates are calculated at the risk grade and class levels by dividing the twelve-quarter average net charge-off amount by the twelve-quarter average loan balances. Qualitative factors are combined with these quantitative factors to arrive at the overall general allowances.
The Company’s internal creditworthiness grading system is based on experiences with similarly graded loans. The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. Additionally, external reviews of a portion of the credits are conducted on a semi-annual basis.
Loans that trend upward on the risk ratings scale, toward more positive risk ratings, generally exhibit lower risk factor characteristics. Conversely, loans that migrate toward more negative ratings generally will result in a higher risk factor being applied to those related loan balances.
Risk Ratings and Historical Loss Factor Assigned
Excellent
A 0% historical loss factor applied, as these loans are secured by cash or fully guaranteed by a U.S. government agency and represent a minimal risk. The Company has never experienced a loss within this category.
Good
A 0% historical loss factor applied, as these loans represent a low risk and are secured by marketable collateral within margin. In an abundance of caution, a nominal loss reserve is applied to these loans. The Company has never experienced a loss within this category.
Pass
A historical loss factor for loans rated “Pass” is applied to current balances of like-rated loans, pooled by class. Loans with the following risk ratings are pooled by class and considered together as “Pass”:
Satisfactory – modest risk loans where the borrower has strong and liquid financial statements and more than adequate cash flow
Average – average risk loans where the borrower has reasonable debt service capacity
Marginal – acceptable risk loans where the borrower has acceptable financial statements but is leveraged
Watch
These loans have an acceptable risk but require more attention than normal servicing. A historical loss factor for loans rated “Watch” is applied to current balances of like-rated loans pooled by class.
Special Mention
These potential problem loans are currently protected but are potentially weak. A historical loss factor for loans rated “Special Mention” is applied to current balances of like-rated loans pooled by class.
Substandard
These problem loans are inadequately protected by the sound worth and paying capacity of the borrower and/or the value of any collateral pledged. These loans may be considered impaired and evaluated on an individual basis. Otherwise, a historical loss factor for loans rated “Substandard” is applied to current balances of all other “Substandard” loans pooled by class.
Doubtful
Loans with this rating have significant deterioration in the sound worth and paying capacity of the borrower and/or the value of any collateral pledged, making collection or liquidation of the loan in full highly questionable. These loans would be considered impaired and evaluated on an individual basis.
The following represents the loan portfolio designated by the internal risk ratings assigned to each credit as of September 30, 2019 and December 31, 2018 (dollars in thousands). There were no loans rated “Doubtful” as of either period.
Special
Mention
Sub-
standard
TOTAL
2,244
18,810
16,564
30
Real estate construction
8,399
1-4 family residential, first lien investment
38,460
3,789
263
16,804
1,051
53
2,129
35
1-4 family residential, first lien - purchased
8,292
662
9,707
266
7,264
323
1,308
82,177
6,620
3,675
112,836
2,642
1,044
91
24,442
442
234
3,637
44,689
2,261
401
167
Total Loans
39,368
46,889
407,700
18,295
7,584
3,692
23,381
13,993
264
28
168
9,588
2,546
9,888
501
505
36,314
3,607
117
273
15,540
1,087
137
2,573
58
22
516
7,911
414
10,704
97
8,719
339
1,339
86,868
6,932
120,720
1,519
975
20,852
644
4,699
535
51,494
2,401
431
365
35,366
48,932
428,096
17,223
609
6,964
In addition, the adequacy of the Company’s allowance for loan losses is evaluated through reference to eight qualitative factors, listed below and ranked in order of importance:
1)
Changes in national and local economic conditions, including the condition of various market segments;
2)
Changes in the value of underlying collateral;
3)
Changes in volume of classified assets, measured as a percentage of capital;
4)
Changes in volume of delinquent loans;
5)
The existence and effect of any concentrations of credit and changes in the level of such concentrations;
6)
Changes in lending policies and procedures, including underwriting standards;
7)
Changes in the experience, ability and depth of lending management and staff; and
8)
Changes in the level of policy exceptions.
It has been the Company’s experience that the first five factors drive losses to a much greater extent than the last three factors; therefore, the first five factors are weighted more heavily. Qualitative factors are not assessed against loans rated “Excellent” or “Good,” as the Company has never experienced a loss within these categories.
For each segment and class of loans, management must exercise significant judgment to determine the estimation method that fits the credit risk characteristics of its various segments. Although this evaluation is inherently subjective, qualified management utilizes its significant knowledge and experience related to both the Company’s market and the history of the Company’s loan losses.
Impaired loans are individually evaluated and, if deemed appropriate, a specific allocation is made for these loans. In reviewing the loans classified as impaired loans totaling $2.6 million at September 30, 2019, specific valuation allowance was recognized after consideration was given for each borrowing as to the fair value of the collateral on the loan or the present value of expected future cash flows from the borrower. The $9 thousand in the allowance total shown below as individually evaluated for impairment was attributed to the impaired student loans that required an allowance as of September 30, 2019 due to the loss of the insurance on this portfolio as discussed previously.
A summary of the transactions in the Allowance for Loan Losses by loan portfolio segment for the nine months ended September 30, 2019 and the year ended December 31, 2018 appears below (dollars in thousands):
Allowance for Loan Losses Rollforward by Portfolio Segment
As of and for the period ended September 30, 2019
Real Estate
Construction
and Land
Mortgages
Allowance for Loan Losses:
Balance as of January 1, 2019
811
119
2,611
4,891
Charge-offs
(1,088
(1,570
Recoveries
104
162
(148
(38
699
Ending Balance
224
2,588
1,065
3,983
Ending Balance:
Individually evaluated for impairment
Collectively evaluated for impairment
1,056
3,974
Loans:
1,007
16,656
346,079
75,231
519,479
As of and for the period ended December 31, 2018
Balance as of January 1, 2018
885
206
2,730
222
4,043
(75
(1,022
(1,097
54
72
(53
(87
(121
2,134
1,873
1,260
4,801
1,132
17,492
351,746
80,159
534,424
18
As previously mentioned, one of the major factors that the Company uses in evaluating the adequacy of its allowance for loan losses is changes in the volume of delinquent loans. Management monitors payment activity on a regular basis. For all classes of loans, the Company considers the entire balance of the loan to be contractually delinquent if the minimum payment is not received by the due date. Interest and fees continue to accrue on past due loans until they are placed in nonaccrual or charged off.
The following tables show the aging of past due loans as of September 30, 2019 and December 31, 2018. (Dollars below reported in thousands.)
Past Due Aging as of
30-59
Days Past
Due
60-89
90 Days or
More Past
Total Past
Current
90 Days
Past Due
and Still
Accruing
Commercial loans
548
36,251
280
8,625
503
17,836
Consumer loans
4,306
657
411
521
1,589
45,929
199
924
1,498
2,943
519,161
172
41,304
30,819
10,878
954
17,693
75
123,139
599
603
4,927
850
2,067
52,624
332
1,934
1,234
1,317
4,485
532,705
895
Note 5. Net Income Per Share
On June 13, 2019, the Board of Directors approved a stock dividend of five percent (5%) on the outstanding shares of common stock of the Company (or .05 share for each share outstanding) which was issued on July 5, 2019 to all shareholders of record as of the close of business on June 26, 2019, referred to as the “5% Stock Dividend”. Shareholders received cash in lieu of any fractional shares that they otherwise would have been entitled to receive in connection with the stock dividend. The price paid for fractional shares was based on the volume-weighted average price of a share of common stock for the most recent three (3) days prior to the record date during which a trade of the Company’s stock occurred.
For the following table, share and per share data have been adjusted to reflect the 5% Stock Dividend. The table shows the weighted average number of shares used in computing net income per common share and the effect on the weighted average number of shares of diluted potential common stock for the three and nine months ended September 30, 2019 and 2018. Potential dilutive common stock equivalents have no effect on net income available to common shareholders. (Dollars below reported in thousands except per share data.)
Three Months Ended
Net
Weighted
Shares
Per
Share
Amount
Basic net income per share
Effect of dilutive stock options
1,050
20,521
(0.01
Diluted net income per share
20
Nine Months Ended
3,679
21,454
(0.03
For the nine months ended September 30, 2019, there were 66,301 option shares, as adjusted, considered anti-dilutive and excluded from this calculation. For the nine months ended September 30, 2018, there were 65,888 options shares, as adjusted, considered anti-dilutive and excluded from this calculation.
Note 6. Stock Incentive Plans
At the Annual Shareholders Meeting on May 21, 2014, shareholders approved the Virginia National Bankshares Corporation 2014 Stock Incentive Plan (“2014 Plan”). The 2014 Plan makes available up to 275,625 shares of the Company’s common stock, as adjusted by the 5% Stock Dividend and prior stock dividends, to be issued to plan participants. The 2014 Plan provides for granting of both incentive and nonqualified stock options, as well as restricted stock and other stock based awards. No new grants will be issued under the 2005 Plan as this plan has expired.
For all of the Company’s stock incentive plans (the “Plans”), the option price of incentive stock options will not be less than the fair value of the stock at the time an option is granted. Nonqualified stock options may be granted at prices established by the Board of Directors, including prices less than the fair value on the date of grant. Outstanding stock options generally expire ten years from the grant date. Stock options generally vest by the fourth or fifth anniversary of the date of the grant.
A summary of the shares issued and available under each of the Plans is shown below as of September 30, 2019. Share data and exercise price range per share have been adjusted to reflect the 5% Stock Dividend. Although the 2005 Plan has expired and no new grants will be issued under this plan, there were options issued before the plan expired that are still outstanding as shown below.
2005 Plan
2014 Plan
Aggregate shares issuable
253,575
275,625
Options or shares issued, net of forfeited and expired options
(59,870
(84,047
Cancelled due to Plan expiration
(193,705
Remaining available for grant
191,578
Grants issued and outstanding:
Total vested and unvested shares
1,379
67,404
Fully vested shares
13,171
Exercise price range
$13.69 to
$27.39 to
13.69
42.62
The Company accounts for all of its stock incentive plans under recognition and measurement accounting principles which require that the compensation cost relating to stock-based payment transactions be recognized in the financial statements. Stock-based compensation arrangements include stock options and restricted stock. All stock-based payments to employees are required to be valued at a fair value on the date of grant and expensed based on that fair value over the applicable vesting period. For the nine months ended September 30, 2019 and 2018, the Company recognized $71 thousand and $41 thousand, respectively, in compensation expense for stock options. As of September 30, 2019, there was $336 thousand in unrecognized compensation expense remaining to be recognized in future reporting periods through 2024.
21
Stock Options
Changes in the stock options outstanding related to all of the Plans are summarized below. Share and per share data have been adjusted to reflect the 5% Stock Dividend. (Dollars in thousands except per share data):
Number of Options
Weighted Average
Exercise Price
Aggregate
Intrinsic Value
Outstanding at January 1, 2019
86,594
36.21
Issued
420
36.19
Exercised
(5,976
(17.04
Expired
(12,255
(16.56
Outstanding at September 30, 2019
68,783
41.38
Options exercisable at September 30, 2019
14,550
39.52
The fair value of any stock option grant is estimated at the grant date using the Black-Scholes pricing model. Stock option grants for 420 and 65,888 shares, as adjusted for the 5% Stock Dividend, were issued during the nine months ended September 30, 2019 and 2018, respectively. The fair value of each option granted in 2019 was estimated based on the assumptions noted in the following table:
Expected volatility1
16.88
%
Expected dividends2
3.24
Expected term (in years)3
6.50
Risk-free rate4
1.83
Based on the monthly historical volatility of the Company’s stock price over the expected life of the options.
Calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant.
Based on the average of the contractual life and vesting period for the respective option.
Based upon an interpolated US Treasury yield curve interest rate that corresponds to the contractual life of the option, in effect at the time of the grant.
Summary information pertaining to options outstanding at September 30, 2019 is shown below. Share and per share data have been adjusted to reflect the 5% Stock Dividend.
Options Outstanding
Options Exercisable
Number of
Options
Outstanding
Weighted-
Remaining
Contractual Life
Exercise
Price
Exercisable
$10.65 to $20.00
3.5 Years
$20.01 to $30.00
1,103
7.6 Years
27.39
$30.01 to $40.00
8,820
8.7 Years
39.36
1,680
$40.01 to $42.62
57,481
11,491
8.6 Years
Stock Grants
On February 20, 2019, a total of 11,535 shares of stock, as adjusted for the 5% Stock Dividend, were granted to non-employee directors and certain members of executive management for services to be provided during the year ending December 31, 2019. Based on the market price on February 20, 2019 of $36.72, as adjusted for the 5% Stock Dividend, the total expense for these shares will be $424 thousand which is being expensed over the twelve months of 2019 as those services are provided. For the nine months ended September 30, 2019, $318 thousand of this total has been realized in stock grant expense. In addition, in September 2019, 4,000 restricted shares were granted to certain members of executive management, vesting over a four-year period. $3 thousand of expense related to such restricted shares was recognized during the third quarter of 2019. There were no stock grants issued during the year ended December 31, 2018.
Note 7. Fair Value Measurements
Determination of Fair Value
The Company follows ASC 820, “Fair Value Measurements and Disclosures,” to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This codification clarifies that the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.
The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.
Fair Value Hierarchy
In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.
Level 1 –
Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –
Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –
Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market
The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:
Securities available for sale
Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are
derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).
The following tables present the balances measured at fair value on a recurring basis as of September 30, 2019 and December 31, 2018 (dollars in thousands):
Fair Value Measurements at September 30, 2019 Using:
Quoted Prices
in Active
Markets for
Identical Assets
Significant
Observable
Inputs
Unobservable
Description
(Level 1)
(Level 2)
(Level 3)
Assets:
Total securities available for sale
Fair Value Measurements at December 31, 2018 Using:
Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write downs of individual assets. The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:
Other Real Estate Owned
Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Consolidated Statements of Income. As of September 30, 2019 and December 31, 2018, the Company had no OREO property.
Impaired Loans
Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either the observable market price of the loan or the fair value of the collateral, or using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data
(Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.
Impaired loans that are measured based on expected future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest are not recorded at fair value, and are therefore excluded from fair value disclosure requirements.
The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).
Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. The Company had impaired loans of $2.6 million as of September 30, 2019 and $2.8 million as of December 31, 2018. All impaired loans were measured based on expected future cash flows discounted at the loan’s effective interest rate.
ASC 825, “Financial Instruments,” requires disclosures about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.
The company uses the exit price notion in calculating the fair values of financial instruments not measured at fair value on a recurring basis.
The carrying values and estimated fair values of the Company's financial instruments as of September 30, 2019 and December 31, 2018 are as follows (dollars in thousands):
Carrying value
Level 1
Level 2
Level 3
Assets
Cash and cash equivalent
Available for sale securities
504,370
Accrued interest receivable
2,258
338
1,920
Liabilities
Demand deposits and
interest-bearing transaction, money market, and savings accounts
455,854
Certificates of deposit
124,278
Accrued interest payable
363
25
514,917
2,100
342
1,758
interest-bearing transaction and money market accounts
464,002
108,323
243
The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Consequently, the fair values of the Company’s financial instruments will fluctuate when interest rate levels change, and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk; however, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.
Note 8. Other Comprehensive Income
A component of the Company’s other comprehensive income, in addition to net income from operations, is the recognition of the unrealized gains and losses on available for sale securities, net of income taxes. Reclassifications of realized gains and losses on available for sale securities are reported in the income statement as “Gains (losses) on sales and calls of securities” with the corresponding income tax effect reflected as a component of income tax expense. Amounts reclassified out of accumulated other comprehensive income are presented below for the three and nine months ended September 30, 2019 and 2018 (dollars in thousands)
Realized gains on sales of securities
Tax effect
Realized gains, net of tax
Note 9. Segment Reporting
Beginning in 2019, the Company has four reportable segments. Each reportable segment is a strategic business unit that offers different products and services. They are managed separately, because each segment appeals to different markets and, accordingly, require different technology and marketing strategies. The accounting policies of the segments are the same as those described in the summary of significant accounting policies provided earlier in this report.
The four reportable segments are:
Bank - The commercial banking segment involves making loans and generating deposits from individuals, businesses and charitable organizations. Loan fee income, service charges from deposit accounts, and other non-interest-related fees, such as fees for debit cards and ATM usage and fees for treasury management services, generate additional income for the Bank segment.
VNB Investment Services - VNB Investment Services offers wealth management and investment advisory services. Revenue for this segment is generated primarily from investment advisory and financial planning fees, with a small and decreasing portion attributable to brokerage commissions.
VNB Trust & Estate Services – VNB Trust & Estate Services offers corporate trustee services, trust and estate administration, IRA administration and custody services. Revenue for this segment is generated from administration, service and custody fees, as well as management fees which are derived from Assets Under Management and incentive income which is based on the investment returns generated on performance-based Assets Under Management. Investment management services currently are offered through in-house and third-party managers. In addition, royalty income, in the form of fixed and incentive fees, from the sale of Swift Run Capital Management, LLC in 2013 is reported as income of VNB Trust & Estate Services. More information on royalty income and the related sale can be found under Summary of Significant Accounting Policies in Note 1 of the notes to consolidated financial statements, which is found in Item 8. Financial Statements and Supplementary Data, in the Company’s Form 10-K Report for December 31, 2018.
Masonry Capital - Masonry Capital offers investment management services for separately managed accounts and a private investment fund employing a value-based, catalyst-driven investment strategy. Revenue for this segment is generated from management fees which are derived from Assets Under Management and incentive income which is based on the investment returns generated on performance-based Assets Under Management.
A management fee for administrative and technology support services provided by the Bank is allocated to the other three lines of business previously combined under VNB Wealth. For both the nine months ended September 30, 2019 and 2018, management fees totaling $75 thousand were charged by the Bank and eliminated in consolidated totals.
Segment information for the three and nine months ended September 30, 2019 and 2018 is shown in the following tables (dollars in thousands).
Three months ended September 30, 2019
Bank
VNB
Services
VNB Trust &
Estate
Masonry
Consolidated
Noninterest income
786
314
68
Noninterest expense
3,905
308
193
2,475
(125
487
(26
1,988
(99
660,513
NR*
Nine months ended September 30, 2019
2,496
1,008
131
11,777
438
918
524
6,722
(393
(82
5,488
(311
Not reportable. Asset information is not reported for these segments, as the assets previously allocated to VNB Wealth are reported at the Bank level subsequent to the merger of VNBTrust into the Bank effective July 1, 2018; also, assets specifically allocated to these VNB Wealth lines of business are insignificant and are no longer provided to the chief operating decision maker.
Prior to January 1, 2019, Virginia National Bankshares Corporation had two reportable segments, the Bank and VNB Wealth.
Three months ended September 30, 2018
VNB Wealth
700
570
3,542
547
2,664
522
2,142
Nine months ended September 30, 2018
17,106
2,046
2,245
10,547
1,586
7,715
732
1,505
154
6,210
578
Note 10. Leases
On January 1, 2019, the Company adopted ASU No. 2016-02 “Leases (Topic 842)” and all subsequent ASUs that modified Topic 842. The Company elected the prospective application approach provided by ASU 2018-11 and did not adjust prior periods for ASC 842. The Company also elected certain practical expedients within the standard and consistent with such elections did not reassess whether any expired or existing contracts are or contain leases, did not reassess the lease classification for any expired or existing leases, and did not reassess any initial direct costs for existing leases. Lease payments for short-term leases are recognized as lease expense on a straight-line basis over the lease term. Payments for leases with terms longer than twelve months are included in the determination of the lease liability.
The implementation of the new standard resulted in recognition of a right-of-use asset and lease liability of $4.3 million at the date of adoption, which is related to the Company’s lease of premises used in operations. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.
Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease for a term similar to the length of the lease, including any probable renewal options available. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.
Each of the Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.
The following tables present information about the Company’s leases (dollars in thousands):
Lease liability
3,776
Right-of-use asset
3,754
Weighted average remaining lease term
5.28 years
Weighted average discount rate
2.84
Three Months Ended September 30,
Nine Months Ended September 30,
Lease Expense
Operating lease expense
203
611
Short-term lease expense
34
107
Total lease expense
237
225
718
676
Cash paid for amounts included in lease liabilities
196
589
Not reportable
A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows (dollars in thousands):
Undiscounted Cash Flow
Three months ending December 31, 2019
198
Twelve months ending December 31, 2020
799
Twelve months ending December 31, 2021
807
Twelve months ending December 31, 2022
767
Twelve months ending December 31, 2023
680
Twelve months ending December 31, 2024
469
Thereafter
354
Total undiscounted cash flows
4,074
Less: Discount
(298
Note 11. Commitments and Contingent Liabilities
During the third quarter of 2019, the Company settled two claims, both relating to the same matter, seeking to recover approximately $2.7 million. While management did not believe that the claims against the Company had merit and was prepared to vigorously defend such claims, the Company agreed to settle for $460 thousand. The Company accrued a contingent liability of $300 thousand related to these claims in the second quarter of 2019 and additional expense of $160 thousand in the third quarter of 2019. The settlement amount has been recognized as a loss and appears as Settlement of claims within noninterest expense in the Consolidated Statements of Income for the nine months ended September 30, 2019. There are no material pending claims against the Company at this time.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with Virginia National Bankshares Corporation’s consolidated financial statements, and notes thereto, for the year ended December 31, 2018, included in the Company’s 2018 Form 10-K. Per share data for September 30, 2019 and all preceding periods disclosed have been adjusted to reflect the 5% stock dividend effective July 5, 2019 (the “5% Stock Dividend”). Operating results for the three and nine months ended September 30, 2019 are not necessarily indicative of the results for the year ending December 31, 2019 or any future period.
FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS
Certain statements contained or incorporated by reference in this quarterly report on Form 10-Q, including but not limited to, statements concerning future results of operations or financial position, borrowing capacity and future liquidity, future investment results, future credit exposure, future loan losses and plans and objectives for future operations, change in laws and regulations applicable to the Company and its subsidiaries, adequacy of funding sources, actuarial expected benefit payment, valuation of foreclosed assets, regulatory requirements, economic environment and other statements contained herein regarding matters that are not historical facts, are “forward-looking statements” as defined in the Securities Exchange Act of 1934. Such statements are often characterized by use of qualified words such as “expect,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “will,” “should” or words of similar meaning or other statements concerning the opinions or judgment of the Company and its management about future events. These statements are not historical facts but instead are subject to numerous assumptions, risks and uncertainties, and represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. Any forward-looking statements made by the Company speak only as of the date on which such statements are made. Our actual results and financial position may differ materially from the anticipated results and financial condition indicated in or implied by these forward-looking statements. The Company makes no commitment to update or revise forward-looking statements in order to reflect new information or subsequent events or changes in expectations.
Factors that could cause our actual results to differ materially from those in the forward-looking statements include, but are not limited to, the following: inflation, interest rates, market and monetary fluctuations; geopolitical developments including acts of war and terrorism and their impact on economic conditions; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; changes, particularly declines, in economic and business conditions, both generally and in the local markets in which the Company operates; the financial condition of the Company’s borrowers; competitive pressures on loan and deposit pricing and demand; changes in technology and their impact on the marketing of new products and services and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services; the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance); changes in accounting principles, policies and guidelines; the ability to retain key personnel; incorrect assumptions regarding the allowance for loan losses; risks and assumptions associated with mergers and acquisitions and other expansion activities; other risks and uncertainties described from time to time in press releases and other public filings; and the Company’s performance in managing the risks involved in any of the foregoing. The foregoing list of important factors is not exclusive, and the Company will not update any forward-looking statement, whether written or oral, that may be made from time to time.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The accounting and reporting policies followed by the Company conform, in all material respects, to GAAP and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s consolidated financial statements. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.
31
For additional information regarding critical accounting policies, refer to the Application of Critical Accounting Policies and Critical Accounting Estimates section under Item 7 in the Company’s 2018 Form 10-K. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2018.
FINANCIAL CONDITION
The total assets of the Company as of September 30, 2019 were $660.8 million. This is a $16.0 million increase from the $644.8 million total assets reported at December 31, 2018 and a $34.0 million increase from the $626.8 million reported at September 30, 2018. A $16.5 million increase in securities since December 31, 2018 was the major reason for the increase in assets since year-end. In addition, fed funds sold increased $6.9 million, while right of use assets, included in accrued interest receivable and other assets, increased $3.8 million. These increases during the first nine months of 2019 were offset by a decrease in gross loans of $15.1 million.
The Company had overnight federal funds sold of $14.0 million as of September 30, 2019, compared to $7.1 million as of December 31, 2018 and $1.1 million as of September 30, 2018. Any excess funds are sold on a daily basis in the federal funds market. The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.
The Company continues to participate in the Federal Reserve Bank of Richmond’s Excess Balance Account (“EBA”). The EBA is a limited-purpose account at the Federal Reserve Bank for the maintenance of excess cash balances held by financial institutions. The EBA eliminates the potential of concentration risk that comes with depositing excess balances with one or multiple correspondent banks.
Securities
The Company’s investment securities portfolio as of September 30, 2019 totaled $79.6 million, an increase of $16.5 million compared with the $63.1 million reported at December 31, 2018 and an increase of $15.4 million from the $64.2 million reported at September 30, 2018. Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company. At September 30, 2019 and September 30, 2018, the investment securities holdings represented 12.0% and 10.2% of the Company’s total assets, respectively.
The Company’s investment securities portfolio included restricted securities totaling $1.7 million as of September 30, 2019 and December 31, 2018, compared to $2.1 million as of September 30, 2018. These securities represent stock in the Federal Reserve Bank of Richmond (“FRB-R”), the Federal Home Loan Bank of Atlanta (“FHLB-A”), and CBB Financial Corporation (“CBBFC”), the holding company for Community Bankers Bank. The level of FRB-R and FHLB-A stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Federal Reserve Bank Board of Governors and the Federal Home Loan Bank of Atlanta, respectively. The decrease compared to September 30, 2018 was due to the decrease in the Company’s short-term borrowing initiated with the FHLB-A from the third quarter of 2018 to the third quarter of 2019. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Bank with several benefits that are not available to non-shareholder correspondent banks. None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.
At September 30, 2019, the unrestricted securities portfolio totaled $77.9 million. The following table summarizes the Company's available for sale securities by type as of September 30, 2019, December 31, 2018, and September 30, 2018 (dollars in thousands):
Percent
of Total
15.4
30.9
18,718
30.1
65.1
40.8
25,877
41.7
19.5
28.3
17,505
28.2
Total available for sale securities
100.0
62,100
The securities are held primarily for earnings, liquidity, and asset/liability management purposes and are reviewed quarterly for possible other-than-temporary impairments. During this review, management analyzes the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to recovery or maturity. These factors are analyzed for each individual security.
Loan portfolio
A management objective is to grow loan balances while maintaining the asset quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of, and the designation of lending limits for, each borrower. The portfolio strategies include seeking industry, loan size, and loan type diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar. The predominant market area for loans includes Charlottesville, Albemarle County, Harrisonburg, Winchester, Frederick County, Richmond and areas in the Commonwealth of Virginia that are within a 75 mile radius of any Virginia National Bank office.
As of September 30, 2019, total loans were $522.1 million, compared to $537.2 million as of December 31, 2018 and $527.3 million at September 30, 2018. Loans as a percentage of total assets at September 30, 2019 were 79.0%, compared to 84.1% as of September 30, 2018. Loans as a percentage of deposits at September 30, 2019 were 90.1%, compared to 97.9% as of September 30, 2018.
The following table summarizes the Company's loan portfolio by type of loan as of September 30, 2019, December 31, 2018, and September 30, 2018 (dollars in thousands):
Commercial and industrial
15.6
15.8
89,579
17.0
Real estate - commercial
246,554
47.2
254,739
47.4
250,368
47.5
Real estate - residential mortgage
100,532
19.3
98,139
18.3
81,845
15.5
Real estate - construction
3.2
3.3
18,781
3.5
14.7
15.2
86,754
16.5
527,327
Loan balances declined $15.1 million, or 2.8%, since December 31, 2018 and declined $5.2 million, or 1.0%, from September 30, 2018. Since year-end, the loan fluctuation consisted of $24.8 million in new funding from organic loan growth and $7.1 million in purchases of government guaranteed loans, offset by the following: 1) $27.6 million in regular payoffs and normal amortization; 2) $10.6 million in payoffs from businesses sold or properties sold by borrowers; 3) $5.4 million reduction in syndicated loans due to a refinance of one and a sale of a second loan; 4) $1.8 million in a participation purchased being recalled by the primary lender; and 5) $1.6 million in charge-offs. The purchase of loans is considered a secondary strategy, which allows the Company to supplement organic loan growth. Purchased loans with balances outstanding of $109.0 million as of September 30, 2019 were comprised of:
Student loans totaling $47.5 million. The Company purchased two student loan packages in 2015 and a third in the fourth quarter of 2016. A fourth tranche was closed in December 2017 for an additional $15.0 million. Along with the purchase of these four packages of student loans, the Company purchased surety bonds to fully insure this portion of the Company’s consumer portfolio. However, during June 2018, ReliaMax Surety, the insurance company which issued the surety bonds, was placed into liquidation due to insolvency. Loss claims were filed for loans in default as of July 27, 2018, when the surety bonds were terminated, and the Company anticipates payment on approved claims. Student loans continue to be profitable for the Company.
Loans guaranteed by a U.S. government agency (“government guaranteed”) totaling $36.8 million, inclusive of premium. During the fourth quarter of 2016, the Company began augmenting the commercial and industrial portfolio with government guaranteed loans which represent the portion of loans that are 100% guaranteed by either the United States Department of Agriculture (“USDA”) or the Small Business Administration (“SBA”); the originating institution holds the unguaranteed portion of each loan and services it. These government guaranteed portion of loans are typically purchased at a premium. In the event of early prepayment, the Company may need to write off any unamortized premium.
Mortgage loans totaling $18.3 million. In the fourth quarter of 2018, the Company purchased a package of 1-to-4 family residential mortgages. Each of the 42 adjustable rate loans purchased were individually underwritten by the Company prior to the closing of the purchase. The collateral on these loans is located primarily on the East Coast of the United States.
Syndicated loans totaling $6.4 million. Syndicated loans represent shared national credits in leveraged lending transactions and are included in the commercial and industrial portfolio. The Company has developed policies to limit overall credit exposure to the syndicated market, as well as limits by industry and amount per borrower. Management proactively manages shared national credits and has opportunistically increased or decreased exposure over time. In the third quarter of 2019, we elected to sell our interest in a credit which significantly lowered our allowance for loan losses and allowed for a recovery of loan loss provision.
Management will continue to evaluate loan purchase transactions to strengthen earnings, diversity the loan portfolio and supplement organic loan growth.
Loan quality
Non-accrual loans totaled $337 thousand at September 30, 2019, compared to the $615 thousand and $566 thousand reported at December 31, 2018 and September 30, 2018, respectively. The Company had loans in its portfolio totaling $199 thousand, $895 thousand and $520 thousand, as of September 30, 2019, December 31, 2018 and September 30, 2018, respectively, that were ninety or more days past due, with all such loans still accruing interest as the Company deems them to be collectible.
At September 30, 2019, the Company had loans classified as impaired loans in the amount of $2.6 million, compared to $2.8 million at December 31, 2018 and September 30, 2018. Based on regulatory guidance on Student Lending, the Company has classified 76 of its purchased student loans as TDRs for a total of $1.3 million as of September 30, 2019. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered restructurings. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Management has evaluated these loans individually for impairment and included any potential loss in the allowance for loan loss; interest continues to accrue on these TDRs during any deferment and forbearance periods.
Management identifies potential problem loans through its periodic loan review process and considers potential problem loans as those loans classified as special mention, substandard, or doubtful.
In general, the Company determines the adequacy of its allowance for loan losses by considering the risk classification and delinquency status of loans and other factors. Management may also establish specific allowances for loans which management believes require allowances greater than those allocated according to their risk classification. The purpose of the allowance is to provide for losses inherent in the loan portfolio. Since risks to the loan portfolio include general economic trends as well as conditions affecting individual borrowers, the allowance is an estimate. The Company is committed to determining, on an ongoing basis, the adequacy of its allowance for loan losses. The Company applies historical loss rates to various pools of loans based on risk rating classifications. In addition, the adequacy of the allowance is further evaluated by applying estimates of loss that could be attributable to any one of the following eight qualitative factors:
As discussed earlier, the Company utilizes a loss migration model. Migration analysis uses loan level attributes to track the movement of loans through various risk classifications in order to estimate the percentage of losses likely in the portfolio.
The relationship of the allowance for loan losses to total loans appears below (dollars in thousands):
Loans held for investment at period-end
4,678
Allowance as a percent of period-end loans
0.76
0.91
0.89
The Allowance for Loan Losses as a percentage of assets declined from 0.91% at December 31, 2018 to 0.76% at September 30, 2019 due to: 1) the recapture of a portion of the loan loss provision previously allocated to a shared national credit that was sold during the third quarter of 2019; 2) the lower level of delinquencies within the student loan portfolio; and 3) the decreased balances in the organic loan portfolio.
Provisions for loan losses totaling $500 thousand and $890 thousand were recorded in the nine months ended September 30, 2019 and 2018, respectively. The following is a summary of the changes in the allowance for loan losses for the nine months ended September 30, 2019 and 2018 (dollars in thousands):
Allowance for loan losses, January 1
(316
61
Allowance for loan losses, September 30
For additional insight into management’s approach and methodology in estimating the allowance for loan losses, please refer to the earlier discussion of “Allowance for Loan Losses” in Note 4 of the Notes to Consolidated Financial Statements. In addition, Note 4 includes details regarding the rollforward of the allowance by loan portfolio segments. The rollforward tables indicate the activity for loans that are charged-off, amounts received from borrowers as recoveries of previously charged-off loan balances, and the allocation by loan portfolio segment of the provision made during the period. The events that can positively impact the amount of allowance in a given loan segment include any one or all of the following: the recovery of a previously charged-off loan balance; the decline in the amount of classified or delinquent loans in a loan segment from the previous period, which most commonly occurs when these loans are repaid or are foreclosed; or when there are improvements in the ratios used to estimate the probability of loan losses. Improvements to the ratios could include lower historical loss rates, improvements to any of the qualitative factors mentioned above, or reduced loss expectations for individually-classified loans.
Management reviews the Allowance for Loan Losses on a quarterly basis to ensure it is adequate based upon the calculated potential losses inherent in the portfolio. Management believes the allowance for loan losses was adequately provided for as of September 30, 2019.
Premises and equipment
The Company’s premises and equipment, net of depreciation, as of September 30, 2019 totaled $6.4 million compared to $7.0 million as of December 31, 2018 and $7.2 million as of September 30, 2018. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.
As of September 30, 2019, the Company and its subsidiaries occupied five full-service banking facilities in the cities of Charlottesville and Winchester, as well as the county of Albemarle in Virginia. The Company also operates a drive-through location at 301 East Water Street, Charlottesville, Virginia. The Bank closed its Orange, Virginia office effective
April 13, 2018; expanded messenger service continues to be available to the customers within and surrounding Orange, Virginia.
The multi-story office building at 404 People Place, Charlottesville, Virginia, located in Albemarle County, also serves as the Company’s corporate headquarters and operations center, as well as the principal offices of VNB Investment Services and Masonry Capital. VNB Trust & Estate Services is located at 112 Third Street, SE, Charlottesville, Virginia.
Both the Arlington Boulevard facility in Charlottesville and the People Place facility also contain office space that is currently under lease to tenants.
Leases
$3.8 million of the increase in each of Other Assets and Other Liabilities resulted from the Company’s implementation of ASU 2016-02 “Leases” (Topic 842). This implementation required the Company to recognize right-of-use assets, which are assets that represent the Company’s right to use, or control the use of, a specified asset for the lease term, offset by the lease liability, which is the Company’s obligation to make lease payments arising from a lease, measured on a discounted basis.
Deposits
Depository accounts represent the Company’s primary source of funds and are comprised of demand deposits, interest-bearing checking, money market, and savings accounts as well as time deposits. These deposits have been provided predominantly by individuals, businesses and charitable organizations in the Charlottesville/Albemarle and Winchester areas.
Total deposits as of September 30, 2019 were $579.4 million, an increase of $6.9 million compared to the balances of $572.5 million at December 31, 2018, and an increase of $40.9 million compared to the $538.5 million total as of September 30, 2018.
Deposit accounts
% of Total
No cost and low cost deposits:
Noninterest demand deposits
26.8
32.4
170,623
31.7
Interest checking accounts
19.0
18.7
87,418
16.2
32.9
29.9
153,271
28.5
Total noninterest and low cost deposit accounts
78.7
81.0
411,312
76.4
Time deposit accounts:
96,040
81,265
14.2
84,164
CDARS deposits
27,552
4.8
27,266
43,026
8.0
Total certificates of deposit and other time deposits
21.3
127,190
23.6
Total deposit account balances
538,502
Noninterest-bearing demand deposits on September 30, 2019 were $155.1 million, representing 26.8% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $300.7 million, and represented 51.9% of total deposits at September 30, 2019. Collectively, noninterest-bearing and interest-bearing transaction and money market accounts represented 78.7% of total deposit accounts at September 30, 2019. These account types are an excellent source of low-cost funding for the Company.
The Company implemented insured cash sweep (“ICS®”) deposit products during the third quarter of 2018. ICS® deposit balances of $18.8 million and $28.8 million are included in the interest checking accounts and the money market and
savings deposit accounts balances, respectively, in the table above, as of September 30, 2019. As of December 31, 2018, ICS® deposit balances of $15.8 million and $21.0 million are included in the interest checking accounts and the money market and savings deposit account balances, respectively.
The remaining 21.3% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $123.6 million at September 30, 2019. Included in this deposit total are Certificate of Deposit Account Registry Service CDs, known as CDARSTM, whereby depositors can obtain FDIC deposit insurance on account balances of up to $50 million. CDARSTM deposits totaled $27.6 million as of September 30, 2019, all of which were reciprocal balances for the Bank’s customers.
Borrowings
Short-term borrowings, consisting primarily of Federal Home Loan Bank (FHLB) advances and federal funds purchased, are additional sources of funds for the Company. The level of these borrowings is determined by various factors, including customer demand and the Company's ability to earn a favorable spread on the funds obtained.
Repurchase agreements, also referred to as securities sold under agreement to repurchase, were available to non-individual accountholders on an overnight term through the Company’s investment sweep product. Under the agreements to repurchase, invested funds were fully collateralized by security instruments that were pledged on behalf of customers utilizing this product. The repurchase agreement product was discontinued by the Company effective December 31, 2018, in connection with the roll-out of ICS® to customers, and therefore, there were no balances in repurchase agreements as of September 30, 2019 or December 31, 2018. Total balances in repurchase agreements as of September 30, 2018 were $7.2 million.
The Company has a collateral dependent line of credit with the FHLB of Atlanta. As of September 30, 2019 and December 31, 2018, the Company had no outstanding balances from FHLB advances. As of September 30, 2018, the Company had outstanding FHLB advances of $10.0 million.
Additional borrowing arrangements maintained by the Bank include formal federal funds lines with four major regional correspondent banks. The Company had no outstanding balances on these lines as of September 30, 2019, December 31, 2018 or September 30, 2018.
Shareholders' equity and regulatory capital ratios
The following table displays the changes in shareholders' equity for the Company from December 31, 2018 to September 30, 2019 (dollars in thousands):
Equity, December 31, 2018
Cash dividends declared
(2,381
Stock granted
427
Equity increase due to expensing of stock options
Equity, September 30, 2019
The Basel III regulatory capital rules effective January 1, 2015 required the Company and its subsidiaries to comply with the following new minimum capital ratios: (i) a new common equity Tier 1 capital ratio of 4.50% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the prior requirement of 4.00%); (iii) a total capital ratio of 8.00% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4.00% of total assets (unchanged from the prior requirement). These were the initial capital requirements.
Beginning January 1, 2016 a capital conservation buffer requirement began to be phased in over a four-year period, beginning at 0.625% of risk-weighted assets and increasing annually to 2.50% at January 1, 2019. Therefore, for the calendar year 2019, this 2.5% buffer effectively results in the minimum (i) common equity Tier 1 capital ratio of 7.00% of
risk-weighted assets; (ii) Tier 1 capital ratio of 8.50% of risk-weighted assets; and (iii) total capital ratio of 10.50% of risk-weighted assets. The minimum leverage ratio remains at 4.00%. For additional information regarding the new capital requirements, refer to the Supervision and Regulation section, under Item 1. Business, found in the Company’s Form 10-K Report for December 31, 2018.
Using the new capital requirements, the Company’s capital ratios remain well above the levels designated by bank regulators as "well capitalized" at September 30, 2019. Under the current risk-based capital guidelines of federal regulatory authorities, the Company’s common equity Tier 1 capital ratio and Tier 1 capital ratio are both at 14.76% of its risk-weighted assets and are in excess of the well-capitalized minimum capital requirements of 6.50% and 8.00%, respectively. Additionally, the Company has a total capital ratio of 15.55% of its risk-weighted assets and leverage ratio of 11.42% of total assets, which are both in excess of the well-capitalized minimum 10.00% and 5.00% levels, respectively, designated by bank regulators under “well capitalized” capital guidelines.
On September 17, 2019 the Federal Deposit Insurance Corporation finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations, referred to as, the community bank leverage ratio (CBLR) framework, as required by the Economic Growth, Regulatory Relief and Consumer Protection Act. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.
In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital.
The CBLR framework will be available for banks to use in their March 31, 2020 Call Report. The Company has decided not to opt into the CBLR framework.
RESULTS OF OPERATIONS
Non-GAAP presentations
The Company, in referring to its net income and net interest income, is referring to income computed in accordance with GAAP, unless otherwise noted. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations also refer to various calculations that are non-GAAP presentations. They include:
Fully taxable-equivalent (“FTE”) adjustments – Net interest margin and efficiency ratios are presented on an FTE basis, consistent with SEC guidance in Industry Guide 3 which states that tax exempt income may be calculated on a tax equivalent basis. This is a non-GAAP presentation. The FTE basis adjusts for the tax-exempt status of net interest income from certain investments using a federal tax rate of 21%, where applicable, to increase tax-exempt interest income to a taxable-equivalent basis.
Net interest margin – Net interest margin (FTE) is calculated as net interest income, computed on an FTE basis, expressed as a percentage of average earning assets. The Company believes this measure to be the preferred industry measurement of net interest margin and that it enhances comparability of net interest margin among peers in the industry.
Efficiency ratio – One of the ratios the Company monitors in its evaluation of operations is the efficiency ratio, which measures the cost to produce one dollar of revenue. The Company computes its efficiency ratio (FTE) by dividing noninterest expense by the sum of net interest income (FTE) and noninterest income. A lower ratio is an indicator of increased operational efficiency. This non-GAAP metric is used to assist investors in understanding how management assesses its ability to generate revenues from its non-funding-related expense base, as well as to align presentation of this financial measure with peers in the industry. The Company believes this measure to be the preferred industry measurement of operational efficiency, which is consistent with Federal Deposit Insurance Corporation (“FDIC”) studies.
Net interest income is discussed in Management’s Discussion and Analysis on a GAAP basis, unless noted as “FTE”; and the reconcilement below shows the fully taxable-equivalent adjustment to net interest income to aid the reader in understanding the computations of net interest margin and the efficiency ratio on a non-GAAP basis (dollars in thousands):
Reconcilement of Non-GAAP
Measures:
Fully taxable-equivalent adjustment
Net interest income (FTE)
5,491
5,814
16,561
17,248
Efficiency ratio
67.1
57.9
66.3
56.5
Impact of FTE adjustment
-0.2
Efficiency ratio (FTE)
66.9
57.7
66.1
56.3
Net interest margin
3.52
3.78
3.64
3.79
Fully tax-equivalent adjustment
0.02
Net interest margin (FTE)
3.54
3.80
3.66
3.81
Net income for the three months ended September 30, 2019 was $1.9 million, a 12.2% decrease compared to the $2.2 million reported for the three months ended September 30, 2018. Net income per diluted share was $0.71 for the quarter ended September 30, 2019 compared to $0.80 per diluted share for the same quarter in the prior year, each adjusted to reflect the 5% Stock Dividend. The decrease in net income for the third quarter of 2019, when compared to the same period of 2018, was driven by a $317 decrease in net interest income, a $219 thousand increase in salaries and employee benefits and a $160 thousand loss accrual, included in other noninterest expense, related to the settlement of pending and threatened legal proceedings, offset by $405 thousand positive fluctuation in the provision for (recovery of) loan losses. The loss accrual had the impact of reducing net income by $126 thousand and earnings per share, diluted and adjusted for the 5% Stock Dividend, by $0.05, in the third quarter of 2019. For more information regarding this accrual, please refer to the earlier discussion of Commitments and Contingent Liabilities in Note 11 of the Notes to Consolidated Financial Statements.
Net income for the first nine months of 2019 was $5.3 million, a 22.5% decrease compared to the $6.8 million reported for the nine months ended September 30, 2018. Net income per diluted share was $1.96 for the nine months ended September 30, 2019 compared to $2.52 per diluted share for the same quarter in the prior year, as adjusted to reflect the 5% Stock Dividend. The decrease in net income for the first nine months of 2019, when compared to the same period of 2018, was driven by a $778 thousand increase in salaries and employee benefits, a $676 thousand decrease in net interest income, a $556 thousand decrease in royalty income, and a $460 thousand loss accrual included in other noninterest expense, as noted above, offset by a $390 positive fluctuation in the provision for (recovery of) loan losses and $354 thousand increase in earnings from the proceeds of bank owned life insurance. The loss accrual had the impact of reducing net income by $363 thousand and earnings per share, diluted and adjusted for the 5% Stock Dividend, by $0.14, for the first nine months of 2019.
Net interest income (FTE) for the three months ended September 30, 2019 was $5.5 million, a 5.5% decrease compared to net interest income of $5.8 million for the three months ended September 30, 2018. Net interest income was negatively impacted by the decrease in average gross loan balances of $16.2 million, which reduced interest income by $189 thousand, as well as the effect of higher rates paid on deposit accounts, increasing interest expense by $354 thousand. The lower volume of the Company’s borrowing, reduced from an average of $38.7 million in the third quarter of 2018 to zero in the third quarter of 2019 positively impacted net interest income by $159 thousand on a period over period comparison.
39
Net interest income (FTE) for the first nine months of 2019 was $16.6 million, a 4.0% decrease compared to net interest income of $17.2 million for the first nine months of 2018. Net interest income was negatively impacted by the effect of higher rates paid on deposit balances, increasing interest expense by $1.3 million, offset by the effect of higher rates earned on loans, which positively impacted net interest income by $537 thousand. The lower volume of the Company’s borrowing positively impacted net interest income by $288 thousand for the third quarter of 2019 as compared to the third quarter of 2018.
Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets for the period. The level of interest rates, together with the volume and mix of earning assets and interest-bearing liabilities, impact net interest income (FTE) and net interest margin (FTE). The net interest margin (FTE) of 3.54% for the three months ended September 30, 2019 was twenty-six basis points lower than the 3.80% for the three months ended September 30, 2018. The net interest margin (FTE) of 3.66% for the nine months ended September 30, 2019 was fifteen basis points lower than the 3.81% for the nine months ended September 30, 2018. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP net interest margin.
Total interest income (FTE) for the three months ended September 30, 2019 was $67 thousand lower than the same period in the prior year. The decrease in average gross loans balances was the major contributor to the decreased interest income. This shift resulted in an earning asset yield, as computed on a tax-equivalent basis, of 4.25% on average earning asset balances of $616.3 million for the three months ended September 30, 2019. The earning asset yield, as computed on a tax-equivalent basis, was 4.35% on average earning asset balances of $607.7 million for the three months ended September 30, 2018.
Total interest income (FTE) for the nine months ended September 30, 2019 was $432 thousand higher than the same period in the prior year. The increased yield on loans was the major contributor to the increased interest income. This shift resulted in an earning asset yield, as computed on a tax-equivalent basis, of 4.34% on average earning asset balances of $605.4 million for the nine months ended September 30, 2019. The earning asset yield, as computed on a tax-equivalent basis, was 4.24% on average earning asset balances of $605.8 million for the nine months ended September 30, 2018.
Interest expense increased $257 thousand for the three months ended September 30, 2019 compared to the same period in the prior year. Interest expense increased $1.1 million for the nine months ended September 30, 2019 compared to the same period in the prior year. The primary reason for the increase in interest expense is the increased rates paid on deposits to be competitive in the market. The rate paid on interest-bearing deposits averaged 106 basis points in the three months ended September 30, 2019, compared to 75 basis points for the three months ended September 30, 2018. The rate paid on interest-bearing deposits averaged 101 basis points for the nine months ended September 30, 2019, compared to 59 basis points for the nine months ended September 30, 2018. Average balances of interest-bearing deposits also increased, from $363.2 million in the three months ended September 30, 2018 to $414.5 million in the three months ended September 30, 2019 and from $362.9 million for the nine months ended September 30, 2018 to $397.3 million for the nine months ended September 30, 2019. Average balances of borrowed funds decreased from $38.7 million in the three months ended September 30, 2018 to zero in the three months ended September 30, 2019, and decreased from $38.2 million for the nine months ended September 30, 2018 to $4.6 million for the nine months ended September 30, 2019, causing a decrease in interest expense on borrowed funds over both periods. A table showing the mix of no cost and low cost deposit accounts is shown under “Financial Condition - Deposits” earlier in this report.
The following tables detail the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest bearing liabilities, for the three and nine months ended September 30, 2019 and 2018. These tables also include a rate/volume analysis for these same periods (dollars in thousands).
40
Consolidated Average Balance Sheet and Analysis of Net Interest Income
Change in Interest Income/ Expense
Change Due to : 4
Yield/Cost
Volume
Rate
Increase/
Expense
(Decrease)
Interest Earning Assets:
Taxable Securities
58,210
2.20
52,765
2.33
(19
Tax Exempt Securities 1
9,505
81
3.41
13,195
108
3.27
(31
(27
Total Securities 1
67,715
2.37
65,960
416
516,637
4.62
532,876
6,201
(189
(180
Fed Funds Sold
31,956
2.16
8,904
2.05
125
Total Earning Assets
616,308
6,596
4.25
607,740
6,663
4.35
(64
(3
(67
Less: Allowance for Loan Losses
(4,827
(4,702
Total Non-Earning Assets
43,604
37,983
Total Assets
655,085
641,021
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking
107,179
57
0.21
85,754
0.06
Money Market and Savings Deposits
185,019
474
1.02
154,231
0.68
60
211
Time Deposits
122,274
1.86
123,213
1.33
164
161
Total Interest-Bearing Deposits
414,472
1.06
363,198
690
0.75
415
Repurchase agreements and other borrowed funds
0.00
38,698
1.62
(79
(158
Total Interest-Bearing Liabilities
401,896
0.84
(18
275
Non-Interest-Bearing Liabilities:
Demand deposits
160,491
169,720
Other liabilities
4,574
Total Liabilities
579,537
571,859
Shareholders' Equity
75,548
69,162
Total Liabilities & Shareholders' Equity
Net Interest Income (FTE)
5,815
(46
(278
(324
Interest Rate Spread 2
3.19
3.51
Interest Expense as a Percentage of Average Earning Assets
0.55
Net Interest Margin (FTE) 3
(1)
Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measured table within the Non-GAAP Presentations earlier in this section.
(2)
Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.
(3)
Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.
(4)
The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
52,798
874
2.21
53,890
917
2.27
(43
Tax Exempt Securities (1)
11,705
13,253
325
(8
(45
Total Securities (1)
64,503
1,154
2.39
67,143
1,242
2.47
(55
(88
524,723
4.64
529,556
17,850
4.51
(164
373
16,124
9,142
1.75
110
147
605,350
19,644
4.34
605,841
19,212
4.24
(109
541
432
(4,892
(4,247
42,602
37,912
643,060
639,506
103,708
153
0.20
90,781
0.05
171,971
1,222
0.95
155,548
736
0.63
84
402
121,646
1,620
1.78
116,573
0.93
768
805
397,325
2,995
1.01
362,902
1,588
0.59
1,280
1,407
4,580
2.57
38,249
1.31
(483
195
(288
401,905
1.03
401,151
0.65
(356
1,475
1,119
164,093
170,135
3,443
569,441
571,699
73,619
67,807
247
(934
Interest Rate Spread (2)
3.31
3.59
0.43
A recovery of loan losses of $120 thousand was recognized in the third quarter of 2019 due primarily to the recapture of a portion of the loan loss provision previously allocated to a shared national credit that was sold during the quarter, the lower level of delinquencies within the student loan portfolio, along with the decreased balances in the organic loan portfolio. A provision of $285 thousand was recognized in the third quarter of 2018. A provision for loan losses of $500 thousand was recorded in the first nine months of 2019, compared to $890 thousand recorded for the first nine months of 2018. The allowance for loan losses as a percentage of total loans at September 30, 2019 was 0.76%, compared to 0.91% as of December 31, 2018 and 0.89% as of September 30, 2018. Further discussion of management’s assessment of the allowance for loan losses is provided earlier in the report and in Note 4 – Allowance for Loan Losses, found in the Notes to the Consolidated Financial Statements. In management’s opinion, the allowance was adequately provided for at September 30, 2019.
The components of noninterest income for the three months ended September 30, 2019 and 2018 are shown below (dollars in thousands):
Variance
(32
-7.8
10.4
-70.6
-8.6
8.5
(2
-1.8
(30
-41.1
N/A
-1.6
4.5
Noninterest income for the quarter ended September 30, 2019 of $1.3 million was $57 thousand or 4.5% higher than the amount recorded for the quarter ended September 30, 2018. This increase was largely due to the collection of loan swap income during the current quarter of $116 thousand.
The components of noninterest income for the nine months ended September 30, 2019 and 2018 are shown below (dollars in thousands):
Non interest income:
-9.9
5.9
(556
-97.7
(128
-18.5
-5.3
106.3
-16.8
Losses on sales of assets
7.6
(205
-4.8
Noninterest income for the nine months ended September 30, 2019 of $4.1 million was $205 thousand or 4.8% lower than the amount recorded for the nine months ended September 30, 2018. This decrease was predominantly due to the lack of performance fee royalty income in the first quarter of 2019, compared to $518 thousand in the first quarter of 2018. Royalty income is collected periodically from SRCM Holdings, LLC, as described in Note 1 – Summary of Significant Accounting Policies, found in the Notes to the Consolidated Financial Statements within the Company’s Form 10-K for the year ended December 31, 2018. The decrease was offset by the increased earnings from bank owned life insurance of $354 thousand and increased loan swap fee income of $151 thousand.
The components of noninterest expense for the three months ended September 30, 2019 and 2018 are shown below (dollars in thousands):
219
10.7
-1.7
-33.6
ATM, debit and credit card
48
6.3
Bank franchise tax
19.8
Computer software
33.3
21.4
FDIC deposit insurance assessment
-86.4
Loan expenses
-6.9
Marketing, advertising and promotion
170
19.4
Professional fees
213
227
(14
-6.2
422
378
11.6
472
11.5
Noninterest expense for the third quarter of 2019 of $4.6 million was $472 thousand higher than the third quarter of 2018. Salaries and employee benefits increased $219 thousand due to increased staffing for our new Richmond market and cyber and network security professionals, as well as the quarterly expense of stock grants for executive management
issued in February 2019. The Company incurred an expense of $160 thousand in the third quarter of 2019, related to settlement of pending and threatened litigation. For more information regarding this accrual, please refer to the earlier discussion of Commitments and Contingent Liabilities in Note 11 of the Notes to Consolidated Financial Statements. FDIC deposit insurance assessment expense decreased as a result of the Deposit Insurance Fund restoration plan, which provides automatic small bank credits to reduce small banks’ regular deposit insurance assessments up to the full amount of their assessments or the full amount of their credits, whichever is less. The reserve ratio reached the required limits effective June 30, 2019. Management continues to evaluate expenses for potential containments and reductions that would have a positive impact on net income on an ongoing basis.
The components of noninterest expense for the nine months ended September 30, 2019 and 2018 are shown below (dollars in thousands):
778
12.9
-1.0
-15.5
142
163
(21
-12.9
455
375
80
391
307
27.4
19.2
(118
-76.6
208
228
(20
-8.8
592
520
13.8
620
654
-5.2
1,277
1,121
156
13.9
1,524
12.6
Noninterest expense for the first nine months of 2019 of $13.7 million was $1.5 million higher than the first nine months of 2018. Salaries and employee benefits increased $778 thousand due to increased staffing for our new Richmond market and cyber and network security professionals, as well as the expense of stock grants for executive management issued in February 2019. The Company incurred an expense of $460 thousand in the first nine months of 2019, related to settlement of pending and threatened litigation. FDIC deposit insurance assessment expense decreased $118 thousand from the nine months ended September 30, 2018 to the nine months ended September 30, 2019 for the reason as noted above.
The efficiency ratio (FTE) of 66.9% for the third quarter of 2019 was less favorable than the 57.7% for the same quarter of 2018, due to the increase in noninterest expense. Noninterest expense will continue to increase as the Company positions itself for growth and enters into new markets. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.
Provision for Income Taxes
The Company benefited from the Tax Cuts and Jobs Act (“Tax Act”) enacted on December 22, 2017, which permanently lowered the corporate income tax rate to 21% effective January 1, 2018, amongst other significant changes to the U.S. tax law. For the three months ended September 30, 2019 and September 30, 2018, the Company provided $463 thousand and $527 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 19.6% for each period. For the nine months ended September 30, 2019 and September 30, 2018, the Company provided $1.2 million and $1.7 million for Federal income taxes, respectively, resulting in an effective income tax rate of 18.3% and 19.6%, respectively. The effective income tax rates differed from the U.S. statutory rate of 21% primarily due to the effect of tax-exempt income from life insurance policies and municipal bonds.
OTHER SIGNIFICANT EVENTS
None
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not required
ITEM 4. CONTROLS AND PROCEDURES
The Company maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in Securities and Exchange Commission’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.
In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.
Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective at the reasonable assurance level. There was no change in the internal control over financial reporting that occurred during the quarter ended September 30, 2019 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS.
ITEM 1A. RISK FACTORS.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES.
ITEM 4. MINE SAFETY DISCLOSURES.
Not applicable
ITEM 5. OTHER INFORMATION.
(a)
Required 8-K disclosures.
(b)
Changes in procedures for director nominations by security holders.
ITEM 6. EXHIBITS.
Exhibit
Description of Exhibit
2.0
Reorganization Agreement and Plan of Share Exchange, dated as of March 6, 2013, between Virginia National Bank and Virginia National Bankshares Corporation (incorporated by reference to Virginia National Bankshares Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013).
3.1
Articles of Incorporation of Virginia National Bankshares Corporation, as amended and restated (incorporated by reference to Virginia National Bankshares Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013).
Bylaws of Virginia National Bankshares Corporation (incorporated by reference to Virginia National Bankshares Corporation’s Current Report on Form 8-K, filed with the Securities and Exchange Commission on December 18, 2013).
31.1
302 Certification of Principal Executive Officer
31.2
302 Certification of Principal Financial Officer
32.1
906 Certification
101.0
Interactive data files pursuant to Rule 405 of Regulation S-T: (i) the Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, (ii) the Consolidated Statements of Income for the three and nine months ended September 30, 2019 and September 30, 2018, (iii) the Consolidated Statements of Comprehensive Income for the three and nine months ended September 30, 2019 and September 30, 2018, (iv) the Consolidated Statements of Changes in Shareholders’ Equity for the quarterly periods within 2019 and 2018, (v) the Consolidated Statements of Cash Flows for the nine months ended September 30, 2019 and September 30, 2018 and (vi) the Notes to the Consolidated Financial Statements (furnished herewith).
47
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
(Registrant)
By:
/s/ Glenn W. Rust
Glenn W. Rust
President and Chief Executive Officer
Date:
November 8, 2019
/s/ Tara Y. Harrison
Tara Y. Harrison
Executive Vice President and Chief Financial Officer