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, 2020
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
None
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, a 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 5, 2020, the registrant had 2,714,273 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 35
Application of Critical Accounting Policies and Estimates
Page 37
Financial Condition
Results of Operations
Page 44
Item 3 Quantitative and Qualitative Disclosures About Market Risk
Page 52
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 53
Signatures
Page 54
2
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
September 30, 2020
December 31, 2019*
ASSETS
(Unaudited)
Cash and due from banks
$
11,399
14,908
Federal funds sold
273
4,177
Securities:
Available for sale, at fair value
141,245
114,041
Restricted securities, at cost
3,436
1,683
Total securities
144,681
115,724
Loans
636,935
539,533
Allowance for loan losses
(5,334
)
(4,209
Loans, net
631,601
535,324
Premises and equipment, net
5,444
6,145
Bank owned life insurance
16,739
16,412
Goodwill
372
Other intangible assets, net
357
408
Accrued interest receivable and other assets
10,092
9,157
Total assets
820,958
702,627
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits:
Noninterest-bearing
190,204
166,975
Interest-bearing
135,569
122,994
Money market and savings deposit accounts
270,653
221,964
Certificates of deposit and other time deposits
98,095
109,278
Total deposits
694,521
621,211
Advances from the FHLB
40,000
—
Accrued interest payable and other liabilities
5,980
5,309
Total liabilities
740,501
626,520
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;
2,714,273 (including 25,268 nonvested) shares issued
and outstanding as of September 30, 2020 and 2,692,005
(including 4,000 nonvested) shares issued and outstanding
as of December 31, 2019
6,722
6,720
Capital surplus
32,377
32,195
Retained earnings
40,158
37,235
Accumulated other comprehensive income (loss)
1,200
(43
Total shareholders' equity
80,457
76,107
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, 2019
Interest and dividend income:
Loans, including fees
6,175
6,021
18,202
18,223
174
98
267
Investment securities:
Taxable
412
291
1,150
789
Tax exempt
159
64
326
221
Dividends
22
29
70
86
Total interest and dividend income
6,771
6,579
19,846
19,586
Interest expense:
Demand and savings deposits
383
531
1,468
1,375
Certificates and other time deposits
306
574
1,166
1,619
Repurchase agreements and other borrowings
35
89
Total interest expense
724
1,105
2,669
3,083
Net interest income
6,047
5,474
17,177
16,503
Provision for (recovery of) loan losses
224
(120
1,367
500
Net interest income after provision for (recovery of) loan losses
5,823
5,594
15,810
16,003
Noninterest income:
Wealth management fees
263
377
801
1,126
Advisory and brokerage income
175
516
451
Royalty income
16
5
87
13
Deposit account fees
162
192
484
565
Debit/credit card and ATM fees
144
191
435
537
Earnings/increase in value of bank owned life insurance
111
327
687
Fees on mortgage sales
43
77
129
Gains on sales of securities
91
7
734
71
Loan swap fee income
344
116
977
151
Other
119
126
282
356
Total noninterest income
1,425
1,327
4,720
4,086
Noninterest expense:
Salaries and employee benefits
2,322
2,268
7,004
6,800
Net occupancy
501
450
1,405
1,373
Equipment
134
85
401
316
Data processing
302
341
968
987
Merger expenses
549
Settlement of claims
160
460
1,127
1,257
3,555
3,721
Total noninterest expense
4,935
4,561
13,882
13,657
Income before income taxes
2,313
2,360
6,648
6,432
Provision for income taxes
443
463
1,286
1,174
Net income
1,870
1,897
5,362
5,258
Net income per common share, basic
0.69
0.71
1.98
1.96
Net income per common share, diluted
4
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Dollars in thousands)
Other comprehensive income
Unrealized gain on securities, net of tax
of $81 and $484 for the three and nine months
ended September 30, 2020; and net of tax of
$29 and $372 for the three and nine months
ended September 30, 2019
309
106
1,823
1,396
Reclassification adjustment for realized gains
on sales of securities, net of tax of ($19) and
($154) for the three and nine months ended
September 30, 2020; and net of tax of ($1)
and ($15) for the three and nine months
(72
(6
(580
(56
Total other comprehensive income
237
100
1,243
1,340
Total comprehensive income
2,107
1,997
6,605
6,598
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
FOR THE THREE AND NINE MONTHS ENDED SEPTEMBER 30, 2020 AND 2019
Accumulated
Common
Capital
Retained
Comprehensive
Stock
Surplus
Earnings
Income (Loss)
Total
Balance, December 31, 2018
6,359
27,013
38,647
(1,277
70,742
Stock options exercised
14
88
102
Stock option expense
24
Unrestricted stock grants
27
397
424
Cash dividends declared ($0.30 per share)
(767
1,246
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
Stock grants
Cash in lieu of fractional shares
(5
(808
Balance, September 30, 2019
32,160
36,611
63
75,554
Balance, December 31, 2019
Restricted stock grant expense
15
(811
1,404
Other comprehensive loss
(448
Balance, March 31, 2020
32,234
37,828
(491
76,291
34
39
(814
2,088
1,454
Balance, June 30, 2020
32,307
39,102
963
79,092
30
42
Vested stock grants
(2
Balance, September 30, 2020
* Common stock and capital surplus as of June 30, 2019 includes the 5% stock dividend distributable effective July 5, 2019.
6
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
471
200
Net gains on sale of securities
(734
(71
Earnings on bank owned life insurance
(327
(687
Amortization of intangible assets
74
67
Depreciation and other amortization
1,395
1,338
Stock grants, unrestricted
Stock grant expense, restricted
96
Net change in:
(1,117
(2,447
(19
(58
Net cash provided by operating activities
6,656
4,598
CASH FLOWS FROM INVESTING ACTIVITIES:
Net increase in restricted investments
(1,753
(1
Purchases of available for sale securities
(122,372
(40,608
Proceeds from maturities, calls and principal payments of available for sale securities
34,821
4,573
Proceeds from sales of available for sale securities
62,184
21,065
Net decrease (increase) in organic loans
(117,081
9,654
Net decrease in purchased loans
19,437
4,024
Cash payment for wealth management book of business
(50
Proceeds from settlement of bank owned life insurance
1,176
Purchase of bank premises and equipment
(132
(124
Net cash used in investing activities
(124,946
(291
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase (decrease) in demand deposits, NOW accounts, and money market accounts
84,493
(8,148
Net increase (decrease) in certificates of deposit and other time deposits
(11,183
15,061
Net increase in borrowings
Proceeds from stock options exercised
Cash payment for stock dividend fractional shares
Cash dividends paid
(2,433
(2,336
Net cash provided by financing activities
110,877
4,674
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS
(7,413
8,981
CASH AND CASH EQUIVALENTS:
Beginning of period
19,085
18,874
End of period
11,672
27,855
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest
2,788
2,963
Taxes
1,991
1,650
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING
ACTIVITIES
Unrealized gain on available for sale securities
1,573
1,697
Initial right-of-use assets obtained in exchange for new operating lease liabilities
711
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 advisor. Beginning in 2019, the services offered under the umbrella of VNB Wealth are provided by Masonry Capital or by the Bank under VNB Trust & Estate Services or Sturman Wealth Advisors, formerly known as 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, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.
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, 2019. If needed, certain previously reported amounts have been reclassified to conform to current period presentation. No such reclassifications were significant.
Adoption of New Accounting Guidance
Interagency COVID-19 Guidance In March 2020, various regulatory agencies, including the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System and the Federal Deposit Insurance Corporation (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by COVID-19. The interagency statement was effective immediately and impacted accounting for loan modifications. Under Accounting Standards Codification (“ASC”) 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” (“ASC 310-40”), issued by the Financial Accounting Standards Board (“FASB”), a restructuring of debt constitutes a troubled debt restructuring (“TDR”) if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. This interagency guidance may have a material impact on the Company’s financial statements; however, this impact cannot be quantified at this time.
Recent Accounting Pronouncements
Financial Instruments – Credit Losses In June 2016, the FASB issued Accounting Standards Update (“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. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASUs 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S.
8
Securities and Exchange Commission (“SEC”), such as the Company, and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. 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 Company is capturing the additional loan data which is anticipated to be needed for this calculation. 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.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (“SAB”) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
Income Taxes In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2019-12 to have a material impact on its consolidated financial statements.
Investments – Equity Securities In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the FASB’s Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2016-01 made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, the amendments in the ASU are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its consolidated financial statements.
LIBOR and Other Reference Rates In March 2020, the FASB issued ASU No. 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Inter-bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. To facilitate an orderly transition from LIBOR, Inter-bank Offered Rate (“IBOR”) and other benchmark rates to alternative reference rates (“ARRs”), the Company has established a focus committee, which includes members of senior management, including the Chief Credit Officer and Chief Financial Officer, among others. The task of this committee is to identify, assess and monitor risk associated with the expected discontinuation or unavailability of benchmarks, including LIBOR, achieve operations readiness and engage impacted clients in connection with the transition to ARRs. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
SEC Filing Requirements On March 12, 2020, the SEC finalized amendments to the definitions of its “accelerated filer” and “large accelerated filer” definitions. The amendments increase the threshold criteria for meeting these filer classifications and are effective on April 27, 2020. Any changes in filer status are to be applied beginning with the filer’s first annual report filed with the SEC subsequent to the effective date. Prior to these changes, the Company was required to comply with section 404(b) of the Sarbanes Oxley Act concerning auditor attestation over internal control over financial reporting as an “accelerated filer” as it had more than $75 million in public float but less than $700 million at the end of the Company’s most recent second quarter. The rule change expands the definition of “smaller reporting companies” to include entities with public float of less than $700 million and less than $100 million in annual revenues. The Company expects that it will no longer be considered an accelerated filer beginning in 2021. If the Company’s annual revenues
9
exceed $100 million, its category will change back to “accelerated filer”. The classifications of “accelerated filer” and “large accelerated filer” require a public company to obtain an auditor attestation concerning the effectiveness of internal control over financial reporting (“ICFR”) and include the opinion on ICFR in its annual report on Form 10-K. All public companies are required to obtain and file annual financial statement audits, as well as provide management’s assertion on effectiveness of internal control over financial reporting, but the external auditor attestation of internal control over financial reporting is not required for smaller reporting companies. As the Bank’s total assets exceed $500 million, it remains subject to FDICIA’s internal reporting requirements, but does not require an auditor attestation concerning internal controls over financial reporting. As such, professional and consulting expenditures should decline by an immaterial amount.
Nonrefundable Fees and Other Costs In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. For public business entities, the ASU is effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. Early adoption is not permitted. All entities should apply ASU No. 2020-08 on a prospective basis as of the beginning of the period of adoption for existing or newly purchased callable debt securities. The Company does not expect the adoption of ASU 2020-08 to have a material impact on its consolidated financial statements.
Note 2. Securities
The amortized cost and fair values of securities available for sale as of September 30, 2020 and December 31, 2019 were as follows (dollars in thousands):
Gross
Amortized
Unrealized
Fair
Cost
Gains
(Losses)
Value
U.S. Government agencies
19,996
(159
19,840
Mortgage-backed securities/CMOs
63,462
790
(94
64,158
Municipal bonds
56,268
1,075
(96
57,247
Total Securities Available for Sale
139,726
1,868
(349
December 31, 2019
15,000
(48
14,952
Corporate bonds
7,469
71,970
76
(314
71,732
19,656
19,888
114,095
358
(412
As of September 30, 2020, there were $53.1 million, or 32 issues of individual securities, held in an unrealized loss position. These securities have an unrealized loss of $349 thousand and consisted of 11 mortgage-backed/collateralized mortgage obligations (“CMOs”), 12 municipal bonds, and 9 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, 2020, and December 31, 2019 (dollars in thousands):
Less than 12 Months
12 Months or more
Fair Value
Losses
15,340
Mortgage-backed/CMOs
22,496
15,266
53,102
10
9,957
1,995
11,952
39,061
(228
7,716
(86
46,777
5,922
54,940
(321
9,711
(91
64,651
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, 2020, 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, 2020, 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 $6.0 million at September 30, 2020 were pledged as collateral to secure public deposits and facilitate borrowing from the Federal Reserve Bank of Richmond (“FRB”). At December 31, 2019, securities having carrying values of $5.0 million were similarly pledged.
For the nine months ended September 30, 2020, proceeds from the sales of securities amounted to $62.2 million, with gross realized gains of $882 thousand and gross realized losses of $147 thousand, for a net realized gain of $734 thousand. For the nine months ended September 30, 2019, proceeds from the sales of securities amounted to $21.1 million, with gross realized gains of $114 thousand and gross realized losses of $43 thousand, for a net realized gain of $71 thousand.
Restricted securities are securities with limited marketability and consist of stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation, the holding company for Community Bankers Bank. These restricted securities, totaling $3.4 million and $1.7 million as of September 30, 2020 and December 31, 2019, are carried at cost. The increase was attributed to the required purchase of additional FHLB stock with the advances made in the third quarter of 2020.
11
Note 3. Loans
The composition of the loan portfolio by loan classification at September 30, 2020 and December 31, 2019 appears below (dollars in thousands).
September 30,
December 31,
2020
2019
Commercial
Commercial and industrial - organic
32,949
38,843
Commercial and industrial - Paycheck Protection Program
84,706
Commercial and industrial - government guaranteed
32,455
35,347
Commercial and industrial - syndicated
6,367
6,398
Total commercial and industrial
156,477
80,588
Real estate construction and land
Residential construction
1,597
2,197
Commercial construction
15,565
6,880
Land and land development
6,591
8,063
Total construction and land
23,753
17,140
Real estate mortgages
1-4 family residential, first lien, investment
61,656
44,099
1-4 family residential, first lien, owner occupied
18,848
20,671
1-4 family residential, junior lien
2,625
2,520
1-4 family residential - purchased
22,368
33,428
Home equity lines of credit, first lien
9,827
10,268
Home equity lines of credit, junior lien
8,537
9,671
Farm
7,217
8,808
Multifamily
36,113
27,093
Commercial owner occupied
98,219
96,117
Commercial non-owner occupied
128,999
118,561
Total real estate mortgage
394,409
371,236
Consumer
Consumer revolving credit
19,312
20,081
Consumer all other credit
3,953
5,741
Student loans purchased
39,031
44,747
Total consumer
62,296
70,569
Total loans
Less: Allowance for loan losses
Net loans
During the nine months ended September 30, 2020, the Bank originated $86.9 million of Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans, which were designed to provide economic relief to small businesses adversely impacted by COVID-19.
The balances in the table above include unamortized premiums and net deferred loan costs (fees). As of September 30, 2020 and December 31, 2019, unamortized premiums on loans purchased were $2.0 million and $2.5 million, respectively. Net deferred loan costs (fees) totaled $(2.1) million and $100 thousand as of September 30, 2020 and December 31, 2019. The deferred fees increased $2.2 million due to the fees collected from the SBA for the PPP loans that are being amortized over the contractual life of the underlying loans, most of which are over a 24-month period.
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.
12
Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition of the borrower, and current economic conditions.
The following tables reflect the breakdown by class of the loans classified as impaired loans as of September 30, 2020 and December 31, 2019. 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, 2020 or the twelve months ended December 31, 2019. Interest income recognized is for the nine months ended September 30, 2020 or the twelve months ended December 31, 2019 (dollars below reported in thousands).
Recorded
Investment
Unpaid
Principal
Balance
Associated
Allowance
Average
Income
Recognized
Impaired loans without a valuation allowance:
56
185
1-4 family residential mortgages, junior lien
110
115
Commercial non-owner occupied real estate
838
865
Total impaired loans without a valuation allowance
957
1,004
1,165
Impaired loans with a valuation allowance
1,202
1,110
58
Total impaired loans with a valuation allowance
Total impaired loans
2,159
2,206
2,275
97
279
324
1-4 family residential mortgages, first lien, owner occupied
20
117
122
1
879
900
48
1,295
1,112
1,184
21
1,549
2,479
2,524
2,661
156
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):
Total non-accrual loans
299
Additionally, 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.
In accordance with regulatory guidance, the Bank has approved for certain customers who have been adversely affected by COVID-19 to defer principal-only, or principal and interest, payments for a 90- to 180-day period. Such short-term modifications, which were made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. While interest will continue to accrue to income, in accordance with GAAP, if the Bank ultimately incurs a credit loss on these deferred payments, interest income would need to be reversed and therefore, interest income in future periods could be negatively impacted. A total of $58.4 million in loan deferments have been approved since the beginning of the pandemic. As of September 30, 2020, $48.9 million, or 83.8%, of the total loan deferments approved have returned to normal payment schedules and are now current.
Based on regulatory guidance on student lending, the Company has classified 81 of its student loans purchased as TDRs for a total of $1.2 million as of September 30, 2020. 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 probable 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
No. of
Performing TDRs
81
Total performing TDRs
83
2,150
69
2,180
Nonperforming TDRs
Total nonperforming TDRs
Total TDRs
84
2,193
A summary of loans shown above that were modified under the terms of a TDR during the three and nine months ended September 30, 2020 and 2019 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-
78
Total loans modified during the period
168
133
During the nine months ended September 30, 2020, there were two 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 $7 thousand prior to being charged off. There were three loans modified as a TDR that subsequently defaulted during the year ended December 31, 2019 which had been modified as a TDR during the twelve months prior to default. These student loans had balances totaling $23 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, 2020 or December 31, 2019.
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:
Commercial and industrial - government guaranteed 1
Real estate construction and land loan segment:
Real estate mortgage loan segment:
Consumer loan segment:
1 Commercial and industrial – government guaranteed class excludes PPP loans
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:
•
Commercial and industrial PPP loans – These loans require no reserve as these are 100% guaranteed by the SBA.
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 purchased loans require no reserve as these are 100% guaranteed by either the SBA or the United States Department of Agriculture.
Commercial and industrial syndicated loans - Beginning with the quarter ended September 30, 2016, migration analysis was utilized on the Pass pool. For all other pools, there was not an established loss history; therefore the S&P credit and recovery ratings on the credit facilities were utilized to calculate a three-year weighted average historical default rate. As of December 31, 2019, only migration analysis was utilized since all outstanding syndicated loans at that time were in the Pass pool.
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 annually.
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.
17
Risk Ratings and Historical Loss Factor Assigned
Excellent
A 0% historical loss factor is 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 is 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.
18
The following represents the loan portfolio designated by the internal risk ratings assigned to each credit as of September 30, 2020 and December 31, 2019 (dollars in thousands). There were no loans rated “Doubtful” as of either period.
Special
Mention
Sub-
standard
TOTAL
6,313
14,985
11,084
567
Real estate construction
6,375
216
1-4 family residential, first lien investment
58,089
2,349
544
674
16,633
1,012
640
563
2,471
1-4 family residential, first lien - purchased
8,371
82
5,650
1,265
35,720
228
165
88,810
1,153
8,256
126,754
995
1,250
844
18,218
250
409
3,027
37,339
1,407
132
153
Total Loans
124,727
36,230
453,786
7,560
1,330
13,302
19
6,463
16,453
14,257
1,493
37
140
7,563
207
293
39,641
4,076
382
19,578
1,040
53
2,029
33
441
9,591
677
9,357
232
6,149
318
2,341
26,690
403
86,884
5,928
1,677
1,628
116,092
1,558
911
19,176
606
199
5,035
507
42,598
1,729
211
209
42,288
40,664
430,445
17,714
1,942
6,480
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.
As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarter ended September 30, 2020. If economic conditions improve or worsen, the Company could experience changes in the required ALLL. It is possible that asset quality metrics could decline in the future if the effects of COVID-19 are sustained.
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 $2.2 million at September 30, 2020, a 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 $4 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, 2020 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, 2020 and the year ended December 31, 2019 appears below (dollars in thousands):
Allowance for Loan Losses Rollforward by Portfolio Segment
As of and for the period ended September 30, 2020
Real Estate
Construction
and Land
Mortgages
Allowance for Loan Losses:
Balance as of beginning of year
109
2,684
1,114
4,209
Charge-offs
(643
Recoveries
378
65
997
391
Ending Balance
239
3,681
1,240
5,334
Ending Balance:
Individually evaluated for impairment
Collectively evaluated for impairment
1,236
5,330
Loans:
948
23,744
393,461
61,094
634,776
As of and for the period ended December 31, 2019
811
2,611
1,350
4,891
(482
(1,777
(2,259
51
136
202
(78
(11
59
1,093
4,188
996
80,568
16,861
370,240
69,385
537,054
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, 2020 and December 31, 2019 (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
491
31,964
75
61,581
21,868
Consumer loans
205
61
399
38,632
696
720
1,477
635,458
604
624
38,219
548
34,799
280
281
7,782
188
43,911
123
20,548
158
659
32,769
20,061
5,698
697
218
1,124
43,623
2,054
519
1,037
3,610
535,923
771
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 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 of the weighted average number of shares of potential dilutive common stock for the three and nine months ended September 30, 2020 and 2019. Diluted net income per share is computed based on the weighted average number of shares of common stock equivalents outstanding, to the extent dilutive. The Company’s common stock equivalents relate to outstanding common stock options. Unvested restricted stock as noted in the Consolidated Balance Sheets as of September 30, 2020 and December 31, 2019 is included in the calculation of basic and diluted net income per share (dollars below reported in thousands except per share data).
Three Months Ended
Net
Weighted
Shares
Per
Share
Amount
Basic net income per share
2,714,273
2,689,092
Effect of dilutive stock options
1,022
Diluted net income per share
2,714,897
2,690,114
Nine Months Ended
2,705,730
2,685,134
708
3,627
2,706,438
2,688,761
For the nine months ended September 30, 2020, there were 145,404 option shares considered anti-dilutive and excluded from this calculation. For the nine months ended September 30, 2019, there were 66,301 option 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 Stock Incentive Plan (“2005 Plan”) as this plan has expired.
For the 2014 Plan and the 2005 Plan (the “Plans”), the option price of incentive stock options cannot 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, 2020. Share data and exercise price range per share have been adjusted to reflect the 5% Stock Dividend and prior stock dividends. 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 issued, net of forfeited and expired options
(59,870
(162,047
Unrestricted stock issued
(11,535
Restricted stock grants issued
(26,268
Cancelled due to Plan expiration
(193,705
Remaining available for grant
75,775
Grants issued and outstanding:
Total vested and unvested shares
1,379
145,404
Fully vested shares
26,977
Exercise price range
$13.69 to $13.69
$23.75 to $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.
Stock Options
Changes in the stock options outstanding related to the Plans are summarized below (dollars in thousands except per share data):
Number of Options
Weighted Average
Exercise Price
Aggregate
Intrinsic Value
Outstanding at January 1, 2020
80,783
40.76
Issued
66,000
24.64
Exercised
Expired
Outstanding at September 30, 2020
146,783
33.51
28
Options exercisable at September 30, 2020
28,356
40.53
For the nine months ended September 30, 2020 and 2019, the Company recognized $88 thousand and $71 thousand, respectively, in compensation expense for stock options. As of September 30, 2020, there was $432 thousand in unrecognized compensation expense remaining to be recognized in future reporting periods through 2025. The fair value of any stock option grant is estimated at the grant date using the Black-Scholes pricing model. Stock option grants for 40,000 shares were issued during the three months ended September 30, 2020 and no stock option grants were issued during the three months ended September 30, 2019. Stock option grants for 66,000 shares were issued during the nine months ended September 30, 2020, and stock option grants for 420 shares were issued during the nine months ended September 30, 2019.
25
The fair value of each option granted in 2020 was estimated based on the assumptions noted in the following table:
Expected volatility1
22.97
%
Expected dividends2
4.75
Expected term (in years)3
6.50
Risk-free rate4
0.68
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 U.S. 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, 2020 is shown below. Share and per share data have been adjusted to reflect the 5% Stock Dividend and prior stock dividends.
Options Outstanding
Options Exercisable
Number of
Options
Outstanding
Weighted-
Remaining
Contractual Life
Exercise
Price
Exercisable
$10.65 to $20.00
2.4 Years
13.69
$20.01 to $30.00
67,103
9.7 Years
24.68
551
27.39
$30.01 to $40.00
20,820
8.4 Years
38.14
3,444
39.44
$40.01 to $42.62
57,481
7.6 Years
42.62
22,982
8.7 Years
Stock Grants
Unrestricted stock grants - No unrestricted stock grants were issued in the nine months ended September 30, 2020. On February 20, 2019, a total of 11,535 shares of unrestricted 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 ended December 31, 2019. Based on the market price on February 20, 2019 of $38.65, the total expense for these shares of $424 thousand was expensed in 2019 as those services were provided. As of September 30, 2019, $318 thousand of this total had been realized in stock grant expense.
Restricted stock grants – In September 2019, 4,000 restricted shares were granted to certain members of executive management, vesting over a four-year period. In March 2020, 10,368 restricted shares were granted to non-employee directors, vesting over a four-year period. In April 2020, 1,900 shares were issued to lenders in accordance with an internal lender incentive plan, vesting over a five-year period, and in May 2020, 10,000 restricted shares were granted to certain members of executive management, vesting over a four-year period. For the three and nine months ended September 30, 2020, $42 thousand and $96 thousand, respectively, was expensed as a result of restricted stock grants. As of September 30, 2020, there was $599 thousand in unrecognized compensation expense for restricted stock grants remaining to be recognized in future reporting periods through 2025. For the three and nine months ended September 30, 2019, $3 thousand in expense was incurred.
26
Changes in the restricted stock grants outstanding during the nine months ended September 30, 2020 are summarized below (dollars in thousands except per share data):
Number of Shares
Grant Date
Per Share
Nonvested as of January 1, 2020
4,000
36.00
22,268
25.34
Vested
(1,000
(36.00
(24
Nonvested at September 30, 2020
25,268
26.60
609
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, 2020 and December 31, 2019 (dollars in thousands):
Fair Value Measurements at September 30, 2020 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, 2019 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, 2020 and December 31, 2019, 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 (a) the observable market price of the loan or the fair value of the collateral, or (b) 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 $2.2 million as of September 30, 2020 and $2.5 million as of December 31, 2019. All impaired loans were measured based on expected future cash flows discounted at the loan’s effective interest rate, or fair value of collateral, as noted above.
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, 2020 and December 31, 2019 are as follows (dollars in thousands):
Carrying value
Level 1
Level 2
Level 3
Assets
Cash and cash equivalent
Available for sale securities
633,165
Accrued interest receivable
2,878
530
2,348
Liabilities
Demand deposits and
interest-bearing transaction, money market, and savings accounts
596,426
98,995
Accrued interest payable
176
523,507
2,240
385
1,855
interest-bearing transaction and money market accounts
511,933
109,848
295
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 on sales 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, 2020 and 2019 (dollars in thousands)
Realized gains on sales of securities
Tax effect
(154
(15
Realized gains, net of tax
72
580
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.
Sturman Wealth Advisors – Sturman Wealth Advisors, formerly known as 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 that are derived from Assets Under Management and, prior to 2020, incentive income that was 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, 2019.
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 that are derived from Assets Under Management and incentive income that 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. For both the three months ended September 30, 2020 and 2019, management fees totaling $25 thousand were charged by the Bank and eliminated in consolidated totals. For both the nine months ended September 30, 2020 and 2019, management fees totaling $75 thousand were charged by the Bank and eliminated in consolidated totals.
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Segment information for the three and nine months ended September 30, 2020 and 2019 is shown in the following tables (dollars in thousands). Note that asset information is not reported below, as the assets of Sturman Wealth Advisors and VNB Trust & Estate Services are reported at the Bank level; also, assets specifically allocated to the lines of business other than the Bank are insignificant and are no longer provided to the chief operating decision maker.
Three months ended September 30, 2020
Bank
Sturman Wealth Advisors
VNB Trust &
Estate
Services
Masonry
Consolidated
Noninterest income
970
Noninterest expense
4,373
155
196
Income (loss) before income taxes
2,420
(4
466
(26
Net income (loss)
1,954
(3
(98
Nine months ended September 30, 2020
3,316
625
12,147
483
668
584
6,979
1,355
(9
(67
5,624
(34
(254
Three months ended September 30, 2019
786
314
68
3,905
308
193
2,475
(125
487
1,988
(99
Nine months ended September 30, 2019
2,496
1,008
131
11,777
438
918
524
90
(393
1,234
(82
5,488
(311
32
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 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
3,783
Right-of-use asset
3,725
Weighted average remaining lease term
5.35 years
Weighted average discount rate
2.55
Three Months Ended September 30,
Nine Months Ended September 30,
Lease Expense
Operating lease expense
203
636
611
Short-term lease expense
107
Total lease expense
256
721
718
Cash paid for amounts included in lease liabilities
597
589
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, 2020
Twelve months ending December 31, 2021
877
Twelve months ending December 31, 2022
839
Twelve months ending December 31, 2023
753
Twelve months ending December 31, 2024
Twelve months ending December 31, 2025
469
Thereafter
Total undiscounted cash flows
4,072
Less: Discount
(289
Note 11. Subsequent Event
On October 1, 2020, the Company announced the signing of a definitive merger agreement with Fauquier Bankshares, Inc. (“Fauquier”), pursuant to which the companies will combine in an all-stock merger with the Company as the surviving company. At or immediately following consummation of the merger, The Fauquier Bank, the wholly owned banking subsidiary of Fauquier, will be merged with and into the Bank, with the Bank as the surviving bank. Under the terms of the merger agreement, Fauquier shareholders will receive 0.675 shares of Company stock for each share of Fauquier common stock they own. Shareholders of the Company will own approximately 51.4% and Fauquier shareholders will own approximately 48.6% of the combined company. The combined company will operate under the Virginia National Bankshares name and the combined bank will operate under the Virginia National Bank name. Additional information on the merger can be found in the Company’s 8-Ks filed with the SEC on October 1, 2020 and October 2, 2020.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the unaudited consolidated financial statements, and notes thereto, of Virginia National Bankshares Corporation (the “Company”) included in this report and the audited consolidated financial statements, and notes thereto, of the Company included in the Company’s Form 10-K for the year ended December 31, 2019. Operating results for the three and nine months ended September 30, 2020 are not necessarily indicative of the results for the year ending December 31, 2020 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” within the meaning of the Private Securities Litigation Reform Act of 1995. 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 judgement of the Company and its management about future events. While Company management believes such statements to be reasonable, future events and predictions are subject to circumstances that are not within the control of the Company and its management. Actual results may differ materially from those included in the forward-looking statements due to a number of factors, including, without limitation, the effects of and changes in: general economic and market conditions, including the effects of declines in real estate values, an increase in unemployment levels and general economic contraction as a result of COVID-19 or other pandemics; fluctuations in interest rates, deposits, loan demand, and asset quality; assumptions that underlie the Company’s allowance for loan losses (“ALLL”); the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events (e.g., COVID-19 or other pandemics), and of governmental and societal responses thereto; the performance of vendors or other parties with which the Company does business; competition; technology; laws, regulations and guidance; accounting principles or guidelines; performance of assets under management; expenses related to the Company’s proposed merger with Fauquier Bankshares, Inc. (“Fauquier”), unexpected delays related to the merger, or the inability to obtain regulatory and shareholder approvals or satisfy other closing conditions required to complete the merger; and other factors impacting financial services businesses. Many of these factors and additional risks and uncertainties are described in the Company’s Form 10-K for the year ended December 31, 2019 (the “Company’s 2019 Form 10-K”) and other reports filed from time to time by the Company with the Securities and Exchange Commission (“SEC”). These statements speak only as of the date made, and the Company does not undertake to update any forward-looking statements to reflect changes or events that may occur after this release.
MERGER WITH FAUQUIER BANKSHARES, INC., AND THE FAUQUIER BANK
On October 1, 2020, the Company announced the signing of a definitive merger agreement with Fauquier, pursuant to which the companies will combine in an all-stock merger with the Company as the surviving company. At or immediately following consummation of the merger, The Fauquier Bank, the wholly owned banking subsidiary of Fauquier, will be merged with and into the Virginia National Bank (the “Bank”), with the Bank as the surviving bank. Under the terms of the merger agreement, Fauquier shareholders will receive 0.675 shares of Company stock for each share of Fauquier common stock they own. Shareholders of the Company will own approximately 51.4% and Fauquier shareholders will own approximately 48.6% of the combined company. The combined company will operate under the Virginia National Bankshares name and the combined bank will operate under the Virginia National Bank name. Additional information on the merger can be found in the Company’s 8-Ks filed with the SEC on October 1, 2020 and October 2, 2020.
IMPACT OF COVID-19
The COVID-19 pandemic has caused, and will likely continue to cause, economic and social disruption, significantly affecting many industries, including many of our clients. Significant uncertainty exists regarding the magnitude of the impact and duration of this pandemic. Following are brief descriptions of areas within our Company that have been or may be impacted.
Financial Condition and Results of Operations
The Company’s consolidated financial statements include estimates and assumptions made by management which affect the reported amounts of assets and liabilities, including the level of the ALLL that is established. The ALLL calculation and resulting provision for loan losses are impacted by changes in economic conditions. As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarter ended September 30, 2020. If economic conditions improve or worsen, the Company could experience further changes in the required ALLL. It is possible that asset quality metrics could decline in the future if the effects of COVID-19 are sustained.
While most industries have been adversely impacted by COVID-19, the Company has exposures on its balance sheet as of September 30, 2020 in the following categories of loans that are considered to have higher risk of significant impact:
Retail trade - $13.7 million, or 2.5% of loans
Hotels and motels - $13.7 million, or 2.5% of loans
Wholesale trade - $10.9 million, or 2.0% of loans
Arts, entertainment and recreation - $6.5 million, or 1.2% of loans
Caterers - $5.3 million, or 1.0% of loans, and
Full-service restaurants - $2.2 million, or 0.4% of loans
Note that the loan balances and percentages above do not include Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans made to entities within such categories.
Interest income could be reduced due to the economic impact of COVID-19. In accordance with guidance from regulators, we are working with borrowers who have been adversely affected by COVID-19 to defer principal only, or principal and interest payments for a 90- to 180-day period. While interest will continue to accrue to income, in accordance with accounting principles generally accepted in the United States (“GAAP”), if the Company ultimately incurs a credit loss on these deferred payments, interest income would need to be reversed and therefore, interest income in future periods could be negatively affected. Since the beginning of the pandemic, the Company has accommodated 192 deferrals on outstanding loan balances of $58.4 million (of which 131 deferrals on outstanding loan balances of $1.8 million were related to student loans). In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings (“TDRs”).
Primarily within the second quarter of 2020, the Company devoted significant resources to accept PPP applications, a program designed to provide a direct incentive for small businesses to keep employees on their payroll. In total, the Company has closed 574 loans representing $86.9 million in funding, with average origination fees of 3.4%, assisting many nonprofits and local businesses through this program. Loans funded through the PPP are fully guaranteed by the U.S. government. The Company performed the required due diligence pursuant to the established SBA criteria; nonetheless, if a determination was made that certain loans did not meet the criteria established for the program, the Company may be required to establish additional ALLL through provision for loan loss expense which will negatively impact net income.
Throughout the onset of this pandemic, the Company has maintained its high standards of credit quality on organic loan funding to limit credit risk exposure.
Capital and Liquidity
As of September 30, 2020, capital ratios of the Company were in excess of regulatory requirements. While currently included in the category of “well capitalized” by bank regulators, a prolonged economic recession could adversely impact reported and regulatory capital ratios.
The Company maintains access to multiple sources of liquidity. Management has also revisited its capital and liquidity stress tests, as well as capital and liquidity contingency plans to validate how the Company can react effectively to the economic downturn caused by this pandemic and to gauge the amount of SBA PPP loans the Company could and should accept.
As of September 30, 2020, the goodwill on our balance sheet was not deemed to be impaired. However, management may determine that goodwill is required to be evaluated for impairment in the future due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations.
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Operations, Processes, Controls and Business Continuity Plan
The Company reacted quickly to the COVID-19 pandemic. We began internal social distancing in mid-March, as well as distancing from the public by keeping our drive-thru services available, and encouraging customers to conduct transactions at ATMs, through online banking and the mobile app. The Company also increased consumer and business mobile deposit limits to encourage customers to make deposits remotely from the safety of their home or business. The Company implemented a schedule whereby most staff members are working remotely at any given time, allowing the remaining essential staff to create more distance between each other within the offices. We temporarily increased the number of staff in the client service center to assist more customers by telephone and encourage them to utilize online and mobile banking. The client service center was also temporarily moved to a larger location to allow for appropriate social distancing. In addition, the Company enhanced disinfecting procedures to include hospital-grade cleaning solution and foggers, increased the frequency of cleaning and issued personal protective equipment, including N-95 and disposable face masks, face shields, sneeze guards, gloves and thermometers, to employees, along with specific instructions for use, to enhance their safety. We also installed disinfecting protective strips to high touch areas and placed free-standing air filter machines throughout our facilities. We purchased COVID-19 instant test kits that we have on-site, ready to be deployed when needed, and we provided antibody testing options to all employees. Management provides frequent email communications and social media updates regarding COVID-19, helpful tips and status of Company initiatives, as well as warning customers of potential scams during this pandemic. Beginning mid-July, the Company took steps to resume normal branch activities with specific guidelines in place to continue protecting our customers and employees.
The Company’s preparedness resulted in minimal impact to the Company’s operations as a result of COVID-19. Business continuity planning allowed for successful deployment of most of our employees to work in a remote environment. No material operational or internal control risks have been identified to date, and the Company has enhanced fraud-related controls.
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.
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 2019 Form 10-K. There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2019.
FINANCIAL CONDITION
The total assets of the Company as of September 30, 2020 were $821.0 million. This is a $118.4 million increase from the $702.6 million total assets reported at December 31, 2019 and a $160.2 million increase from the $660.8 million reported at September 30, 2019. A $97.4 million increase in gross loans, primarily from the origination of $86.9 million in PPP loans, was the major reason for the increase in assets since year-end. In addition, the Company increased the balances in its securities portfolio by $29.0 million since year-end.
The Company had overnight federal funds sold of $273 thousand as of September 30, 2020, compared to $4.2 million as of December 31, 2019 and $14.0 million as of September 30, 2019. 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 Excess Balance Account (“EBA”) of the Federal Reserve Bank of Richmond (“FRB”). The EBA is a limited-purpose account at the FRB 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, 2020 totaled $144.7 million, an increase of $29.0 million compared with the $115.7 million reported at December 31, 2019 and an increase of $65.1 million from the $79.6 million reported at September 30, 2019. Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company. At September 30, 2020 and December 31, 2019, the investment securities holdings represented 17.6% and 16.5% of the Company’s total assets, respectively.
The Company’s investment securities portfolio included restricted securities totaling $3.4 million as of September 30, 2020, and $1.7 million as of December 31, 2019 and September 30, 2019. These securities represent stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation, the holding company for Community Bankers Bank. The level of FRB and FHLB stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the FHLB, respectively. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Company 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, 2020, the unrestricted securities portfolio totaled $141.2 million. The following table summarizes the Company's available for sale securities by type as of September 30, 2020, December 31, 2019, and September 30, 2019 (dollars in thousands):
Percent
of Total
14.1
13.1
11,975
15.4
6.5
45.4
63.0
50,771
65.1
40.5
17.4
15,184
19.5
Total available for sale securities
100.0
77,930
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 borrowing relationship. The portfolio strategies include seeking industry, loan size, and loan type diversification 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, Winchester, Frederick County, Richmond and areas in the Commonwealth of Virginia that are within a 75-mile radius of any office of the Company.
As of September 30, 2020, total loans were $636.9 million, compared to $539.5 million as of December 31, 2019 and $522.1 million at September 30, 2019. Loans as a percentage of total assets at September 30, 2020 were 77.6%, compared to 79.0% as of September 30, 2019. Loans as a percentage of deposits at September 30, 2020 were 91.7%, compared to 90.1% as of September 30, 2019.
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The following table summarizes the Company's loan portfolio by type of loan as of September 30, 2020, December 31, 2019, and September 30, 2019 (dollars in thousands):
Commercial and industrial
24.6
14.9
81,513
15.6
Real estate - commercial
270,548
42.5
250,579
46.4
246,554
47.2
Real estate - residential mortgage
123,861
19.4
120,657
22.4
100,532
19.3
Real estate - construction
3.7
3.2
16,671
9.8
76,834
14.7
522,104
Loan balances increased $97.4 million, or 18.1%, since December 31, 2019 and increased $114.8 million, or 22.0%, from September 30, 2019. The increases are largely due to the origination of $86.9 million in PPP loans, as well as $10.5 million in net non-PPP loan growth in the first nine months of 2020 and the purchase of a $17.4 million 1-4 family residential mortgage package in the fourth quarter of 2019.
The purchase of loans is considered a secondary strategy, which allows the Company to supplement organic loan growth. Purchased loans with balances outstanding of $100.2 million as of September 30, 2020 were comprised of:
Student loans totaling $39.0 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. 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 received payment in the fourth quarter of 2019 on the balance of the claims approved by the liquidator. The liquidator has notified the Company that it will be making distributions related to unearned premiums. The Company expects to receive approximately $800 thousand from this distribution. Student loans continue to be profitable for the Company.
Loans guaranteed by a U.S. government agency (“government guaranteed”) totaling $32.4 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 or the SBA; the originating institution holds the unguaranteed portion of each loan and services it. These government guaranteed portions 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 $22.4 million, inclusive of premium. In each of the fourth quarters of 2019 and 2018, the Company purchased a package of 1-to-4 family residential mortgages. Each of the adjustable rate loans purchased were individually underwritten by the Company prior to the closing of the purchases. The collateral on these loans is located primarily on the East Coast of the United States. The balance in purchased mortgage loans declined $11.1 million, or 33.1%, from December 31, 2019 to September 30, 2020, due to significant payoffs during this low rate environment.
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 ALLL 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 $9 thousand at September 30, 2020, compared to the $299 thousand and $337 thousand reported at December 31, 2019 and September 30, 2019, respectively. The December 31, 2019 non-accrual balance included a loan which was foreclosed upon during the second quarter of 2020, with the Company being made whole on the loan with the proceeds from a third-party bidder without the Company’s taking title to the property. The September 30, 2019 non-accrual balance included $337 thousand of student loan balances for which the Company has received payment from the liquidation process in the fourth quarter of 2019.
The Company had loans in its portfolio totaling $61 thousand, $771 thousand and $199 thousand, as of September 30, 2020, December 31, 2019 and September 30, 2019, respectively, that were 90 or more days past due, with all such loans still accruing interest as the Company deemed them to be collectible. The balance as of December 31, 2019 included a loan of approximately $548 thousand, which was granted a deferral by the USDA and is 100% guaranteed by such governmental entity.
At September 30, 2020, the Company had loans classified as impaired loans in the amount of $2.2 million, compared to $2.5 million at December 31, 2019 and $2.6 million at September 30, 2019. Based on regulatory guidance on student lending, the Company has classified 81 of its purchased student loans as TDRs for a total of $1.2 million as of September 30, 2020. 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 probable 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 ALLL 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 ALLL. The Company applies historical loss rates to various pools of loans based on risk rating classifications. In addition, the adequacy of the ALLL 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. As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarter ended September 30, 2020. If economic conditions improve or worsen, the Company could experience changes in the required ALLL. It is possible that asset quality metrics could decline in the future if the effects of COVID-19 are sustained.
40
The relationship of the ALLL to total loans appears below (dollars in thousands):
Loans held for investment at period-end
3,983
Allowance as a percent of period-end loans
0.84
0.78
0.76
The ALLL as a percentage of assets was 0.84% as of September 30, 2020, 0.78% as of December 31, 2019, and 0.76% as of September 30, 2019. The percentage increased as compared to year-end was primarily due to the increase in the necessary allowance on most of the Company’s loans due to worsening economic qualitative factors, and was partially offset by the SBA-guaranteed PPP loans not requiring an allowance.
Provisions for loan losses totaling $1.4 million and $500 thousand were recorded in the nine months ended September 30, 2020 and 2019, respectively. The following is a summary of the changes in the ALLL for the nine months ended September 30, 2020 and 2019 (dollars in thousands):
Allowance for loan losses, January 1
(1,570
Allowance for loan losses, September 30
For additional insight into management’s approach and methodology in estimating the ALLL, 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 ALLL on a quarterly basis to ensure it is adequate based upon the calculated probable losses inherent in the portfolio. Management believes the ALLL was adequately provided for as of September 30, 2020 and acknowledges that the ALLL may increase throughout the year as economic conditions may continue to deteriorate for the foreseeable future.
Premises and equipment
The Company’s premises and equipment, net of depreciation, as of September 30, 2020 totaled $5.4 million compared to $6.1 million as of December 31, 2019 and $6.4 million as of September 30, 2019. 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, 2020, the Company 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 Company entered into a lease for branch and office space in Richmond, Virginia during the first quarter of 2020 and anticipates opening the office within 90 days, absent delays as a result of COVID-19.
41
The five-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 both Masonry Capital and Sturman Wealth Advisors. VNB Trust & Estate Services is located at 112 Third Street, SE, Charlottesville, Virginia, which is part of the same leased space that the Company uses to operate the drive-through location at 301 East Water Street, 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
As of September 30, 2020, $3.7 million of right-of-use assets and $3.8 million of lease liabilities are included in Other Assets and Other Liabilities, respectively, in accordance with Accounting Standards Update 2016-02 “Leases” (Topic 842). As of September 30, 2019, $3.8 million of right-of-use assets and lease liabilities were included in Other Assets and Other Liabilities, respectively. Right-of-use assets 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
Deposit 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, Richmond and Winchester areas.
Total deposits as of September 30, 2020 were $694.5 million, an increase of $73.3 million compared to the balances of $621.2 million at December 31, 2019, and an increase of $115.1 million compared to the $579.4 million total as of September 30, 2019. The primary reason for the increase since year-end is due to increased balances in PPP customer accounts.
Deposit accounts
% of Total
No cost and low cost deposits:
Noninterest demand deposits
27.4
26.9
155,134
26.8
Interest checking accounts
19.8
110,152
19.0
39.0
35.7
190,568
32.9
Total noninterest and low cost deposit accounts
85.9
82.4
455,854
78.7
Time deposit accounts:
Certificates of deposit
89,596
12.9
95,621
96,040
16.5
CDARS deposits
8,499
1.2
2.2
27,552
4.8
Total certificates of deposit and other time deposits
17.6
123,592
21.3
Total deposit account balances
579,446
Noninterest-bearing demand deposits on September 30, 2020 were $190.2 million, representing 27.4% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $406.2 million, and represented 58.5% of total deposits at September 30, 2020. Collectively, noninterest-bearing and interest-bearing transaction and money market accounts represented 85.9% of total deposit accounts at September 30, 2020. These account types are an excellent source of low-cost funding for the Company.
The Company also offers insured cash sweep (“ICS®”) deposit products. ICS® deposit balances of $28.9 million and $67.2 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, 2020. As of December 31, 2019, ICS® deposit balances of $19.3 million and $53.6 million are included in the interest checking accounts and the money market and savings deposit account balances, respectively. All ICS accounts consist of reciprocal balances for the Company’s customers.
The remaining 14.1% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $98.1 million at September 30, 2020. 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 $8.5 million as of September 30, 2020, all of which were reciprocal balances for the Company’s customers.
Borrowings
Short-term borrowings, consisting primarily of 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.
The Company has a collateral dependent line of credit with the FHLB. As of September 30, 2020, the Company has $40.0 million in outstanding balances from FHLB advances. As of December 31, 2019 and September 30, 2019, the Company had no outstanding balances from FHLB advances.
Additional borrowing arrangements maintained by the Company include formal federal funds lines with four major regional correspondent banks and the Federal Reserve discount window. The Company had no outstanding balances on these lines or facilities as of September 30, 2020, December 31, 2019 or September 30, 2019.
Shareholders' equity and regulatory capital ratios
The following table displays the changes in shareholders' equity for the Company from December 31, 2019 to September 30, 2020 (dollars in thousands):
Equity, December 31, 2019
Cash dividends declared
(2,439
Equity increase due to expensing of restricted stock
Equity increase due to expensing of stock options
Equity, September 30, 2020
The Basel III Capital Rules require banks and bank holding companies to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%); (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).
The Company’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 14.42%, 14.42%, 15.41% and 9.41%, respectively, as of September 30, 2020, thus exceeding the minimum requirements. The Bank’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 14.46%, 14.46%, 15.44% and 9.45%, respectively, as of September 30, 2020, also exceeding the minimum requirements.
As of September 30, 2020, the Bank exceeded all of the following minimum capital ratios in order to be considered “well capitalized” under the “prompt corrective action” regulations, as revised: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.
On September 17, 2019 the Federal Deposit Insurance Corporation (“FDIC”) 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 was made available for community banking organizations to use in their March 31, 2020 Call Report. The Company 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 FDIC studies.
44
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 tax-equivalent adjustment
Net interest income (FTE)
6,089
5,491
17,264
16,561
Efficiency ratio
66.0
67.1
63.4
66.3
-0.3
-0.2
Efficiency ratio (FTE)
65.7
66.9
63.1
66.1
Net interest margin
3.03
3.52
3.10
3.64
0.02
Net interest margin (FTE)
3.05
3.54
3.12
3.66
Net income for the three months ended September 30, 2020 was $1.9 million, a $27 thousand or 1.4% decrease compared to net income reported for the three months ended September 30, 2019. Net income per diluted share was $0.69 for the quarter ended September 30, 2020 compared to $0.71 per diluted share for the same quarter in the prior year. The decrease in net income for the three months ended September 30, 2020, when compared to the same period of 2019, was attributable to the combination of: i) a $344 thousand increase in provision for loan losses, largely as a result of worsening economic factors associated with the COVID-19 pandemic; ii) a $573 thousand increase in net interest income, primarily due to lower cost of funds; iii) a $98 thousand increase in noninterest income, as explained in the Noninterest income section below; iv) a $374 thousand increase in noninterest expense, as explained in the Noninterest expense section below, and v) an $20 thousand decrease in provision for income taxes.
Net income for the nine months ended September 30, 2020 was $5.4 million, a $104 thousand or 2.0% increase compared to net income reported for the nine months ended September 30, 2019. Net income per diluted share was $1.98 for the nine months ended September 30, 2020, compared to $1.96 per diluted share for the same period in the prior year. The increase in net income for the nine months ended September 30, 2020, when compared to the same period in the prior year, was attributable to the combination of: i) a $867 thousand increase in provision for loan losses largely as a result of worsening economic factors associated with the COVID-19 pandemic; ii) a $674 thousand increase in net interest income, primarily due to lower cost of funds incurred in the second and third quarters of the current year; iii) a $634 thousand increase in noninterest income, as explained in the Noninterest income section below; iv) a $225 thousand increase in noninterest expense, as explained in the Noninterest expense section below, and v) a $112 thousand increase in provision for income taxes.
Net interest income (FTE) for the three months ended September 30, 2020 was $6.1 million, a $598 thousand or 10.9% increase compared to net interest income (FTE) of $5.5 million for the three months ended September 30, 2019. Net interest income (FTE) was positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $510 thousand, offset by the increased volume of deposits, which increased interest expense by $94 thousand. The increased volume of loans, increasing from an average of $516.6 million in the third quarter of 2019 to $630.7 million in the third quarter of 2020, positively impacted interest income by $1.2 million; however, the lower rate earned on loans, declining from 4.62% to 3.89% for the periods noted, negatively impacted interest income by $1.1 million, nearly offsetting the positive impact of the increase in volume. The increase in volume of securities held, increasing from an average balance of $67.7 million for the third quarter of 2019 to $146.0 million for the third quarter of 2020, positively impacted net interest income by $382 thousand, while the decline in yield earned on such securities decreased from 2.37% to 1.74% for the periods noted, negatively impacting net interest income by $148 thousand.
45
Net interest income (FTE) for the nine months ended September 30, 2020 was $17.3 million, a $703 thousand or 4.2% increase compared to net interest income (FTE) of $16.6 million for the nine months ended September 30, 2019. Net interest income (FTE) was positively impacted by the increase in the volume of the securities portfolio, which increased from an average of $64.5 million in the nine months ended September 30, 2019 to $109.8 million in the nine months ended September 30, 2020, increasing interest income by $690 thousand. The decline in rates paid on securities modestly offset the impact of the volume increase, declining from an average yield of 2.39% to 1.98% for the periods noted, negatively impacting interest income by $211 thousand. The increase in the volume of loans, up from an average of $524.7 million in the nine months ended September 30, 2019 to $595.0 million in nine months ended September 30, 2020, positively impacted interest income by $2.3 million; however, the lower rate earned on loans, declining from 4.64% to 4.09% for the periods noted, negatively impacted interest income by $2.3 million, completely offsetting the positive impact of the increase in volume. Net interest income (FTE) was positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $648 thousand, offset by the increased volume of deposits, which increased interest expense by $287 thousand.
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 3.05% for the three months ended September 30, 2020 was 49 basis points lower than the 3.54% for the three months ended September 30, 2019. The net interest margin (FTE) of 3.12% for the nine months ended September 30, 2020 was 54 basis points lower than the 3.66% for the nine months ended September 30, 2019. 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.
Interest expense decreased $381 thousand for the three months ended September 30, 2020 compared to the same period in the prior year, due predominantly to rate decreases. The rate paid on interest-bearing deposits averaged 53 basis points in the three months ended September 30, 2020, compared to 106 basis points for the three months ended September 30, 2019. Average balances of interest-bearing deposits increased from $414.5 million in the three months ended September 30, 2019 to $518.2 million in the three months ended September 30, 2020. Average balances of borrowed funds, from FHLB advances, increased from zero in the three months ended September 30, 2019 to $28.6 million in the three months ended September 30, 2020, causing an increase in interest expense on borrowed funds of $35 thousand.
Interest expense decreased $414 thousand for the nine months ended September 30, 2020, compared to the same period in the prior year, due predominantly to the lower rates paid on deposits, as noted above. The increased volume of deposits increased interest expense by $287 thousand, while the decrease in rates paid on deposit accounts decreased interest expense by $648 thousand, netting to an overall impact of increasing net interest income by $361 thousand. The rate paid on interest-bearing deposits averaged 72 basis points in the nine months ended September 30, 2020, compared to 101 basis points for the nine months ended September 30, 2019. Average balances of interest-bearing deposits increased from $397.3 million in the nine months ended September 30, 2019 to $488.8 million in the nine months ended September 30, 2020. A table showing the mix of no cost and low-cost deposit accounts is shown under “Financial Condition - Deposits” earlier in this report. Average balances of borrowed funds increased from $4.6 million in the nine months ended September 30, 2019 to $9.6 million in the nine months ended September 30, 2020. The increase in volume of borrowed funds increased interest expense by $51 thousand; however, the decline in the rate paid on borrowed funds, from 2.57% in the prior period to 0.49% in the current period, had a positive impact on interest expense of $104 thousand. The combination of the volume and rate differences resulted in a decrease in interest expense on borrowed funds of $53 thousand.
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, 2020 and 2019. These tables also include a rate/volume analysis for these same periods (dollars in thousands).
46
Consolidated Average Balance Sheet and Analysis of Net Interest Income
Change in Interest Income/ Expense
Change Due to : 4
Income/
Yield/Cost
Volume
Rate
Increase/
Expense
(Decrease)
Interest Earning Assets:
Taxable Securities
118,557
433
1.46
58,210
2.20
248
(135
113
Tax Exempt Securities 1
27,473
2.94
9,505
3.41
(13
121
Total Securities 1
146,030
635
1.74
67,715
2.37
(148
234
630,704
3.89
516,637
4.62
1,206
(1,052
154
Fed Funds Sold
16,980
0.07
31,956
2.16
(115
(171
Total Earning Assets
793,714
6,813
616,308
6,596
4.25
1,532
(1,315
217
Less: Allowance for Loan Losses
(5,141
(4,827
Total Non-Earning Assets
47,736
43,604
Total Assets
836,309
655,085
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking
139,698
0.11
107,179
57
0.21
(31
(17
Money Market and Savings Deposits
281,161
343
0.49
185,019
474
1.02
182
(313
(131
Time Deposits
97,300
1.25
122,274
1.86
(102
(166
(268
Total Interest-Bearing Deposits
518,159
689
0.53
414,472
1.06
94
(510
(416
Other borrowed funds
28,620
Total Interest-Bearing Liabilities
546,779
112
(493
(381
Non-Interest-Bearing Liabilities:
Demand deposits
203,798
160,491
Other liabilities
4,870
4,574
Total Liabilities
755,447
579,537
Shareholders' Equity
80,862
75,548
Total Liabilities & Shareholders' Equity
Net Interest Income (FTE)
1,420
(822
598
Interest Rate Spread 2
2.89
3.19
Interest Expense as a Percentage of Average Earning Assets
0.36
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 Measures 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.
47
For the Nine Months Ended
91,863
1,220
1.77
52,798
874
2.21
546
(200
346
Tax Exempt Securities (1)
17,933
413
3.07
11,705
Total Securities (1)
109,796
1,633
64,503
1,154
2.39
690
(211
479
594,998
4.09
524,723
4.64
2,287
(2,308
(21
34,535
0.38
16,124
(169
739,329
19,933
3.60
605,350
19,644
4.34
3,135
(2,846
289
(4,731
(4,892
46,995
42,602
781,593
643,060
131,281
0.10
103,708
0.20
(57
255,837
1,372
0.72
171,971
1,222
0.95
499
150
101,651
1.53
121,646
1,620
1.78
(246
(208
(454
488,769
2,634
397,325
2,995
1.01
287
(648
(361
9,610
4,580
2.57
(104
(53
498,379
401,905
1.03
338
(752
(414
199,490
164,093
4,607
3,443
702,476
569,441
79,117
73,619
2,797
(2,094
703
Interest Rate Spread (2)
3.31
0.48
A provision for loan losses of $224 thousand was recognized during the three months ended September 30, 2020 compared to a recovery of loan loss provision of $120 thousand recognized during the three months ended September 30, 2019. A provision for loan losses of $1.4 million was recognized during the nine months ended September 30, 2020, compared to $500 thousand recognized during the nine months ended September 30, 2019, primarily due to the deterioration in the economic outlook resulting from the impact of COVID-19.
The period-end ALLL as a percentage of assets was 0.84% as of September 30, 2020, 0.78% as of December 31, 2019, and 0.76% as of September 30, 2019. The percentage increase as compared to year-end was primarily due to the increase in the necessary allowance on most of the Company’s loans due to worsening economic qualitative factors, which was partially offset by the SBA-guaranteed PPP loans not needing an allowance.
Further discussion of management’s assessment of the ALLL 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, 2020. The ALLL calculation, provision for loan losses, asset quality and collateral values may be significantly impacted by deterioration in economic conditions. We have downgraded the qualitative factors pertaining to economic conditions within our ALLL methodology; should economic conditions worsen, we could experience further increases in our required ALLL and record additional provision for loan loss exposure.
The components of noninterest income for the three months ended September 30, 2020 and 2019 are shown below (dollars in thousands):
Variance
(114
-30.2
10.1
220.0
(30
-15.6
(47
-24.6
0
0.0
-100.0
1200.0
196.6
(7
-5.6
7.4
Noninterest income for the three months ended September 30, 2020 of $1.4 million was $98 thousand or 7.4% higher than the amount recorded for the three months ended September 30, 2019. Noninterest income rose due to fluctuations in several categories. Loan swap fee income increased $228 thousand and gains on sales of securities increased $84 thousand. Wealth management fees declined $114 thousand due to restructuring of the entities and market conditions. In addition, deposit account fees and debit/credit card and ATM fees declined in total by $77 thousand due to suppressed customer activity. In addition, fees on mortgage sales declined $43 thousand due to elimination of that business line.
The components of noninterest income for the nine months ended September 30, 2020 and 2019 are shown below (dollars in thousands):
49
(325
-28.9
14.4
569.2
(81
-14.3
-19.0
(360
-52.4
(52
-40.3
663
933.8
826
547.0
(74
-20.8
634
15.5
Noninterest income for the nine months ended September 30, 2020 of $4.7 million was $634 thousand or 15.5% higher than the amount recorded for the nine months ended September 30, 2019. Noninterest income increased due to fluctuations in several categories. Loan swap fee income increased $826 thousand and gains on sales of securities increased $663 thousand over the periods noted. Earnings from the proceeds of bank owned life insurance declined by $360 thousand as death proceeds were collected in the prior year, and wealth management fees declined $325 thousand due to the reasons noted above. Deposit account fees and debit/credit card and ATM fees declined in total by $183 thousand due to suppressed customer activity.
The components of noninterest expense for the three months ended September 30, 2020 and 2019 are shown below (dollars in thousands):
54
2.4
11.3
57.6
ATM, debit and credit card
-9.8
Bank franchise tax
161
6.6
Computer software
10.4
(39
-11.4
FDIC deposit insurance assessment
55
916.7
Loan expenses
3.0
Marketing, advertising and promotion
-72.9
N/A
Professional fees
213
(213
(160
576
422
36.5
374
8.2
Noninterest expense for the quarter ended September 30, 2020 of $4.9 million was $374 thousand or 8.2% higher than the quarter ended September 30, 2019. The predominant reason for the increase was that the Company incurred $549 thousand in merger-related expenses during the three months ended September 30, 2020. All professional fees accrued during the third quarter were related to due diligence and other merger-related expenses. During the three months ended September 30, 2019, $160 thousand was accrued in connection with a settlement of claims related to pending and threatened legal proceedings. Other noninterest expense increased $154 thousand period over period, primarily due to
50
increased expense of stock grants and cash compensation for directors. Marketing, advertising and promotion expenses declined over the period noted by $148 thousand, due to a conscious effort to reduce such expenses.
The components of noninterest expense for the nine months ended September 30, 2020 and 2019 are shown below (dollars in thousands):
204
2.3
142
-1.4
455
7.0
-1.9
147.2
226
208
8.7
334
592
(258
-43.6
376
620
(244
-39.4
(460
1,277
15.0
225
1.6
Noninterest expense for the nine months ended September 30, 2020 of $13.9 million was $225 thousand or 1.6% higher than the nine months ended September 30, 2019. The predominant reason for the increase was that the Company incurred $549 thousand in merger-related expenses during the nine months ended September 30, 2020. During the nine months ended September 30, 2019, $460 thousand was accrued in connection with a settlement of claims related to pending and threatened legal proceedings. Other noninterest expense increased $191 thousand period over period, primarily due to increased expense of stock grants and cash compensation for directors. Marketing, advertising and promotion expenses declined $258 thousand for the periods noted due to concerted efforts to reduce those expenses in 2020. Management continues to evaluate expenses for potential containments and reductions that would have a positive impact on net income on an ongoing basis.
The efficiency ratio (FTE) of 65.75% for the three months ended September 30, 2020 compared favorably to the 66.9% for the same quarter of 2019, due primarily to the increase in net interest income. The efficiency ratio (FTE) of 63.1% for the nine months ended September 30, 2020 also compared favorably to the 66.1% for the same period of 2019, due to a combination of increased net interest income and increased noninterest income. 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
For the nine months ended September 30, 2020 and 2019, the Company provided $1.3 million and $1.2 million for Federal income taxes, respectively, resulting in an effective income tax rate of 19.1% and 18.3%, 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, and the effective rate for the nine months ended September 30, 2019 was lower than the current year, as the proceeds from a bank-owned life insurance death benefit received during that period were tax-exempt. Certain merger related expenses will be non-deductible for tax purposes.
OTHER SIGNIFICANT EVENTS
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 the SEC’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, 2020 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.
52
ITEM 6. EXHIBITS.
Exhibit
Description of Exhibit
2.1
3.1
Agreement and Plan of Reorganization, dated September 30, 2020, between Virginia National Bankshares Corporation and Fauquier Bankshares, Inc. (incorporated by reference to Exhibit 2.1 to Virginia National Bankshares Corporation’s Form 8-K filed with the SEC on October 2, 2020).
Articles of Incorporation of Virginia National Bankshares Corporation, as amended and restated (incorporated by reference to Exhibit 3.1 to Virginia National Bankshares Corporation’s Pre-effective Amendment No. 1 to Form S-4 Registration Statement filed with the SEC on April 12, 2013).
Bylaws of Virginia National Bankshares Corporation, as amended and restated, (incorporated by reference to Exhibit 3.2 to Virginia National Bankshares Corporation’s Current Report on Form 8-K filed with the SEC on March 30, 2020).
Form of Amended and Restated Management Continuity Agreement, executed September 28, 2020, between Virginia National Bankshares Corporation and each of Glenn W. Rust, Virginia R. Bayes, Tara Y. Harrison and Donna G. Shewmake (incorporated by reference to Exhibit 10.1 to Virginia National Bankshares Corporation’s Form 8-K filed with the SEC on September 28, 2020).
31.1
302 Certification of Principal Executive Officer
31.2
302 Certification of Principal Financial Officer
32.1
906 Certification
101
The following financial statements from the Company's Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline eXtensible Business Reporting Language, pursuant to Rule 405 of Regulation S-T (1): (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Net Loss and Comprehensive Loss (unaudited), (iv) Consolidated Statements of Stockholders' Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited), tagged as blocks of text and including detailed tags
104
The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2020, formatted in Inline eXtensible Business Reporting Language (included with Exhibit 101.0)
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
(principal executive officer)
Date:
November 6, 2020
/s/ Tara Y. Harrison
Tara Y. Harrison
Executive Vice President and Chief Financial Officer
(principal financial and accounting officer)