Item 2. Management’s Discussion and Analysis
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the unaudited consolidated financial statements, and notes thereto, of Virginia National Bankshares Corporation (the “Company”) included in this report and the audited consolidated financial statements, and notes thereto, of the Company included in the Company’s Form 10-K for the year ended December 31, 2020. Operating results for the three and six months ended June 30, 2021 are not necessarily indicative of the results for the year ending December 31, 2021 or any future period.
FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS
Certain statements contained or incorporated by reference in this quarterly report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, statements with respect to the Company’s operations, performance, future strategy and goals, and are often characterized by use of qualified words such as “expect,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “will,” “should,” or words of similar meaning or other statements concerning the opinions or judgement of the Company and its management about future events. While Company management believes such statements to be reasonable, future events and predictions are subject to circumstances that are not within the control of the Company and its management. Actual results may differ materially from those included in the forward-looking statements due to a number of factors, including, without limitation, the effects of and changes in: general economic and market conditions, including the effects of declines in real estate values, an increase in unemployment levels and general economic contraction as a result of COVID-19 or other pandemics; fluctuations in interest rates, deposits, loan demand, and asset quality; assumptions that underlie the Company’s allowance for loan losses (“ALLL”); the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events (e.g., COVID-19 or other pandemics), and of governmental and societal responses thereto; the performance of vendors or other parties with which the Company does business; competition; technology; changes in laws, regulations and guidance; changes in accounting principles or guidelines; performance of assets under management; expected revenue synergies and cost savings from the recently completed merger with Fauquier Bankshares, Inc. (“Fauquier”) may not be fully realized or realized within the expected timeframe; the businesses of the Company and Fauquier may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected; revenues following the merger may be lower than expected; customer and employee relationships and business operations may be disrupted by the merger; and other factors impacting financial services businesses. Many of these factors and additional risks and uncertainties are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and other reports filed from time to time by the Company with the Securities and Exchange Commission (“SEC”). These statements speak only as of the date made, and the Company does not undertake to update any forward-looking statements to reflect changes or events that may occur after this release.
MERGER WITH FAUQUIER BANKSHARES, INC., AND THE FAUQUIER BANK
On April 1, 2021, the Company completed its merger with Fauquier. The merger of Fauquier with and into the Company (the “Merger”) was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of September 30, 2020, between the Company and Fauquier, and a related Plan of Merger (together, the “Merger Agreement”). Immediately after the Merger, The Fauquier Bank, Fauquier’s wholly-owned bank subsidiary, merged with and into Virginia National Bank (the “Bank”), the Company’s wholly-owned bank subsidiary.
Pursuant to the Merger Agreement, former holders of shares of Fauquier common stock received 0.675 shares of the Company’s common stock for each share of Fauquier common stock held immediately prior to the Merger, with cash paid in lieu of fractional shares. Each share of common stock of the Company outstanding immediately prior to the Merger remained outstanding and was unaffected by the Merger.
Refer to Note 2 - Business Combinations, in the Notes to Consolidated Financial Statements, for further detail on the accounting policy for business combinations, fair values of assets and liabilities assumed, assumptions used in determining the fair values of assets and liabilities and the resulting goodwill.
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OVERVIEW
Our primary financial goal is to maximize the Company’s earnings to increase long-term shareholder value. We monitor three key financial performance measures to determine our success in realizing this goal: 1) return on average assets (ROAA), 2) return on average equity (ROAE), and 3) net income per share (EPS).
•
Return on average assets (“ROAA”) for the second quarter of 2021 was 0.03% compared to 1.07% realized in the same period in the prior year. ROAA excluding the impact of merger expenses (a non-GAAP financial measure) would have been 1.02% for the second quarter of 2021. ROAA for the six months ended June 30, 2021 was 0.24% compared to 0.93% realized in the same period in the prior year. ROAA excluding the impact of merger expenses (a non-GAAP financial measure) would have been 0.93% for the six months ended June 30, 2021, equaling the ROAA for the prior comparable period.
•
Return on average equity (“ROAE”) for the second quarter of 2021 was 0.37% compared to 10.64% realized in same period in the prior year. ROAE excluding the impact of merger expenses (a non-GAAP financial measure) would have been 11.89% for the second quarter of 2021. ROAE for the six months ended June 30, 2021 was 2.76% compared to 8.98% realized in same period in the prior year. ROAE excluding the impact of merger expenses (a non-GAAP financial measure) would have been 10.66% for the six months ended June 30, 2021, exceeding the ROAE from the comparable period in the prior year.
•
The Company incurred $5.9 million in merger expenses during the second quarter of 2021 related to the combination with Fauquier, which closed on April 1, 2021. Of this total, $2.2 million was incurred for system deconversion, termination and conversion fees, $1.5 million was accrued for the change-of-control payment for Marc Bogan resulting from his resignation, $1.1 million related to buyer investment banker fees, $510 thousand was associated with valuation and integration professional fees, $269 thousand related to other personnel expenses, $235 thousand was incurred for regulatory and shareholder expenses, and $150 thousand was recognized for legal expenses. This pre-tax expense of $5.9 million represents $1.11 per diluted share for the second quarter of 2021. The Company incurred $6.2 million in merger expenses during the six months ended June 30, 2021. First quarter expenses of $278 thousand related primarily to professional fees.
•
Net income per share was $0.03 for the second quarter of 2021, compared to $0.77 for the second quarter in the prior year. Net income per share, excluding merger expenses (a non-GAAP financial measure), would have been $0.89 in the current quarter, exceeding the net income per share of the comparable prior period. Net income per share was $0.41 for the first half of 2021, compared to $1.29 for the same period in the prior year. Net income per share, excluding merger expenses (a non-GAAP financial measure), would have been $1.33 for the first half of 2021, exceeding the net income per share of the comparable prior period.
We also manage our capital levels through growth, quarterly cash dividends, periodic stock dividends and share repurchases, when prudent, while maintaining a strong capital position. Refer to the Results of Operations, Non-GAAP Presentation section, later in this Management’s Discussion and Analysis for more discussion on these financial performance measures.
IMPACT OF COVID-19
Continuing cases of COVID-19, including the emergence of variants of the COVID-19 virus, continue to be a public health concern in the Company’s markets. While more than 50% of adults in the U.S. and in Virginia are fully vaccinated against COVID-19, the rate of vaccinations appears to have peaked during the second quarter of 2021, and the Delta variant has shown that there remains a threat of a resurgence of cases. There have been encouraging signs of strength in the economic recovery, including growth in consumer spending and improvement in the labor market, but many businesses continue to face difficulty in hiring desirable employees and meeting consumer demand, and certain portions of the global supply chain remain challenged by shortages and delays that first occurred due to the initial COVID-19 outbreak. There remains uncertainty about the pace of economic recovery, including uncertainty related to the labor market, inflation and fiscal and monetary policy responses from the federal government. There remains a risk that consumers and borrowers who have been supported during the pandemic by government stimulus measures may not return to employment and may not be able to repay debts as agreed following the cessation of government stimulus programs, including expanded unemployment benefits.
Management continues to carefully monitor the pandemic and its impact on the Company’s markets, customers and employees, and believes that the pandemic continues to present risks of elevated loan losses, sustained net interest margin compression and falling demand for loans; however, at this time management cannot determine the ultimate impact of the pandemic on the results of operations of the Company.
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Financial Condition and Results of Operations
Throughout the onset of this pandemic, the Company has maintained its high standards of credit quality on organic loan funding to limit credit risk exposure.
During the year ended December 31, 2020, we provided an additional $1.6 million for loan losses primarily by downgrading the qualitative economic factors within the ALLL model in light of the effects of COVID-19 on the economy. As of June 30, 2021, credit deterioration since the onset of the COVID-19 pandemic has so far not been experienced to the extent previously anticipated, and therefore, during the second quarter of 2021, we released a portion of these added reserves through a reversal of provision for loan losses. The Company continues to maintain reserves for loan losses at June 30, 2021 related to the pandemic and believe that our allowance for loan losses will be adequate to absorb probable losses that are inherent in our loan portfolio. If loan losses ultimately are not realized to the extent of the reserves provided for during the pandemic, our allowance for loan losses may be reduced in future periods through further reversals of provision for loan losses, which could benefit our results of operations for any such future period. However, if there are further challenges to the economic recovery, including a resurgence in COVID-19 cases or the emergence of variants of the COVID-19 virus that threaten to disrupt economic activity, additional provision for loan losses may be required in future periods.
Interest income could be reduced due to the economic impact of COVID-19. In accordance with guidance from regulators, the Company is working 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 194 deferrals on outstanding loan balances of $59.7 million (of which 131 deferrals on outstanding loan balances of $1.8 million were related to student loans). As of June 30, 2021, $57.7 million in loan balances, or 96.6% of the total loan deferments approved, have returned to normal payment schedules and are now current, leaving a remaining balance of deferments of $2.0 million. Of this remaining balance, $1.9 million, or 92.8%, are 100% government-guaranteed loans for which the deferrals were approved by the United States Department of Agriculture; and $144 thousand, or 7.2%, are student loans, which are private student loans not subject to potential federal forgiveness. In accordance with interagency guidance issued in March 2020 and the CARES Act, these short-term deferrals are not considered troubled debt restructurings (“TDRs”).
Primarily within the second quarter of 2020 and the first quarter of 2021, the Company devoted significant resources to accept PPP applications, a program designed to provide a direct incentive for small businesses to keep employees on their payroll. In total, the Company, including Virginia National Bank and The Fauquier Bank, funded $207.5 million in PPP loans, with average origination fees of 3.9%, assisting many nonprofits and local businesses through this program. As of June 30, 2021, 66.9% of the total dollars of PPP loans had been forgiven by the SBA, with $68.8 million outstanding. Loans funded through the PPP are fully guaranteed by the U.S. government. The Company believes that it performed the required due diligence pursuant to the established SBA criteria; nonetheless, if a determination is made that certain loans did not meet the criteria established for the program, the Company may be required to establish additional ALLL through provision for loan loss expense which will negatively impact net income.
Capital and Liquidity
As of June 30, 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.
Goodwill
The Company’s goodwill was recognized in connection with the acquisition of Fauquier in 2021 and Sturman Wealth Management in 2016. The Company reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exists. In testing goodwill for impairment, the Company may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the events and circumstance, the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the no further testing is required and the goodwill of the reporting unit is not impaired. If the Company elects to bypass the qualitative assessment or if the conclusion is that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying value to determine whether an impairment exists. As of June 30, 2021, the goodwill on the balance sheet was not deemed to be impaired. However,
38
management may determine that goodwill is required to be evaluated for impairment in the future due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations.
Operations, Processes, Controls and Business Continuity Plan
The Company reacted quickly to the COVID-19 pandemic. We began internal social distancing in mid-March of 2020, as well as distancing from the public by keeping our drive-thru services available, and encouraging customers to conduct transactions at ATMs, through online banking and/or the mobile app. The Company also increased consumer and business mobile deposit limits to encourage customers to make deposits remotely from the safety of their home or business. The Company implemented a schedule whereby most staff members are working remotely at any given time, allowing the remaining essential staff to create more distance between each other within the offices. We temporarily increased the number of staff in the client service center to assist more customers by telephone and encourage them to utilize online and mobile banking. The client service center was also temporarily moved to a larger location to allow for appropriate social distancing. In addition, the Company enhanced disinfecting procedures to include hospital-grade cleaning solution and foggers, increased the frequency of cleaning and issued personal protective equipment, including N-95 and disposable face masks, face shields, sneeze guards, gloves and thermometers, to employees, along with specific instructions for use, to enhance their safety. We also installed disinfecting protective strips to high touch areas and placed free-standing air filter machines throughout our facilities. We purchased COVID-19 instant test kits that we have on-site, ready to be deployed when needed, and we provided antibody testing options to all employees. Management provides frequent email communications and social media updates regarding COVID-19, helpful tips and status of Company initiatives, as well as warning customers of potential scams during this pandemic. Beginning mid-July of 2020, the Company took steps to resume normal branch activities with specific guidelines in place to continue protecting our customers and employees.
The Company’s preparedness resulted in minimal impact to the Company’s operations as a result of COVID-19. Business continuity planning allowed for successful deployment of most of our employees to work in a remote environment. No material operational or internal control risks have been identified to date, and the Company has enhanced fraud-related controls.
APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES
The accounting and reporting policies followed by the Company conform, in all material respects, to GAAP and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.
The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain, and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s consolidated financial statements. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.
For additional information regarding critical accounting policies, refer to the Application of Critical Accounting Policies and Critical Accounting Estimates section under Item 7 in the Company’s 2020 Form 10-K. The only significant changes in the Company’s application of critical accounting policies since December 31, 2020 relates to loans acquired in a business combination, as follows.
Loans acquired in a business combination : Acquired Loans are classified as either i) purchased credit-impaired (PCI) loans or ii) purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.
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On a quarterly basis, we evaluate our estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for loan losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan or pool(s) of loans. Disposals of loans, which may include sale of loans to third parties, receipt of payments in full or in part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.
PCI loans are not classified nonperforming loans by the Company at the time they are acquired, regardless of whether they had been classified as nonperforming by the previous holder of such loans, and they will not be classified as nonperforming so long as, at quarterly re-estimation periods, we believe we will fully collect the new carrying value of the pools of loans.
The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the Acquired Loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses may be required for any deterioration in these loans in future periods.
FINANCIAL CONDITION
Total assets
The total assets of the Company as of June 30, 2021 were $1.8 billion. This is a $998.7 million, or 117.7%, increase from the $848.4 million total assets reported at December 31, 2020 and a $1.0 billion, or 131.0%, increase from the $799.6 million reported at June 30, 2020. These increases were substantially due to the acquisition of Fauquier, which became effective April 1, 2021.
Interest-bearing deposits in other banks
The Company had $177.8 million of interest-bearing deposits in other banks as of June 30, 2021, compared to zero as of December 31, 2020 and June 30, 2020, as the current balance included accounts held by Fauquier, primarily at the Federal Reserve Bank of Richmond.
Federal funds sold
The Company had overnight federal funds sold of $106.6 million as of June 30, 2021, compared to $26.6 million as of December 31, 2020 and $24.8 million as of June 30, 2020. Any excess funds are sold on a daily basis in the federal funds market. The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.
The Company continues to participate in the Excess Balance Account (“EBA”) of the Federal Reserve Bank of Richmond (“FRB”). The EBA is a limited-purpose account at the FRB for the maintenance of excess cash balances held by financial institutions. The EBA eliminates the potential of concentration risk that comes with depositing excess balances with one or multiple correspondent banks.
Securities
The Company’s investment securities portfolio as of June 30, 2021 totaled $271.2 million, an increase of $94.1 million compared with the $177.1 million reported at December 31, 2020 and an increase of $166.7 million from the $104.5 million reported at June 30, 2020. The increases are primarily due to the inclusion of the investment securities portfolio of Fauquier upon effective date of the merger as of April 1, 2021. Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company. At June 30, 2021 and December 31, 2020, the investment securities holdings represented 14.7% and 20.9% of the Company’s total assets, respectively.
The Company’s investment securities portfolio included restricted securities totaling $4.3 million as of June 30, 2021, compared to $3.0 million as of December 31, 2020 and $1.7 million as of June 30, 2020. These securities represent stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), CBB Financial Corporation, the holding company for Community Bankers Bank, and stock in an SBA loan fund. The level of FRB and FHLB stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the FHLB, respectively. Stock ownership in the bank holding company
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for Community Bankers’ Bank provides the Company with several benefits that are not available to non-shareholder correspondent banks. None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.
At June 30, 2021, the unrestricted securities portfolio totaled $267.0 million. The following table summarizes the Company's available for sale securities by type as of June 30, 2021, December 31, 2020, and June 30, 2020 (dollars in thousands):
June 30, 2021
December 31, 2020
June 30, 2020
Percent
Percent
Percent
Balance
of Total
Balance
of Total
Balance
of Total
U.S. Government agencies
$
35,228
13.2
%
$
25,305
14.5
%
$
9,037
8.8
%
Mortgage-backed securities/CMOs
136,418
51.1
%
78,100
44.9
%
58,402
56.8
%
Municipal bonds
95,327
35.7
%
70,681
40.6
%
35,333
34.4
%
Total available for sale securities
$
266,973
100.0
%
$
174,086
100.0
%
$
102,772
100.0
%
The securities are held primarily for earnings, liquidity, and asset/liability management purposes and are reviewed quarterly for possible other-than-temporary impairments. During this review, management analyzes the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to recovery or maturity. These factors are analyzed for each individual security.
Loan portfolio
A management objective is to grow loan balances while maintaining the asset quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of, and the designation of lending limits for, each borrowing relationship. The portfolio strategies include seeking industry, loan size, and loan type diversification to minimize credit exposure and originating loans in markets with which the Company is familiar. The predominant market area for the loans shown below includes the cities of Charlottesville, Winchester and Richmond, the counties of Albemarle, Fauquier, Prince William and Frederick, and areas in the Commonwealth of Virginia that are within a 75-mile radius of any office of the Company.
As of June 30, 2021, total loans were $1.2 billion, compared to $609.4 million as of December 31, 2020 and $632.4 million at June 30, 2020. Loans as a percentage of total assets at June 30, 2021 were 63.1%, compared to 79.1% as of June 30, 2020. Loans as a percentage of deposits at June 30, 2021 were 71.6%, compared to 88.5% as of June 30, 2020.
The following table summarizes the Company's loan portfolio by type of loan as of June 30, 2021, December 31, 2020, and June 30, 2020 (dollars in thousands):
June 30, 2021
December 31, 2020
June 30, 2020
Balance
Percent
of Total
Balance
Percent
of Total
Balance
Percent
of Total
Commercial
$
160,473
13.8
%
$
118,688
19.5
%
$
162,036
25.6
%
Real estate construction and land
96,421
8.3
%
22,509
3.7
%
26,500
4.2
%
1-4 family residential mortgages
381,801
32.7
%
132,966
21.8
%
129,051
20.4
%
Commercial mortgages
455,795
39.1
%
277,109
45.5
%
251,420
39.8
%
Consumer
71,671
6.1
%
58,134
9.5
%
63,387
10.0
%
Total loans
$
1,166,161
100.0
%
$
609,406
100.0
%
$
632,394
100.0
%
Loan balances increased $556.8 million, or 91.4%, since December 31, 2020 and increased $533.8 million, or 84.4%, from June 30, 2020. The increases are primarily due to the inclusion of Fauquier’s loans of $602.6 million, net of the fair value mark, as of the effective date of the merger of April 1, 2021, for which the carrying amount as of June 30, 2021 amounts to $537.5 million. The increase from the same period in the prior year was offset by the decline in PPP loans of $18.1 million due to loan forgiveness. As of June 30, 2021, 67% of the total dollars of PPP loans had been forgiven by the SBA, with $68.8 million outstanding.
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Loan quality
Non-accrual loans totaled $17 thousand at June 30, 2021, compared to the $8 thousand and $11 thousand reported at December 31, 2020 and June 30, 2020, respectively.
The Company had loans in its portfolio totaling $2.8 million, $137 thousand and $1.1 million, as of June 30, 2021, December 31, 2020 and June 30, 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 June 30, 2021 includes three government-guaranteed loans in the amount $1.7 million and 54 federally insured student loans totaling $572 thousand. This past due total only includes four non-insured student loans that are 90 days or more past due and still accruing interesting, amounting to $52 thousand.
At June 30, 2021, the Company had loans classified as impaired loans in the amount of $1.1 million, a decline compared to $1.3 million at December 31, 2020 and $2.1 million at June 30, 2020. Based on regulatory guidance on student lending, the Company has classified 57 of its Purchased Student Loans as TDRs for a total of $1.0 million as of June 30, 2021. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered TDRs. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Management has evaluated these loans individually for impairment and included any probable loss in the allowance for loan loss; interest continues to accrue on these TDRs during any deferment and forbearance periods.
Management identifies potential problem loans through its periodic loan review process and considers potential problem loans as those loans classified as special mention, substandard, or doubtful.
Allowance for loan losses
In general, the Company determines the adequacy of its ALLL by considering the risk classification and delinquency status of loans and other factors. Management may also establish specific allowances for loans which management believes require allowances greater than those allocated according to their risk classification. The purpose of the allowance is to provide for losses inherent in the loan portfolio. Since risks to the loan portfolio include general economic trends as well as conditions affecting individual borrowers, the allowance is an estimate. The Company is committed to determining, on an ongoing basis, the adequacy of its ALLL. The Company applies historical loss rates to various pools of loans based on risk rating classifications. In addition, the adequacy of the ALLL is further evaluated by applying estimates of loss that could be attributable to any one of the following eight qualitative factors:
1)
Changes in national and local economic conditions, including the condition of various market segments;
2)
Changes in the value of underlying collateral;
3)
Changes in volume of classified assets, measured as a percentage of capital;
4)
Changes in volume of delinquent loans;
5)
The existence and effect of any concentrations of credit and changes in the level of such concentrations;
6)
Changes in lending policies and procedures, including underwriting standards;
7)
Changes in the experience, ability and depth of lending management and staff; and
8)
Changes in the level of policy exceptions.
The Company utilizes a loss migration model, which uses loan level attributes to track the movement of loans through various risk classifications in order to estimate the percentage of losses likely in the portfolio. As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarter ended September 30, 2020, December 31, 2020 or March 31, 2021. As of June 30, 2021, credit deterioration since the onset of the pandemic has so far not been experienced to the extent previously anticipated and therefore, during the second quarter of 2021, we released a portion of these added reserves through a reversal of provision for loan losses. 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 there are further challenges to the economic recovery, including a resurgence in COVID-19 cases or the emergence of variants of the COVID-19 virus.
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The relationship of the ALLL to total loans appears below (dollars in thousands):
June 30,
2021
December 31,
2020
June 30,
2020
Loans held for investment at period-end
$
1,166,161
$
609,406
$
632,394
Allowance for loan losses
$
5,522
$
5,455
$
4,917
Allowance as a percent of period-end loans
0.47
%
0.90
%
0.78
%
The ALLL as a percentage of loans was 0.47% as of June 30, 2021, 0.90% as of December 31, 2020, and 0.78% as of June 30, 2020. The percentage decrease as compared to year-end and the same period in the prior year relate to the elimination of Fauquier’s ALLL as the Acquired Loans were recorded at fair value. The ALLL as a percentage of loans, excluding the impact of Acquired Loans and the fair value mark (a non-GAAP financial measure), would have been 0.88% as of June 30, 2021. The ALLL as a percentage of loans, excluding PPP loans (a non-GAAP financial measure), would have been 0.51% as of June 30, 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 $210 thousand and $1.1 million were recorded in the six months ended June 30, 2021 and 2020, respectively. The following is a summary of the changes in the ALLL for the six months ended June 30, 2021 and 2020 (dollars in thousands):
2021
2020
Allowance for loan losses, January 1
$
5,455
$
4,209
Charge-offs
(397
)
(581
)
Recoveries
254
146
Provision for loan losses
210
1,143
Allowance for loan losses, June 30
$
5,522
$
4,917
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 5 of the Notes to Consolidated Financial Statements. In addition, Note 5 includes details regarding the rollforward of the allowance by loan portfolio segments. The rollforward tables indicate the activity for loans that are charged-off, amounts received from borrowers as recoveries of previously charged-off loan balances, and the allocation by loan portfolio segment of the provision made during the period. The events that can positively impact the amount of allowance in a given loan segment include any one or all of the following: the recovery of a previously charged-off loan balance; the decline in the amount of classified or delinquent loans in a loan segment from the previous period, which most commonly occurs when these loans are repaid or are foreclosed; or when there are improvements in the ratios used to estimate the probability of loan losses. Improvements to the ratios could include lower historical loss rates, improvements to any of the qualitative factors mentioned above, or reduced loss expectations for individually-classified loans.
Management reviews the ALLL on a quarterly basis to ensure it is adequate based upon the calculated probable losses inherent in the portfolio. Management believes the ALLL was adequately provided for as of June 30, 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 June 30, 2021 totaled $25.4 million compared to $5.2 million as of December 31, 2020 and $5.7 million as of June 30, 2020, with the increases due to the inclusion of Fauquier’s land and buildings at fair value effective April 1, 2021. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.
43
As of June 30, 2021 , the Company occupied sixteen full-service banking facilities throughout Albemarle, Fauquier and Prince William counties and the cities of Charlottesville and Winchester, Virginia. The Company also operates a drive-through location at 301 East Water Street, Charlottesville, Virginia. 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 half of 2021 .
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. TFB Wealth Management is located at 10 Courthouse Square, Warrenton, Virginia.
Both the Arlington Boulevard facility in Charlottesville and the People Place facility in Albemarle County also contain office space that is currently under lease to tenants.
Leases
As of June 30, 2021, the Company has recorded $8.4 million of right-of-use assets and $7.8 million of lease liabilities, in accordance with Accounting Standards Update 2016-02 “Leases” (Topic 842). As of December 31, 2020, $3.5 million of right-of-use assets and $3.6 million of lease liabilities were included on the balance sheet. The increase is due to the inclusion of Fauquier’s leases effective April 1, 2021, at fair value. Right-of-use assets are assets that represent the Company’s right to use, or control the use of, a specified asset for the lease term, offset by the lease liability, which is the Company’s obligation to make lease payments arising from a lease, measured on a discounted basis.
Deposits
Deposit accounts represent the Company’s primary source of funds and are comprised of demand deposits, interest-bearing checking, money market, and savings accounts as well as time deposits. These deposits have been provided predominantly by individuals, businesses and charitable organizations in the Charlottesville, Albemarle, Fauquier, Prince William, Richmond and Winchester areas.
Total deposits as of June 30, 2021 were $1.6 billion, an increase of $898.7 million compared to the balances of $730.8 million at December 31, 2020, and an increase of $915.2 million compared to the $714.2 million total as of June 30, 2020. The primary reason for the increases in the periodic comparisons is the inclusion of Fauquier’s deposits of $817.7 million, at fair value, effective upon the merger date of April 1, 2021, as well as increased balances in PPP customer accounts.
Deposit accounts
(dollars in thousands)
June 30, 2021
December 31, 2020
June 30, 2020
Balance
% of Total
Deposits
Balance
% of Total
Deposits
Balance
% of Total
Deposits
No cost and low cost deposits:
Noninterest demand deposits
$
449,483
27.6
%
$
209,772
28.71
%
$
197,227
27.6
%
Interest checking accounts
431,556
26.5
%
148,910
20.37
%
136,274
19.1
%
Money market and savings deposit accounts
577,414
35.4
%
272,980
37.36
%
284,101
39.8
%
Total noninterest and low cost deposit accounts
1,458,453
89.5
%
631,662
86.4
%
617,602
86.5
%
Time deposit accounts:
Certificates of deposit
162,217
10.0
%
90,615
12.4
%
88,071
12.3
%
CDARS deposits
8,778
0.5
%
8,487
1.2
%
8,528
1.2
%
Total certificates of deposit and other time deposits
170,995
10.5
%
99,102
13.6
%
96,599
13.5
%
Total deposit account balances
$
1,629,448
100.0
%
$
730,764
100.0
%
$
714,201
100.0
%
44
Noninterest-bearing demand deposits on June 30, 2021 were $449.5 million, representing 27.6% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $1.0 billion, and represented 61.9% of total deposits at June 30, 2021. Collectively, noninterest-bearing and interest-bearing transaction and money market accounts represented 89.5% of total deposit accounts at June 30, 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 $29.2 million and $121.7 million are included in the interest checking accounts and the money market and savings deposit accounts balances, respectively, in the table above, as of June 30, 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 10.5% and 13.6% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $171.0 million and $99.1 million at June 30, 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 $8.8 million as of June 30, 2021 and $ 8.5 million as of December 31, 2020, all of which were reciprocal balances for the Company’s customers.
Borrowings
Short-term borrowings, consisting primarily of FHLB advances and federal funds purchased, are additional sources of funds for the Company. The level of these borrowings is determined by various factors, including customer demand and the Company's ability to earn a favorable spread on the funds obtained.
The Company has a collateral dependent line of credit with the FHLB. As of June 30, 2021 and December 31, 2020, the Company had $43.0 million and $30 million in outstanding balances from FHLB advances, respectively. As of June 30, 2020, the Company had no outstanding balances from FHLB advances.
Additional borrowing arrangements maintained by the Company include formal federal funds lines with five major regional correspondent banks and the Federal Reserve discount window. The Company had no outstanding balances on these lines or facilities as of June 30, 2021, December 31, 2020 or June 30, 2020.
Shareholders' equity and regulatory capital ratios
The following table displays the changes in shareholders' equity for the Company from December 31, 2020 to June 30, 2021 (dollars in thousands):
Equity, December 31, 2020
$
82,598
Net income
1,652
Acquisition of Fauquier Bankshares, Inc.
78,036
Other comprehensive loss
(1,595
)
Cash dividends declared
(2,410
)
Equity increase due to exercise of stock options
30
Equity increase due to expensing of stock options
65
Equity increase due to expensing of restricted stock
226
Equity, June 30, 2021
$
158,602
The Basel III capital rules require banks and bank holding companies to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%); (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).
45
The Company’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 1 2.96 %, 1 2.96 %, 1 3.47 % and 7.66 %, respectively, as of June 30, 2021 , thus exceeding the minimum requirements. The Bank’s Tier 1, common equity Tier 1, total capital to risk-weighted asset s, and leverage ratios were 1 3.26 %, 1 3.26 %, 1 3.77 % and 7.86 %, respectively, as of June 30, 2021 , also exceeding the minimum requirements.
As of June 30, 2021, the Bank exceeded all of the following minimum capital ratios in order to be considered “well capitalized” under the “prompt corrective action” regulations, as revised: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.
RESULTS OF OPERATIONS
Non-GAAP presentations
The Company, in referring to its net income and net interest income, is referring to income computed in accordance with GAAP, unless otherwise noted. Management’s Discussion and Analysis of Consolidated Financial Condition and Results of Operations also refer to various calculations that are non-GAAP presentations. They include:
•
Performance measures exclude nonrecurring merger expenses, which were incurred in connection with change-in-control, severance, due diligence, legal, and other professional fees associated with the 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.
•
Fully taxable-equivalent (“FTE”) adjustments – Net interest margin and efficiency ratios are presented on an FTE basis, consistent with SEC guidance in Industry Guide 3 which states that tax exempt income may be calculated on a tax equivalent basis. This is a non-GAAP presentation. The FTE basis adjusts for the tax-exempt status of net interest income from certain investments using a federal tax rate of 21%, where applicable, to increase tax-exempt interest income to a taxable-equivalent basis.
•
Efficiency ratio – One of the ratios the Company monitors in its evaluation of operations is the efficiency ratio, which measures the cost to produce one dollar of revenue. The Company computes its efficiency ratio (FTE) by dividing noninterest expense by the sum of net interest income (FTE) and noninterest income. A lower ratio is an indicator of increased operational efficiency. This non-GAAP metric is used to assist investors in understanding how management assesses its ability to generate revenues from its non-funding-related expense base, as well as to align presentation of this financial measure with peers in the industry. The Company believes this measure to be the preferred industry measurement of operational efficiency, which is consistent with FDIC studies.
•
Net interest margin – Net interest margin (FTE) is calculated as net interest income, computed on an FTE basis, expressed as a percentage of average earning assets. The Company believes this measure to be the preferred industry measurement of net interest margin and that it enhances comparability of net interest margin among peers in the industry.
•
The ALLL as a percentage of loans, excluding the impact of acquired loans and the related fair value mark, excluded the fair value of Acquired Loans from Fauquier. Management believes that the exclusion of the Acquired Loans provides users of the Company’s financial information a presentation of the Company’s ALLL percentage that is representative of its ongoing operations.
•
The ALLL 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 ALLL 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.”
46
The reconcilement below shows how these non-GAAP measures are computed from their respective GAAP measures (dollars in thousands):
Reconcilement of Non-GAAP Measures:
As of or for the Three Months Ended
For the Six Months Ended
June 30,
2021
June 30,
2020
June 30,
2021
June 30,
2020
Performance measures
Return on average assets ("ROAA")
0.03
%
1.07
%
0.24
%
0.93
%
Impact of merger expenses, net of tax
0.99
%
—
0.69
%
—
ROAA, excluding merger expenses (non-GAAP)
1.02
%
1.07
%
0.93
%
0.93
%
Return on average equity ("ROAE")
0.37
%
10.64
%
2.76
%
8.98
%
Impact of merger expenses, net of tax
11.51
%
—
7.90
%
—
ROAE, excluding merger expenses (non-GAAP)
11.88
%
10.64
%
10.66
%
8.98
%
Net income
$
147
$
2,088
$
1,652
$
3,492
Impact of merger expenses, net of tax
4,553
-
4,722
-
Net income, excluding merger expenses (non-GAAP)
$
4,700
$
2,088
$
6,374
$
3,492
Net income per share, basic and diluted
$
0.03
$
0.77
$
0.41
$
1.29
Impact of merger expenses, net of tax
0.86
-
0.92
-
Net income per share, excluding merger expenses (non-GAAP), basic and diluted
$
0.89
$
0.77
$
1.33
$
1.29
Fully tax-equivalent measures
Net interest income
$
13,151
$
5,755
$
19,125
$
11,130
Fully tax-equivalent adjustment
73
25
120
45
Net interest income (FTE)
$
13,224
$
5,780
$
19,245
$
11,175
Efficiency ratio
99.5
%
59.7
%
90.0
%
62.0
%
Fully tax-equivalent adjustment
-0.4
%
-0.2
%
-0.5
%
-0.2
%
Efficiency ratio (FTE)
99.1
%
59.5
%
89.5
%
61.8
%
Net interest margin
3.03
%
3.11
%
3.02
%
3.14
%
Fully tax-equivalent adjustment
0.02
%
0.01
%
-0.02
%
0.02
%
Net interest margin (FTE)
3.05
%
3.12
%
3.00
%
3.16
%
Other financial measures
ALLL to total loans
0.47
%
0.78
%
Impact of acquired loans and fair value mark
0.41
%
0.00
%
ALLL to total loans, excluding acquired loans and
fair value mark (non-GAAP)
0.88
%
0.78
%
ALLL to total loans
0.47
%
0.78
%
Impact of PPP loans
0.04
%
0.12
%
ALLL to total loans, excluding PPP loans (non-GAAP)
0.51
%
0.90
%
Book value per share
$
29.89
$
29.14
Impact of intangible assets
(3.29
)
(0.28
)
Tangible book value per share (non-GAAP)
$
26.60
$
28.86
47
Net income
Net income for the three months ended June 30, 2021 was $147 thousand, a $1.9 million or 93.0% decrease compared to net income reported for the three months ended June 30, 2020. Net income per diluted share was $0.03 for the quarter ended June 30, 2021 compared to $0.77 per diluted share for the same quarter in the prior year. The entirety of the decrease in net income for the three months ended June 30, 2021, when compared to the same period of 2020, was attributable to $5.9 million in pre-tax ($4.6 million after-tax) merger expenses incurred in the second quarter of 2021. Excluding merger costs, the Company would have posted net income of $0.89 per diluted share (a non-GAAP financial measure).
Net interest income
Net interest income (FTE) for the three months ended June 30, 2021 was $13.2 million, a $7.4 million or 128.8% increase compared to net interest income (FTE) of $5.8 million for the three months ended June 30, 2020. Net interest income (FTE) increased primarily due to the inclusion of Fauquier’s net interest income (FTE) for the current quarter, as the merger was effective April 1, 2021. Net interest income (FTE) was also positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $431 thousand, offset by the increased volume of deposits, which increased interest expense by $547 thousand. The increased volume of loans, also a result of the merger with Fauquier, increasing from an average of $618.1 million in the second quarter of 2020 to $1.2 billion in the second quarter of 2021, positively impacted interest income by $6.4 million. The higher average yield earned on loans, increasing from 4.01% to 4.30% for the periods noted, positively impacted interest income by $500 thousand. In addition, the fair value accretion on loans acquired positively impacted net interest income by 16 basis points during the three months ended June 30, 2021. The increase in volume of securities held, increasing from an average balance of $68.7 million for the second quarter of 2020 to $270.2 million for the second quarter of 2021, positively impacted net interest income by $865 thousand, while the decline in yield earned on such securities decreased from 2.15% to 1.68% for the periods noted, negatively impacted net interest income by $97 thousand.
Net interest income (FTE) for the six months ended June 30, 2021 was $19.2 million, an $8.1 million or 72.2% increase compared to net interest income (FTE) of $11.2 million for the six months ended June 30, 2020 Net interest income (FTE) increased primarily due to the inclusion of Fauquier’s net interest income (FTE) for the first half of the current year as the merger was effective April 1, 2021. Net interest income (FTE) was also positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $1.2 million, offset partially by the increased volume of deposits, which increased interest expense by $938 thousand. The increased volume of loans, also a result of the merger with Fauquier, increasing from an average of $577.0 million in the six months ended June 30, 2020 to $910.0 million in the six months ended June 30, 2021, positively impacted interest income by $6.9 million. The increase in volume of securities held, increasing from an average balance of $91.5 million for the six months ended June 30, 2020 to $222.0 million for the six months ended June 30, 2021, positively impacted net interest income by $1.2 million, while the decline in yield earned on such securities decreased from 2.18% to 1.65% for the periods noted, negatively impacted net interest income by $335 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 June 30, 2021 was 7 basis points lower than the 3.12% for the three months ended June 30, 2020. The net interest margin (FTE) of 3.00% for the six months ended June 30, 2021 was 16 basis points lower than the 3.16% for the six months ended June 30, 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 increased $224 thousand for the three months ended June 30, 2021 compared to the same period in the prior year, due to increased volume of deposits from the Fauquier merger, as average interest-bearing deposits increased $681.8 million for the period noted, negatively impacting interest expense by $547 thousand, offset by lower rates paid on deposits, positively impacting interest expense by $431 thousand. The rate paid on interest-bearing deposits averaged 30 basis points in the three months ended June 30, 2021, compared to 62 basis points for the three months ended June 30, 2020. Average balances of borrowed funds, from FHLB advances, increased from zero in the three months ended June 30, 2020 to $43.0 million in the three months ended June 30, 2021, causing an increase in interest expense on borrowed funds of $59 thousand. Average balances of junior subordinated debt, increased from zero in the three months ended June 30, 2020 to $3.3 million in the three months ended June 30, 2021, causing an increase in interest expense on borrowed funds of $49 thousand.
48
Interest expense decreased $272 thousand for the six months ended June 30, 2021 compared to the same period in the prior year, due primarily to the lower rates paid on deposits, positively impacting interest expense by $1.2 million, offset by the increased volume of deposits from the Fauquier merger, as average interest-bearing deposits increased $373.5 million for the period noted, negatively impacting interest expense by $794 thousand. The rate paid on interest-bearing deposits averaged 36 basis points in the six months ended June 30, 2021 , compared to 83 basis points for the six months ended June 30, 2020 . Average balances of borrowed funds, from FHLB advances, increased from zero in the six months ended June 30, 2020 to $36.60 million in the six months ended June 30, 2021 , causing an increase in interest expense on borrowed funds of $95 thousand. Average balances of junior subordinated debt, increased from zero in the six months ended June 30, 2020 to $1.3 million in the six months ended June 30, 2021 , causing an increase in interest expense on borrowed funds of $49 thousand.
49
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 six months ended June 30, 2021 and 2020. These tables also include rate/volume analyses for these same periods (dollars in thousands).
Consolidated Average Balance Sheet and Analysis of Net Interest Income
For the three months ended
June 30, 2021
June 30, 2020
Change in Interest Income/ Expense
Average
Interest
Average
Average
Interest
Average
Change Due to : 4
Total
Balance
Income/
Yield/Cost
Balance
Income/
Yield/Cost
Volume
Rate
Increase/
(dollars in thousands)
Expense
Expense
(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities
$
211,827
$
792
1.50
%
$
53,953
$
253
1.88
%
$
600
$
(61
)
$
539
Tax Exempt Securities 1
58,398
346
2.37
%
14,793
117
3.16
%
265
(36
)
229
Total Securities 1
270,225
1,138
1.68
%
68,746
370
2.15
%
865
(97
)
768
Total Loans
1,214,123
13,009
4.30
%
618,096
6,156
4.01
%
6,353
500
6,853
Fed Funds Sold
106,934
21
0.08
%
57,920
10
0.07
%
9
2
11
Other interest-bearing deposits
149,056
36
0.10
%
—
—
—
36
0
36
Total Earning Assets
1,740,338
14,204
3.27
%
744,762
6,536
3.53
%
7,263
405
7,668
Less: Allowance for Loan Losses
(5,732
)
(4,788
)
Total Non-Earning Assets
124,287
46,543
Total Assets
$
1,858,893
$
786,517
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking
$
437,611
$
93
0.09
%
$
131,333
$
26
0.08
%
$
65
$
2
$
67
Money Market and Savings Deposits
561,940
455
0.32
%
257,174
365
0.57
%
296
(206
)
90
Time Deposits
169,556
324
0.77
%
98,762
365
1.49
%
186
(227
)
(41
)
Total Interest-Bearing Deposits
1,169,107
872
0.30
%
487,269
756
0.62
%
547
(431
)
116
Short term borrowings
43,030
59
0.55
%
—
—
—
59
—
59
Junior subordinated debt
3,334
49
5.89
%
—
—
—
49
0
49
Total Interest-Bearing Liabilities
1,215,471
980
0.32
%
487,269
756
0.62
%
655
(431
)
224
Non-Interest-Bearing Liabilities:
Demand deposits
471,078
216,747
Other liabilities
14,109
3,577
Total Liabilities
1,700,658
707,593
Shareholders' Equity
158,235
78,924
Total Liabilities & Shareholders' Equity
$
1,858,893
$
786,517
Net Interest Income (FTE)
$
13,224
$
5,780
$
6,608
$
836
$
7,444
Interest Rate Spread 2
2.95
%
2.91
%
Interest Expense as a Percentage of Average Earning Assets
0.23
%
0.41
%
Net Interest Margin (FTE) 3
3.05
%
3.12
%
( 1)
Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations earlier in this section.
(2)
Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.
(3)
Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.
(4)
The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
50
Consolidated Average Balance Sheet and Analysis of Net Interest Income
For the Six Months Ended
June 30, 2021
June 30, 2020
Change in Interest Income/ Expense
Average
Interest
Average
Average
Interest
Average
Change Due to : 4
Total
Balance
Income/
Yield/Cost
Balance
Income/
Yield/Cost
Volume
Rate
Increase/
(dollars in thousands)
Expense
Expense
(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities
$
176,151
$
1,264
1.44
%
$
78,370
$
786
2.01
%
$
753
$
(275
)
$
478
Tax Exempt Securities (1)
45,818
569
2.48
%
13,109
212
3.23
%
417
(60
)
357
Total Securities (1)
221,969
1,833
1.65
%
91,479
998
2.18
%
1,170
(335
)
835
Total Loans
910,040
18,947
4.20
%
576,952
12,027
4.19
%
6,935
(15
)
6,920
Fed Funds Sold
87,276
72
0.17
%
43,409
95
0.44
%
59
(82
)
(23
)
Other interest-bearing deposits
74,475
66
0.18
%
—
—
—
66
0
66
Total Earning Assets
1,293,760
20,918
3.26
%
711,840
13,120
3.71
%
8,230
(432
)
7,798
Less: Allowance for Loan Losses
(5,624
)
(4,523
)
Total Non-Earning Assets
84,069
45,650
Total Assets
$
1,372,205
$
752,967
LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking
$
291,025
$
119
0.08
%
$
127,026
$
57
0.09
%
$
67
$
(5
)
$
62
Money Market and Savings Deposits
422,048
806
0.39
%
243,036
1,029
0.85
%
520
(743
)
(223
)
Time Deposits
134,355
604
0.91
%
103,851
859
1.66
%
207
(462
)
(255
)
Total Interest-Bearing Deposits
847,428
1,529
0.36
%
473,913
1,945
0.83
%
794
(1,210
)
(416
)
Short term borrowings
36,551
95
0.52
%
—
—
—
95
—
95
Junior subordinated debt
1,255
49
7.87
%
—
—
—
49
—
49
Total Interest-Bearing Liabilities
885,234
1,673
0.38
%
473,913
1,945
0.83
%
938
(1,210
)
(272
)
Non-Interest-Bearing Liabilities:
Demand deposits
363,709
197,312
Other liabilities
2,877
3,507
Total Liabilities
1,251,820
674,732
Shareholders' Equity
120,385
78,235
Total Liabilities & Shareholders' Equity
$
1,372,205
$
752,967
Net Interest Income (FTE)
$
19,245
$
11,175
$
7,292
$
778
$
8,070
Interest Rate Spread 2
2.88
%
2.88
%
Interest Expense as a Percentage of Average Earning Assets
0.26
%
0.55
%
Net Interest Margin (FTE) 3
3.00
%
3.16
%
( 1)
Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations earlier in this section.
(2)
Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.
(3)
Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.
(4)
The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each.
51
Provision for loan losses
A recovery of loan losses of $141 thousand was recognized during the three months ended June 30, 2021 compared to a provision for loan losses of $378 thousand recognized during the three months ended June 30, 2020, and a provision for loan losses of $210 thousand was recognized during the six months ended June 30, 2021, compared to $1.1 million recognized during the six months ended June 30, 2020. During the first two quarters of 2020, the Company increased the economic qualitative factors in the ALLL calculation due to the deterioration in the economic outlook resulting from the impact of COVID-19. During the second quarter of 2021, the Company released of a portion of the reserves that were added during 2020 since the credit deterioration has so far not been experienced to the extent previously anticipated.
The period-end ALLL as a percentage of assets was 0.47% as of June 30, 2021, 0.90% as of December 31, 2020 and 0.78% as of June 30, 2020. The percentage decrease as compared to the prior year end and the same period in the prior year was due to the addition of purchased loans upon the acquisition of Fauquier, and the elimination of their ALLL as the loans were acquired and booked at fair value. The ALLL as of June 30, 2021, excluding the impact of the Acquired Loans and the fair value mark, would have been 0.88%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to Non-GAAP ALLL.
Further discussion of management’s assessment of the ALLL is provided earlier in the report and in Note 5 – Allowance for Loan Losses, found in the Notes to the Consolidated Financial Statements. In management’s opinion, the allowance was adequately provided for at June 30, 2021. The ALLL calculation, provision for loan losses, asset quality and collateral values may be significantly impacted by deterioration in economic conditions. We have downgraded, then upgraded slightly, the qualitative factors pertaining to economic conditions within our ALLL methodology; should economic conditions worsen, we could experience further increases in our required ALLL and record additional provision for loan loss exposure.
Noninterest income
The components of noninterest income for the three months ended June 30, 2021 and 2020 are shown below (dollars in thousands):
For the three months ended
Variance
June 30,
2021
June 30,
2020
$
%
Noninterest income:
Wealth management fees
$
980
$
228
$
752
329.8
%
Advisory and brokerage income
359
163
196
120.2
%
Royalty income
12
24
(12
)
-50.0
%
Deposit account fees
426
143
283
197.9
%
Debit/credit card and ATM fees
599
134
465
347.0
%
Earnings/increase in value of bank owned life insurance
199
109
90
82.6
%
Fees on mortgage sales
-
30
(30
)
-100.0
%
Gains on sales of securities
-
590
(590
)
-100.0
%
Loan swap fee income
20
124
(104
)
-83.9
%
Other
325
81
244
301.2
%
Total noninterest income
$
2,920
$
1,626
$
1,294
79.6
%
Noninterest income for the three months ended June 30, 2021 of $2.9 million was $1.3 million or 79.6% higher than the amount recorded for the three months ended June 30, 2020. Noninterest income increased predominantly due to the inclusion of TFB’s wealth management fees of $647 thousand, advisory and brokerage income of $157 thousand, deposit fees of $258 thousand and debit card income of $418 thousand. Gains on sales of securities declined from the second quarter of the prior year by $590 thousand, as no securities were sold and swap fee income declined $104 thousand, as swap arrangements are not as attractive to borrowers in the current rate environment.
52
The components of noninterest income for the six months ended June 30, 2021 and 2020 are shown below (dollars in thousands):
For the Six Months Ended
Variance
June 30,
2021
June 30,
2020
$
%
Noninterest income:
Wealth management fees
$
1,309
$
538
$
771
143.3
%
Advisory and brokerage income
550
341
209
61.3
%
Royalty income
17
71
(54
)
-76.1
%
Deposit account fees
586
322
264
82.0
%
Debit/credit card and ATM fees
753
291
462
158.8
%
Earnings/increase in value of bank owned life insurance
306
216
90
41.7
%
Fees on mortgage sales
-
77
(77
)
-100.0
%
Gains on sales of securities
-
643
(643
)
-100.0
%
Loan swap fee income
35
633
(598
)
-94.5
%
Other
403
163
240
147.2
%
Total noninterest income
$
3,959
$
3,295
$
664
20.2
%
Noninterest income for the six months ended June 30, 2021 of $4.0 million was $664 thousand or 20.2% higher than the amount recorded for the six months ended June 30, 2020. Noninterest income increased predominantly due to the inclusion of TFB’s wealth management fees of $647 thousand, advisory and brokerage income of $157 thousand, deposit fees of $258 thousand and debit card income of $418 thousand, which are the same increases as noted above, as the effective date of the merger was April 1, 2021 and therefore, only TFB’s second quarter is included in the year-to-date figures. Gains on sales of securities declined from the second quarter of the prior year by $643 thousand, as no securities were sold and swap fee income declined $598 thousand, as swap arrangements are not as attractive to borrowers in the current rate environment.
Noninterest expense
The components of noninterest expense for the three months ended June 30, 2021 and 2020 are shown below (dollars in thousands):
For the three months ended
Variance
June 30,
2021
June 30,
2020
$
%
Noninterest expense:
Salaries and employee benefits
$
4,741
$
2,258
$
2,483
110.0
%
Net occupancy
1,109
452
657
145.4
%
Equipment
340
136
204
150.0
%
ATM, debit and credit card
73
41
32
78.0
%
Bank franchise tax
429
163
266
163.2
%
Computer software
216
136
80
58.8
%
Data processing
994
338
656
194.1
%
FDIC deposit insurance assessment
182
28
154
550.0
%
Loan expenses
145
66
79
119.7
%
Marketing, advertising and promotion
232
140
92
65.7
%
Merger expenses
5,874
-
5,874
N/A
Professional fees
510
190
320
168.4
%
Core deposit intangible amortization
428
-
428
N/A
Other
720
456
264
57.9
%
Total noninterest expense
$
15,993
$
4,404
$
11,589
263.1
%
53
Noninterest expense for the quarter ended June 30, 2021 of $16.0 million was $11.6 million or 263.1% higher than the quarter ended June 30, 2020. The predominant reason for the increase was that the Company incurred $5.9 million in merger-related expenses during the three months ended June 30, 2021. Additionally, the second quarter of 2021 includes the salaries of the employees of the combined company, as the effective date of merger with Fauquier was April 1, 2021.
The components of noninterest expense for the six months ended June 30, 2021 and 2020 are shown below (dollars in thousands):
For the Six Months Ended
Variance
June 30,
2021
June 30,
2020
$
%
Noninterest expense:
Salaries and employee benefits
$
7,143
$
4,682
$
2,461
52.6
%
Net occupancy
1,604
904
700
77.4
%
Equipment
456
267
189
70.8
%
ATM, debit and credit card
115
94
21
22.3
%
Bank franchise tax
602
326
276
84.7
%
Computer software
383
276
107
38.8
%
Data processing
1,283
666
617
92.6
%
FDIC deposit insurance assessment
245
28
217
775.0
%
Loan expenses
208
157
51
32.5
%
Marketing, advertising and promotion
369
279
90
32.3
%
Merger expenses
6,152
-
6,152
N/A
Professional fees
687
376
311
82.7
%
Core deposit intangible amortization
428
-
428
N/A
Other
1,099
892
207
23.2
%
Total noninterest expense
$
20,774
$
8,947
$
11,827
132.2
%
Noninterest expense for the six months ended June 30, 2021 of $20.8 million was $11.8 million or 132.2% higher than the six months ended June 30, 2020. The predominant reason for the increase was that the Company incurred $6.2 million in merger-related expenses during the six months ended June 30, 2021. Additionally, the first half of 2021 includes the salaries of the employees of the combined company, as the effective date of merger with Fauquier was April 1, 2021.
The efficiency ratio (FTE) of 99.1% for the three months ended June 30, 2021 was elevated compared to the 59.5% for the same quarter of 2020, due primarily to the increase in noninterest expense, as described above. The efficiency ratio (FTE) of 89.5% for the six months ended June 30, 2021 was elevated compared to the 61.8% for the same period of 2020, also due to the increase in noninterest expense, as described above. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.
Provision for Income Taxes
For the three months ended June 30, 2021 and 2020, the Company provided $72 thousand and $511 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 32.9% and 19.7%, respectively. The effective income tax rate for the three months ended June 30, 2021 was higher than the prior year, as certain merger related expenses are non-deductible for tax purposes. For the six months ended June 30, 2021 and 2020, the Company provided $448 thousand and $843 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 21.3% and 19.4%, respectively. The effective income tax rate for the six months ended June 30, 2021 was higher than the prior year, as certain merger related expenses are non-deductible for tax purposes. For all periods, the effective income tax rate differed from the U.S. statutory rate of 21% due to the effect of tax-exempt income from life insurance policies and municipal bonds.
OTHER SIGNIFICANT EVENTS
None
54
ITEM 3. QUANTITATIVE AND QUALITAT IVE DISCLOSURES ABOUT MARKET RISK
Not required
Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.