UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended March 31, 2021

OR

☐ 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: 001-40305

VIRGINIA NATIONAL BANKSHARES CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Virginia	46-2331578
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
404 People Place
Charlottesville, Virginia	22911
(Address of principal executive offices)	(Zip Code)

Registrant’s telephone number, including area code: (434) 817-8621

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

Title of each class	Trading Symbol(s)	Name of each exchange on which registered
Common Stock	VABK	The Nasdaq Capital Market

Indicate by check mark 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  ☒    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  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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	☒	Smaller reporting company	☒
		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  ☒

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court.     Yes  ☒    No  ☐

As of May 7, 2021, the registrant had 5,305,270 shares of common stock, $2.50 par value per share, outstanding.

VIRGINIA NATIONAL BANKSHARES CORPORATION

FORM 10-Q

TABLE OF CONTENTS

Part I. Financial Information
Item 1    Financial Statements	Page   3
Consolidated Balance Sheets (unaudited)	Page   3
Consolidated Statements of Income (unaudited)	Page   4
Consolidated Statements of Comprehensive Income (unaudited)	Page   5
Consolidated Statements of Changes in Shareholders’ Equity (unaudited)	Page   6
Consolidated Statements of Cash Flows (unaudited)	Page   7
Notes to Consolidated Financial Statements (unaudited)	Page   8
Item 2    Management’s Discussion and Analysis of Financial Condition and Results of Operations	Page 33
Application of Critical Accounting Policies and Estimates	Page 35
Financial Condition	Page 36
Results of Operations	Page 42
Item 3    Quantitative and Qualitative Disclosures About Market Risk	Page 47
Item 4    Controls and Procedures	Page 48
Part II. Other Information
Item 1    Legal Proceedings	Page 48
Item 1A  Risk Factors	Page 48
Item 2    Unregistered Sales of Equity Securities and Use of Proceeds	Page 48
Item 3    Defaults Upon Senior Securities	Page 48
Item 4    Mine Safety Disclosures	Page 48
Item 5    Other Information	Page 48
Item 6    Exhibits	Page 49
Signatures	Page 50

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PART I.  FINANCIAL INFORMATION

ITEM 1.   FINANCIAL STATEMENTS

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

	March 31, 2021			December 31, 2020*
ASSETS	(Unaudited)
Cash and due from banks	$	17,407		$	8,116
Federal funds sold		77,089			26,579
Securities:
Available for sale, at fair value		173,088			174,086
Restricted securities, at cost		2,653			3,010
Total securities		175,741			177,096
Loans		621,068			609,406
Allowance for loan losses		(5,615	)		(5,455	)
Loans, net		615,453			603,951
Premises and equipment, net		5,104			5,238
Bank owned life insurance		16,956			16,849
Goodwill		372			372
Other intangible assets, net		324			341
Accrued interest receivable and other assets		9,957			9,868
Total assets	$	918,403		$	848,410
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits:
Noninterest-bearing	$	248,212		$	209,772
Interest-bearing		162,218			148,910
Money market and savings deposit accounts		292,886			272,980
Certificates of deposit and other time deposits		100,844			99,102
Total deposits		804,160			730,764
Advances from the FHLB		30,000			30,000
Accrued interest payable and other liabilities		4,231			5,048
Total liabilities		838,391			765,812
Commitments and contingent liabilities
Shareholders' equity:
Preferred stock, $2.50 par value, 2,000,000 shares authorized, no    shares outstanding		-			-
Common stock, $2.50 par value, 10,000,000 shares authorized;    2,728,327 (including 36,179 nonvested) shares issued    and outstanding as of March 31, 2021 and 2,714,273    (including 25,268 nonvested) shares issued and outstanding    as of December 31, 2020		6,730			6,722
Capital surplus		32,559			32,457
Retained earnings		42,650			41,959
Accumulated other comprehensive income (loss)		(1,927	)		1,460
Total shareholders' equity		80,012			82,598
Total liabilities and shareholders' equity	$	918,403		$	848,410

* Derived from audited Consolidated Financial Statements

See Notes to Consolidated Financial Statements

3

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

(Unaudited)

	For the three months ended
	March 31, 2021		March 31, 2020
Interest and dividend income:
Loans, including fees	$	5,938	$	5,871
Federal funds sold		12		85
Investment securities:
Taxable		507		509
Tax exempt		176		75
Dividends		34		24
Total interest and dividend income		6,667		6,564
Interest expense:
Demand and savings deposits		377		695
Certificates and other time deposits		280		494
Repurchase agreements and other borrowings		36	-
Total interest expense		693		1,189
Net interest income		5,974		5,375
Provision for loan losses		351		765
Net interest income after provision for loan losses		5,623		4,610
Noninterest income:
Wealth management fees		329		310
Advisory and brokerage income		191		178
Royalty income		5		47
Deposit account fees		160		179
Debit/credit card and ATM fees		154		157
Earnings/increase in value of bank owned life insurance		107		107
Fees on mortgage sales		-		47
Gains on sales of securities		-		53
Loan swap fee income		15		509
Other		78		82
Total noninterest income		1,039		1,669
Noninterest expense:
Salaries and employee benefits		2,402		2,424
Net occupancy		495		452
Equipment		116		131
Data processing		289		301
Merger expenses		278		-
Other		1,201		1,235
Total noninterest expense		4,781		4,543
Income before income taxes		1,881		1,736
Provision for income taxes		376		332
Net income	$	1,505	$	1,404
Net income per common share, basic	$	0.55	$	0.52
Net income per common share, diluted	$	0.55	$	0.52

See Notes to Consolidated Financial Statements

4

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

(Unaudited)

	For the three months ended
	March 31, 2021			March 31, 2020
Net income	$	1,505		$	1,404
Other comprehensive income (loss)
Unrealized losses on securities, net of tax    of ($900) for the three months ended    March 31, 2021; and net of tax of    ($109) for the three months ended    March 31, 2020		(3,387	)		(406	)
Reclassification adjustment for realized gains    on sales of securities, net of tax of ($0)    for the three months ended    March 31, 2021; and net of tax of ($11)    for the three months ended    March 31, 2020		—			(42	)
Total other comprehensive loss		(3,387	)		(448	)
Total comprehensive (loss) income	$	(1,882	)	$	956

See Notes to Consolidated Financial Statements

5

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

FOR THE THREE MONTHS ENDED MARCH 31, 2021 AND 2020

(Dollars in thousands, except per share data)

(Unaudited)

									Accumulated
									Other
	Common		Capital			Retained			Comprehensive
	Stock		Surplus			Earnings			Income (Loss)			Total
Balance, December 31, 2019	$	6,720	$	32,195		$	37,235		$	(43	)	$	76,107
Stock option expense		-		24			-			-			24
Restricted stock grant expense		-		15			-			-			15
Cash dividends declared ($0.30 per share)		-		-			(811	)		-			(811	)
Net income		-		-			1,404			-			1,404
Other comprehensive loss		-		-			-			(448	)		(448	)
Balance, March 31, 2020	$	6,720	$	32,234		$	37,828		$	(491	)	$	76,291
Balance, December 31, 2020	$	6,722	$	32,457		$	41,959		$	1,460		$	82,598
Exercise of stock options		1		14			-			-			15
Stock option expense		-		34			-			-			34
Restricted stock grant expense		-		61			-			-			61
Vested stock grants		7		(7	)		-			-			-
Cash dividends declared ($0.30 per share)		-		-			(814	)		-			(814	)
Net income		-		-			1,505			-			1,505
Other comprehensive loss		-		-			-			(3,387	)		(3,387	)
Balance, March 31, 2021	$	6,730	$	32,559		$	42,650		$	(1,927	)	$	80,012

See Notes to Consolidated Financial Statements

6

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)

	For the three months ended
	March 31, 2021			March 31, 2020
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,505		$	1,404
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		351			765
Net amortization and accretion of securities		241			103
Net gains on sale of securities		-			(53	)
Earnings on bank owned life insurance		(107	)		(107	)
Amortization of intangible assets		17			40
Deferred tax		25			-
Depreciation and other amortization		476			518
Stock option expense		34			24
Stock grant expense, restricted		61			15
Net change in:
Accrued interest receivable and other assets		586			(205	)
Accrued interest payable and other liabilities		(3	)		387
Net cash provided by operating activities		3,186			2,891
CASH FLOWS FROM INVESTING ACTIVITIES:
Net decrease (increase) in restricted investments		358			(53	)
Purchases of available for sale securities		(7,974	)		(7,109	)
Proceeds from maturities, calls and principal payments of available for sale securities		4,443			13,112
Proceeds from sales of available for sale securities		—			5,366
Net increase in organic loans		(17,745	)		(20,641	)
Net decrease in purchased loans		5,892			5,945
Cash payment for wealth management book of business		-			(50	)
Purchase of bank premises and equipment		(142	)		(89	)
Net cash used in investing activities		(15,168	)		(3,519	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW accounts, and money market accounts		71,654			21,467
Net increase (decrease) in certificates of deposit and other time deposits		1,742			(7,542	)
Proceeds from stock options exercised		15			-
Cash dividends paid		(1,628	)		(808	)
Net cash provided by financing activities		71,783			13,117
NET INCREASE IN CASH AND CASH EQUIVALENTS	$	59,801		$	12,489
CASH AND CASH EQUIVALENTS:
Beginning of period	$	34,695		$	19,085
End of period	$	94,496		$	31,574
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	702		$	1,215
SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING    ACTIVITIES
Unrealized losses on available for sale securities	$	(4,287	)	$	(568	)

See Notes to Consolidated Financial Statements

7

VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

March 31, 2021

Note 1.  Significant Accounting Policies

Basis of Presentation

The consolidated financial statements include the accounts of Virginia National Bankshares Corporation (the “Company”), and its subsidiaries Virginia National Bank (the “Bank”) and Masonry Capital Management, LLC (“Masonry Capital”), a registered investment advisor.  Beginning in 2019, the services offered under the umbrella of VNB Wealth are provided by Masonry Capital or by the Bank under VNB Trust & Estate Services or Sturman Wealth Advisors, formerly known as VNB Investment Services.  All significant intercompany balances and transactions have been eliminated in consolidation.

The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included.

The preparation of financial statements in conformity with GAAP and the reporting guidelines prescribed by regulatory authorities requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses (including impaired loans), other-than-temporary impairment of securities, intangible assets, and fair value measurements. Operating results for the three months ended March 31, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.

The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2020. If needed, certain previously reported amounts have been reclassified to conform to current period presentation. No such reclassifications were significant.

Merger with Fauquier Bankshares, Inc.

On April 1, 2021, the Company completed its merger with Fauquier Bankshares, Inc. (“Fauquier”).  The merger of Fauquier with and into the Company (the “Merger”) was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of September 30, 2020, between the Company and Fauquier, and a related Plan of Merger (together, the “Merger Agreement”).

Pursuant to the Merger Agreement, holders of shares of Fauquier common stock received 0.675 shares of the Company’s common stock for each share of Fauquier common stock held immediately prior to the effective date of the Merger, plus cash in lieu of fractional shares. Each share of the Company’s common stock outstanding immediately prior to the Merger remained outstanding and was unaffected by the Merger.

Shortly after the effective time of the Merger, The Fauquier Bank, Fauquier’s wholly-owned bank subsidiary, was merged with and into Virginia National Bank, the Company’s wholly-owned bank subsidiary, with Virginia National Bank surviving. 

The first quarter balance sheet and financial results of the Company do not include the financial position or results of Fauquier.  At March 31, 2021, Fauquier had total assets of $911.3 million, net loans of $616.4 million and total deposits of $817.5 million. 

Recent Accounting Pronouncements

Financial Instruments – Credit Losses In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 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,

8

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 U.S. Securities and Exchange Commission (“SEC”), such as the Company, 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. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements.  Early in 2017, the Company formed a cross-functional steering committee, including some members of senior management, to provide governance and guidance over the project plan.  The Company is capturing the additional loan data which is anticipated to be needed for this calculation.  The extent of the change is indeterminable at this time as it will be dependent upon portfolio composition and credit quality at the adoption date, as well as economic conditions and forecasts at that time.  Upon adoption, the impact to the allowance for credit losses (currently allowance for loan losses) will have an offsetting one-time cumulative-effect adjustment to retained earnings.  

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

LIBOR and Other Reference Rates 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 the London Inter-bank Offered Rate (“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.  Subsequently, in January 2021, the FASB issued ASU 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020.  The Company has identified all loans that are directly or indirectly impacted by LIBOR.  The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

Recently Adopted Accounting Developments

Accounting for Income Taxes 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.  ASU 2019-12 was effective for the Company on January 1, 2021.  The adoption of ASU 2019-12 did not have a material impact on the Company’s consolidated financial statements.  

Nonrefundable Fees and Other Costs In October 2020, the FASB issued ASU 2020-08, “Codification Improvements to Subtopic 310-20, Receivables – Nonrefundable fees and Other Costs.” This ASU clarifies that an entity should reevaluate whether a callable debt security is within the scope of ASC paragraph 310-20-35-33 for each reporting period. ASU 2020-08 was effective for the Company on January 1, 2021. The adoption of ASU 2020-08 did not have a material impact on the Company’s consolidated financial statements.

CARES Act In December 2020, the Consolidated Appropriates Act of 2021 (“CAA”) was passed.  Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), including the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”)

9

and treatment of certain loan modifications related to the COVID-19 pandemic. The adoption of the CARES Act had no material impact on the Company’s consolidated financial statements.   See further discussion of PPP loans and loan modifications in Notes 3 and 4 of the notes to the Consolidated Financial Statements.

Note 2.  Securities

The amortized cost and fair values of securities available for sale as of March 31, 2021 and December 31, 2020 were as follows (dollars in thousands):

March 31, 2021			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	33,471	$	-	$	(910	)	$	32,561
Mortgage-backed securities/CMOs		72,795		443		(910	)		72,328
Municipal bonds		69,261		585		(1,647	)		68,199
Total Securities Available for Sale	$	175,527	$	1,028	$	(3,467	)	$	173,088

December 31, 2020			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	25,496	$	7	$	(198	)	$	25,305
Mortgage-backed securities/CMOs		77,438		844		(182	)		78,100
Municipal bonds		69,303		1,499		(121	)		70,681
Total Securities Available for Sale	$	172,237	$	2,350	$	(501	)	$	174,086

As of March 31, 2021, there were $130.7 million, or 80 issues of individual securities, held in an unrealized loss position.  These securities have an unrealized loss of $3.5 million and consisted of 29 mortgage-backed/collateralized mortgage obligations (“CMOs”), 34 municipal bonds, and 17 agency bonds.  

The following table summarizes all securities with unrealized losses, segregated by length of time in a continuous unrealized loss position, at March 31, 2021, and December 31, 2020 (dollars in thousands):

March 31, 2021
	Less than 12 Months					12 Months or more					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
U.S. Government agencies	$	30,561	$	(910	)	$	—	$	—		$	30,561	$	(910	)
Mortgage-backed/CMOs		52,510		(910	)		—		—			52,510		(910	)
Municipal bonds		46,852		(1,632	)		750		(15	)		47,602		(1,647	)
	$	129,923	$	(3,452	)	$	750	$	(15	)	$	130,673	$	(3,467	)

December 31, 2020
	Less than 12 Months					12 Months or more				Total
			Unrealized					Unrealized				Unrealized
	Fair Value		Losses			Fair Value		Losses		Fair Value		Losses
U.S. Government agencies	$	19,298	$	(198	)	$	—	$	—	$	19,298	$	(198	)
Mortgage-backed/CMOs		24,523		(182	)		—		—		24,523		(182	)
Municipal bonds		21,501		(121	)		—		—		21,501		(121	)
	$	65,322	$	(501	)	$	—	$	—	$	65,322	$	(501	)

The Company’s securities portfolio is primarily made up of fixed rate bonds, the prices of which move inversely with interest rates.  Any unrealized losses are considered by management to be driven by increases in market interest rates over the

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yields available at the time the underlying securities were purchased.  The fair value is expected to recover as the bonds approach their maturity date or repricing date or if market yields for such investments decline.  At the end of any accounting period, the portfolio may have both unrealized gains and losses.  Management does not believe any of the securities in an unrealized loss position are impaired due to credit quality.  Accordingly, as of March 31, 2021, management believes the impairments detailed in the table above are temporary, and no impairment loss has been realized in the Company’s consolidated income statement.

An “other-than-temporary impairment” (“OTTI”) is considered to exist if either of the following conditions are met: it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or the Company does not expect to recover the security’s entire amortized cost basis (even if the Company does not intend to sell).  In the event that a security would suffer impairment for a reason that was “other than temporary,” the Company would be expected to write down the security’s value to its new fair value, and the amount of the write down would be included in earnings as a realized loss.  As of March 31, 2021, management has concluded that none of its investment securities have an OTTI based upon the information available.  Additionally, management has the ability to hold any security with an unrealized loss until maturity or until such time as the value of the security has recovered from its unrealized loss position.

Securities having carrying values of $5.9 million at March 31, 2021 were pledged as collateral to secure public deposits and facilitate borrowing from the Federal Reserve Bank of Richmond (“FRB”).  At December 31, 2020, securities having carrying values of $6.0 million were similarly pledged.

For the three months ended March 31, 2021, there were no sales of securities. For the three months ended March 31, 2020, proceeds from the sales of securities amounted to $5.4 million, with realized gains of $53 thousand.    

Restricted securities are securities with limited marketability and consist of stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation, the holding company for Community Bankers Bank.  These restricted securities, totaling $2.7 million and $3.0 million as of March 31, 2021 and December 31, 2020, are carried at cost.

11

Note 3.  Loans

The composition of the loan portfolio by loan classification at March 31, 2021 and December 31, 2020 appears below (dollars in thousands).  

	March 31,			December 31,
	2021			2020
Commercial
Commercial and industrial - organic	$	26,753		$	27,238
Commercial and industrial - Paycheck Protection Program		68,254			54,176
Commercial and industrial - government guaranteed		29,027			30,920
Commercial and industrial - syndicated		6,354			6,354
Total commercial and industrial		130,388			118,688
Real estate construction and land
Residential construction		3,544			2,238
Commercial construction		17,109			14,302
Land and land development		5,601			5,969
Total construction and land		26,254			22,509
Real estate mortgages
1-4 family residential, first lien, investment		75,388			69,851
1-4 family residential, first lien, owner occupied		18,595			19,864
1-4 family residential, junior lien		1,768			2,938
1-4 family residential - purchased		16,097			18,534
Home equity lines of credit, first lien		9,299			8,715
Home equity lines of credit, junior lien		8,074			7,392
Farm		5,605			5,672
Multifamily		46,818			43,490
Commercial owner occupied		91,444			95,726
Commercial non-owner occupied		136,348			137,893
Total real estate mortgage		409,436			410,075
Consumer
Consumer revolving credit		16,992			17,624
Consumer all other credit		2,327			3,074
Student loans purchased		35,671			37,436
Total consumer		54,990			58,134
Total loans		621,068			609,406
Less:  Allowance for loan losses		(5,615	)		(5,455	)
Net loans	$	615,453		$	603,951

During the last three quarters of 2020, the Company assisted nonprofit organizations and local businesses by funding $86.9 million of Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans, which were designed to provide economic relief to small businesses adversely impacted by COVID-19.  During the three months ended March 31, 2021, the Company funded an additional $36.2 million in PPP loans.  

The balances in the table above include unamortized premiums and net deferred loan costs (fees). As of March 31, 2021 and December 31, 2020, unamortized premiums on loans purchased were $1.7 million and $1.8 million, respectively.  Net deferred loan costs (fees) totaled $(2.0) million and $(931) thousand as of March 31, 2021 and December 31, 2020, respectively.  The deferred fees increased $1.1 million due to the fees collected from the SBA for the additional PPP loans funded during the three months ended March 31, 2021. Net deferred fees on PPP loans are being amortized over the contractual life of the underlying loans, most of which are over a 60-month period.

Accounting guidance requires certain disclosures about investments in impaired loans, the allowance for loan losses and interest income recognized on impaired loans.  A loan is considered impaired when it is probable that the Company will be unable to collect all principal and interest amounts when due according to the contractual terms of the loan agreement.  

12

Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition of the borrower, and current economic conditions.

The following tables reflect the breakdown by class of the loans classified as impaired loans as of March 31, 2021 and December 31, 2020.  These loans are reported at their recorded investment, which is the carrying amount of the loan as reflected on the Company’s balance sheet, net of charge-offs and other amounts applied to reduce the net book balance.  Average recorded investment in impaired loans is computed using an average of month-end balances for these loans for either the three months ended March 31, 2021 or the twelve months ended December 31, 2020.  Interest income recognized is for the three months ended March 31, 2021 or the twelve months ended December 31, 2020 (dollars below reported in thousands).

March 31, 2021	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Land and land development	$	5	$	53	$	-	$	6	$	-
1-4 family residential mortgages, junior lien		106		105		-		107		1
Total impaired loans without a valuation allowance		111		158		-		113		1
Impaired loans with a valuation allowance
Student loans purchased		1,053		1,053		6		1,053		15
Total impaired loans with a valuation allowance		1,053		1,053		6		1,053		15
Total impaired loans	$	1,164	$	1,211	$	6	$	1,166	$	16

December 31, 2020	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Land and land development	$	8	$	55	$	-	$	97	$	-
1-4 family residential mortgages, junior lien		109		109		-		113		6
Commercial non-owner occupied real estate		-		-		-		781		48
Total impaired loans without a valuation allowance		117		164		-		991		54
Impaired loans with a valuation allowance
Student loans purchased		1,156		1,156		4		1,145		70
Total impaired loans with a valuation allowance		1,156		1,156		4		1,145		70
Total impaired loans	$	1,273	$	1,320	$	4	$	2,136	$	124

Included in the impaired loans above are non-accrual loans.  Generally, a loan is placed on non-accrual when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more.  Any unpaid interest previously accrued on those loans is reversed from income.  Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote.  Interest payments received on such loans are applied as a reduction of the loan principal balance.  Interest income on other non-accrual loans is recognized only to the extent of interest payments received.  The recorded investment in non-accrual loans is shown below by class (dollars in thousands):

	March 31, 2021		December 31, 2020
Land and land development	$	5	$	8
Total non-accrual loans	$	5	$	8

Additionally, troubled debt restructurings (“TDRs”) are considered impaired loans.  TDRs occur when the Company agrees to modify the original terms of a loan by granting a concession that it would not otherwise consider due to the deterioration in the financial condition of the borrower.  These concessions are done in an attempt to improve the paying capacity of the borrower, and in some cases to avoid foreclosure, and are made with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated.  These concessions could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance, or other actions.

13

In accordance with regulatory guidance, the Company has approved for certain customers who have been adversely affected by COVID-19 to defer principal-only, or principal and interest.  Such short-term modifications, which were 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.  While interest will continue to accrue to income, in accordance with GAAP, if the Company ultimately incurs a credit loss on these deferred payments, interest income would need to be reversed and therefore, interest income in future periods could be negatively impacted.  A total of $59.0 million in loan deferments have been approved since the beginning of the pandemic.  As of March 31, 2021, $57.5 million, or 97.4%, of the total loan deferments approved have returned to normal payment schedules and are now current.  

Based on regulatory guidance on student lending, the Company has classified 68 of its student loans purchased as TDRs for a total of $1.1 million as of March 31, 2021.  These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered TDRs.  Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance.  Initially, all student loans were fully insured by a surety bond, and the Company did not expect to experience a loss on these loans.  Based on the loss of insurance after July 27, 2018 due to the insolvency of the insurer, management has evaluated these loans individually for impairment and included any probable loss in the allowance for loan losses; interest continues to accrue on these TDRs during any deferment and forbearance periods.

The following provides a summary, by class, of TDRs that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing, and TDRs that have been placed in non-accrual status, which are considered to be nonperforming (dollars in thousands).

Troubled debt restructurings	March 31, 2021				December 31, 2020
	No. of		Recorded		No. of		Recorded
	Loans		Investment		Loans		Investment
Performing TDRs
1-4 family residential mortgages, junior lien		1	$	106		1	$	109
Student loans purchased		68		1,053		75		1,156
Total performing TDRs		69	$	1,159		76	$	1,265
Nonperforming TDRs
Land and land development		1	$	5		1	$	8
Total nonperforming TDRs		1	$	5		1	$	8
Total TDRs		70	$	1,164		77	$	1,273

A summary of loans shown above that were modified under the terms of a TDR during the three months ended March 31, 2021 and 2020 is shown below by class (dollars in thousands).  The Post-Modification Recorded Balance reflects the period end balances, inclusive of any interest capitalized to principal, partial principal paydowns, and principal charge-offs since the modification date.  Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

	For three months ended						For three months ended
	March 31, 2021						March 31, 2020
	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance
Student loans purchased		6	$	63	$	63		5	$	60	$	60
Total loans modified during the period		6	$	63	$	63		5	$	60	$	60

During the three months ended March 31, 2021, there was one loan modified as a TDR that subsequently defaulted which had been modified as a TDR during the twelve months prior to default.  This student loan had a balance of $19 thousand prior to being charged off. There were five loans modified as a TDR that subsequently defaulted during the year ended December 31, 2020 which had been modified as a TDR during the twelve months prior to default.  These student loans had balances totaling $48 thousand prior to being charged off.

14

There were no loans secured by 1-4 family residential property that were in the process of foreclosure at either March 31, 2021 or December 31, 2020.

Note 4.  Allowance for Loan Losses

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s quarterly evaluation of the collectability of the loan portfolio, credit concentrations, historical loss experience, specific impaired loans, and economic conditions. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and loans analyzed on a pooled basis. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows.  

For purposes of determining the allowance for loan losses, the Company has segmented certain loans in the portfolio by product type.  Within these segments, the Company has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes.  

Loan Classes by Segments
Commercial loan segment:
	Commercial and industrial - organic
	Commercial and industrial - Paycheck Protection Program
	Commercial and industrial - government guaranteed 1
	Commercial and industrial - syndicated
Real estate construction and land loan segment:
	Residential construction
	Commercial construction
	Land and land development
Real estate mortgage loan segment:
	1-4 family residential, first lien, investment
	1-4 family residential, first lien, owner occupied
	1-4 family residential, junior lien
	Home equity lines of credit, first lien
	Home equity lines of credit, junior lien
	Farm
	Multifamily
	Commercial owner occupied
	Commercial non-owner occupied
Consumer loan segment:
	Consumer revolving credit
	Consumer all other credit
	Student loans purchased

¹ Commercial and industrial – government guaranteed class excludes PPP loans

15

Management utilizes a loss migration model for determining the quantitative risk assigned to unimpaired loans in order to capture historical loss information at the loan level, track loss migration through risk grade deterioration, and increase efficiencies related to performing the calculations.  The quantitative risk factor for each loan class primarily utilizes a migration analysis loss method based on loss history for the prior twelve quarters.

The migration analysis loss method is used for all loan classes except for the following:

• Commercial and industrial PPP loans – These loans require no reserve as these are 100% guaranteed by the SBA.  

• Student loans purchased - On June 27, 2018, the Company was notified that ReliaMax Surety Company (“ReliaMax Surety”), the South Dakota insurance company which issued surety bonds for the student loan pools, was placed into liquidation due to insolvency.  As such, the historical charge-off rate on this portfolio is determined by using the Company’s own losses/charge-offs since July 1, 2018 together with prior insurance claim history. For reporting periods prior to June 30, 2018, the Company did not charge off student loans as the insurance covered the past due loans, but the Company did apply qualitative factors to calculate a reserve on these loans, net of the deposit reserve accounts held by the Company for this group of loans.

• Commercial and industrial government guaranteed loans - These purchased loans require no reserve as these are 100% guaranteed by either the SBA or the United States Department of Agriculture.

• Commercial and industrial syndicated loans - Beginning with the quarter ended September 30, 2016, migration analysis was utilized on the Pass pool. For all other pools, there was not an established loss history; therefore the S&P credit and recovery ratings on the credit facilities were utilized to calculate a three-year weighted average historical default rate. As of December 31, 2019, only migration analysis was utilized since all outstanding syndicated loans at that time were in the Pass pool.

Under the migration analysis method, average loss rates are calculated at the risk grade and class levels by dividing the twelve-quarter average net charge-off amount by the twelve-quarter average loan balances.  Qualitative factors are combined with these quantitative factors to arrive at the overall general allowances.

The Company’s internal creditworthiness grading system is based on experiences with similarly graded loans. The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. Additionally, external reviews of a portion of the credits are conducted annually.

Loans that trend upward on the risk ratings scale, toward more positive risk ratings, generally exhibit lower risk factor characteristics. Conversely, loans that migrate toward more negative ratings generally will result in a higher risk factor being applied to those related loan balances.

16

Risk Ratings and Historical Loss Factor Assigned

Excellent

A 0% historical loss factor is applied, as these loans are secured by cash or fully guaranteed by a U.S. government agency and represent a minimal risk.  The Company has never experienced a loss within this category.

Good

A 0% historical loss factor is applied, as these loans represent a low risk and are secured by marketable collateral within margin. In an abundance of caution, a nominal loss reserve is applied to these loans. The Company has never experienced a loss within this category.

Pass

A historical loss factor for loans rated “Pass” is applied to current balances of like-rated loans, pooled by class.  Loans with the following risk ratings are pooled by class and considered together as “Pass”:

Satisfactory – modest risk loans where the borrower has strong and liquid financial statements and more than adequate cash flow

Average – average risk loans where the borrower has reasonable debt service capacity

Marginal – acceptable risk loans where the borrower has acceptable financial statements but is leveraged

Watch

These loans have an acceptable risk but require more attention than normal servicing.  A historical loss factor for loans rated “Watch” is applied to current balances of like-rated loans pooled by class.

Special Mention

These potential problem loans are currently protected but are potentially weak.  A historical loss factor for loans rated “Special Mention” is applied to current balances of like-rated loans pooled by class.

Substandard

These problem loans are inadequately protected by the sound worth and paying capacity of the borrower and/or the value of any collateral pledged.  These loans may be considered impaired and evaluated on an individual basis.  Otherwise, a historical loss factor for loans rated “Substandard” is applied to current balances of all other “Substandard” loans pooled by class.

Doubtful

Loans with this rating have significant deterioration in the sound worth and paying capacity of the borrower and/or the value of any collateral pledged, making collection or liquidation of the loan in full highly questionable.  These loans would be considered impaired and evaluated on an individual basis.  

17

The following represents the loan portfolio designated by the internal risk ratings assigned to each credit as of March 31, 2021 and December 31, 2020 (dollars in thousands). There were no loans rated “Doubtful” as of either period.

March 31, 2021	Excellent		Good		Pass		Watch		Special Mention		Sub- standard		TOTAL
Commercial
Commercial and industrial - organic	$	1,688	$	12,556	$	12,371	$	44	$	-	$	94	$	26,753
Commercial and industrial - Paycheck Protection Program		68,254		-		-		-		-		-		68,254
Commercial and industrial - government guaranteed		29,027		-		-		-		-		-		29,027
Commercial and industrial - syndicated		-		-		6,354		-		-		-		6,354
Real estate construction
Residential construction		-		-		3,544		-		-		-		3,544
Commercial construction		-		-		17,109		-		-		-		17,109
Land and land development		-		-		5,411		-		-		190		5,601
Real estate mortgages
1-4 family residential, first lien investment		-		-		72,558		1,910		268		652		75,388
1-4 family residential, first lien, owner occupied		-		-		17,400		889		96		210		18,595
1-4 family residential, junior lien		-		-		1,651		-		11		106		1,768
1-4 family residential, first lien - purchased		-		-		16,097		-		-		-		16,097
Home equity lines of credit, first lien		-		-		9,237		62		-		-		9,299
Home equity lines of credit, junior lien		-		-		7,897		95		-		82		8,074
Farm		-		-		5,313		292		-		—		5,605
Multifamily		-		-		45,860		795		-		163		46,818
Commercial owner occupied		-		-		72,086		4,856		-		14,502		91,444
Commercial non-owner occupied		-		-		132,453		152		-		3,743		136,348
Consumer
Consumer revolving credit		323		16,372		297		-		-		-		16,992
Consumer all other credit		184		1,692		448		-		-		3		2,327
Student loans purchased		-		-		35,133		398		88		52		35,671
Total Loans	$	99,476	$	30,620	$	461,219	$	9,493	$	463	$	19,797	$	621,068

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December 31, 2020	Excellent		Good		Pass		Watch		Special Mention		Sub- standard		TOTAL
Commercial
Commercial and industrial - organic	$	1,918	$	14,336	$	9,772	$	485	$	-	$	727	$	27,238
Commercial and industrial - Paycheck Protection Program		54,176		-		-		-		-		-		54,176
Commercial and industrial - government guaranteed		30,920		-		-		-		-		-		30,920
Commercial and industrial - syndicated		-		-		6,354		-		-		-		6,354
Real estate construction
Residential construction		-		-		2,238		-		-		-		2,238
Commercial construction		-		-		14,302		-		-		-		14,302
Land and land development		-		-		5,765		-		-		204		5,969
Real estate mortgages
1-4 family residential, first lien, investment		-		-		66,336		2,149		704		662		69,851
1-4 family residential, first lien, owner occupied		-		-		18,010		1,002		640		212		19,864
1-4 family residential, junior lien		-		-		2,788		28		13		109		2,938
1-4 family residential, first lien - purchased		-		-		18,534		-		-		-		18,534
Home equity lines of credit, first lien		-		-		8,653		62		-		-		8,715
Home equity lines of credit, junior lien		-		-		7,214		96		-		82		7,392
Farm		-		-		5,375		297		-		-		5,672
Multifamily		-		-		42,525		801		-		164		43,490
Commercial owner occupied		-		-		82,629		4,898		-		8,199		95,726
Commercial non-owner occupied		-		-		136,509		155		-		1,229		137,893
Consumer										-
Consumer revolving credit		845		16,489		290		-		-		-		17,624
Consumer all other credit		167		2,440		464		-		-		3		3,074
Student loans purchased		-		-		35,819		1,373		64		180		37,436
Total Loans	$	88,026	$	33,265	$	463,577	$	11,346	$	1,421	$	11,771	$	609,406

In addition, the adequacy of the Company’s allowance for loan losses is evaluated through reference to eight qualitative factors, listed below and ranked in order of importance:

1) Changes in national and local economic conditions, including the condition of various market segments;

2) Changes in the value of underlying collateral;

3) Changes in volume of classified assets, measured as a percentage of capital;

4) Changes in volume of delinquent loans;

5) The existence and effect of any concentrations of credit and changes in the level of such concentrations;

6) Changes in lending policies and procedures, including underwriting standards;

7) Changes in the experience, ability and depth of lending management and staff; and

8) Changes in the level of policy exceptions.

It has been the Company’s experience that the first five factors drive losses to a much greater extent than the last three factors; therefore, the first five factors are weighted more heavily. Qualitative factors are not assessed against loans rated “Excellent” or “Good,” as the Company has never experienced a loss within these categories.

As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy.  No additional downgrades of such factors were taken during the quarters ended September 30, 2020, December 31, 2020 or March 31, 2021.  If economic conditions improve or worsen, the Company could experience changes in the required ALLL.  It is possible that asset quality metrics could decline in the future if the effects of COVID-19 are sustained.

19

For each segment and class of loans, management must exercise significant judgment to determine the estimation method that fits the credit risk characteristics of its various segments. Although this evaluation is inherently subjective, qualified management utilizes its significant knowledge and experience related to both the Company’s markets and the history of the Company’s loan losses.

Impaired loans are individually evaluated and, if deemed appropriate, a specific allocation is made for these loans. In reviewing the loans classified as impaired loans totaling $1.2 million at March 31, 2021, a specific valuation allowance was recognized after consideration was given for each borrowing as to the fair value of the collateral on the loan or the present value of expected future cash flows from the borrower.  The $6 thousand in the allowance total shown below as individually evaluated for impairment was attributed to the impaired student loans that required an allowance as of March 31, 2021 due to the loss of the insurance on this portfolio as discussed previously.

A summary of the transactions in the Allowance for Loan Losses by loan portfolio segment for the three months ended March 31, 2021 and the year ended December 31, 2020 appears below (dollars in thousands):

Allowance for Loan Losses Rollforward by Portfolio Segment
As of and for the period ended March 31, 2021
	Commercial Loans			Real Estate Construction and Land		Real Estate Mortgages		Consumer Loans			Total
Allowance for Loan Losses:
Balance as of beginning of year	$	209		$	160	$	3,897	$	1,189		$	5,455
Charge-offs		-			-		-		(241	)		(241	)
Recoveries		6			-		2		42			50
Provision for (recovery of) loan losses		(52	)		20		155		228			351
Ending Balance	$	163		$	180	$	4,054	$	1,218		$	5,615
Ending Balance:
Individually evaluated for impairment	$	-		$	-	$	-	$	6		$	6
Collectively evaluated for impairment		163			180		4,054		1,212			5,609
Loans:
Individually evaluated for impairment	$	-		$	5	$	106	$	1,053		$	1,164
Collectively evaluated for impairment		130,388			26,249		409,330		53,937			619,904
Ending Balance	$	130,388		$	26,254	$	409,436	$	54,990			621,068

As of and for the period ended December 31, 2020
	Commercial Loans			Real Estate Construction and Land		Real Estate Mortgages		Consumer Loans			Total
Allowance for Loan Losses:
Balance as of beginning of year	$	302		$	109	$	2,684	$	1,114		$	4,209
Charge-offs		-			-		-		(805	)		(805	)
Recoveries		28			-		1		400			429
Provision for (recovery of) loan losses		(121	)		51		1,212		480			1,622
Ending Balance	$	209		$	160	$	3,897	$	1,189		$	5,455
Ending Balance:
Individually evaluated for impairment	$	-		$	-	$	-	$	4		$	4
Collectively evaluated for impairment		209			160		3,897		1,185			5,451
Loans:
Individually evaluated for impairment	$	-		$	8	$	109	$	1,156		$	1,273
Collectively evaluated for impairment		118,688			22,501		409,966		56,978			608,133
Ending Balance	$	118,688		$	22,509	$	410,075	$	58,134		$	609,406

20

As previously mentioned, one of the major factors that the Company uses in evaluating the adequacy of its allowance for loan losses is changes in the volume of delinquent loans.  Management monitors payment activity on a regular basis.  For all classes of loans, the Company considers the entire balance of the loan to be contractually delinquent if the minimum payment is not received by the due date.  Interest and fees continue to accrue on past due loans until they are placed in nonaccrual or charged off.

The following tables show the aging of past due loans as of March 31, 2021 and December 31, 2020 (dollars below reported in thousands).

Past Due Aging as of March 31, 2021	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing
Commercial loans
Commercial and industrial - organic	$	-	$	-	$	-	$	-	$	26,753	$	26,753	$	-
Commercial and industrial - Paycheck Protection Program		-		-		-		-		68,254		68,254		-
Commercial and industrial - government guaranteed		1,347		-		382		1,729		27,298		29,027		382
Commercial and industrial - syndicated		-		-		-		-		6,354		6,354		-
Real estate construction and land
Residential construction		-		-		-		-		3,544		3,544		-
Commercial construction		-		-		-		-		17,109		17,109		-
Land and land development		10		-		-		10		5,591		5,601		-
Real estate mortgages
1-4 family residential, first lien, investment		-		-		-		-		75,388		75,388		-
1-4 family residential, first lien, owner occupied		-		-		-		-		18,595		18,595		-
1-4 family residential, junior lien		-		-		-		-		1,768		1,768		-
1-4 family residential - purchased		500		-		-		500		15,597		16,097		-
Home equity lines of credit, first lien		-		-		-		-		9,299		9,299		-
Home equity lines of credit, junior lien		-		-		-		-		8,074		8,074		-
Farm		-		-		-		-		5,605		5,605		-
Multifamily		-		-		-		-		46,818		46,818		-
Commercial owner occupied		-		-		-		-		91,444		91,444		-
Commercial non-owner occupied		-		-		-		-		136,348		136,348		-
Consumer loans
Consumer revolving credit		-		-		-		-		16,992		16,992		-
Consumer all other credit		-		1		-		1		2,326		2,327		-
Student loans purchased		268		88		17		373		35,298		35,671		17
Total Loans	$	2,125	$	89	$	399	$	2,613	$	618,455	$	621,068	$	399

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Past Due Aging as of December 31, 2020	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing
Commercial loans
Commercial and industrial - organic	$	-	$	-	$	-	$	-	$	27,238	$	27,238	$	-
Commercial and industrial - Paycheck Protection Program		-		-		-		-		54,176		54,176		-
Commercial and industrial - government guaranteed		1,130		470		-		1,600		29,320		30,920		-
Commercial and industrial - syndicated		-		-		-		-		6,354		6,354		-
Real estate construction and land
Residential construction		-		-		-		-		2,238		2,238		-
Commercial construction		-		-		-		-		14,302		14,302		-
Land and land development		-		-		-		-		5,969		5,969		-
Real estate mortgages
1-4 family residential, first lien, investment		-		-		-		-		69,851		69,851		-
1-4 family residential, first lien, owner occupied		-		-		-		-		19,864		19,864		-
1-4 family residential, junior lien		-		-		-		-		2,938		2,938		-
1-4 family residential - purchased		501		-		-		501		18,033		18,534		-
Home equity lines of credit, first lien		-		-		-		-		8,715		8,715		-
Home equity lines of credit, junior lien		-		-		-		-		7,392		7,392		-
Farm		-		-		-		-		5,672		5,672		-
Multifamily		-		-		-		-		43,490		43,490		-
Commercial owner occupied		-		-		-		-		95,726		95,726		-
Commercial non-owner occupied		46		-		-		46		137,847		137,893		-
Consumer loans
Consumer revolving credit		3		-		-		3		17,621		17,624		-
Consumer all other credit		39		1		-		40		3,034		3,074		-
Student loans purchased		256		65		137		458		36,978		37,436		137
Total Loans	$	1,975	$	536	$	137	$	2,648	$	606,758	$	609,406	$	137

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Note 5.  Net Income Per Share

The table below shows the weighted average number of shares used in computing net income per common share and the effect of the weighted average number of shares of potential dilutive common stock for the three months ended March 31, 2021 and 2020. Diluted net income per share is computed based on the weighted average number of shares of common stock equivalents outstanding, to the extent dilutive.  The Company’s common stock equivalents relate to outstanding common stock options. Unvested restricted stock as noted in the Consolidated Balance Sheets as of March 31, 2021 and March 31, 2020 is included in the calculation of basic and diluted net income per share (dollars below reported in thousands except per share data).

Three Months Ended	March 31, 2021						March 31, 2020
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic net income per share	$	1,505		2,719,840	$	0.55	$	1,404		2,692,803	$	0.52
Effect of dilutive stock options		-		7,608		-		-		1,287		-
Diluted net income per share	$	1,505		2,727,448	$	0.55	$	1,404		2,694,090	$	0.52

For the three months ended March 31, 2021, there were 78,301 option shares considered anti-dilutive and excluded from this calculation. For the three months ended March 31, 2020, there were 104,301 option shares considered anti-dilutive and excluded from this calculation.

Note 6.  Stock Incentive Plans

At the Annual Shareholders Meeting on May 21, 2014, shareholders approved the Virginia National Bankshares Corporation 2014 Stock Incentive Plan (“2014 Plan”). The 2014 Plan makes available up to 275,625 shares of the Company’s common stock, as adjusted by prior issued stock dividends, to be issued to plan participants. The 2014 Plan provides for granting of both incentive and nonqualified stock options, as well as restricted stock, unrestricted stock and other stock based awards.  No new grants will be issued under the 2005 Stock Incentive Plan (“2005 Plan”) as this plan has expired.

For the 2014 Plan and the 2005 Plan (the “Plans”), the option price of incentive stock options cannot be less than the fair value of the stock at the time an option is granted. Nonqualified stock options may be granted at prices established by the Board of Directors, including prices less than the fair value on the date of grant. Outstanding stock options generally expire ten years from the grant date. Stock options generally vest by the fourth or fifth anniversary of the date of the grant.

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A summary of the shares issued and available under each of the Plans is shown below as of March 31, 2021.  Share data and exercise price range per share have been adjusted to reflect prior issued stock dividends.  Although the 2005 Plan has expired and no new grants will be issued under this plan, there were options issued before the plan expired that are still outstanding as shown below.

	2005 Plan			2014 Plan
Aggregate shares issuable		253,575			275,625
Options issued, net of forfeited and expired options		(59,870	)		(146,506	)
Unrestricted stock issued		-			(11,535	)
Restricted stock grants issued		-			(39,770	)
Cancelled due to Plan expiration		(193,705	)		-
Remaining available for grant		-			77,814
Stock grants issued and outstanding:
Total vested and unvested shares		—			51,306
Fully vested shares		—			15,127
Option grants issued and outstanding:
Total vested and unvested shares		1,379			144,853
Fully vested shares		1,379			34,578
Exercise price range	$13.69 to $13.69			$23.75 to $42.62

The Company accounts for all of its stock incentive plans under recognition and measurement accounting principles which require that the compensation cost relating to stock-based payment transactions be recognized in the financial statements. Stock-based compensation arrangements include stock options and restricted stock. All stock-based payments to employees are required to be valued at a fair value on the date of grant and expensed based on that fair value over the applicable vesting period.

Stock Options

Changes in the stock options outstanding related to the Plans are summarized below (dollars in thousands except per share data):

	March 31, 2021
	Number of Options			Weighted Average Exercise Price		Aggregate Intrinsic Value
Outstanding at January 1, 2021		146,783		$	33.51	$	184
Issued		—			—
Exercised		(551	)		27.39
Expired		—			—
Outstanding at March 31, 2021		146,232		$	33.51	$	403
Options exercisable at March 31, 2021		35,957		$	38.05	$	49

For the three months ended March 31, 2021 and 2020, the Company recognized $34 thousand and $24 thousand, respectively, in compensation expense for stock options.  As of March 31, 2021, there was $361 thousand in unrecognized compensation expense remaining to be recognized in future reporting periods through 2025. The fair value of any stock option grant is estimated at the grant date using the Black-Scholes pricing model.  No stock option grants were issued during the three months ended March 31, 2021.  Stock option grants for 26,000 shares were issued during the three months ended March 31, 2020.

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The fair value of each option granted in the first three months of 2021 and 2020 was estimated based on the assumptions noted in the following table:

	For the three months ended
	March 31, 2021	March 31, 2020
Expected volatility1	N/A	22.97%
Expected dividends2	N/A	4.75%
Expected term (in years)3	N/A		6.50
Risk-free rate4	N/A	0.68%

1 Based on the monthly historical volatility of the Company’s stock price over the expected life of the options.

2 Calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant.

3 Based on the average of the contractual life and vesting period for the respective option.

4 Based upon an interpolated U.S. Treasury yield curve interest rate that corresponds to the contractual life of the option, in effect at the time of the grant.

Summary information pertaining to options outstanding at March 31, 2021 is shown below. Share and per share data have been adjusted to reflect the prior stock dividends issued.

	Options Outstanding					Options Exercisable
Exercise Price	Number of Options Outstanding		Weighted- Average Remaining Contractual Life	Weighted- Average Exercise Price		Number of Options Exercisable		Weighted- Average Exercise Price
$10.65 to $20.00		1,379	1.9 Years	$	13.69		1,379	$	13.69
$20.01 to $30.00		66,552	9.3 Years		24.66		5,752		26.13
$30.01 to $40.00		20,820	7.9 Years		38.14		5,844		38.54
$40.01 to $42.62		57,481	7.1 Years		42.62		22,982		42.62
Total		146,232	8.2 Years	$	33.54		35,957	$	38.21

Stock Grants

Restricted stock grants – In February 2021, 13,503 restricted shares were granted to employee and non-employee directors, vesting over a four-year period.  In March 2020, 10,368 restricted shares were granted to non-employee directors, vesting over a four-year period. For the three months ended March 31, 2021, $61 thousand was expensed as a result of restricted stock grants.  As of March 31, 2021, there was $898 thousand in unrecognized compensation expense for restricted stock grants remaining to be recognized in future reporting periods through 2025. For the three months ended March 31, 2020, $15 thousand in expense was incurred.  

Changes in the restricted stock grants outstanding during the three months ended March 31, 2021 are summarized below (dollars in thousands except per share data):

	March 31, 2021
	Number of Shares			Weighted Average Grant Date Fair Value Per Share		Aggregate Intrinsic Value
Nonvested as of January 1, 2021		25,268		$	26.60	$	767
Issued		13,503			29.85	410
Vested		(2,592	)		26.00		(79	)
Nonvested at March 31, 2021		36,179		$	27.86	$	1,098

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Note 7.  Fair Value Measurements

Determination of Fair Value

The Company follows ASC 820, “Fair Value Measurements and Disclosures,” to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This codification clarifies that the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

Level 1 –	Valuation is based on quoted prices in active markets for identical assets and liabilities.
Level 2 –	Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.
Level 3 –	Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

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The following tables present the balances measured at fair value on a recurring basis as of March 31, 2021 and December 31, 2020 (dollars in thousands):

			Fair Value Measurements at March 31, 2021 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Government agencies	$	32,561	$	-	$	32,561	$	-
Mortgage-backed securities/CMOs		72,328		-		72,328		-
Municipal bonds		68,199		-		68,199		-
Total securities available for sale	$	173,088	$	-	$	173,088	$	-

			Fair Value Measurements at December 31, 2020 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Government agencies	$	25,305	$	-	$	25,305	$	-
Mortgage-backed securities/CMOs		78,100		-		78,100		-
Municipal bonds		70,681		-		70,681		-
Total securities available for sale	$	174,086	$	-	$	174,086	$	-

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write downs of individual assets. The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Other Real Estate Owned

Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses.  Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Consolidated Statements of Income. As of March 31, 2021 and December 31, 2020, the Company had no OREO property.

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either (a) the observable market price of the loan or the fair value of the collateral, or (b) using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the 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 outside of the Company using observable market data

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(Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.

Impaired loans that are measured based on expected future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest are not recorded at fair value, and are therefore excluded from fair value disclosure requirements.

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).

Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. The Company had impaired loans of $1.2 million as of March 31, 2021 and $1.3 million as of December 31, 2020. All impaired loans were measured based on expected future cash flows discounted at the loan’s effective interest rate, or fair value of collateral, as noted above.

ASC 825, “Financial Instruments,” requires disclosures about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The Company uses the exit price notion in calculating the fair values of financial instruments not measured at fair value on a recurring basis.  

The carrying values and estimated fair values of the Company's financial instruments as of March 31, 2021 and December 31, 2020 are as follows (dollars in thousands):

			Fair Value Measurements at March 31, 2021 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	94,496	$	94,496	$	-	$	-	$	94,496
Available for sale securities		173,088		-		173,088		-		173,088
Loans, net		615,453		-		-		610,410		610,410
Bank owned life insurance		16,956		-		16,956		-		16,956
Accrued interest receivable		2,691		-		695		1,996		2,691
Liabilities
Demand deposits and
interest-bearing transaction, money market, and savings accounts	$	703,316	$	-	$	703,316	$	-	$	703,316
Certificates of deposit and other time deposits		100,844		-		101,144		-		101,144
Borrowings		30,000		-		30,000		-		30,000
Accrued interest payable		150		-		150		-		150

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			Fair Value Measurements at December 31, 2020 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	34,695	$	34,695	$	-	$	-	$	34,695
Available for sale securities		174,086		-		174,086		-		174,086
Loans, net		603,951		-		-		602,859		602,859
Bank owned life insurance		16,849		-		16,849		-		16,849
Accrued interest receivable		2,904		-		729		2,175		2,904
Liabilities
Demand deposits and
interest-bearing transaction and money market accounts	$	631,662	$	-	$	631,662	$	-	$	631,662
Certificates of deposit and other time deposits		99,102		-		99,580		-		99,580
Borrowings		30,000		-		30,000		-		30,000
Accrued interest payable		159		-		159		-		159

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Consequently, the fair values of the Company’s financial instruments will fluctuate when interest rate levels change, and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk; however, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Note 8.  Other Comprehensive Income

A component of the Company’s other comprehensive income, in addition to net income from operations, is the recognition of the unrealized gains and losses on available for sale securities, net of income taxes.  Reclassifications of realized gains and losses on available for sale securities are reported in the income statement as “Gains on sales of securities” with the corresponding income tax effect reflected as a component of income tax expense.  There were no sales of securities in the first quarter of 2021.  Amounts reclassified out of accumulated other comprehensive income are presented below for the three months ended March 31, 2021 and 2020 (dollars in thousands)

	Three Months Ended
	March 31, 2021		March 31, 2020
Available for sale securities
Realized gains on sales of securities	$	—	$	53
Tax effect	---			(11	)
Realized gains, net of tax	$	—	$	42

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Note 9.  Segment Reporting

The Company has four reportable segments.  Each reportable segment is a strategic business unit that offers different products and services.  They are managed separately, because each segment appeals to different markets and, accordingly, require different technology and marketing strategies.  The accounting policies of the segments are the same as those described in the summary of significant accounting policies provided earlier in this report.  

The four reportable segments are:

• Bank - The commercial banking segment involves making loans and generating deposits from individuals, businesses and charitable organizations.  Loan fee income, service charges from deposit accounts, and other non-interest-related fees, such as fees for debit cards and ATM usage and fees for treasury management services, generate additional income for the Bank segment.

• Sturman Wealth Advisors – Sturman Wealth Advisors, formerly known as VNB Investment Services, offers wealth management and investment advisory services.  Revenue for this segment is generated primarily from investment advisory and financial planning fees, with a small and decreasing portion attributable to brokerage commissions.  

• VNB Trust & Estate Services – VNB Trust & Estate Services offers corporate trustee services, trust and estate administration, IRA administration and custody services.  Revenue for this segment is generated from administration, service and custody fees, as well as management fees that are derived from Assets Under Management and, prior to 2020, incentive income that was based on the investment returns generated on performance-based Assets Under Management.  Investment management services currently are offered through in-house and third-party managers.  In addition, royalty income, in the form of fixed and incentive fees, from the sale of Swift Run Capital Management, LLC in 2013 is reported as income of VNB Trust & Estate Services.  More information on royalty income and the related sale can be found under Summary of Significant Accounting Policies in Note 1 of the notes to consolidated financial statements, which is found in Item 8. Financial Statements and Supplementary Data, in the Company’s Form 10-K Report for December 31, 2019.

• Masonry Capital - Masonry Capital offers investment management services for separately managed accounts and a private investment fund employing a value-based, catalyst-driven investment strategy.  Revenue for this segment is generated from management fees that are derived from Assets Under Management and incentive income that is based on the investment returns generated on performance-based Assets Under Management.

A management fee for administrative and technology support services provided by the Bank is allocated to the other three lines of business.  For both the three months ended March 31, 2021 and 2020, management fees totaling $25 thousand were charged by the Bank and eliminated in consolidated totals.  

Segment information for the three months ended March 31, 2021 and 2020 is shown in the following tables (dollars in thousands). Note that asset information is not reported below, as the assets of Sturman Wealth Advisors and VNB Trust & Estate Services are reported at the Bank level; also, assets specifically allocated to the lines of business other than the Bank are insignificant and are no longer provided to the chief operating decision maker.  

Three months ended March 31, 2021	Bank		Sturman Wealth Advisors		VNB Trust & Estate Services			Masonry Capital			Consolidated
Net interest income	$	5,974	$	-	$	-		$	-		$	5,974
Provision for loan losses		351		-		-			-			351
Noninterest income		514		191		201			133			1,039
Noninterest expense		4,255		160		206			160			4,781
Income (loss) before income taxes		1,882		31		(5	)		(27	)		1,881
Provision for (benefit from) income taxes		376		7		(1	)		(6	)		376
Net income (loss)	$	1,506	$	24	$	(4	)	$	(21	)	$	1,505

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Three months ended March 31, 2020	Bank		Sturman Wealth Advisors		VNB Trust & Estate Services		Masonry Capital			Consolidated
Net interest income	$	5,375	$	-	$	-	$	-		$	5,375
Provision for loan losses		765		-		-		-			765
Noninterest income		1,135		178		258		98			1,669
Noninterest expense		3,963		174		238		168			4,543
Income (loss) before income taxes		1,782		4		20		(70	)		1,736
Provision for (benefit from) income taxes		342		1		4		(15	)		332
Net income (loss)	$	1,440	$	3	$	16	$	(55	)	$	1,404

Note 10.  Leases

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows.  Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease for a term similar to the length of the lease, including any probable renewal options available.  Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

Lease payments for short-term leases are recognized as lease expense on a straight-line basis over the lease term.  Payments for leases with terms longer than twelve months are included in the determination of the lease liability. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.

Each of the Company’s long-term lease agreements are classified as operating leases.  Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised.  The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

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

	March 31, 2021			March 31, 2020
Lease liability	$	3,392		$	3,430
Right-of-use asset	$	3,327		$	3,397
Weighted average remaining lease term	4.97 years			4.81 years
Weighted average discount rate		2.53	%		2.83	%

	Three Months Ended March 31,
Lease Expense	2021		2020
Operating lease expense	$	222	$	204
Short-term lease expense		29		28
Total lease expense	$	251	$	232
Cash paid for amounts included in lease liabilities	$	219	$	199

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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):

Undiscounted Cash Flow	March 31, 2021
Nine months ending December 31, 2021	$	658
Twelve months ending December 31, 2022		839
Twelve months ending December 31, 2023		753
Twelve months ending December 31, 2024		544
Twelve months ending December 31, 2025		430
Twelve months ending December 31, 2026		77
Thereafter		295
Total undiscounted cash flows	$	3,596
Less:  Discount		(204	)
Lease liability	$	3,392

Note 11.  Mergers and Acquisitions

On April 1, 2021, the Company completed the Merger with Fauquier, a bank holding company based in Warrenton, Virginia, in an all-stock transaction.  Fauquier shareholders received 0.675 shares of Company common stock for each share of Fauquier common stock they own, resulting in the Company issuing 2,571,213 shares of common stock at a fair value of $78.0 million. As a result of the transaction and on the same date, Fauquier’s former bank subsidiary, The Fauquier Bank, merged with and into the Company’s wholly-owned bank subsidiary, Virginia National Bank. The Company’s balance sheet and results of operations as of and for the period ended March 31, 2021 do not include the impact of Fauquier’s financial position and results of operations for the first quarter of 2021.  

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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the unaudited consolidated financial statements, and notes thereto, of Virginia National Bankshares Corporation (the “Company”) included in this report and the audited consolidated financial statements, and notes thereto, of the Company included in the Company’s Form 10-K for the year ended December 31, 2020. Operating results for the three months ended March 31, 2021 are not necessarily indicative of the results for the year ending December 31, 2021 or any future period.

FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS

Certain statements contained or incorporated by reference in this quarterly report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, statements with respect to the Company’s operations, performance, future strategy and goals, and are often characterized by use of qualified words such as “expect,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “will,” “should,” or words of similar meaning or other statements concerning the opinions or judgement of the Company and its management about future events. While Company management believes such statements to be reasonable, future events and predictions are subject to circumstances that are not within the control of the Company and its management.  Actual results may differ materially from those included in the forward-looking statements due to a number of factors, including, without limitation, the effects of and changes in: general economic and market conditions, including the effects of declines in real estate values, an increase in unemployment levels and general economic contraction as a result of COVID-19 or other pandemics; fluctuations in interest rates, deposits, loan demand, and asset quality; assumptions that underlie the Company’s allowance for loan losses (“ALLL”); the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events (e.g., COVID-19 or other pandemics), and of governmental and societal responses thereto; the performance of vendors or other parties with which the Company does business; competition; technology; changes in laws, regulations and guidance; changes in accounting principles or guidelines; performance of assets under management;  expected revenue synergies and cost savings from the recently completed merger with Fauquier Bankshares, Inc. (“Fauquier”) may not be fully realized or realized within the expected timeframe; the businesses of the Company and Fauquier may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected; revenues following the merger may be lower than expected; customer and employee relationships and business operations may be disrupted by the merger; and other factors impacting financial services businesses.  Many of these factors and additional risks and uncertainties are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and other reports filed from time to time by the Company with the Securities and Exchange Commission (“SEC”). These statements speak only as of the date made, and the Company does not undertake to update any forward-looking statements to reflect changes or events that may occur after this release.

MERGER WITH FAUQUIER BANKSHARES, INC., AND THE FAUQUIER BANK

On April 1, 2021, the Company completed its merger with Fauquier. The merger of Fauquier with and into the Company (the “Merger”) was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of September 30, 2020, between the Company and Fauquier, and a related Plan of Merger (together, the “Merger Agreement”). Immediately after the Merger, The Fauquier Bank, Fauquier’s wholly-owned bank subsidiary, merged with and into Virginia National Bank (the “Bank”), the Company’s wholly-owned bank subsidiary.

Pursuant to the Merger Agreement, former holders of shares of Fauquier common stock received 0.675 shares of the Company’s common stock for each share of Fauquier common stock held immediately prior to the Merger, with cash paid in lieu of fractional shares. Each share of common stock of the Company outstanding immediately prior to the Merger remained outstanding and was unaffected by the Merger.

The Company’s balance sheet and results of operations as of and for the period ended March 31, 2021 do not include the impact of Fauquier’s financial position and results of operations for the first quarter of 2021.  At March 31, 2021, Fauquier had total assets of $911.3 million, net loans of $616.4 million and total deposits of $817.5 million.

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IMPACT OF COVID-19

The COVID-19 pandemic has caused, and will likely continue to cause, economic and social disruption, significantly affecting many industries, including many of our clients.  Significant uncertainty exists regarding the magnitude of the impact and duration of this pandemic.  Following are brief descriptions of areas within our Company that have been or may be impacted.  

Financial Condition and Results of Operations

The Company’s consolidated financial statements include estimates and assumptions made by management which affect the reported amounts of assets and liabilities, including the level of the ALLL that is established.  The ALLL calculation and resulting provision for loan losses are impacted by changes in economic conditions.  As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarter ended September 30, 2020, December 31, 2020 or March 31, 2021. If economic conditions improve or worsen, the Company could experience further changes in the required ALLL.  It is possible that asset quality metrics could decline in the future if the effects of COVID-19 are sustained.  

While most industries have been adversely impacted by COVID-19, the Company has exposures on its balance sheet as of March 31, 2021 in the following categories of loans that are considered to have higher risk of significant impact:

• Travel accommodations (hotels/motels/B&B) – $16.6 million, or 3.0% of loans

• Retail trade - $12.3 million, or 2.2% of loans

• Restaurants - $7.5 million, or 1.4% of loans

• Wholesale trade - $7.3 million, or 1.3% of loans

• Arts, entertainment and recreation - $6.5 million, or 1.2% of loans, and

• Caterers - $5.8 million, or 1.1% of loans

Note that the loan balances and percentages above do not include Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans made to entities within such categories.  

Interest income could be reduced due to the economic impact of COVID-19.  In accordance with guidance from regulators, we worked with borrowers who were adversely affected by COVID-19 to defer principal only, or principal and interest.  While interest will continue to accrue to income, in accordance with accounting principles generally accepted in the United States (“GAAP”), if the Company ultimately incurs a credit loss on these deferred payments, interest income would need to be reversed and therefore, interest income in future periods could be negatively affected.  Since the beginning of the pandemic, the Company has accommodated 193 deferrals on outstanding loan balances of $59.0 million (of which 131 deferrals on outstanding loan balances of $1.8 million were related to student loans).  As of March 31, 2021, $57.5 million in loan balances, or 97.4% of the total loan deferments approved, have returned to normal payment schedules and are now current, leaving a remaining balance of deferments of $1.5 million.  Of this remaining balance, $1.2 million, or 77.3%, are 100% government-guaranteed loans for which the deferrals were approved by the United States Department of Agriculture; and $349 thousand, or 22.7%, are student loans, which are private student loans not subject to potential federal forgiveness. In accordance with interagency guidance issued in March 2020, these short-term deferrals are not considered troubled debt restructurings (“TDRs”).

Primarily within the second quarter of 2020 and the first quarter of 2021, the Company devoted significant resources to accept PPP applications, a program designed to provide a direct incentive for small businesses to keep employees on their payroll.  In total, the Company has closed 924 loans representing $123.1 million in funding, with average origination fees of 3.9%, assisting many nonprofits and local businesses through this program.  As of March 31, 2021, 43% of the total dollars of PPP loans had been forgiven by the SBA, with $70.2 million outstanding. Loans funded through the PPP are fully guaranteed by the U.S. government.  The Company performed the required due diligence pursuant to the established SBA criteria; nonetheless, if a determination was made that certain loans did not meet the criteria established for the program, the Company may be required to establish additional ALLL through provision for loan loss expense which will negatively impact net income.

Throughout the onset of this pandemic, the Company has maintained its high standards of credit quality on organic loan funding to limit credit risk exposure.

Capital and Liquidity

As of March 31, 2021, capital ratios of the Company were in excess of regulatory requirements.  While currently included in the category of “well capitalized” by bank regulators, a prolonged economic recession could adversely impact reported and regulatory capital ratios.  

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The Company maintains access to multiple sources of liquidity.  Management has also revisited its capital and liquidity stress tests, as well as capital and liquidity contingency plans to validate how the Company can react effectively to the economic downturn caused by this pandemic and to gauge the amount of SBA PPP loans the Company could and should accept.

Goodwill

As of March 31, 2021, the goodwill on our balance sheet was not deemed to be impaired.  However, management may determine that goodwill is required to be evaluated for impairment in the future due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations.  

Operations, Processes, Controls and Business Continuity Plan

The Company reacted quickly to the COVID-19 pandemic.  We began internal social distancing in mid-March of 2020, as well as distancing from the public by keeping our drive-thru services available, and encouraging customers to conduct transactions at ATMs, through online banking and/or the mobile app.  The Company also increased consumer and business mobile deposit limits to encourage customers to make deposits remotely from the safety of their home or business. The Company implemented a schedule whereby most staff members are working remotely at any given time, allowing the remaining essential staff to create more distance between each other within the offices.  We temporarily increased the number of staff in the client service center to assist more customers by telephone and encourage them to utilize online and mobile banking.  The client service center was also temporarily moved to a larger location to allow for appropriate social distancing.  In addition, the Company enhanced disinfecting procedures to include hospital-grade cleaning solution and foggers, increased the frequency of cleaning and issued personal protective equipment, including N-95 and disposable face masks, face shields, sneeze guards, gloves and thermometers, to employees, along with specific instructions for use, to enhance their safety.  We also installed disinfecting protective strips to high touch areas and placed free-standing air filter machines throughout our facilities. We purchased COVID-19 instant test kits that we have on-site, ready to be deployed when needed, and we provided antibody testing options to all employees.  Management provides frequent email communications and social media updates regarding COVID-19, helpful tips and status of Company initiatives, as well as warning customers of potential scams during this pandemic.  Beginning mid-July of 2020, the Company took steps to resume normal branch activities with specific guidelines in place to continue protecting our customers and employees.

The Company’s preparedness resulted in minimal impact to the Company’s operations as a result of COVID-19.  Business continuity planning allowed for successful deployment of most of our employees to work in a remote environment.  No material operational or internal control risks have been identified to date, and the Company has enhanced fraud-related controls.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accounting and reporting policies followed by the Company conform, in all material respects, to GAAP and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s consolidated financial statements. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.

For additional information regarding critical accounting policies, refer to the Application of Critical Accounting Policies and Critical Accounting Estimates section under Item 7 in the Company’s 2020 Form 10-K.  There have been no significant changes in the Company’s application of critical accounting policies since December 31, 2020.

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FINANCIAL CONDITION

Total assets

The total assets of the Company as of March 31, 2021 were $918.4 million. This is a $70.0 million, or 8.2%, increase from the $848.4 million total assets reported at December 31, 2020 and a $201.3 million, or 28.1%, increase from the $717.1 million reported at March 31, 2020. The year-over-year increase was funded by a $169.0 million increase in deposits.

Federal funds sold

The Company had overnight federal funds sold of $77.1 million as of March 31, 2021, compared to $26.6 million as of December 31, 2020 and $12.3 million as of March 31, 2020. Any excess funds are sold on a daily basis in the federal funds market.  The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.

The Company continues to participate in the Excess Balance Account (“EBA”) of the Federal Reserve Bank of Richmond (“FRB”). The EBA is a limited-purpose account at the FRB for the maintenance of excess cash balances held by financial institutions. The EBA eliminates the potential of concentration risk that comes with depositing excess balances with one or multiple correspondent banks.

Securities

The Company’s investment securities portfolio as of March 31, 2021 totaled $175.7 million, a decrease of $1.4 million compared with the $177.1 million reported at December 31, 2020 and an increase of $71.9 million from the $103.8 million reported at March 31, 2020.  Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company.  At March 31, 2021 and December 31, 2020, the investment securities holdings represented 19.1% and 20.9% of the Company’s total assets, respectively.

The Company’s investment securities portfolio included restricted securities totaling $2.7 million as of March 31, 2021, compared to $3.0 million as of December 31, 2020 and $1.7 million as of March 31, 2020. These securities represent stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation, the holding company for Community Bankers Bank. The level of FRB and FHLB stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the FHLB, respectively. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Company with several benefits that are not available to non-shareholder correspondent banks. None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.

At March 31, 2021, the unrestricted securities portfolio totaled $173.1 million. The following table summarizes the Company's available for sale securities by type as of March 31, 2021, December 31, 2020, and March 31, 2020 (dollars in thousands):

	March 31, 2021					December 31, 2020					March 31, 2020
			Percent					Percent					Percent
	Balance		of Total			Balance		of Total			Balance		of Total
U.S. Government agencies	$	32,561		18.8	%	$	25,305		14.5	%	$	13,013		12.8	%
Mortgage-backed securities/CMOs		72,328		41.8	%		78,100		44.9	%		67,394		66.0	%
Municipal bonds		68,199		39.4	%		70,681		40.6	%		21,647		21.2	%
Total available for sale securities	$	173,088		100.0	%	$	174,086		100.0	%	$	102,054		100.0	%

The securities are held primarily for earnings, liquidity, and asset/liability management purposes and are reviewed quarterly for possible other-than-temporary impairments.  During this review, management analyzes the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to recovery or maturity.  These factors are analyzed for each individual security.

Loan portfolio

A management objective is to grow loan balances while maintaining the asset 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 borrowing relationship. The portfolio strategies include seeking industry, loan size, and loan type diversification to minimize credit exposure and originating loans in markets with

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which the Company is familiar. The predominant market area for the loans shown below includes Charlottesville, Albemarle County, Winchester, Frederick County, Richmond and areas in the Commonwealth of Virginia that are within a 75-mile radius of any office of the Company.

As of March 31, 2021, total loans were $621.1 million, compared to $609.4 million as of December 31, 2020 and $554.0 million at March 31, 2020. Loans as a percentage of total assets at March 31, 2021 were 67.6%, compared to 77.3% as of March 31, 2020. Loans as a percentage of deposits at March 31, 2021 were 77.2%, compared to 87.2% as of March 31, 2020.

The following table summarizes the Company's loan portfolio by type of loan as of March 31, 2021, December 31, 2020, and March 31, 2020 (dollars in thousands):

	March 31, 2021					December 31, 2020					March 31, 2020
	Balance		Percent of Total			Balance		Percent of Total			Balance		Percent of Total
Commercial and industrial	$	130,388		21.0	%	$	118,688		19.5	%	$	79,997		14.4	%
Real estate - commercial		280,215		45.1	%		282,781		46.4	%		259,277		46.8	%
Real estate - residential mortgage		129,221		20.8	%		127,294		20.9	%		121,601		22.0	%
Real estate - construction		26,254		4.2	%		22,509		3.7	%		25,105		4.5	%
Consumer loans		54,990		8.9	%		58,134		9.5	%		67,979		12.3	%
Total loans	$	621,068		100.0	%	$	609,406		100.0	%	$	553,959		100.0	%

Loan balances increased $11.7 million, or 1.9%, since December 31, 2020 and increased $67.1 million, or 12.1%, from March 31, 2020.  The increases are largely due to the origination of PPP loans of $86.9 million in 2020, as well as $36.2 million during the first quarter of 2021.  As of March 31, 2021, 43% of the total dollars of PPP loans had been forgiven by the SBA, with $70.2 million outstanding.

The purchase of loans is considered a secondary strategy, which allows the Company to supplement organic loan growth. Balances in purchased loans were $113.7 million as of March 31, 2020 and have declined $26.6 million compared to $87.1 million as of March 31, 2021 Balances outstanding in purchased loans as of March 31, 2021 were comprised of:

• Student loans totaling $35.7 million. The Company purchased two student loan packages in 2015, a third tranche in the fourth quarter of 2016, and a fourth tranche in the fourth quarter of 2017. Along with the purchase of these four packages of student loans, the Company purchased surety bonds to fully insure this portion of the Company’s consumer portfolio.  However, during June 2018, ReliaMax Surety, the insurance company which issued the surety bonds, was placed into liquidation due to insolvency.  Loss claims were filed for loans in default as of July 27, 2018, when the surety bonds were terminated, and the Company received payment in the fourth quarter of 2019 on the balance of the claims approved by the liquidator.  Also, in 2020 the Company realized a partial recovery of unearned insurance premiums related to the loss of insurance on the student loan portfolio in the amount of $401 thousand.  The Company expects to receive the balance of unearned premiums of approximately $400 thousand.  Student loans continue to be profitable for the Company.

• Loans guaranteed by a U.S. government agency (“government guaranteed”) totaling $29.0 million, inclusive of premium. During the fourth quarter of 2016, the Company began augmenting the commercial and industrial portfolio with government guaranteed loans which represent the portion of loans that are 100% guaranteed by either the United States Department of Agriculture or the SBA; the originating institution holds the unguaranteed portion of each loan and services it. These government guaranteed portions of loans are typically purchased at a premium. In the event of early prepayment, the Company may need to write off any unamortized premium.  

• Mortgage loans totaling $16.1 million, inclusive of premium.  In each of the fourth quarters of 2019 and 2018, the Company purchased a package of 1-to-4 family residential mortgages.  Each of the adjustable rate loans purchased were individually underwritten by the Company prior to the closing of the purchases.  The collateral on these loans is located primarily on the East Coast of the United States.  The balance in purchased mortgage loans declined $13.6 million, or 45.8%, from March 31, 2020 to March 31, 2021, due to significant payoffs during this low rate environment.  

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• Syndicated loans totaling $6.4 million. Syndicated loans represent shared national credits in leveraged lending transactions and are included in the commercial and industrial portfolio. The Company has developed policies to limit overall credit exposure to the syndicated market, as well as limits by industry and amount per borrower.  Management proactively manages shared national credits and has opportunistically increased or decreased exposure over time.

Management will continue to evaluate loan purchase transactions to strengthen earnings, diversify the loan portfolio and supplement organic loan growth.  

Loan quality

Non-accrual loans totaled $5 thousand at March 31, 2021, compared to the $8 thousand and $273 thousand reported at December 31, 2020 and March 31, 2020, respectively. The March 31, 2020 non-accrual balance included a loan which was foreclosed upon during the second quarter of 2020, with the Company being made whole on the loan with the proceeds from a third-party bidder without the Company’s taking title to the property.

The Company had loans in its portfolio totaling $399 thousand, $137 thousand and $733 thousand, as of March 31, 2021, December 31, 2020 and March 31, 2020, respectively, that were 90 or more days past due, with all such loans still accruing interest as the Company deemed them to be collectible.  The balance as of March 31, 2021 consists of one government-guaranteed loan in the amount $382 thousand and one student loan in the amount of $17 thousand.  

At March 31, 2021, the Company had loans classified as impaired loans in the amount of $1.2 million, a decline compared to $1.3 million at December 31, 2020 and $2.4 million at March 31, 2020.  Based on regulatory guidance on student lending, the Company has classified 68 of its purchased student loans as TDRs for a total of $1.1 million as of March 31, 2021.  These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered TDRs.  Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance.  Management has evaluated these loans individually for impairment and included any probable loss in the allowance for loan loss; interest continues to accrue on these TDRs during any deferment and forbearance periods.

Management identifies potential problem loans through its periodic loan review process and considers potential problem loans as those loans classified as special mention, substandard, or doubtful.

Allowance for loan losses

In general, the Company determines the adequacy of its ALLL by considering the risk classification and delinquency status of loans and other factors.  Management may also establish specific allowances for loans which management believes require allowances greater than those allocated according to their risk classification.  The purpose of the allowance is to provide for losses inherent in the loan portfolio.  Since risks to the loan portfolio include general economic trends as well as conditions affecting individual borrowers, the allowance is an estimate.  The Company is committed to determining, on an ongoing basis, the adequacy of its ALLL.  The Company applies historical loss rates to various pools of loans based on risk rating classifications.  In addition, the adequacy of the ALLL is further evaluated by applying estimates of loss that could be attributable to any one of the following eight qualitative factors:

1) Changes in national and local economic conditions, including the condition of various market segments;

2) Changes in the value of underlying collateral;

3) Changes in volume of classified assets, measured as a percentage of capital;

4) Changes in volume of delinquent loans;

5) The existence and effect of any concentrations of credit and changes in the level of such concentrations;

6) Changes in lending policies and procedures, including underwriting standards;

7) Changes in the experience, ability and depth of lending management and staff; and

8) Changes in the level of policy exceptions.

As discussed earlier, the Company utilizes a loss migration model.  Migration analysis uses loan level attributes to track the movement of loans through various risk classifications in order to estimate the percentage of losses likely in the portfolio. As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy.  No additional downgrades of such factors were taken during the quarter

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ended September 30, 2020, December 31, 2020 or March 31, 2021.  If economic conditions improve or worsen, the Company could experience changes in the required ALLL.  It is possible that asset quality metrics could decline in the future if the effects of COVID-19 are sustained.

The relationship of the ALLL to total loans appears below (dollars in thousands):

	March 31, 2021			December 31, 2020			March 31, 2020
Loans held for investment at period-end	$	621,068		$	609,406		$	553,959
Allowance for loan losses	$	5,615		$	5,455		$	4,704
Allowance as a percent of period-end loans		0.90	%		0.90	%		0.85	%

The ALLL as a percentage of loans was 0.90% as of March 31, 2021 and December 31, 2020, and 0.85% as of March 31, 2020.  The percentage increase as compared to a year ago was primarily due to the increase in the necessary allowance on most of the Company’s loans due to worsening economic qualitative factors, as well as impact of the increase in substandard loans, partially offset by the SBA-guaranteed PPP loans not requiring an allowance.  The ALLL as a percentage of loans, excluding PPP loans (a non-GAAP financial measure), would have been 1.02% as of March 31, 2021 and 0.98% as of December 31, 2020.  Refer to the Reconciliation of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP ALLL as a percentage of loans.  

Provisions for loan losses totaling $351 thousand and $765 thousand were recorded in the three months ended March 31, 2021 and 2020, respectively.  The following is a summary of the changes in the ALLL for the three months ended March 31, 2021 and 2020 (dollars in thousands):

	2021			2020
Allowance for loan losses, January 1	$	5,455		$	4,209
Charge-offs		(241	)		(388	)
Recoveries		50			118
Provision for loan losses		351			765
Allowance for loan losses, March 31	$	5,615		$	4,704

For additional insight into management’s approach and methodology in estimating the ALLL, please refer to the earlier discussion of “Allowance for Loan Losses” in Note 4 of the Notes to Consolidated Financial Statements.  In addition, Note 4 includes details regarding the rollforward of the allowance by loan portfolio segments. The rollforward tables indicate the activity for loans that are charged-off, amounts received from borrowers as recoveries of previously charged-off loan balances, and the allocation by loan portfolio segment of the provision made during the period. The events that can positively impact the amount of allowance in a given loan segment include any one or all of the following: the recovery of a previously charged-off loan balance; the decline in the amount of classified or delinquent loans in a loan segment from the previous period, which most commonly occurs when these loans are repaid or are foreclosed; or when there are improvements in the ratios used to estimate the probability of loan losses. Improvements to the ratios could include lower historical loss rates, improvements to any of the qualitative factors mentioned above, or reduced loss expectations for individually-classified loans.

Management reviews the ALLL on a quarterly basis to ensure it is adequate based upon the calculated probable losses inherent in the portfolio. Management believes the ALLL was adequately provided for as of March 31, 2021 and acknowledges that the ALLL may increase throughout the year as economic conditions may continue to deteriorate for the foreseeable future.   

Premises and equipment

The Company’s premises and equipment, net of depreciation, as of March 31, 2021 totaled $5.1 million compared to $5.2 million as of December 31, 2020 and $6.0 million as of March 31, 2020. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.

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As of March 31, 2021, the Company occupied five full-service banking facilities in the cities of Charlottesville and Winchester, as well as the county of Albemarle in Virginia. The Company also operates a drive-through location at 301 East Water Street, Charlottesville, Virginia. The Company entered into a lease for branch and office space in Richmond, Virginia during the first quarter of 2020 and anticipates opening the office during the second quarter of 2021, absent delays as a result of COVID-19.

The five-story office building at 404 People Place, Charlottesville, Virginia, located in Albemarle County, also serves as the Company’s corporate headquarters, operations center, and offices of both Masonry Capital and Sturman Wealth Advisors.  VNB Trust & Estate Services is located at 112 Third Street, SE, Charlottesville, Virginia, which is part of the same leased space that the Company uses to operate the drive-through location at 301 East Water Street, Charlottesville, Virginia.  

Both the Arlington Boulevard facility in Charlottesville and the People Place facility also contain office space that is currently under lease to tenants.

Leases

As of March 31, 2021, $3.3 million of right-of-use assets and $3.4 million of lease liabilities are included in Other Assets and Other Liabilities, respectively, in accordance with Accounting Standards Update 2016-02 “Leases” (Topic 842).  As of March 31, 2020, $3.4 million of right-of-use assets and lease liabilities were included in Other Assets and Other Liabilities.  Right-of-use assets are assets that represent the Company’s right to use, or control the use of, a specified asset for the lease term, offset by the lease liability, which is the Company’s obligation to make lease payments arising from a lease, measured on a discounted basis.  

Deposits

Deposit accounts represent the Company’s primary source of funds and are comprised of demand deposits, interest-bearing checking, money market, and savings accounts as well as time deposits. These deposits have been provided predominantly by individuals, businesses and charitable organizations in the Charlottesville/Albemarle County, Richmond and Winchester areas.

Total deposits as of March 31, 2021 were $804.2 million, an increase of $73.4 million compared to the balances of $730.8 million at December 31, 2020, and an increase of $169.1 million compared to the $635.1 million total as of March 31, 2020.  The primary reason for the increase since year-end is due to increased balances in PPP customer accounts.  

Deposit accounts
(dollars in thousands)	March 31, 2021					December 31, 2020					March 31, 2020
	Balance		% of Total Deposits			Balance		% of Total Deposits			Balance		% of Total Deposits
No cost and low cost deposits:
Noninterest demand deposits	$	248,212		30.9	%	$	209,772		28.71	%	$	190,618		30.0	%
Interest checking accounts		162,218		20.2	%		148,910		20.37	%		124,350		19.6	%
Money market and savings deposit accounts		292,886		36.4	%		272,980		37.36	%		218,432		34.4	%
Total noninterest and low cost deposit accounts		703,316		87.5	%		631,662		86.4	%		533,400		84.0	%
Time deposit accounts:
Certificates of deposit		92,352		11.4	%		90,615		12.4	%		89,681		14.1	%
CDARS deposits		8,492		1.1	%		8,487		1.2	%		12,055		1.9	%
Total certificates of deposit and other time deposits		100,844		12.5	%		99,102		13.6	%		101,736		16.0	%
Total deposit account balances	$	804,160		100.0	%	$	730,764		100.0	%	$	635,136		100.0	%

Noninterest-bearing demand deposits on March 31, 2021 were $248.2 million, representing 30.9% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $455.1 million, and represented 56.6% of total deposits at March 31, 2021. Collectively, noninterest-bearing and interest-bearing transaction and money market accounts

40

represented 87.5% of total deposit accounts at March 31, 2021. These account types are an excellent source of low-cost funding for the Company.

The Company also offers insured cash sweep (“ICS^®”) deposit products.  ICS^® deposit balances of $40.6 million and $88.0 million are included in the interest checking accounts and the money market and savings deposit accounts balances, respectively, in the table above, as of March 31, 2021.  As of December 31, 2020, ICS^® deposit balances of $28.0 million and $81.1 million are included in the interest checking accounts and the money market and savings deposit account balances, respectively.  All ICS accounts consist of reciprocal balances for the Company’s customers.

The remaining 12.5% and 13.6% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $100.8 million and $99.1 million at March 31, 2021 and December 31, 2020, respectively. Included in these deposit totals are Certificate of Deposit Account Registry Service CDs, known as CDARS^TM, whereby depositors can obtain Federal Deposit Insurance Corporation (“FDIC”) deposit insurance on account balances of up to $50 million. CDARS^TM deposits totaled $8.5 million as of March 31, 2021 and December 31, 2020, all of which were reciprocal balances for the Company’s customers.

Borrowings

Short-term borrowings, consisting primarily of FHLB advances and federal funds purchased, are additional sources of funds for the Company. The level of these borrowings is determined by various factors, including customer demand and the Company's ability to earn a favorable spread on the funds obtained.

The Company has a collateral dependent line of credit with the FHLB. As of March 31, 2021 and December 31, 2020, the Company had $30.0 million in outstanding balances from FHLB advances.  As of March 31, 2020, the Company had no outstanding balances from FHLB advances.  

Additional borrowing arrangements maintained by the Company include formal federal funds lines with four major regional correspondent banks and the Federal Reserve discount window. The Company had no outstanding balances on these lines or facilities as of March 31, 2021, December 31, 2020 or March 31, 2020.

Shareholders' equity and regulatory capital ratios

The following table displays the changes in shareholders' equity for the Company from December 31, 2019 to March 31, 2021 (dollars in thousands):

Equity, December 31, 2020	$	82,598
Net income		1,505
Other comprehensive loss		(3,387	)
Cash dividends declared		(814	)
Equity increase due to exercise of stock options		15
Equity increase due to expensing of stock options		34
Equity increase due to expensing of restricted stock		61
Equity, March 31, 2021	$	80,012

The Basel III capital rules require banks and bank holding companies to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%); (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

The Company’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 14.49%, 14.49%, 15.49% and 9.02%, respectively, as of March 31, 2021, thus exceeding the minimum requirements. The Bank’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 14.35%, 14.35%, 15.35% and 8.94%, respectively, as of March 31, 2021, also exceeding the minimum requirements.

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As of March 31, 2021, the Bank exceeded all of the following minimum capital ratios in order to be considered “well capitalized” under the “prompt corrective action” regulations, as revised: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.

RESULTS OF OPERATIONS

Non-GAAP presentations

The Company, in referring to its net income and net interest income, is referring to income computed in accordance with GAAP, unless otherwise noted.  Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations also refer to various calculations that are non-GAAP presentations.  They include:

• Fully taxable-equivalent (“FTE”) adjustments – Net interest margin and efficiency ratios are presented on an FTE basis, consistent with SEC guidance in Industry Guide 3 which states that tax exempt income may be calculated on a tax equivalent basis.  This is a non-GAAP presentation. The FTE basis adjusts for the tax-exempt status of net interest income from certain investments using a federal tax rate of 21%, where applicable, to increase tax-exempt interest income to a taxable-equivalent basis.

• Net interest margin – Net interest margin (FTE) is calculated as net interest income, computed on an FTE basis, expressed as a percentage of average earning assets.  The Company believes this measure to be the preferred industry measurement of net interest margin and that it enhances comparability of net interest margin among peers in the industry.

• Efficiency ratio – One of the ratios the Company monitors in its evaluation of operations is the efficiency ratio, which measures the cost to produce one dollar of revenue.  The Company computes its efficiency ratio (FTE) by dividing noninterest expense by the sum of net interest income (FTE) and noninterest income.  A lower ratio is an indicator of increased operational efficiency. This non-GAAP metric is used to assist investors in understanding how management assesses its ability to generate revenues from its non-funding-related expense base, as well as to align presentation of this financial measure with peers in the industry.  The Company believes this measure to be the preferred industry measurement of operational efficiency, which is consistent with FDIC studies.

• Performance measures exclude nonrecurring merger expenses, which were incurred in connection with due diligence, legal and other professional fees associated with the proposed merger with Fauquier.  Management believes that the exclusion of the significant one-time effect of merger expenses provides users of the Company’s financial information a presentation of the Company’s financial results that is representative of its ongoing operations.  In this non-GAAP presentation, the merger expenses incurred is added to the Company’s net income.  

• The allowance for loan losses as a percentage of loans, excluding PPP loans, measure eliminates the impact of PPP loans.  Management believes that the elimination of the impact of PPP loans provides users of the Company’s financial information a presentation of the Company’s allowance for loan loss percentage that is representative of its ongoing operations.

• Tangible book value per share excludes the impact of the balances of goodwill and other intangibles.  Tangible book value per share is often regarded as a more meaningful comparative ratio than book value per share as calculated under GAAP, to evaluate use of equity, financial condition and capital strength.  

Management uses these non-GAAP measures to evaluate the Company’s operating performance on a basis comparable to other financial periods.  Net income is discussed in Management’s Discussion and Analysis on a GAAP basis unless noted as “non-GAAP.”

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The reconcilement below shows how these non-GAAP measures are computed from their respective GAAP measures (dollars in thousands):

Reconcilement of Non-GAAP Measures:	Three Months Ended
	March 31, 2021			March 31, 2020
Fully tax-equivalent measures
Net interest income	$	5,974		$	5,375
Fully tax-equivalent adjustment		47			20
Net interest income (FTE)	$	6,021		$	5,395
Efficiency ratio		68.2	%		64.5	%
Fully tax-equivalent adjustment		-0.5	%		-0.2	%
Efficiency ratio (FTE)		67.7	%		64.3	%
Net interest margin		2.81	%		3.18	%
Fully tax-equivalent adjustment		0.02	%		0.02	%
Net interest margin (FTE)		2.83	%		3.20	%
Performance measures
Return on average assets		0.68	%		0.78	%
Impact of merger expenses		0.03	%		—
Operating return on average assets (non-GAAP)		0.71	%		0.78	%
Return on average equity		7.40	%		7.28	%
Impact of merger expenses		0.34	%		—
Operating return on average equity (non-GAAP)		7.74	%		7.28	%
Other financial measures
ALLL to total loans		0.90	%		0.85	%
Impact of PPP loans		0.12	%		—
ALLL to total loans, excluding PPP loans (non-GAAP)		1.02	%		0.85	%
Book value per share	$	29.33		$	28.23
Impact of intangibles		(0.26	)		(0.28	)
Tangible book value per share (non-GAAP)	$	29.07		$	27.95

Net income

Net income for the three months ended March 31, 2021 was $1.5 million, a $101 thousand or 7.2% increase compared to net income reported for the three months ended March 31, 2020.  Net income per diluted share was $0.55 for the quarter ended March 31, 2021 compared to $0.52 per diluted share for the same quarter in the prior year.  The increase in net income for the three months ended March 31, 2021, when compared to the same period of 2020, was attributable to the combination of: i) a $599 thousand increase in net interest income, primarily due to lower cost of funds; ii) a $414 thousand decrease in provision for loan losses, largely due to a larger provision taken in the first quarter of the prior year driven by deterioration in the economic outlook resulting from the initial onset of COVID-19, iii) a $630 thousand decrease in noninterest income, as explained in the Noninterest income section below; iv) a $238 thousand increase in noninterest expense, as explained in the Noninterest expense section below, and v) a $44 thousand increase in provision for income taxes.  

Net interest income

Net interest income (FTE) for the three months ended March 31, 2021 was $6.0 million, a $626 thousand or 11.6% increase compared to net interest income (FTE) of $5.4 million for the three months ended March 31, 2020.  Net interest income (FTE) was positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by

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$631 thousand, offset by the increased volume of deposits, which increased interest expense by $99 thousand. The increased volume of loans, increasing from an average of $535.8 million in the first quarter of 2020 to $618.9 million in the first quarter of 2021, positively impacted interest income by $847 thousand; however, the lower rate earned on loans, declining from 4.41% to 3.89% for the periods noted, negatively impacted interest income by $780 thousand, nearly offsetting the positive impact of the increase in volume.  The increase in volume of securities held, increasing from an average balance of $114.2 million for the first quarter of 2020 to $176.1 million for the first quarter of 2021, positively impacted net interest income by $325 thousand, while the decline in yield earned on such securities decreased from 2.20% to 1.74% for the periods noted, negatively impacted net interest income by $189 thousand.

Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets for the period. The level of interest rates, together with the volume and mix of earning assets and interest-bearing liabilities, impact net interest income (FTE) and net interest margin (FTE). The net interest margin (FTE) of 2.83% for the three months ended March 31, 2021 was 37 basis points lower than the 3.20% for the three months ended March 31, 2020.  Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP net interest margin.

Interest expense decreased $496 thousand for the three months ended March 31, 2021 compared to the same period in the prior year, due predominantly to rate decreases.  The rate paid on interest-bearing deposits averaged 50 basis points in the three months ended March 31, 2021, compared to 104 basis points for the three months ended March 31, 2020. Average balances of interest-bearing deposits increased from $460.6 million in the three months ended March 31, 2020 to $530.8 million in the three months ended March 31, 2021.  Average balances of borrowed funds, from FHLB advances, increased from zero in the three months ended March 31, 2020 to $30.0 million in the three months ended March 31, 2021, causing an increase in interest expense on borrowed funds of $36 thousand.  

The following table details the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest-bearing liabilities, for the three months ended March 31, 2021 and 2020.  This table also includes a rate/volume analysis for these same periods (dollars in thousands).

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Consolidated Average Balance Sheet and Analysis of Net Interest Income

	For the three months ended
	March 31, 2021								March 31, 2020								Change in Interest Income/ Expense
	Average			Interest		Average			Average			Interest		Average			Change Due to : 4						Total
	Balance			Income/		Yield/Cost			Balance			Income/		Yield/Cost			Volume			Rate			Increase/
(dollars in thousands)				Expense								Expense											(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities	$	142,837		$	541		1.52	%	$	102,786		$	533		2.07	%	$	175		$	(167	)	$	8
Tax Exempt Securities 1		33,234			223		2.68	%		11,425			95		3.33	%		150			(22	)		128
Total Securities 1		176,071			764		1.74	%		114,211			628		2.20	%		325			(189	)		136
Total Loans		618,902			5,938		3.89	%		535,832			5,871		4.41	%		847			(780	)		67
Fed Funds Sold		67,400			12		0.07	%		28,898			85		1.18	%		51			(124	)		(73	)
Total Earning Assets		862,373			6,714		3.16	%		678,941			6,584		3.90	%		1,223			(1,093	)		130
Less: Allowance for Loan Losses		(5,476	)							(4,081	)
Total Non-Earning Assets		45,619								45,520
Total Assets	$	902,516							$	720,380
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking	$	146,781		$	26		0.07	%	$	122,719		$	31		0.10	%		5		$	(10	)	$	(5	)
Money Market and Savings Deposits		284,333			351		0.50	%		228,891			664		1.17	%		133			(446	)		(313	)
Time Deposits		99,692			280		1.14	%		108,941			494		1.82	%		(39	)		(175	)		(214	)
Total Interest-Bearing Deposits		530,806			657		0.50	%		460,551			1,189		1.04	%		99			(631	)		(532	)
Other borrowed funds		30,000			36		0.49	%		—			—		—			18			18			36
Total Interest-Bearing Liabilities		560,806			693		0.50	%		460,551			1,189		1.04	%		117			(613	)		(496	)
Non-Interest-Bearing Liabilities:
Demand deposits		255,227								177,878
Other liabilities		3,948								4,405
Total Liabilities		819,981								642,834
Shareholders' Equity		82,535								77,546
Total Liabilities & Shareholders' Equity	$	902,516							$	720,380
Net Interest Income (FTE)				$	6,021							$	5,395				$	1,106		$	(480	)	$	626
Interest Rate Spread 2							2.66	%							2.86	%
Interest Expense as a Percentage of Average Earning Assets							0.33	%							0.70	%
Net Interest Margin (FTE) 3							2.83	%							3.20	%

(1) Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations earlier in this section.

(2) Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.

(3) Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.

(4) The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.

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Provision for loan losses

A provision for loan losses of $351 thousand was recognized during the three months ended March 31, 2021 compared to a provision for loan losses of $765 thousand recognized during the three months ended March 31, 2020, primarily due to the deterioration in the economic outlook resulting from the impact of COVID-19.

The period-end ALLL as a percentage of assets was 0.90% as of March 31, 2021 and December 31, 2020 and 0.85% as of March 31, 2020.  The percentage increase as compared to the prior year was primarily due to the increase in the necessary allowance on most of the Company’s loans due to worsening economic qualitative factors later in 2020, which was partially offset by the SBA-guaranteed PPP loans not needing an allowance.  

Further discussion of management’s assessment of the ALLL is provided earlier in the report and in Note 4 – Allowance for Loan Losses, found in the Notes to the Consolidated Financial Statements.  In management’s opinion, the allowance was adequately provided for at March 31, 2021.  The ALLL calculation, provision for loan losses, asset quality and collateral values may be significantly impacted by deterioration in economic conditions.  We have downgraded the qualitative factors pertaining to economic conditions within our ALLL methodology; should economic conditions worsen, we could experience further increases in our required ALLL and record additional provision for loan loss exposure.

Noninterest income

The components of noninterest income for the three months ended March 31, 2021 and 2020 are shown below (dollars in thousands):

	For the three months ended				Variance
	March 31, 2021		March 31, 2020		$			%
Noninterest income:
Wealth management fees	$	329	$	310	$	19			6.1	%
Advisory and brokerage income		191		178		13			7.3	%
Royalty income		5		47		(42	)		-89.4	%
Deposit account fees		160		179		(19	)		-10.6	%
Debit/credit card and ATM fees		154		157		(3	)		-1.9	%
Earnings/increase in value of bank owned life insurance		107		107		0			0.0	%
Fees on mortgage sales		-		47		(47	)		-100.0	%
Gains on sales of securities		-		53		(53	)		-100.0	%
Loan swap fee income		15		509		(494	)		-97.1	%
Other		78		82		(4	)		-4.9	%
Total noninterest income	$	1,039	$	1,669	$	(630	)		-37.7	%

Noninterest income for the three months ended March 31, 2021 of $1.0 million was $630 thousand or 37.7% lower than the amount recorded for the three months ended March 31, 2020.  Noninterest income fell predominantly due to the decline in loan swap fee income of $494 thousand, as swap arrangements are less attractive to borrowers in the current interest rate environment.  Additionally, there were no sales of securities in the first quarter of 2021, compared to gains on sales of securities of $53 thousand for the first quarter of 2021, and there were no fees on mortgage sales earned in the first quarter of the current year due to elimination of the department.  

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Noninterest expense

The components of noninterest expense for the three months ended March 31, 2021 and 2020 are shown below (dollars in thousands):

	For the three months ended				Variance
	March 31, 2021		March 31, 2020		$			%
Noninterest expense:
Salaries and employee benefits	$	2,402	$	2,424	$	(22	)		-0.9	%
Net occupancy		495		452		43			9.5	%
Equipment		116		131		(15	)		-11.5	%
ATM, debit and credit card		42		54		(12	)		-22.2	%
Bank franchise tax		173		163		10			6.1	%
Computer software		167		140		27			19.3	%
Data processing		289		328		(39	)		-11.9	%
FDIC deposit insurance assessment		63		0		63		N/A
Loan expenses		63		91		(28	)		-30.8	%
Marketing, advertising and promotion		137		139		(2	)		-1.4	%
Merger expenses		278		-		278		N/A
Professional fees		177		186		(9	)		-4.8	%
Other		379		435		(56	)		-12.9	%
Total noninterest expense	$	4,781	$	4,543	$	238			5.2	%

Noninterest expense for the quarter ended March 31, 2021 of $4.8 million was $238 thousand or 5.2% higher than the quarter ended March 31, 2020.  The predominant reason for the increase was that the Company incurred $278 thousand in merger-related expenses during the three months ended March 31, 2021.  During the three months ended March 31, 2021, the Company expensed $63 thousand related to FDIC deposit insurance assessment, compared to zero in the first quarter of the prior year.  

The efficiency ratio (FTE) of 67.7% for the three months ended March 31, 2021 was elevated compared to the 64.3% for the same quarter of 2020, due primarily to the decrease in noninterest income. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.

Provision for Income Taxes

For the three months ended March 31, 2021 and 2020, the Company provided $376 thousand and $332 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 20.0% and 19.1%, respectively. The effective income tax rates differed from the U.S. statutory rate of 21% primarily due to the effect of tax-exempt income from life insurance policies and municipal bonds, and the effective rate for the three months ended March 31, 2021 was higher than the prior year, as certain merger related expenses are non-deductible for tax purposes.

OTHER SIGNIFICANT EVENTS

None

ITEM 3.  QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required

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ITEM 4.  CONTROLS AND PROCEDURES

The Company maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective at the reasonable assurance level. There was no change in the internal control over financial reporting that occurred during the quarter ended March 31, 2021 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

PART II.  OTHER INFORMATION

ITEM 1.  LEGAL PROCEEDINGS.

None

ITEM 1A.  RISK FACTORS.

There have been no material changes from the risk factors described in the Company’s Form 10-K for the year ended December 31, 2020.  The risks described may not be the only risks facing us.  Additional risks and uncertainties not currently known to us or that are currently considered to not be material also may materially adversely affect our business, financial condition and/or operating results.  

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

None

ITEM 3.  DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4.  MINE SAFETY DISCLOSURES.

Not applicable

ITEM 5.  OTHER INFORMATION.

(a) Required 8-K disclosures.

None

(b) Changes in procedures for director nominations by security holders.

None

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ITEM 6.  EXHIBITS.

Exhibit Number	Description of Exhibit
31.1	302 Certification of Principal Executive Officer
31.2	302 Certification of Principal Financial Officer
32.1	906 Certification
101	The following financial statements from the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in Inline eXtensible Business Reporting Language, pursuant to Rule 405 of Regulation S-T (1): (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) (unaudited), (iv) Consolidated Statements of Stockholders' Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited), tagged as blocks of text and including detailed tags
104	The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2021, formatted in Inline eXtensible Business Reporting Language (included with Exhibit 101.0)

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SIGNATURES

Pursuant to 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.

VIRGINIA NATIONAL BANKSHARES CORPORATION
(Registrant)
By:	/s/ Glenn W. Rust
	Glenn W. Rust
	President and Chief Executive Officer (principal executive officer)
Date:	May 10, 2021
By:	/s/ Tara Y. Harrison
	Tara Y. Harrison
	Executive Vice President and Chief Financial Officer
	(principal financial and accounting officer)
Date:	May 10, 2021

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