Table of Contents
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2021
☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d)
For the transition period from ______ to ______
Commission file number: 0-50765
VILLAGE BANK AND TRUST FINANCIAL CORP.
(Exact name of registrant as specified in its charter)
Virginia
16-1694602
(State or other jurisdiction of
(I.R.S. Employer
incorporation or organization)
Identification No.)
13319 Midlothian Turnpike, Midlothian, Virginia
23113
(Address of principal executive offices)
(Zip code)
804-897-3900
(Registrant’s telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock, par value $4.00 per share
VBFC
Nasdaq Capital Market
Indicate by check whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large Accelerated Filer ☐
Accelerated Filer ☐
Non-Accelerated Filer ☒
Smaller Reporting Company ☒
Emerging growth company ☐
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Indicate the number of shares outstanding of each of the issuer’s classes of common equity, as of the latest practicable date.
1,473,469 shares of common stock, $4.00 par value, outstanding as of November 8, 2021
Village Bank and Trust Financial Corp.
Form 10-Q
TABLE OF CONTENTS
Part I – Financial Information
Item 1. Financial Statements
Consolidated Balance Sheets September 30, 2021 (unaudited) and December 31, 2020
3
Consolidated Statements of Income For the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)
4
Consolidated Statements of Comprehensive Income For the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)
5
Consolidated Statements of Shareholders’ Equity For the Three and Nine Months Ended September 30, 2021 and 2020 (unaudited)
6
Consolidated Statements of Cash Flows For the Nine Months Ended September 30, 2021 and 2020 (unaudited)
7
Notes to Consolidated Financial Statements (unaudited)
8
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
39
Item 3. Quantitative and Qualitative Disclosures About Market Risk
54
Item 4. Controls and Procedures
Part II – Other Information
Item 1. Legal Proceedings
55
Item 1A. Risk Factors
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Item 3. Defaults Upon Senior Securities
Item 4. Mine Safety Disclosures
Item 5. Other Information
Item 6. Exhibits
Signatures
56
2
PART I – FINANCIAL INFORMATION
ITEM 1 – FINANCIAL STATEMENTS
Village Bank and Trust Financial Corp. and Subsidiary
Consolidated Balance Sheets
September 30, 2021 (Unaudited) and December 31, 2020*
(in thousands, except share and per share data)
September 30,
December 31,
2021
2020
Assets
Cash and due from banks
$
14,362
12,709
Federal funds sold
49,918
30,742
Total cash and cash equivalents
64,280
43,451
Investment securities available for sale, at fair value
88,549
40,844
Restricted stock, at cost
694
825
Loans held for sale
13,275
34,421
Loans
Outstandings
534,306
561,003
Allowance for loan losses
(3,443)
(3,970)
Deferred fees and costs, net
(1,401)
(2,048)
Total loans, net
529,462
554,985
Other real estate owned, net of valuation allowance
—
336
Premises and equipment, net
11,940
11,779
Bank owned life insurance
12,416
7,806
Accrued interest receivable
3,569
4,943
Other assets
5,876
6,846
Total Assets
730,061
706,236
Liabilities and Shareholders’ Equity
Liabilities
Deposits
Noninterest bearing demand
270,397
222,305
Interest bearing
375,655
366,077
Total deposits
646,052
588,382
Long-term debt - trust preferred securities
8,764
Subordinated debt, net
5,652
5,628
Other borrowings
41,529
Accrued interest payable
71
194
Other liabilities
7,792
9,743
Total liabilities
668,331
654,240
Shareholders’ equity
Common stock, $4 par value, 10,000,000 shares authorized; 1,466,765 shares issued and outstanding at September 30, 2021 and 1,435,009 shares issued and outstanding at December 31, 2020
5,822
5,794
Additional paid-in capital
54,700
54,510
Retained earnings (accumulated deficit)
1,352
(8,738)
Stock in directors rabbi trust
(730)
(771)
Directors deferred fees obligation
730
771
Accumulated other comprehensive income (loss)
(144)
430
Total shareholders’ equity
61,730
51,996
Total liabilities and shareholders' equity
* Derived from audited consolidated financial statements.
See accompanying notes to consolidated financial statements.
Consolidated Statements of Income
Three and Nine Months Ended September 30, 2021 and 2020
(Unaudited)
(in thousands, except per share data)
Three Months Ended
Nine Months Ended
Interest income
6,655
6,307
20,148
17,622
Investment securities
244
230
743
740
22
32
Total interest income
6,921
6,540
20,923
18,417
Interest expense
349
728
1,275
2,502
Borrowed funds
143
341
453
1,073
Total interest expense
492
1,069
1,728
3,575
Net interest income
6,429
5,471
19,195
14,842
Provision for (recovery of) loan losses
250
(500)
950
Net interest income after provision for (recovery of) loan losses
5,221
19,695
13,892
Noninterest income
Service charges and fees
580
535
1,711
1,502
Mortgage banking income, net
2,171
2,859
7,827
6,517
Gain on sale of asset held for sale
1
Gain on sale of investment securities, net
12
Gain on sale of Small Business Administration loans
86
Other
108
344
238
Total noninterest income
3,481
9,882
8,356
Noninterest expense
Salaries and benefits
3,607
3,644
10,541
9,278
Occupancy
315
326
948
965
Equipment
267
225
788
640
Supplies
49
50
138
141
Professional and outside services
835
2,085
2,276
Advertising and marketing
99
90
347
261
Foreclosed assets, net
(8)
(152)
FDIC insurance premium
38
47
142
167
Other operating expense
532
534
1,716
1,588
Total noninterest expense
5,637
5,755
16,697
15,164
Income before income tax expense
3,651
2,947
12,880
7,084
Income tax expense
752
678
2,790
1,582
Net income
2,899
2,269
10,090
5,502
Earnings per share, basic
1.97
1.55
6.88
3.78
Earnings per share, diluted
Consolidated Statements of Comprehensive Income
Three and Nine Months ended September 30, 2021 and 2020
(in thousands)
Other comprehensive income (loss)
Unrealized holding gains (losses) arising during the period
(237)
(52)
(736)
386
Tax effect
11
156
(81)
Net change in unrealized holding gains (losses) on securities available for sale, net of tax
(187)
(41)
(580)
305
Reclassification adjustment
Reclassification adjustment for gains realized in income
(12)
Reclassification for gains included in net income, net of tax
(9)
Minimum pension adjustment
9
(1)
(3)
Minimum pension adjustment, net of tax
Total other comprehensive income (loss)
(185)
(39)
(574)
302
Total comprehensive income
2,714
2,230
9,516
5,804
Consolidated Statements of Shareholders' Equity
(In thousands)
Three Months Ended September 30, 2021
Directors
Accumulated
Additional
Stock in
Deferred
Common
Paid-in
Retained
Fees
Comprehensive
Stock
Capital
Earnings
Rabbi Trust
Obligation
Income (loss)
Total
Balance, June 30, 2021
5,796
54,691
(1,547)
41
58,981
Vesting of restricted stock
26
(26)
Stock based compensation
35
Other comprehensive loss
Balance, September 30, 2021
Three Months Ended September 30, 2020
Deficit
Balance, June 30, 2020
5,779
54,414
(14,059)
483
46,617
(11)
28
Balance, September 30, 2020
5,790
54,431
(11,790)
444
48,875
Nine Months Ended September 30, 2021
Loss
Balance, December 31, 2020
(28)
218
Nine Months Ended September 30, 2020
Balance, December 31, 2019
54,285
(17,292)
(856)
856
42,914
85
(85)
157
Other comprehensive income
See accompanying notes to consolidated financial statements
Consolidated Statements of Cash Flows
Nine Months Ended September 30, 2021 and 2020
Cash Flows from Operating Activities
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
Depreciation and amortization
447
442
Amortization of debt issuance costs
24
25
Deferred income taxes
499
905
Write-down of other real estate owned
10
16
Gain on sale of investment securities
Gain on sales of loans held for sale
(9,608)
(6,517)
Gain on sale of assets held for sale
Gain on sale of other real estate owned
(18)
(175)
Loss on sale and disposal of premises and equipment
Stock compensation expense
Proceeds from sale of mortgage loans
271,454
247,205
Origination of mortgage loans held for sale
(240,700)
(255,491)
Amortization of premiums and accretion of discounts on securities, net
189
159
Increase in bank owned life insurance
(202)
Net change in:
Interest receivable
1,374
(2,283)
633
1,669
Interest payable
(123)
(1,951)
608
Net cash provided by (used in) operating activities
31,846
(6,975)
Cash Flows from Investing Activities
Purchases of available for sale securities
(62,613)
(3,387)
Proceeds from the sale of available for sale securities
7,936
Proceeds from the sale of assets held for sale
515
Proceeds from maturities, calls and paydowns of available for sale securities
13,983
6,309
Net decrease (increase) in loans
26,023
(166,510)
Proceeds from sale of other real estate owned
Purchases of premises and equipment, net
(618)
(117)
Purchase of bank owned life insurance
(4,408)
Redemptions (purchase) of restricted stock, net
131
(447)
Net cash used in investing activities
(27,158)
(155,352)
Cash Flows from Financing Activities
Net increase in deposits
57,670
130,644
Repayments of Federal Home Loan Bank advances
10,000
Net (decrease) increase in other borrowings
(41,529)
39,803
Net cash provided by financing activities
16,141
180,447
Net increase in cash and cash equivalents
20,829
18,120
Cash and cash equivalents, beginning of period
19,967
Cash and cash equivalents, end of period
38,087
Supplemental Disclosure of Cash Flow Information
Cash payments for interest
1,851
3,565
Supplemental Schedule of Non-Cash Activities
Unrealized gains on securities available for sale
373
Right of use assets obtained in exchange for new operating lease liabilities
243
Notes to Consolidated Financial Statements
Note 1 – Principles of presentation
Village Bank and Trust Financial Corp. (the “Company”) is the holding company of Village Bank (the “Bank”). The consolidated financial statements include the accounts of the Company, the Bank and the Bank’s subsidiary, Village Bank Mortgage Corporation. All material intercompany balances and transactions have been eliminated in consolidation.
In the opinion of management, the accompanying condensed consolidated financial statements of the Company have been prepared on the accrual basis in accordance with generally accepted accounting principles for interim financial information. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. However, all adjustments that are, in the opinion of management, necessary for a fair presentation have been included. The results of operations for the three and nine month periods ended September 30, 2021 are not necessarily indicative of the results to be expected for the full year ending December 31, 2021. The unaudited interim financial statements should be read in conjunction with the audited financial statements and notes to financial statements that are presented in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 as filed with the Securities and Exchange Commission (“SEC”).
Note 2 – Use of estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America (“GAAP”) requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the balance sheets and statements of income for the period. Actual results could differ significantly from those estimates. Material estimates that are particularly susceptible to significant change include the determination of the allowance for loan losses and its related provision including impaired loans and troubled debt restructurings (“TDRs”).
Note 3 – Earnings per common share
The following table presents the basic and diluted earnings per common share computation (in thousands, except per share data):
Three Months Ended September 30,
Nine Months Ended September 30,
Numerator
Net income - basic and diluted
Denominator
Weighted average shares outstanding - basic
1,468
1,462
1,467
1,456
Dilutive effect of common stock options
Weighted average shares outstanding - diluted
Earnings per share - basic
Earnings per share - diluted
Applicable guidance requires that outstanding, unvested share-based payment awards that contain voting rights and rights to nonforfeitable dividends participate in undistributed earnings with common shareholders. Accordingly, the weighted average number of shares of the Company’s common stock used in the calculation of basic and diluted net income per common share includes unvested shares of the Company’s outstanding restricted common stock.
The vesting of 5,793 and 6,573 at September 30, 2021 and 2020, respectively, of the unvested restricted units included in Note 10 “Stock incentive plan” was dependent upon meeting certain performance criteria. As of September 30, 2021 and 2020, it was indeterminable
whether these unvested restricted units would vest and as such the underlying shares were excluded from common shares issued and outstanding at such date and were not included in the computation of earnings per share for such period.
Note 4 – Investment securities available for sale
The amortized cost and fair value of investment securities available for sale as of September 30, 2021 and December 31, 2020 are as follows (in thousands):
Gross
Amortized
Unrealized
Cost
Gains
Losses
Fair Value
September 30, 2021
U.S. Government agency obligations
41,791
(2)
41,830
Mortgage-backed securities
35,861
389
(434)
35,816
Municipals
2,272
(90)
2,182
Subordinated debt
8,772
65
(116)
8,721
88,696
495
(642)
December 31, 2020
8,048
94
8,142
23,412
645
(51)
24,006
8,795
37
(136)
8,696
40,255
776
At September 30, 2021 and December 31, 2020, the Company had no investment securities pledged to secure borrowings from the Federal Home Loan Bank of Atlanta ("FHLB").
Gross realized gains and losses pertaining to available for sale securities are detailed as follows for the periods indicated (in thousands):
Gross realized gains
Gross realized losses
(27)
The Company sold approximately $7,900,000 of investment securities available for sale at a net gain of $12,000 for the nine months ended September 30, 2020. The sales of these securities, which had fixed interest rates, allowed the Company to decrease its exposure to upward movement in interest rates that would result in unrealized losses being recognized in shareholders’ equity.
Investment securities available for sale that have an unrealized loss position at September 30, 2021 and December 31, 2020 are detailed below (in thousands):
Securities in a loss
position for less than
position for more than
12 Months
Fair
Value
29,812
24,075
(412)
1,730
(22)
25,805
2,181
929
(71)
959
(45)
1,888
56,997
(575)
2,689
(67)
59,686
5,475
1,747
2,807
(125)
4,554
7,222
(62)
10,029
As of September 30, 2021, there were 19 investments available for sale totaling $56,997,000 that were in a continuous loss position for less than 12 months and had an unrealized loss of $575,000. There were three investments available for sale totaling $2,689,000 that had been in a continuous loss position for more than 12 months and had an unrealized loss of $67,000.
All of the unrealized losses are attributable to movements in interest rates and not to credit deterioration. Currently, the Company believes that it is probable that the Company will be able to collect all amounts due according to the contractual terms of the investments. Because the decline in fair value is attributable to changes in interest rates and not to credit quality, and because it is not more likely than not that the Company will be required to sell the investments before recovery of their amortized cost bases, which may be maturity, the Company does not consider these investments to be other than temporarily impaired at September 30, 2021.
The amortized cost and estimated fair value of investment securities available for sale as of September 30, 2021, by contractual maturity, are as follows (in thousands):
Less than one year
40,158
40,157
One to five years
165
166
Five to ten years
11,127
11,160
More than ten years
37,246
37,066
Note 5 – Loans and allowance for loan losses
Loans classified by type as of September 30, 2021 and December 31, 2020 are as follows (dollars in thousands):
Amount
%
Construction and land development
Residential
8,981
1.68
8,103
1.44
Commercial
41,810
7.82
21,466
3.82
50,791
9.50
29,569
5.26
Commercial real estate
Owner occupied
106,499
19.93
99,784
17.79
Non-owner occupied
130,867
24.49
121,184
21.60
Multifamily
12,027
2.25
9,889
1.75
Farmland
1,099
0.21
367
0.07
250,492
46.88
231,224
41.21
Consumer real estate
Home equity lines
17,194
3.22
18,394
3.28
Secured by 1-4 family residential,
First deed of trust
55,918
10.47
57,089
10.18
Second deed of trust
14,172
2.65
11,097
1.98
87,284
16.34
86,580
15.44
Commercial and industrial loans
(except those secured by real estate)
115,129
21.55
181,088
32.28
Guaranteed student loans
27,624
5.17
29,657
5.29
Consumer and other
2,986
0.56
2,885
0.51
Total loans
100.0
Less: allowance for loan losses
The Bank has a purchased portfolio of rehabilitated student loans guaranteed by the Department of Education (“DOE”). The guarantee covers approximately 98% of principal and accrued interest. The loans are serviced by a third-party servicer that specializes in handling the special needs of the DOE student loan programs.
Small Business Administration ("SBA") Paycheck Protection Program ("PPP") loans, included in commercial and industrial loans in the above table, were $56,809,000 and $136,674,000 as of September 30, 2021 and December 31, 2020, respectively.
Loans pledged as collateral with the FHLB as part of their lending arrangement with the Company totaled $41,571,000 and $65,587,000 as of September 30, 2021 and December 31, 2020, respectively.
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on nonaccrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on nonaccrual status regardless of whether or not such loans are considered past due as long as the remaining recorded investment in the loan is deemed fully collectible. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all principal and interest amounts contractually due are brought current and future payments are reasonably assured.
The following table provides information on nonaccrual loans segregated by type at the dates indicated (in thousands):
292
303
300
Secured by 1-4 family residential
618
630
240
317
1,158
1,247
27
1,472
1,577
The Company assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:
The following tables provide information on the risk rating of loans at the dates indicated (in thousands):
Risk Rated
1‑4
39,173
2,637
48,154
95,415
7,496
3,588
121,446
9,129
229,987
16,625
3,880
16,269
625
52,798
2,316
804
13,473
432
82,540
3,373
1,371
112,959
1,890
280
2,952
34
504,216
24,559
5,531
21,370
96
29,473
88,066
9,405
2,313
116,161
4,244
779
214,483
13,649
3,092
17,298
796
53,731
2,212
1,146
9,425
1,236
436
80,454
1,882
178,217
2,602
269
2,844
535,128
20,632
5,243
13
The following table presents the aging of the recorded investment in past due loans and leases as of the dates indicated (in thousands):
Greater
Investment >
30‑59 Days
60‑89 Days
Than
Total Past
90 Days and
Past Due
90 Days
Due
Current
Accruing
Secured by 1‑4 family residential
92
55,826
87,192
412
114,717
1,092
393
2,496
3,981
23,643
1,184
805
4,485
529,821
14
Recorded
30-59 Days
60-89 Days
99,698
231,138
133
56,956
57
11,040
190
86,390
181,063
1,428
1,009
2,193
4,630
25,027
2,884
1,673
1,066
4,932
556,071
Loans greater than 90 days past due are student loans that are guaranteed by the DOE which covers approximately 98% of the principal and interest. Accordingly, these loans will not be placed on nonaccrual status and are not considered to be impaired.
Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts when due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, non-guaranteed loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or
15
portions thereof, are charged off when deemed uncollectible. Impaired loans are set forth in the following table as of the dates indicated (in thousands):
Unpaid
Principal
Related
Investment
Balance
Allowance
With no related allowance recorded
5,106
5,121
2,780
2,795
1,843
1,991
6,949
6,964
4,771
4,786
1,850
1,937
1,940
692
699
992
2,842
2,926
2,936
3,232
9,985
10,084
7,848
8,159
With an allowance recorded
1,125
148
74
3,905
3,920
5,896
5,911
1,998
2,011
2,014
2,990
3,074
3,010
3,306
10,133
10,232
9,047
9,358
17
The following is a summary of average recorded investment in impaired loans with and without a valuation allowance and interest income recognized on those loans for the periods indicated (in thousands):
For the Three Months Ended
For the Nine Months Ended
Average
Interest
Income
Recognized
5,176
40
4,569
136
1,870
1,900
7,046
67
6,469
222
19
1,942
20
882
690
3,124
46
2,930
123
199
184
10,369
113
9,583
346
281
150
4,850
151
6,750
237
2,092
2,071
72
3,274
51
3,061
130
10,519
118
9,995
368
Included in impaired loans are loans classified as TDRs. A modification of a loan’s terms constitutes a TDR if the creditor grants a concession to the borrower for economic or legal reasons related to the borrower’s financial difficulties that it would not otherwise consider. For loans classified as impaired TDRs, the Company further evaluates the loans as performing or nonaccrual. To restore a nonaccrual loan that has been formally restructured in a TDR to accrual status, we perform a current, well documented credit analysis supporting a return to accrual status based on the borrower’s financial condition and prospects for repayment under the revised terms. Otherwise, the TDR must remain in nonaccrual status. The analysis considers the borrower’s sustained historical repayment performance for a reasonable period to the return-to-accrual date, but may take into account payments made for a reasonable period prior to the restructuring if the payments are consistent with the modified terms. A sustained period of repayment performance generally would be a minimum of six months and would involve payments in the form of cash or cash equivalents.
An accruing loan that is modified in a TDR can remain in accrual status if, based on a current well-documented credit analysis, collection of principal and interest in accordance with the modified terms is reasonably assured, and the borrower has demonstrated sustained historical repayment performance for a reasonable period before modification. The following is a summary of performing and nonaccrual TDRs and the related specific valuation allowance by portfolio segment for the periods indicated (dollars in thousands).
Specific
Valuation
Performing
Nonaccrual
3,287
1,551
5,130
4,838
First deeds of trust
1,679
1,140
539
Second deeds of trust
511
452
59
2,190
1,592
598
7,342
6,430
912
Number of loans
3,396
1,688
5,387
5,084
1,460
910
550
617
556
61
2,077
1,466
611
7,491
6,550
941
18
The following table provides information about TDRs identified during the indicated periods (dollars in thousands).
September 30, 2020
Pre-
Post-
Modification
Number of
Commercial real estate Non-owner occupied
311
There were no TDR’s identified during the three months ended September 30, 2021 and 2020.
There were no defaults on TDR’s that were modified as TDRs during the prior 12 month period ended September 30, 2021 and 2020.
The Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), as amended by the Consolidated Appropriations Act 2021 (“CAA”), permits financial institutions to suspend requirements under GAAP for loan modifications to borrowers affected by COVID-19 that would otherwise be characterized as TDRs and suspend any determination related thereto if (i) the loan modification is made between March 1, 2020 and the earlier of January 1, 2022 or 60 days after the end of the COVID-19 emergency declaration and (ii) the applicable loan was not more than 30 days past due as of December 31, 2019. In addition, federal bank regulatory authorities have issued guidance to encourage financial institutions to make prudent loan modifications for borrowers affected by COVID-19 and have assured financial institutions that they will neither receive supervisory criticism for such prudent loan modifications, nor be required by examiners to automatically categorize COVID-19-related loan modifications as TDRs. As of September 30, 2021, all previously modified loans had returned to contractual payment terms. As of December 31, 2020, the Company had approximately $38.0 million in loans still under their modified terms. The Company’s modification program primarily included payment deferrals and interest only modifications.
Activity in the allowance for loan losses is as follows for the periods indicated (in thousands):
Provision for
Beginning
(Recovery of)
Ending
Loan Losses
Charge-offs
Recoveries
66
76
203
231
307
802
58
860
1,059
30
1,089
36
1,898
89
1,987
111
21
196
(6)
212
422
480
Student loans
80
70
(4)
Unallocated
528
(173)
355
3,429
3,443
213
(23)
204
295
23
318
508
522
904
1,022
1,202
171
1,373
48
2,153
2,445
(30)
(7)
160
75
44
45
327
348
101
(10)
97
(13)
359
(86)
273
3,759
64
4,050
214
(138)
285
(54)
(192)
1,047
1,421
(346)
2,517
(544)
(65)
79
(84)
(31)
408
87
(24)
154
201
3,970
(126)
139
137
181
185
320
671
351
831
542
(37)
1,589
271
(261)
343
(188)
42
(407)
572
(114)
(135)
(36)
(17)
249
3,186
102
Year Ended December 31, 2020
289
376
590
(38)
928
(247)
(190)
(392)
68
(58)
29
(48)
(292)
126
The amount of the loan loss provision (recovery) is determined by an evaluation of the level of loans outstanding, the level of nonperforming loans, historical loan loss experience, delinquency trends, underlying collateral values, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions. Loans originated under PPP are not considered in the evaluation of the allowance for loan losses because these loans carry a 100% guarantee from the SBA; however, if the collectability on the guarantee on a loan is at risk that loan will be included in the evaluation of the allowance for loan losses.
The level of the allowance reflects changes in the size of the portfolio or in any of its components as well as management’s continuing evaluation of industry concentrations, specific credit risk, loan loss experience, current loan portfolio quality, and present economic, political and regulatory conditions. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgement, should be charged off. While management utilizes its best judgement and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
The Company recorded a recovery of provision expense of $500,000 for the nine month period ended September 30, 2021 compared to a provision expense of $950,000 for the nine month period ended September 30, 2020. The recovery of provision for the nine month period ended September 30, 2021 resulted from a reduction in qualitative factors which was driven by improving economic factors, improved credit metrics, and reductions in loan deferrals. The provision expense for the nine month period ended September 30, 2020 was the result of an increase in the qualitative factors driven by economic uncertainty surrounding the COVID-19 pandemic. While the Delta variant of the COVID-19 virus remains a risk to credit quality, we believe our current level of allowance for loan losses is sufficient.
The allowance for loan losses at each of the periods presented includes an amount that could not be identified to individual types of loans referred to as the unallocated portion of the allowance. We recognize the inherent imprecision in estimates of losses due to various uncertainties and the variability related to the factors used in calculation of the allowance. The allowance for loan losses included an unallocated portion of approximately $355,000, $154,000, and $273,000 at September 30, 2021, December 31, 2020, and September 30, 2020, respectively.
Loans were evaluated for impairment as follows for the periods indicated (in thousands):
Recorded Investment in Loans
Individually
Collectively
101,393
129,024
243,543
16,894
104
53,920
13,480
205
84,294
114,935
387
3,436
524,173
1,038
95,879
119,193
2,508
225,328
18,094
158
55,078
10,398
83,570
180,947
3,953
551,956
Note 6 – Deposits
Deposits as of September 30, 2021 and December 31, 2020 were as follows (dollars in thousands):
Demand accounts
41.9
37.8
Interest checking accounts
76,693
11.9
70,342
Money market accounts
183,096
28.3
152,726
26.0
Savings accounts
46,750
7.2
38,083
6.5
Time deposits of $250,000 and over
8,189
1.3
16,014
2.7
Other time deposits
60,927
9.4
88,912
15.1
Note 7 – Borrowings
The Company uses both short-term and long-term borrowings to supplement deposits when they are available at a lower overall cost to the Company or they can be invested at a positive rate of return.
As a member of the Federal Home Loan Bank of Atlanta, the Bank is required to own capital stock in the FHLB and is authorized to apply for advances from the FHLB. The Company held $353,000 in FHLB stock at September 30, 2021 and $484,000 at December 31, 2020, which is held at cost. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses to which the advances may be put, as well as on the size of the advances and repayment provisions. The FHLB borrowings are secured by the pledge of commercial, 1-4 family residential loans. The Company had no outstanding FHLB advances at September 30, 2021 or December 31, 2020.
Through the Federal Reserve Bank of Richmond, the Company could borrow funds through the Paycheck Protection Program Liquidity Fund (“PPPLF”), which were secured by the Company’s PPP loans. The PPPLF ceased extending credit on July 30, 2021. The Company did not have outstanding advances under the PPPLF at September 30, 2021 and had $41.5 million in outstanding advances under the PPPLF at December 31, 2020. The Company’s available borrowing capacity under the PPPLF was $95.2 million as of December 31, 2020.
The Company uses federal funds purchased and repurchase agreements for short-term borrowing needs. Securities sold under agreements to repurchase are classified as borrowings and generally mature within one to four days from the transaction date. Securities sold under agreements to repurchase are reflected at the amount of cash received in connection with the transaction. The Company may be required to provide additional collateral based on the fair value of the underlying securities. There were no borrowings against the lines at September 30, 2021 or December 31, 2020.
The Company’s unused lines of credit for future borrowings total approximately $73.1 million at September 30, 2021, which consists of $30.3 million available from the FHLB, $10 million on revolving bank line of credit, $7.8 million under secured federal funds agreements with third party financial institutions, and $25 million in repurchase lines of credit with third party financial institutions. Additional loans and securities are available that can be pledged as collateral for future borrowings from the Federal Reserve Bank of Richmond or the FHLB above the current lendable collateral value.
Note 8 – Trust preferred securities
During the first quarter of 2005, Southern Community Financial Capital Trust I, a wholly-owned unconsolidated subsidiary of the Company, was formed for the purpose of issuing redeemable securities. On February 24, 2005, $5.2 million of Trust Preferred Capital Notes were issued through a pooled underwriting. The securities have a floating rate of interest indexed to the London InterBank Offered Rate (“LIBOR”) (three-month LIBOR plus 2.15)% which adjusts, and is payable, quarterly. The interest rate at September 30, 2021 was 2.27%. The securities were redeemable at par beginning on March 15, 2010 and each quarter after such date until the securities mature on March 15, 2035. No amounts have been redeemed at September 30, 2021 and there are no plans to do so. The principal asset of the Trust is $5.2 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.
During the third quarter of 2007, Village Financial Statutory Trust II, a wholly-owned unconsolidated subsidiary of the Company, was formed for the purpose of issuing redeemable securities. On September 20, 2007, $3.6 million of Trust Preferred Capital Notes were issued through a pooled underwriting. The securities have LIBOR-indexed floating rate of interest (three-month LIBOR plus 1.4)% which adjusts, and is also payable, quarterly. The interest rate at September 30, 2021 was 1.52%. The securities may be redeemed at par at any time commencing in December 2012 until the securities mature in 2037. No amounts have been redeemed at September 30, 2021 and there are no plans to do so. The principal asset of the Trust is $3.6 million of the Company’s junior subordinated debt securities with like maturities and like interest rates to the Trust Preferred Capital Notes.
The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. The portion of the Trust Preferred Capital Notes not considered as Tier 1 capital may be included in Tier 2 capital.
The obligations of the Company with respect to the issuance of the Trust Preferred Capital Notes constitute a full and unconditional guarantee by the Company of the Trust’s obligations with respect to the Trust Preferred Capital Notes. Subject to certain exceptions and limitations, the Company may elect from time to time to defer interest payments on the junior subordinated debt securities, which would result in a deferral of distribution payments on the related Trust Preferred Capital Notes and require a deferral of common dividends. The Company is current on these interest payments.
Note 9 – Subordinated Debt
On March 21, 2018, the Company issued $5,700,000 of fixed-to-floating rate subordinated notes due March 31, 2028 in a private placement. The Company received $5,539,000 in net proceeds after deducting issuance costs. The subordinated notes accrue interest at a fixed rate of 6.50% for the first five years until March 31, 2023; thereafter, the subordinated notes will accrue interest at an annual floating rate equal to three-month LIBOR plus a spread of 3.73% until maturity or early redemption. The Company may redeem the subordinated notes in whole or in part, on or after March 31, 2023. The subordinated notes are unsecured and subordinated in right of payment to all of the Company’s existing and future senior indebtedness, whether secured or unsecured, including claims of depositors and general creditors, and rank equally in right of payment with any unsecured, subordinated indebtedness that the Company may incur in the future. The carrying value of the notes totaled $5,652,000 and $5,628,000 at September 30, 2021 and December 31, 2020, respectively.
Note 10 – Stock incentive plan
In accordance with accounting standards, the Company measures the cost of employee services received in exchange for an award of equity instruments based on the grant-date fair value of the award (with limited exceptions). That cost is recognized over the period during which an employee is required to provide service in exchange for the award rather than disclosed in the financial statements.
The following table summarizes options outstanding under the Company's stock incentive plans at the indicated dates:
Weighted
Exercise
Intrinsic
Options
Price
Per Share
Options outstanding, beginning of period
734
25.63
9.76
Granted
Forfeited
Exercised
Options outstanding, end of period
Options exercisable, end of period
During 2020, we granted certain officers time-based restricted shares of common stock and performance-based restricted stock units. The time-based restricted shares vest ratably over a three year period provided the officer is employed with the Company on the applicable vesting date. The performance-based units, which have a two-year performance period that began on January 2, 2021, vest based on the Company’s achievement of performance targets related to return on tangible common equity and the adversely classified items ratio over the performance period with possible payouts ranging from 0% to 150% of the target awards.
The total number of shares underlying non-vested restricted stock was 17,077 and 24,736 at September 30, 2021 and 2020, respectively. The fair value of the stock is based on the grant date of the award and the expense is recognized over the vesting period. Unamortized stock-based compensation related to non-vested share-based compensation arrangements granted under the stock incentive plan as of September 30, 2021 and 2020 was $437,600 and $271,600, respectively. The time-based unrecognized compensation of $297,500 is expected to be recognized over a weighted average period of 1.60 years. For the period ended September 30, 2021, there were no forfeitures, and for the period ended September 30, 2020, there 1,094 forfeitures of restricted stock and restricted stock units.
A summary of changes in the Company’s non-vested restricted stock and restricted stock unit awards for the nine months ended September 30, 2021 follows:
Weighted-
Aggregate
Grant-Date
Shares
Fair-Value
25,247
30.88
1,305,270
Vested
(8,771)
31.23
(453,461)
601
31.86
31,072
17,077
30.73
882,881
Stock-based compensation expense was approximately $35,000 and $218,000 for the three and nine months ended September 30, 2021, respectively compared to $28,000 and $157,000 for the three and nine months ended September 30, 2020, respectively.
Note 11 – Fair value
The Company determines the fair value of its financial instruments based on the requirements established in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification ("ASC") 820: Fair Value Measurements, which provides a framework for measuring fair value under GAAP and requires an entity to maximize the use of observable inputs when measuring fair value. ASC 820 defines fair value as the exit price, the price that would be received for an asset or paid to transfer a liability, in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date under current market conditions.
ASC 820 establishes a hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair values hierarchy is as follows:
Level 1 Inputs — Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2 Inputs — Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3 Inputs — Significant unobservable inputs that reflect a company’s own assumptions about the assumptions that market participants would use in pricing an asset or liability.
The Company used the following methods to determine the fair value of each type of financial instrument:
Securities: Fair values for securities available-for-sale are obtained from an independent pricing service. The prices are not adjusted. The independent pricing service uses industry-standard models to price U.S. Government agency obligations and mortgage backed securities that consider various assumptions, including time value, yield curves, volatility factors, prepayment speeds, default rates, loss severity, current market and contractual prices for the underlying financial instruments, as well as other relevant economic measures. Securities of obligations of state and political subdivisions are valued using a type of matrix, or grid, pricing in which securities are benchmarked against the treasury rate based on credit rating. Substantially all assumptions used by the independent pricing service are observable in the marketplace, can be derived from observable data, or are supported by observable levels at which transactions are executed in the marketplace (Levels 1 and 2). If the inputs used to provide the evaluation for certain securities are unobservable and/or there is little, if any, market activity, then the security would fall to the lowest level of the hierarchy (Level 3).
Impaired loans: The Company does not record loans held for investment at fair value on a recurring basis. However, there are instances when a loan is considered impaired and an allowance for loan losses is established. The Company measures impairment either based on the fair value of the loan using the loan’s obtainable market price or the fair value of the collateral if the loan is collateral dependent, or using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. The Company maintains a valuation allowance to the extent that this measure of the impaired loan is less than the recorded investment in the loan. When an impaired loan is measured at fair value based solely on observable market prices or a current appraisal without further adjustment for unobservable inputs, the Company records the impaired loan as a nonrecurring fair value measurement classified as Level 2. However, if based on management’s review, additional discounts to observed market prices or appraisals are required or if observable inputs are not available, the Company records the impaired loan as a nonrecurring fair value measurement classified as 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
Loans held for sale: Fair value of the Company's loans held for sale is based on observable market prices for similar instruments traded in the secondary mortgage loan markets in which the Company conducts business. The Company's portfolio of loans held for sale is classified as Level 2. Gains and losses on the sale of loans are recorded within mortgage banking income, net on the Consolidated Statements of Income.
Derivative asset – interest rate lock commitments (“IRLCs”): The Company recognizes IRLCs at fair value based on the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis while taking into consideration the probability that the rate lock commitments will close. All of the Company's IRLCs are classified as Level 2.
Derivative asset/liability – forward sale commitments: Best efforts sale commitments are entered into for loans intended for sale in the secondary market at the time the borrower commitment is made. The best efforts commitments are valued using the committed price to the counter-party against the current market price of the interest rate lock commitment or mortgage loan held for sale. All of the Company’s forward sale commitments are classified as Level 2.
Other Real Estate Owned ("OREO"): OREO assets are initially recorded at fair value less costs to sell when acquired, establishing a new cost basis. Subsequently, OREO assets are carried at lower of cost or fair value less estimated costs to sell. Fair value is based upon independent market prices, appraised values of the collateral or management’s estimation of the value of the collateral. When the fair value of the collateral is based on an observable market price or a current appraised value, the Company records the foreclosed asset as nonrecurring Level 2. When an appraised value is not available or management determines the fair value of the collateral is further impaired below the appraised value and there is no observable market price, the Company records the foreclosed asset as nonrecurring Level 3.
Assets and liabilities measured at fair value under Topic 820 on a recurring and non-recurring basis are summarized below for the indicated dates (dollars in thousands):
Fair Value Measurement
at September 30, 2021 Using
Quoted Prices
in Active
Significant
Markets for
Observable
Unobservable
Carrying
Identical Assets
Inputs
(Level 1)
(Level 2)
(Level 3)
Financial Assets - Recurring
US Government Agencies
7,921
IRLC
513
Financial Liabilities - Recurring
Forward sales commitment
842
at December 31, 2020 Using
8,446
1,552
3,105
Financial Assets - Non-Recurring
Other real estate owned
The following table presents qualitative information about Level 3 fair value measurements for financial instruments measured on a non-recurring basis at fair value at December 31, 2020, there were no outstanding level 3 instruments at September 30, 2021 (dollars in thousands):
Range
(Weighted
Estimate
Techniques
Input
Average)
Appraisal (1) or Internal Valuation (2)
Selling costs
6%-10% (7%)
(1) Fair Value is generally determined through independent appraisals of the underlying collateral, which generally includes various Level 3 inputs which are not identifiable.
(2) Internal valuations may be conducted to determine Fair Value for assets with nominal carrying balances.
ASC 825, Financial Instruments, requires disclosure about fair value of financial instruments, including those financial assets and financial liabilities that are not required to be measured and reported at fair value on a recurring or nonrecurring basis. ASC 825 excludes certain financial instruments and all nonfinancial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company. In accordance with Accounting Standards Update ("ASU") 2016-01, the Company uses the exit price notion, rather than the entry price notion, in calculating the fair values of financial instruments not measured at fair value on a recurring basis.
The following tables reflect the carrying amounts and estimated fair values of the Company’s financial instruments whether or not recognized on the Consolidated Balance Sheets at fair value.
Level in Fair
Estimated
Hierarchy
Financial assets
Cash
Level 1
Cash equivalents
Level 2
Investment securities available for sale
40,407
1,193
47,592
48,142
39,401
Level 3
Federal Home Loan Bank stock
353
484
535,555
562,362
Interest rate lock commitments
Financial liabilities
645,989
589,017
Trust preferred securities
9,601
9,697
47,157
Note 12 – Segment Reporting
The Company has two reportable segments: traditional commercial banking and mortgage banking. Revenues from commercial banking operations consist primarily of interest earned on loans and securities and fees from deposit services. Mortgage banking operating revenues consist principally of interest earned on mortgage loans held for sale, gains on sales of loans in the secondary mortgage market, and loan origination fee income.
The Commercial Banking Segment provides the Mortgage Banking Segment with the short-term funds needed to originate mortgage loans through a warehouse line of credit and charges the Mortgage Banking Segment interest based on the Commercial Banking Segment’s cost of funds. Additionally, the Mortgage Banking Segment leases premises from the Commercial Banking Segment. These transactions are eliminated in the consolidation process.
The following table presents segment information as of and for the three and nine months ended September 30, 2021 and 2020 (in thousands):
Mortgage
Consolidated
Banking
Eliminations
Totals
Revenues
6,818
Gain on sale of loans
2,704
Other revenues
733
228
(70)
891
Total revenues
7,551
3,036
10,516
Expenses
493
2,632
975
Commissions
736
Other expenses
1,738
362
2,030
Total operating expenses
4,863
2,073
6,865
Income before income taxes
2,688
963
202
2,138
761
Total assets
733,611
19,417
(22,967)
(46)
3,585
666
7,096
4,087
(108)
11,075
Provision for loan losses
2,526
1,118
1,054
1,873
2,111
5,718
2,518
8,128
1,378
1,569
329
1,029
1,240
728,707
13,789
(15,132)
727,364
31
20,606
9,608
(205)
2,679
22,796
10,643
(229)
33,210
7,274
3,267
2,405
5,372
989
6,156
13,874
6,685
20,330
8,922
3,958
1,959
6,963
3,127
18,107
401
(91)
8,014
1,970
820
(179)
2,611
20,077
9,235
(270)
29,042
91
6,362
2,916
5,187
878
5,886
16,074
6,154
21,958
4,003
3,081
935
647
3,068
2,434
Note 13 – Shareholders’ Equity and Regulatory Matters
Accumulated Other Comprehensive Income
The following table presents the cumulative balances of the components of accumulated other comprehensive income (loss) , net of deferred taxes of $38,000 and $114,000 as of September 30, 2021 and December 31, 2020, respectively (in thousands):
Net unrealized gains (losses) on securities
466
Net unrecognized losses on defined benefit plan
Total accumulated other comprehensive income (loss)
Regulatory Matters
The Company meets the eligibility criteria of a small bank holding company in accordance with the Board of Governors of the Federal Reserve System’s (“Federal Reserve”) Small Bank Holding Company Policy Statement (the “SBHC Policy Statement”). On August 28, 2018, the Federal Reserve issued an interim final rule required by the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018, which was signed into law on May 24, 2018 (the “EGRRCPA”), that expands the applicability of the SBHC Policy Statement to bank holding companies with total consolidated assets of less than $3 billion (up from the prior $1 billion threshold). Under the SBHC Policy Statement, qualifying bank holding companies, such as the Company, have additional flexibility in the amount of debt they can issue and are also exempt from the Basel III capital framework as outlined by the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act (the "Basel III Capital Rules"). The SBHC Policy Statement does not apply to the Bank and the Bank must comply with the Basel III Capital Rules.
The Basel III Capital Rules require banks to comply with the following minimum capital ratios: (1) 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)%; (2) 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)%; (3) 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 (4) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter). The phase-in of the capital conservation buffer requirement began on January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until it was fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking organizations with a ratio of common equity Tier 1 capital to risk-weighted assets above the minimum but below the conservation buffer face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall. As of September 30, 2021, the Bank exceeded the minimum ratios under the Basel III Capital Rules.
The Bank must also comply with the capital requirements set forth in the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Act of 1950. To be well capitalized under these regulations, a bank must have the following minimum capital ratios: (1) a common equity Tier 1 capital ratio of at least 6.5%; (2) a Tier 1 risk-based capital ratio of at least 8.0%; (3) a total risk-based capital ratio of at least 10.0%; and (4) a leverage ratio of at least 5.0%. As of September 30, 2021, the Bank exceeded the minimum ratios to be classified as well capitalized.
33
On September 17, 2019, the federal bank regulators issued a final rule required by the EGRRCPA that permits qualifying banks and bank holding companies that have less than $10 billion of assets, like the Company and the Bank, to elect to be subject to a 9% leverage ratio that would be applied using less complex leverage calculations (commonly referred to as the community bank leverage ratio or “CBLR”). Under the rule, which became effective January 1, 2020, banks and bank holding companies that opt into the CBLR framework and maintain a CBLR of greater than 9% would not be subject to other risk-based and leverage capital requirements under the Basel III Capital Rules and would be deemed to have met the well capitalized ratio requirements under the “prompt corrective action” framework. In April 2020, as required by the CARES Act, which was passed in response to the COVID-19 pandemic, federal bank regulators issued two interim final rules related to the CBLR framework. One interim final rule provides that, as of the second quarter of 2020, banking organizations with leverage ratios of 8% or greater (and that meet the other existing qualifying criteria) may elect to use the CBLR framework. It also establishes a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall below the 8% CBLR requirement, so long as the banking organization maintains a leverage ratio of 7% or greater. The second interim final rule provides a transition from the temporary 8% CBLR requirement to a 9% CBLR requirement. It establishes a minimum CBLR of 8% for the second through fourth quarters of 2020, 8.5% for 2021, and 9% thereafter, and maintains a two-quarter grace period for qualifying community banking organizations whose leverage ratios fall no more than 100 basis points below the applicable CBLR requirement. The Bank elected not to opt into the CBLR framework as of September 30, 2021 and December 31, 2020.
The capital amounts and ratios at September 30, 2021 and December 31, 2020 for the Bank are presented in the table below (dollars in thousands):
For Capital
Actual
Adequacy Purposes
To be Well Capitalized
Ratio
Total capital (to risk- weighted assets) Village Bank
75,416
14.63
41,250
8.00
51,563
10.00
Tier 1 capital (to risk- weighted assets) Village Bank
71,973
13.96
30,938
6.00
Leverage ratio (Tier 1 capital to average assets) Village Bank
9.96
28,914
4.00
36,142
5.00
Common equity tier 1 (to risk- weighted assets) Village Bank
23,203
4.50
33,516
6.50
65,723
14.20
37,015
46,269
61,753
13.35
27,761
9.28
26,607
33,259
20,821
30,075
Note 14 – Commitments and contingencies
Off-balance-sheet risk – The Company is a party to financial instruments with off-balance-sheet risk in the normal course of business to meet the financial needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve, to varying degrees, elements of credit and interest-rate risk in excess of the amounts recognized in the financial statements. The contract amounts of these instruments reflect the extent of involvement that the Company has in particular classes of instruments.
The Company’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit, and to potential credit loss associated with letters of credit issued, is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for loans and other such on-balance sheet instruments.
At September 30, 2021 and December 31, 2020, the Company had outstanding the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk (in thousands):
Undisbursed credit lines
101,428
107,130
Commitments to extend or originate credit
22,737
38,910
Standby letters of credit
4,877
4,934
Total commitments to extend credit
129,042
150,974
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require the payment of a fee. Historically, many commitments expire without being drawn upon; therefore, the total commitment amounts shown in the above table are not necessarily indicative of future cash requirements. The Company evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, as deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the customer. Collateral held varies but may include personal or income-producing commercial real estate, accounts receivable, inventory and equipment.
Standby letters of credit are written conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loans to customers.
Concentrations of credit risk – Generally, the Company’s loans, commitments to extend credit, and standby letters of credit have been granted to customers in the Company’s market area. Although the Company is building a diversified loan portfolio, a substantial portion of its clients’ ability to honor contracts is reliant upon the economic stability of the Richmond, Virginia area, including the real estate markets in the area. The concentrations of credit by type of loan are set forth in Note 5. The distribution of commitments to extend credit approximates the distribution of loans outstanding.
Note 15 – Mortgage Banking and Derivatives
Loans held for sale. The Company, through the Bank’s mortgage banking subsidiary, originates residential mortgage loans for sale in the secondary market. Residential mortgage loans held for sale are sold to the permanent investor with the mortgage servicing rights released. The Company’s portfolio of loans held for sale (“LHFS”) is accounted for in accordance with ASC 820 - Fair Value Measurement and Disclosures. Fair value of the Company’s LHFS is based on observable market prices for the identical instruments traded in the secondary mortgage loan markets in which the Company conducts business and totaled $13.3 million as of September 30, 2021, of which $13.0 million is related to unpaid principal, and totaled $34.4 million as of December 31, 2020, of which $32.9 million is related to unpaid principal. The Company’s portfolio of LHFS is classified as Level 2.
Interest Rate Lock Commitments and Forward Sales Commitments. The Company, through the Bank’s mortgage banking subsidiary, enters into commitments to originate residential mortgage loans in which the interest rate on the loan is determined prior to funding, termed interest rate lock commitments. Such rate lock commitments on mortgage loans to be sold in the secondary market are considered to be derivatives. Upon entering into a commitment to originate a loan, the Company protects itself from changes in interest rates during the period prior to sale by requiring a firm purchase agreement from a permanent investor before a loan can be closed (forward sales commitment). The Company locks in the loan and rate with an investor and commits to deliver the loan if settlement occurs on a best efforts basis, thus limiting interest rate risk. Certain additional risks exist if the investor fails to meet its purchase obligation; however, based on historical performance and the size and nature of the investors the Company does not expect them to fail to meet their obligation. The Company determines the fair value of IRLCs based on the price of the underlying loans obtained from an investor for loans that will be delivered on a best efforts basis while taking into consideration the probability that the rate lock commitments will close. The fair value of these derivative instruments is reported in “Other Assets” in the Consolidated Balance Sheet at September 30, 2021, and totaled $513,000 with a notional amount of $22,737,000 million and total positions of 85 and was reported in “Other Assets” at December 31, 2020, and totaled $1.6 million, with a notional amount of $38.9 million and total positions of 150. Changes in fair value are recorded as a component of mortgage banking income, net in the Consolidated Income Statement for the period ended September 30, 2021. The Company’s IRLCs are classified as Level 2. At September 30, 2021 and December 31, 2020, each IRLC and all LHFS were subject to a forward sales commitment on a best efforts basis.
The Company uses fair value accounting for its forward sales commitments related to IRLCs and LHFS under ASC 825-10-15-4(b). The fair value of forward sales commitments is reported in “Other Liabilities” in the Consolidated Balance Sheet at September 30, 2021, and totaled $842,000, with a notional amount of $35.7 million and total positions of 134, and was reported in “Other Liabilities” at December 31, 2020, and totaled $3.1 million, with a notional amount of $71.7 million and total positions of 289.
Note 16 – Recent accounting pronouncements
In June 2016, the FASB issued 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, 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 SEC and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. While the Company is currently evaluating the provisions of ASU 2016-13 to determine the potential impact the new standard will have on the Company’s Consolidated Financial Statements, it has taken steps to prepare for the implementation when it becomes effective, such as forming an internal task force, gathering pertinent data, consulting with outside professionals, and evaluating its current IT systems. The Company is currently assessing the impact that ASU 2016-13 will have on the Company’s consolidated financial statements.
Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin ("SAB") 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB ASC 326, "Financial Instruments - Credit Losses." It covers topics including (1) measuring current expected credit losses; (2) development governance, and documentation of systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.
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.
In January 2020, the FASB issued ASU 2020-01, “Investments – Equity Securities (Topic 321), Investments – Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815) – Clarifying the Interactions between Topic 321, Topic 323, and Topic 815.” The ASU is based on a consensus of the Emerging Issues Task Force and is expected to increase comparability in accounting for these transactions. ASU 2020-01 amends ASU 2016-01, which made targeted improvements to accounting for financial instruments, including providing an entity the ability to measure certain equity securities without a readily determinable fair value at cost, less any impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Among other topics, the amendments in ASU 2020-01 clarify that an entity should consider observable transactions that require it to either apply or discontinue the equity method of accounting. ASU 2020-01 was effective for the Company on January 1, 2021. The adoption of ASU 2020-01 did not have a material impact on the Company’s consolidated financial statements.
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 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 a team to assess ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.
In August 2020, the FASB issued ASU 2020-06 “Debt – Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Accounting for Convertible Instruments and Contracts in an Entity’s Own Equity.” The ASU simplifies accounting for convertible instruments by removing major separation models required under current GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument and more convertible preferred stock as a single equity instrument with no separate accounting for embedded conversion features. The ASU removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. The ASU also simplifies the diluted earnings per share calculation in certain areas. In addition, the amendment updates the disclosure requirements for convertible instruments to increase the information transparency. For public business entities, excluding smaller reporting companies, the amendments in the ASU are effective for fiscal years beginning after December 15, 2021, and interim periods within those fiscal years. For all other entities, including the Company, the standard will be effective for fiscal years beginning after December 15, 2023, including interim periods within those fiscal years. Early adoption is permitted. The Company does not expect the adoption of ASU 2020-06 to have a material impact on its consolidated financial statements.
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.
In December 2020, the CAA was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the CARES Act, including the PPP loan program and treatment of certain loan modifications related to the COVID-19 pandemic. As of September 30, 2021, the Company had no loans modified under the CAA. The Company’s modification program primarily included payment deferrals and interest only modifications. For more financial data and other information about loan deferrals refer to Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
In May 2021, the FASB issued ASU 2021-04, “Earnings Per Share (Topic 260), Debt - Modifications and Extinguishments (Subtopic 470-50), Compensation - Stock Compensation (Topic 718), and Derivatives and Hedging – Contracts in Entity’s Own Equity (Subtopic 815-40): Issuer’s Accounting for Certain Modifications or Exchanges of Freestanding Equity – Classified Written Call Options (a consensus of the FASB Emerging Issues Task Force).” The ASU addresses how an issuer should account for modifications or an exchange of freestanding written call options classified as equity that is not within the scope of another Topic. For both public and private companies, the ASU is effective for fiscal years beginning after December 15, 2021. Transition is prospective. Early adoption is permitted. The Company does not expect the adoption of ASU 2021-04 to have a material impact on its consolidated financial statements.
In August 2021, the FASB issued ASU 2021-06, “'Presentation of Financial Statements (Topic 205), Financial Services—Depository and Lending (Topic 942), and Financial Services—Investment Companies (Topic 946): Amendments to SEC Paragraphs Pursuant to SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants. This ASU incorporates recent SEC rule changes into the FASB Codification, including SEC Final Rule Releases No. 33-10786, Amendments to Financial Disclosures about Acquired and Disposed Businesses, and No. 33-10835, Update of Statistical Disclosures for Bank and Savings and Loan Registrants”. The ASU is effective upon addition to the FASB Codification. The Company does not expect the adoption of ASU 2021-06 to have a material impact on its consolidated financial statements.
ITEM 2 - MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Caution about forward-looking statements
In addition to historical information, this report may contain forward-looking statements. For this purpose, any statement that is not a statement of historical fact may be deemed to be a forward-looking statement. These forward-looking statements may include statements regarding profitability, liquidity, allowance for loan losses, interest rate sensitivity, market risk, growth strategy and financial and other goals. Forward-looking statements often use words such as “believes,” “expects,” “plans,” “may,” “will,” “should,” “projects,” “contemplates,” “anticipates,” “forecasts,” “intends” or other words of similar meaning. You can also identify them by the fact that they do not relate strictly to historical or current facts. Forward-looking statements are subject to numerous assumptions, risks and uncertainties, and actual results could differ materially from historical results or those anticipated by such statements.
There are many factors that could have a material adverse effect on the operations and future prospects of the Company including, but not limited to:
These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made. In addition, past results of operations are not necessarily indicative of future results.
General
The Company’s primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk. The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company’s results of operations and financial condition.
Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions. If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income.
Continued Response to COVID-19
We continue to see signs of recovery in both the economy and our customers. All loans that were modified pursuant to the CARES Act as of June 30, 2021 returned to contractual payment terms, and as of September 30, 2021 there were no such modified loans. With the continued uncertainty around the Delta variant of COVID-19, we continue to take the necessary measures to protect the health and wellbeing of our employees and customers. We remain well positioned to weather the economic uncertainty created by the COVID-19 pandemic.
Small Business Administration Paycheck Protection Program
Through PPP rounds one and two, our team provided essential funds to over 2,300 businesses and nonprofits and protected more than 28,600 jobs in our community. PPP Loans were $56,809,000 and $136,674,000 as of September 30, 2021 and December 31, 2020, respectively. As of September 30, 2021, approximately $182,144,000 in PPP round one loans and $24,119,000 in PPP round two loans had received SBA approval for forgiveness. PPP loans decreased by $40,808,000, or 41.80%, from the period ended June 30, 2021, and decreased by $79,865,000, or 58.43%, from the period ended December 31, 2020. Our expectations are that the majority of the remaining PPP loans will receive forgiveness by the end of 2021.
Capital Risk Management
The Bank maintains a strong, well-capitalized position with a common equity Tier 1 capital ratio of 13.96%, a Tier 1 risk-based capital ratio of 13.96%, a total risk-based capital ratio of 14.63% and a leverage ratio of 9.96% as of September 30, 2021. The most significant risk to capital as a result of the COVID-19 pandemic is the risk of default within our loan portfolio and the potential loan losses as a result of those defaults. The Company has taken several steps to mitigate this risk to our capital by building a diversified loan portfolio over the years to be capable of sustaining through a crisis, working with our customers during this time to defer loan payments, as permitted under the CARES Act, to allow time for economic stabilization and participating in the SBA PPP round one and round two loan programs to help provide much needed funds to our borrowers and the community. As of September 30, 2021, the Company has provided essential funds to its community through rounds one and two of the SBA PPP loan program, credit metrics have improved and all loans that were on deferral have returned to contractual payment terms as a result of improving local and national economic factors. While the Delta variant of COVID-19 virus remains a risk to capital, the Company believes the actions we are taking will protect our capital levels.
Results of operations
The following presents management’s discussion and analysis of the financial condition of the Company at September 30, 2021 and December 31, 2020 and the results of operations for the Company for the three and nine months ended September 30, 2021 and 2020. This discussion should be read in conjunction with the Company’s consolidated financial statements and the notes thereto appearing elsewhere in this Quarterly Report.
Summary
For the three months ended September 30, 2021, the Company had net income of $2,899,000, or $1.97 per fully diluted share, compared to net income of $2,269,000, or $1.55 per fully diluted share, for the same period in 2020. For the nine months ended September 30, 2021, the Company had net income of $10,090,000, or $6.88 per fully diluted share, compared to net income of $5,502,000, or $3.78 per fully diluted share, for the same period in 2020.
Net interest income, which represents the difference between interest earned on interest-earning assets and interest incurred on interest-bearing liabilities, is the Company’s primary source of earnings. Net interest income can be affected by changes in market interest rates as well as the level and composition of assets, liabilities and shareholders’ equity. Net interest spread is the difference between the average rate earned on interest-earning assets and the average rate paid on interest-bearing liabilities. The net yield on interest-earning assets (“net interest margin” or “NIM”) is calculated by dividing tax equivalent net interest income by average interest-earning assets. Generally, the net interest margin will exceed the net interest spread because a portion of interest earning assets are funded by various noninterest-bearing sources, principally noninterest-bearing deposits and shareholders’ equity.
For the Three Months Ended September 30,
Change
(dollars in thousands)
Average interest-earning assets
681,164
677,338
3,826
381
Yield on interest-earning assets
4.03
3.84
0.19
Average interest-bearing liabilities
396,194
451,090
(54,896)
(577)
Cost of interest-bearing liabilities
0.49
0.94
(0.45)
958
Net interest margin
3.74
3.21
0.53
The following are variances of note for the three months ended September 30, 2021 compared to the three months ended September 30, 2020:
For the Nine Months Ended September 30,
669,583
612,705
56,878
2,506
4.18
4.02
0.16
400,963
415,689
(14,726)
(1,847)
0.58
1.15
(0.57)
4,353
3.83
3.24
0.59
The following are variances of note for the nine months ended September 30, 2021 compared to the nine months ended September 30, 2020:
The following tables illustrate average balances of total interest-earning assets and total interest-bearing liabilities for the periods indicated, showing the average distribution of assets, liabilities, shareholders' equity and related income, expense and corresponding weighted-average yields and rates (dollars in thousands). The average balances used in these tables and other statistical data were calculated using daily average balances. We had no tax exempt interest-earning assets for the periods presented.
Income/
Yield
Expense
Rate
Loans net of deferred fees
539,945
6,551
4.81
600,261
6,151
4.08
13,668
3.02
21,540
2.88
56,931
1.70
38,876
2.35
Federal funds and other
70,620
0.12
16,661
Total interest earning assets
(3,444)
(3,779)
12,592
9,484
11,793
22,765
21,016
725,104
715,852
Interest bearing deposits
Interest checking
80,049
0.13
59,123
0.17
Money market
180,261
103
0.23
144,890
Savings
41,245
0.15
30,255
Certificates
80,229
1.01
126,237
1.53
381,784
0.36
360,505
0.80
Borrowings
14,410
3.94
90,585
1.50
Total interest bearing liabilities
Noninterest bearing deposits
261,714
211,257
6,035
5,331
663,943
667,678
Equity capital
61,161
48,174
Total liabilities and capital
Net interest income before provision for loan losses
Interest spread - average yield on interest earning assets, less average rate on interest bearing liabilities
3.54
2.90
Net interest margin (net interest income expressed as a percentage of average earning assets)
43
Loans net of deferred
564,261
19,807
4.69
531,792
17,221
4.33
16,162
2.82
16,160
3.31
48,219
2.06
40,759
2.43
40,941
0.10
23,994
0.31
(3,803)
(3,474)
12,826
9,708
11,980
(639)
23,008
34,389
713,594
652,689
75,823
54,373
0.18
171,093
0.28
125,687
664
0.71
39,827
27,002
92,328
793
136,762
1,732
1.69
379,071
0.45
343,824
0.97
21,892
2.77
71,865
1.99
247,523
185,223
7,252
5,528
655,738
606,440
57,856
46,249
3.60
2.87
The amount of the allowance for loan losses is determined by an evaluation of the level of loans outstanding, the level of non-performing loans, historical loan loss experience, delinquency trends, underlying collateral values, the amount of actual losses charged to the reserve in a given period and assessment of present and anticipated economic conditions.
The level of the allowance reflects changes in the size of the portfolio or in any of its components as well as management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality, and present economic, political and regulatory conditions. Portions of the allowance may be allocated for specific credits; however, the entire allowance is available for any credit that, in management’s judgment, should be charged off. While management utilizes its best judgment and information available, the ultimate adequacy of the allowance is dependent upon a variety of factors beyond the Company’s control, including the performance of the Company’s loan portfolio, the economy, changes in interest rates and the view of the regulatory authorities toward loan classifications.
The Company did not record provision expense for the three months ended September 30, 2021 and recorded a recovery of the provision expense of $500,000 for the nine months ended September 30, 2021 compared to a provision expense of $250,000 and $950,000 for the three and nine months ended September 30, 2020, respectively.
The recovery of provision for the nine months ended September 30, 2021 resulted from a reduction in the qualitative factors driven by improving economic factors, improved credit metrics, and reductions in loan deferrals. While the Delta variant of the COVID-19 virus remains a risk to credit quality, we believe our current level of allowance for loan losses is sufficient.
The provision expense for the three and nine months ended September 30, 2020 was a result of growth in the loan portfolio, an increase in the historical loan loss experience and an increase in the qualitative factors due to the anticipated economic impact of COVID-19.
The increase in the qualitative factors due to COVID-19 were a result of deterioration in local economic factors such as the higher levels of unemployment and the increased credit risk due to loan payment deferrals under the CARES Act.
For more financial data and other information about the allowance for loan losses refer to section, “Balance Sheet Analysis under this Item 2 – “Management’s Discussion and Analysis of Financial Condition and Results of Operations”, and Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
Noninterest income includes service charges and fees on deposit accounts, fee income related to loan origination, mortgage banking income, net, and gains and losses on securities available for sale. The most significant noninterest income item has been mortgage banking income, net, representing 76% and 82% for the three month periods ended September 30, 2021 and 2020, respectively, and 79% and 78% for the nine month periods ended September 30, 2021 and 2020, respectively.
8.4
(688)
(24.1)
(100.0)
25.6
(622)
(17.9)
The decrease in noninterest income of $622,000 for the three months ended September 30, 2021, was the result of the following:
209
13.9
1,310
20.1
Gain on sale of SBA loans
106
44.5
1,526
18.3
The increase in noninterest income of $1,526,000 for the nine months ended September 30, 2021, was the result of the following:
(1.0)
(3.4)
18.7
(2.0)
(105)
(12.6)
10.0
(19.1)
(0.4)
(118)
(2.1)
The decrease in noninterest expense of $118,000 for the three months ended September 30, 2021, was the result of the following:
1,263
13.6
(1.8)
23.1
(191)
(8.4)
33.0
144
(94.7)
(25)
(15.0)
128
8.1
1,533
10.1
The increase in noninterest expense of $1,533,000 for the nine months ended September 30, 2021, was the result of the following:
Income taxes
The Company’s effective tax rate, income tax as a percent of pre-tax income, may vary significantly from the statutory rate due to permanent difference and available tax credits. Income tax expense for the three and nine months ended September 30, 2021 was $752,000 and $2,790,000, respectively, resulting in an effective tax rate of 20.6% and 21.7%, respectively, compared to $678,000 and $1,582,000, or 23.0% and 22.3%, respectively, for the same periods in 2020. The decrease in the effective tax rate was primarily related to an increase in the tax credit received related to state taxes attributed to the Company and the Mortgage Banking Segment. The Bank is not subject Virginia income taxes, and instead is subject to a franchise tax based on bank capital.
Balance Sheet Analysis
At September 30, 2021 and December 31, 2020, all of our investment securities were classified as available for sale.
For more financial data and other information about investment securities refer to Note 4 “Investment Securities Available for Sale” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
The Company maintains rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower. The portfolio strategies include seeking industry, loan type and loan size diversification in order to minimize credit concentration risk. Management also focuses on originating loans in markets with which the Company is familiar. Additionally, as a significant amount of the loan losses we have experienced in the past is attributable to construction and land development loans, our strategy has shifted from reducing this type of lending to closely managing the quality and concentration in these loan types.
Approximately 72.7% of all loans are secured by mortgages on real property located principally in the Commonwealth of Virginia. Approximately 5.2% of the loan portfolio consists of rehabilitated student loans purchased by the Bank from 2014 to 2017 (see discussion following). The Company’s commercial and industrial loan portfolio represents approximately 21.6% of all loans. Loans in this category are typically made to individuals and small and medium-sized businesses, and range between $250,000 and $2.5 million; however, the increase in the portfolio was the result of the Company originating $185,137,000 in first round of PPP loans and $77,539,000 in second round PPP loans through September 30, 2021, which are 100% guaranteed by the SBA. Based on underwriting standards, commercial and industrial loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory, and real property. The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions. The remainder of our loan portfolio is in consumer loans which represent less than 1% of the total.
0.52
PPP loans included in commercial and industrial loans in the above table were $56,809,000 and $136,674,000 as of September 30, 2021 and December 31, 2020, respectively.
For more financial data and other information about loans refer to Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. The allowance for loan losses at September 30, 2021 was $3,443,000, compared to $3,970,000 at December 31, 2020. The ratio of the allowance for loan losses to gross portfolio loans (net of unearned income and excluding mortgage loans held for sale) at September 30, 2021 and December 31, 2020 was 0.64% and 0.71%, respectively. The ratio of the allowance for loan losses to gross portfolio loans (net of unearned income and excluding mortgage loans held for sale and government guaranteed loans) at September 30, 2021 and December 31, 2020 was 0.77% and 1.02%, respectively. The decrease in the allowance for loan losses for the first nine months of 2021 was the result of a recovery of provision expenses of $500,000 during that period which was driven by a reduction in the qualitative factors due to improving economic factors, improved credit metrics, and the movement of all loan deferrals back to contractual payment terms. While the Delta variant of the COVID-19 virus remains a risk to credit quality, we believe our current level of allowance for loan losses is sufficient. For more financial data and other information about loans refer to Note 5 “Loans and allowance for loan losses” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
Asset quality
The following table summarizes asset quality information at the dates indicated (dollars in thousands):
Nonaccrual loans
2,226
Foreclosed properties
Total nonperforming assets
1,913
2,562
Restructured loans (not included in nonaccrual loans above)
6,584
Loans past due 90 days and still accruing (1)
1,674
Nonperforming assets to loans (2)
0.34
0.42
Nonperforming assets to total assets
0.20
0.27
0.35
Allowance for loan losses to
Loans, net of deferred fees and costs
0.64
0.60
Loans, net of deferred fees and costs (excluding guaranteed loans)
0.77
1.02
1.06
233.90
251.75
181.96
(1) All loans 90 days past due and still accruing are rehabilitated student loans which have a 98% guarantee by the DOE.
(2) Loans are net of unearned income and deferred cost.
Nonperforming assets totaled $1,472,000 at September 30, 2021, compared to $1,913,000 at December 31, 2020. Nonperforming assets at September 30, 2021 consisted of $1,472,000 in nonaccrual loans, compared to $1,577,000 at December 31, 2020.
The following table presents an analysis of the changes in nonperforming assets for the nine months ended September 30, 2021 (in thousands):
OREO
Balance December 31, 2020
Additions
316
Loans placed back on accrual
Repayments
(278)
Sales
(336)
Balance September 30, 2021
Nonperforming restructured loans are included in nonaccrual loans. Until a nonperforming restructured loan has performed in accordance with its restructured terms for a minimum of nine months, it will remain on nonaccrual status.
Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful. Commercial and unsecured consumer loans are designated as non-accrual when the Company considers collection of expected principal and interest doubtful. Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and interest is not significant. When loans are placed on non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received. Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.
There were no specific allowances associated with the total nonaccrual loans of $1,472,000 and $1,577,000 at September 30, 2021 and December 31, 2020, respectively, that were considered impaired.
Cumulative interest income that would have been recorded had nonaccrual loans been performing would have been approximately $82,000 and $98,000 for the nine months ended September 30, 2021 and 2020, respectively. Student loans totaling $2,496,000 and $2,193,000 at September 30, 2021 and December 31, 2020, respectively, were past due 90 days or more and interest was still being accrued as principal and interest on such loans have a 98% guarantee by the DOE. The 2% not covered by the DOE guarantee is provided for in the allowance for loan losses.
Total deposits increased by $57,670,000, or 9.8%, from December 31, 2020. Variances of note are as follows:
The variety of deposit accounts that we offer has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility to, although not to eliminate, the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities). Our ability to attract and retain deposits, and our cost of funds, has been, and is expected to continue to be, significantly affected by market conditions.
We utilize borrowings to supplement deposits to address funding or liability duration needs. For more financial data and other information about borrowings refer to Note 7 “Borrowings” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
Capital resources
Shareholders’ equity at September 30, 2021 was $61,730,000 compared to $51,996,000 at December 31, 2020. The $9,734,000 increase in shareholders’ equity during the nine months ended September 30, 2021 is primarily due to net income of $10,090,000.
The following table presents the composition of regulatory capital and the capital ratios for the Bank at the dates indicated (dollars in thousands):
Tier 1 capital
Total bank equity capital
71,829
62,183
Net unrealized gain on available-for-sale securities
114
(466)
Defined benefit postretirement plan
Disallowed deferred tax asset
Total Tier 1 capital
Tier 2 capital
Tier 2 capital deduction
Total Tier 2 capital
Total risk-based capital
Risk-weighted assets
515,629
462,690
Average assets
722,840
665,172
Capital ratios
Leverage ratio (Tier 1 capital to average assets)
Common equity tier 1 capital ratio (CET 1)
Tier 1 capital to risk-weighted assets
Total capital to risk-weighted assets
Equity to total assets
9.86
8.81
For more financial data and other information about capital resources, refer to Note 13 “Shareholders’ Equity and Regulatory Matters” in the “Notes to Consolidated Financial Statements” contained in Item 1 of this Form 10-Q.
Liquidity
Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.
At September 30, 2021, our liquid assets, consisting of cash, cash equivalents and investment securities available for sale, totaled $152,829,000, or 20.9% of total assets. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner.
Our holdings of liquid assets plus the ability to maintain and expand our deposit base and borrowing capabilities serve as our principal sources of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain two federal funds lines of credit with correspondent banks totaling $15 million for which there were no borrowings against the lines at September 30, 2021 and December 31, 2020.
We are also a member of the Federal Home Loan Bank of Atlanta, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from
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the FHLB. The unused borrowing capacity currently available from the FHLB at September 30, 2021 was $30.3 million, based on the Bank's qualifying collateral available to secure any future borrowings. However, we are able to pledge additional collateral to the FHLB in order to increase our available borrowing capacity up to 25% of assets.
Liquidity provides us with the ability to meet normal deposit withdrawals, while also providing for the credit needs of customers. We are committed to maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth, and fully comply with all regulatory requirements.
At September 30, 2021, we had commitments to originate $129,127,000 of loans. Fixed commitments to incur capital expenditures were less than $100,000 at September 30, 2021. Certificates of deposit scheduled to mature in the 12-month period ending September 30, 2022 totaled $44,013,000. We believe that a significant portion of such deposits will remain with us. We further believe that deposit growth, loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs.
Interest rate sensitivity
An important element of asset/liability management is the monitoring of our sensitivity to interest rate movements. In order to measure the effects of interest rates on our net interest income, management takes into consideration the expected cash flows from the securities and loan portfolios and the expected magnitude of the repricing of specific asset and liability categories. We evaluate interest sensitivity risk and then formulate guidelines to manage this risk based on management’s outlook regarding the economy, forecasted interest rate movements and other business factors. Our goal is to maximize and stabilize the net interest margin by limiting exposure to interest rate changes.
Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolio. The average lives of mortgage loans are substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which gives us the right to declare a loan immediately due and payable in the event, among other things, the borrower sells the real property subject to the mortgage and the loan is not repaid. In addition, certain borrowers increase their equity in the security property by making payments in excess of those required under the terms of the mortgage.
The sale of fixed rate loans is intended to protect us from precipitous changes in the general level of interest rates. The valuation of adjustable rate mortgage loans is not as directly dependent on the level of interest rates as is the value of fixed rate loans. As with other investments, we regularly monitor the appropriateness of the level of adjustable rate mortgage loans in our portfolio and may decide from time to time to sell such loans and reinvest the proceeds in other adjustable rate investments.
Impact of inflation and changing prices
The Company’s financial statements included herein have been prepared in accordance with GAAP, which require the Company to measure financial position and operating results primarily in terms of historical dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.
LIBOR and Other Benchmark Rates
Following the announcement by the U.K.’s Financial Conduct Authority in July 2017 that it will no longer persuade or require banks to submit rates for LIBOR after 2021, central banks and regulators around the world have commissioned working groups to find suitable replacements for Interbank Offered Rates (“IBOR”) and other benchmark rates and to implement financial benchmark reforms more generally. These actions have resulted in uncertainty regarding the use of alternative reference rates (“ARRs”) and could cause disruptions in a variety of markets, as well as adversely impact our business, operations and financial results.
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To facilitate an orderly transition from IBORs and other benchmark rates to ARRs, the Company has established a company-wide initiative led by senior management. The objective of this initiative is to identify and assess the Company’s exposure and develop an appropriate action plan to address prior to transition.
ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Not Applicable.
ITEM 4 – CONTROLS AND PROCEDURES
The Company’s Chief Executive Officer and Chief Financial Officer evaluated the effectiveness of the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (the “Exchange Act”)) as of September 30, 2021. Based on that evaluation, management concluded that the Company’s disclosure controls and procedures were effective as of September 30, 2021 in ensuring that all material information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed summarized and reported with the time periods specified in SEC rules and regulations and that such information is accumulated and communicated to the Company’s management, including the Company’s Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.
The Company’s management is also responsible for establishing and maintaining adequate internal control over financial reporting, as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act. There were no changes in our internal control over financial reporting identified in connection with the evaluation of it that occurred during the Company’s last fiscal quarter that materially affected, or are reasonably likely to materially affect, internal control over financial reporting.
PART II – OTHER INFORMATION
ITEM 1 – LEGAL PROCEEDINGS
In the course of its operations, the Company may become a party to legal proceedings. There are no material pending legal proceedings to which the Company is party or of which the property of the Company is subject.
ITEM 1A – RISK FACTORS
There have been no material changes to the risk factors disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 filed with the SEC on March 19, 2021.
ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Not applicable.
ITEM 3 – DEFAULTS UPON SENIOR SECURITIES
ITEM 4 – MINE SAFETY DISCLOSURES
None.
ITEM 5 – OTHER INFORMATION
ITEM 6 – EXHIBITS
31.1
Certification of Chief Executive Officer
31.2
Certification of Chief Financial Officer
32.1
Statement of Chief Executive Officer and Chief Financial Officer Pursuant to 18 U.S.C. Section 1350
The following materials from the Village Bank and Trust Financial Corp. Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 formatted in eXtensible Business Reporting Language (XBRL): (i) Consolidated Balance Sheets, (ii) Consolidated Statements of Income, (iii) Consolidated Statements of Comprehensive Income, (iv) Consolidated Statements of Shareholders' Equity, (v) Consolidated Statements of Cash Flows, and (vi) Notes to Condensed
Consolidated Financial Statements.
Cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2021, formatted in Inline eXtensible Business Reporting Language (included with Exhibit 101).
SIGNATURES
In accordance with the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date:
November 12, 2021
By:
/s/ James E. Hendricks, Jr.
James E. Hendricks, Jr.
President and Chief Executive Officer
/s/ Donald M. Kaloski, Jr.
Donald M. Kaloski, Jr.
Executive Vice President and Chief Financial Officer