Item 1A. RISK FACTORS.
The Company’s business is subject to risk. The following discussion, along with management’s discussion and analysis and the financial statements and footnotes, sets forth the most significant risks and uncertainties that management believes could adversely affect the Company’s business, financial condition or results of operations. Additional risks and uncertainties that management is not aware of or that management currently deems immaterial may also have a material adverse effect on the Company’s business, financial condition or results of operations. There is no assurance that this discussion covers all potential risks that the Company faces.
Summary of Risk Factors
The following is a summary of the most significant risks and uncertainties that the Company believes could adversely affect its business, financial condition or results of operations.
Credit Risks
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The Company must effectively manage its credit risks, as credit standards and credit assessment processes might not protect it from significant losses.
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The Bank’s ALLL may be insufficient and any increases in the ALLL may have a material adverse effect on the Company’s financial condition and results of operations.
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Lending to small to mid-sized community-based businesses may increase the Company’s credit risk.
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The concentration in loans secured by real estate may increase the Company’s future credit losses.
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The Company has a moderate concentration of credit exposure in commercial real estate and loans with this type of collateral are viewed as having more risk of default.
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The ability of borrowers to repay their loans significantly affect the Company’s results of operations.
Liquidity Risks
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While the Company believes that liquidity sources are currently adequate, the Company must effectively manage its liquidity risk, as liquidity needs could adversely affect results of operations and financial condition.
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The Company may need to raise additional capital in the future and may not be able to do so on acceptable terms, or at all.
Market Risks
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The Company may be adversely impacted by changes in market conditions.
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Change in economic conditions, especially in the areas in which the Company conducts operations, could materially and negatively affect its business.
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The Company’s business is subject to interest rate risk, and variations in interest rates and inadequate management of interest rate risk may negatively affect financial performance.
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The Company may be adversely affected by changes in the method of determining LIBOR, or the replacement of LIBOR with an alternative reference rate, for variable rate loans.
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The Company relies upon independent appraisals to determine the value of the real estate that secures a significant portion of its loans and the value of any foreclosed properties that may be carried on its books, and the values indicated by such appraisals may not be realizable if it is forced to foreclose upon such loans or liquidate such foreclosed property.
Strategic Risks
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The Company faces strong and growing competition from financial services companies and other companies that offer banking and other financial services, which could negatively affect the Company’s business.
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The Company may not be able to successfully manage its long-term growth.
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The success of the Company’s strategy depends on its ability to identify and retain individuals with experience and relationships in its markets.
Operational Risks
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The Company must effectively manage its operational risks, as it is subject to a variety of operational risks, including reputational risk, legal and compliance risk, and the risk of fraud or theft by employees or outsiders.
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Changes in accounting standards could impact reported earnings.
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Failure to maintain effective systems of internal and disclosure control could have a material adverse effect on the Company’s results of operation and financial condition.
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The Company depends on the accuracy and completeness of information about clients and counterparties.
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The Company’s success depends on its management team, and the unexpected loss of any of these personnel could adversely affect operations.
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The Company relies on other companies to provide key components of its business infrastructure.
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The soundness of other financial institutions could adversely affect the Company.
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The Company’s operations may be adversely affected by cybersecurity risks.
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Consumers may increasingly decide not to use banks to complete their financial transactions.
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The Company’s ability to operate profitably may be dependent on its ability to integrate or introduce various technologies into its operations.
Legal, Regulatory and Compliance Risks
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The Company operates in a highly regulated industry.
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Regulations issued by the CFPB could adversely impact earnings due to, among other things, increased compliance costs or costs due to noncompliance.
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The Company is subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws or another incident involving personal, confidential or proprietary information of individuals could damage the Company’s reputation.
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The Company’s business and earnings are impacted by governmental, fiscal and monetary policy over which it has no control.
Risks Relating to the Company’s Common Stock
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The Company is not obligated to pay dividends and its ability to pay dividends is limited.
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Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive.
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The Company’s governing documents and Virginia law contain provisions that may discourage or delay an acquisition of the Company.
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An investment in the Company’s common stock is not an insured deposit.
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The Company qualifies as a “smaller reporting company,” and the reduced disclosure obligations applicable to smaller reporting companies may make its common stock less attractive to investors.
General Risk Factors
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The ongoing COVID-19 pandemic and measures intended to prevent its spread may adversely affect the Company’s business, financial condition and operations; the extent of such impacts are highly uncertain and difficult to predict.
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The Company is exposed to environmental liabilities with respect to properties to which it takes title.
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Severe weather, earthquakes, other natural disasters, pandemics, acts of war or terrorism and other external events could significantly impact our business.
Risk Factors Associated with the Company’s Business
Credit Risks
The Company’s credit standards and its on-going credit assessment processes might not protect it from significant credit losses.
The Company assumes credit risk by virtue of making loans and extending loan commitments and letters of credit. The Company manages credit risk through a program of underwriting standards, the review of certain credit decisions and a continuous quality assessment process of credit already extended. The Company’s exposure to credit risk is managed through the use of consistent underwriting standards that emphasize local lending while avoiding highly leveraged transactions, as well as excessive industry and other concentrations. The Company’s credit administration function employs risk management techniques to help ensure that problem loans are promptly identified. While these procedures are designed to provide the Company with the information needed to implement policy adjustments where necessary and to take appropriate corrective actions, there can be no assurance that such measures will be effective in avoiding undue credit risk.
The Bank’s ALLL may be insufficient and any increases in the ALLL may have a material adverse effect on the Company’s financial condition and results of operations.
The Bank maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents the Bank’s best estimate of probable losses that will be incurred within the existing portfolio of loans. The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio.
The level of the allowance reflects management’s evaluation of the level of loans outstanding, the level of nonperforming loans, historical loan loss experience, delinquency trends, underlying collateral values, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions. The determination of the appropriate level of the ALLL inherently involves a high degree of subjectivity and requires the Bank to make significant
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estimates of current credit risks and future trends, all of which may undergo material changes. The outbreak of COVID-19 and the unprecedented governmental response have made these subjective judgments even more difficult. Although the Bank believes the ALLL is a reasonable estimate of known and inherent losses in the loan portfolio, it cannot precisely predict such losses or be certain that the loan loss allowance will be adequate in the future. Deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification of additional problem loans and other factors, both within and outside the Bank’s control, may require an increase in the allowance for loan losses. In addition, bank regulatory agencies and the Bank’s auditors periodically review its ALLL and may require an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different than those of management. Further, if charge-offs in future periods exceed the allowance for loan losses, the Bank will need additional provisions to increase the allowance for loan losses.
The Company’s focus on lending to small to mid-sized community-based businesses may increase its credit risk.
Most of the Company’s commercial business and commercial real estate loans are made to small and mid-sized businesses and non-profits. These businesses generally have fewer financial resources in terms of capital or borrowing capacity than larger entities and have a heightened vulnerability to economic conditions. If general economic conditions in the market areas in which the Company operates negatively impact this important customer sector, the Company’s results of operations and financial condition may be adversely affected. Moreover, a portion of these loans have been made by the Company in recent years and the borrowers may not have experienced a complete business or economic cycle. Any deterioration of the borrowers’ businesses may hinder their ability to repay their loans with the Company, which could have a material adverse effect on its financial condition and results of operations. Steps to mitigate such risks include underwriting multiple sources of repayment, including but not limited, to business cash flow, personal guarantees, collateral, and government guarantees, where applicable. Although the Company has taken these mitigation steps, there is no guarantee that such practices will be effective to prevent the increased credit risk.
The Company’s concentration in loans secured by real estate may increase its future credit losses, which would negatively affect the Company’s financial results.
The Company offers a variety of secured loans, including commercial lines of credit, commercial term loans, real estate, construction, home equity, consumer and other loans. Credit risk and credit losses can increase if its loans are concentrated to borrowers who, as a group, may be uniquely or disproportionately affected by economic or market conditions. As of December 31, 2021, approximately 78.4% of the Company’s loans are secured by real estate, both residential and commercial. The Company has established concentration limits that are regularly monitored by management and reported to the Board. A major change in the real estate market in the regions in which the Company operates, resulting in a deterioration in real estate values, or in the local or national economy, including changes caused by the COVID-19 pandemic, could adversely affect the Company’s customers’ ability to pay these loans, which in turn could adversely impact the Company. Risk of loan defaults and foreclosures are inherent in the banking industry, and the Company tries to limit its exposure to this risk by carefully underwriting and monitoring its extensions of credit. The Company cannot fully eliminate credit risk, and as a result, credit losses may occur in the future.
The Company has a moderate concentration of credit exposure in commercial real estate and loans with this type of collateral are viewed as having more risk of default.
As of December 31, 2021, the Company had approximately $374.0 million in loans secured by commercial real estate, which represented approximately 35.2% of total loans outstanding at that date; such loans consist of non-owner occupied commercial real estate, construction, land development, multi-family and other land loans. These types of loans are generally viewed as having more risk of default than residential real estate loans. They are also typically larger than residential real estate loans and consumer loans and depend on cash flows from the property to service the debt, successful completion of construction projects and, for development loans, sale of the underlying asset. It may be more difficult for commercial real estate borrowers to repay their loans in a timely manner, as commercial real estate borrowers’ abilities to repay their loans frequently depends on the successful rental of their properties. Cash flows may be affected significantly by general economic conditions, and a sustained downturn in the local economy or in occupancy rates in the local economy where the property is located could increase the likelihood of default. Because the Company’s loan portfolio contains a number of commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in its percentage of nonperforming loans. An increase in nonperforming loans could result in a loss of earnings from these loans, an increase in the provision for loan losses and an increase in charge-offs, all of which could have a material adverse effect on the Company’s financial condition. The Company’s banking regulators generally give commercial real estate lending greater scrutiny and may require banks with higher levels of commercial real estate loans to implement improved underwriting, internal controls, risk management policies and portfolio stress testing, as well as possibly higher levels of allowances for losses and capital as a result of commercial real estate lending growth and exposures, which could have a material adverse effect on the Company’s results of operations. Steps to mitigate such risks
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include underwriting multiple sources of repayment, including but not limited, to business cash flow, personal guarantees, collateral, and government guarantees, where applicable. In addition, the Company has established concentration limits that are regularly monitored by management and reported to the Board. Although the Company has taken these mitigation steps, there is no guarantee that such practices will be effective to prevent the increased credit risk.
The Company’s results of operations are significantly affected by the ability of borrowers to repay their loans.
A significant source of risk for the Company is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements. Most of the Company’s loans are secured but some loans are unsecured. With respect to the secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans. Collateral values may be adversely affected by changes in economic, environmental and other conditions, including the impacts of the COVID-19 pandemic, declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, terrorist activity, environmental contamination and other external events. In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not. The Company has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss. An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations.
Liquidity Risks
The Company’s liquidity needs could adversely affect results of operations and financial condition.
The Company’s primary sources of funds are deposits and loan repayments. While scheduled loan repayments are a relatively stable source of funds, they are subject to the ability of borrowers to repay the loans. The ability of borrowers to repay loans can be adversely affected by a number of factors, including, but not limited to, changes in economic conditions, adverse trends or events affecting business industry groups, reductions in real estate values or markets, availability of, and/or access to, sources of refinancing, business closings or lay-offs, pandemics or endemics, inclement weather, natural disasters and international instability. Additionally, deposit levels may be affected by a number of factors, including, but not limited to, rates paid by competitors, general interest rate levels, regulatory capital requirements, returns available to customers on alternative investments and general economic conditions. Accordingly, the Company may be required from time to time to rely on secondary sources of liquidity to meet withdrawal demands or otherwise fund operations. Such sources include FHLB advances, sales of securities and loans, federal funds lines of credit from correspondent banks and borrowings from the Federal Reserve Discount Window, as well as additional out-of-market time deposits and brokered deposits. While the Company believes that these sources are currently adequate, there can be no assurance they will be sufficient to meet future liquidity demands, particularly if the Company continues to grow and experiences increasing loan demand. The Company may be required to slow or discontinue loan growth, capital expenditures or other investments or liquidate assets should such sources not be adequate.
The Company may need to raise additional capital in the future and may not be able to do so on acceptable terms, or at all.
Access to sufficient capital is critical in order to enable the Company to implement its business plan, support its business, expand its operations and meet applicable capital requirements. The inability to have sufficient capital, whether internally generated through earnings or raised in the capital markets, could adversely impact the Company’s ability to support and to grow its operations. If the Company grows its operations faster than it generates capital internally, it will need to access the capital markets. The Company may not be able to raise additional capital in the form of additional debt or equity on acceptable terms, or at all. The Company’s ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, the Company’s financial condition and its results of operations. Economic conditions and a loss of confidence in financial institutions may increase the Company’s cost of capital and limit access to some sources of capital. Further, if the Company needs to raise capital in the future, it may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse impact on the Company’s business, financial condition and results of operations.
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Market Risks
The Company may be adversely impacted by changes in market conditions.
The Company is directly and indirectly affected by changes in market conditions. Market risk generally represents the risk that values of assets and liabilities or revenues will be adversely affected by changes in market conditions. As a financial institution, market risk is inherent in the financial instruments associated with the Company’s operations and activities, including loans, deposits, securities, and short-term borrowings. A few of the market conditions that may shift from time to time, thereby exposing the Company to market risk, include fluctuations in interest rates, equity and futures prices, and price deterioration or changes in value due to changes in market perception or actual credit quality of issuers. The Company’s investment securities portfolio, in particular, may be impacted by market conditions beyond its control, including rating agency downgrades of the securities, defaults of the issuers of the securities, lack of market pricing of the securities, and inactivity or instability in the credit markets. Any changes in these conditions, in current accounting principles or interpretations of these principles could impact the Company’s assessment of fair value and thus the determination of other-than-temporary impairment of the securities in the investment securities portfolio, which could adversely affect the Company’s earnings and capital ratios.
Asset values also directly impact revenues in the Company’s wealth management businesses. The Company receives asset-based management fees based on the value of clients’ portfolios or investments in funds managed by the Company and, in some cases, the Company may also receive performance fees based on increases in the value of such investments. Declines in asset values can reduce the value of clients’ portfolios or fund assets, which in turn can result in lower fees earned for managing such assets.
Changes in economic conditions, especially in the areas in which the Company conducts operations, could materially and negatively affect its business.
The Company’s business is directly impacted by economic conditions, legislative and regulatory changes, changes in government monetary and fiscal policies, and inflation, all of which are beyond its control. A deterioration in economic conditions, whether caused by global, national or local concerns (including the COVID-19 pandemic), especially within the Company’s market area, could result in the following potentially material consequences: loan delinquencies increasing; problem assets and foreclosures increasing; demand for products and services decreasing; low cost or noninterest bearing deposits decreasing; and collateral for loans, especially real estate, declining in value, in turn reducing customers’ borrowing power, and reducing the value of assets and collateral associated with existing loans. A continued economic downturn could result in losses that materially and adversely affect the Company’s business.
The Company’s business is subject to interest rate risk, and variations in interest rates and inadequate management of interest rate risk may negatively affect financial performance.
Changes in the interest rate environment may reduce the Company’s profits. It is expected that the Company will continue to realize income from the differential or “spread” between the interest earned on loans, securities, and other interest-earning assets, and interest paid on deposits, borrowings and other interest-bearing liabilities. Net interest spreads are affected by the difference between the maturities and repricing characteristics of interest-earning assets and interest-bearing liabilities. In addition, loan volume and yields are affected by market interest rates on loans, and the current interest rate environment encourages extreme competition for new loan originations from qualified borrowers. The Company’s management cannot ensure that it can minimize interest rate risk. If the interest rates paid on deposits and other borrowings increase at a faster rate than the interest rates received on loans and other investments, the Company’s net interest income, and therefore earnings, could be adversely affected. Earnings could also be adversely affected if the interest rates received on loans and other investments fall more quickly than the interest rates paid on deposits and other borrowings. Accordingly, changes in levels of market interest rates could materially and adversely affect the net interest spread, asset quality, loan origination volume and the Company’s overall profitability.
The Company may be adversely affected by changes in the method of determining LIBOR, or the replacement of LIBOR with an alternative reference rate, for variable rate loans.
LIBOR and certain other interest rate benchmarks are the subject of recent national and international reform. Intercontinental Exchange, Inc., the company that administers LIBOR, stated in March 2021 that it would cease the publication of one week and two month LIBOR rates immediately after the LIBOR publication on December 31, 2021, and the remaining LIBOR rates immediately following the LIBOR publication on June 30, 2023. The U.S. federal banking agencies have issued statements to encourage U.S. banks to transition away from U.S. dollar LIBOR as soon as practicable and not to enter into new contracts that use U.S. dollar LIBOR after December 31, 2021.
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Given LIBOR’s extensive use across financial markets, the transition away from LIBOR presents various risks and challenges to financial markets and institutions, including to the Company, and liquidity in the interbank markets on which those LIBOR estimates are based has been declining. It is not possible to predict the effect of these changes, other reforms or the establishment of alternative reference rates in the United Kingdom or elsewhere. Efforts in the United States to identify a set of alternative U.S. dollar reference rates include a proposal by the Alternative Reference Rates Committee of the Federal Reserve Board and the Federal Reserve Bank of New York for the market to transition from LIBOR to the Secured Overnight Financing Rate. Whether or not the SOFR attains market acceptance as a LIBOR replacement remains in question and the future of LIBOR at this time is uncertain. The Company has begun offering lending solutions to its customers based on SOFR and certain prime-linked variable rates, and has ceased origination of new loans or other products using a LIBOR rate or index.
The market transition away from LIBOR to alternative reference rates is a complex process and could have a range of effects on the Company’s business, financial condition and results of operations, including but not limited to by (i) adversely affecting the interest rates received or paid on the revenues and expenses associated with, or the value of the Company’s LIBOR-based assets and liabilities; (ii) adversely affecting the interest rates paid on or received from other securities or financial arrangements, given LIBOR’s historically prominent role in determining market interest rates globally, or (iii) resulting in disputes, litigation or other actions with borrowers or other counterparties about the interpretation or enforceability of certain fallback language contained in LIBOR-based loans, securities or other contracts. In addition, uncertainty regarding the nature of such potential changes, alternative reference rates or other reforms may adversely affect the trading market for securities on which the interest or dividend is determined by reference to LIBOR, including the Company’s trust preferred securities. The discontinuation of LIBOR could also result in operational, legal and compliance risks, and if the Company is unable to adequately manage such risks, they could have a material adverse impact on the Company’s reputation and on its business, financial condition, results of operations or future prospects.
The Company relies upon independent appraisals to determine the value of the real estate that secures a significant portion of its loans and the value of any foreclosed properties that may be carried on its books, and the values indicated by such appraisals may not be realizable if it is forced to foreclose upon such loans or liquidate such foreclosed property.
As indicated above, a significant portion of the Company’s loan portfolio consists of loans secured by real estate and it may also hold foreclosed properties from time to time. The Company relies upon independent appraisers to estimate the value of such real estate. Appraisals are only estimates of value and the independent appraisers may make mistakes of fact or judgment that adversely affect the reliability of their appraisals. In addition, events occurring after the initial appraisal may cause the value of the real estate to increase or decrease. As a result of any of these factors, the real estate securing some of the Company’s loans and any foreclosed properties that may be held by the Company may be more or less valuable than anticipated. If a default occurs on a loan secured by real estate that is less valuable than originally estimated, the Company may not be able to recover the outstanding balance of the loan. It may also be unable to sell any foreclosed properties for the values estimated by their appraisals.
Strategic Risks
The Company faces strong and growing competition from financial services companies and other companies that offer banking and other financial services, which could negatively affect the Company’s business.
The Company encounters substantial competition from other financial institutions in its market area and competition is increasing. Ultimately, the Company may not be able to compete successfully against current and future competitors. Many competitors offer the same banking services that the Company offers in its service area. These competitors include national, regional and community banks. The Company also faces competition from many other types of financial institutions, including finance companies, mutual and money market fund providers, brokerage firms, insurance companies, credit unions, financial subsidiaries of certain industrial corporations, financial technology companies and mortgage companies. Increased competition may result in reduced business for the Company.
Additionally, banks and other financial institutions with larger capitalization and financial intermediaries not subject to bank regulatory restrictions have larger lending limits and are thereby able to serve the credit needs of larger customers. Areas of competition include interest rates for loans and deposits, efforts to obtain loans and deposits, and range and quality of products and services provided, including new technology-driven products and services. If the Company is unable to attract and retain banking customers, it may be unable to continue to grow loan and deposit portfolios and its results of operations and financial condition may otherwise be adversely affected.
The Company may not be able to successfully manage its long-term growth, which may adversely affect its results of operations and financial condition.
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A key aspect of the Company’s long-term business strategy is its continued growth and expansion. The Company’s ability to continue to grow depends, in part, upon its ability to (i) open new branch offices or acquire existing branches or other financial institutions, such as Fauquier, (ii) attract deposits to those locations, and (iii) identify attractive loan and investment opportunities.
The Company may not be able to successfully implement its growth strategy if it is unable to identify attractive markets, locations or opportunities to expand in the future, or if the Company is subject to regulatory restrictions on growth or expansion of its operations. The Company’s ability to manage its growth successfully also will depend on whether it can maintain capital levels adequate to support its growth, maintain cost controls and asset quality and successfully integrate any businesses the Company acquires into its organization. As the Company identifies opportunities to implement its growth strategy by opening new branches or acquiring branches or other banks, it may incur increased personnel, occupancy and other operating expenses. In the case of new branches, the Company must absorb those higher expenses while it begins to generate new deposits, and there is a further time lag involved in redeploying new deposits into attractively priced loans and other higher yielding assets.
The Company may consider acquiring other businesses or expanding into new product lines that it believes will help it fulfill its strategic objectives. The Company expects that other banking and financial companies, some of which have significantly greater resources, will compete with it to acquire financial services businesses. This competition could increase prices for potential acquisitions that the Company believes are attractive. Acquisitions may also be subject to various regulatory approvals. If the Company fails to receive the appropriate regulatory approvals, it will not be able to consummate acquisitions that it believes are in its best interests.
When the Company enters into new markets or new lines of business, its lack of history and familiarity with those markets, clients and lines of business may lead to unexpected challenges or difficulties that inhibit its success. The Company’s plans to expand could depress earnings in the short run, even if it efficiently executes a growth strategy leading to long-term financial benefits.
The success of the Company’s strategy depends on its ability to identify and retain individuals with experience and relationships in its markets.
In order to be successful, the Company must identify and retain experienced key management members and sales staff with local expertise and relationships. Competition for qualified personnel is intense and there is a limited number of qualified persons with knowledge of and experience in the community banking and mortgage industry in the Company’s chosen geographic market. Even if the Company identifies individuals that it believes could assist it in building its franchise, it may be unable to recruit these individuals away from their current employers. In addition, the process of identifying and recruiting individuals with the combination of skills and attributes required to carry out the Company’s strategy is often lengthy. The Company’s inability to identify, recruit and retain talented personnel could limit its growth and could materially adversely affect its business, financial condition and results of operations.
Operational Risks
The Company is subject to a variety of operational risks, including reputational risk, legal and compliance risk, and the risk of fraud or theft by employees or outsiders.
The Company is exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, unauthorized transactions by employees, operational errors, clerical or record-keeping errors, and errors resulting from faulty or disabled computer or communications systems.
Reputational risk, or the risk to the Company’s earnings and capital from negative public opinion, could result from the Company’s actual or alleged conduct in any number of activities, including lending practices, corporate governance, and from actions taken by government regulators and community organizations in response to those activities. Negative public opinion can adversely affect the Company’s ability to attract and keep customers and employees and can expose it to litigation and regulatory action.
Further, if any of the Company’s financial, accounting, or other data processing systems fail or have other significant issues, the Company could be adversely affected. The Company depends on internal systems and outsourced technology to support these data storage and processing operations. The Company’s inability to use or access these information systems at critical points in time could unfavorably impact the timeliness and efficiency of the Company’s business operations. It could be adversely affected if one of its employees causes a significant operational break-down or failure, either as a result of human error or where an individual purposefully sabotages or fraudulently manipulates its operations or systems. The Company is also at risk of the impact of natural disasters, terrorism and international hostilities on its systems and from the
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effects of outages or other failures involving power or communications systems operated by others. The Company may also be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or communications outages), which may give rise to disruption of service to customers and to financial loss or liability. In addition, there have been instances where financial institutions have been victims of fraudulent activity in which criminals pose as customers to initiate wire and automated clearinghouse transactions out of customer accounts. Although the Company has policies and procedures in place to verify the authenticity of its customers, it cannot guarantee that such policies and procedures will prevent all fraudulent transfers. Such activity can result in financial liability and harm to the Company’s reputation. If any of the foregoing risks materialize, it could have a material adverse effect on the Company’s business, financial condition and results of operations.
Changes in accounting standards could impact reported earnings.
The authorities that promulgate accounting standards, including the FASB, the SEC and other regulatory authorities, periodically change the financial accounting and reporting standards that govern the preparation of the Company’s consolidated financial statements. These changes are difficult to predict and can materially impact how the Company records and reports its financial condition and results of operations. In some cases, the Company could be required to apply a new or revised standard retroactively, resulting in the restatement of financial statements for prior periods. Such changes could also require the Company to incur additional personnel or technology costs.
Failure to maintain effective systems of internal and disclosure control could have a material adverse effect on the Company’s results of operation and financial condition.
Effective internal and disclosure controls are necessary for the Company to provide reliable financial reports and effectively prevent fraud and to operate successfully as a public company. The Bank is also required to establish and maintain an adequate internal control structure over financial reporting pursuant to regulations of the FDIC. As a public company, the Company is required by the Sarbanes-Oxley Act to design and maintain a system of internal control over financial reporting and include management’s assessment regarding internal control over financial reporting. If the Company cannot provide reliable financial reports or prevent fraud, its reputation and operating results would be harmed. As part of the Company’s ongoing monitoring of internal control, it may discover material weaknesses or significant deficiencies in its internal control that require remediation. A “material weakness” is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of a company’s annual or interim financial statements will not be prevented or detected on a timely basis.
The Company’s inability to maintain the operating effectiveness of the controls described above could result in a material misstatement to the Company’s financial statements or other disclosures, which could have an adverse effect on its business, financial condition or results of operations. In addition, any failure to maintain effective controls or to timely effect any necessary improvement of the Company’s internal and disclosure controls could, among other things, result in losses from fraud or error, harm the Company’s reputation or cause investors to lose confidence in its reported financial information, all of which could have a material adverse effect on its results of operation and financial condition.
The Company depends on the accuracy and completeness of information about clients and counterparties, and the Company’s financial condition could be adversely affected if it relies on misleading or incorrect information.
In deciding whether to extend credit or to enter into other transactions with clients and counterparties, the Company may rely on information furnished to it by or on behalf of clients and counterparties, including financial statements and other financial information, which it does not independently verify. The Company also may rely on representations of clients and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. For example, in deciding whether to extend credit to clients, the Company may assume that a client’s audited financial statements conform with GAAP and present fairly, in all material respects, the financial condition, results of operations and cash flows of that client. The Company’s financial condition and results of operations could be negatively impacted to the extent it relies on financial statements that do not comply with GAAP or are materially misleading.
The Company’s success depends on its management team, and the unexpected loss of any of these personnel could adversely affect operations.
The Company’s success is, and is expected to remain, highly dependent on its management team. This is particularly true because, as a community bank, the Company depends on the management team’s ties to the community and customer relationships to generate business. The Company’s growth will continue to place significant demands on management, and the loss of any such person’s services may have an adverse effect upon growth and profitability. If the Company fails to retain or continue to recruit qualified employees, growth and profitability could be adversely affected.
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The Company relies on other companies to provide key components of its business infrastructure.
Third parties provide key components of the Company’s business operations such as data processing, recording and monitoring transactions, online banking interfaces and services, internet connections and network access. While the Company has selected these third-party vendors carefully, it does not control their actions. Any problem caused by these third parties, including poor performance of services, failure to provide services, disruptions in communication services provided by a vendor and failure to handle current or higher volumes, could adversely affect the Company’s ability to deliver products and services to its customers and otherwise conduct its business, and may harm its reputation. Financial or operational difficulties of a third-party vendor could also hurt the Company’s operations if those difficulties interfere with the vendor’s ability to serve the Company. Replacing these third-party vendors could also create significant delay and expense. Accordingly, use of such third-parties creates an unavoidable inherent risk to the Company’s business operations.
The soundness of other financial institutions could adversely affect the Company.
The Company’s ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. The Company has exposure to many different industries and counterparties, and routinely executes transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by the Company or by other institutions. Many of these transactions expose the Company to credit risk in the event of default of its counterparty or client. In addition, credit risk may be exacerbated when the collateral held cannot be realized upon or is liquidated at prices insufficient to recover the full amount of the financial instrument exposure due. There is no assurance that any such losses would not materially and adversely affect results of operations.
The Company’s operations may be adversely affected by cybersecurity risks.
In the ordinary course of business, the Company collects and stores sensitive data, including proprietary business information and personally identifiable information related to its customers and employees in systems and on networks. The secure processing, maintenance, and use of this information is critical to operations and the Company’s business strategy. The Company has invested in accepted technologies, and continually reviews processes and practices that are designed to protect its networks, computers, and data from damage or unauthorized access. Despite these security measures, the Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance or other disruptions. A breach of any kind could compromise systems and the information stored there could be accessed, damaged or disclosed. A breach in security could result in legal claims, regulatory penalties, disruption in operations, and damage to the Company’s reputation, which could adversely affect its business and financial condition. Furthermore, as cyber threats continue to evolve and increase, the Company may be required to expend significant additional financial and operational resources to modify or enhance its protective measures, or to investigate and remediate any identified information security vulnerabilities.
In addition, multiple major U.S. retailers have experienced data systems incursions reportedly resulting in the thefts of credit and debit card information, online account information and other financial or privileged data. Retailer incursions affect cards issued and deposit accounts maintained by many banks, including Virginia National Bank. Although the Company’s systems are not breached in retailer incursions, these events can cause it to reissue a significant number of cards and take other costly steps to avoid significant theft loss to the Company and its customers. In some cases, the Company may be required to reimburse customers for the losses they incur. Other possible points of intrusion or disruption not within the Company’s control include internet service providers, electronic mail portal providers, social media portals, distant-server (cloud) service providers, electronic data security providers, data processing service providers, telecommunications companies, and smart phone manufacturers.
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Consumers may increasingly decide not to use banks to complete their financial transactions, which would have a material adverse impact on the Company’s financial condition and operations.
Technology and other changes are allowing parties to complete financial transactions through alternative methods that historically have involved banks. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts, mutual funds or general-purpose reloadable prepaid cards. Consumers can also complete transactions such as paying bills or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries, known as “disintermediation,” could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost of deposits as a source of funds could have a material adverse effect on the Company’s financial condition and results of operations.
The Company’s ability to operate profitably may be dependent on its ability to integrate or introduce various technologies into its operations.
The market for financial services, including banking and consumer finance services, is increasingly affected by advances in technology, including developments in telecommunications, data processing, computers, automation, online banking and tele-banking. The Company’s ability to compete successfully in its market may depend on the extent to which it is able to implement or exploit such technological changes. If the Company is not able to afford such technologies, properly or timely anticipate or implement such technologies, or effectively train its staff to use such technologies, its business, financial condition or operating results could be adversely affected.
Legal, Regulatory and Compliance Risks
The Company operates in a highly regulated industry and the laws and regulations that govern the Company’s operations, corporate governance, executive compensation and financial accounting, or reporting, including changes in them or the Company’s failure to comply with them, may adversely affect the Company.
The Company is subject to extensive regulation and supervision that govern almost all aspects of its operations. These laws and regulations, among other matters, prescribe minimum capital requirements, impose limitations on the Company’s business activities, limit the dividends or distributions that it can pay, restrict the ability of institutions to guarantee its debt and impose certain specific accounting requirements that may be more restrictive and may result in greater or earlier charges to earnings or reductions in its capital than GAAP. Compliance with laws and regulations can be difficult and costly, and changes to laws and regulations often impose additional compliance costs.
The Company is currently facing increased regulation and supervision of its industry as a result of the financial crisis in the banking and financial markets. The Dodd-Frank Act instituted major changes to the banking and financial institutions regulatory regimes. Other changes to statutes, regulations or regulatory policies or supervisory guidance, including changes in interpretation or implementation of statutes, regulations, policies or supervisory guidance, could affect the Company in substantial and unpredictable ways. Such additional regulation and supervision has increased, and may continue to increase, the Company’s costs and limit its ability to pursue business opportunities. Further, the Company’s failure to comply with these laws and regulations, even if the failure was inadvertent or reflects a difference in interpretation, could subject it to restrictions on its business activities, fines and other penalties, any of which could adversely affect the Company’s results of operations, capital base and the price of its securities. Further, any new laws, rules and regulations could make compliance more difficult or expensive or otherwise adversely affect the Company’s business and financial condition.
Regulations issued by the CFPB could adversely impact earnings due to, among other things, increased compliance costs or costs due to noncompliance.
The CFPB has broad rulemaking authority to administer and carry out the provisions of the Dodd-Frank Act with respect to financial institutions that offer covered financial products and services to consumers. The CFPB has also been directed to write rules identifying practices or acts that are unfair, deceptive or abusive in connection with any transaction with a consumer for a consumer financial product or service, or the offering of a consumer financial product or service. For example, the CFPB issued a final rule, effective January 10, 2014, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms, or to originate “qualified mortgages” that meet specific requirements with respect to terms, pricing and fees. The rule also contains additional disclosure requirements at mortgage loan origination and in monthly statements. The requirements under the CFPB’s regulations and policies could limit the Company’s ability to make certain types of loans or loans to certain borrowers, or could make it more expensive and/or time consuming to make these loans, which could adversely impact the Company’s profitability.
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The Company is subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws or another incident involving personal, confidential or proprietary information of individuals could damage the Company’s reputation and otherwise adversely affect its business.
The Company’s business requires the collection and retention of large volumes of customer data, including PII in various information systems that the Company maintains and in those maintained by third party service providers. The Company also maintains important internal company data such as PII about its employees and information relating to its operations. The Company is subject to complex and evolving laws and regulations governing the privacy and protection of PII of individuals (including customers, employees and other third-parties). For example, the Company’s business is subject to the Gramm-Leach-Bliley Act of 1999, which, among other things: (i) imposes certain limitations on the Company’s ability to share nonpublic PII about its customers with nonaffiliated third parties; (ii) requires that the Company provides certain disclosures to customers about its information collection, sharing and security practices and affords customers the right to “opt out” of any information sharing by it with nonaffiliated third parties (with certain exceptions); and (iii) requires that the Company develops, implements and maintains a written comprehensive information security program containing appropriate safeguards based on the Company’s size and complexity, the nature and scope of its activities, and the sensitivity of customer information it processes, as well as plans for responding to data security breaches. Various federal and state banking regulators and states have also enacted data breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in the event of a security breach. Ensuring that the Company’s collection, use, transfer and storage of PII complies with all applicable laws and regulations can increase the Company’s costs. Furthermore, the Company may not be able to ensure that customers and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused, the Company could be exposed to litigation or regulatory sanctions under privacy and data protection laws and regulations. Concerns regarding the effectiveness of the Company’s measures to safeguard PII, or even the perception that such measures are inadequate, could cause the Company to lose customers or potential customers and thereby reduce its revenues. Accordingly, any failure, or perceived failure, to comply with applicable privacy or data protection laws and regulations may subject the Company to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage the Company’s reputation and otherwise adversely affect its operations, financial condition and results of operations.
The Company’s business and earnings are impacted by governmental, fiscal and monetary policy over which it has no control.
The Company is affected by domestic monetary policy. The Federal Reserve regulates the supply of money and credit in the United States, and its policies determine in large part the Company’s cost of funds for lending, investing and capital raising activities and the return it earns on those loans and investments, both of which affect the Company’s net interest margin. The actions of the Federal Reserve also can materially affect the value of financial instruments that the Company holds, such as loans and debt securities, and also can affect the Company’s borrowers, potentially increasing the risk that they may fail to repay their loans. The Company’s business and earnings also are affected by the fiscal or other policies that are adopted by various regulatory authorities of the United States. Changes in fiscal or monetary policy are beyond the Company’s control and hard to predict.
Risks Related to the Company’s Common Stock
The Company is not obligated to pay dividends and its ability to pay dividends is limited.
The Company’s ability to make dividend payments on its common stock depends primarily on certain regulatory considerations and the receipt of dividends and other distributions from the Bank. There are various regulatory restrictions on the ability of banks, such as the Bank, to pay dividends or make other payments to their holding companies. The Company is currently paying a quarterly cash dividend to holders of its common stock at a rate of $0.30 per share. Although the Company has paid a quarterly cash dividend to the holders of its common stock since July 2013, holders of its common stock are not entitled to receive dividends, and the Company is not obligated to pay dividends in any particular amounts or at any particular times. Regulatory, economic and other factors may cause the Company’s Board to consider, among other things, the reduction of dividends paid on its common stock.
Future issuances of the Company’s common stock could adversely affect the market price of the common stock and could be dilutive.
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The Company’s Board, without the approval of shareholders, could from time to time decide to issue additional shares of common stock or shares of preferred stock, which may adversely affect the market price of the shares of common stock and could be dilutive to the Company’s shareholders. Any sale of additional shares of the Company’s common stock may be at prices lower than the current market value of the Company’s shares. In addition, new investors may have rights, preferences and privileges that are senior to, and that could adversely affect, the Company’s existing shareholders. For example, preferred stock would be senior to common stock in right of dividends and as to distributions in liquidation. The Company cannot predict or estimate the amount, timing, or nature of its future offerings of equity securities. Thus, the Company’s shareholders bear the risk of future offerings diluting their stock holdings, adversely affecting their rights as shareholders, and/or reducing the market price of the Company’s common stock.
An investment in the Company’s common stock is not an insured deposit.
The Company’s common stock is not a bank deposit and, therefore, it is not insured against loss by the FDIC or by any other public or private entity. An investment in the Company’s common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company and, as a result, shareholders may lose some or all of their investment.
The Company qualifies as a “smaller reporting company,” and the reduced disclosure obligations applicable to smaller reporting companies may make its common stock less attractive to investors.
The Company is a “smaller reporting company” as defined in federal securities laws, and will remain a smaller reporting company until the fiscal year following the determination that the market value of its voting and non-voting common shares held by non-affiliates is more than $250 million measured on the last business day of its second fiscal quarter, or its annual revenues are less than $100 million during the most recently completed fiscal year and the market value of its voting and non-voting common shares held by non-affiliates is more than $700 million measured on the last business day of its second fiscal quarter. Smaller reporting companies have reduced disclosure obligations, such as an exemption from providing selected financial data and an ability to provide simplified executive compensation information and only two years of audited financial statements. If some investors find the Company’s common stock less attractive because the Company may rely on these reduced disclosure obligations, there may be a less active trading market for its common stock and its stock price may be more volatile.
General Risk Factors
The ongoing COVID-19 pandemic and measures intended to prevent its spread may adversely affect the Company’s business, financial condition and operations; the extent of such impacts are highly uncertain and difficult to predict.
Global health and economic concerns relating to the COVID-19 pandemic and government actions taken to reduce the spread of the virus have had a material adverse impact on the macroeconomic environment, and the outbreak has significantly increased economic uncertainty. The pandemic has resulted in federal, state and local authorities, including those who govern the markets in which it operates, implementing numerous measures to try to contain the virus. These measures, including shelter in place orders and business limitations and shutdowns, have significantly contributed to rising unemployment and negatively impacted consumer and business spending.
The COVID-19 pandemic has adversely impacted and may continue to adversely impact the Company’s workforce and operations and the operations of its customers and business partners. In particular, the Company may experience adverse effects due to a number of operational factors impacting it or its customers or business partners, including but not limited to: (i) loan losses resulting from financial stress experienced by the Company’s borrowers, especially those operating in industries hardest hit by government measures to contain the spread of the virus; (ii) collateral for loans, especially real estate, may decline in value, which could cause loan losses to increase; (iii) as a result of the decline in the Federal Reserve’s target federal funds rate, the yield on the Company’s assets may decline to a greater extent than the decline in its cost of interest-bearing liabilities, reducing net interest margin and spread, and reducing net income; (iv) operational failures, disruptions or inefficiencies due to changes in the Company’s normal business practices necessitated by its internal measures to protect employees and government-mandated measures intended to slow the spread of the virus; (v) possible business disruptions experienced by the Company’s vendors and business partners in carrying out work that supports its operations; (vi) decreased demand for the Company’s products and services due to economic uncertainty, volatile market conditions and temporary business closures; (vii) potential financial liability, loan losses, litigation costs or reputational damage resulting from the Company’s origination of loans as a participating lender in the PPP as administered through the SBA; and (viii) heightened levels of cyber and payment fraud, as cyber criminals try to take advantage of the disruption and increased online activity brought about by the pandemic.
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The extent to which the pandemic impacts the Company’s business, liquidity, financial condition and operations will depend on future developments, which are highly uncertain and are difficult to predict, including, but not limited to, its duration and severity, the actions to contain it or treat its impact, and how quickly and to what extent normal economic and operating conditions can resume. In addition, the rapidly changing and unprecedented nature of COVID-19 heightens the inherent uncertainty of forecasting future economic conditions and their impact on the Company’s loan portfolio, thereby increasing the risk that the assumptions, judgments and estimates used to determine the ALLL and other estimates are incorrect. Further, the Company’s loan deferral program could delay or make it difficult to identify the extent of asset quality deterioration during the deferral period. As a result of these and other conditions, the ultimate impact of the pandemic is highly uncertain and subject to change, and the Company cannot predict the full extent of the impacts on its business, its operations or the global economy as a whole. To the extent any of the foregoing risks or other factors that develop as a result of COVID-19 materialize, it could exacerbate the other risk factors discussed in this report or otherwise and materially and adversely affect the Company’s business, liquidity, financial condition and results of operations.
The Company is exposed to risk of environmental liabilities with respect to properties to which it takes title.
In the course of its business, the Company may foreclose and take title to real estate, potentially becoming subject to environmental liabilities associated with the properties. The Company may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs or the Company may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. Costs associated with investigation or remediation activities can be substantial. If the Company is the owner or former owner of a contaminated site, it may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. These costs and claims could adversely affect the Company’s business.
Severe weather, earthquakes, other natural disasters, pandemics, acts of war or terrorism and other external events could significantly impact our business.
Severe weather, earthquakes, other natural disasters, pandemics (such as the COVID-19 pandemic), acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, results in loss of revenue and/or cause the Company to incur additional expenses. Although management has established disaster recovery policies and procedures, the occurrence of any such events could have a material adverse effect on our business, financial condition and results of operations.
Item 1B. UNRESOLVED STAFF COMMENTS.
None
Item 2. PROPERTIES.
The Company and its subsidiaries currently occupy sixteen full-service banking facilities in the cities of Charlottesville, Manassas, Richmond and Winchester, and the counties of Albemarle, Fauquier and Prince William. The Company’s main office, a full-service banking facility, operations, and offices of both Masonry Capital and Sturman Wealth are located at 404 People Place, Charlottesville, Virginia. VNB Trust and Estate Services is located at 103 Third Street, SE, Charlottesville, Virginia. Of the fifteen locations used as bank branches and commercial lending offices, eight of the buildings are owned by the Company and seven are leased from nonaffiliates. Leases with affiliates are described below.
The five-story building located at 404 People Place, Charlottesville, Virginia, just east of the Charlottesville city limits on Pantops Mountain, was constructed by the Bank on a pad site leased in 2005 from Pantops Park, LLC for a term of twenty years, with seven five-year renewal options. William D. Dittmar, Jr., a director of the Company, is the manager and indirect owner of Pantops Park, LLC. The building, consisting of approximately 43,000 square feet, was completed in early 2008, and the Bank opened this full-service office in April 2008. In addition to the Company’s use of this building as outlined in the preceding paragraph, a portion of the additional space is leased to tenants.
The drive-through location at 301 East Water Street, Charlottesville, which is a limited-service banking facility, and the adjoining office space located at 112 Third Street, SE, Charlottesville Virginia is leased from East Main Investments, LLC. Hunter E. Craig, a director of the Company and the Bank, serves as manager of East Main Investments, LLC, which is owned by Mr. Craig and his spouse.
See Note 6 – Premises and Equipment and Note 7 – Leases in the Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data for information with respect to the amounts at which the Company’s premises and equipment are carried and commitments under long-term leases. All of the Company's properties are in good operating condition and are adequate for the Company's present and anticipated future needs.
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Item 3. LEGAL PROCEEDINGS.
In the ordinary course of its operations, the Company and/or its subsidiaries are parties to various legal proceedings from time to time. Based on the information presently available, and after consultation with legal counsel, management believes that the ultimate outcome of such proceedings, in the aggregate, will not have a material adverse effect on the business or financial condition of the Company and its subsidiaries.
Item 4. MINE SAFETY DISCLOSURES.
Not applicable
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Part II
Item 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES.
Common Stock Performance and Dividends
Virginia National Bankshares Corporation’s common stock is listed for trading on the NASDAQ Capital Market under the symbol VABK. As of December 31, 2021, the Company had issued and outstanding 5,308,335 shares of common stock, which included 37,011 shares of restricted stock that have not yet vested. These shares were held by approximately 680 registered shareholders of record, not including beneficial holders of securities held in street name at a brokerage or other firm.
The payment of dividends is at the discretion of the Company’s Board of Directors and is subject to various federal and state regulatory limitations. As a bank holding company, the ability to pay dividends is dependent upon the overall performance and capital requirements of the Bank.
Prior to April 5, 2021, the Company's common stock was quoted on the OTC Markets Group's OTCQX tier, also under the symbol VABK. The data in the table below represents the high sales and low sales prices that occurred between April 5, 2021 and December 31, 2021 as reported by NASDAQ and the high bid and low bid quotations that occurred between January 1, 2020 and April 1, 2021 as reported by the OTCQX. The OTCQX over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. Additionally, the table shows the dividends declared per quarter in 2021 and 2020.
Dividends Declared
High Low High Low
American Stock Transfer and Trust Company is the Company’s stock transfer agent and registrar.
Recent Issuances of Unregistered Securities
No unregistered shares were issued in 2020 or 2021.
Item 6. [RESERVED].
Not applicable.
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Item 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS.
The following discussion provides information about the major components of the results of operations and financial condition, liquidity, and capital resources of Virginia National Bankshares Corporation. This discussion and analysis should be read in conjunction with the consolidated financial statements and Notes to Consolidated Financial Statements in Item 8. Financial Statements and Supplementary Data.
Merger with Fauquier
On April 1, 2021, the Company merged with Fauquier, pursuant to the Agreement and Plan of Reorganization dated October 1, 2020, including a related Plan of Merger. Pursuant to the Merger Agreement, Fauquier shareholders received 0.675 shares of Company stock for each share of Fauquier common stock, with cash paid in lieu of fractional shares, resulting in the Company issuing 2,571,213 shares of common stock. In connection with the transaction, TFB, Fauquier's wholly-owned bank subsidiary, was merged with and into the Bank.
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 the Company that have been negatively impacted.
Allowance for loan losses -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. During the first and second quarters of 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of the COVID-19 pandemic on the economy. No additional downgrades of such factors were taken during the third and fourth quarters of 2020,or the first quarter of 2021. During the second quarter of 2021, the Company upgraded the economic qualitative factors, resulting in a release of a portion of the reserves for loan losses related to the pandemic, as credit deterioration since the onset of COVID-19 had not been experienced to the extent anticipated. No additional changes were made to the economic qualitative factors during the third or fourth quarters of 2021. 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 the COVID-19 pandemic are sustained.
Potential credit exposures -While most industries have been adversely impacted by the COVID-19 pandemic, the Company has exposures on its balance sheet as of December 31, 2021 in the following categories of loans that are considered to have higher risk of significant impact:
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Travel accommodations (hotels/motels/B&B) - $29.0 million, or 2.8% of loans,
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Restaurants - $19.8 million, or 1.9% of loans,
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Retail trade - $13.3 million, or 1.3% of loans,
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Arts, entertainment and recreation - $13.0 million, or 1.3% of loans, and
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Wholesale trade - $9.5 million, or 0.9% of loans.
Note that the loan balances and percentages above do not include PPP loans made to entities within such categories.
Loan deferrals - In accordance with guidance from regulators and the CARES Act, the Bank worked 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 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. Loan deferrals as of December 31, 2021 amount to $1.2 million and consist of only two loans. Both loans are 100% government-guaranteed for which the deferrals were approved by the United States Department of Agriculture. In accordance with interagency guidance issued in March 2020 and the CARES Act, these short-term deferrals are not considered TDRs.
PPP Loans - Primarily within the second quarter of 2020 and the first quarter of 2021, 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, including the Bank and TFB, funded
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$207.5 million in PPP loans, with average origination fees of 3.9%, assisting many nonprofits and local businesses through this program. As of December 31, 2021, 89.9% of the total dollars of PPP loans had been forgiven by the SBA, with $20.7 million outstanding. Loans funded through the PPP are fully guaranteed by the U.S. government. The Company believes that it performed the required due diligence pursuant to the established SBA criteria; nonetheless, if a determination is 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.
Credit quality standards - 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 December 31, 2021, 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 enhanced its capital, liquidity, loan and deposit 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 other potential impacts on the economy.
Goodwill
As of December 31, 2021, the goodwill on the Company's 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.
Operations, Processes, Controls and Business Continuity Plan
The Company reacted quickly to the COVID-19 pandemic and began internal social distancing in mid-March 2020, as well as distancing from the public by keeping 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 worked remotely, allowing the remaining essential staff to create more distance between each other within the offices. The Company 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. The Company also installed disinfecting protective strips to high touch areas, placed free-standing air filter machines throughout our facilities, purchased COVID-19 instant test kits for on-site testing and 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.
The Company’s preparedness resulted in minimal impact to the Company’s operations as a result of the COVID-19 pandemic. Effective and thorough business continuity planning allowed for successful deployment of most 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 Critical Accounting Critical 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.
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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 financial statements.The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.
Following are the accounting policies and estimates that the Company considers as critical:
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Loans acquired in a business combination: Acquired Loans are classified as either (i) purchased credit-impaired loans or (ii) purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.
On a semi-annual basis, the Company evaluates the estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for loan losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan or pool(s) of loans. Disposals of loans, which may include sale of loans to third parties, receipt of payments in full or in part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.
PCI loans are not classified as nonperforming loans by the Company at the time they are acquired, regardless of whether they had been classified as nonperforming by the previous holder of such loans, and they will not be classified as nonperforming so long as, at semi-annual re-estimation periods, we believe we will fully collect the new carrying value of the pools of loans.
The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the Acquired Loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses may be required for any deterioration in these loans in future periods.
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Allowance for loan lossesis a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that are inherent in the loan portfolio. Accounting policies related to the allowance for loan losses are considered to be critical, as these policies involve considerable subjective judgment and estimation by management. The Company’s allowance for loan loss methodology includes allowance allocations calculated in accordance with ASC Topic 310, “Receivables” and allowance allocations calculated in accordance with ASC Topic 450, “Contingencies.” The level of the allowance reflects management’s continuing evaluation of: industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions; and unidentified losses inherent in the current loan portfolio, as well as trends in the foregoing. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications. See the section captioned “Allowance for Loan Losses” elsewhere in this discussion and Note 4 – Loans and Note 5 – Allowance for Loan Losses in the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data, elsewhere in this report for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.
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Impaired loansare loans so designated when, based on current information and events, it is probable the Company will be unable to collect all amounts when due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net of the impairment, using either the present value of estimated future cash flows at the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. Additional information on impaired loans, which includes both TDRs and
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non-accrual loans, is included in Note 4 – Loans and Note 5 – Allowance for Loan Losses, in the Notes to Consolidated Financial Statements.
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Fair value measurementsare used by the Company to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. The Company’s valuation methodologies may produce a fair value calculation that may not be indicative of net realized value or reflective of future fair values. While management believes the Company’s valuation methodologies are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. Additional discussion of valuation methodologies is presented in Note 17 – Fair Value Measurements, in the Notes to Consolidated Financial Statements.
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Other-than-temporary impairment of securities accounting policies require a periodic review by management to determine if the decline in the fair value of any security appears to be other-than-temporary. Factors considered in determining whether the decline is other-than-temporary include, but are not limited to: the length of time and the extent to which fair value has been below cost; the financial condition and near-term prospects of the issuer; and the Company’s intent to sell. See Note 1 – Summary of Significant Accounting Policies and Note 3 – Securities, in the Notes to Consolidated Financial Statements, for further details on the accounting policies for other-than-temporary impairment of securities and the methodology used by management to make this evaluation.
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Intangible assetaccounting policies require that goodwill and other intangible assets acquired in a purchase business combination and determined to have an indefinite useful life are not amortized, but tested for impairment at least annually, or more frequently if events and circumstances exist that indicate that a goodwill impairment test should be performed. Intangible assets with definite useful lives are amortized over their estimated useful lives, which range from 3 to 10 years, to their estimated residual values. Goodwill is the only intangible asset with an indefinite life on the Company’s Consolidated Balance Sheets. Additional discussion of the accounting policies and composition of goodwill and other intangibles assets is presented in Note 1 – Summary of Significant Accounting Policies, Note 2 - Business Combinations and Note 8 – Goodwill and Other Intangible Assets, in the Notes to Consolidated Financial Statements.
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Income taxaccounting policies have the objective to recognize the amount of taxes payable or refundable for the current year and the deferred tax assets and liabilities for future tax consequences of events that have been recognized in an entity’s financial statements or tax returns. Judgment is required in assessing the future tax consequences of events that have been recognized in the Company’s consolidated financial statements or tax returns. Fluctuations in the actual outcome of these future tax consequences could impact the Company’s consolidated financial condition or results of operations.
See Note 1 – Summary of Significant Accounting Policies and Note 11 – Income Taxes, in the Notes to Consolidated Financial Statements, for further detail on the accounting policies for income taxes and for components of the deferred tax assets and liabilities.
Non-GAAP Presentations
The accounting and reporting policies of the Company conform to GAAP and prevailing practices in the banking industry. However, certain non-GAAP measures are used by management to supplement the evaluation of the Company’s performance. These include adjusted ROAA, adjusted ROAE, adjusted net income, adjusted earnings per share, adjusted ALLL to total loans, tangible book value per share and the following fully-taxable equivalent measures: net interest income-FTE, efficiency ratio-FTE and net interest margin-FTE. Interest on tax-exempt loans and securities is presented on a taxable-equivalent basis (which converts the income on loans and investments for which no income taxes are paid to the equivalent yield as if income taxes were paid) using the federal corporate income tax rate of 21 percent that was applicable for all periods presented.
Management believes that the use of these non-GAAP measures provides meaningful information about operating performance by enhancing comparability with other financial periods, other financial institutions, and between different sources of interest income. The non-GAAP measures used by management enhance comparability by excluding the effects of (1) items that do not reflect ongoing operating performance, such as merger and merger-related expenses, (2) items that do not reflect the implicit percentage of the ALLL to total loans, such as the impact of fair value adjustment and PPP loans, (3) balances of intangible assets, including goodwill, that vary significantly between institutions, and (4) tax benefits that are not consistent across different opportunities for investment. These non-GAAP financial measures should not be considered an alternative to GAAP-basis financial statements, and other banks and bank holding companies may define or calculate these or similar measures differently. Net income is discussed in Management’s Discussion and Analysis on a GAAP basis unless noted as “non-GAAP.”
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A reconcilement of the non-GAAP financial measures used by the Company to evaluate and measure the Company's performance to the most directly comparable GAAP financial measures is presented below:
(Dollars in thousands, except per share data)
Reconcilement of Non-GAAP Measures: Year Ended December 31
Performance measures
Return on average assets 0.61 % 1.00 %
Impact of merger expenses 1 0.33 % 0.09 %
Operating return on average assets 1 (non-GAAP) 0.94 % 1.09 %
Return on average equity 7.17 % 10.01 %
Impact of merger expenses 1 3.91 % 0.88 %
Operating return on average equity 1 (non-GAAP) 11.08 % 10.89 %
Net income, excluding merger expenses 1 (non-GAAP) $ 15,566 $ 8,682
Net income per share, diluted $ 2.14 $ 2.95
Impact of merger expenses 1 1.17 0.26
Net income per share, excluding merger expenses 1 (non-GAAP) $ 3.32 $ 3.21
Fully taxable-equivalent measures
Fully taxable-equivalent adjustment 271 126
Impact of FTE adjustment -0.4 % -0.3 %
Efficiency ratio (FTE) 4 76.3 % 61.4 %
Net interest margin 2.92 % 3.16 %
Fully tax-equivalent adjustment 0.02 % 0.01 %
Net interest margin (FTE) 2 2.94 % 3.17 %
Other financial measures
ALLL to total loans 0.56 % 0.90 %
Impact of acquired loans and fair value mark 0.39 % 0.00 %
ALLL to total loans 0.56 % 0.90 %
Impact of PPP loans 0.02 % 0.08 %
ALLL to total loans, excluding PPP loans (non-GAAP) 0.58 % 0.98 %
Impact of intangible assets (3.14 ) (0.26 )
Tangible book value per share (non-GAAP) $ 27.36 $ 30.17
1 References to merger expenses include merger and merger-related expenses and are net of tax.
2 FTE calculations use a Federal income tax rate of 21%.
3 The efficiency ratio, GAAP basis, is computed by dividing noninterest expense by the sum of net interest income and noninterest income.
4 The efficiency ratio, FTE, is computed by dividing noninterest expense by the sum of net interest income (FTE) and noninterest income.
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Results of Operations
Consolidated Return on Assets and Equity and Other Key Ratios
The ratio of net income to average total assets and average shareholders' equity and certain other ratios for the years indicated are as follows:
Return on average assets 0.61 % 1.00 %
Operating return on average assets (non-GAAP) 0.94 % 1.09 %
Return on average equity 7.17 % 10.01 %
Operating return on average equity (non-GAAP) 11.08 % 10.89 %
Average equity to average assets 8.52 % 10.00 %
Cash dividend payout ratio 55.95 % 40.82 %
Net income for the year ended December 31, 2021 was $10.1 million, or $2.14 per diluted share, a 26.2% increase compared to $8.0 million, or $2.95 per diluted share for the year ended December 31, 2020. This $2.1 million increase was primarily the result of a $21.1 million increase in net interest income, a $3.9 million increase in noninterest income, and a $608 thousand reduction in provision for loan losses. Negatively affecting net income for 2021 compared to 2020 was a $23.7 million increase in noninterest expense. Each component of such year-over-year changes are described in more detail below.
The efficiency ratio (FTE) was 76.3% for the year ended December 31, 2021, compared to 61.4% for the same period of 2020, increasing due primarily to the one-time impact of merger and merger-related expenses.
The Company has four reportable segments: the Bank, VNB Trust and Estate Services, Sturman Wealth and Masonry Capital.
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Bank - The Bank’s commercial banking activities involve making loans, taking deposits and offering related services to individuals, businesses and charitable organizations. Loan fee income, service charges from deposit accounts, and other non-interest-related revenue, such as fees for debit cards and ATM usage and fees for treasury management services, generate additional income for this segment.
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Sturman Wealth Advisors – This segment offers wealth 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. During February 2016, the Company purchased the book of business, including interest in the client relationships, (“Purchased Relationships”), from a current officer (the “Seller”) of the Company pursuant to an employment and asset purchase agreement (the “Purchase Agreement”). Prior to becoming an employee of the Company and until the effective date of the sale, the Seller provided services to the Purchased Relationships as a sole proprietor. Under the terms of the Purchase Agreement, the Company will receive all future revenue for investment management, advisory, brokerage, insurance, consulting, and related services performed for the Purchased Relationships. More information on this purchase can be found under Goodwill and Other Intangible Assets in Note 8 of the Notes to Consolidated Financial Statements, which is found in Item 8. Financial Statements and Supplementary Data.
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VNB Trust and Estate Services - This segment offers corporate trustee services, trust and estate administration, IRA administration and custody services and offers in-house investment management services. Revenue for this segment is generated from administration, service and custody fees, as well as management fees which are derived from Assets Under Management. Investment management services currently are offered through affiliated and third-party managers.
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Masonry Capital - Masonry Capital offers investment management services for separately managed accounts and a private investment fund employing a value-based, catalyst-driven investment strategy. Revenue for this segment is generated from management fees which are derived from Assets Under Management and incentive income which is based on the investment returns generated on performance-based Assets Under Management.
The Bank segment earned net income of $9.0 million in 2021, a $708 thousand increase over the $8.3 million netted in 2020. Sturman Wealth earned $384 thousand in 2021 compared to $48 thousand in the prior year. VNB Trust and Estate Services realized net income of $162 thousand in 2021, compared to a net loss of $52 thousand in 2020. Masonry Capital realized net income of $561 thousand in 2021, compared to a net loss of $274 thousand in 2020.
Details of the changes in the various components of net income are further discussed below.
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Net Interest Income
Net interest income is computed as the difference between the interest income on earning assets and the interest expense on deposits and other interest bearing liabilities. Net interest income represents the principal source of revenue for the Company and accounted for 81.1% of the total revenue in 2021. Net interest margin (FTE) is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income (FTE) and net interest margin (FTE).
The following table details the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest bearing liabilities, for the years ended December 31, 2021, 2020, and 2019.
Consolidated Average Balance Sheets and Analysis of Net Interest Income (FTE)
Interest Average Interest Average Interest Average
ASSETS
Interest earning assets:
Securities
Loans:
Other interest-bearing deposits 160,960 233 0.14 % - - - - - -
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing deposits:
Junior subordinated debt 2,565 148 5.77 % - - - - - -
Non-Interest-Bearing Liabilities:
Interest expense as a percentage of average earning assets 0.21 % 0.44 % 0.69 %
(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 rate 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 (FTE) expressed as a percentage of average earning assets.
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The purpose of the volume and rate analysis below is to describe the impact on the net interest income (FTE) of the Company resulting from changes in average balances and average interest rates for the periods 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. Interest income is reported on a tax-equivalent basis.
Volume and Rate Analysis
2021 compared to 2020
Change due to: Increase/
(Dollars in thousands) Volume Rate (Decrease)
Assets:
Loans:
Other interest-bearing deposits 233 - 233
Liabilities and Shareholders' equity:
Interest-bearing deposits:
Junior subordinated debt 148 - 148
Total interest-bearing liabilities 2,129 (2,196 ) (67 )
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2020 compared to 2019
Change due to: Increase/
(Dollars in thousands) Volume Rate (Decrease)
Assets:
Loans:
Liabilities and Shareholders' equity:
Interest-bearing deposits:
Interest checking $ 43 (133 ) $ (90 )
Total interest-bearing deposits 386 (1,293 ) (907 )
Total interest-bearing liabilities 490 (1,412 ) (922 )
For 2021, net interest income (FTE) of $45.3 million was recognized, an increase of $21.3 million over 2020. Net interest income (FTE) for 2020 totaled $24.0 million and was $2.0 million increase over the 2019 total of $22.0 million. Average earning assets increased $783.1 million or 103.5% in 2021 compared to 2020 and increased $140.6 million or 22.8% in 2020 compared to 2019. The increases in volume of real estate and commercial loans from 2020 to 2021 were the primary contributing factors of the increase in net interest income. The declines in rates paid on deposits over the same period also positively impacted net interest income. The average balance for loans as a percentage of earnings assets for 2021 was 66.1%, compared to 79.4% and 85.1% in 2020 and 2019, respectively.
The 2021 net interest margin (FTE) declined 23 bps to 2.94% from 3.17% in 2020. The 2020 net interest margin (FTE) declined 40 bps from 3.57% in 2019. The tax-equivalent yield on average earning assets for 2021 of 3.15% was 47 bps lower than the 2020 yield of 3.62%. The 2019 tax-equivalent yield on average earning assets of 4.27% was 65 bps higher than the comparable 2020 yield. Loan yields for 2021 were 4.32%, improving 17 bps from the loan yield of 4.15% for 2020. Average loans for 2021 of $1.0 billion were $416.4 million higher than the 2020 average of $600.9 million, due to the Merger. 2020’s average loan balances were $77.1 million higher than the 2019 average of $523.8 million due to the origination of PPP loans during 2020.
Interest expense as a percentage of average earning assets declined to 21 bps for 2021, compared to 44 and 69 bps for 2020 and 2019, respectively. Net interest margin will be impacted by future changes in short-term and long-term interest rate levels on deposits, as well as the impact from the competitive environment. A continuing primary driver of the Company’s low cost of funds is the Company’s level of non-interest bearing demand deposits and low-cost deposit accounts. Following is a table illustrating the average balances of deposit accounts as a percentage of total deposit account balances.
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Provision for Loan Losses
The level of the allowance reflects changes in the size of the portfolio or in any of its components, as well as management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, and economic, political and regulatory conditions. Additional information concerning management’s methodology in determining the adequacy of the allowance for loan losses is contained later in this section under Allowance for Loan Losses, in addition to Note 1 and Note 5 of the Notes to Consolidated Financial Statements, found in Item 8. Financial Statements and Supplementary Data.
Based on management’s continuing evaluation of the loan portfolio in 2021, the Company recorded a provision for loan losses of $1.0 million, compared to a provision of $1.6 million in 2020 and $1.4 million in 2019. The decrease in 2021 is the result of the Company releasing of a portion of the reserves that were added during 2020 since the credit deterioration was not experienced to the extent previously anticipated. The increase in the 2020 provision for loan losses was largely the result of worsening economic qualitative factors associated with COVID-19.
The allowance for loan losses as a percentage of total loans was 0.56% at December 31, 2021 compared to 0.90% at December 31, 2020.
The following is a summary of the changes in the allowance for loan losses for the years ended December 31, 2021, 2020, and 2019:
Noninterest Income
The major components of noninterest income are detailed below. Year-to-year variances are shown for each noninterest income category.
(Dollars in thousands) For the year ended December 31 Variance
Noninterest income:
Earnings/increase in value of bank owned life insurance 708 437 271 62.0 %
Gains on sales and calls of securities - 743 (743 ) -100.0 %
Noninterest income of $10.5 million for the year ended December 31, 2021 experienced a net increase over the prior year of $3.9 million, as a result of the following variances:
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Debit/credit card and ATM fees, Trust and estate services fees, deposit accounts fees, advisory and brokerage income and investment management income increased $1.5 million, $1.2 million, $808 thousand, $454 thousand and $379 thousand, respectively, due primarily to the Merger and the addition of Fauquier's customers in each of the respective areas;
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Performance fees on assets under management increased $789 thousand due to improved market conditions period over period;
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Earnings from bank owned life insurance increased $271 thousand primarily as a result of the addition of the Fauquier policies;
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The above increases were offset by:
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Loan swap fee income decreased $1.2 million, as a result of decreased demand of such product due to the interest rate environment, and
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Gains on sales and calls of securities decreased $743 thousand, as no securities were sold in 2021.
Noninterest Expense
Noninterest expense of $42.5 million reported for 2021 increased $23.7 million or 126.4% from the $18.8 million for 2020. The major components of noninterest expense are detailed below. Year-over-year variances are shown for each noninterest expense category.
(Dollars in thousands) December 31, December 31, Variance
Noninterest expense:
Core deposit intangible amortization 1,389 - 1,389 --
Salaries and employee benefits accounted for the largest increase, increasing 70.4% from $9.5 million in 2020 to $16.1 million in 2021. This increase was due to the Merger and the addition of Fauquier's employees effective April 1, 2021, offset by a reduction in salaries for redundant positions, occurring through the year. At December 31, 2021, the Company had 173 full-time equivalent employees compared to 86 at year-end 2020.
Merger expenses accounted for the next largest increase, amounting to $7.4 million in 2021, compared to $988 thousand in 2020. These expenses included investment banker fees, expenses related to the integration of systems and operations, change of control payments, severance and stay-put bonuses, and legal and consulting expenses, which have been expensed as incurred.
Core deposit intangible amortization expense is a result of the Merger and amounted to $1.4 million in 2021.
Provision for Income Taxes
The provision for income taxes is based upon the results of operations, adjusted for the effect of certain tax-exempt income and non-deductible expenses. In addition, certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and the income tax bases of assets and liabilities using the applicable enacted marginal tax rate.
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For 2021, the Company provided $1.8 million for Federal income taxes, resulting in an effective income tax rate of 15.5%. In 2020, the Company provided $2.1 million for Federal income taxes, resulting in an effective income tax rate of 20.6%. The effective tax rate is lower in 2021 due to the impact of low-income housing tax credits acquired during the Merger, offset by the non-deductibility of certain merger-related expenses for tax purposes. Additionally, the effective income tax rates for 2021 and 2020 were lower than the U.S. statutory rate of 21% due to the effect of tax-exempt income from municipal bonds and bank owned life insurance policies.
More information on income taxes, including net deferred taxes can be found in Note 11 – Income Taxes of the Notes to Consolidated Financial Statements which is found in Item 8. Financial Statements and Supplementary Data.
BALANCE SHEET ANALYSIS
Securities
The investment securities portfolio has a primary role in the management of the Company’s liquidity requirements and interest rate sensitivity, as well as generating significant interest income. Investment securities also play a key role in diversifying the Company’s balance sheet. In addition, a portion of the investment securities portfolio is pledged as collateral for public fund deposits. Changes in deposit and other funding balances and in loan production will impact the overall level of the investment portfolio.
As of December 31, 2021, the Company’s investment portfolio totaled $308.8 million, with obligations of U.S. government corporations and government-sponsored enterprises amounting to $202.5 million, or approximately 66% of the total. The Company’s investment portfolio totaled $177.1 million as of December 31, 2020.
During the year ended December 31, 2021, there were no sales of securities. For the year ended December 31, 2020, proceeds from the sales of securities amounted to $69.5 million, and gross realized gains on these securities were $742 thousand. An additional $1 thousand gain was realized from a call of a security during 2020. Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company.
In accordance with ASC 320, “Investments - Debt and Equity Securities,” the Company has categorized its unrestricted securities portfolio as Available for Sale. Securities classified as AFS may be sold in the future, prior to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. AFS securities are carried at fair value. Net aggregate unrealized gains or losses on these securities are included, net of taxes, as a component of shareholders’ equity. All of the Company’s unrestricted securities were investment grade or better as of December 31, 2021. Given the generally high credit quality of the Company’s AFS investment portfolio, management expects to realize all of its investment upon market recovery or the maturity of such instruments and thus believes that any impairment in value is interest-rate-related and therefore temporary. AFS securities included gross unrealized gains of $1.4 million and gross unrealized losses of $4.2 million as of December 31, 2021.
Amount Percent Amount Percent
All mortgage-backed securities included in the above tables were issued by U.S. government agencies and corporations. At December 31, 2021, the securities issued by political subdivisions or agencies were highly rated with 100% of the municipal bonds having AA or higher ratings. Approximately 65% of the municipal bonds are general obligation bonds, and issuers are geographically diverse. The Company held no issues that exceeded 10% of the Company’s shareholders' equity at December 31, 2021.
The Company’s holdings of restricted securities totaled $5.0 million and $3.0 million at December 31, 2021 and December 31, 2020, respectively, and consisted of stock in the Federal Reserve Bank, stock in the FHLB, and stock in CBB Financial Corporation, the holding company for Community Bankers’ Bank, and an investment in an SBA loan fund. The Bank is required to hold stock in the Federal Reserve Bank and the FHLB as a condition of membership with each of these correspondent banks. The amount of stock required to be held by the Bank is periodically assessed by each bank, and the Bank may be subject to purchase or surrender stock held in these banks, as determined by their respective calculations. The amount of FHLB stock held decreased $2.0 million from December 31, 2020 to December 31, 2021, as stock was relinquished due to the paydown of advances during the period. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Bank with several benefits that are not available to non-shareholder correspondent banks. None of these stock issues are traded on the open market and can only be redeemed by the respective issuer. Restricted stock holdings are recorded at cost.
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The table shown below details the amortized cost and fair value of AFS securities at December 31, 2021 based upon contractual maturities, by major investment categories. Expected maturities may differ from contractual maturities because issuers have the right to call or prepay obligations. The tax-equivalent yield is based upon a federal tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations section earlier in Item 7.
Maturity Distribution and Average Yields
Contractual Maturities of Debt Securities at December 31, 2021
U.S. Government-Sponsored Agencies:
Mortgage-backed securities/CMOs
Municipal bonds
Weighted average yield is calculated based on the relative amortized cost of the securities. Yields on tax-exempt securities have been computed on a tax-equivalent basis using the federal corporate income tax rate of 21 percent.
As stated, the preceding table reflects the distribution of the contractual maturities of the investment portfolio at December 31, 2021. Management’s investment portfolio strategy is to structure the portfolio so that it is a constant source of liquidity for the balance sheet. In order to achieve greater liquidity in the portfolio, securities that have a monthly flow of principal repayments become a key component. To illustrate the difference between contractual maturity and average life, consider the difference for the fixed rate mortgage-backed securities (MBS) component of this portfolio. At December 31, 2021, the weighted average maturity of the fixed rate MBS sector was 18.75 years, and the projected average life for this group of securities is 5.0 years.
Another indication of the investment portfolio’s liquidity potential is shown by the projected annual principal cash flow from maturities, callable bonds, and monthly principal repayments. For the next three years, the principal cash flows are estimated to be $27.9 million for 2022, $29.2 million for 2023, and $26.9 million for 202, based upon rates remaining at current levels. This represents approximately 28% of the investment portfolio’s AFS balance at December 31, 2021 that will be available to support the future liquidity needs of the Company. Cash flow projections are subject to change based upon changes to market interest rates.
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Loan Portfolio
The Company’s loan portfolio totaled $1.1 billion as of December 31, 2021 or 53.8% of total assets. Loan balances increased $451.8 million, or 74.1%, from the balance of $609.4 million as of December 31, 2020. Note that all loan balances are presented net of credit and other fair value discounts, when applicable. The table below shows the composition of the loan portfolio:
(Dollars in thousands) As of December 31,
Real estate mortgage:
Less: Allowance for loan losses (5,984 ) (5,455 )
During 2020 and 2021, the Company assisted nonprofit organizations and local businesses by funding $207.5 million of PPP loans, which were designed to provide economic relief to small businesses adversely impacted by the COVID-19 pandemic. These loans carry a 1% annual interest rate; however, in addition, the Company recognized $2.3 million and $2.1 million in PPP loan origination fees in 2021 and 2020, respectively. As of December 31, 2021, 89% of the total dollars of PPP loans had been forgiven by the SBA, with $20.7 million outstanding.
The addition of purchased loans in connection with the Merger with Fauquier accounted for the bulk of the $451.8 million increase from December 31, 2020 to December 31, 2021.
At December 31, 2021, the loan-to-deposit ratio stood at 59.1%, compared to 83.4% at December 31, 2020.
The Company’s objective is to maintain the historically strong credit quality of the loan portfolio by maintaining rigorous underwriting standards. These standards coupled with regular evaluation of the creditworthiness of, and the designation of lending limits for, each borrower has helped the Company achieve this objective. The primary portfolio strategy includes seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar. The predominant market area for loans includes Charlottesville, Albemarle County, Fauquier County, Prince William County, Winchester, Frederick County, Manassas, Richmond and areas in the Commonwealth of Virginia that are within a 75 mile radius of any Virginia National Bank location.
Based on underwriting standards, loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory and real property. The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions.
The Company’s real estate loan portfolio increased by $478.5 million to a balance of $911.1 million at December 31, 2021 from $432.6 million at December 31, 2020. This category comprised 85.9% of all loans, and these loans are secured by mortgages on real property located principally in Virginia. Of this amount, approximately $358.2 million represented loans on residential properties. Commercial real estate loans totaled $473.6 million as of December 31, 2021. Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral. The remaining real estate loans were comprised of construction and land development loans which totaled $79.3 million as of December 31, 2021, an increase of $56.8 million compared to the December 31, 2020 balance of $22.5 million as a result of the addition of Fauquier loans as part of the Merger.
As of December 31, 2021, the Company’s commercial and industrial loan portfolio totaled $96.7 million, a $22.0 million decline from the $118.7 million balance at year-end 2020. This category, representing approximately 9.1% of all loans, includes loans made to individuals and small to medium-sized businesses, as well as loans purchased on the syndicated and government guaranteed markets. As discussed previously, the Company participated in the PPP loan initiative during 2020 and 2021 with balances of $54.2 million and $20.7 million as of December 31, 2020 and December 31, 2021, respectively. Forgiveness of a significant amount of loans during 2021 caused the overall decline.
Consumer loans, comprised of student loans purchased, revolving credit, and other fixed payment loans, totaled $53.4 million as of December 31, 2021 or 5.0% of all loans. Consumer loans ended 2021 with balances $4.7 million lower than the prior year-end, primarily due to normal amortization within the student loan portfolio.
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The following table presents the maturity/repricing distribution of the Company’s loans at December 31, 2021. The table also presents the portion of loans that have fixed interest rates or variable/floating interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index such as the Wall Street Journal prime rate, LIBOR rates, or U.S. Treasury bond indices.
Maturities and Sensitivities of Loans to Changes in Interest Rates
(Dollars in thousands) As of December 31, 2021
One Year or Less After 1 to 5 Years After Five to 15 Years After 15 Years Total
Fixed Rate:
Variable Rate:
Total loans at December 31, 2021 included loans purchased in connection with the Merger. These loans were recorded at estimated fair value on the date of acquisition without the carryover of the related ALLL. The following table presents the outstanding principal balance and the carrying amount of purchased loans:
(Dollars in thousands) December 31, 2021
Carrying amount:
For a description of the Company's accounting for purchased performing and PCI loans, see "Critical Accounting Estimates" earlier in Item 7.
Loan Asset Quality
Intrinsic to the lending process is the possibility of loss. While management endeavors to minimize this risk, it recognizes that loan losses will occur and that the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio, which in turn depend on current and future economic conditions, the financial condition of borrowers, the realization of collateral, and the credit management process.
Generally, loans are placed on non-accrual status when management believes, after considering economic and business conditions and collections efforts, that it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, or when the loan is past due for 90 days or more, unless the debt is both well-secured and in the process of collection.
At December 31, 2021 and 2020, the Company had loans classified as non-accrual with balances of $495 thousand and $8 thousand, respectively. The non-accrual balance as of December 31, 2021 consists of only one loan. Acquired Loans which otherwise would be in non-accrual status are not included in this figure, as they earn interest through the yield accretion.
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Loans 90 days or more past due and still accruing interest amounted to $801 thousand as of December 31, 2021, compared to $137 thousand as of December 31, 2020. The 2021 balance includes a government-guaranteed loan in the amount of $548 thousand and $115 thousand of defaulted PPP loans for which claims have been filed with the SBA. The portfolio only includes eight non-insured student loans that are 90 days or more past due and still accruing interest, amounting to $83 thousand. Loans acquired during the Merger which are greater than 90 days past due and still accruing interest are included in this figure, net of their fair value mark.
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. TDRs that are considered to be performing continue to accrue interest under the terms of the restructuring agreement. TDRs that have been placed in non-accrual status are considered to be nonperforming.
Total performing TDR balances declined to $1.0 million as of December 31, 2021 compared to $1.3 million as of December 31, 2020. Based on regulatory guidance issued in 2016 on Student Lending, the Company classified 58 of its student loans purchased as TDRs for a total of $935 thousand as of December 31, 2021 and 75 of its student loans purchased as TDRs for a total of $1.2 million as of December 31, 2020. Nonperforming TDR balances increased to $495 thousand as of December 31, 2021 compared to $8 thousand as of December 31, 2020.
The table below summarizes the Company's credit ratios as of December 31, 2021 and 2021:
Nonaccrual loans $ 495 $ 8
Allowance for loan losses $ 5,984 $ 5,455
Nonaccrual loans to total loans 0.05 % 0.00 %
ALLL to total loans 0.56 % 0.90 %
In accordance with 2020 regulatory guidance and the CARES Act, the Bank has approved for certain customers who have been adversely affected by the COVID-19 pandemic 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 the COVID-19 pandemic 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 $59.0 million in loan deferments have been approved since the beginning of the pandemic. As of December 31, 2021, $57.8 million, or 98.0%, of the total loan deferments approved have returned to normal payment schedules and are now current.
See Note 4 – Loans and Note 5 – Allowance for Loan Losses in the accompanying Notes to Consolidated Financial Statements included in Item 8. Financial Statements and Supplementary Data for further details regarding the Company’s loan asset quality measurements.
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Allowance for Loan Losses
In general, the Company determines the adequacy of its allowance for loan losses by considering the risk classification and delinquency status of loans and other factors. Management may also establish specific allowances for loans which management believes require allowances greater than those allocated according to their risk classification. The purpose of the allowance is toprovide for losses inherent in the loan portfolio. Since risks to the loan portfolio include general economic trends as well as conditions affecting individual borrowers, the allowance is an estimate. The Company is committed to determining, on an ongoing basis, the adequacy of its allowance for loan losses.
The Company applies historical loss rates to various pools of loans based on risk rating classifications. In addition, the adequacy of the allowance is further evaluated by applying estimates of loss that could be attributable to any one of the following eight qualitative factors:
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.
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 by further segmenting the loan classes. The quantitative risk factor for each loan class primarily utilizes a migration analysis loss method based on loss history for the prior twelve quarters.
See Note 4 – Loans and Note 5 – Allowance for Loan Losses in the Notes to Consolidated Financial Statements, included in Item 8. Financial Statements and Supplementary Data, for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.
Activity for the allowance for loan losses is provided in the following table:
As of and for the year ended December 31, 2021
Allowance for Loan Losses:
As of and for the year ended December 31, 2020
Allowance for Loan Losses:
Charge-offs - - - (805 ) (805 )
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As of December 31, 2021, the ALLL was $6.0 million, a net increase of $529 thousand from $5.5 million at December 31, 2020. Management’s estimates for the ALLL resulted in the Company’s allowance to total loans outstanding ratio of 0.56% at December 31, 2021, compared to 0.90% at December 31, 2020 and 0.78% at December 31, 2019. The primary reason that the ALLL as a percentage of loans decreased from December 31, 2020 to December 31, 2021 was due to the addition of TFB loans effective with the Merger, which do not require an ALLL based on the fair value mark. Note that without the impact of acquired loans and the fair value mark, the ALLL to total loans outstanding would have been 0.95% as of December 31, 2021 (for reconcilement of this non-GAAP measure, see the “Non-GAAP Presentation” section earlier in Item 7).
During 2021, there were $835 thousand in loan balances charged off, with a total of $350 thousand in recoveries of previously charged-off balances, resulting in net charge-offs of $485 thousand. During 2020, there were $805 thousand in loan balances charged off, with a total of $429 thousand in recoveries of previously charged-off balances, resulting in net charge-offs of $376 thousand. The ratio of net charge-offs to average loans was 0.05% and 0.06% for 2021 and 2020, respectively.
The table below provides an allocation of year-end allowance for loan losses by loan type; however, allocation of a portion of the allowance to one loan category does not preclude its availability to absorb losses in other categories.
Allocation of the Allowance for Loan Losses
Real estate construction and land 399 7.48 %
Real estate construction 160 3.69 %
Deposits
Depository accounts represent the Company’s primary source of funding and are comprised of demand deposits, interest-bearing checking accounts, money market deposit accounts and time deposits. These deposits have been provided predominantly by individuals, businesses and charitable organizations in the Charlottesville/Albemarle County, Fauquier County, Manassas, Prince William County, Richmond and Winchester areas.
Depository accounts held by the Company as of December 31, 2021, totaled $1.8 billion, an increase of $1.0 billion or 145.8% compared to the December 31, 2020 total of $730.8 million.
At December 31, 2021, the balances of non-interest bearing demand deposits were $522.3 million or 29.1% of total deposits, a 149.0% increase from $209.8 million at December 31, 2020. Interest-bearing transaction and money market accounts totaled $1.1 billion at December 31, 2021, an increase of $690.0 million compared to $421.9 million at December 31, 2020. The Company offers ICS®, which allows customers access to multi-million-dollar FDIC insurance on funds placed into demand deposit and/or money market deposit accounts. As of December 31, 2021, the reciprocal ICS® balances included in demand deposit and money market accounts were $39.2 million and $225.9 million, respectively. The Company’s low-cost deposit accounts, which include both non-interest and interest bearing checking accounts as well as money market accounts, represented 91.0% of total deposit account balances at December 31, 2021 and compared favorably to the 86.4% of total deposit account balances at December 31, 2020.
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Certificates of deposit and other time deposit balances increased $62.9 million to $162.0 million at December 31, 2021 from the balance of $99.1 million at December 31, 2020. Included in this deposit total were reciprocal relationships under CDARSTM, whereby depositors can obtain FDIC insurance on deposits up to $50 million. These reciprocal CDARSTM deposits totaled $6.1 million and $8.5 million at December 31, 2021 and 2020, respectively.
Average Balances and Rates Paid
(Dollars in thousands) Years Ended December 31
Average Average Average Average
Balance Rate Balance Rate
Interest-bearing deposits:
As of December 31, 2021 and 2020, the estimated amounts of total uninsured deposits were $585.6 million and $276.4 million, respectively.
Maturities of time deposits in excess of FDIC insurance limits as of December 31, 2021 were as follows:
(Dollars in thousands)
Amount Percentage
Over three months to six months 5,607 12.38 %
Over six months to one year 6,963 15.37 %
Borrowings
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. During the third quarter of 2021, the Company prepaid 100% of its outstanding FHLB advances, which positively impacted interest expense by $416 thousand as a result of accelerating the accretion of the fair value purchase mark on such acquired Fauquier debt. A prepayment penalty in the amount of $243 thousand was incurred and is reported in noninterest expense, netting to an overall gain on the transaction of $173 thousand. Due to this repayment, at December 31, 2021, the Company had no outstanding borrowings from the FHLB. As of December 31, 2020, the Company had outstanding balances of $30.0 million from three FHLB advances with $10 million maturing in each of the years 2021, 2023, and 2025. The Company had no outstanding borrowings as of December 31, 2019.
As of December 31, 2021, the Company had a letter of credit for $60.0 million issued in favor of the Commonwealth of Virginia Department of the Treasury to secure public fund depository accounts and collateralized against these pledged commercial mortgages.
Additional borrowing arrangements maintained by the Bank include formal federal funds lines with five correspondent banks. The Company had no outstanding balances in federal funds purchased as of December 31, 2021, 2020, or 2019.
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Total borrowings consist of the following as of December 31, 2021, 2020, and 2019:
FHLB advances $ - $ 30,000 $ -
Total borrowings $ - $ 30,000 $ -
Annual average interest rate paid 0.82 % 0.47 % 2.58 %
Annual interest rate at end of period - 0.48 % -
Details on available borrowing lines can be found later under Liquidity in the Asset/Liability Management section.
Junior Subordinated Debt
In 2006, a subsidiary of Fauquier, Fauquier Statutory Trust II, privately issued $4.0 million face amount of the trust’s Floating Rate Capital Securities in a pooled capital securities offering. Simultaneously, the trust used the proceeds of that sale to purchase $4.0 million principal amount of the Fauquier’s Floating Rate Junior Subordinated Deferrable Interest Debentures due 2036. As of December 31, 2021, total capital securities were $3.4 million, as adjusted to fair value as of the date of the Merger. The interest rate on the capital security resets every three months at 1.70% above the then current three-month LIBOR and is paid quarterly. Management is in communication with the issuer regarding the alternative reference rate that will apply after the discontinuance of LIBOR.
The Trust II issuance of capital securities and the respective subordinated debentures are callable at any time. The subordinated debentures are an unsecured obligation of the Company and are junior in right of payment to all present and future senior indebtedness of the Company. The capital securities are guaranteed by the Company on a subordinated basis.
ASSET/LIABILITY MANAGEMENT
The Company’s primary earnings source is its net interest income; therefore, the Company devotes significant time and resources to assist in the management of interest rate risk and asset quality. The Company’s net interest income is affected by changes in market interest rates and by the level and composition of interest-earning assets and interest-bearing liabilities. The Company’s objectives in its asset/liability management are to utilize its capital effectively, to provide adequate liquidity and to enhance net interest income, without taking undue risks or subjecting the Company unduly to interest rate fluctuations. The Company takes a coordinated approach to the management of its liquidity, capital and interest rate risk. This risk management process is governed by policies and limits established by the Bank’s Asset/Liability Committee, which are reviewed and approved by the Bank’s Board of Directors. This committee, which is comprised of directors and members of management, meets to review, among other things, economic conditions, interest rates, yield curves, cash flow projections, expected customer actions, liquidity levels, capital ratios and repricing characteristics of assets, liabilities and financial instruments.
Market Risk
Market risk is the risk of loss in a financial instrument arising from adverse changes in market indices such as interest rates. The Company’s principal market risk exposure is interest rate risk. Interest rate risk is the exposure to changes in market interest rates. Interest rate sensitivity is the relationship between market interest rates and net interest income due to the repricing characteristics of assets and liabilities. The Company monitors the interest rate sensitivity of its balance sheet positions by examining its near-term sensitivity and its longer-term gap position. In its management of interest rate risk, the Company utilizes several financial and statistical tools including traditional gap analysis and sophisticated income simulation models.
A traditional gap analysis is prepared based on the maturity and repricing characteristics of interest-earning assets and interest-bearing liabilities for selected time bands. The mismatch between repricings or maturities within a time band is commonly referred to as the “gap” for that period. A positive gap (asset sensitive) where interest rate sensitive assets exceed interest rate sensitive liabilities generally will result in the net interest margin increasing in a rising rate environment and decreasing in a falling rate environment. A negative gap (liability sensitive) will generally have the opposite result on the net interest margin. The Company’s balance sheet structure is primarily short-term in nature with a substantial portion
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of rate-sensitive assets and rate-sensitive liabilities repricing or maturing within one year, as shown in the Gap Interest Sensitivity Analysis table below.
Gap Interest Sensitivity Analysis
As of December 31, 2021
Within 90 to 365 1 to 4 Over Non Rate
90 days days years 4 years Sensitive Total
Assets
Interest-bearing deposits in other banks 336,032 - - - - 336,032
Liabilities and Shareholders' Equity
Junior subordinated debt - 3,367 - - - 3,367
The Company utilizes the gap analysis to complement its income simulations modeling. However, the traditional gap analysis does not assess the relative sensitivity of assets and liabilities to changes in interest rates and other factors that could have an impact on interest rate sensitivity or net interest income.
ALCO routinely monitors simulated net interest income sensitivity over a rolling two-year horizon. It also utilizes additional tools to monitor potential longer-term interest rate risk. The income simulation models measure the Company’s net interest income volatility or sensitivity to interest rate changes utilizing statistical techniques that allow the Company to consider various factors which impact net interest income. These factors include actual maturities, estimated cash flows, repricing characteristics, deposit growth/retention and, most importantly, the relative sensitivity of the Company’s assets and liabilities to changes in market interest rates. This relative sensitivity is important to consider as the Company’s core deposit base has not been subject to the same degree of interest rate sensitivity as its assets. The core deposit costs are internally managed and tend to exhibit less sensitivity to changes in interest rates than the Company’s adjustable rate assets whose yields are based on external indices and generally change in concert with market interest rates. The Company’s interest rate sensitivity is determined by identifying the probable impact of changes in market interest rates on the yields on the Company’s assets and the rates that would be paid on its liabilities. This modeling technique involves a degree of estimation based on certain assumptions that management believes to be reasonable. Utilizing this process, management projects the impact of changes in interest rates on net interest margin. The Company has established certain policy limits for the potential volatility of its net interest margin assuming certain levels of changes in market interest rates with the objective of maintaining a stable net interest margin under various probable rate scenarios. Management generally has maintained a risk position well within the policy limits.
As market conditions vary from those assumed in the income simulation models, actual results will also differ due to: prepayment/refinancing levels likely deviating from those assumed, the varying impact of interest rate change caps or floors on adjustable rate assets, the potential effect of changing debt service levels on customers with adjustable rate loans, depositor early withdrawals and product preference changes, and other variables. Furthermore, this sensitivity analysis does not reflect actions that the ALCO might take in responding to or anticipating changes in interest rates.
In simulating the effects of upward and downward changes in market rates to net interest income over a rolling two-year horizon, the model utilizes a “static” balance sheet approach where balance sheet composition or mix as of the measurement date is maintained over the two-year horizon. Similarly, the base case simulation performed assumes interest rates on the measurement date are unchanged for the next 24 months. Then the simulation assumes all rate indices are instantaneously shocked upward and downward by 100 bps to 400 basis points, in 100 basis point increments. Due to the low level of
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interest rates, the shock down analysis where the rates fall 300 basis points or more are not considered meaningful and are therefore not shown in the results below as ofDecember 31, 2021.
(Dollars in thousands) Change in Net Interest Income
Change in Yield Curve Percentage Amount
Base case 0.00 % -
In addition to monitoring the effects to interest income, the model computes the effects to the economic value of equity using the same “static” balance sheet with immediate and parallel rate changes for the same rate change horizons. The Asset/Liability Committee monitors the results compared to policy limits that have been established.
As individual rate indices have not historically moved to the same degree, non-parallel rate shocks are also performed to add a degree of sophistication over the parallel rate shocks. In these analyses, the effects to net interest income and market value of equity are computed using eight different scenarios. Changing slopes and twists of the yield curve are achieved by incorporating both likely and unlikely change across different tenors. Since Federal funds rates may not change to the same degree or direction that longer term Treasury bonds may move, the different scenarios are analyzed so that management and the Asset/Liability Committee can monitor risks as they more severely stress the Company’s balance sheet.
The shape of the yield curve can cause downward pressure on net interest income. In general, if and to the extent that the yield curve is flatter (i.e., the differences between interest rates for different maturities are relatively smaller) than previously anticipated, then the yield on the Company’s interest earning assets and its cash flows will tend to be lower. Management believes that a relatively flat yield curve could continue to affect adversely the Company’s net interest income in 2022.
Liquidity
Liquidity represents the Company’s ability to provide funds to meet customer demand for loan and deposit withdrawals without impairing profitability. Effective management of balance sheet liquidity is necessary to fund growth in earning assets and to pay liability maturities and depository customers’ withdrawal requirements. The Company maintains a Liquidity Management Policy that is approved by the Board of Directors. The policy sets limits in a number of areas, including limits on the amount of non-core liabilities, and funding long-term assets with non-core liabilities.
The Bank’s customer base has provided a stable source of funds and liquidity. Limits contained within the Bank’s Investment Policy also provides for appropriate levels of liquidity through maturities and cash flows within the securities portfolio. Other sources of balance sheet liquidity are obtained from the repayment of loan proceeds and overnight investments. The Bank has numerous secondary sources of liquidity including access to borrowing arrangements from a number of correspondent banks. Available borrowing arrangements maintained by the Bank include formal federal funds lines with five major regional correspondent banks, access to advances from the Federal Home Loan Bank and access to the discount window at the Federal Reserve Bank.
Borrowing Lines
As of December 31, 2021
Correspondent Banks $ 95,000
Federal Home Loan Bank of Atlanta 14,200
As of December 31, 2021, the Company had no outstanding advances with the FHLB.
Any excess funds are sold on a daily basis in the federal funds market or maintained on account at the Federal Reserve. The Company maintained an average of $109.1 million outstanding in federal funds sold, an average of $161.0 million at the Federal Reserve and an average of less than $1 thousand in federal funds purchased during 2021 due to annual testing of the federal funds lines. On December 31, 2021 the Company had no balance outstanding in federal funds purchased. The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.
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Capital
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 Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios of the Bank were 14.15%, 14.15%, 14.72% and 7.69%, respectively, as of December 31, 2021, exceeding the minimum requirements.