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.
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Bank - The Bank’s commercial banking activities involve making loans, taking deposits and offering related services to individuals, businesses and charitable organizations. Loan fee income, service charges from deposit accounts, and other non-interest-related revenue, such as fees for debit cards and ATM usage and fees for treasury management services, generate additional income for this segment.
•
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.
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Masonry Capital - Masonry Capital offers investment management services for separately managed accounts and a private investment fund employing a value-based, catalyst-driven investment strategy. Revenue for this segment is generated from management fees which are derived from Assets Under Management and incentive income which is based on the investment returns generated on performance-based Assets Under Management. 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
Stock option expense - 142 - - 142
Restricted stock grant expense - 585 - - 585
Vested stock grants 41 (41 ) - - -
Cash dividends declared ($1.32 per share) - - (7,074 ) - (7,074 )
Impact of adoption of CECL (1,890 ) (1,890 )
Other comprehensive income - - - 8,580 8,580
See Notes to Consolidated Financial Statements
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VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(dollars in thousands)
For the years ended December 31,
CASH FLOWS FROM OPERATING ACTIVITIES:
Provision for credit losses 734 106
Net accretion of certain acquisition-related adjustments (6,191 ) (2,340 )
Amortization of intangible assets 1,493 1,746
Net amortization and (accretion) of securities (2,444 ) (364 )
Net losses on sale of AFS 206 -
Net gains on sales of other assets (112 ) (1,084 )
Bank owned life insurance income (1,764 ) (963 )
Depreciation and other amortization 3,276 3,339
Gain on sale of business line - (404 )
Impairment charge on assets held for sale - 242
Deferred tax (benefit) (473 ) (138 )
Net change in:
Accrued interest receivable and other assets 52 (828 )
Accrued interest payable and other liabilities (863 ) (1,336 )
Net cash provided by operating activities 13,904 22,685
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of available for sale securities (83,164 ) (316,350 )
Net increase in restricted investments (3,248 ) (188 )
Proceeds from sale of premises and equipment 2,358 6,311
Proceeds from sale of other real estate owned - 610
Proceeds from settlement of bank owned life insurance 1,412 -
Purchase of bank owned life insurance - (6,355 )
Purchase of bank premises and equipment, net (1,171 ) (546 )
Net cash (used in) provided by investing activities (19,767 ) (167,197 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in Federal funds purchased 3,462 -
Net increase in other borrowings 66,500 -
Proceeds from termination of interest swap 460 -
Proceeds from stock options exercised 18 23
Net cash (used in) provided by financing activities (5,883 ) (324,192 )
NET (DECREASE) IN CASH AND CASH EQUIVALENTS $ (11,746 ) $ (468,704 )
CASH AND CASH EQUIVALENTS:
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Unrealized gains (losses) on available for sale securities $ 11,367 $ (59,347 )
Unrealized gains on interest rate swaps - 695
Change in goodwill - (372 )
See Notes to Consolidated Financial Statements
61
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note 1 – Summary of Significant Accounting Policies
The Company - Headquartered in Charlottesville, Virginia, Virginia National Bankshares Corporation (the Company) (NASDAQ: VABK) is a bank holding company incorporated under the laws of the Commonwealth of Virginia. The Company is authorized to issue (a) 10,000,000 shares of common stock with a par value of $2.50 per share and (b) 2,000,000 shares of preferred stock at a par value $2.50 per share. There is currently no preferred stock outstanding. The Company is regulated under the Bank Holding Company Act of 1956, as amended and is subject to inspection, examination, and supervision by the Federal Reserve Board.
Virginia National Bank (the Bank) is a wholly-owned subsidiary of the Company and was organized in 1998 under federal law as a national banking association to engage in a general commercial and retail banking business. The Bank is also headquartered in Charlottesville, Virginia and primarily serves the Virginia communities in and around the cities of Charlottesville, Winchester, Manassas and Richmond, and the counties of Albemarle, Fauquier, Frederick and Prince William. As a national bank, the Bank is subject to the supervision, examination and regulation of the OCC.
The Bank offers a full range of banking and related financial services to meet the needs of individuals, businesses and charitable organizations, including the fiduciary services of VNB Trust and Estate Services. Until the sale of the business line on December 19, 2022, the Bank also offered, through networking agreements with third parties, investment advisory and other investment services under Sturman Wealth Advisors. Refer to Note 27 - Sale of Sturman Wealth Advisors for more information regarding the sale of such business line. Investment management services are offered through Masonry Capital Management, LLC, a registered investment adviser and wholly-owned subsidiary of the Company.
The Bank, through its financial subsidiary Fauquier Bank Services, Inc., has equity ownership interests in Bankers Insurance, LLC, a Virginia independent insurance company, and Bankers Title Shenandoah, LLC, a title insurance company, both of which are owned by a consortium of Virginia community banks.
The Bank has another subsidiary, Special Properties Acquisition - VA, LLC, which was originally formed by Fauquier to hold other real estate owned; however, there are no assets currently held by this subsidiary.
In addition, the Company owns Fauquier Statutory Trust II (“Trust II”), which is an unconsolidated subsidiary. The subordinated debt owed to Trust II is reported as a liability of the Company.
On April 1, 2021, the Company completed the Merger with Fauquier with and into the Company for total consideration paid of $78.0 million. In connection with the transaction, TFB, Fauquier's wholly-owned bank subsidiary, was merged with and into the Bank.
Basis of Financial Information - The accounting and reporting policies of the Company conform to accounting principles generally accepted in the United States of America and to the reporting guidelines prescribed by regulatory authorities. The following is a description of the more significant of those policies and practices.
Principles of consolidation –The consolidated financial statements include the accounts of the Company, and its wholly-owned subsidiaries, the Bank and Masonry Capital. All significant intercompany balances and transactions have been eliminated in consolidation.
Use of estimates –The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for credit losses (including individually evaluated loans), acquisition accounting, intangible assets, income taxes, and fair value measurements.
62
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cash flow reporting –For purposes of the statements of cash flows, the Company considers all highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. Cash and cash equivalents consist of cash on hand, funds due from banks, interest bearing deposits in other banks and federal funds sold.
Securities – Unrestricted investments are classified in two categories as described below.
•
Securities held to maturity – Securities classified as held to maturity are those debt securities the Company has both the positive intent and ability to hold to maturity regardless of changes in market conditions, liquidity needs or changes in general economic conditions. Currently the Company has no securities classified as held to maturity because of Management’s desire to have more flexibility in managing the investment portfolio.
•
Securities available for sale – Securities classified as AFS are those debt securities that the Company intends to hold for an indefinite period of time but not necessarily 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. Unrealized gains or losses are reported as a separate component of other comprehensive income. Realized gains or losses, determined on the basis of the cost of specific securities sold, are included in earnings.
Purchase premiums and discounts are recognized in interest income using the interest method over the terms of the securities or to “call” dates, whichever occurs first. Gains and losses on the sale of securities are recorded on the trade date and are determined using the specific identification method.
For AFS securities, management evaluates all investments in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings.
If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, performance on any underlying collateral, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specifically related to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any excess is recorded as an ACL, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an ACL is recognized in other comprehensive income.
Changes in the ACL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the ACL when management believes an AFS security is confirmed to be uncollectible or when either of the criteria regarding intent or requirement to sell is met. At December 31, 2023, there was no ACL related to the AFS securities portfolio.
Restricted securities – As members of the FRB and the FHLB, the Company is required to maintain certain minimum investments in the common stock of the FRB and FHLB. Required levels of investments are based upon the Bank’s capital and a percentage of qualifying assets. Additionally, the Company has purchased common stock in CBBFC, the holding company for Community Bankers’ Bank and an investment in an SBA loan fund. These restricted securities are carried at cost.
Loans –Loans are reported at the principal balance outstanding net of unearned discounts and of the allowance for credit losses. Interest income on loans is reported on the level-yield method and includes amortization of deferred loan fees and costs over the loan term.
Loans acquired in a business combination are recorded at estimated fair value on the date of acquisition. In the case of loans that have experienced more than insignificant deterioration in credit quality since origination as of the acquisition date, the loan’s amortized cost basis is increased above estimated fair value by the amount of expected credit losses as of the acquisition date, and a corresponding ACL is also
63
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
recorded. Any remaining non-credit discount or premium for such purchased loans with credit deterioration (or PCD loans) and any fair value discount or premium for non-PCD loans is accreted or amortized as an adjustment to yield over the estimated lives of the loans using the level-yield method. There is no allowance for credit losses established for non-PCD loans as part of a business combination.
Further information regarding the Company’s accounting policies related to past due loans, non-accrual loans and impaired loans is presented in Note 4 - Loans.
Allowance for credit losses – The allowance for credit losses on loans is established through charges to earnings in the form of a provision for credit losses. Loan losses are charged against the ACL 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. No ACL is recorded on accrued interest receivable and amounts written-off are reversed by an adjustment to interest income. 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. Loans that share common risk characteristics are evaluated collectively using a discounted cash flow approach for all loans except for student loans and Minute Lender loans, which are evaluated using a remaining life methodology. The discounted cash flow approach used by the Company utilizes loan-level cash flow projections and pool-level assumptions. Further information regarding the Company’s policies and methodology used to estimate the ACL is presented in Note 5 – Allowance for Credit Losses.
Management’s estimate of the ACL on loans that are collectively evaluated also includes a qualitative assessment of available information relevant to assessing collectability that is not captured in the loss estimation process. Factors considered by management are detailed in Note 2 - Adoption of New Accounting Standards. This evaluation is inherently subjective, as it requires estimates that are susceptible to significant revision as more information becomes available.
Transfers of financial assets – Transfers of financial assets are accounted for as sales when control over the assets has been surrendered. Control over transferred assets is deemed to be surrendered when (1) the assets have been isolated from the Company or its subsidiaries – put presumptively beyond reach of the transferor and its creditors, even in bankruptcy or other receivership, (2) the transferee obtains the right (free of conditions that constrain it from taking advantage of that right) to pledge or exchange the transferred assets, and (3) the Company or its subsidiaries does not maintain effective control over the transferred assets through an agreement to repurchase them before their maturity or the ability to unilaterally cause the holder to return specific assets.
Premises and equipment –Land is carried at cost. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of assets, which range from 3 to 40 years. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, the asset and related accumulated depreciation are removed from the books and any resulting gain or loss is charged to income. More information regarding premises and equipment is presented in Note 6 – Premises and Equipment.
Leases –The Company recognizes a lease liability and a right-of-use asset in connection with leases in which it is a lessee, except for leases with a term of twelve months or less. A lease liability represents the Company’s obligation to make future payments under lease contracts, and a right-of-use asset represents the Company’s right to control the use of the underlying property during the lease term. Lease liabilities and right-of-use assets are recognized upon commencement of a lease and measured as the present value of lease payments over the lease term, discounted at the incremental borrowing rate of the lessee. Further information regarding leases is presented in Note 7 – Leases.
Intangible assets –Goodwill is determined as the excess of the fair value of the consideration transferred over the fair value of the net assets acquired and liabilities assumed as of the acquisition date. Goodwill and other intangible assets acquired in a business combination and determined to have an indefinite useful
64
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
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. The Company performs the test as of December 31 of each year whereby the estimated fair value is compared to the carrying value. 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 included on the Company’s Consolidated Balance Sheets. Management has concluded that no impairment of these assets existed as of the balance sheet date. More information regarding intangible assets is presented in Note 8 – Goodwill and Other Intangible Assets.
BOLI –The Company has purchased life insurance on certain key employees and acquired BOLI policies as part of the Merger. These policies are recorded at their cash surrender value on the Consolidated Balance Sheets. Income generated from polices is recorded as noninterest income.
Other Real Estate Owned – Assets acquired through or in lieu of loan foreclosures are held for sale and are initially recorded at fair value less selling costs at the date of foreclosure, establishing a new cost basis. When the carrying amount exceeds the acquisition date fair value less selling costs, the excess is charged off against the ACL. Subsequent to foreclosure, valuations are periodically performed by management and the assets are carried at the lower of carrying amount or fair value less cost to sell, and any valuation adjustments occurring from post-acquisition reviews are charged to expense as incurred. Revenue and expenses from operations and changes in the valuation allowance are included in other expenses on the Company’s Consolidated Statements of Income.
Fair value measurements – ASC Topic 820, “Fair Value Measurements and Disclosures,” defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles, and requires certain disclosures about fair value measurements. In general, fair values of financial instruments are based upon internally developed models that primarily use, as inputs, observable market-based parameters. Any such valuation adjustments are applied consistently over time. Additional information on fair value measurements is presented in Note 17 – Fair Value Measurements.
Stock-based compensation –The Company accounts for all plans under recognition and measurement accounting principles which require that the compensation cost relating to stock-based payment transactions be recognized in the financial statements. Stock-based compensation arrangements include stock options and unrestricted or restricted stock grants. For stock options, compensation is estimated at the date of grant, using the Black-Scholes option valuation model for determining fair value. The model employs the following assumptions:
•
Dividend yield - calculated as the ratio of historical cash dividends paid per share of common stock to the stock price on the date of grant;
•
Expected life (term of the option) - based on the average of the contractual life and vesting schedule for the respective option;
•
Expected volatility - based on the monthly historical volatility of the Company’s stock price over the expected life of the options;
•
Risk-free interest rate - based upon the U.S. Treasury bill yield curve, for periods within the contractual life of the option, in effect at the time of grant.
The Company has elected to estimate forfeitures when recognizing compensation expense, and this estimate of forfeitures is adjusted over the requisite service period or vesting schedule based on the extent to which actual forfeitures differ from such estimates. Changes in estimated forfeitures are recognized through a cumulative catch-up adjustment, which is recognized in the period of change, and also will impact the amount of estimated unamortized compensation expense to be recognized in future periods. Further information on stock-based compensation is presented in Note 19 – Stock Incentive Plans.
Net income per common share –Basic net income per share, commonly referred to as earnings per share, represent income available to common shareholders divided by the weighted-average number of common shares outstanding during the period, including restricted shares that have not yet vested as these are considered participating securities during the vesting period. Diluted net income per share reflect additional common shares that would have been outstanding if dilutive potential common shares had been
65
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
issued, as well as any adjustment to income that would result from the assumed issuance. Potential common shares that may be issued by the Company relate solely to outstanding stock options and are determined using the treasury stock method. Additional information on net income per share is presented in Note 20 – Net Income per Share.
Comprehensive income –Accounting principles generally require that recognized revenue, expenses, gains and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on AFS securities and interest rate swaps, are reported as a separate component of the equity section of the balance sheet, such items, along with net income, are components of comprehensive income (loss). Further information on the Company’s other comprehensive income (loss) is presented in the Consolidated Statements of Comprehensive Income (Loss).
Derivative Financial Instruments –The Company recognizes derivative financial instruments in the consolidated balance sheets at fair value. The fair value of a derivative is determined by quoted market prices and mathematical models using current and historical data. If certain hedging criteria are met, including testing for hedge effectiveness, special hedge accounting may be applied. The Company assesses each hedge, both at inception and on an ongoing basis, to determine whether the derivative used in a hedging transaction is effective in offsetting changes in the fair value or cash flows of the hedged item and whether the derivative is expected to remain effective during subsequent periods. The Company discontinues hedge accounting when (i) it determines that a derivative is no longer effective in offsetting changes in fair value or cash flows of a hedged item; (ii) the derivative expires or is sold, terminated or exercised; (iii) probability exists that the forecasted transaction will no longer occur or; (iv) management determines that designating the derivative as a hedging instrument is no longer appropriate. When hedge accounting is discontinued and a derivative remains outstanding, the Company recognizes the derivative in the balance sheet at its fair value and changes in the fair value are recognized in net income.
At inception, the Company designates a derivative as (i) a fair value hedge of recognized assets or liabilities or of unrecognized firm commitments (fair value hedge) or (ii) a hedge of forecasted transactions or variable cash flows to be received or paid in conjunction with recognized assets or liabilities (cash flow hedge). For a derivative treated as a fair value hedge, a change in fair value is recorded as an adjustment to the hedged item and recognized in net income. For a derivative treated as a cash flow hedge, the effective portion of a change in fair value is recorded as an adjustment to the hedged item and recognized as a component of accumulated other comprehensive income (loss) within shareholders’ equity. For a derivative treated as a cash flow hedge, the ineffective portion of a change in fair value is recorded as an adjustment to the hedged item and recognized in net income. Further information on the Company's derivative financial instruments is presented in Note 23 -Derivatives Instruments and Hedging Activities.
Advertising costs –The Company follows the policy of charging the costs of advertising to expense as they are incurred.
Income taxes –Deferred taxes are provided on the asset and liability method whereby deferred tax assets are recognized for deductible temporary differences, operating loss carry forwards, and tax credit carry forwards. Deferred tax liabilities are recognized for taxable temporary differences. Temporary differences are the differences between the reported amounts of assets and liabilities and their tax basis. Deferred tax assets are reduced by a valuation allowance when, in the opinion of management, it is more likely than not that some portion or all of the deferred tax assets will not be realized. Deferred tax assets and liabilities are adjusted for the effects of changes in tax laws and rates on the date of enactment.
When tax returns are filed, it is highly probable that some positions taken would be sustained upon examination by the taxing authorities, while others are subject to uncertainty about the merits of the position taken or the amount of the position that would be ultimately sustained. The benefit of a tax position is recognized in the financial statements in the period during which, based on all available evidence, management believes it is more likely than not that the position will be sustained upon examination, including the resolution of appeals or litigation processes, if any. Tax positions taken are not offset or aggregated with other positions. Tax positions that meet the more-likely-than-not recognition threshold are measured as the largest amount of tax benefit that is more than 50 percent likely of being realized upon settlement with the applicable taxing authority. The portion of the benefits associated with tax positions taken that exceeds the amount measured as described above is reflected as a liability for unrecognized tax
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
benefits in the accompanying consolidated balance sheets along with any associated interest and penalties that would be payable to the taxing authorities upon examination.
Interest and penalties associated with unrecognized tax benefits, if any, are classified as additional income taxes in the statements of income. For the years ended December 31, 2023 and 2022, there were no such interest or penalties recognized. Further information on the Company’s accounting policies for income taxes is presented in Note 11 – Income Taxes.
Securities and other property held in a fiduciary capacity– Securities and other property held by VNB Trust and Estate Services or Masonry Capital in a fiduciary or agency capacity are not assets of the Company and are not included in the accompanying consolidated financial statements.
Revenue Recognition – ASU 2014-09, “Revenue from Contracts with Customers”, and all subsequent amendments to the ASU (collectively “Topic 606”), (i) creates a single framework for recognizing revenue from contracts with customers that fall within its scope and (ii) revises when it is appropriate to recognize a gain (loss) from the transfer of nonfinancial assets, such as OREO. The majority of the Company’s revenue is from interest income, including loans and securities, which are outside the scope of the standard. The services that fall within the scope of the standard are presented within noninterest income on the consolidated statement of income and are recognized as revenue as the Company satisfies its obligations to the customer. The revenue that falls within the scope of Topic 606 is primarily related to service charges on deposit accounts, debit/credit card and ATM fees, asset management fees and sales of other real estate owned, when applicable.
Reclassifications – Certain reclassifications have been made to the prior year financial statements to conform to current year presentation. The results of the reclassifications are not considered material.
Recent Accounting Pronouncements
Improvements to Income Tax Disclosures – In December 2023, the FASB issued ASU 2023-09, “Income Taxes (Topic 740): Improvements to Income Tax Disclosures.” The amendments in this ASU require an entity to disclose specific categories in the rate reconciliation and provide additional information for reconciling items that meet a quantitative threshold, which is greater than five percent of the amount computed by multiplying pretax income by the entity’s applicable statutory rate, on an annual basis. Additionally, the amendments in this ASU require an entity to disclose the amount of income taxes paid (net of refunds received) disaggregated by federal, state, and foreign taxes and the amount of income taxes paid (net of refunds received) disaggregated by individual jurisdictions that are equal to or greater than five percent of total income taxes paid (net of refunds received). Lastly, the amendments in this ASU require an entity to disclose income (or loss) from continuing operations before income tax expense (or benefit) disaggregated between domestic and foreign and income tax expense (or benefit) from continuing operations disaggregated by federal, state, and foreign. This ASU is effective for annual periods beginning after December 15, 2024. Early adoption is permitted. The amendments should be applied on a prospective basis; however, retrospective application is permitted. The Company does not expect the adoption of ASU 2023-09 to have a material impact on its consolidated financial statements.
Segment Reporting– In November 2023, the FASB issued ASU 2023-07, “Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures.” The amendments in this ASU are intended to improve reportable segment disclosure requirements primarily through enhanced disclosures about significant segment expenses. This ASU requires disclosure of significant segment expenses that are regularly provided to the chief operating decision maker (CODM), an amount for other segment items by reportable segment and a description of its composition, all annual disclosures required by FASB ASU Topic 280 in interim periods as well, and the title and position of the CODM and how the CODM uses the reported measures. Additionally, this ASU requires that at least one of the reported segment profit and loss measures should be the measure that is most consistent with the measurement principles used in an entity’s consolidated financial statements. Lastly, this ASU requires public business entities with a single reportable segment to provide all disclosures required by these amendments in this ASU and all existing segment disclosures in Topic 280. This ASU is effective for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. The amendments should be applied retrospectively. The Company does not expect the adoption of ASU 2023-07 to have a material impact on its consolidated financial statements.
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
LIBOR and Other Reference Rates– In December 2022, the FASB issued ASU 2022-06, “Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848”. ASU 2022-06 extends the period of time preparers can utilize the reference rate reform relief guidance in Topic 848. The objective of the guidance in Topic 848 is to provide relief during the temporary transition period, so the FASB included a sunset provision within Topic 848 based on expectations of when the LIBOR would cease being published. In 2021, the UK Financial Conduct Authority (FCA) delayed the intended cessation date of certain tenors of USD LIBOR to June 30, 2023.
To ensure the relief in Topic 848 covers the period of time during which a significant number of modifications may take place, the ASU defers the sunset date of Topic 848 from December 31, 2022, to December 31, 2024, after which entities will no longer be permitted to apply the relief in Topic 848. The ASU is effective for all entities upon issuance.
The Company has identified all loans that are directly or indirectly impacted by LIBOR.
Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Company's financial position, results of operations or cash flows.
Note 2 - Adoption of New Accounting Standards
Financial Instruments – Credit Losses - On January 1, 2023, the Company adopted ASU 2016-13, “Financial Instruments – Credit Losses: Measurement of Credit Losses on Financial Instruments," and ASU 2022-02, “Financial Instruments-Credit Losses, Troubled Debt Restructurings and Vintage Disclosures,” collectively referred to as ASC 326. This standard, in part, replaced the incurred loss methodology with an expected loss methodology that is referred to as the current expected credit loss ("CECL") methodology. ASC 326 requires an estimate of credit losses for the remaining estimated life of the financial assets using historical experience, current conditions, and reasonable and supportable forecasts and generally applies to financial assets measured at amortized cost, including loan receivables and held-to-maturity debt securities, and some off-balance sheet credit exposures such as unfunded commitments to extend credit. Financial assets measured at amortized cost will be presented at the net amount expected to be collected by using an allowance for credit losses. Purchased credit deteriorated loans will receive an initial allowance at the acquisition date that represents an adjustment to the amortized cost basis of the loan, with no impact to earnings.
In addition, ASU 326 made changes to the accounting for available-for-sale debt securities. One change is to require credit losses to be presented as an allowance rather than as a write-down on available for sale debt securities if management does not intend to sell and does not believe that it is more likely than not, they will be required to sell.
The Company adopted ASC 326 and all related subsequent amendments thereto effective January 1, 2023 using the modified retrospective approach for all financial assets measured at amortized cost and off-balance sheet credit exposures. The transition adjustment of the adoption included an increase in the ACL on loans of $2.5 million, which is presented as a reduction to net loans outstanding, and an increase in the ACL for unfunded loan commitments of $253 thousand, which is recorded within Accrued interest payable and other liabilities on the consolidated balance sheets. The Company recorded a net decrease to opening retained earnings as of January 1, 2023 of $1.9 million, for the cumulative effect of adopting ASC 326, which reflects the transition adjustments noted above, net of the applicable deferred tax assets recorded. Results for reporting periods beginning after January 1, 2023 are presented under ASC 326 while prior period amounts continue to be reported in accordance with previously applicable accounting standards ("Incurred Loss"). Subsequent to adoption, the Company will record adjustments to its ACL and reserve for unfunded commitments through the provision for credit losses in the consolidated statements of income.
ASC 326 also replaced the Company's previous accounting policies for PCI loans and TDRs. With the adoption of ASC 326, loans previously designated as PCI loans were designated as purchased loans with credit deterioration (PCD loans). The Company adopted ASC 326 using the prospective transition approach for PCD loans that were previously identified as PCI and accounted for under ASC 310-30. On January 1, 2023, the Company's PCD loans were adjusted to reflect the addition of $355 thousand of expected credit losses to the amortized cost basis of the loans and a corresponding increase to the ACL. The remaining noncredit discount, the difference between the adjusted amortized cost basis and the outstanding principal
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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
balance on PCD loans, will be accreted into interest income over the estimated remaining lives of the loans using the effective interest rate method. The evaluation of the ACL will include PCD loans together with other loans that share similar risk characteristics, rather than using the separate pools that were used under PCI accounting. The adoption of ASC 326 also replaced previous TDR accounting guidance, and the evaluation of the ACL will include loans previously designated as TDRs together with other loans that share similar risk characteristics.
The adoption of ASC 326 did not affect the carrying value of debt securities or the amount of unrealized gains and losses recorded in accumulated other comprehensive loss. Upon adoption of ASC 326, the Company did not have any securities included in its portfolio where OTTI had previously been recognized or that required an ACL. Therefore, the Company determined that an ACL on AFS securities was not deemed material.
The following table illustrates the impact of adopting ASC 326:
Assets:
Allowance for credit losses:
Liabilities:
Reserve for credit losses on unfunded commitments 60 253 313
Available for Sale Securities - For AFS securities, management evaluates all investments in an unrealized loss position on a quarterly basis, and more frequently when economic or market conditions warrant such evaluation. If the Company has the intent to sell the security or it is more likely than not that the Company will be required to sell the security, the security is written down to fair value and the entire loss is recorded in earnings.
If either of the above criteria is not met, the Company evaluates whether the decline in fair value is the result of credit losses or other factors. In making the assessment, the Company may consider various factors including the extent to which fair value is less than amortized cost, performance on any underlying collateral, downgrades in the ratings of the security by a rating agency, the failure of the issuer to make scheduled interest or principal payments and adverse conditions specifically related to the security. If the assessment indicates that a credit loss exists, the present value of cash flows expected to be collected are compared to the amortized cost basis of the security and any excess is recorded as an ACL, limited by the amount that the fair value is less than the amortized cost basis. Any amount of unrealized loss that has not been recorded through an ACL is recognized in other comprehensive income.
Changes in the ACL are recorded as provision for (or reversal of) credit loss expense. Losses are charged against the ACL when management believes an AFS security is confirmed to be uncollectible or when either
69
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
of the criteria regarding intent or requirement to sell is met. At December 31, 2023, there was no ACL related to the AFS securities portfolio.
Loans- Loans that management has the intent and ability to hold for the foreseeable future or until maturity or payoff are reported at amortized cost. Amortized cost is the principal balance outstanding, net of purchase premiums and discounts and deferred fees and costs. Accrued interest receivable related to loans totaled $4.3 million at December 31, 2023 and was reported in Accrued interest receivable and other assets on the consolidated balance sheets. Interest income is accrued on the unpaid principal balance. Loan origination fees, net of certain direct origination costs, are deferred and recognized in interest income using methods that approximate a level yield without anticipating prepayments.
The accrual of interest is generally discontinued when a loan becomes 90 days past due and is not well collateralized and in the process of collection, or when management believes, after considering economic and business conditions and collection efforts, that the principal or interest will not be collectible in the normal course of business. Past due status is based on contractual terms of the loan. A loan is considered to be past due when a scheduled payment has not been received 30 days after the contractual due date.
All accrued interest is reversed against interest income when a loan is placed on nonaccrual status. Interest received on such loans is accounted for using the cost-recovery method, until qualifying for return to accrual. Under the cost-recovery method, interest income is not recognized until the loan balance is reduced to zero. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current, there is a sustained period of repayment performance, and future payments are reasonably assured.
Allowance for Credit Losses - Purchased Credit Deteriorated Loans- Upon adoption of ASC 326, loans that were designated as PCI loans under the previous accounting guidance were classified as PCD loans without reassessment.
In future acquisitions, the Company may purchase loans, some of which may have experienced more than insignificant credit deterioration since origination. In those cases, the Company will consider internal loan grades, delinquency status and other relevant factors in assessing whether purchased loans are PCD. PCD loans are recorded at the amount paid. An initial ACL is determined using the same methodology as other loans held for investment, but with no impact to earnings. The initial ACL determined on a collective basis is allocated to individual loans. The sum of the loan's purchase price and ACL becomes its initial amortized cost basis. The difference between the initial amortized cost basis and the par value of the loan is a noncredit discount or premium, which is amortized into interest income over the life of the loan. Subsequent to initial recognition, PCD loans are subject to the same interest income recognition and impairment model as non-PCD loans, with changes to the ACL recorded through provision expense.
Allowance for Credit Losses - Loans - The ACL is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on the loans. Loans are charged off against the allowance when management believes the uncollectibility of a loan balance is confirmed. Expected recoveries do not exceed the aggregate of amounts previously charged-off and expected to be charged-off. Accrued interest receivable is excluded from the estimate of credit losses.
The ACL represents management’s estimate of lifetime credit losses inherent in loans as of the balance sheet date. The ACL is estimated by management using relevant available information, from both internal and external sources, relating to past events, current conditions, and reasonable and supportable forecasts.
The Company measures expected credit losses for loans on a pooled basis when similar risk characteristics exist. The Company has identified ten portfolio segments and calculates the ACL for each using the methodology specified below (with the major classification noted in italics):
Discounted cash flow methodology:
1.