Virginia National Bankshares Corp 10-Q

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, 202 2. 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. T h e Company is capturing the additional loan data which is anticipated to be needed for th is 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 CAR E S Act had no material impact on the Company’s consolidated financial statements. See further discussion of PPP loans and loan modifications in Note s 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 10 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 18 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 market s 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 21 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 22 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. 23 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. 24 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 volatility 1 N/A 22.97 % Expected dividends 2 N/A 4.75 % Expected term (in years) 3 N/A 6.50 Risk-free rate 4 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 25 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). 26 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 27 (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 28 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 29 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 30 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 31 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. 32