Note 13.

Stockholders’ equity and regulatory matters

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 (“EESA”), the Company entered into a Letter Agreement and Securities Purchase Agreement—Standard Terms (collectively, the “Purchase Agreement”) with the Treasury, pursuant to which 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, for an aggregate purchase price of $14,738,000 in cash. The fair value of the preferred stock was estimated using discounted cash flow methodology at an assumed market equivalent rate of 13%, with 20 quarterly payments over a five year period, and was determined to be $10,208,000. The fair value of the warrant was estimated using the Black-Scholes option pricing model, with assumptions of 25% volatility, a risk-free rate of 2.03%, a yield of 6.162% and an estimated life of 5 years, and was determined to be $534,000. The aggregate fair value for both the preferred stock and common stock warrants was determined to be $10,742,000 with 95% of the aggregate attributable to the preferred stock and 5% attributable to the common stock warrant. Therefore, the $14,738,000 issuance was allocated with $14,006,000 being assigned to the preferred stock and $732,000 being allocated to the common stock warrant. The difference between the $14,738,000 face value of the preferred stock and the amount allocated of $14,006,000 to the preferred stock is being accreted as a discount on the preferred stock using the effective interest rate method over five years.

The preferred stock qualifies as Tier 1 capital and pays cumulative dividends at a rate of 5% until May 1, 2014 and 9% thereafter, unless the shares are redeemed by the Company. The preferred stock is generally non-voting, other than on certain matters that could adversely affect the preferred stock.

The Warrant was immediately exercisable. The Warrant provides for the adjustment of the exercise price and the number of shares of common stock issuable upon exercise pursuant to customary anti-dilution provisions, such as upon stock splits or distributions of securities or other assets to holders of common stock, and upon certain issuances of common stock at or below a specified price relative to the then-current market price of common stock. The Warrant expires ten years from the issuance date. Pursuant to the Purchase Agreement, the Treasury has agreed not to exercise voting power with respect to any shares of common stock issued upon exercise of the Warrant.

As required by the Federal Reserve Bank of Richmond, the Company notified the Treasury in May 2011 that the Company was going to defer the payment of the quarterly cash dividend of $184,225 due on May 16, 2011, and subsequent quarterly payments, on the Fixed Rate Cumulative Perpetual Preferred Stock, Series A. The total arrearage on such preferred stock as of December 31, 2013 is $2,023,142. This amount has been accrued for and is included in other liabilities in the consolidated balance sheet.

In November 2013, the Company participated in a successful auction of the Company’s preferred stock securities by the Treasury that resulted in the purchase of the securities by private and institutional investors.

On December 4, 2013, the Company issued 1,086,500 new shares of common stock through a private placement to directors and executive officers. The sale raised $1,684,075 in new capital for the Company. The $1.55 sale price for the common shares was the stock’s book value at September 30, 2013, which represented a 30% premium over the closing price of the stock on December 3, 2013.

The Bank is subject to various regulatory capital requirements administered by the federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possible additional discretionary, actions by regulators that, if undertaken, could have a direct material effect on the Bank’s financial statements. Under the capital adequacy guidelines and the regulatory framework for prompt corrective action, the Bank must meet specific capital guidelines that involve quantitative measures of the Bank’s assets, liabilities, and certain off-balance-sheet items as calculated under regulatory accounting practices. The Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.

Quantitative measures are established by regulation to ensure capital adequacy require the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier 1 Capital (as defined in the regulations) to risk-weighted assets, and of Tier 1 Capital to average assets (the Leverage ratio).

Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized. The Bank met the ratio criteria to be categorized as a “well capitalized” institution as of December 31, 2013, 2012 and 2011. However, due to the Consent Order the Bank is currently considered adequately capitalized. The Consent Order requires the Bank to maintain a leverage ratio of at least 8% and a total capital to risk-weighted assets ratio of at least 11%. At December 31, 2013, the Banks leverage ratio was 6.92% and the total capital to risk-weighted assets ratio was 10.90%. As required by the Consent Order, the Bank has provided a capital plan to the FDIC and BFI that demonstrates how the Bank will come into compliance with the required minimum capital ratios set forth in the Consent Order. When capital falls fellow the “well capitalized” requirement, consequences can include: new branch approval could be withheld, more frequent examinations by the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC; and other potential limitation as described in FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section 29. In addition, the FDIC insurance assessment increases when an institution falls below the “well capitalized” classification.

The capital amounts and ratios at December 31, 2013 and 2012 for the Company and the Bank are presented in the table below:

						For Capital
	Actual					Adequacy Purposes					To be Well Capitalized ⁽¹⁾
	Amount		Ratio			Amount		Ratio			Amount		Ratio

December 31, 2013
Total capital (to risk- weighted assets)
Consolidated	$	34,652,000		10.66	%	$	25,997,000		8.00	%	$	32,496,000		10.00	%
Village Bank		35,192,000		10.90	%		25,828,000		8.00	%		32,285,000		10.00	%

Tier 1 capital (to risk- weighted assets)
Consolidated		24,027,000		7.39	%		12,999,000		4.00	%		19,498,000		6.00	%
Village Bank		31,117,000		9.64	%		12,914,000		4.00	%		19,371,000		6.00	%

Leverage ratio (Tier 1 capital to average assets)
Consolidated		24,027,000		5.32	%		18,069,000		4.00	%		22,587,000		5.00	%
Village Bank		31,117,000		6.92	%		17,984,000		4.00	%		22,480,000		5.00	%

December 31, 2012
Total capital (to risk- weighted assets)
Consolidated	$	38,296,000		10.14	%	$	30,206,000		8.00	%	$	37,757,000		10.00	%
Village Bank		37,705,000		10.04	%		30,036,000		8.00	%		37,545,000		10.00	%

Tier 1 capital (to risk- weighted assets)
Consolidated		28,043,000		8.72	%		15,103,000		4.00	%		22,654,000		6.00	%
Village Bank		32,936,000		8.77	%		15,018,000		4.00	%		22,527,000		6.00	%

Leverage ratio (Tier 1 capital to average assets)
Consolidated		28,043,000		6.53	%		20,186,000		4.00	%		25,233,000		5.00	%
Village Bank		32,936,000		6.52	%		20,206,000		4.00	%		25,257,000		5.00	%

(1)

As a result of the Consent Order, the Bank is not considered well capitalized even though it meets the ratio requirements to be classified as such. The Consent Order requires the total capital to risk-weighted assets to be at least 11% and the leverage ratio to be at least 8%.

The Company is currently prohibited by its Written Agreement with the Reserve Bank from making dividend or interest payments on the TARP program preferred stock or trust preferred capital notes without prior regulatory approval. In addition, the Consent Order with the FDIC and BFI provides that the Bank will not pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction of capital, without regulatory approval. At December 31, 2013, the Company’s total accrued but deferred payments on TARP dividends was $2,119,000 and interest payments on trust preferred capital notes was $845,892. Although we elected to defer payment of the interest due, the amounts have been accrued in the consolidated balance sheet and included in interest expense in the consolidated statement of operations.