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.
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 Company’s ACL may be insufficient and any increases in the ACL may have a material adverse effect on the Company’s financial condition and results of operations.
On January 1, 2023, the Company adopted ASC 326, more commonly referred to as "CECL," which replaced prior accounting principles for the recognition of loan losses based on losses that have been incurred with a requirement to record an allowance for credit losses that represents expected credit losses over the lifetime of all loans in the Company’s portfolio. Under ASC 326, the Company’s estimate of expected credit losses is based on reasonable and supportable forecasts of future economic conditions and loan performance. While the adoption of ASC 326 will not affect ultimate loan performance or cash flows of the Company from making loans, the period in which expected credit losses affect net income of the Company may not be similar to the recognition of loan losses under prior accounting guidance, and recognizing an allowance based on expected credit losses may create more volatility in the level of our ACL and our results of operations, including based on volatility in economic forecasts and our expectations of loan performance in future periods, as actual results may differ materially from our estimates. If we are required to materially increase our level of ACL for any reason, such increase could adversely affect our business, financial condition, and results of operations.
The level of the allowance reflected 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 ACL inherently involved a high degree of subjectivity and required the Company to make significant estimates of credit risks and future trends, all of which could undergo material changes. Although the Company believed the ACL was a reasonable estimate of known and inherent losses in the loan portfolio at the time, it could not precisely predict such losses or be certain that the loan loss allowance would 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 Company’s control, may have required an increase in the ACL. In addition, bank regulatory agencies and the Company’s auditors periodically reviewed its ACL and may have required an increase in the provision for loan losses or the recognition of further loan charge-offs, based on judgments different from those of management. No adjustments to the ACL have been recommended or required as a result of audits.
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 501(c)3 organizations. 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
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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, 2023, approximately 82.6% 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, 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 higher risk of default.
As of December 31, 2023, the Company had approximately $396.1 million in loans secured by commercial real estate, which represented approximately 36.3% 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 higher 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 depend on the successful rental of their properties. Some degree of instability in the commercial real estate markets is expected in the coming quarters as loans are refinanced in markets with higher vacancy rates under current economic conditions. The outlook for commercial real estate remains dependent on the broader economic environment and, specifically, how major subsectors respond to a higher interest rate environment and higher prices for commodities, goods and services. 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 credit 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 ACL 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 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, 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
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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 credit 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. 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. Additionally, negative news about the Company or the banking industry in general could negatively impact market and/or customer perceptions of the Company, which could lead to a loss of depositor confidence and an increase in deposit withdrawals, particularly among those with uninsured deposits. Furthermore, as many regional banking organizations experienced in 2023, the failure of other financial institutions may cause deposit outflows as customers spread deposits among several different banks so as to maximize their amount of FDIC insurance, move deposits to banks deemed “too big to fail” or remove deposits from the banking system entirely. As of December 31, 2023, approximately 25.5% of our deposits were uninsured and we rely on these deposits for liquidity. 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 or available 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.
Recent negative developments affecting the banking industry, and resulting media coverage, have eroded customer confidence in the banking system.
The closures of Silicon Valley Bank and Signature Bank in March 2023, and First Republic Bank in May 2023, and concerns about similar future events, have generated significant market volatility among publicly traded bank holding companies and, in particular, regional banks. More recently, concerns about commercial real estate concentrations at regional and community banks have exacerbated this volatility. These market developments have negatively impacted customer confidence in the safety and soundness of regional and community banks. As a result, customers may choose to maintain deposits with larger financial institutions or invest in higher yielding short-term fixed income securities, all of which could materially adversely impact the Company’s liquidity, loan funding capacity, net interest margin, capital and results of operations. While federal bank regulators took action to ensure that depositors of the failed banks had access to their deposits, including uninsured deposit accounts, there is no guarantee that such actions will be successful in restoring customer confidence in regional and community banks and the banking system more broadly. Furthermore, there is no guarantee that regional bank failures or bank runs similar to the ones that occurred in 2023 will not occur in the future and, if they were to occur, they may have a material and adverse impact on customer and investor confidence in regional and community banks negatively impacting the Company’s liquidity, capital, results of operations and stock price.
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.
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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.
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, 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.
Inflation can have an adverse impact on the Company’s business and on its customers.
During 2022, the United States experienced the highest level of inflation since the 1980s. In response, the Federal Reserve increased the federal funds target rate at the fastest pace in over 40 years, increasing 425 bps during 2022 and an additional 100 bps in 2023. Price-wage inflation may cause the Company to give higher than normal raises to employees and start new employees at a higher wage. Furthermore, the Company’s customers are also affected by inflation and the rising costs of goods and services used in their households and businesses, which could have a negative impact on their ability to repay their loans with the Company. As market interest rates rise, the value of the Company’s investment securities generally decreases, although this effect can be less pronounced for floating rate instruments. Higher interest rates reduce the demand for loans and increase the attractiveness of alternative investment and savings products, like U.S. Treasury securities and money market funds, which can make it difficult to attract and retain deposits.
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
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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 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. The Company had no foreclosed property as of December 31, 2023 or December 31, 2022.
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 and financial technology 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.
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, (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
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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, customers 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.
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 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 Company 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
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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 customers 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 customers and counterparties, the Company may rely on information furnished to it by or on behalf of customers and counterparties, including financial statements and other financial information, which it does not independently verify. The Company also may rely on representations of customers 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 customers, the Company may assume that a customer’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 customer. 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.
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 performed due diligence and 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 customer. 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.
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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.
Consumers may increasingly decide not to directly 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, general-purpose reloadable prepaid cards, or in other types of assets, including cryptocurrencies or other digital assets. 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 loss of deposits as a lower cost source of funds could have a material adverse effect on our 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.
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The Company is currently facing increased regulation and supervision of its industry. 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.
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.
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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 $0.33 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.
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.
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While the Company’s common stock is currently listed on the Nasdaq Capital Market, it has less liquidity than stocks for larger companies listed on national securities exchanges.
The trading volume in the Company’s common stock on the Nasdaq Capital Market has been relatively low when compared with larger companies listed on national securities exchanges. There is no assurance that a more active and liquid trading market for the common stock will exist in the future. Consequently, shareholders may not be able to sell a substantial number of shares for the same price at which shareholders could sell a smaller number of shares. In addition, the Company cannot predict the effect, if any, that future sales of its common stock in the market, or the availability of shares of common stock for sale in the market, will have on the market price of the common stock. Sales of substantial amounts of common stock in the market, or the potential for large amounts of sales in the market, could cause the price of the Company’s common stock to decline, or reduce the Company’s ability to raise capital through future sales of common stock.
General Risk Factors
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, endemics, acts of war or terrorism and other external events could significantly impact our business.
Severe weather, earthquakes, other natural disasters, pandemics, 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
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Item 1C. CYBERSECURITY.
Cybersecurity Risk Management and Strategy
As a corporation committed to maintaining the integrity, confidentiality, and availability of our digital assets and sensitive information, the Company recognizes the critical importance of cybersecurity in today's interconnected business landscape. The Company's cybersecurity measures are designed to safeguard our systems, networks, data, and information from unauthorized access, disruption, or misuse.
The Company recognizes that cybersecurity is fundamental to maintaining trust with shareholders, customers, and other stakeholders. By prioritizing cybersecurity as a strategic imperative, the Company strives to safeguard business operations, sensitive information, and integrity which preserves the value delivered to all our constituents.
Key components of the Company's cybersecurity program:
•
Risk Management: The Company continuously assesses and mitigates cybersecurity risks across the organization by leveraging industry best practices and frameworks such as NIST Cybersecurity Framework.
•
Governance and Oversight: The Company's Board of Directors (the Board) regularly reviewscybersecurity matters, ensuring alignment with business objectives and regulatory requirements. A designated Information Technology Strategic Committee, which includes many subject matter experts from the Board and Executive Management, meets quarterly to provide additional focus and expertise in this area.
•
Security Controls: The Company has implemented robust technical and procedural controls to protect information assets, including firewalls, intrusion detection systems, encryption, access controls, and multifactor authentication. These controls are tested periodically by external technology audit firms with penetration tests and security audits.
•
Policy Controls: Annually all employees sign off on the Company’s data and device controls. The Company ensures that all information access points are the Company’s assets and all data passing through these access points are accessible by the Company and can be deleted whenever the Company deems necessary.
•
Employee Training and Awareness: Ongoing cybersecurity training and awareness programs are implemented to educate employees about potential threats, phishing attacks, social engineering tactics, and best practices for safeguarding company information.
•
Incident Response: The Company maintains a comprehensive incident response plan to promptly detect, contain, and recover from cybersecurity incidents. Regular testing and simulation exercises ensure readiness and effectiveness of response capabilities.
•
Third-Party Risk Management: The Company regularly evaluates and monitors the cybersecurity posture of third-party vendors and partners with whom data is shared or relied upon for critical services, to ensure they meet the Company's security standards.
•
Continuous Improvement: The Company regularly reviews and makes enhancements to the cybersecurity program to adapt to emerging threats, technological advancements, and changes in regulatory requirements. Implementation of new technologies, practices, and infrastructures to target security vulnerabilities is ongoing.
•
Compliance and Reporting: The Company adheres to relevant cybersecurity regulations and standards applicable to our industry and maintains transparency by disclosing material cybersecurity incidents or risks in accordance with regulatory obligations.
The Company had no material cybersecurity incidents in 2023.
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Item 2. PROPERTIES.
The Company and its subsidiaries currently occupy fourteen 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 Masonry Capital are located at 404 People Place, Charlottesville, Virginia. VNB Trust and Estate Services is located at 103 Third Street, SE, Charlottesville, Virginia. Of the fourteen locations used as bank branches, seven of the buildings are owned by the Company and six 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 and the Bank, 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.
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, 2023, the Company had issued and outstanding 5,365,982 shares of common stock, which included 62,721 shares of restricted stock that have not yet vested. These shares were held by approximately 690 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.
The data in the table below represents the high sales and low sales prices that occurred between January 1, 2022 and December 31, 2023 as reported by Nasdaq. Additionally, the table shows the dividends declared per quarter in 2023 and 2022.
Dividends Declared
High Low High Low
Equiniti Trust Company, LLC (formerly 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 2023 or 2022.
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 September 30, 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.
Application of Critical Accounting Policies and Critical Accounting Estimates
The accounting and reporting policies followed by the Company conform, in all material respects, to GAAP and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information, and other factors deemed to be relevant, actual results could differ from those estimates.
The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s 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:
•
Allowance for credit losses - The Company establishes the ACL through charges to earnings in the form of a provision for credit losses. Loan losses are charged against the allowance for credit losses for the difference between the carrying value of the loan and the estimated net realizable value or fair value of the collateral, if collateral dependent, when management believes that the collectability of the principal is unlikely. Subsequent recoveries, if any, are credited to the ACL. The ACL represents management’s current estimate of expected credit losses over the contractual term of loans held for investment, and is recorded at an amount that, in management’s judgment, reduces the recorded investment in loans to the net amount expected to be collected. Management’s judgment in determining the level of the ACL is based on evaluations of historical loan losses, current conditions and reasonable and supportable forecasts relevant to the collectability of loans. Various national economic variables are utilized in the development of the ACL, including the national unemployment rate and national gross domestic product. In addition, management’s estimate of expected credit losses is based on the remaining life of certain consumer loans held for investment, and changes in expected prepayment behavior may result in changes in the remaining life of loans and expected credit losses. Management also assesses the risk of credit losses arising from changes in general market, economic and business conditions; the nature and volume of the loan portfolio; the volume and severity of delinquencies and adversely classified loan balances and the value of underlying collateral in determining the recorded balance of the ACL. This evaluation is inherently subjective because it requires estimates that are susceptible to significant revision as more information becomes available. In evaluating the level of the ACL, we consider a range of possible assumptions and outcomes related to the various factors identified above. The level of the allowance is particularly sensitive to changes in the actual and forecasted national unemployment rate and changes in current conditions or reasonably expected future conditions affecting the collectability of loans.
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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.
•
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 and Note 8 – Goodwill and Other Intangible Assets, in the Notes to Consolidated Financial Statements.
•
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 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) balances of intangible assets, including goodwill, that vary significantly between institutions and (2) 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
Fully taxable-equivalent measures
Fully taxable-equivalent adjustment 349 333
Impact of FTE adjustment -0.4 % -0.3 %
Efficiency ratio (FTE) 3 58.3 % 57.1 %
Net interest margin 3.34 % 3.19 %
Fully tax-equivalent adjustment 0.02 % 0.02 %
Net interest margin (FTE) 1 3.36 % 3.21 %
Other financial measures
Impact of intangible assets (2.40 ) (2.69 )
Tangible book value per share (non-GAAP) $ 26.12 $ 22.31
1 FTE calculations use a Federal income tax rate of 21%.
2 The efficiency ratio, GAAP basis, is computed by dividing noninterest expense by the sum of net interest income and noninterest income.
3 The efficiency ratio, FTE, is computed by dividing noninterest expense by the sum of net interest income (FTE) and noninterest income.
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 1.22 % 1.30 %
Average equity to average assets 8.85 % 7.85 %
Cash dividend payout ratio 33.47 % 27.40 %
Net income for the year ended December 31, 2023 was $19.3 million, or $3.58 per diluted share, an 17.81% decrease compared to $23.4 million, or $4.38 per diluted share for the year ended December 31, 2022. This decrease was the result of a $4.6 million decrease in net interest income, a $4.6 million decrease in noninterest income, offset by a $4.5 million decrease in noninterest expense. Each component of such year-over-year changes are described in more detail below.
The efficiency ratio (FTE) was 58.3% for the year ended December 31, 2023, compared to 57.1% for the same period of 2022, increasing due to the fluctuations in net interest income, noninterest income and noninterest expense noted above.
The Company had four reportable segments during the period(s) presented: the Bank, VNB Trust and Estate Services, Sturman Wealth and Masonry Capital.
•
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.
•
Sturman Wealth Advisors – This segment offered wealth and investment advisory services. Revenue for this segment was generated primarily from investment advisory and financial planning fees, with a small and decreasing portion attributable to brokerage commissions. During December 2022, the Company sold this segment, including interest in the client relationships, to the individual running this line of business. More
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information on this sale can be found under Sale of Sturman Wealth Segment in Note 27 of the Notes to Consolidated Financial Statements, which is found in Item 8. Financial Statements and Supplementary Data.
•
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.
•
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. Note that the membership interests in this business line are planned to be sold to an officer of the Company effective April 1, 2024. Subsequent to the date of sale, the Company will receive an annual revenue-share amount for a period of six years. No expenses will be incurred by the Company related to Masonry Capital subsequent to April 1, 2024.
The Bank segment earned net income of $19.4 million in 2023, a $2.2 million decrease compared to the $21.6 million netted in 2022. VNB Trust and Estate Services realized a net loss of $307.0 thousand in 2023, compared to net income of $1.6 million in 2022. Masonry Capital realized net income of $145 thousand in 2023, compared to $103 thousand in 2022. Sturman Wealth earned $122 thousand in the prior year and was sold in the fourth quarter of 2022.
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 84.3% of the total revenue in 2023. 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, 2023, 2022, and 2021.
Consolidated Average Balance Sheets and Analysis of Net Interest Income (FTE)
Interest Average Interest Average Interest Average
ASSETS
Interest earning assets:
Securities
Loans:
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest bearing liabilities:
Interest bearing deposits:
Federal Funds Purchased 2,632 138 5.24 % - - - - - -
Non-interest bearing liabilities:
Interest expense as a percentage of average earning assets 1.43 % 0.19 % 0.21 %
(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
2023 compared to 2022
Change due to: Increase/
(Dollars in thousands) Volume Rate (Decrease)
Assets:
Loans:
Liabilities and Shareholders' equity:
Interest bearing deposits:
Federal Funds Purchased - 138 138
Change in net interest income $ (3,263 ) $ (1,299 ) $ (4,562 )
2022 compared to 2021
Change due to: Increase/
(Dollars in thousands) Volume Rate (Decrease)
Assets:
Loans:
Liabilities and Shareholders' equity:
Interest bearing deposits:
Interest checking $ 36 (67 ) $ (31 )
Money market and savings 130 (80 ) 50
Total interest bearing deposits 113 (545 ) (432 )
Short term borrowings 280 - 280
Junior subordinated debt 14 38 52
Total interest bearing liabilities 407 (507 ) (100 )
For 2023, net interest income (FTE) of $49.3 million was recognized, a decrease of $4.6 million over 2022. Net interest income (FTE) for 2022 totaled $53.9 million, a $8.6 million increase over the 2021 total of $45.3 million. Average earning assets decreased $212.1 million or 12.6% in 2023 compared to 2022 and increased $139.7 million or 9.1% in 2022 compared to 2021. The increase in rates in all categories of loans were the primary drivers of the increase in interest income from 2022 to 2023. The increase in the average balance of commercial loans as well as the increases in volume and rate of the securities portfolio from 2022 to 2023 also contributed to the increase in net interest income. The average balance for loans as a percentage of earnings assets for 2023 was 66.8%, compared to 58.3% and 66.1% in 2022 and 2021, respectively.
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The 2023 net interest margin (FTE) improved 15 bps to 3.36% from 3.21% in 2022. The 2022 net interest margin (FTE) improved 27 bps from 2.94% in 2021. The tax-equivalent yield on average earning assets for 2023 of 4.79% was 140 bps higher than the 2022 yield of 3.40%. The 2022 tax-equivalent yield on average earning assets was 25 bps higher than the comparable 2021 yield of 3.15%. Loan yields for 2023 were 5.72%, improving 120 bps from the loan yield of 4.52% for 2022. Average loans for 2023 of $980.6 million were $2.3 million higher than the 2022 average of $978.3 million.
The increase in rates paid on deposits in 2023 compared to 2022 negatively impacted net interest income. Interest expense as a percentage of average earning assets increased to 143 bps for 2023, compared to 19 and 21 bps for 2022 and 2021, 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 compared to peers 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.
Provision for Credit Losses
The level of the ACL 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 ACL is contained later in this section under allowance for credit losses, in addition to Note 1 – Summary of Significant Accounting Policies and Note 5 – Allowance for Credit Losses 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 2023, the Company recorded a provision for credit losses of $734 thousand, which includes $38 thousand of provision for unfunded commitments, compared to $106 thousand in 2022 and $1.0 million in 2021. The increase in 2023 is primarily the result of the adoption of ASC 326, which increased the ACL by $2.5 million effective January 1, 2023, as well as increase in provision related to organic loan growth. The decrease in 2022 was impacted by the decline in overall loan balances as part of the Company's strategy to further improve asset quality through negotiation of loan paydowns.
The allowance for credit losses as a percentage of total loans was 0.77% at December 31, 2023 compared to 0.59% at December 31, 2022.
The following is a summary of the changes in the allowance for credit losses for the years ended December 31, 2023, 2022, and 2021:
Impact of ASC 326 adoption $ 2,491 $ - $ -
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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:
Advisory and brokerage income - 770 (770 ) -
Resolution of commercial dispute - 2,400 (2,400 ) -
Gain on termination of interest rate swap 460 - 460 -
Gain on sale of business line - 404 (404 ) -
Losses on sales of AFS, net (206 ) - (206 ) -
Noninterest income of $9.1 million for the year ended December 31, 2023 decreased $4.6 million over the prior year, as a result of the following nonrecurring items in the year ended December 31, 2022:
•
The Company received and recognized a $2.4 million one-time payment to resolve a commercial dispute in the first quarter of 2022;
•
A $1.0 million gain was recognized in connection with the sale of two buildings during the second quarter of 2022, and
•
$770 thousand of advisory and brokerage income was earned in the prior year by Sturman Wealth Advisors, and a $404 thousand gain was recognized in the fourth quarter of 2022 in connection with the sale of this business line.
These decreases were partially offset by an increase in non-interest income from proceeds of bank owned life insurance collected related to the death of a former employee.
Noninterest Expense
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:
Impairment on assets held for sale - 242 (242 ) -
Noninterest expense of $34.1 million for the year ended December 31, 2023 decreased $4.5 million from the prior year, predominantly due to continued efficiencies gained from the Merger in the areas of salaries and employee benefits, occupancy and professional fees. In addition, expenses in salaries and employee benefits and professional fees declined
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year-over-year from the sale of Sturman Wealth Advisors in the fourth quarter of 2022. At December 31, 2023, the Company had 155 full-time equivalent employees compared to 157 at December 31, 2022.
Core deposit intangible amortization expense is a result of the Merger and amounted to $1.5 million in 2023 and $1.7 million in 2022.
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.
For 2023, the Company provided $4.0 million for Federal income taxes, resulting in an effective income tax rate of 17.2%. In 2022, the Company provided $5.1 million for Federal income taxes, resulting in an effective income tax rate of 17.9%. The effective tax rate was lower in 2023 due to the nontaxability of proceeds from bank owned life insurance as a result of the death of a former employee. The effective income tax rates for 2023 and 2022 were lower than the U.S. statutory rate of 21% due to the effect of tax-exempt income from municipal bonds and tax-exempt interest from 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.
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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, 2023, the Company’s investment portfolio totaled $429.0 million, with obligations of U.S. government corporations and government-sponsored enterprises amounting to $316.5 million, or approximately 74% of the total. The Company’s investment portfolio totaled $543.3 million as of December 31, 2022.
During the year ended December 31, 2023, $49.8 million of securities were sold incurring a pre-tax loss of $206 thousand, as part of a strategic decision to reinvest proceeds into higher yielding assets. During the year ended December 31, 2022, there were no sales of securities. 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, 2023. Management has evaluated whether the decline in fair value is the result of credit losses and has determined that no credit loss provision is required as of December 31, 2023 related to the AFS portfolio. AFS securities included gross unrealized losses of $50.9 million as of December 31, 2023.
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, 2023, the securities issued by political subdivisions or agencies were highly rated with 100% of the municipal bonds having A+ or higher ratings. Approximately 63% 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, 2023.
The Company’s holdings of restricted securities totaled $8.4 million and $5.1 million at December 31, 2023 and December 31, 2022, 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. 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.
The table shown below details the amortized cost and fair value of AFS securities at December 31, 2023 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.
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Maturity Distribution and Average Yields
Contractual Maturities of Debt Securities at December 31, 2023
U.S. treasury securities
U.S. government-sponsored agencies:
MBS/CMOs
Corporate bonds
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, 2023. 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, 2023, the weighted average maturity of the fixed rate MBS sector was 16.5 years, and the projected average life for this group of securities is 7.3 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 $161.0 million for 2024, $32.4 million for 2025, and $25.0 million for 2026, based upon rates remaining at current levels. This represents approximately 46% of the investment portfolio’s AFS balance at December 31, 2023 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 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, State of Maryland, District of Columbia and portions of West Virginia that are within a 100 mile radius of any Virginia National Bank location.
The Company’s loan portfolio totaled $1.1 billion as of December 31, 2023 or 66.4% of total assets. Loan balances increased $156.3 million, or 16.7%, from the balance of $936.4 million as of December 31, 2022. 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 credit losses (8,395 ) (5,552 )
At December 31, 2023, the loan-to-deposit ratio stood at 77.5%, compared to 63.3% at December 31, 2022.
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 $82.3 million to a balance of $902.1 million at December 31, 2023 from $819.9 million at December 31, 2022. This category comprises 82.6% of all loans, and these loans are secured by mortgages on real property located principally in our market area. Of this amount, approximately $317.6 million represented loans on 1-4 family residential properties. Commercial real estate loans totaled $550.9 million as of December 31, 2023. 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 $33.7 million as of December 31, 2023.
The following table details the Company's levels of non-owner occupied commercial real estate as of December 31, 2023, along with the average loan size and % of risk ratings for each category:
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Total Non-Owner Occupied CRE $ 274,153
As of December 31, 2023, the Company’s commercial and industrial loan portfolio totaled $152.5 million, a $81.4 million increase from the $71.1 million balance at year-end 2022. This category, representing approximately 14.0% of all loans, includes loans made to individuals and small to medium-sized businesses, as well as loans purchased in the government guaranteed market.
Consumer loans, comprised of student loans purchased, revolving credit, and other fixed payment loans, totaled $38.0 million as of December 31, 2023 or 3.5% of all loans. Consumer loans ended 2023 with balances $7.4 million lower than the prior year-end, primarily due to normal amortization within the student loan portfolio.
The following table presents the maturity/repricing distribution of the Company’s loans at December 31, 2023. 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 or U.S. Treasury bond indices.
Maturities and Sensitivities of Loans to Changes in Interest Rates
(Dollars in thousands) As of December 31, 2023
Fixed Rate:
Variable Rate:
Total loans at December 31, 2023 and 2022 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 as of December 31, 2023:
(Dollars in thousands) December 31, 2023
Carrying amount:
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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, 2023 and 2022, the Company had loans classified as non-accrual with balances of $1.9 million and $673 thousand, respectively. The non-accrual balance as of December 31, 2023 consists of eight loans to seven borrowers.
Loans 90 days or more past due and still accruing interest amounted to $879 thousand as of December 31, 2023, compared to $705 thousand as of December 31, 2022. The 2023 balance includes two loans totaling $782 thousand which are 100% government-guaranteed, and five student loans totaling $97 thousand.
Allowance for Credit Losses
The relationship of the ACL to total loans and nonaccrual loans appears below:
Allowance for credit losses $ 8,395 $ 5,552
Nonaccrual loans to total loans 0.17 % 0.07 %
ACL to total loans 0.77 % 0.59 %
See Note 4 – Loans and Note 5 – Allowance for Credit 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.
Activity for the allowance for credit losses is provided in the following table:
As of and for the year ended December 31, 2023
Allowance for Credit Losses:
Charge-offs - - - - (721 ) (721 )
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As of and for the year ended December 31, 2022
Allowance for Loan Losses:
As of December 31, 2023, the ACL was $8.4 million, an increase of $2.8 million from $5.6 million at December 31, 2022, due to the adoption of CECL and increased balances in the loan portfolio. Management’s estimates for the ACL resulted in the Company’s allowance to total loans outstanding ratio of 0.77% at December 31, 2023, compared to 0.59% at December 31, 2022.
During 2023, there were $721 thousand in loan balances charged off, with a total of $377 thousand in recoveries of previously charged-off balances, resulting in net charge-offs of $344 thousand. During 2022, there were $1.3 million in loan balances charged off, with a total of $717 thousand in recoveries of previously charged-off balances, resulting in net charge-offs of $538 thousand. The ratio of net charge-offs to average loans was 0.04% and 0.05% for 2023 and 2022, respectively.
The table below provides an allocation of year-end allowance for credit 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 Credit Losses
Real estate construction and land 462 3.08 %
Real estate construction and land 221 4.01 %
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 market areas.
Depository accounts held by the Company as of December 31, 2023, totaled $1.4 billion, a decrease of $69.2 million or 4.68% compared to the December 31, 2022 total of $1.5 billion.
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At December 31, 2023, the balances of non-interest bearing demand deposits were $372.9 million or 26.5% of total deposits, a 24.8% decrease from $495.6 million at December 31, 2022. interest bearing transaction and money market accounts totaled $717.7 million at December 31, 2023, a decrease of $149.9 million compared to $0.9 billion at December 31, 2022. 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, 2023, the reciprocal ICS® balances included in demand deposit and money market accounts were $44.2 million and $107.3 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 77.4% of total deposit account balances at December 31, 2023 compared to 92.2% of total deposit account balances at December 31, 2022, declining due to the rising rate environment and customers' desires to earn higher rates of interest. Management intentionally delayed deposit rate increases in the first half of 2023 in order to lessen the impact of the Company's cost of funds.
Certificates of deposit and other time deposit balances increased $203.5 million to $318.6 million at December 31, 2023 from the balance of $115.1 million at December 31, 2022. 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 $5.5 million and $4.0 million at December 31, 2023 and 2022, 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, 2023 and 2022, the estimated amounts of total uninsured deposits were $360.0 million and $459.4 million, respectively.
Maturities of time deposits in excess of FDIC insurance limits as of December 31, 2023 were as follows:
(Dollars in thousands)
Amount Percentage
Over three months to six months 20,033 18.8 %
Over six months to one year 33,497 31.4 %
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. As of December 31, 2023, the Company had $66.5 million in outstanding advances from the FHLB, compared to no outstanding borrowings as of December 31, 2022.
As of December 31, 2022, the Company had an off-balance sheet letter of credit in the amount of $30.0 million, issued in favor of the Commonwealth of Virginia Department of the Treasury to secure public fund depository accounts. This letter of credit was cancelled by the Company in 2023 and was previously secured by commercial mortgages.
Additional borrowing arrangements maintained by the Bank include formal federal funds lines with five correspondent banks. The Company had $3.5 million in federal funds purchased as of December 31, 2023 compared to no outstanding balances in federal funds purchased as of December 31, 2022 or 2021.
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Borrowings, excluding federal funds purchased, consist of the following as of December 31, 2023, 2022, and 2021:
FHLB advances $ 66,500 $ - $ -
Total borrowings $ 66,500 $ - $ -
Maximum amount at any month-end during the year $ 66,500 $ - $ 42,575
Annual average balance outstanding $ 37,286 $ - $ 23,700
Annual average interest rate paid 5.19 % 0.00 % 0.82 %
Annual interest rate at end of period - - 0.00 %
Details on available borrowing lines can be found later under Liquidity in the Asset/Liability Management section.
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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, 2023, total capital securities were $3.5 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 of rate-sensitive assets and rate-sensitive liabilities repricing or maturing within one year, as shown in the Gap Interest Sensitivity Analysis table below.
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Gap Interest Sensitivity Analysis
As of December 31, 2023
Within 90 to 365 One to Four Over Non Rate
90 Days Days Years Four Years Sensitive Total
Assets
Federal funds sold - - - - - -
Interest bearing deposits in other banks 10,316 - - - - 10,316
Liabilities and Shareholders' Equity
Federal funds purchased 3,462 - - - - 3,462
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.
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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.
(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 an inverted or relatively flat yield curve could adversely the Company’s net interest income in 2024.
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 six 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, 2023
Federal Home Loan Bank of Atlanta 70,446
As of December 31, 2023, the Company had $66.5 million in outstanding advances with the FHLB.
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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 $3.8 million outstanding in federal funds sold, an average of $15.5 million at the Federal Reserve during 2023. On the liability side of the balance sheet, the Company maintained an average of $37.3 million in FHLB advances and $2.6 million in federal funds purchased during 2023. On December 31, 2023 the Company had a $3.5 million balance outstanding in federal funds purchased. The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.
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 17.29%, 17.29%, 18.12% and 11.05%, respectively, as of December 31, 2023, exceeding the minimum requirements.
With respect to the Bank, to be “well capitalized” under the PCA regulations, a bank must have the following minimum capital ratios: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%. The Bank exceeds the thresholds to be considered well capitalized as of December 31, 2023.
On September 17, 2019 the FDIC finalized a rule that introduced an optional simplified measure of capital adequacy for qualifying community banking organizations, referred to as, the community bank leverage ratio framework, as required by the EGRRCPA. The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.
In order to qualify for the CBLR framework, a community banking organization must have a Tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities. A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the PCA regulations and will not be required to report or calculate risk-based capital.
The CBLR framework was made available for community banking organizations to use in their March 31, 2020 Call Report. The Company has not opted into the CBLR framework.
The Basel III capital regulations and CBLR framework are discussed in greater detail under the caption “Supervision and Regulation,” found earlier in this report under “Item 1. Business.” In addition, information regarding the Company’s risk-based capital at December 31, 2023 and December 31, 2022 is presented in Note 15 – Capital Requirements of the Notes to Consolidated Financial Statements, contained in Item 8. Financial Statements and Supplementary Data. Using the most recent capital requirements, the Bank’s capital ratios remain above the levels designated by bank regulators as "well capitalized" at December 31, 2023.
Impact of Inflation and Changing Prices
The Company’s financial statements included herein have been prepared in accordance with GAAP, which requires the financial position and operating results to be measured principally in terms of historical dollars without considering the change in the relative purchasing power of money over time due to inflation. Inflation affects the Company’s results of operations mainly through increased operating costs, but since nearly all of the Company’s assets and liabilities are monetary in nature, changes in interest rates affect the financial condition of the Company to a greater degree than changes in the rate of inflation. Although interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. The Company’s management reviews pricing of its products and services, in light of current and expected costs due to inflation, to mitigate the inflationary impact on financial performance.
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Off-Balance Sheet Arrangements
The Company is party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments consist primarily of commitments to extend credit and standby letters of credit. Additional information concerning the Company’s off-balance sheet arrangements is contained in Note 13 of the Notes to Consolidated Financial Statements, found in Item 8. Financial Statements and Supplementary Data.
Related Party Transactions
The Company and its subsidiaries have business dealings with companies owned by directors and beneficial shareholders of the Company. In 2023 and 2022, leasing/rental expenditures of $543 thousand and $528 thousand respectively, (including reimbursements for taxes, insurance, and other expenses) were paid to an entity indirectly owned by a director of the Company.
Contractual Commitments
In the normal course of business, the Company and its subsidiaries enter into contractual obligations, including obligations on lease arrangements, contractual commitments for capital expenditures, and service contracts. The significant contractual obligations include the leasing of certain of its banking and operations offices under operating lease agreements on terms ranging from 1 to 10 years, most with renewal options.
Following is a schedule of future minimum rental payments under non-cancelable operating leases that have initial or remaining terms in excess of one year as of December 31, 2023:
(Dollars in thousands) 1 year or less 1-3 years 3-5 years After 5 years Total
Item 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK.
Not required for smaller reporting company.
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Item 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA.
Report of Independent Registered Public Accounting Firm
To the Shareholders and Board of Directors
Virginia National Bankshares Corporation
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Virginia National Bankshares Corporation and Subsidiaries (the Corporation) as of December 31, 2023 and 2022, the related consolidated statements of income, comprehensive income (loss), changes in shareholders' equity and cash flows for the years then ended, and the related notes to the consolidated financial statements (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Corporation as of December 31, 2023 and 2022, and the results of its operations and its cash flows for the years then ended, in conformity with accounting principles generally accepted in the United States of America.
Adoption of New Accounting Standard
As discussed in Notes 2, 4 and 5 to the financial statements, the Corporation changed its method of accounting for credit losses in 2023 due to the adoption of Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, including all related amendments.
Basis for Opinion
These financial statements are the responsibility of the Corporation’s management. Our responsibility is to express an opinion on the Corporation’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Corporation in accordance with U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Corporation is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Corporation’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective, or complex judgments. The communication of
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critical audit matters does not alter in any way our opinion on the financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing separate opinions on the critical audit matter or on the accounts or disclosures to which it relates.
Allowance for Credit Losses (ACL) – Loans Collectively Evaluated for Credit Losses
Description of the Matter
As discussed in Note 1 (Summary of Significant Accounting Policies), Note 2 (Adoption of New Accounting Standards) and Note 5 (Allowance for Credit Losses) to the financial statements, the Corporation changed its method of accounting for credit losses on January 1, 2023, due to the adoption of Accounting Standards Update 2016-13, Financial Instruments – Credit Losses (Topic 326), Measurement of Credit Losses on Financial Instruments, as amended. The allowance for credit losses on loans is a valuation allowance that represents management’s best estimate of expected credit losses on loans measured at amortized cost considering available information, from internal and external sources, relevant to assessing collectability over the loans’ contractual terms. Loans which share common risk characteristics are pooled and collectively evaluated by the Corporation using historical data, as well as assessments of current conditions and reasonable and supportable forecasts of future conditions. The Corporation’s total ACL for loans was $8.4 million, of which all but $4 thousand was for loans collectively evaluated. The collectively evaluated ACL consists of quantitative and qualitative components.
Loans are segmented into pools based upon similar characteristics and risk profiles and based on the degree of correlation of how loans within each pool respond to various economic conditions. To determine the quantitative component of the ACL, the Corporation uses the discounted cash flow method to estimate expected credit losses for the identified loan pools other than student and Minute Lender loans, which use the remaining life method. The discounted cash flow method estimates the difference between the amortized cost of the loans and present value of expected cash flows. The remaining life method applied to the student and Minute Lender loans, determines a quantitative ACL by utilizing historical information to determine a quarterly expected loss rate and applying it to an expected remaining balance for each period to determine the expected loss for the segment.
In addition to the quantitative component, the collectively evaluated ACL also includes a qualitative component which aggregates management’s assessment of available information relevant to assessing collectability that is not captured in the quantitative loss estimation process. The qualitative factors considered by management include changes in lending policies and procedures; nature and volume of the portfolio; experience, depth and ability of lending personnel; trends in credit quality; quality of the loan review system; value of underlying collateral; volume and concentrations of credit; and the effects of other external factors. A qualitative factor for reasonable and supportable forecasts of economic conditions is also determined for those segments utilizing the remaining life method as it is not already incorporated into the quantitative component. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available.
Management exercised significant judgment when assessing the qualitative factors in estimating the ACL for collectively evaluated loans. We identified the measurement of the ACL for collectively evaluated loans as a critical audit matter as auditing this estimate involved especially complex and subjective auditor judgment in evaluating and testing management’s assertions over an inherently complex estimation process that requires significant management judgment.
The primary audit procedures we performed to address this critical audit matter included:
•
Obtaining an understanding of the Corporation’s ACL methodology, internal controls, and management review controls related to collectively evaluated loans, including the process of:
•
The continued usage of the discounted cashflow method as the primary expected loss model, including assessment and reasonableness of loan pools, model validation, monitoring, and the completeness and accuracy of key data inputs and assumptions.
•
Qualitative factors, including sources of reasonable and supportable economic forecasts and other key inputs.
•
Governance and management review processes.
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•
Substantively testing management’s process for measuring the ACL related to collectively evaluated loans including:
•
Evaluating conceptual soundness, assumptions, and key data inputs of the Corporation’s discounted cashflow methodology, including the identification of loan pools, the probability of default and loss given default rate inputs, and the prepayment/curtailment rate inputs for each pool.
•
Evaluating the methodology and testing the accuracy of incorporating reasonable and supportable forecasts in the ACL for collectively evaluated loans.
•
Evaluating the completeness and accuracy of data inputs used as a basis for the qualitative factors.
•
Evaluating the qualitative factors for directional consistency in comparison to prior periods and for reasonableness in comparison to underlying supporting data.
•
Testing the mathematical accuracy of the ACL for collectively evaluated loans including both the discounted cashflow and qualitative factor components of the calculations.
/s/ Yount, Hyde & Barbour, P.C.
We have served as the Corporation’s auditor since 1998.
Richmond, Virginia
March 28, 2024
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VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(dollars in thousands, except per share data)
ASSETS
Interest bearing deposits in other banks 10,316 19,098
Federal funds sold - 45
Securities:
Restricted securities, at cost 8,385 5,137
Allowance for credit losses (8,395 ) (5,552 )
Assets held for sale - 965
Accrued interest receivable and other assets 14,287 13,507
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits:
Certificates of deposit and other time deposits 318,581 115,106
Federal funds purchased 3,462 -
Accrued interest payable and other liabilities 3,954 2,019
Commitments and contingent liabilities
Shareholders' equity:
Preferred stock, $2.50 par value - -
Accumulated other comprehensive (loss) (40,044 ) (48,624 )
Preferred shares outstanding - -
See Notes to Consolidated Financial Statements
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VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
(dollars in thousands, except per share data)
For the years ended December 31,
Interest and dividend income:
Other interest bearing deposits 501 1,467
Investment securities:
Interest and dividend income:
Money market and savings deposits 9,673 2,097
Certificates and other time deposits 8,617 657
Federal funds purchased 138 -
Junior subordinated debt 313 -
Provision for credit losses 734 106
Net interest income after provision for credit losses 48,235 53,441
Noninterest income:
Advisory and brokerage income - 770
Debit/credit card and ATM fees 2,268 2,794
Bank owned life insurance income 1,764 963
Resolution of commercial dispute - 2,400
Gains on sale of assets, net 112 1,043
Gain on termination of interest swap 460 -
Gain on sale of business line - 404
Losses on sales of AFS, net (206 ) -
Noninterest expense:
FDIC deposit insurance assessment 710 511
Marketing, advertising and promotion 1,098 1,224
Core deposit intangible amortization 1,493 1,684
Impairment on assets held for sale - 242
Net income per common share, basic $ 3.60 $ 4.40
Net income per common share, diluted $ 3.58 $ 4.38
See Notes to the Consolidated Financial Statements
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VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(dollars in thousands)
For the years endedDecember 31,
Other comprehensive income (loss):
Reclassification of unrealized loss on swap - (86 )
Total other comprehensive income (loss) 8,580 (46,413 )
Total comprehensive income (loss) $ 27,843 $ (22,975 )
See Notes to Consolidated Financial Statements
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VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY
(dollars in thousands, except per share data)
Accumulated
Other
Common Capital Retained Comprehensive
Stock Surplus Earnings Income (Loss) Total
Exercise of stock options 2 21 - - 23
Stock option expense - 167 - - 167
Restricted stock grant expense - 520 - - 520
Vested stock grants 34 (34 ) - - -
Cash dividends declared ($1.20 per share) - - (6,392 ) - (6,392 )
Exercise of stock options 3 15 - - 18