10-Q 1 tm2014657-1_10q.htm FORM 10-Q

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended March 31, 2020

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from ______ to ______

 

Commission file number: 0-50765

 

VILLAGE BANK AND TRUST FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

Virginia 16-1694602
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)

 

13319 Midlothian Turnpike, Midlothian, Virginia 23113
(Address of principal executive offices) (Zip code)

 

804-897-3900

(Registrant’s telephone number, including area code)

 

Title of each class Trading Symbol(s) Name of each exchange on which registered
Common Stock, par value $4.00 per share VBFC Nasdaq Capital Market

 

Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x No ¨

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes x No ¨

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer ¨ Accelerated Filer ¨
Non-Accelerated Filer x Smaller Reporting Company x
Emerging growth company ¨  

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ¨ No x

 

Securities registered pursuant to Section 12(b) of the Act:

 

Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date.

 

1,453,759 shares of common stock, $4.00 par value, outstanding as of April 30, 2020

 

 

 

 

 

 

Village Bank and Trust Financial Corp.

Form 10-Q

 

TABLE OF CONTENTS

 

Part I – Financial Information 3
   
Item 1. Financial Statements 3
   
Consolidated Balance Sheets  
March 31, 2020 (unaudited) and December 31, 2019 3
   
Consolidated Statements of Income  
For the Three Months Ended  
March 31, 2020 and 2019 (unaudited) 4
   
Consolidated Statements of Comprehensive Income  
For the Three Months Ended  
March 31, 2020 and 2019 (unaudited) 5
   
Consolidated Statements of Shareholders’ Equity  
For the Three Months Ended  
March 31, 2020 and 2019 (unaudited) 6
   
Consolidated Statements of Cash Flows  
For the Three Months Ended  
March 31, 2020 and 2019 (unaudited) 7
   
Notes to Consolidated Financial Statements (unaudited) 8
   
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations 38
   
Item 3. Quantitative and Qualitative Disclosures About Market Risk 53
   
Item 4. Controls and Procedures 53
   
Part II – Other Information 54
   
Item 1. Legal Proceedings 54
   
Item 1A. Risk Factors 54
   
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds 54
   
Item 3. Defaults Upon Senior Securities 55
   
Item 4. Mine Safety Disclosures 55
   
Item 5. Other Information 55
   
Item 6. Exhibits 56
   
Signatures 57

 

2

 

 

 

Part I – Financial Information

 

ITEM 1 – FINANCIAL STATEMENTS

 

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Balance Sheets
March 31, 2020 (Unaudited) and December 31, 2019*
(in thousands, except share and per share data)

 

   March 31,   December 31, 
   2020   2019 
Assets          
Cash and due from banks  $23,613   $19,967 
Federal funds sold   24,365    - 
Total cash and cash equivalents   47,978    19,967 
Investment securities available for sale, at fair value   39,081    46,937 
Restricted stock, at cost   2,355    2,035 
Loans held for sale, at fair value   17,219    12,722 
Loans          
Outstandings   435,234    429,295 
Allowance for loan losses   (3,444)   (3,186)
Deferred fees and costs, net   704    764 
Total loans, net   432,494    426,873 
Other real estate owned, net of valuation allowance   526    526 
Assets held for sale   514    514 
Premises and equipment, net   11,929    12,036 
Bank owned life insurance   7,657    7,612 
Accrued interest receivable   2,578    2,597 
Other assets   7,874    8,494 
           
Total Assets  $570,205   $540,313 
           
Liabilities and Shareholders' Equity          
Liabilities          
Deposits          
Noninterest bearing demand  $139,660   $131,228 
Interest bearing   329,183    311,980 
Total deposits   468,843    443,208 
Federal Home Loan Bank advances   36,000    29,000 
Long-term debt - trust preferred securities   8,764    8,764 
Subordinated debt, net   5,604    5,595 
Other borrowings   -    5,317 
Accrued interest payable   214    221 
Other liabilities   6,618    5,294 
Total liabilities   526,043    497,399 
           
Shareholders' equity          
Common stock, $4 par value, 10,000,000 shares authorized;          
1,453,759 shares issued and outstanding at March 31, 2020 and 1,453,009 shares issued and outstanding at December 31, 2019   5,779    5,779 
Additional paid-in capital   54,339    54,285 
Accumulated deficit   (16,394)   (17,292)
Common stock warrant   -    - 
Stock in directors rabbi trust   (771)   (856)
Directors deferred fees obligation   771    856 
Accumulated other comprehensive income   438    142 
Total shareholders' equity   44,162    42,914 
           
Total liabilities and shareholders' equity  $570,205   $540,313 

 

* Derived from audited consolidated financial statements

See accompanying notes to consolidated financial statements.                

 

3

 

 

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Income
Three Months Ended March 31, 2020 and 2019
(Unaudited)
(in thousands, except per share data)

 

   Three Months Ended 
   2020   2019 
Interest income          
Loans  $5,369   $5,365 
Investment securities   270    293 
Federal funds sold   45    51 
Total interest income   5,684    5,709 
           
Interest expense          
Deposits   900    882 
Borrowed funds   357    361 
Total interest expense   1,257    1,243 
           
Net interest income   4,427    4,466 
Provision for loan losses   400    - 
Net interest income after provision for  loan losses   4,027    4,466 
           
Noninterest income          
Service charges and fees   518    458 
Mortgage banking income, net   1,370    787 
Gain on sale of investment securities   12    101 
Gain on sale of Small Business Administration loans   86    92 
Other   74    80 
Total noninterest income   2,060    1,518 
           
Noninterest expense          
Salaries and benefits   3,022    2,936 
Occupancy   326    349 
Equipment   200    226 
Supplies   38    41 
Professional and outside services   716    809 
Advertising and marketing   78    58 
Foreclosed assets, net   -    1 
FDIC insurance premium   60    90 
Other operating expense   510    489 
Total noninterest expense   4,950    4,999 
           
Income before income tax expense   1,137    985 
Income tax expense   239    176 
           
Net income  $898   $809 
           
Earnings per share, basic  $0.62   $0.56 
Earnings per share, diluted  $0.62   $0.56 

 

See accompanying notes to consolidated financial statements.

 

4

 

 

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Comprehensive Income
Three Months ended March 31, 2020 and 2019
(Unaudited)
(in thousands)

 

   Three Months Ended 
   March 31, 
   2020   2019 
Net income  $898   $809 
Other comprehensive income          
Unrealized holding gains arising during the period   384    510 
Tax effect   (81)   (107)
Net change in unrealized holding gains on securities available for sale, net of tax   303    403 
           
Reclassification adjustment          
Reclassification adjustment for gains realized in income   (12)   (101)
Tax effect   3    21 
Reclassification for gains included in net income, net of tax   (9)   (80)
           
Minimum pension adjustment   3    3 
Tax effect   (1)   (1)
Minimum pension adjustment, net of tax   2    2 
           
           
Total other comprehensive income   296    325 
           
        Total comprehensive income  $1,194   $1,134 

 

See accompanying notes to consolidated financial statements.        

 

5

 

 

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Shareholders' Equity
(Unaudited)
(In thousands)

 

                       Directors   Accumulated     
       Additional       Common   Stock in   Deferred   Other     
   Common   Paid-in   Accumulated   Stock   Directors   Fees   Comprehensive     
   Stock   Capital   Deficit   Warrant   Rabbi Trust   Obligation   Income   Total 
Balance, December 31, 2019  $5,779   $54,285   $(17,292)  $-   $(856)  $856   $142   $42,914 
                                         
Restricted stock redemption   -    -    -    -    85    (85)   -    - 
Vesting of restricted stock   -    -    -    -    -    -    -    - 
Stock based compensation   -    54    -    -    -    -    -    54 
Net income   -    -    898    -    -    -    -    898 
Other comprehensive income   -    -    -    -    -    -    296    296 
Balance, March 31, 2020   5,779    54,339    (16,394)   -    (771)   771    438    44,162 
                                         
Balance, December 31, 2018  $5,707   $53,212   $(21,769)  $732   $(883)  $883   $(749)  $37,133 
                                         
Restricted stock redemption   -    -    -    -    27    (27)   -    - 
Vesting of restricted stock   13    (13)   -    -    -    -    -    - 
Stock based compensation   -    46    -    -    -    -    -    46 
Net income   -    -    809    -    -    -    -    809 
Other comprehensive income   -    -    -    -    -    -    325    325 
Balance, March 31, 2019  $5,720   $53,245   $(20,960)  $732   $(856)  $856   $(424)  $38,313 

 

See accompanying notes to consolidated financial statements.

 

6

 

 

 

Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Statements of Cash Flows
Three Months Ended March 31, 2020 and 2019
(Unaudited)
(in thousands)
 

 

   2020   2019 
Cash Flows from Operating Activities          
Net income  $898   $809 
Adjustments to reconcile net income to net cash provided by operating activities:          
Depreciation and amortization   149    268 
Amortization of debt issuance costs   9    8 
Deferred income taxes   239    - 
Provision for loan losses   400    177 
(Gain) loss on sale of investment securities   (12)   (101)
Gain on sales of loans held for sale   (2,084)   (928)
Stock compensation expense   54    46 
Proceeds from sale of mortgage loans   51,959    30,310 
Origination of mortgage loans held for sale   (54,372)   (28,472)
Amortization of premiums and accretion of discounts on securities, net   67    31 
Increase in bank owned life insurance   (45)   (37)
Net change in:          
Interest receivable   19    (67)
Other assets   307    (1,152)
Interest payable   (7)   20 
Other liabilities   1,324    1,847 
Net cash (used in) provided by operating activities   (1,095)   2,759 
           
Cash Flows from Investing Activities          
Purchases of available for sale securities   (1,013)   (4,632)
Proceeds from the sale of available for sale securities   7,936    6,491 
Proceeds from maturities, calls and paydowns of available for sale securities   1,248    1,038 
Net increase in loans   (6,021)   (3,428)
Purchases of premises and equipment, net   (42)   (184)
Purchase of restricted stock   (320)   (34)
Net cash provided by (used in) by investing activities   1,788    (749)
           
Cash Flows from Financing Activities          
Net increase in deposits   25,635    4,353 
Net increase in Federal Home Loan Bank advances   7,000    - 
Net decrease in other borrowings   (5,317)   - 
Net cash provided by financing activities   27,318    4,353 
           
Net increase in cash and cash equivalents   28,011    6,363 
Cash and cash equivalents, beginning of period   19,967    19,543 
           
Cash and cash equivalents, end of period  $47,978   $25,906 
           
Supplemental Disclosure of Cash Flow Information          
Cash payments for interest  $1,264   $1,223 
Supplemental Schedule of Non-Cash Activities          
Unrealized gains (losses) on securities available for sale  $370   $409 
Right of use assets obtained in exchange for new operating lease liabilities  $-   $1,405 
Minimum pension adjustment  $3   $3 

 

See accompanying notes to consolidated financial statements.            

 

7

 

 

Village Bank and Trust Financial Corp. and Subsidiary

Notes to Consolidated Financial Statements

Three Months Ended March 31, 2020 and 2019

(Unaudited)

 

Note 1 – Principles of presentation

 

Village Bank and Trust Financial Corp. (the “Company”) is the holding company of Village Bank (the “Bank”). The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s subsidiary, Village Bank Mortgage Corporation. All material intercompany balances and transactions have been eliminated in consolidation.

 

In the opinion of management, the accompanying condensed consolidated financial statements of the Company have been prepared on the accrual basis in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included. The results of operations for the three month period ended March 31, 2020 is not necessarily indicative of the results to be expected for the full year ending December 31, 2020. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 as filed with the Securities and Exchange Commission (“SEC”).

 

Note 2 – Use of estimates

 

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and statements of income for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses and its related provision including impaired loans and troubled debt restructurings (“TDRs”), the valuation allowance on the deferred tax asset, valuation of other real estate owned (“OREO”) and the estimate of the fair value of assets held for sale.

 

Note 3 – Earnings per common share

 

The following table presents the basic and diluted earnings per common share computation (in thousands, except share and per share data):

 

   Three Months Ended March 31, 
   2020   2019 
Numerator          
Net income - basic and diluted  $898   $809 
           
Denominator          
Weighted average shares outstanding - basic   1,454    1,435 
Dilutive effect of common stock options   -    - 
           
Weighted average shares outstanding - diluted   1,454    1,435 
           
Earnings per share - basic  $0.62   $0.56 
Earnings per share - diluted  $0.62   $0.56 

 

8 

 

 

Applicable guidance requires that outstanding, unvested share-based payment awards that contain voting rights and rights to nonforfeitable dividends participate in undistributed earnings with common shareholders. Accordingly, the weighted average number of shares of the Company’s common stock used in the calculation of basic and diluted net income per common share includes unvested shares of the Company’s outstanding restricted common stock.

 

The vesting of 4,155 and 8,650 at March 31, 2020 and 2019, respectively, of the unvested restricted units included in Note 11 “Stock incentive plan” was dependent upon meeting certain performance criteria. As of March 31, 2020 and 2019, it was indeterminable whether these unvested restricted units would vest and as such the underlying shares were excluded from common shares issued and outstanding at such date and were not included in the computation of earnings per share for such period.

 

Outstanding options and warrants to purchase common stock were considered in the computation of diluted earnings per share for the periods presented. Stock options for 514 and 578 shares were not included in computing diluted earnings per share for the three months ended March 31, 2020 and 2019, respectively, because their effects were anti-dilutive. Additionally, the impact of the warrant to acquire shares of the Company’s common stock in connection with the Company’s participation in the Troubled Asset Relief Program is not included for the period ended March 31, 2019, as the warrant was anti-dilutive. The warrant expired on May 1, 2019 and as such was not included in the period ended March 31, 2020.

 

Note 4 – Investment securities available for sale

 

The amortized cost and fair value of investment securities available for sale as of March 31, 2020 and December 31, 2019 are as follows (in thousands):

 

       Gross   Gross     
   Amortized   Unrealized   Unrealized     
   Cost   Gains   Losses   Fair Value 
March 31, 2020                    
U.S. Government agency obligations  $12,706   $154   $(3)  $12,857 
Mortgage-backed securities   17,989    631    -    18,620 
Subordinated debt   7,779    43    (218)   7,604 
                     
   $38,474   $828   $(221)  $39,081 
                     
December 31, 2019                    
U.S. Government agency obligations  $14,797   $57   $(9)  $14,845 
Mortgage-backed securities   25,124    204    (26)   25,302 
Subordinated debt   6,779    91    (80)   6,790 
                     
   $46,700   $352   $(115)  $46,937 

 

At March 31, 2020 the Company had investment securities with a fair value of approximately $6,196,000 pledged to secure borrowings from the Federal Home Loan Bank of Atlanta (“FHLB”). At December 31, 2019, the Company had no investment securities pledged to secure borrowings from the FHLB.

 

9 

 

 

Gross realized gains and losses pertaining to available for sale securities are detailed as follows for the periods indicated (in thousands):

 

   Three Months 
   Ended March 31, 
   2020   2019 
Gross realized gains  $39   $101 
Gross realized losses   (27)   - 
           
   $12   $101 

 

The Company sold approximately $7,900,000 and $6,500,000 in 2020 and 2019, respectively, of investment securities available for sale at a net gain of $12,000 in 2020 and $101,000 in 2019. The sales of these securities, which had fixed interest rates, allowed the Company to decrease its exposure to upward movement in interest rates that would result in unrealized losses being recognized in shareholders’ equity.

 

Investment securities available for sale that have an unrealized loss position at March 31, 2020 and December 31, 2019 are detailed below (in thousands):

 

   Securities in a loss   Securities in a loss         
   position for less than   position for more than         
   12 Months   12 Months   Total 
   Fair   Unrealized   Fair   Unrealized   Fair   Unrealized 
   Value   Losses   Value   Losses   Value   Losses 
March 31, 2020                              
U.S. Government agency obligations  $-   $-   $1,201   $(3)  $1,201   $(3)
Subordinated debt   4,344    (136)   418    (82)   4,762    (218)
                               
   $4,344   $(136)  $1,619   $(85)  $5,963   $(221)
                               
December 31, 2019                              
U.S. Government agency obligations  $2,001   $(1)  $5,368   $(8)  $7,369   $(9)
Mortgage-backed securities   2,747    (26)   -    -    2,747    (26)
Subordinated debt   759    (6)   940    (74)   1,699    (80)
                               
   $5,507   $(33)  $6,308   $(82)  $11,815   $(115)

 

As of March 31, 2020, there were $1.6 million, or six issues, of individual available for sale securities that had been in a continuous loss position for more than 12 months. These securities had an unrealized loss of $85,000 and consisted of U.S. Government agency obligations, and subordinated debt.

 

All of the unrealized losses are attributable to movements in interest rates and not to credit deterioration. Currently, the Company believes that it is probable that the Company will be able to collect all amounts due according to the contractual terms of the investments. Because the decline in fair value is attributable to changes in interest rates and not to credit quality, and because it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other than temporarily impaired at March 31, 2020.

 

10 

 

 

The amortized cost and estimated fair value of investment securities available for sale as of March 31, 2020, by contractual maturity, are as follows (in thousands):

 

   Amortized     
   Cost   Fair Value 
Less than one year  $6,208   $6,257 
One to five years   4,489    4,557 
Five to ten years   10,114    9,989 
More than ten years   17,663    18,278 
           
Total  $38,474   $39,081 

 

Note 5 – Loans and allowance for loan losses

 

Loans classified by type as of March 31, 2020 and December 31, 2019 are as follows (dollars in thousands):

 

   March 31, 2020   December 31, 2019 
   Amount   %   Amount   % 
Construction and land development                    
Residential  $8,143    1.87%  $7,887    1.84%
Commercial   24,027    5.52%   24,063    5.60%
    32,170    7.39%   31,950    7.44%
Commercial real estate                    
Owner occupied   103,210    23.71%   98,353    22.91%
Non-owner occupied   115,278    26.49%   116,508    27.14%
Multifamily   14,046    3.23%   13,332    3.10%
Farmland   150    0.03%   156    0.04%
    232,684    53.46%   228,349    53.19%
Consumer real estate                    
Home equity lines   20,590    4.73%   21,509    5.01%
Secured by 1-4 family residential,                    
First deed of trust   57,352    13.18%   55,856    13.01%
Second deed of trust   11,348    2.61%   10,411    2.43%
    89,290    20.52%   87,776    20.45%
Commercial and industrial loans                    
(except those secured by real estate)   45,838    10.53%   45,074    10.50%
Guaranteed student loans   32,251    7.41%   33,525    7.81%
Consumer and other   3,001    0.69%   2,621    0.60%
                     
Total loans   435,234    100.0%   429,295    100.0%
Deferred fees and costs, net   704         764      
Less: allowance for loan losses   (3,444)        (3,186)     
                     
   $432,494        $426,873      

 

The Bank has a purchased portfolio of rehabilitated student loans guaranteed by the Department of Education (“DOE”). The guarantee covers approximately 98% of principal and accrued interest. The loans are serviced by a third-party servicer that specializes in handling the special needs of the DOE student loan programs.

 

Loans pledged as collateral with the FHLB as part of their lending arrangement with the Company totaled $49,013,000 and $49,736,000 as of March 31, 2020 and December 31, 2019, respectively.

 

11 

 

 

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due as long as the remaining recorded investment in the loan is deemed fully collectible. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.

 

The following table provides information on nonaccrual loans segregated by type at the dates indicated (in thousands):

 

         
   March 31,   December 31, 
   2020   2019 
Commercial real estate          
Owner occupied  $-   $497 
    -    497 
Consumer real estate          
Home equity lines   300    300 
Secured by 1-4 family residential          
First deed of trust   745    842 
Second deed of trust   62    63 
    1,107    1,205 
Commercial and industrial loans          
(except those secured by real estate)   210    166 
           
Total loans  $1,317   $1,868 

 

 

The Company assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

 

· Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating. These assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;
·  Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;
·  Risk rated 6 loans are inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any; and
·  Risk rated 7 loans have all the weaknesses inherent in substandard loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

 

12 

 

 

The following tables provide information on the risk rating of loans at the dates indicated (in thousands):

 

   Risk Rated   Risk Rated   Risk Rated   Risk Rated   Total 
   1-4   5   6   7   Loans 
March 31, 2020                         
Construction and land development                         
Residential  $7,825   $318   $-   $-   $8,143 
Commercial   23,542    185    300    -    24,027 
    31,367    503    300    -    32,170 
Commercial real estate                         
Owner occupied   92,362    8,759    2,089    -    103,210 
Non-owner occupied   114,560    226    492    -    115,278 
Multifamily   13,903    143    -    -    14,046 
Farmland   150    -    -    -    150 
    220,975    9,128    2,581    -    232,684 
Consumer real estate                         
Home equity lines   19,585    705    300    -    20,590 
Secured by 1-4 family residential                         
First deed of trust   54,634    1,594    1,124    -    57,352 
Second deed of trust   11,136    13    199    -    11,348 
    85,355    2,312    1,623    -    89,290 
Commercial and industrial loans (except those secured by real estate)   44,026    1,301    511    -    45,838 
Guaranteed student loans   32,251    -    -    -    32,251 
Consumer and other   2,954    47    -    -    3,001 
                          
Total loans  $416,928   $13,291   $5,015   $-   $435,234 

 

   Risk Rated   Risk Rated   Risk Rated   Risk Rated   Total 
   1-4   5   6   7   Loans 
December 31, 2019                         
Construction and land development                         
Residential  $7,887   $-   $-   $     -   $7,887 
Commercial   23,758    -    305    -    24,063 
    31,645    -    305    -    31,950 
Commercial real estate                         
Owner occupied   90,146    8,072    135    -    98,353 
Non-owner occupied   115,781    230    497    -    116,508 
Multifamily   13,186    146    -    -    13,332 
Farmland   71    85    -    -    156 
    219,184    8,533    632    -    228,349 
Consumer real estate                         
Home equity lines   20,486    723    300    -    21,509 
Secured by 1-4 family residential                         
First deed of trust   53,200    1,660    996    -    55,856 
Second deed of trust   10,130    167    114    -    10,411 
    83,816    2,550    1,410    -    87,776 
Commercial and industrial loans (except those secured by real estate)   41,837    2,891    346    -    45,074 
Guaranteed student loans   33,525    -    -    -    33,525 
Consumer and other   2,621    -    -    -    2,621 
                          
Total loans  $412,628   $13,974   $2,693   $-   $429,295 

 

13 

 

 

The following table presents the aging of the recorded investment in past due loans and leases as of the dates indicated (in thousands):

 

                           Recorded 
           Greater               Investment > 
   30-59 Days   60-89 Days   Than   Total Past       Total   90 Days and 
   Past Due   Past Due   90 Days   Due   Current   Loans   Accruing 
March 31, 2020                                   
Construction and land development                                   
Residential  $-   $-   $-   $-   $8,143   $8,143   $- 
Commercial   -    -    -    -    24,027    24,027    - 
    -    -    -    -    32,170    32,170    - 
Commercial real estate                                   
Owner occupied   758    -    -    758    102,452    103,210    - 
Non-owner occupied   -    -    -    -    115,278    115,278    - 
Multifamily   -    -    -    -    14,046    14,046    - 
Farmland   -    -    -    -    150    150    - 
    758    -    -    758    231,926    232,684    - 
Consumer real estate                                   
Home equity lines   120    -    -    120    20,470    20,590    - 
Secured by 1-4 family residential                                   
First deed of trust   227    217    -    444    56,908    57,352    - 
Second deed of trust   49    -    -    49    11,299    11,348    - 
    396    217    -    613    88,677    89,290    - 
Commercial and industrial loans (except those secured by real estate)   417    427    -    844    44,994    45,838    - 
Guaranteed student loans   1,929    652    2,765    5,346    26,905    32,251    2,765 
Consumer and other   -    4    -    4    2,997    3,001    - 
                                    
Total loans  $3,500   $1,300   $2,765   $7,565   $427,669   $435,234   $2,765 

 

                           Recorded 
           Greater               Investment > 
   30-59 Days   60-89 Days   Than   Total Past       Total   90 Days and 
   Past Due   Past Due   90 Days   Due   Current   Loans   Accruing 
December 31, 2019                                   
Construction and land development                                   
Residential  $-   $-   $-   $-   $7,887   $7,887   $- 
Commercial   -    -    -    -    24,063    24,063    - 
    -    -    -    -    31,950    31,950    - 
Commercial real estate                                   
Owner occupied   701    -    -    701    97,652    98,353    - 
Non-owner occupied   -    -    -    -    116,508    116,508    - 
Multifamily   -    -    -    -    13,332    13,332    - 
Farmland   -    -    -    -    156    156    - 
    701    -    -    701    227,648    228,349    - 
Consumer real estate                                   
Home equity lines   52    -    -    52    21,457    21,509    - 
Secured by 1-4 family residential                                   
First deed of trust   290    -    -    290    55,566    55,856    - 
Second deed of trust   133    -    -    133    10,278    10,411    - 
    475    -    -    475    87,301    87,776    - 
Commercial and industrial loans (except those secured by real estate)   773    -    -    773    44,301    45,074    - 
Guaranteed student loans   1,694    1,309    2,567    5,570    27,955    33,525    2,567 
Consumer and other   4    -    -    4    2,617    2,621    - 
                                    
Total loans  $3,647   $1,309   $2,567   $7,523   $421,772   $429,295   $2,567 

 

Loans greater than 90 days past due are student loans that are guaranteed by the DOE which covers approximately 98% of the principal and interest. Accordingly, these loans will not be placed on nonaccrual status and are not considered to be impaired.

 

Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts when due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

14 

 

 

Impaired loans are set forth in the following table as of the dates indicated (in thousands):

 

   March 31, 2020   December 31, 2019 
       Unpaid           Unpaid     
   Recorded   Principal   Related   Recorded   Principal   Related 
   Investment   Balance   Allowance   Investment   Balance   Allowance 
With no related allowance recorded                              
Construction and land development                              
Commercial  $300   $300   $       -   $337   $337   $             - 
    300    300    -    337    337    - 
Commercial real estate                              
Owner occupied   2,582    2,597    -    2,089    2,104    - 
Non-owner occupied   2,128    2,128    -    2,304    2,304    - 
    4,710    4,725    -    4,393    4,408    - 
Consumer real estate                              
Home equity lines   300    300    -    300    300    - 
Secured by 1-4 family residential                              
First deed of trust   2,128    2,128    -    1,752    1,774    - 
Second deed of trust   904    1,112    -    752    960    - 
    3,332    3,540    -    2,804    3,034    - 
Commercial and industrial loans (except those secured by real estate)   161    161    -    211    373    - 
    8,503    8,726    -    7,745    8,152    - 
                               
With an allowance recorded                              
Commercial real estate                              
Owner occupied   1,403    1,403    13    1,414    1,414    15 
    1,403    1,403    13    1,414    1,414    15 
Consumer real estate                              
Secured by 1-4 family residential                              
First deed of trust   77    77    9    78    78    9 
    77    77    9    78    78    9 
Commercial and industrial loans (except those secured by real estate)   180    342    48    135    334    135 
    1,660    1,822    70    1,627    1,826    159 
                               
Total                              
Construction and land development                              
Commercial   300    300    -    337    337    - 
    300    300    -    337    337    - 
Commercial real estate                              
Owner occupied   3,985    4,000    13    3,503    3,518    15 
Non-owner occupied   2,128    2,128    -    2,304    2,304    - 
    6,113    6,128    13    5,807    5,822    15 
Consumer real estate                              
Home equity lines   300    300    -    300    300    - 
Secured by 1-4 family residential,                              
First deed of trust   2,205    2,205    9    1,830    1,852    9 
Second deed of trust   904    1,112    -    752    960    - 
    3,409    3,617    9    2,882    3,112    9 
Commercial and industrial loans (except those secured by real estate)   341    503    48    346    707    135 
   $10,163   $10,548   $70   $9,372   $9,978   $159 

 

15 

 

 

The following is a summary of average recorded investment in impaired loans with and without a valuation allowance and interest income recognized on those loans for the periods indicated (in thousands):

 

   For the Three Months Ended March 31, 
   2020   2019 
   Average   Interest   Average   Interest 
   Recorded   Income   Recorded   Income 
   Investment   Recognized   Investment   Recognized 
With no related allowance recorded                    
Construction and land development                    
Residential  $-   $           -   $267   $               - 
Commercial   315    -    475    - 
    315    -    742    - 
Commercial real estate                    
Owner occupied   2,696    29    3,460    42 
Non-owner occupied   2,324    32    2,597    23 
    5,020    61    6,057    65 
Consumer real estate                    
Home equity lines   363    4    550    - 
Secured by 1-4 family residential                    
First deed of trust   2,072    19    2,972    42 
Second deed of trust   740    14    704    13 
    3,175    37    4,226    55 
Commercial and industrial loans (except those secured by real estate)   646    -    477    8 
Consumer and other   1    -    1    - 
    9,157    98    11,503    128 
                     
With an allowance recorded                    
Construction and land development                    
Commercial   -    -    26    - 
Commercial real estate                    
Owner occupied   1,420    15    1,461    15 
    1,420    15    1,461    15 
Consumer real estate                    
Secured by 1-4 family residential                    
First deed of trust   136    1    262    3 
Second deed of trust   78    -    162    2 
    214    1    424    5 
Commercial and industrial loans (except those secured by real estate)   162    6    176    - 
Consumer and other   4    -    14    - 
    1,800    22    2,101    20 
                     
Total                    
Construction and land development                    
Residential  $-   $-   $267   $- 
Commercial   315    -    501    - 
    315    -    768    - 
Commercial real estate                    
Owner occupied   4,116    44    4,921    57 
Non-owner occupied   2,324    32    2,597    23 
    6,440    76    7,518    80 
Consumer real estate                    
Home equity lines   363    4    550    - 
Secured by 1-4 family residential,                    
First deed of trust   2,208    20    3,234    45 
Second deed of trust   818    14    866    15 
    3,389    38    4,650    60 
Commercial and industrial loans (except those secured by real estate)   808    6    653    8 
Consumer and other   5    -    15    - 
   $10,957   $120   $13,604   $148 

 

16 

 

 

Included in impaired loans are loans classified as TDRs. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. For loans classified as impaired TDRs, the Company further evaluates the loans as performing or nonaccrual. To restore a nonaccrual loan that has been formally restructured in a TDR to accrual status, we perform a current, well documented credit analysis supporting a return to accrual status based on the borrower’s financial condition and prospects for repayment under the revised terms. Otherwise, the TDR must remain in nonaccrual status. The analysis considers the borrower’s sustained historical repayment performance for a reasonable period to the return-to-accrual date, but may take into account payments made for a reasonable period prior to the restructuring if the payments are consistent with the modified terms. A sustained period of repayment performance generally would be a minimum of six months and would involve payments in the form of cash or cash equivalents.

 

An accruing loan that is modified in a TDR can remain in accrual status if, based on a current well-documented credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured, and the borrower has demonstrated sustained historical repayment performance for a reasonable period before modification. The following is a summary of performing and nonaccrual TDRs and the related specific valuation allowance by portfolio segment for the periods indicated (dollars in thousands).

 

               Specific 
               Valuation 
   Total   Performing   Nonaccrual   Allowance 
March 31, 2020                    
Commercial real estate                    
Owner occupied  $3,462   $3,462   $-   $13 
Non-owner occupied   2,128    2,128             -                - 
    5,590    5,590    -    13 
Consumer real estate                    
Secured by 1-4 family residential                    
First deeds of trust   1,630    1,128    502    9 
Second deeds of trust   816    754    62    - 
    2,446    1,882    564    9 
Commercial and industrial loans (except those secured by real estate)   210    -    210    48 
   $8,246   $7,472   $774   $70 
                     
Number of loans   37    28    9    4 

 

               Specific 
               Valuation 
   Total   Performing   Nonaccrual   Allowance 
December 31, 2019                    
Commercial real estate                    
Owner occupied  $3,502   $3,502   $-   $15 
Non-owner occupied   2,304    1,807    497            - 
    5,806    5,309    497    15 
Consumer real estate                    
Secured by 1-4 family residential                    
First deeds of trust   1,641    881    760    9 
Second deeds of trust   752    689    63    - 
    2,393    1,570    823    9 
Commercial and industrial loans (except those secured by real estate)   211    180    31    - 
   $8,410   $7,059   $1,351   $24 
                     
Number of loans   38    29    9    3 

 

17 

 

 

The following table provides information about TDRs identified during the indicated periods (dollars in thousands).

 

   Three Months Ended   Three Months Ended 
   March 31, 2020   March 31, 2019 
       Pre-   Post-       Pre-   Post- 
       Modification   Modification       Modification   Modification 
   Number of   Recorded   Recorded   Number of   Recorded   Recorded 
   Loans   Balance   Balance   Loans   Balance   Balance 
Commercial real estate                              
Non-owner occupied         -   $      -   $      -          1   $      515   $      515 
    -   $-   $-    1   $515   $515 

 

There were no defaults on TDRs that were modified as TDRs during the prior twelve month period ended March 31, 2020 and 2019.

 

18 

 

 

 

Activity in the allowance for loan losses is as follows for the periods indicated (in thousands):

 

       Provision for             
   Beginning   (Recovery of)           Ending 
   Balance   Loan Losses   Charge-offs   Recoveries   Balance 
Three Months Ended March 31, 2020                         
Construction and land development                         
Residential  $48   $170   $-   $1   $219 
Commercial   137    133    -    -    270 
    185    303    -    1    489 
Commercial real estate                         
Owner occupied   671    188    -    -    859 
Non-owner occupied   831    227    -    -    1,058 
Multifamily   85    (17)   -    -    68 
Farmland   2    (1)   -    -    1 
    1,589    397    -    -    1,986 
Consumer real estate                         
Home equity lines   271    (231)   -    -    40 
Secured by 1-4 family residential                         
First deed of trust   343    (189)   -    3    157 
Second deed of trust   64    8    -    4    76 
    678    (412)   -    7    273 
Commercial and industrial loans                         
(except those secured by real estate)   572    (31)   (135)   3    409 
Student loans   108    16    (20)   -    104 
Consumer and other   30    9    (1)   3    41 
Unallocated   24    118    -    -    142 
                          
   $3,186   $400   $(156)  $14   $3,444 

 

18 

 

 

       Provision for             
   Beginning   (Recovery of)           Ending 
   Balance   Loan Losses   Charge-offs   Recoveries   Balance 
Three Months Ended March 31, 2019                         
Construction and land development                         
Residential  $42   $3   $          -   $1   $46 
Commercial   220    (48)   -    1    173 
    262    (45)   -    2    219 
Commercial real estate                         
Owner occupied   673    37    -    -    710 
Non-owner occupied   673    19    -    -    692 
Multifamily   87    1    -    -    88 
Farmland   2    -    -    -    2 
    1,435    57    -    -    1,492 
Consumer real estate                         
Home equity lines   244    (10)   -    6    240 
Secured by 1-4 family residential                         
First deed of trust   385    8    -    2    395 
Second deed of trust   51    2    -    4    57 
    680    -    -    12    692 
Commercial and industrial loans                         
(except those secured by real estate)   308    48    (15)   11    352 
Student loans   121    33    (33)   -    121 
Consumer and other   34    (3)   (2)   1    30 
Unallocated   211    (90)   -    -    121 
                          
   $3,051   $-   $(50)  $26   $3,027 

 

       Provision for             
   Beginning   (Recovery of)           Ending 
   Balance   Loan Losses   Charge-offs   Recoveries   Balance 
Year Ended December 31, 2019                         
Construction and land development                         
Residential  $42   $(1)  $         -   $         7   $48 
Commercial   220    (85)   -    2    137 
    262    (86)   -    9    185 
Commercial real estate                         
Owner occupied   673    (2)   -    -    671 
Non-owner occupied   673    158    -    -    831 
Multifamily   87    (2)   -    -    85 
Farmland   2    -    -    -    2 
    1,435    154    -    -    1,589 
Consumer real estate                         
Home equity lines   244    50    (35)   12    271 
Secured by 1-4 family residential                         
First deed of trust   385    (56)   -    14    343 
Second deed of trust   51    (56)   -    69    64 
    680    (62)   (35)   95    678 
Commercial and industrial loans                         
(except those secured by real estate)   308    239    (64)   89    572 
Student loans   121    80    (93)   -    108 
Consumer and other   34    (3)   (26)   25    30 
Unallocated   211    (187)   -    -    24 
                          
   $3,051   $135   $(218)  $218   $3,186 

 

The amount of the loan loss provision (recovery) is determined by an evaluation of the level of loans outstanding, the level of nonperforming loans, historical loan loss experience, delinquency trends, underlying collateral values, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions.

 

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The level of the allowance reflects changes in the size of the portfolio or in any of its components as well as management’s continuing evaluation of industry concentrations, specific credit risk, loan loss experience, current loan portfolio quality, and present economic, political and regulatory conditions. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgement, should be charged off. While management utilizes its best judgement and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

 

The Company recorded a provision for loan losses of $400,000 for the three month period ended March 31, 2020 as a result of growth in the loan portfolio, an increase in the historical loan loss experience and an increase in the qualitative factors due to the anticipated economic impact of COVID-19. The Company recorded a provision for loan losses of $135,000 for the year ended December 31, 2019 because of an increase in the specific reserves associated with a relationship evaluated individually for impairment. The Company did not record a provision for loan losses for the three month period ended March 31, 2019 because of minimal net charge-offs, no significant changes in qualitative factors and stable asset quality.

 

The allowance for loan losses at each of the periods presented includes an amount that could not be identified to individual types of loans referred to as the unallocated portion of the allowance. We recognize the inherent imprecision in estimates of losses due to various uncertainties and the variability related to the factors used in calculation of the allowance. The allowance for loan losses included an unallocated portion of approximately $142,000, $24,000, and $121,000 at March 31, 2020, December 31, 2019, and March 31, 2019, respectively.

 

20 

 

 

Loans were evaluated for impairment as follows for the periods indicated (in thousands):

 

   Recorded Investment in Loans 
   Allowance       Loans 
   Ending           Ending         
   Balance   Individually   Collectively   Balance   Individually   Collectively 
Three Months Ended March 31, 2020                              
Construction and land development                              
Residential  $219   $-   $219   $8,143   $-   $8,143 
Commercial   270    -    270    24,027    300    23,727 
    489    -    489    32,170    300    31,870 
Commercial real estate                              
Owner occupied   859    13    846    103,210    3,985    99,225 
Non-owner occupied   1,058    -    1,058    115,278    2,128    113,150 
Multifamily   68    -    68    14,046    -    14,046 
Farmland   1    -    1    150    -    150 
    1,986    13    1,973    232,684    6,113    226,571 
Consumer real estate                              
Home equity lines   40    -    40    20,590    300    20,290 
Secured by 1-4 family residential                              
First deed of trust   157    9    148    57,352    2,205    55,147 
Second deed of trust   76    -    76    11,348    904    10,444 
    273    9    264    89,290    3,409    85,881 
Commercial and industrial loans                              
(except those secured by real estate)   409    48    361    45,838    341    45,497 
Student loans   104    -    104    32,251    -    32,251 
Consumer and other   183    -    183    3,001    -    3,001 
                               
   $3,444   $70   $3,374   $435,234   $10,163   $425,071 
                               
Year Ended December 31, 2019                              
Construction and land development                              
Residential  $48   $-   $48   $7,887   $-   $7,887 
Commercial   137    -    137    24,063    337    23,726 
    185    -    185    31,950    337    31,613 
Commercial real estate                              
Owner occupied   671    15    656    98,353    3,503    94,850 
Non-owner occupied   831    -    831    116,508    2,304    114,204 
Multifamily   85    -    85    13,332    -    13,332 
Farmland   2    -    2    156    -    156 
    1,589    15    1,574    228,349    5,807    222,542 
Consumer real estate                              
Home equity lines   271    -    271    21,509    300    21,209 
Secured by 1-4 family residential                              
First deed of trust   343    9    334    55,856    1,830    54,026 
Second deed of trust   64    -    64    10,411    752    9,659 
    678    9    669    87,776    2,882    84,894 
Commercial and industrial loans                              
(except those secured by real estate)   572    135    437    45,074    346    44,728 
Student loans   108    -    108    33,525    -    33,525 
Consumer and other   54    -    54    2,621    -    2,621 
                               
   $3,186   $159   $3,027   $429,295   $9,372   $419,923 

 

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Note 6 – Deposits

 

Deposits as of March 31, 2020 and December 31, 2019 were as follows (dollars in thousands):

 

   March 31, 2020   December 31, 2019 
   Amount   %   Amount   % 
                 
Checking accounts                    
Noninterest bearing demand   139,660    29.8%  $131,228    29.6%
Interest bearing   51,008    10.9%   48,428    10.9%
Money market accounts   114,461    24.4%   99,955    22.6%
Savings accounts   26,618    5.7%   26,396    6.0%
Time deposits of $250,000 and over   24,535    5.2%   22,327    5.0%
Other time deposits   112,561    24.0%   114,874    25.9%
                     
Total  $468,843    100.0%  $443,208    100.0%

 

Note 7 – Borrowings

 

The Company uses both short-term and long-term borrowings to supplement deposits when they are available at a lower overall cost to the Company or they can be invested at a positive rate of return.

 

As a member of the Federal Home Loan Bank of Atlanta, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances from the FHLB. The Company held $2,014,000 in FHLB stock at March 31, 2020 and $1,694,000 at December 31, 2019, which is held at cost. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses to which the advances may be put, as well as on the size of the advances and repayment provisions. The FHLB borrowings are secured by the pledge of commercial, 1-4 family residential loans and investment securities. The Company had FHLB advances of $36,000,000 and $29,000,000 at March 31, 2020 and December 31, 2019, respectively, maturing through 2023.

 

The Company uses federal funds purchased and repurchase agreements for short-term borrowing needs. Securities sold under agreements to repurchase are classified as borrowings and generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. The carrying value of these short term borrowing agreements was $5,317,000 at December 31, 2019. There were no borrowings against the lines at March 31, 2020.

 

The Company’s unused lines of credit for future borrowings total approximately $49 million at March 31, 2020, which consists of $6.2 million available from the FHLB, $10 million on revolving bank line of credit, $7.8 million under secured federal funds agreements with third party financial institutions, and $25 million in repurchase lines of credit with third party financial institutions. Additional loans and securities are available that can be pledged as collateral for future borrowings from the Federal Reserve Bank of Richmond or the FHLB above the current lendable collateral value.

 

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Note 8 – Leases

 

The following tables present information about the Company’s leases (dollars in thousands):

 

   March 31, 2020 
Lease liabilities  $928 
Right-of-use assets  $915 
Weighted average remaining lease term   4.04 years 
Weighted average discount rate   2.98%

 

 
 
 
 
For the Three Months Ended  
 
   March 31, 2020 
Lease cost     
Operating lease cost  $107 
Total lease cost  $107 

 

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows (dollars in thousands): 

 

   As of 
   March 31, 2020 
Lease payments due     
Nine months ending December 31, 2020   310 
Twelve months ending December 31, 2021   277 
Twelve months ending December 31, 2022   120 
Twelve months ending December 31, 2023   44 
Twelve months ending December 31, 2024   48 
Thereafter   203 
Total undiscounted cash flows  $1,002 
Discount   74 
Lease liabilities  $928 

 

Cash paid for amounts included in the measurement of lease liabilities during the three months ended March 31, 2020 and 2019 was $106,000 and $103,000, respectively. The Company recognized lease expense of $107,000 and $103,000 for the three month period ended March 31, 2020 and 2019, respectively.

 

Note 9 – Trust preferred securities

 

During the first quarter of 2005, Southern Community Financial Capital Trust I, a wholly-owned unconsolidated subsidiary of the Company, was formed for the purpose of issuing redeemable securities. On February 24, 2005, $5.2 million of Trust Preferred Capital Notes were issued through a pooled underwriting. The securities have a LIBOR-indexed floating rate of interest (three-month LIBOR plus 2.15%) which adjusts, and is payable, quarterly. The interest rate at March 31, 2020 was 3.25%. The securities were redeemable at par beginning on March 15, 2010 and each quarter after such date until the securities mature on March 15, 2035. No amounts have been redeemed at March 31, 2020 and there are no plans to do so. The principal asset of the Trust is $5.2 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

 

During the third quarter of 2007, Village Financial Statutory Trust II, a wholly-owned unconsolidated subsidiary of the Company, was formed for the purpose of issuing redeemable securities. On September 20, 2007, $3.6 million of Trust Preferred Capital Notes were issued through a pooled underwriting. The securities have LIBOR-indexed floating rate of interest (three-month LIBOR plus 1.4%) which adjusts, and is also payable, quarterly. The interest rate at March 31, 2020 was 2.50%. The securities may be redeemed at par at any time commencing in December 2012 until the securities mature in 2037. No amounts have been redeemed at March 31, 2020 and there are no plans to do so. The principal asset of the Trust is $3.6 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.

 

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The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. The portion of the Trust Preferred Capital Notes not considered as Tier 1 capital may be included in Tier 2 capital. 

 

The obligations of the Company with respect to the issuance of the Trust Preferred Capital Notes constitute a full and unconditional guarantee by the Company of the Trust’s obligations with respect to the Trust Preferred Capital Notes. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related Trust Preferred Capital Notes and require a deferral of common dividends. The Company is current on these interest payments. 

 

Note 10 – Subordinated Debt

 

On March 21, 2018, the Company issued $5,700,000 of fixed-to-floating rate subordinated notes due March 31, 2028 in a private placement. The Company received $5,539,000 in net proceeds after deducting issuance costs. The subordinated notes accrue interest at a fixed rate of 6.50% for the first five years until March 31, 2023; thereafter, the subordinated notes will accrue interest at an annual floating rate equal to three-month LIBOR plus a spread of 3.73% until maturity or early redemption. The Company may redeem the subordinated notes in whole or in part, on or after March 31, 2023. The subordinated notes are unsecured and subordinated in right of payment to all of the Company’s existing and future senior indebtedness, whether secured or unsecured, including claims of depositors and general creditors, and rank equally in right of payment with any unsecured, subordinated indebtedness that the Company may incur in the future. The carrying value of the notes totaled $5,604,000 and $5,595,000 at March 31, 2020 and December 31, 2019, respectively.

 

Note 11 – Stock incentive plan

 

In accordance with accounting standards, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost is recognized over the period during which an employee is required to provide service in exchange for the award rather than disclosed in the financial statements.

 

The following table summarizes options outstanding under the Company’s stock incentive plans at the indicated dates:

 

   Three Months Ended March 31, 
   2020   2019 
       Weighted               Weighted         
       Average               Average         
       Exercise   Fair Value   Intrinsic       Exercise   Fair Value   Intrinsic 
   Options   Price   Per Share   Value   Options   Price   Per Share   Value 
Options outstanding,                                        
beginning of period   734   $25.63   $9.76         734   $25.63   $9.76      
Granted   -    -    -         -    -    -      
Forfeited   -    -    -         -    -    -      
Exercised   -    -    -         -    -    -      
Options outstanding,                                        
end of period   734   $25.63   $9.76   $-    734   $25.63   $9.76   $- 
Options exercisable,                                        
end of period   734                   734                
                                         

 

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During the first quarter of 2020, we granted certain officers 750 time-based restricted shares of common stock with a weighted average fair market value of $42.99 per share on the date of grant. These restricted stock awards vest ratably over a three-year period provided the officer is employed with the Company on the applicable vesting date.

 

The total number of shares underlying non-vested restricted stock was 13,060 and 17,646 at March 31, 2020 and 2019, respectively. The fair value of the stock is based on the grant date of the award and the expense is recognized over the vesting period. Unamortized stock-based compensation related to non-vested share-based compensation arrangements granted under the stock incentive plan as of March 31, 2020 and 2019 was $346,946 and $354,185, respectively. As of March 31, 2020, the time based unrecognized compensation expense of $237,471 is expected to be recognized over a weighted average period of 2.32 years. There were no forfeitures for the period ended March 31, 2020. For the period ended March 31, 2019 there were forfeitures of 2,763 shares of restricted stock awards.

 

A summary of changes in the Company’s non-vested restricted stock awards for the three months ended March 31, 2020 follows:

 

   Shares   Weighted-Average Grant-Date Fair-Value   Aggregate Intrinsic Value 
December 31, 2019   12,310   $33.83   $311,197 
Granted   750    42.99    18,960 
Vested   -    -    - 
Forefited   -    -    - 
Other   -    -    - 
                
March 31, 2020   13,060   $34.36   $330,157 

 

Stock-based compensation expense was approximately $54,000 and $46,000 for the three months ended March 31, 2020 and 2019, respectively.

 

Note 12 – Fair value

 

The Company determines the fair value of its financial instruments based on the requirements established in ASC 820: Fair Value Measurements, which provides a framework for measuring fair value under GAAP and requires an entity to maximize the use of observable inputs when measuring fair value. ASC 820 defines fair value as the exit price, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions.

 

ASC 820 establishes a hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair values hierarchy is as follows:

 

  Level 1 Inputs — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
   
  Level 2 Inputs — Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
   

24 

 

 

  Level 3 Inputs — Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
   

The Company used the following methods to determine the fair value of each type of financial instrument:

 

Securities: Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Levels 1 and 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity, then the security would fall to the lowest level of the hierarchy (Level 3).

 

Impaired loans: The fair values of impaired loans are measured for impairment using the fair value of the collateral for collateral-dependent loans on a nonrecurring basis. Collateral may be in the form of real estate or business assets including equipment, inventory and accounts receivable. The vast majority of the Company’s collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser using observable market data (Level 2). However, if the collateral is a house or building in the process of construction or if an appraisal of the property is more than two years old, then a Level 3 valuation is considered to measure the fair value. The value of business equipment is based upon an outside appraisal if deemed significant using observable market data. Likewise, values for inventory and account receivables collateral are based on financial statement balances or aging reports (Level 3). Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income.

 

Loans held for sale: During the first quarter of 2020, the Company elected to begin using fair value accounting for its entire portfolio of loans held for sale in accordance with ASC 820 - Fair Value Measurement and Disclosures. Fair value of the Company's loans held for sale is based on observable market prices for similar instruments traded in the secondary mortgage loan markets in which the Company conducts business. The Company's portfolio of loans held for sale is classified as Level 2. At December 31, 2019, these loans were carried at the lower of cost or estimated fair value on an aggregate basis as determined by outstanding commitments from investors. Gains and losses on the sale of loans are recorded within mortgage banking income, net on the Consolidated Statements of Income.

 

Derivative asset – IRLCs: Beginning with the first quarter of 2020, the Company recognizes IRLCs at fair value based on the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis while taking into consideration the probability that the rate lock commitments will close. All of the Company's IRLCs are classified as Level 2. The fair value of interest rate lock commitments was considered immaterial at December 31, 2019.

 

Derivative asset/liability – forward sale commitments: During the first quarter of 2020, the Company elected to begin using fair value accounting for its forward sales commitments related to IRLCs and LHFS. Best efforts sale commitments are entered into for loans intended for sale in the secondary market at the time the borrower commitment is made. The best efforts commitments are valued using the committed price to the counter-party against the current market price of the interest rate lock commitment or mortgage loan held for sale. All of the Company’s forward sale commitments are classified as Level 2.

 

Other Real Estate Owned: OREO assets are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Subsequently, OREO assets are carried at lower of cost or fair value less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.

 

25 

 

 

Assets held for sale: Assets held for sale were transferred from premises and equipment at the lower of cost less accumulated depreciation or fair value at the date of transfer. The Company periodically evaluates the value of assets held for sale and records an impairment charge for any subsequent declines in fair value less selling costs. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the assets held for sale as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the asset held for sale as nonrecurring Level 3.

 

Assets and liabilities measured at fair value under Topic 820 on a recurring and non-recurring basis are summarized below for the indicated dates (dollars in thousands): 

 

   Fair Value Measurement 
   at March 31, 2020 Using 
 
 
 
 
 
 
 
 
 
 
 
Carrying
 
 
 
 
 
 
 
 
Quoted Prices
in Active
Markets for
Identical Assets
 
 
 
 
 
 
 
 
 
Other
Observable
Inputs
 
 
 
 
 
 
 
 
 
Significant
Unobservable
Inputs
 
 
 
 
   Value   (Level 1)   (Level 2)   (Level 3) 
Financial Assets - Recurring                    
US Government Agencies  $12,857   $-   $12,857   $- 
Mortgage-backed securities   18,620    -    18,620    - 
Subordinated debt   7,604    500    7,104    - 
Loans held for sale   17,219    -    17,219    - 
IRLC   728    -    728    - 
                     
Financial Liabilities - Recurring                    
Forward sales commitment   1,188    -    1,188    - 
                     
Financial Assets - Non-Recurring                    
Impaired loans   1,590    -    -    1,590 
Assets held for sale   514    -    -    514 
Other real estate owned   526    -    -    526 

 

   Fair Value Measurement 
   at December 31, 2019 Using 
       Quoted Prices         
       in Active   Other   Significant 
       Markets for   Observable   Unobservable 
   Carrying   Identical Assets   Inputs   Inputs 
   Value   (Level 1)   (Level 2)   (Level 3) 
Financial Assets - Recurring                   
US Government Agencies  $14,845   $-   $14,845   $- 
Mortgage-backed securities   25,302    -    25,302    - 
Subordinated debt   6,790    -    6,540    250 
                     
Financial Assets - Non-Recurring                    
Impaired loans   1,468    -    -    1,468 
Assets held for sale   514    -    -    514 
Other real estate owned   526    -    -    526 

 

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The following table presents qualitative information about Level 3 fair value measurements for financial instruments measured at fair value at March 31, 2020 and December 31, 2019 (dollars in thousands): 

 

   March 31, 2020 
             Range 
   Fair Value   Valuation  Unobservable  (Weighted 
   Estimate   Techniques  Input  Average) 
Impaired loans - real estate secured  $1,590   Appraisal (1) or Internal
Valuation (2)
  Selling costs   6%-10% (7%) 
           Discount for lack of     
           marketability and age     
           of appraisal   6%-30% (10%) 
                 
Assets held for sale  $514   Appraisal (1) or Internal
Valuation (2)
  Selling costs   6%-10% (7%) 
           Discount for lack of     
           marketability and age     
           of appraisal   6%-30% (15%) 
                 
Other real estate owned  $526   Appraisal (1) or Internal
Valuation (2)
  Selling costs   6%-10% (7%) 

 

 

 

(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally

     includes various level 3 inputs which are not identifiable

(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances  

 

 

   December 31, 2019 
             Range 
   Fair Value   Valuation  Unobservable  (Weighted 
   Estimate   Techniques  Input  Average) 
Impaired loans - real estate secured  $1,468   Appraisal (1) or Internal
Valuation (2)
  Selling costs   6%-10% (7%) 
           Discount for lack of     
           marketability and age     
           of appraisal   6%-30% (10%) 
                 
Assets held for sale  $514   Appraisal (1) or Internal
Valuation (2)
  Selling costs   6%-10% (7%) 
           Discount for lack of     
           marketability and age     
           of appraisal   6%-30% (15%) 
                 
Other real estate owned  $526   Appraisal (1) or Internal
Valuation (2)
  Selling costs   6%-10% (7%) 

 

 

 

(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally

     includes various level 3 inputs which are not identifiable

(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances  

 

FASB ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. In accordance with ASU 2016-01, the Company uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis.

 

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The following tables reflect the carrying amounts and estimated fair values of the Company’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.

 

      March 31,   December 31, 
   Level in Fair  2020   2019 
   Value  Carrying   Estimated   Carrying   Estimated 
   Hierarchy  Value   Fair Value   Value   Fair Value 
   (In thousands)
Financial assets                       
Cash  Level 1  $23,613   $23,613   $19,967   $19,967 
Cash equivalents  Level 2   24,365    24,365    -    - 
Investment securities available for sale  Level 1   500    500    -    - 
Investment securities available for sale  Level 2   38,581    38,581    46,687    46,687 
Investment securities available for sale  Level 3   -    -    250    250 
Federal Home Loan Bank stock  Level 2   2,014    2,014    1,694    1,694 
Loans held for sale  Level 2   17,219    17,219    12,722    12,722 
Loans  Level 3   433,644    434,392    427,827    429,254 
Impaired loans  Level 3   1,590    1,590    1,468    1,468 
Assets held for sale  Level 3   514    514    514    514 
Other real estate owned  Level 3   526    526    526    526 
Bank owned life insurance  Level 3   7,657    7,657    7,612    7,612 
Accrued interest receivable  Level 2   2,578    2,578    2,597    2,597 
Interest rate lock commitments  Level 2   728    728    -    - 
                        
Financial liabilities                       
Deposits  Level 2   468,843    469,440    443,208    443,645 
FHLB borrowings  Level 2   36,000    36,448    29,000    29,285 
Trust preferred securities  Level 2   8,764    9,851    8,764    9,812 
Other borrowings  Level 2   5,604    5,604    10,912    10,912 
Accrued interest payable  Level 2   214    214    221    221 
Forward sales commitment  Level 2   1,188    1,188    -    - 

 

Note 13 – Segment Reporting

 

The Company has two reportable segments: traditional commercial banking and mortgage banking. Revenues from commercial banking operations consist primarily of interest earned on loans and securities and fees from deposit services. Mortgage banking operating revenues consist principally of interest earned on mortgage loans held for sale, gains on sales of loans in the secondary mortgage market, and loan origination fee income.

 

The commercial banking segment provides the mortgage banking segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the mortgage banking segment interest based on the commercial banking segment’s cost of funds. Additionally, the mortgage banking segment leases premises from the commercial banking segment. These transactions are eliminated in the consolidation process.

 

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The following table presents segment information as of and for the three months ended March 31, 2020 and 2019 (in thousands):

 

   Commercial   Mortgage       Consolidated 
   Banking   Banking   Eliminations   Totals 
Three Months Ended March 31, 2020                    
                     
Revenues                    
Interest income  $5,590   $109   $(15)  $5,684 
Gain on sale of loans   -    1,624    -    1,624 
Other revenues   733    197    (57)   873 
Total revenues   6,323    1,930    (72)   8,181 
                     
Expenses                    
Provision for loan losses   400    -    -    400 
Interest expense   1,257    15    (15)   1,257 
Salaries and benefits   2,208    814    -    3,022 
Commissions   -    437    -    437 
Other expenses   1,709    276    (57)   1,928 
Total operating expenses   5,574    1,542    (72)   7,044 
                     
Income before income taxes   749    388    -    1,137 
Income tax expense   158    81    -    239 
Net income  $591   $307   $-   $898 
                     
Total assets  $570,751   $12,433   $(12,979)  $570,205 

 

   Commercial   Mortgage       Consolidated 
   Banking   Banking   Eliminations   Totals 
Three Months Ended March 31, 2019                    
                     
Revenues                    
Interest income  $5,646   $63   $-   $5,709 
Gain on sale of loans   -    928    -    928 
Other revenues   774    112    (57)   829 
Total revenues   6,420    1,103    (57)   7,466 
                     
Expenses                    
Interest expense   1,243    -    -    1,243 
Salaries and benefits   2,200    736    -    2,936 
Commissions   -    239    -    239 
Other expenses   1,882    238    (57)   2,063 
Total operating expenses   5,325    1,213    (57)   6,481 
                     
Income before income taxes   1,095    (110)   -    985 
Income tax expense   199    (23)        176 
Net income  $896   $(87)  $-   $809 
                     
Total assets  $525,782   $9,892   $(13,400)  $522,274 

 

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Note 14 – Shareholders’ Equity and Regulatory Matters

 

Preferred Stock

 

On May 1, 2009, as part of the Capital Purchase Program established by the U.S. Department of the Treasury (the “Treasury”) under the Emergency Economic Stabilization Act of 2008, the Company sold (i) 14,738 shares of the Company’s Fixed Rate Cumulative Perpetual Preferred Stock, Series A, par value $4.00 per share, having a liquidation preference of $1,000 per share (the “preferred stock”) and (ii) a warrant (the “Warrant”) to purchase 499,029 shares of the Company’s common stock at an initial exercise price of $4.43 per share, subject to certain anti-dilution and other adjustments, to the Treasury for an aggregate purchase price of $14,738,000 in cash. During the first quarter of 2018, the Company used the proceeds from a subordinated note issuance to redeem the remaining 5,027 outstanding shares of preferred stock plus accrued dividends of $56,554. The Warrant expired on May 1, 2019.

 

Accumulated Other Comprehensive Income (Loss)

 

The following table presents the cumulative balances of the components of accumulated other comprehensive income (loss), net of deferred taxes of $116,000 and $38,000 as of March 31, 2020 and December 31, 2019, respectively (in thousands):

 

   March 31,   December 31, 
   2020   2019 
Net unrealized gains on securities  $480   $186 
Net unrecognized losses on defined benefit plan   (42)   (44)
Total accumulated other comprehensive income  $438   $142 

 

Regulatory Matters

 

The Company meets the eligibility criteria of a small bank holding company in accordance with the Federal Reserve’s Small Bank Holding Company Policy Statement (the “SBHC Policy Statement”). On August 28, 2018, the Federal Reserve issued an interim final rule required by the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, which was signed into law on May 24, 2018 (the “EGRRCPA”), that expands the applicability of the SBHC Policy Statement to bank holding companies with total consolidated assets of less than $3 billion (up from the prior $1 billion threshold). Under the SBHC Policy Statement, qualifying bank holding companies, such as the Company, have additional flexibility in the amount of debt they can issue and are also exempt from the Basel III Capital Rules. The SBHC Policy Statement does not apply to the Bank and the Bank must comply with the Basel III Capital Rules.

 

The Bank is required to comply with the capital adequacy standards established by the Board of Governors of the Federal Reserve System (the “Federal Reserve”), in the case of the Company, and the Federal Deposit Insurance Corporation (“FDIC”), in the case of the Bank. The Federal Reserve and the FDIC have adopted rules to implement the Basel III capital framework as outlined by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (the “Basel III Capital Rules”).  The Basel III Capital Rules implement minimum capital ratios and establish risk weightings that are applied to many classes of assets held by community banks, including applying higher risk weightings to certain commercial real estate loans.

 

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The Basel III Capital Rules require banks to comply with the following minimum capital ratios: (1) 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%); (2) 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%); (3) 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 (4) 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 phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress.  Banking organizations with a ratio of common equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. As of March 31, 2020, the Bank exceeded the minimum ratios under the Basel III Capital Rules.

 

The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act of 1950. To be well capitalized under these regulations, a bank must have the following minimum capital ratios: (1) a common equity Tier 1 capital ratio of at least 6.5%; (2) a Tier 1 risk-based capital ratio of at least 8.0%; (3) a total risk-based capital ratio of at least 10.0%; and (4) a leverage ratio of at least 5.0%. As of March 31, 2020, the Bank exceeded the minimum ratios to be classified as well capitalized.

 

On September 17, 2019, the federal bank regulators issued a final rule required by the EGRRCPA that permits qualifying banks and bank holding companies that have less than $10 billion of assets, like the Company and the Bank, to elect to be subject to a 9% leverage ratio that would be applied using less complex leverage calculations (commonly referred to as the community bank leverage ratio or “CBLR”). Under the rule, which became effective January 1, 2020, banks and bank holding companies that opt into the CBLR framework and maintain a CBLR of greater than 9% would not be subject to other risk-based and leverage capital requirements under the Basel III Capital Rules and would be deemed to have met the well capitalized ratio requirements under the “prompt corrective action” framework. In April 2020, as required by the Coronavirus Aid, Relief, and Economic Security Act, which was passed in response to the COVID-19 pandemic, federal bank regulators issued two interim final rules related to the CBLR framework. One interim final rule provides that, as of the second quarter of 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement. The Bank elected not to opt into the CBLR framework as of March 31, 2020.

 

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The capital amounts and ratios at March 31, 2020 and December 31, 2019 for the Bank are presented in the table below (dollars in thousands):

 

           For Capital         
   Actual   Adequacy Purposes   To be Well Capitalized 
   Amount   Ratio   Amount   Ratio   Amount   Ratio 
March 31, 2020                              
Total capital (to risk-weighted assets)                              
Village Bank  $57,746    12.62%  $36,620    8.00%  $45,775    10.00%
                               
Tier 1 capital (to risk-weighted assets)                              
Village Bank   54,302    11.86%   27,465    6.00%   36,620    8.00%
                               
Leverage ratio (Tier 1 capital to average assets)                              
Village Bank   54,302    10.10%   21,515    4.00%   26,894    5.00%
                               
Common equity tier 1 (to risk-weighted assets)                              
Village Bank   54,302    11.86%   20,599    4.50%   29,754    6.50%
                               
December 31, 2019                              
Total capital (to risk-weighted assets)                              
Village Bank  $54,653    12.56%  $34,807    8.00%  $43,508    10.00%
                               
Tier 1 capital (to risk-weighted assets)                              
Village Bank   52,867    12.15%   26,015    6.00%   34,807    8.00%
                               
Leverage ratio (Tier 1 capital to average assets)                              
Village Bank   52,867    9.69%   21,823    4.00%   27,278    5.00%
                               
Common equity tier 1 (to risk-weighted assets)                              
Village Bank   52,867    12.15%   19,579    4.50%   28,280    6.50%

 

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Note 15 – Commitments and contingencies

 

Off-balance-sheet risk – The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the financial statements. The contract amounts of these instruments reflect the extent of involvement that the Company has in particular classes of instruments.

 

The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, and to potential credit loss associated with letters of credit issued, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for loans and other such on-balance sheet instruments.

 

At March 31, 2020 and December 31, 2019, the Company had outstanding the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk (in thousands):

 

   March 31,   December 31, 
   2020   2019 
Undisbursed credit lines  $93,097   $83,366 
Commitments to extend or originate credit   37,590    15,722 
Standby letters of credit   7,007    6,732 
           
Total commitments to extend credit  $137,694   $105,820 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Historically, many commitments expire without being drawn upon; therefore, the total commitment amounts shown in the above table are not necessarily indicative of future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include personal or income-producing commercial real estate, accounts receivable, inventory and equipment.

 

Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.

 

Concentrations of credit risk – Generally, the Company’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area. Although the Company is building a diversified loan portfolio, a substantial portion of its clients’ ability to honor contracts is reliant upon the economic stability of the Richmond, Virginia area, including the real estate markets in the area. The concentrations of credit by type of loan are set forth in Note 5. The distribution of commitments to extend credit approximates the distribution of loans outstanding.

 

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Note 16 – Mortgage Banking and Derivatives

 

Loans held for sale. The Company, through the Bank’s mortgage banking subsidiary, the Mortgage Company, originates residential mortgage loans for sale in the secondary market. Residential mortgage loans held for sale are sold to the permanent investor with the mortgage servicing rights released. During the first quarter of 2020, the Company elected to begin using fair value accounting for its entire portfolio of loans held for sale (LHFS) in accordance with ASC 820 - Fair Value Measurement and Disclosures. Fair value of the Company’s LHFS is based on observable market prices for the identical instruments traded in the secondary mortgage loan markets in which the Company conducts business and totaled $17.2 million as of March 31, 2020, of which $16.8 million is related to unpaid principal. The Company’s portfolio of LHFS is classified as Level 2. These loans were previously carried as of December 31, 2019 at the lower of cost or estimated fair value on an aggregate basis as determined by outstanding commitments from investors and totaled $12.7 million.

 

Interest Rate Lock Commitments and Forward Sales Commitments. The Company, through the Mortgage Company, enters into commitments to originate residential mortgage loans in which the interest rate on the loan is determined prior to funding, termed interest rate lock commitments (IRLCs). Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. Upon entering into a commitment to originate a loan, the Company protects itself from changes in interest rates during the period prior to sale by requiring a firm purchase agreement from a permanent investor before a loan can be closed (forward sales commitment). The Company locks in the loan and rate with an investor and commits to deliver the loan if settlement occurs on a best efforts basis, thus limiting interest rate risk. Certain additional risks exist if the investor fails to meet its purchase obligation; however, based on historical performance and the size and nature of the investors the Company does not expect them to fail to meet their obligation.  The Company determines the fair value of IRLCs based on the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis while taking into consideration the probability that the rate lock commitments will close. The fair value of these derivative instruments is reported in “Other Assets” in the Consolidated Balance Sheet at March 31, 2020, and totaled $728,000, with a notional amount of $37.6 million and total positions of 158. The fair value of IRLCs was considered immaterial at December 31, 2019. Changes in fair value are recorded as a component of mortgage banking income, net in the Consolidated Income Statement for the period ended March 31, 2020. The Company’s IRLCs are classified as Level 2. At March 31, 2020 and December 31, 2019, each IRLC and all LHFS were subject to a forward sales commitment on a best efforts basis.

 

During the first quarter of 2020, the Company elected to begin using fair value accounting for its forward sales commitments related to IRLCs and LHFS under ASC 825-10-15-4(b). The fair value of forward sales commitments is reported in “Other Liabilities” in the Consolidated Balance Sheet at March 31, 2020, and totaled $1.2 million, with a notional amount of $54.8 million and total positions of 235. The fair value of the forward sales commitments was considered immaterial at December 31, 2019.

 

Note 17 – Recent accounting pronouncements

 

In June 2016, the FASB issued ASU No. 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASUs 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the SEC and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. While the Company is currently evaluating the provisions of ASU No. 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, and evaluating its current IT systems. This guidance may result in material changes in the Company's accounting for credit losses on financial instruments.

 

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In August 2018, the FASB issued ASU 2018-13, “Fair Value Measurement (Topic 820) - Changes to the Disclosure Requirements for Fair Value Measurement” (“ASU 2018-13”). ASU 2018-13 modifies the disclosure requirements on fair value measurements by requiring that Level 3 fair value disclosures include the range and weighted average of significant unobservable inputs used to develop those fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. Certain disclosure requirements in Topic 820 were also removed or modified. ASU 2018-13 was effective for the Company on January 1, 2020. The adoption of ASU 2018-13 did not have a material impact on the Company’s consolidated financial statements.

 

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (“SAB”) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development governance, and documentation of systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

 

In August 2018, the FASB issued ASU 2018-14, “Compensation—Retirement Benefits—Defined Benefit Plans—General (Subtopic 715-20): Disclosure Framework—Changes to the Disclosure Requirements for Defined Benefit Plans.” These amendments modify the disclosure requirements for employers that sponsor defined benefit pension or other postretirement plans. Certain disclosure requirements have been deleted while the following disclosure requirements have been added: the weighted-average interest crediting rates for cash balance plans and other plans with promised interest crediting rates and an explanation of the reasons for significant gains and losses related to changes in the benefit obligation for the period. The amendments also clarify the disclosure requirements in paragraph 715-20-50-3, which state that the following information for defined benefit pension plans should be disclosed: The projected benefit obligation (“PBO”) and fair value of plan assets for plans with PBOs in excess of plan assets and the accumulated benefit obligation (“ABO”) and fair value of plan assets for plans with ABOs in excess of plan assets. The amendments are effective for fiscal years ending after December 15, 2020. Early adoption is permitted. The Company does not expect the adoption of ASU 2018-14 to have a material impact on its consolidated financial statements.

 

In December 2019, the FASB issued ASU 2019-12, “Income Taxes (Topic 740) – Simplifying the Accounting for Income Taxes.” The ASU is expected to reduce cost and complexity related to the accounting for income taxes by removing specific exceptions to general principles in Topic 740 (eliminating the need for an organization to analyze whether certain exceptions apply in a given period) and improving financial statement preparers’ application of certain income tax-related guidance. This ASU is part of the FASB’s simplification initiative to make narrow-scope simplifications and improvements to accounting standards through a series of short-term projects. For public business entities, such as the Company, the amendments are effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company is currently assessing the impact that ASU 2019-12 will have on its consolidated financial statements.

 

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In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2020-01 amends ASU 2016-01, which made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments in ASU 2020-01 clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. For public business entities, such as the Company, the amendments in the ASU are effective for fiscal years beginning after December 31, 2020, and interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-01 to have a material impact on its consolidated financial statements.

 

In March 2020, the FASB issued ASU 2020-04, “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference LIBOR or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. The Company has a team to assess ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

 

In March 2020, various regulatory agencies, including the Board of Governors of the Federal Reserve and the FDIC, (“the agencies”) issued an interagency statement on loan modifications and reporting for financial institutions working with customers affected by the Coronavirus. The interagency statement was effective immediately and impacted accounting for loan modifications. Under ASC 310-40, “Receivables – Troubled Debt Restructurings by Creditors,” a restructuring of debt constitutes a TDR if the creditor, for economic or legal reasons related to the debtor’s financial difficulties, grants a concession to the debtor that it would not otherwise consider. The agencies confirmed with the staff of the FASB that short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. This includes short-term (e.g., six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or other delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. As of March 31, 2020, the Company had a total of $7,565,000 in loans past due greater than 30 days of which $5,346,000 were rehabilitated student loans which have a 98% guarantee by the DOE of principal and interest. For more financial data and other information about loan deferral refer to section, “Response to COVID-19” under Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. This interagency guidance is expected to have an impact on the Company’s financial statements; however, this impact cannot be quantified at this time.

 

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Item 2 – Management’s Discussion and Analysis OF Financial condition and results of operations

 

Caution about forward-looking statements

 

In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy and financial and other goals. Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.

 

There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to:

 

·changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;
·the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
·the effects of future economic, business and market conditions;
·legislative and regulatory changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
·our inability to maintain our regulatory capital position;
·the Company’s computer systems and infrastructure may be vulnerable to attacks by hackers or breached due to employee error, malfeasance, or other disruptions despite security measures implemented by the Company;
·changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;
·risks inherent in making loans such as repayment risks and fluctuating collateral values;
·changes in operations of the mortgage company as a result of the activity in the residential real estate market;
·exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
·governmental monetary and fiscal policies;
·changes in accounting policies, rules and practices;
·reliance on our management team, including our ability to attract and retain key personnel;
·competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
·demand, development and acceptance of new products and services;
·problems with technology utilized by us;
·natural disasters, war, terrorist activities, pandemics, or the outbreak of COVID-19 or similar outbreaks, and their effects on economic and business environments in which the Company operates;

 

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·adverse effects due to COVID-19 on the Company and its customers, counterparties, employees, and third-party service providers, and the adverse impacts to our business, financial position, results of operations, and prospects;
·changing trends in customer profiles and behavior; and
·other factors described from time to time in our reports filed with the SEC.

 

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.  In addition, past results of operations are not necessarily indicative of future results.

 

General

 

The Company’s primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk. The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company’s results of operations and financial condition.

 

Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions. If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income.

 

Response to COVID-19

 

As the circumstances with the COVID-19 pandemic began to unfold, the Company rapidly mobilized over 80% of non-branch team members, went to drive-thru only at our branches with lobby access by appointment and actively began working with borrowers to defer loan payments for up to six months to allow the COVID-19 pandemic to stabilize and operations return to some level of normalcy. We believe that we are well positioned to weather the storm created by the COVID-19 pandemic and have built the balance sheet around a philosophy of prudent risk taking.

 

Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”)

 

The Company was successful in getting SBA PPP funds out to our community under the Coronavirus Aid, Relief, Economic Security (“CARES”) Act, which was designed to protect jobs and provide economic relief to small business that were negatively impacted by the COVID-19 pandemic. The Bank garnered approval for approximately $185 million in PPP loans; however, the final funded amount of loans may be lower as some borrowers may not finalize the closing process. The PPP loans will help to provide essential funds to over 1,300 businesses and nonprofits and will help to protect more than 20,000 jobs in our community. The processing fees we earn on these loans will help to support our loan deferral program and reserve building associated with the crisis. We expect that our community leadership during the crisis and our PPP lending activity will open the door to a number of new commercial and consumer banking relationships.

 

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Supporting customers through payment deferrals

 

In response to the COVID-19 pandemic, we began deferring payments for up to six months for impacted customers. Below is a breakdown of the loan portfolio as of March 31, 2020 showing the percentage of loans deferred in each category at May 12, 2020 (dollars in thousands).

 

       Deferred Loans(1)(2) 
Loan Type  March 31, 2020   Amount   Number 
C&I + Owner occupied commercial real estate  $149,048    19.93%   8.48%
Nonowner occupied commercial real estate   129,474    31.57%   19.70%
Acquisition, development and construction   32,170    17.30%   1.45%
Total commercial loans   310,692    24.51%   9.05%
Consumer/Residential   89,290    7.37%   4.35%
Student   32,251    0.00%   0.00%
Other   3,001    0.70%   1.12%
Total loans  $435,234    19.01%   6.11%

 

(1) Deferrals are as of May 12, 2020 and are expressed as a percentage of the outstanding balance (“Amount” column) and number of loans (“Number” column) per category.

 

(2) The SBA is providing a financial reprieve to small business during the COVID-19 pandemic. The SBA will automatically pay the principal, interest, and fees on current loans issued under the SBA’s 7(a) program for a period of six months. These loans have been excluded from the above metrics.

 

Below is a breakdown of a portion of the loan portfolio as of March 31, 2020 organized by industry showing the percentage of loans deferred in each category at May 12, 2020 (dollars in thousands).

 

       Deferred Loans(1)(2) 
Select Industries  March 31, 2020   Amount   Number 
Hotels  $25,721    67.24%   55.56%
Food Service   23,796    30.44%   21.05%
Retail(3)   18,073    21.10%   6.67%
    Medical and Child Care   11,998    34.71%   16.67%
Total  $79,588    40.86%   15.15%

  

(1) Deferrals are as of May 12, 2020 and are expressed as a percentage of the outstanding balance (“Amount” column) and number of loans (“Number” column) per category.

 

(2) The SBA is providing a financial reprieve to small business during the COVID-19 pandemic. The SBA will automatically pay the principal, interest, and fees on current loans issued under the SBA’s 7(a) program for a period of six months. These loans have been excluded from the above metrics.

 

 (3) Loans within this group include business such as grocery, convenience stores, drug stores, consumer durables, apparel, and personal services.

 

Liquidity Risk Management

 

Over the past eight years, the Company has worked to fund the balance sheet with core deposits and reserve wholesale funding capacity for short periods of rapid loan growth or for crises such as the current economic environment. During the three month period ended March 31, 2020, the Company took aggressive measures to bolster our liquidity to ensure that we could meet customer demands in the event they made significant deposit withdrawals and fully drew on lines of credit. During the period, it seemed that any number of extreme scenarios were possible, and we thought it prudent to be prepared for them. The Company increased liquid assets by $20,155,000, or 30.12% from $66,904,000 at December 31, 2019 to $87,059,000 which was partially accomplished by raising an additional $3,733,000 in internet listing service time deposits, $15,000,000 in FHLB Advances and $6,136,000 in brokered time deposits, which were at zero at December 31, 2019. As of the date of this filing we have not experienced excessive demand for deposit withdrawal or advances under lines of credit, and based on what we know as of this filing we would place a low probability on either occurring in the near term. However, if the need were to arise we are able to pledge additional collateral to the FHLB in order to increase or available borrowing capacity up to 25% of assets, we have two federal funds lines of credit with correspondent banks totaling $15,000,000 for which there were no borrowings against the lines at March 31, 2020 and we could add additional funding through raising internet listing service and brokered time deposits.

 

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Capital Risk Management

 

The Bank maintains a strong, well capitalized position with a common equity Tier 1 capital ratio of 11.89%, a Tier 1 risk-based capital ratio of 11.89%, a total risk-based capital ratio of 12.64% and a leverage ratio of 10.10% as of March 31, 2020. The most significant risk to capital as a result of the COVID-19 pandemic is the risk of default within our loan portfolio and the potential loan losses as a result of those defaults. The Company has taken several steps to mitigate this risk to our capital by building a diversified loan portfolio over the years to be capable of sustaining through a crisis, working with our customers during this time to defer loan payments for up to six months to allow time for economic stabilization and participating in the SBA PPP loan program to help provide much needed funds to our borrowers and the community. While there will be pressure on capital levels as a result of the COVID-19 pandemic, the Company believes the actions we are taking will protect our capital levels and allow the Company to support all stakeholders through this difficult time.

 

While the long-term economic impacts from the COVID-19 pandemic are unknown at this time, we believe that our culture of disciplined and conservative risk taking across the balance sheet has the Company well positioned to not only carry through the current crisis but to be a pillar of support for our employees, our customers, and our communities.

 

Results of operations

 

The following presents management’s discussion and analysis of the financial condition of the Company at March 31, 2020 and December 31, 2019 and the results of operations for the Company for the three months ended March 31, 2020 and 2019. The Company’s first quarter 2020 results of operations were negatively impacted by the deteriorating economic environment as a result of the COVID-19 pandemic, which resulted in the Company recognizing a $400,000 provision for loan losses. For more financial data and other information about the provision for loan losses refer to section, “Provision for Loan Losses” under this Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations”. This discussion should be read in conjunction with the Company’s consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report.

 

Summary

 

For the three months ended March 31, 2020, the Company had net income of $898,000, or $0.62 per fully diluted share, compared to net income of $809,000 or $0.56 per fully diluted share, for the same period in 2019. This represents an increase in profitability of $89,000, or 11%.

 

Net interest income

 

Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company’s primary source of earnings. Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholders’ equity. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. The net yield on interest-earning assets (“net interest margin”) is calculated by dividing tax equivalent net interest income by average interest-earning assets. Generally, the net interest margin will exceed the net interest spread because a portion of interest earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing deposits and shareholders’ equity.

 

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   For the Three Months Ended March 31, 
   2020   2019   Change 
   (dollars in thousands) 
Average interest-earning assets  $502,033   $472,426   $29,607 
Interest income  $5,684   $5,709   $(25)
Yield on interest-earning assets   4.55%   4.90%   (0.35)%
Average interest-bearing liabilities  $357,989   $352,430   $5,559 
Interest expense  $1,257   $1,243   $14 
Cost of interest-bearing liabilities   1.41%   1.43%   (0.02)%
Net interest income  $4,427   $4,466   $(39)
Net interest margin   3.55%   3.83%   (0.28)%

 

The decrease in net interest income of $39,000 in the first quarter of 2020 was a result of a 35 basis points lower yield on earning assets because of the 225 basis points drop in the Federal Reserve’s target federal funds rate from March 31, 2019. Interest income decreased by $25,000 because of a decrease in interest income on loans held for investment of $41,000, a decrease in interest income on investment securities of $23,000, and an increase in interest income on loans held for sale of $45,000. The decrease in interest income on loans held for investment was attributable to a 28 basis point decrease in the yield with the impact partially offset by an increase in the average balance outstanding of $16,207,000. The decrease in interest income on investment securities was attributable to the 26 basis point decrease in the yield. The increase in interest income on loans held for sale was attributable to an increase in the average balance outstanding of $5,812,000 with the impact partially offset by a 91 basis point decrease in the yield. Interest expense increased $14,000 primarily because of an increase in the average interest bearing liabilities of $5,559,000 with a two basis points decrease in the cost of interest bearing liabilities.

 

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The following tables illustrate average balances of total interest-earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, shareholders' equity and related income, expense and corresponding weighted-average yields and rates (dollars in thousands). The average balances used in these tables and other statistical data were calculated using daily average balances. We had no tax exempt interest-earning assets for the periods presented.

 

Average Balance Sheets, Income and Expense, Yields and Rates
                         
   Three Months Ended March 31, 2020   Three Months Ended March 31, 2019 
       Interest   Annualized       Interest   Annualized 
   Average   Income/   Yield   Average   Income/   Yield 
   Balance   Expense   Rate   Balance   Expense   Rate 
Loans net of deferred fees  $431,611   $5,261    4.90%  $415,404   $5,302    5.18%
Loans held for sale   11,117    108    3.91%   5,305    63    4.82%
Investment securities   44,763    270    2.43%   44,152    293    2.69%
Federal funds and other   14,542    45    1.24%   7,565    51    2.73%
Total interest earning assets   502,033    5,684    4.55%   472,426    5,709    4.90%
                               
Allowance for loan losses and deferred fees   (3,185)             (3,048)          
Cash and due from banks   9,359              8,944           
Premises and equipment, net   11,997              12,432           
Other assets   20,523              21,559           
Total assets  $540,727             $512,313           
                               
Interest bearing deposits                              
Interest checking  $50,060   $22    0.18%  $47,531   $20    0.17%
Money market   106,727    215    0.81%   89,053    138    0.63%
Savings   23,691    10    0.17%   24,174    10    0.17%
Certificates   137,709    653    1.91%   157,699    714    1.84%
Total   318,187    900    1.14%   318,457    882    1.12%
Borrowings   39,802    357    3.61%   33,973    361    4.31%
Total interest bearing liabilities   357,989    1,257    1.41%   352,430    1,243    1.43%
Noninterest bearing deposits   134,280              115,491           
Other liabilities   4,595              6,643           
Total liabilities   496,864              474,564           
Equity capital   43,863              37,749           
Total liabilities and capital  $540,727             $512,313           
                               
Net interest income       $4,427             $4,466      
                               
Interest spread - average yield on interest                              
earning assets, less average rate on                              
interest bearing liabilities             3.14%             3.47%
                               
Annualized net interest margin (net                              
interest income expressed as                              
percentage of average earning assets)             3.55%             3.83%

 

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Provision for (recovery of) loan losses

 

The amount of the allowance for loan losses is determined by an evaluation of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, delinquency trends, underlying collateral values, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions.

 

The level of the allowance reflects changes in the size of the portfolio or in any of its components as well as management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, and present economic, political and regulatory conditions. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.

 

The Company recorded a provision for loan losses of $400,000 for the three month period ended March 31, 2020 as a result of growth in the loan portfolio, an increase in the historical loan loss experience and an increase in the qualitative factors due to the anticipated economic impact of COVID-19. The increase in the qualitative factors due to COVID-19 were a result of deterioration in local economic factors such as the higher levels of unemployment and the potential impact of elevated loan deferral requests. The Company believes the current level of allowance for loan loss reserves are adequate to cover anticipated losses. However, the full economic impact of the COVID-19 pandemic is currently unknown and the Company will continue to monitor our loan portfolio for loss indicators which may have the potential for further significant provisions for loan losses through the second quarter of 2020 and beyond. The Company did not record a provision for loan losses for the three month period ended March 31, 2019 because of minimal net charge-offs, no significant changes in qualitative factors and stable asset quality.

 

For more financial data and other information about the allowance for loan losses refer to section, “Balance Sheet Analysis under this Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

 

Noninterest income

 

Noninterest income includes service charges and fees on deposit accounts, fee income related to loan origination, mortgage banking income, net, and gains and losses on securities available for sale. The most significant noninterest income item has been mortgage banking income, net, representing 67% and 52% for the three month periods ended March 31, 2020 and 2019, respectively.

 

   For the Three Months Ended         
   March 31,   Change 
   2020   2019   $   % 
   (dollars in thousands) 
Service charges and fees  $518   $458   $60    13.1%
Mortgage banking income, net   1,370    787    583    74.1%
Gain on sale of investment securities   12    101    (89)   (88.1)%
Gain on sale of SBA loans   86    92    (6)   100.0%
Other   74    80    (6)   (7.5)%
Total noninterest income  $2,060   $1,518   $542    35.7%

 

·Service charges and fees increased primarily because of the growth in deposit transaction accounts.
·The increase in mortgage banking income, net is a result of increased loan originations and sales compared to the prior year.
·The Company sold approximately $7,900,000 and $6,500,000 in investment securities resulting in a gain of net $12,000 and $101,000 for the three months ended March 31, 2020 and 2019, respectively. The sales of these securities, which had fixed interest rates, allowed the Company to decrease its exposure to upward movement in interest rates that would result in unrealized losses being recognized in shareholders’ equity.

 

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Noninterest expense

 

   For the Three Months Ended         
   March 31,   Change 
   2020   2019   $   % 
   (dollars in thousands) 
Salaries and benefits  $3,022   $2,936   $86    2.9%
Occupancy   326    349    (23)   (6.6)%
Equipment   200    226    (26)   (11.5)%
Supplies   38    41    (3)   (7.3)%
Professional and outside services   716    809    (93)   (11.5)%
Advertising and marketing   78    58    20    34.5%
Foreclosed assets, net   -    1    (1)   (100.0)%
FDIC insurance premium   60    90    (30)   (33.3)%
Other operating expense   510    489    21    4.3%
Total noninterest expense  $4,950   $4,999   $(49)   (1.0)%

 

·The decrease in professional and outside services is due to the recognition of additional fees paid to our prior external auditors as well as increased consultant fees in the three month period ended March 31, 2019 that did not occur in the three month period ended March 31, 2020.
·The decrease in the FDIC insurance premium is related to a decrease in our quarterly assessment.

 

Income taxes

 

The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent difference and available tax credits. Income tax expense for the three months ended March 31, 2020 was $239,000, resulting in an effective tax rate of 21.0% compared to $176,000 or 17.9% for the same period in 2019. The increase in the effective tax rate was primarily related to a reduction in the tax credit received related to state taxes attributed to the Company and the mortgage banking segment. The Bank is not subject Virginia income taxes, and instead is subject to a franchise tax based on bank capital.

 

Balance Sheet Analysis

 

Investment securities

 

At March 31, 2020 and December 31, 2019, all of our investment securities were classified as available for sale.

 

For more financial data and other information about investment securities refer to Note 4 “Investment Securities Available for Sale” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this From 10-Q.

 

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Loans

 

One of management’s objectives is to improve the quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower. The portfolio strategies include seeking industry, loan type and loan size diversification in order to minimize credit concentration risk. Management also focuses on originating loans in markets with which the Company is familiar. Additionally, as a significant amount of the loan losses we have experienced in the past is attributable to construction and land development loans, our strategy has shifted from reducing this type of lending to closely managing the quality and concentration in these loan types.

 

Approximately 81% of all loans are secured by mortgages on real property located principally in the Commonwealth of Virginia. Approximately 7% of the loan portfolio consists of rehabilitated student loans purchased by the Bank from 2014 to 2017 (see discussion following). The Company’s commercial and industrial loan portfolio represents approximately 11% of all loans. Loans in this category are typically made to individuals and small and medium-sized businesses, and range between $250,000 and $2.5 million. Based on underwriting standards, commercial and industrial 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 remainder of our loan portfolio is in consumer loans which represent less than 1% of the total.

 

Loans classified by type as of March 31, 2020 and December 31, 2019 are as follows (dollars in thousands):

 

   March 31, 2020   December 31, 2019 
   Amount   %   Amount   % 
Construction and land development                    
Residential  $8,143    1.87%  $7,887    1.84%
Commercial   24,027    5.52%   24,063    5.60%
    32,170    7.39%   31,950    7.44%
Commercial real estate                    
Owner occupied   103,210    23.71%   98,353    22.91%
Non-owner occupied   115,278    26.49%   116,508    27.14%
Multifamily   14,046    3.23%   13,332    3.10%
Farmland   150    0.03%   156    0.04%
    232,684    53.46%   228,349    53.19%
Consumer real estate                    
Home equity lines   20,590    4.73%   21,509    5.01%
Secured by 1-4 family residential,                    
First deed of trust   57,352    13.18%   55,856    13.01%
Second deed of trust   11,348    2.61%   10,411    2.43%
    89,290    20.52%   87,776    20.45%
Commercial and industrial loans                    
(except those secured by real estate)   45,838    10.53%   45,074    10.50%
Guaranteed student loans   32,251    7.41%   33,525    7.81%
Consumer and other   3,001    0.69%   2,621    0.60%
                     
Total loans   435,234    100.0%   429,295    100.0%
Deferred fees and costs, net   704         764      
Less: allowance for loan losses   (3,444)        (3,186)     
                     
   $432,494        $426,873      

 

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For more financial data and other information about loans refer to Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

 

Allowance for loan losses

 

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. For more financial data and other information about loans refer to Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

 

Asset quality

 

The following table summarizes asset quality information at the dates indicated (dollars in thousands):

 

   March 31,   December 31,   March 31, 
   2020   2019   2019 
Nonaccrual loans  $1,317   $1,868   $2,113 
Foreclosed properties   526    526    526 
Total nonperforming assets  $1,843   $2,394   $2,639 
                
Restructured loans (not included in               
nonaccrual loans above)  $7,472   $7,059   $8,587 
                
Loans past due 90 days and still               
accruing (1)  $2,765   $2,567   $4,164 
                
Nonperforming assets to loans (2)   0.42%   0.56%   0.63%
                
Nonperforming assets to total assets   0.32%   0.44%   0.51%
                
Allowance for loan losses to               
nonaccrual loans   261.60%   170.57%   143.27%

 

 

 

(1) All loans 90 days past due and still accruing are rehabilitated student loans which have a 98% guarantee by the DOE.

(2) Loans are net of unearned income and deferred cost.

    

Nonperforming assets totaled $1,843,000 at March 31, 2020, compared to $2,394,000 at December 31, 2019. Nonperforming assets at March 31, 2020 consisted primarily of $1,317,000 in nonaccrual loans, compared to $1,868,000 at December 31, 2019. The decrease in nonaccrual loans from December 31, 2019 was primarily the result of $749,000 in loans placed back on accrual.

 

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The following table presents an analysis of the changes in nonperforming assets for the three months ended March 31, 2020 (in thousands):

 

   Nonaccrual   Foreclosed     
   Loans   Properties   Total 
Balance December 31, 2019  $1,868   $526   $2,394 
Additions   342    -    342 
Loans placed back on accrual   (749)   -    (749)
Transfers to OREO   -    -    - 
Repayments   (9)   -    (9)
Charge-offs   (135)   -    (135)
Sales   -    -    - 
                
 Balance March 31, 2020  $1,317   $526   $1,843 

 

Nonperforming restructured loans are included in nonaccrual loans. Until a nonperforming restructured loan has performed in accordance with its restructured terms for a minimum of six months, it will remain on nonaccrual status.

 

Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful. Commercial and unsecured consumer loans are designated as non-accrual when the Company considers collection of expected principal and interest doubtful. Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and interest is not significant. When loans are placed on non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received. Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

 

Of the total nonaccrual loans of $1,317,000 at March 31, 2020 that were considered impaired, one loan totaling $132,000 had a specific allowances for loan losses totaling $48,000. This compares to $1,868,000 in nonaccrual loans at December 31, 2019 of which one loan totaling $135,000 had specific allowance for loan loss of $135,000. This loan was charged off during the quarter ended March, 31, 2020.

 

Cumulative interest income that would have been recorded had nonaccrual loans been performing would have been approximately $77,000 and $202,000 for the three months ended March 31, 2020 and 2019, respectively.

 

Deposits

 

Deposits as of March 31, 2020 and December 31, 2019 were as follows (dollars in thousands):

 

                 
   March 31, 2020   December 31, 2019 
   Amount   %   Amount   % 
Checking accounts                    
Noninterest bearing demand  $139,660    29.8%  $131,228    29.6%
Interest bearing   51,008    10.9%   48,427    10.9%
Money market accounts   114,461    24.4%   99,955    22.6%
Savings accounts   26,618    5.7%   26,396    6.0%
Time deposits of $250,000 and over   24,535    5.2%   22,327    5.0%
Other time deposits   112,561    24.0%   114,874    25.9%
                     
Total  $468,843    100.0%  $443,208    100.0%

 

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2

 

Total deposits increased by $25,635,000, or 5.78%, from $443,208,000 at December 31, 2019 to $468,843,000 at March 31, 2020. Variances of note are as follows:

 

·Noninterest bearing demand account balances increased $8,432,000 from December 31, 2019, and represented 29.79% of total deposits at March 31, 2020 compared to 29.61% as of December 31, 2019. The increase in noninterest bearing deposits for the three month period ended March 31, 2020 was a result of growth in business account and business seasonality in a number of business sectors in which we focus.

 

·Low cost relationship deposit account (i.e. interest bearing checking, money market, and savings) balances increased $17,309,000 from December 31, 2019, and represented 40.97% of total deposits at March 31, 2020 compared to 39.43% as of December 31, 2019.

 

·Time deposits decreased by $105,000 from December 31, 2019, and represented 29.24% of total deposits at March 31, 2020 compared to 30.96% as of December 2019. The decrease in time deposits is a result of our continued focus on building low cost relationship deposits and working to improve our deposits mix and cost of funds. Wholesale time deposits were $11,114,000 as of March 31, 2020 compared to $1,494,000 as of December 31, 2019.

 

The variety of deposit accounts that we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility to, although not to eliminate, the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities). Our ability to attract and retain deposits, and our cost of funds, has been, and is expected to continue to be, significantly affected by market conditions.

 

Borrowings

 

We utilize borrowings to supplement deposits to address funding or liability duration needs. For more financial data and other information about borrowings refer to Note 7 “Borrowings” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

 

Capital resources

 

Shareholders’ equity at March 31, 2020 was $44,162,000 compared to $42,914,000 at December 31, 2019. The $1.2 million increase in shareholders’ equity during the three months ended March 31, 2020 is primarily due to net income of $898,000.

 

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The following table presents the composition of regulatory capital and the capital ratios for the Bank at the dates indicated (dollars in thousands):

 

   March 31,   December 31, 
   2020   2019 
Tier 1 capital          
Total bank equity capital  $55,182   $53,768 
Net unrealized (gain) loss on available-for-sale securities   (480)   (186)
Defined benefit postretirement plan   42    44 
Dissallowed deferred tax asset   (442)   (759)
Total Tier 1 capital   54,302    52,867 
           
Tier 2 capital          
Allowance for loan losses   3,444    3,186 
Tier 2 capital deduction   -    (1,400)
Total Tier 2 capital   3,444    1,786 
           
Total risk-based capital   57,746    54,653 
           
Risk-weighted assets  $457,751   $435,082 
           
Average assets  $537,884   $545,567 
           
Capital ratios          
Leverage ratio (Tier 1 capital to average assets)   10.10%   9.69%
Common equity tier 1 capital ratio (CET 1)   11.86%   12.15%
Tier 1 capital to risk-weighted assets   11.86%   12.15%
Total capital to risk-weighted assets   12.62%   12.56%
Equity to total assets   9.72%   10.00%

 

For more financial data and other information about capital resources, refer to Note 14 “Shareholders’ Equity and Regulatory Matters” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.

 

Liquidity

 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

At March 31, 2020, our liquid assets, consisting of cash, cash equivalents and investment securities available for sale, totaled $87,059,000, or 15.3% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $6,196,000 of these securities were pledged against current and potential fundings.

 

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Our holdings of liquid assets plus the ability to maintain and expand our deposit base and borrowing capabilities serve as our principal sources of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain two federal funds lines of credit with correspondent banks totaling $15 million for which there were no borrowings against the lines at March 31, 2020 and $5,317,000 borrowings against the line at December 31, 2019.

 

We are also a member of the Federal Home Loan Bank of Atlanta, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at March 31, 2020 was $6.2 million, based on the Bank's qualifying collateral available to secure any future borrowings. However, we are able to pledge additional collateral to the FHLB in order to increase our available borrowing capacity up to 25% of assets. Liquidity provides us with the ability to meet normal deposit withdrawals, while also providing for the credit needs of customers. We are committed to maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth, and fully comply with all regulatory requirements.

 

At March 31, 2020, we had commitments to originate $137,694,000 of loans. Fixed commitments to incur capital expenditures were less than $100,000 at March 31, 2020. Certificates of deposit scheduled to mature in the 12-month period ending March 31, 2021 totaled $77,537,000. We believe that a significant portion of such deposits will remain with us. We further believe that deposit growth, loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs.

 

Interest rate sensitivity

 

An important element of asset/liability management is the monitoring of our sensitivity to interest rate movements. In order to measure the effects of interest rates on our net interest income, management takes into consideration the expected cash flows from the securities and loan portfolios and the expected magnitude of the repricing of specific asset and liability categories. We evaluate interest sensitivity risk and then formulate guidelines to manage this risk based on management’s outlook regarding the economy, forecasted interest rate movements and other business factors. Our goal is to maximize and stabilize the net interest margin by limiting exposure to interest rate changes.

 

Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolio. The average lives of mortgage loans are substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which gives us the right to declare a loan immediately due and payable in the event, among other things, the borrower sells the real property subject to the mortgage and the loan is not repaid. In addition, certain borrowers increase their equity in the security property by making payments in excess of those required under the terms of the mortgage.

 

The sale of fixed rate loans is intended to protect us from precipitous changes in the general level of interest rates. The valuation of adjustable rate mortgage loans is not as directly dependent on the level of interest rates as is the value of fixed rate loans. As with other investments, we regularly monitor the appropriateness of the level of adjustable rate mortgage loans in our portfolio and may decide from time to time to sell such loans and reinvest the proceeds in other adjustable rate investments.

 

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Impact of inflation and changing prices

 

The Company’s financial statements included herein have been prepared in accordance with GAAP, which require the Company to measure financial position and operating results primarily in terms of historical dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While 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. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

 

LIBOR and Other Benchmark Rates

 

Following the announcement by the U.K.’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for the London InterBank Offered Rate (“LIBOR”) after 2021, central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates (“IBOR”) and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates (“ARRs”) and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.

 

To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, the Company has established a company-wide initiative led by senior management. The objective of this initiative is to identify and assess the Company’s exposure and develop an appropriate action plan to address prior to transition.

 

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ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not Applicable.

 

ITEM 4 – CONTROLS AND PROCEDURES

 

The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of March 31, 2020. Based on that evaluation, management concluded that the Company’s disclosure controls and procedures were effective as of March 31, 2020 in ensuring that all material information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed summarized and reported with the time periods specified in SEC rules and regulations and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

 

The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. There were no changes in our internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.

 

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PART II – OTHER INFORMATION

 

ITEM 1 – LEGAL PROCEEDINGS

 

In the course of its operations, the Company may become a party to legal proceedings. There are no material pending legal proceedings to which the Company is party or of which the property of the Company is subject.

 

ITEM 1A – RISK FACTORS

 

The impacts of COVID-19, or the outbreak of another highly infectious or contagious disease, could adversely affect the Company’s business, financial condition and results of operations.

 

The Company’s business is dependent upon the willingness and ability of its customers to conduct banking and other financial transactions. Since the beginning of January 2020, the COVID-19 outbreak has caused significant disruption in the financial markets both globally and in the United States. The continuing spread of COVID-19 and the related government actions to mandate or encourage quarantines and social distancing has resulted in a significant decrease in commercial activity nationally and in the Company’s markets, and may cause customers, vendors, and counterparties to be unable to meet existing payment or other obligations to the Company and the Bank.

 

The national public health crisis arising from the COVID-19 pandemic (and public expectations about it), combined with certain pre-existing factors, including, but not limited to, international trade disputes, inflation risks, and oil price volatility, could further destabilize the financial markets and the markets in which the Company operates. The resulting impacts on consumers, including the sudden increase in the unemployment rate, is expected to cause changes in consumer and business spending, borrowing needs and saving habits, which will likely affect the demand for loans and other products and services the Company offers, as well as the creditworthiness of potential and current borrowers. Borrower loan defaults that adversely affect the Company’s earnings correlate with deteriorating economic conditions, which, in turn, may impact borrowers’ creditworthiness and the Bank’s ability to make loans.

 

The use of quarantines and social distancing methods to curtail the spread of COVID-19 – whether mandated by governmental authorities or recommended as a public health practice – may adversely affect the Company’s operations as key personnel, employees and customers avoid physical interaction. In response to the COVID-19 pandemic, the Bank has been directing branch customers to use drive-thru windows and online banking services, and many employees are telecommuting. It is not yet known what impact these operational changes may have on the Company’s financial performance. The continued spread of COVID-19 (or an outbreak of a similar highly contagious disease) could also negatively impact the business and operations of third-party service providers who perform critical services for the Company’s business.

 

As a result, if COVID-19 continues to spread or the response to contain the COVID-19 pandemic is unsuccessful, the Company could experience a material adverse effect on its business, financial condition, and results of operations.

 

Except as previously set forth above, there have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019 filed with the SEC on March 16, 2020.

 

ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

 

Not applicable.

 

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ITEM 3 – DEFAULTS UPON SENIOR SECURITIES

 

Not applicable.

 

ITEM 4 – MINE SAFETY DISCLOSURES

 

None.

 

ITEM 5 – OTHER INFORMATION

 

Not applicable.

 

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ITEM 6 – EXHIBITS

 

3.2Bylaws of Village Bank and Trust Financial Corp., as amended March 24, 2020 (incorporated herein by reference to Exhibit 3.2 of the Current Report on Form 8-K, filed with the SEC on March 26, 2020).

 

10.1Change of Control Agreement, dated March 24, 2020, by and between Village Bank and Trust Financial Corp. and Donald M. Kaloski, Jr. (incorporated herein by reference to Exhibit 10.1 of the Current Report on Form 8-K, filed with the SEC on March 26, 2020).

 

10.2Change of Control Agreement, dated March 24, 2020, by and between Village Bank and Max C. Morehead, Jr. (incorporated herein by reference to Exhibit 10.2 of the Current Report on Form 8-K, filed with the SEC on March 26, 2020).

 

31.1Certification of Chief Executive Officer

 

31.2Certification of Chief Financial Officer

 

32.1Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350

 

101The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended March 31, 2020 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Shareholders' Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements.

 

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SIGNATURES

 

In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

VILLAGE BANK AND TRUST FINANCIAL CORP.

     
Date: May 14, 2020 By:    /s/ William G. Foster, Jr.
  William G. Foster, Jr.
  President and Chief Executive Officer
     
Date: May 14, 2020 By:   /s/ Donald M. Kaloski, Jr.
  Donald M. Kaloski, Jr.
  Executive Vice President and Chief Financial Officer

 

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