Village Bank and Trust Financial (VBFC) - 2023 Q3 - Quarterly Report

PART I – FINANCIAL INFORMATION ITEM 1 – FINANCIAL STATEMENTS This section presents the unaudited consolidated financial statements of Village Bank and Trust Financial Corp. and its subsidiary for the periods ended September 30, 2023, and December 31, 2022, including balance sheets, statements of operations, comprehensive income (loss), shareholders' equity, and cash flows, along with accompanying notes detailing accounting policies, estimates, and specific financial instrument information Consolidated Balance Sheets This statement provides a snapshot of the company's financial position, detailing assets, liabilities, and shareholders' equity at specific points in time | Metric | Sep 30, 2023 (in thousands) | Dec 31, 2022 (in thousands) | Change (in thousands) | % Change | | :-------------------------------- | :-------------------------- | :-------------------------- | :-------------------- | :------- | | Assets | | | | | | Total cash and cash equivalents | $19,331 | $16,678 | $2,653 | 15.91% | | Investment securities available for sale, at fair value | $104,046 | $133,853 | $(29,807) | -22.27% | | Total loans, net | $563,449 | $535,645 | $27,804 | 5.19% | | Total Assets | $727,504 | $723,270 | $4,234 | 0.59% | | Liabilities | | | | | | Total deposits | $626,774 | $624,743 | $2,031 | 0.33% | | Total liabilities | $663,819 | $662,159 | $1,660 | 0.25% | | Shareholders' Equity | | | | | | Total shareholders' equity | $63,685 | $61,111 | $2,574 | 4.21% | | Total liabilities and shareholders' equity | $727,504 | $723,270 | $4,234 | 0.59% | Consolidated Statements of Operations This statement reports the company's revenues, expenses, and net income (loss) over specific periods, reflecting operational performance | Metric | Three Months Ended Sep 30, 2023 (in thousands) | Three Months Ended Sep 30, 2022 (in thousands) | Nine Months Ended Sep 30, 2023 (in thousands) | Nine Months Ended Sep 30, 2022 (in thousands) | | :------------------------------------------ | :--------------------------------------------- | :--------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | | Total interest income | $8,462 | $6,955 | $24,144 | $19,954 | | Total interest expense | $2,348 | $420 | $5,541 | $1,238 | | Net interest income | $6,114 | $6,535 | $18,603 | $18,716 | | Provision for (recovery of) credit losses | $0 | $100 | $0 | $(300) | | Total noninterest income (loss) | $(3,669) | $1,750 | $(1,191) | $5,317 | | Total noninterest expense | $5,752 | $5,524 | $17,341 | $16,720 | | Income (loss) before income tax expense (benefit) | $(3,307) | $2,661 | $71 | $7,613 | | Income tax expense (benefit) | $(754) | $508 | $(155) | $1,470 | | Net income (loss) | $(2,553) | $2,153 | $226 | $6,143 | | Earnings (loss) per share, basic | $(1.72) | $1.46 | $0.15 | $4.16 | | Earnings (loss) per share, diluted | $(1.72) | $1.46 | $0.15 | $4.16 | Consolidated Statements of Comprehensive Income (Loss) This statement presents net income (loss) and other comprehensive income (loss) items, such as unrealized gains or losses on available-for-sale securities, for the reporting periods | Metric | Three Months Ended Sep 30, 2023 (in thousands) | Three Months Ended Sep 30, 2022 (in thousands) | Nine Months Ended Sep 30, 2023 (in thousands) | Nine Months Ended Sep 30, 2022 (in thousands) | | :------------------------------------------ | :--------------------------------------------- | :--------------------------------------------- | :-------------------------------------------- | :-------------------------------------------- | | Net income (loss) | $(2,553) | $2,153 | $226 | $6,143 | | Total other comprehensive income (loss) | $2,371 | $(3,689) | $2,821 | $(10,824) | | Total comprehensive income (loss) | $(182) | $(1,536) | $3,047 | $(4,681) | Consolidated Statements of Shareholders' Equity This statement details changes in shareholders' equity components, including common stock, additional paid-in capital, retained earnings, and accumulated other comprehensive loss | Metric | Balance, Dec 31, 2022 (in thousands) | Net income (loss) (in thousands) | Other comprehensive income (in thousands) | Cash dividend declared (in thousands) | Balance, Sep 30, 2023 (in thousands) | | :-------------------------------- | :----------------------------------- | :------------------------------- | :---------------------------------------- | :------------------------------------ | :----------------------------------- | | Common Stock | $5,868 | — | — | — | $5,894 | | Additional Paid-in Capital | $55,167 | — | — | — | $55,499 | | Retained Earnings | $10,957 | $226 | — | $(712) | $10,352 | | Accumulated Other Comprehensive Loss | $(10,881) | — | $2,821 | — | $(8,060) | | Total Shareholders' Equity | $61,111 | $226 | $2,821 | $(712) | $63,685 | - Total shareholders' equity increased by $2,574,000 from December 31, 2022, to September 30, 2023, primarily due to a decrease in accumulated other comprehensive loss and net income[203] Consolidated Statements of Cash Flows This statement categorizes cash inflows and outflows from operating, investing, and financing activities, providing insights into liquidity and solvency | Metric | Nine Months Ended Sep 30, 2023 (in thousands) | Nine Months Ended Sep 30, 2022 (in thousands) | | :------------------------------------ | :-------------------------------------------- | :-------------------------------------------- | | Net cash provided by operating activities | $1,523 | $5,329 | | Net cash provided by (used in) investing activities | $(189) | $(68,915) | | Net cash provided by financing activities | $1,319 | $3,151 | | Net increase (decrease) in cash and cash equivalents | $2,653 | $(60,435) | | Cash and cash equivalents, end of period | $19,331 | $32,181 | Notes to Consolidated Financial Statements These notes provide detailed explanations and supplementary information about the accounting policies, estimates, and specific financial instrument data presented in the financial statements Note 1 – Principles of presentation This note outlines the basis of financial statement preparation, including significant accounting policies and the impact of new accounting pronouncements - The Company adopted ASU 2016-13 (CECL methodology) on January 1, 2023, resulting in a net decrease to retained earnings of $119,000, net of taxes. This included adjustments to the allowance for credit losses on loans and a reserve for unfunded loan commitments[31] - The CECL methodology uses a weighted average remaining maturity (WARM) approach, segmenting the loan portfolio by risk characteristics and forecasting expected losses based on a twelve-month unemployment rate projection from the Federal Open Market Committee[32] Impact of ASC 326 Adoption on Allowance for Credit Losses (in thousands) | Metric | Dec 31, 2022 (As Previously Reported) | Impact of CECL Adoption | Jan 1, 2023 (As Reported Under CECL) | | :------------------------------------------ | :------------------------------------ | :---------------------- | :----------------------------------- | | Allowance for credit losses (Loans) | $3,370 | $(127) | $3,243 | | Allowance for credit losses on unfunded credit exposure | $0 | $277 | $277 | | Total Allowance for credit losses | $3,370 | $150 | $3,520 | - The Company also adopted ASU 2022-02, removing troubled debt restructuring (TDR) recognition guidance and reducing the allowance for credit losses by $8,000 for non-collateral dependent TDRs[35] Note 2 – Use of estimates This note explains that financial statement preparation requires management to make estimates and assumptions that affect reported amounts and disclosures - The preparation of financial statements requires management to make estimates and assumptions, particularly for the allowance for credit losses and related provision, including collateral-dependent loans, which could differ significantly from actual results[36] Note 3 – Earnings per common share This note provides details on the calculation of basic and diluted earnings per common share, including the components used in the computation Earnings (Loss) Per Share (in thousands, except per share data) | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :-------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Net income (loss) - basic and diluted | $(2,553) | $2,153 | $226 | $6,143 | | Weighted average shares outstanding - basic | 1,485 | 1,476 | 1,485 | 1,475 | | Earnings (Loss) per share - basic | $(1.72) | $1.46 | $0.15 | $4.16 | | Earnings (Loss) per share - diluted | $(1.72) | $1.46 | $0.15 | $4.16 | - Unvested restricted units dependent on performance criteria (10,658 at Sep 30, 2023, and 5,514 at Sep 30, 2022) were excluded from EPS computation as their vesting was indeterminable[38] Note 4 – Investment securities available for sale This note details the composition, fair value, and unrealized gains or losses of investment securities classified as available for sale Investment Securities Available for Sale (in thousands) | Category | Sep 30, 2023 (Fair Value) | Dec 31, 2022 (Fair Value) | Change | | :------------------------------ | :-------------------------- | :-------------------------- | :------- | | U.S. Government agency obligations | $20,449 | $60,902 | $(40,453) | | Mortgage-backed securities | $71,591 | $60,560 | $11,031 | | Municipals | $1,543 | $1,550 | $(7) | | Subordinated debt | $10,463 | $10,841 | $(378) | | Total | $104,046 | $133,853 | $(29,807) | - The Company executed a securities repositioning strategy, selling $55,195,000 of available-for-sale securities at a pre-tax loss of $4,986,000. Proceeds were used to reduce FHLB borrowings by $15.0 million and reinvested in higher-yielding securities (5.48% weighted average yield)[40] - As of September 30, 2023, 62 investments totaling $76,826,000 were in an unrealized loss position of $10,209,000, primarily due to interest rate movements, not credit deterioration. The Company does not consider these impaired[41][42] Note 5 – Loans and allowance for credit losses This note provides a breakdown of the loan portfolio by type and details the methodology and changes in the allowance for credit losses - The Company adopted ASC 326 (CECL methodology) on January 1, 2023, for measuring expected credit losses on financial assets at amortized cost, including loans[44] Loans Classified by Type (in thousands) | Loan Type | Sep 30, 2023 (Amount) | Sep 30, 2023 (%) | Dec 31, 2022 (Amount) | Dec 31, 2022 (%) | | :------------------------------------------ | :---------------------- | :--------------- | :---------------------- | :--------------- | | Construction and land development | $56,260 | 9.94% | $45,127 | 8.38% | | Commercial real estate | $286,281 | 50.57% | $284,617 | 52.86% | | Consumer real estate | $117,014 | 20.67% | $93,680 | 17.40% | | Commercial and industrial loans | $83,045 | 14.67% | $90,348 | 16.78% | | Guaranteed student loans | $18,923 | 3.34% | $20,617 | 3.83% | | Consumer and other | $4,578 | 0.81% | $4,038 | 0.75% | | Total loans | $566,101 | 100.00% | $538,427 | 100.00% | | Total loans, net | $563,449 | | $535,645 | | Nonaccrual Loans by Type (in thousands) | Loan Type | Sep 30, 2023 | Dec 31, 2022 | | :------------------------------------------ | :------------- | :------------- | | Consumer real estate | $269 | $635 | | Commercial and industrial loans | $30 | $19 | | Total loans | $299 | $654 | - The Company recorded a recovery for credit losses for loans of $52,000 for the nine months ended September 30, 2023, driven by loan growth offset by improved credit metrics (non-performing loans decreased from 0.13% to 0.06%) and $162,000 in net-recoveries[77] - A provision for credit losses for unfunded commitments of $52,000 was recorded for the nine months ended September 30, 2023, due to an increase in the total outstanding balance[77] Note 6 – Deposits This note presents a classification of deposits by type, including noninterest-bearing and interest-bearing accounts, and their respective balances Deposits by Type (in thousands) | Deposit Type | Sep 30, 2023 (Amount) | Sep 30, 2023 (%) | Dec 31, 2022 (Amount) | Dec 31, 2022 (%) | | :-------------------------------- | :---------------------- | :--------------- | :---------------------- | :--------------- | | Demand accounts (Noninterest bearing) | $243,390 | 38.8% | $255,236 | 40.9% | | Interest bearing | $383,384 | 61.2% | $369,507 | 59.1% | | Total deposits | $626,774 | 100.0% | $624,743 | 100.0% | Note 7 – Borrowings This note details the company's borrowing activities, including FHLB advances and available lines of credit - The Company had FHLB advances of $20,000,000 at both September 30, 2023, and December 31, 2022[84] - Unused lines of credit for future borrowings totaled approximately $47.3 million at September 30, 2023, including FHLB, revolving bank lines, secured federal funds, and repurchase lines[86] Note 8 – Trust preferred securities This note describes the outstanding trust preferred capital notes, their interest rates, and their treatment for regulatory capital purposes - The Company has $8.764 million in Trust Preferred Capital Notes outstanding, with floating interest rates indexed to SOFR (replacing LIBOR as of June 30, 2023) plus a spread adjustment[87][89] - These securities can be included in Tier 1 capital for regulatory purposes up to 25% of Tier 1 capital, with any excess included in Tier 2 capital[90] Note 9 – Subordinated Debt This note provides information on the company's subordinated notes, including their issuance terms, interest rate structure, and maturity - The Company issued $5.7 million of fixed-to-floating rate subordinated notes due March 31, 2028. The interest rate transitioned from a fixed 6.50% to a floating rate (three-month SOFR plus 3.73%) after March 21, 2023, with an interest rate of 9.05% at September 30, 2023[92] Note 10 – Stock incentive plan This note details the stock-based compensation expense and the number of shares underlying non-vested restricted stock units - Stock-based compensation expense was approximately $358,000 for the nine months ended September 30, 2023, an increase from $272,000 in the prior year period[98] - The total number of shares underlying non-vested restricted stock was 21,930 at September 30, 2023, with unamortized stock-based compensation of $583,220[96] Note 11 – Fair value This note explains the fair value hierarchy and measurement techniques used for financial instruments, classifying them into Level 1, 2, or 3 inputs - The Company classifies financial instruments into a fair value hierarchy (Level 1, 2, or 3) based on the observability of inputs. Most recurring fair value measurements for financial assets (e.g., U.S. Government Agencies, Mortgage-backed securities, Loans held for sale) are classified as Level 2[100][101][102][104][108] Fair Value Measurement of Financial Assets (in thousands) | Financial Asset | Sep 30, 2023 (Carrying Value) | Sep 30, 2023 (Estimated Fair Value) | Dec 31, 2022 (Carrying Value) | Dec 31, 2022 (Estimated Fair Value) | | :------------------------------------ | :------------------------------ | :---------------------------------- | :------------------------------ | :---------------------------------- | | Cash | $14,055 | $14,055 | $12,062 | $12,062 | | Cash equivalents | $5,276 | $5,276 | $4,616 | $4,616 | | Investment securities available for sale | $104,046 | $104,046 | $133,853 | $133,853 | | Loans held for sale | $5,425 | $5,425 | $2,268 | $2,268 | | Loans | $566,101 | $535,409 | $538,427 | $521,150 | Note 12 – Segment Reporting This note provides financial information for the company's reportable segments, commercial banking and mortgage banking, detailing their respective revenues and net income - The Company operates in two reportable segments: traditional commercial banking and mortgage banking. Commercial banking revenues primarily come from interest on loans and securities, and deposit fees, while mortgage banking revenues are mainly from interest on loans held for sale and gains on secondary market sales[112] Net Income (Loss) by Segment (in thousands) | Segment | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :---------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Commercial Banking | $(2,326) | $2,174 | $1,010 | $6,310 | | Mortgage Banking | $(227) | $(21) | $(784) | $(167) | | Consolidated Net Income (Loss) | $(2,553) | $2,153 | $226 | $6,143 | Note 13 – Shareholders' Equity and Regulatory Matters This note details changes in shareholders' equity, including accumulated other comprehensive loss, and provides information on the company's compliance with regulatory capital requirements Accumulated Other Comprehensive Loss (AOCI) (in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | | :------------------------------------------ | :----------- | :----------- | | Unrealized (Losses) on AFS Securities | $(8,048) | $(10,863) | | Defined Benefit Plan | $(12) | $(18) | | Total Accumulated Other Comprehensive Loss | $(8,060) | $(10,881) | - The Bank exceeded all minimum capital ratios under Basel III Capital Rules and 'prompt corrective action' regulations as of September 30, 2023, classifying it as 'well capitalized'[120][121] Bank Capital Ratios (Sep 30, 2023) | Capital Ratio | Actual Ratio | Minimum Including Conservation Buffer | To Be Well Capitalized | | :------------------------------------ | :----------- | :------------------------------------ | :--------------------- | | Total capital (to risk-weighted assets) | 14.19% | 10.50% | 10.00% | | Tier 1 capital (to risk-weighted assets) | 13.58% | 8.50% | 8.00% | | Leverage ratio (Tier 1 capital to average assets) | 10.74% | 4.00% | 5.00% | | Common equity tier 1 (to risk-weighted assets) | 13.58% | 7.00% | 6.50% | Note 14 – Commitments and contingencies This note discloses off-balance-sheet financial instruments, such as credit lines and letters of credit, and discusses credit risk concentrations Off-Balance-Sheet Financial Instruments (in thousands) | Instrument | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :------------- | :------------- | | Undisbursed credit lines | $138,311 | $119,454 | | Commitments to extend or originate credit | $10,166 | $9,899 | | Standby letters of credit | $1,164 | $922 | | Total commitments to extend credit | $149,641 | $130,275 | - The Company's credit risk concentration is primarily within the Richmond, Virginia area, particularly in real estate markets, though it aims for diversification across loan types and sizes[128] Note 15 – Mortgage Banking and Derivatives This note provides information on loans held for sale and derivative instruments like interest rate lock commitments and forward sales commitments - Loans held for sale (LHFS) increased to $5.4 million at September 30, 2023, from $2.3 million at December 31, 2022, and are accounted for at fair value (Level 2)[129] - Interest Rate Lock Commitments (IRLCs) are treated as derivatives and increased to $183,000 (notional $10.2 million) at September 30, 2023, from $142,000 (notional $9.9 million) at December 31, 2022. Forward sales commitments, also at fair value, increased to $262,000 (notional $15.6 million) from $207,000 (notional $12.1 million)[130][133] Note 16 Recent Accounting Pronouncements This note discusses recently issued accounting standards and their expected or actual impact on the company's financial statements - The FASB issued ASU 2023-03, amending financial statement presentation, which the Company does not expect to have a material impact[134] - ASU 2022-06 extended the sunset date for reference rate reform relief guidance (Topic 848) from December 31, 2022, to December 31, 2024, to cover the transition away from LIBOR. The Company is assessing its impact[135][136] - ASU 2020-04 and ASU 2021-01 provide optional expedients for accounting for reference rate reform, which the Company does not expect to have a material impact[137] ITEM 2 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides management's perspective on the Company's financial condition and operational results for the three and nine months ended September 30, 2023, compared to the same periods in 2022. It covers key financial metrics, strategic actions, and the impact of accounting changes and market conditions Caution about forward-looking statements This section warns readers that the report contains forward-looking statements subject to various risks and uncertainties that could cause actual results to differ materially - The report contains forward-looking statements regarding profitability, liquidity, credit losses, interest rate sensitivity, and growth strategy, which are subject to numerous assumptions, risks, and uncertainties[138] - Key risk factors include changes in interest rates, ability to maintain liquidity, economic conditions, regulatory changes (e.g., Dodd-Frank, Basel III), cybersecurity risks, real estate market declines, and reliance on management[139] General This section discusses the company's primary earnings source, net interest income, and its exposure to interest rate risk and assumptions regarding loan portfolio collectability - The Company's primary earnings source is net interest income, with interest rate risk being its principal market risk exposure. The asset/liability management strategy may not fully mitigate adverse effects of interest rate changes[141] - Management makes assumptions about loan portfolio collectability; if incorrect, the current allowance for credit losses may be insufficient, negatively impacting net income[142] Summary This section provides a high-level overview of the company's financial performance, including net income, EPS, and key strategic actions like CECL adoption and securities repositioning Net Income (Loss) and EPS Summary | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :-------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Net income (loss) (in thousands) | $(2,553) | $2,153 | $226 | $6,143 | | Diluted EPS | $(1.72) | $1.46 | $0.15 | $4.16 | - The Company adopted the CECL methodology on January 1, 2023, increasing the allowance for credit losses to $3.52 million, including $3.24 million for loans and $277,000 for unfunded commitments. By September 30, 2023, the total allowance reached $3.68 million[145][146] - A securities repositioning strategy was executed, selling $55.2 million in available-for-sale securities at a $5.0 million pre-tax loss. This reduced FHLB borrowings by $15.0 million and reinvested funds into higher-yielding securities (5.48% vs. 1.48% yield), projected to be accretive to EPS, NIM, ROA, and tangible common equity[147] Net interest income This section analyzes the components of net interest income and net interest margin, explaining the factors influencing changes in interest income and expense Net Interest Income and Margin (NIM) Summary | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :-------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Net interest income (in thousands) | $6,114 | $6,535 | $18,603 | $18,716 | | Net interest margin (NIM) | 3.46% | 3.70% | 3.59% | 3.54% | | Yield on interest-earning assets | 4.79% | 3.94% | 4.66% | 3.78% | | Cost of interest-bearing liabilities | 2.16% | 0.41% | 1.76% | 0.41% | - For the three months ended September 30, 2023, NIM compressed by 24 basis points to 3.46% due to a 175 basis point increase in the cost of interest-bearing liabilities (driven by variable rate debt and deposit rates) outpacing an 85 basis point increase in asset yields[152] - For the nine months ended September 30, 2023, NIM expanded by 5 basis points to 3.59%, as an 88 basis point increase in asset yields (due to asset mix improvement and rising rates) slightly outpaced a 135 basis point increase in the cost of interest-bearing liabilities. Strong non-interest bearing deposits (near 40% of deposit base) helped mitigate the increase in overall cost of funds[154][155] Provision for (recovery of) Credit losses This section details the company's provision or recovery for credit losses, including the impact of the CECL methodology and changes in credit metrics - The Company adopted the CECL methodology on January 1, 2023, increasing the allowance for credit losses to $3.52 million. By September 30, 2023, the total allowance for credit losses was $3.68 million, comprising $3.35 million for loans and $329,000 for unfunded commitments[161][162] - For the three months ended September 30, 2023, a recovery of credit losses for loans of $53,000 was recorded due to improved credit metrics and $150,000 in net-recoveries. A provision of $53,000 for unfunded commitments was recorded due to increased outstanding balances[164] - For the nine months ended September 30, 2023, a recovery for credit losses for loans of $52,000 was recorded, driven by loan growth, improved credit metrics (non-performing loans decreased from 0.13% to 0.06%), and $162,000 in net-recoveries. A provision of $52,000 for unfunded commitments was recorded due to increased outstanding balances[165] Noninterest income This section analyzes the various sources of noninterest income, including service charges, mortgage banking income, and gains or losses on investment securities Noninterest Income (Loss) (in thousands) | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :-------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Service charges and fees | $694 | $670 | $2,074 | $1,960 | | Mortgage banking income, net | $489 | $973 | $1,353 | $2,942 | | Loss on sale of investment securities | $(4,986) | $0 | $(4,986) | $0 | | Total noninterest income (loss) | $(3,669) | $1,750 | $(1,191) | $5,317 | - Total noninterest income decreased by $5,419,000 for the three months and $6,508,000 for the nine months ended September 30, 2023, primarily due to a $4,986,000 loss on the sale of investment securities as part of a balance sheet repositioning strategy[174][176] - Mortgage banking income, net, decreased by $484,000 (three months) and $1,589,000 (nine months) due to lower mortgage originations, which were down 37.6% and 34.94% respectively, driven by rising mortgage rates and low housing inventory[175][177] Noninterest expense This section breaks down noninterest expenses, such as salaries, professional services, and other operating costs, and explains the drivers of changes in these expenses Noninterest Expense (in thousands) | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :-------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Salaries and benefits | $3,310 | $3,446 | $10,173 | $10,394 | | Professional and outside services | $894 | $655 | $2,543 | $2,118 | | Other operating expense | $741 | $681 | $2,165 | $1,893 | | Total noninterest expense | $5,752 | $5,524 | $17,341 | $16,720 | - Total noninterest expense increased by $228,000 (three months) and $621,000 (nine months) ended September 30, 2023[176][179] - Key drivers for the increase include higher professional and outside services expenses (due to data processing and online banking platform rollout) and increased other operating expenses (primarily from check and card fraud). Salaries and benefits decreased due to lower mortgage production[181][182] Income taxes This section discusses the company's income tax expense or benefit and the effective tax rate, highlighting factors influencing tax liabilities Income Tax Expense (Benefit) and Effective Tax Rate | Metric | Three Months Ended Sep 30, 2023 | Three Months Ended Sep 30, 2022 | Nine Months Ended Sep 30, 2023 | Nine Months Ended Sep 30, 2022 | | :-------------------------------- | :------------------------------ | :------------------------------ | :----------------------------- | :----------------------------- | | Income tax expense (benefit) (in thousands) | $(754) | $508 | $(155) | $1,470 | | Effective tax rate | 22.8% | 19.1% | 217.99% | 19.3% | - The effective tax rate for the nine months ended September 30, 2023, was 217.99%, significantly higher than the prior year, primarily due to an increase in tax credits related to state taxes and the impact of permanent differences from bank-owned life insurance[180] Balance Sheet Analysis This section provides a detailed review of the company's balance sheet components, including investment securities, loans, allowance for credit losses, asset quality, deposits, borrowings, capital resources, and liquidity Investment securities This subsection discusses the classification and composition of the company's investment securities portfolio - All investment securities were classified as available for sale at September 30, 2023, and December 31, 2022[181] Loans This subsection details the company's loan portfolio, including underwriting standards, diversification strategies, and geographic concentration - The Company maintains rigorous underwriting standards and focuses on industry, loan type, and loan size diversification, with approximately 81.1% of loans secured by real property in Virginia[183][184] Loans Classified by Type (in thousands) | Loan Type | Sep 30, 2023 (Amount) | Sep 30, 2023 (%) | Dec 31, 2022 (Amount) | Dec 31, 2022 (%) | | :------------------------------------------ | :---------------------- | :--------------- | :---------------------- | :--------------- | | Construction and land development | $56,260 | 9.94% | $45,127 | 8.38% | | Commercial real estate | $286,281 | 50.57% | $284,617 | 52.86% | | Consumer real estate | $117,014 | 20.67% | $93,680 | 17.40% | | Commercial and industrial loans | $83,045 | 14.67% | $90,348 | 16.78% | | Guaranteed student loans | $18,923 | 3.34% | $20,617 | 3.83% | | Consumer and other | $4,578 | 0.81% | $4,038 | 0.75% | | Total loans | $566,101 | 100.00% | $538,427 | 100.00% | Allowance for Credit losses This subsection explains the changes in the allowance for credit losses, reflecting ongoing monitoring and adjustments based on credit metrics and economic conditions - The allowance for credit losses increased to $3.68 million at September 30, 2023, from $3.52 million at January 1, 2023 (post-CECL adoption), reflecting ongoing monitoring and adjustments based on credit metrics and economic conditions[186][187] Allowance for Credit Losses Activity (Nine Months Ended Sep 30, 2023, in thousands) | Loan Type | Beginning Balance (Dec 31, 2022) | Impact of ASC 326 Adoption | Provision (Recovery) of Credit Losses | Charge-offs | Recoveries | Ending Balance (Sep 30, 2023) | | :------------------------------------------ | :------------------------------- | :------------------------- | :------------------------------------ | :---------- | :--------- | :------------------------------ | | Construction and land development | $271 | $37 | $57 | $0 | $0 | $365 | | Commercial real estate | $2,189 | $(276) | $(34) | $0 | $0 | $1,879 | | Consumer real estate | $185 | $125 | $73 | $0 | $13 | $396 | | Commercial and industrial loans | $576 | $1 | $(139) | $0 | $172 | $610 | | Student loans | $52 | $0 | $15 | $(21) | $0 | $46 | | Consumer and other | $37 | $(5) | $5 | $(2) | $0 | $35 | | Unallocated | $60 | $(9) | $(29) | $0 | $0 | $22 | | Total | $3,370 | $(127) | $(52) | $(23) | $185 | $3,353 | Asset quality This subsection provides key metrics related to asset quality, including nonaccrual loans, nonperforming assets, and ratios of allowance to nonaccrual loans Asset Quality Information (in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | | :------------------------------------------ | :------------- | :------------- | | Nonaccrual loans | $299 | $654 | | Total nonperforming assets | $299 | $654 | | Nonaccrual loans to total loans | 0.05% | 0.12% | | Nonperforming assets to total assets | 0.04% | 0.09% | | Allowance for credit losses on loans to Nonaccrual loans | 1,121.40% | 515.29% | - Nonperforming assets decreased to $299,000 at September 30, 2023, from $654,000 at December 31, 2022, consisting solely of nonaccrual loans[193] - Loans past due 90 days and still accruing totaled $2,398,000 at September 30, 2023, primarily rehabilitated student loans with a 98% DOE guarantee[196] Deposits This subsection analyzes the composition and changes in the company's deposit base, including noninterest-bearing, interest-bearing, and time deposits Deposits by Type (in thousands) | Deposit Type | Sep 30, 2023 (Amount) | Sep 30, 2023 (%) | Dec 31, 2022 (Amount) | Dec 31, 2022 (%) | | :-------------------------------- | :---------------------- | :--------------- | :---------------------- | :--------------- | | Demand accounts (Noninterest bearing) | $243,390 | 38.8% | $255,236 | 40.9% | | Interest checking accounts | $81,779 | 13.0% | $90,252 | 14.4% | | Money market accounts | $210,439 | 33.6% | $179,036 | 28.7% | | Savings accounts | $42,367 | 6.8% | $55,695 | 8.9% | | Time deposits of $250,000 and over | $11,813 | 1.9% | $4,740 | 0.8% | | Other time deposits | $36,986 | 5.9% | $39,784 | 6.3% | | Total | $626,774 | 100.0% | $624,743 | 100.0% | - Total deposits increased by $2,031,000 (0.33%) from December 31, 2022. Noninterest-bearing demand accounts decreased by $11,846,000 (4.64%), while low-cost relationship deposits (interest checking, money market, savings) increased by $9,602,000 (2.95%). Time deposits increased by $4,275,000 (9.60%) due to efforts to lock in lower rates[197][198] Borrowings This subsection discusses the company's use of borrowings to supplement deposits and manage liability duration - The Company uses borrowings to supplement deposits and manage liability duration. Further details are provided in Note 7[202] Capital resources This subsection details changes in shareholders' equity and provides an overview of the company's regulatory capital and ratios - Shareholders' equity increased by $2,574,000 to $63,685,000 at September 30, 2023, from $61,111,000 at December 31, 2022, primarily due to a $2,821,000 decrease in accumulated other comprehensive loss and $226,000 in net income[203] Regulatory Capital and Ratios for the Bank (in thousands) | Metric | Sep 30, 2023 | Dec 31, 2022 | | :-------------------------------- | :------------- | :------------- | | Total Tier 1 capital | $81,339 | $81,612 | | Total Tier 2 capital | $3,682 | $3,370 | | Total risk-based capital | $85,021 | $84,982 | | Risk-weighted assets | $599,165 | $573,976 | | Average assets | $757,004 | $745,120 | | Leverage ratio | 10.74% | 10.95% | | Common equity tier 1 capital ratio | 13.58% | 14.22% | | Tier 1 capital to risk-weighted assets | 13.58% | 14.22% | | Total capital to risk-weighted assets | 14.19% | 14.81% | | Equity to total assets | 10.09% | 9.78% | Liquidity This subsection assesses the company's liquidity position, including liquid assets, uninsured deposits, and available borrowing capacity - Liquid assets (cash, cash equivalents, and available-for-sale securities) totaled $123,377,000, representing 16.96% of total assets at September 30, 2023[207] - Uninsured deposits were approximately $222.4 million (35.48% of total deposits) at September 30, 2023, with total liquidity sources of $145.8 million, covering 65.6% of uninsured deposits[208] - The Company had $109.1 million in additional wholesale deposit availability and an unused FHLB borrowing capacity of $4.6 million, which could be increased to $138.5 million by pledging additional collateral[209][212] Interest rate sensitivity This subsection explains how the company monitors and manages its exposure to interest rate fluctuations to protect net interest margin - The Company monitors interest rate sensitivity to manage net interest margin, considering expected cash flows and repricing of assets and liabilities. The sale of fixed-rate loans helps protect against precipitous interest rate changes[215][217] Impact of inflation and changing prices This subsection discusses the relative impact of interest rate changes versus inflation on the company's financial condition - Changes in interest rates affect the Company's financial condition more significantly than inflation, as interest rates are highly sensitive to various factors beyond the Company's control, including economic conditions and monetary policies[219] LIBOR and Other Benchmark Rates This subsection describes the company's transition from LIBOR to SOFR for financial instruments and its impact on financial statements - Following LIBOR's discontinuation on June 30, 2023, the Company replaced LIBOR with the three-month term Secured Overnight Funding Rate (SOFR) plus an applicable tenor spread adjustment for its financial instruments, which did not significantly impact consolidated financial statements[220][221][222] ITEM 3 – QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This section states that there are no quantitative and qualitative disclosures about market risk applicable for this report ITEM 4 – CONTROLS AND PROCEDURES The Company's management, including the CEO and CFO, concluded that disclosure controls and procedures were effective as of September 30, 2023. No material changes in internal control over financial reporting were identified during the last fiscal quarter - The CEO and CFO evaluated and concluded that the Company's disclosure controls and procedures were effective as of September 30, 2023[224] - No material changes in internal control over financial reporting were identified during the last fiscal quarter[225] PART II – OTHER INFORMATION ITEM 1 – LEGAL PROCEEDINGS The Company is not a party to any material pending legal proceedings - There are no material pending legal proceedings to which the Company is a party or whose property is subject[227] ITEM 1A – RISK FACTORS There have been no material changes to the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2022 - No material changes to the risk factors disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2022[228] ITEM 2 – UNREGISTERED SALES OF EQUITY SECURITIES, USE OF PROCEEDS, AND ISSUER PURCHASES OF EQUITY SECURITIES This item is not applicable to the current report ITEM 3 – DEFAULTS UPON SENIOR SECURITIES This item is not applicable to the current report ITEM 4 – MINE SAFETY DISCLOSURES This item is not applicable to the current report ITEM 5 – OTHER INFORMATION This item is not applicable to the current report ITEM 6 – EXHIBITS This section lists the exhibits filed with the Form 10-Q, including employment agreement amendments, certifications from the CEO and CFO, and XBRL formatted financial statements - Exhibits include Amendment No. 1 to Employment Agreements for Donald M. Kaloski, Jr. and Max C. Morehead, Jr., certifications from the CEO and CFO (31.1, 31.2, 32.1), and XBRL formatted financial statements (101, 104)[235] Signatures The report is duly signed on November 13, 2023, by James E. Hendricks, Jr., President and Chief Executive Officer, and Donald M. Kaloski, Jr., Executive Vice President and Chief Financial Officer - The report was signed on November 13, 2023, by James E. Hendricks, Jr. (President and CEO) and Donald M. Kaloski, Jr. (EVP and CFO)[238]