What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-05-10 compared with 2020-11-06 · 176 added, 279 removed, 299 unchanged (60% of the section changed)

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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 and nine months ended September 30, 2020 are not necessarily indicative of the results for the year ending December 31, 2020 or any future period.

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, including but not limited to, statements concerning future results of operations or financial position, borrowing capacity and future liquidity, future investment results, future credit exposure, future loan losses and plans and objectives for future operations, change in laws and regulations applicable to the Company and its subsidiaries, adequacy of funding sources, actuarial expected benefit payment, valuation of foreclosed assets, regulatory requirements, economic environment and other statements contained herein regarding matters that are not historical facts, are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995.

Such statements 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.

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.

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the performance of vendors or other parties with which the Company does business;

laws, regulations and guidance;

accounting principles or guidelines;

changes in laws, regulations and guidance;

changes in accounting principles or guidelines;

performance of assets under management;

expenses related to the Company’s proposed merger with Fauquier Bankshares, Inc.

(“Fauquier”), unexpected delays related to the merger, or the inability to obtain regulatory and shareholder approvals or satisfy other closing conditions required to complete the merger;

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 Form 10-K for the year ended December 31, 2019 (the “Company’s 2019 Form 10-K”) and other reports filed from time to time by the Company with the Securities and Exchange Commission (“SEC”).

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 October 1, 2020, the Company announced the signing of a definitive merger agreement with Fauquier , pursuant to which the companies will combine in an all-stock merger with the Company as the surviving company.

At or immediately following consummation of the merger, The Fauquier Bank, the wholly owned banking subsidiary of Fauquier, will be merged with and into the Virginia National Bank (the “Bank”), with the Bank as the surviving bank.

Under the terms of the merger agreement, Fauquier shareholders will receive 0.675 shares of Company stock for each share of Fauquier common stock they own.

Shareholders of the Company will own approximately 51.4% and Fauquier shareholders will own approximately 48.6% of the combined company.

The combined company will operate under the Virginia National Bankshares name and the combined bank will operate under the Virginia National Bank name.

Additional information on the merger can be found in the Company’s 8-Ks filed with the SEC on October 1, 2020 and October 2, 2020.

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.

IMPACT OF COVID-19

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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.

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 September 30, 2020 in the following categories of loans that are considered to have higher risk of significant impact:

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

Hotels and motels - $13.7 million, or 2.5% 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

Caterers - $5.3 million, or 1.0% of loans, and

Full-service restaurants - $2.2 million, or 0.4% 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 are working with borrowers who have been adversely affected by COVID-19 to defer principal only, or principal and interest payments for a 90- to 180-day period.

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, 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.

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.

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Capital and Liquidity

As of September 30, 2020, capital ratios of the Company were in excess of regulatory requirements.

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.

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.

As of September 30, 2020, the goodwill on our balance sheet was not deemed to be impaired.

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.

O perations, Processes, Controls and Business Continuity Plan

Operations, Processes, Controls and Business Continuity Plan

The Company reacted quickly to the COVID-19 pandemic.

We began internal social distancing in mid-March, 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 the mobile app.

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.

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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, the Company took steps to resume normal branch activities with specific guidelines in place to continue protecting our customers and employees.

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.

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FINANCIAL CONDITION

The total assets of the Company as of September 30, 2020 were $821.0 million.

This is a $118.4 million increase from the $702.6 million total assets reported at December 31, 2019 and a $160.2 million increase from the $660.8 million reported at September 30, 2019.

A $97.4 million increase in gross loans, primarily from the origination of $86.9 million in PPP loans, was the major reason for the increase in assets since year-end.

In addition, the Company increased the balances in its securities portfolio by $29.0 million since year-end.

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 $273 thousand as of September 30, 2020, compared to $4.2 million as of December 31, 2019 and $14.0 million as of September 30, 2019.

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.

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The EBA eliminates the potential of concentration risk that comes with depositing excess balances with one or multiple correspondent banks.

The Company’s investment securities portfolio as of September 30, 2020 totaled $144.7 million, an increase of $29.0 million compared with the $115.7 million reported at December 31, 2019 and an increase of $65.1 million from the $79.6 million reported at September 30, 2019.

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 September 30, 2020 and December 31, 2019, the investment securities holdings represented 17.6% and 16.5% of the Company’s total assets, respectively.

The Company’s investment securities portfolio included restricted securities totaling $3.4 million as of September 30, 2020, and $1.7 million as of December 31, 2019 and September 30, 2019.

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.

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None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.

At September 30, 2020, the unrestricted securities portfolio totaled $141.2 million.

The following table summarizes the Company's available for sale securities by type as of September 30, 2020, December 31, 2019, and September 30, 2019 (dollars in thousands):

September 30, 2020

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

September 30, 2019

March 31, 2020

Government agencies

Corporate bonds

Mortgage-backed securities/CMOs

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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 which the Company is familiar.

The predominant market area for loans 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 September 30, 2020, total loans were $636.9 million, compared to $539.5 million as of December 31, 2019 and $522.1 million at September 30, 2019.

Loans as a percentage of total assets at September 30, 2020 were 77.6%, compared to 79.0% as of September 30, 2019.

Loans as a percentage of deposits at September 30, 2020 were 91.7%, compared to 90.1% as of September 30, 2019.

The following table summarizes the Company's loan portfolio by type of loan as of September 30, 2020 , December 31, 2019 , and September 30, 2019 (dollars in thousands):

September 30, 2020

The portfolio strategies include seeking industry, loan size, and loan type diversification to minimize credit exposure and originating loans in markets with

which the Company is familiar.

The predominant market area for the loans shown below includes Charlottesville, Albemarle County, Winchester, Frederick County , Richmond and area s 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

September 30, 2019

March 31, 2020

Commercial and industrial

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Consumer loans

Loan balances increased $97.4 million, or 18.1%, since December 31, 2019 and increased $114.8 million, or 22.0%, from September 30, 2019.

The increases are largely due to the origination of $86.9 million in PPP loans, as well as $10.5 million in net non-PPP loan growth in the first nine months of 2020 and the purchase of a $17.4 million 1-4 family residential mortgage package in the fourth quarter of 2019.

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.

Purchased loans with balances outstanding of $100.2 million as of September 30, 2020 were comprised of:

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 and a third in the fourth quarter of 2016.

A fourth tranche was closed in December 2017.

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.

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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.

The liquidator has notified the Company that it will be making distributions related to unearned premiums.

The Company expects to receive approximately $800 thousand from this distribution.

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.

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The collateral on these loans is located primarily on the East Coast of the United States.

The balance in purchased mortgage loans declined $11.1 million, or 33.1%, from December 31, 2019 to September 30, 2020, due to significant payoffs during this low rate environment.

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.

Syndicated loans totaling $6.4 million.

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Management proactively manages shared national credits and has opportunistically increased or decreased exposure over time.

In the third quarter of 2019, we elected to sell our interest in a credit which significantly lowered our ALLL and allowed for a recovery of loan loss provision.

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

Non-accrual loans totaled $9 thousand at September 30, 2020, compared to the $299 thousand and $337 thousand reported at December 31, 2019 and September 30, 2019, respectively.

The December 31, 2019 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 September 30, 2019 non-accrual balance included $337 thousand of student loan balances for which the Company has received payment from the liquidation process in the fourth quarter of 2019.

The Company had loans in its portfolio totaling $61 thousand, $771 thousand and $199 thousand, as of September 30, 2020, December 31, 2019 and September 30, 2019, 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 December 31, 2019 included a loan of approximately $548 thousand, which was granted a deferral by the USDA and is 100% guaranteed by such governmental entity.

At September 30, 2020, the Company had loans classified as impaired loans in the amount of $2.2 million, compared to $2.5 million at December 31, 2019 and $2.6 million at September 30, 2019.

Based on regulatory guidance on student lending, the Company has classified 81 of its purchased student loans as TDRs for a total of $1.2 million as of September 30, 2020.

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 restructurings.

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

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.

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.

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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.

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 changes in the required ALLL.

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

September 30, 2020

December 31, 2019

September 30, 2019

Loans held for investment at period-end

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Allowance as a percent of period-end loans

The ALLL as a percentage of assets was 0.84% as of September 30, 2020, 0.78% as of December 31, 2019, and 0.76% as of September 30, 2019.

The percentage increased as compared to year-end was primarily due to the increase in the necessary allowance on most of the Company’s loans due to worsening economic qualitative factors, and was partially offset by the SBA-guaranteed PPP loans not requiring an allowance.

Provisions for loan losses totaling $1.4 million and $500 thousand were recorded in the nine months ended September 30, 2020 and 2019, respectively.

The following is a summary of the changes in the ALLL for the nine months ended September 30, 2020 and 2019 (dollars in thousands):

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):

Allowance for loan losses, January 1

Provision for loan losses

Allowance for loan losses, September 30

Allowance for loan losses, March 31

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.

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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 September 30, 2020 and acknowledges that the ALLL may increase throughout the year as economic conditions may continue to deteriorate for the foreseeable future.

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 September 30, 2020 totaled $5.4 million compared to $6.1 million as of December 31, 2019 and $6.4 million as of September 30, 2019.

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.

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Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.

As of September 30, 2020, the Company occupied five full-service banking facilities in the cities of Charlottesville and Winchester, as well as the county of Albemarle in Virginia.

As of March 31, 2021 , the Company occupied five full-service banking facilities in the cities of Charlottesville and Winchester, as well as the count y of Al bemarle 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 within 90 days, 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 and operations center, as well as the principal offices of both Masonry Capital and Sturman Wealth Advisors .

T he 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 , a bsent 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.

As of September 30, 2020, $3.7 million of right-of-use assets and $3.8 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 September 30, 2019, $3.8 million of right-of-use assets and lease liabilities were included in Other Assets and Other Liabilities, respectively.

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.

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, Richmond and Winchester areas.

Total deposits as of September 30, 2020 were $694.5 million, an increase of $73.3 million compared to the balances of $621.2 million at December 31, 2019, and an increase of $115.1 million compared to the $579.4 million total as of September 30, 2019.

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.

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(dollars in thousands)

September 30, 2020

March 31, 2021

December 31, 2020

September 30, 2019

March 31, 2020

No cost and low cost deposits:

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Total deposit account balances

Noninterest-bearing demand deposits on September 30, 2020 were $190.2 million, representing 27.4% of total deposits.

Interest-bearing transaction, money market, and savings accounts totaled $406.2 million, and represented 58.5% of total deposits at September 30, 2020.

Collectively, noninterest-bearing and interest-bearing transaction and money market accounts represented 85.9% of total deposit accounts at September 30, 2020.

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

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 $ 28.9 million and $ 67 .2 million a re included in the interest checking accounts and the money market and savings deposit accounts balances, respectively, in the table above, as of September 30, 2020 .

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 14.1% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $98.1 million at September 30, 2020.

Included in this deposit total are Certificate of Deposit Account Registry Service CDs, known as CDARS TM , whereby depositors can obtain FDIC deposit insurance on account balances of up to $50 million.

CDARS TM deposits totaled $8.5 million as of September 30, 2020, all of which were 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.

Short-term borrowings, consisting primarily of FHLB advances and federal funds purchased, are additional sources of funds for the Company.

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The Company has a collateral dependent line of credit with the FHLB.

As of September 30, 2020, the Company has $40.0 million in outstanding balances from FHLB advances.

As of December 31, 2019 and September 30, 2019, the Company had no outstanding balances from FHLB advances.

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 September 30, 2020, December 31, 2019 or September 30, 2019.

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 September 30, 2020 (dollars in thousands):

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

Other comprehensive income

Other comprehensive loss

Cash dividends declared

Equity increase due to expensing of restricted stock

Equity increase due to exercise of stock options

Equity increase due to expensing of stock options

Equity, September 30, 2020

Equity increase due to expensing of restricted stock

Equity, March 31, 2021

The Basel III capital rules require banks and bank holding companies to comply with the following minimum capital ratios:

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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 14.42%, 14.42%, 15.41% and 9.41%, respectively, as of September 30, 2020, thus exceeding the minimum requirements.

The Bank’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 14.46%, 14.46%, 15.44% and 9.45%, respectively, as of September 30, 2020, also exceeding the minimum requirements.

As of September 30, 2020, 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:

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.

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%;

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and (iv) a leverage ratio of at least 5.0%.

On September 17, 2019 the Federal Deposit Insurance Corporation (“FDIC”) finalized a rule that introduces an optional simplified measure of capital adequacy for qualifying community banking organizations, referred to as, the community bank leverage ratio ( “ CBLR ” ) framework, as required by the Economic Growth, Regulatory Relief and Consumer Protection Act.

The CBLR framework is designed to reduce burden by removing the requirements for calculating and reporting risk-based capital ratios for qualifying community banking organizations that opt into the framework.

In order to qualify for the CBLR framework, a community banking organization must have a tier 1 leverage ratio of greater than 9 percent, less than $10 billion in total consolidated assets, and limited amounts of off-balance-sheet exposures and trading assets and liabilities.

A qualifying community banking organization that opts into the CBLR framework and meets all requirements under the framework will be considered to have met the well-capitalized ratio requirements under the Prompt Corrective Action regulations and will not be required to report or calculate risk-based capital.

The CBLR framework was made available for community banking organizations to use in their March 31, 2020 Call Report.

The Company decided not to opt into the CBLR framework.

RESULTS OF OPERATIONS

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The Company believes this measure to be the preferred industry measurement of operational efficiency, which is consistent with FDIC studies.

Net interest income is discussed in Management’s Discussion and Analysis on a GAAP basis , unless noted as “FTE” ;

and the reconcilement below shows the fully taxable-equivalent adjustment to net interest income to aid the reader in understanding the computations of net interest margin and the efficiency ratio on a non-GAAP basis (dollars in thousands):

Reconcilement of Non-GAAP

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.”

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

Nine Months Ended

September 30, 2020

September 30, 2019

September 30, 2020

September 30, 2019

Fully tax-equivalent measures

Net interest income

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Net interest margin (FTE)

Net income for the three months ended September 30, 2020 was $1.9 million, a $27 thousand or 1.4% decrease compared to net income reported for the three months ended September 30, 2019.

Net income per diluted share was $0.69 for the quarter ended September 30, 2020 compared to $0.71 per diluted share for the same quarter in the prior year.

The decrease in net income for the three months ended September 30, 2020, when compared to the same period of 2019, was attributable to the combination of:

i) a $344 thousand increase in provision for loan losses, largely as a result of worsening economic factors associated with the COVID-19 pandemic;

ii) a $573 thousand increase in net interest income, primarily due to lower cost of funds;

iii) a $98 thousand increase in noninterest income, as explained in the Noninterest income section below;

iv) a $374 thousand increase in noninterest expense, as explained in the Noninterest expense section below, and v) an $20 thousand decrease in provision for income taxes.

Net income for the nine months ended September 30, 2020 was $5.4 million, a $104 thousand or 2.0% increase compared to net income reported for the nine months ended September 30, 2019.

Net income per diluted share was $1.98 for the nine months ended September 30, 2020, compared to $1.96 per diluted share for the same period in the prior year.

The increase in net income for the nine months ended September 30, 2020, when compared to the same period in the prior year, was attributable to the combination of:

i) a $867 thousand increase in provision for loan losses largely as a result of worsening economic factors associated with the COVID-19 pandemic;

ii) a $674 thousand increase in net interest income, primarily due to lower cost of funds incurred in the second and third quarters of the current year;

iii) a $634 thousand increase in noninterest income, as explained in the Noninterest income section below;

Performance measures

Return on average assets

Impact of merger expenses

Operating return on average assets (non-GAAP)

Return on average equity

Impact of merger expenses

Operating return on average equity (non-GAAP)

Other financial measures

ALLL to total loans

Impact of PPP loans

ALLL to total loans, excluding PPP loans (non-GAAP)

Book value per share

Impact of intangibles

Tangible book value per share (non-GAAP)

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 September 30, 2020 was $6.1 million, a $598 thousand or 10.9% increase compared to net interest income (FTE) of $5.5 million for the three months ended September 30, 2019.

Net interest income (FTE) was positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $510 thousand, offset by the increased volume of deposits, which increased interest expense by $94 thousand.

The increased volume of loans, increasing from an average of $516.6 million in the third quarter of 2019 to $630.7 million in the third quarter of 2020, positively impacted interest income by $1.2 million;

however, the lower rate earned on loans, declining from 4.62% to 3.89% for the periods noted, negatively impacted interest income by $1.1 million, nearly offsetting the positive impact of the increase in volume.

The increase in volume of securities held, increasing from an average balance of $67.7 million for the third quarter of 2019 to $146.0 million for the third quarter of 2020, positively impacted net interest income by $382 thousand, while the decline in yield earned on such securities decreased from 2.37% to 1.74% for the periods noted, negatively impacting net interest income by $148 thousand.

Net interest income (FTE) for the nine months ended September 30, 2020 was $1 7.3 million, a $ 703 thousand or 4.2 % increase compared to net interest income (FTE) of $1 6.6 million for the nine months ended September 30, 2019 .

Net interest income (FTE) was positively impacted by the increase in the volume of the securities portfolio, which increased from an average of $ 64.5 million in the nine months ended September 30, 2019 to $ 109.8 million in the nine months ended September 30, 2020 , increasing interest income by $ 690 thousand.

The decline in rates paid on securities modestly offset the impact of the volume increase, declining from an average yield of 2.

39 % to 1.98 % for the periods noted, negatively impacting interest income by $ 211 thousand.

The increase in the volume of loans, up from an average of $ 524.7 million in the nine months ended September 30, 2019 to $ 595.0 million in nine months ended September 30, 2020 , positively impacted interest income by $ 2.3 million;

however, the lower rate earned on loans, declining from 4.6 4 % to 4.

09 % for the periods noted, negatively impacted interest income by $2 .3 million, completely offsetting the positive impact of the increase in volume.

Net interest income (FTE) was posi tively impacted by the de crease in rates paid on deposit accounts, which de creased interest expense by $ 648 thousand , offset by the increased volume of deposits, which increased interest expense by $287 thousand .

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

$ 631 thousand , offset by the increased volume of deposits, which increased interest expense by $ 9 9 thousand .

The increased volume of loans, increasing from an average of $ 535.8 million in the first quarter of 20 20 to $ 6 18.9 million in the first quarter of 202 1 , positively impacted interest income by $ 847 thousand ;

however, the lower rate earned on loans, declining from 4.

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 20 20 to $1 76.1 million for the first quarter of 202 1 , positively impacted net interest income by $32 5 thousand, while the decline in yield earned on such securities decreased from 2.

20 % to 1.74% for the periods noted, negatively impact ed net interest income by $1 8 9 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 3.05% for the three months ended September 30, 2020 was 49 basis points lower than the 3.54% for the three months ended September 30, 2019.

The net interest margin (FTE) of 3.12% for the nine months ended September 30, 2020 was 54 basis points lower than the 3.66% for the nine months ended September 30, 2019.

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 $381 thousand for the three months ended September 30, 2020 compared to the same period in the prior year, due predominantly to rate decreases.

The rate paid on interest-bearing deposits averaged 53 basis points in the three months ended September 30, 2020, compared to 106 basis points for the three months ended September 30, 2019.

Average balances of interest-bearing deposits increased from $414.5 million in the three months ended September 30, 2019 to $518.2 million in the three months ended September 30, 2020.

Average balances of borrowed funds, from FHLB advances, increased from zero in the three months ended September 30, 2019 to $28.6 million in the three months ended September 30, 2020, causing an increase in interest expense on borrowed funds of $35 thousand.

Interest expense decreased $414 thousand for the nine months ended September 30, 2020, compared to the same period in the prior year, due predominantly to the lower rates paid on deposits, as noted above.

The increased volume of deposits increased interest expense by $287 thousand, while the decrease in rates paid on deposit accounts decreased interest expense by $648 thousand, netting to an overall impact of increasing net interest income by $361 thousand.

The rate paid on interest-bearing deposits averaged 72 basis points in the nine months ended September 30, 2020, compared to 101 basis points for the nine months ended September 30, 2019.

Average balances of interest-bearing deposits increased from $397.3 million in the nine months ended September 30, 2019 to $488.8 million in the nine months ended September 30, 2020.

A table showing the mix of no cost and low-cost deposit accounts is shown under “Financial Condition - Deposits” earlier in this report.

Average balances of borrowed funds increased from $4.6 million in the nine months ended September 30, 2019 to $9.6 million in the nine months ended September 30, 2020.

The increase in volume of borrowed funds increased interest expense by $51 thousand;

however, the decline in the rate paid on borrowed funds, from 2.57% in the prior period to 0.49% in the current period, had a positive impact on interest expense of $104 thousand.

The combination of the volume and rate differences resulted in a decrease in interest expense on borrowed funds of $53 thousand.

The following tables detail the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest-bearing liabilities, for the three and nine months ended September 30, 2020 and 2019.

These tables also include a rate/volume analysis for these same periods (dollars in thousands).

Consolidated Ave rage Balance Sheet and Analysis o f Net Interest Income

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).

Consolidated Average Balance Sheet and Analysis of Net Interest Income

For the three months ended

September 30, 2020

September 30, 2019

Change in Interest Income/ Expense

Change Due to :

(dollars in thousands)

Interest Earning Assets:

Taxable Securities

Tax Exempt Securities 1

Total Securities 1

Fed Funds Sold

Total Earning Assets

Allowance for Loan Losses

Total Non-Earning Assets

LIABILITIES AND SHAREHOLDERS' EQUITY

Interest Bearing Liabilities:

Interest Bearing Deposits:

Interest Checking

Money Market and Savings Deposits

Time Deposits

Total Interest-Bearing Deposits

Other borrowed funds

Total Interest-Bearing Liabilities

Non-Interest-Bearing Liabilities:

Demand deposits

Other liabilities

Total Liabilities

Shareholders' Equity

Total Liabilities & Shareholders' Equity

Net Interest Income (FTE)

Interest Rate Spread 2

Interest Expense as a Percentage of Average Earning Assets

Net Interest Margin (FTE) 3

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.

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

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

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.

Consolidated Ave rage Balance Sheet and Analysis o f Net Interest Income

For the Nine Months Ended

September 30, 2020

September 30, 2019

March 31, 2021

March 31, 2020

Change in Interest Income/ Expense

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Provision for loan losses

A provision for loan losses of $224 thousand was recognized during the three months ended September 30, 2020 compared to a recovery of loan loss provision of $120 thousand recognized during the three months ended September 30, 2019.

A provision for loan losses of $1.4 million was recognized during the nine months ended September 30, 2020, compared to $500 thousand recognized during the nine months ended September 30, 2019, 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 0.84% as of September 30, 2020, 0.78% as of December 31, 2019, and 0.76% as of September 30, 2019.

The percentage increase as compared to year-end was primarily due to the increase in the necessary allowance on most of the Company’s loans due to worsening economic qualitative factors, which was partially offset by the SBA-guaranteed PPP loans not needing an allowance.

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 September 30, 2020.

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.

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Noninterest income

The components of noninterest income for the three months ended September 30, 2020 and 2019 are shown below (dollars in thousands):

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

September 30, 2020

September 30, 2019

Noninterest income:

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Total noninterest income

Noninterest income for the three months ended September 30, 2020 of $1.4 million was $98 thousand or 7.4% higher than the amount recorded for the three months ended September 30, 2019.

Noninterest income rose due to fluctuations in several categories.

Loan swap fee income increased $228 thousand and gains on sales of securities increased $84 thousand.

Wealth management fees declined $114 thousand due to restructuring of the entities and market conditions.

In addition, deposit account fees and debit/credit card and ATM fees declined in total by $77 thousand due to suppressed customer activity.

In addition, fees on mortgage sales declined $43 thousand due to elimination of that business line.

The components of noninterest income for the nine months ended September 30, 2020 and 2019 are shown below (dollars in thousands):

For the Nine Months Ended

September 30, 2020

September 30, 2019

Noninterest income:

Wealth management fees

Advisory and brokerage income

Royalty income

Deposit account fees

Debit/credit card and ATM fees

Earnings/increase in value of bank owned life insurance

Fees on mortgage sales

Gains on sales of securities

Loan swap fee income

Total noninterest income

Noninterest income for the nine months ended September 30, 2020 of $4.7 million was $634 thousand or 15.5% higher than the amount recorded for the nine months ended September 30, 2019.

Noninterest income increased due to fluctuations in several categories.

Loan swap fee income increased $826 thousand and gains on sales of securities increased $663 thousand over the periods noted.

Earnings from the proceeds of bank owned life insurance declined by $360 thousand as death proceeds were collected in the prior year, and wealth management fees declined $325 thousand due to the reasons noted above.

Deposit account fees and debit/credit card and ATM fees declined in total by $183 thousand due to suppressed customer activity.

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.

Noninterest expense

The components of noninterest expense for the three months ended September 30, 2020 and 2019 are shown below (dollars in thousands):

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

September 30, 2020

September 30, 2019

Noninterest expense:

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Professional fees

Settlement of claims

Total noninterest expense

Noninterest expense for the quarter ended September 30, 2020 of $4.9 million was $374 thousand or 8.2% higher than the quarter ended September 30, 2019.

The predominant reason for the increase was that the Company incurred $549 thousand in merger-related expenses during the three months ended September 30, 2020.

All professional fees accrued during the third quarter were related to due diligence and other merger-related expenses.

During the three months ended September 30, 2019, $160 thousand was accrued in connection with a settlement of claims related to pending and threatened legal proceedings.

Other noninterest expense increased $154 thousand period over period, primarily due to

increased expense of stock grants and cash compensation for directors.

Marketing, advertising and promotion expenses declined over the period noted by $148 thousand, due to a conscious effort to reduce such expenses.

The components of noninterest expense for the nine months ended September 30, 2020 and 2019 are shown below (dollars in thousands):

For the Nine Months Ended

September 30, 2020

September 30, 2019

Noninterest expense:

Salaries and employee benefits

Net occupancy

ATM, debit and credit card

Bank franchise tax

Computer software

Data processing

FDIC deposit insurance assessment

Loan expenses

Marketing, advertising and promotion

Merger expenses

Professional fees

Settlement of claims

Total noninterest expense

Noninterest expense for the nine months ended September 30, 2020 of $13.9 million was $225 thousand or 1.6% higher than the nine months ended September 30, 2019.

The predominant reason for the increase was that the Company incurred $549 thousand in merger-related expenses during the nine months ended September 30, 2020.

During the nine months ended September 30, 2019, $460 thousand was accrued in connection with a settlement of claims related to pending and threatened legal proceedings.

Other noninterest expense increased $191 thousand period over period, primarily due to increased expense of stock grants and cash compensation for directors.

Marketing, advertising and promotion expenses declined $258 thousand for the periods noted due to concerted efforts to reduce those expenses in 2020.

Management continues to evaluate expenses for potential containments and reductions that would have a positive impact on net income on an ongoing basis.

The efficiency ratio (FTE) of 65.75% for the three months ended September 30, 2020 compared favorably to the 66.9% for the same quarter of 2019, due primarily to the increase in net interest income.

The efficiency ratio (FTE) of 63.1% for the nine months ended September 30, 2020 also compared favorably to the 66.1% for the same period of 2019, due to a combination of increased net interest income and increased noninterest income.

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 nine months ended September 30, 2020 and 2019, the Company provided $1.3 million and $1.2 million for Federal income taxes, respectively, resulting in an effective income tax rate of 19.1% and 18.3%, respectively.

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 nine months ended September 30, 2019 was lower than the current year, as the proceeds from a bank-owned life insurance death benefit received during that period were tax-exempt.

Certain merger related expenses will be non-deductible for tax purposes.

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

QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis