Village Bank and Trust Financial (VBFC) - 2023 Q4 - Annual Report

PART I ITEM 1. BUSINESS Village Bank and Trust Financial Corp. operates as a bank holding company through its subsidiary Village Bank and its mortgage arm, offering diverse financial services primarily in Central Virginia - The Company operates as a bank holding company with two main segments: traditional commercial banking (Village Bank) and mortgage banking (Village Bank Mortgage Corporation)[13][14] - The Bank offers a wide range of banking and related financial services, including checking, savings, certificates of deposit, commercial, real estate, and consumer loans, primarily in the Richmond and Williamsburg, Virginia metropolitan areas[14] Revenue Contribution by Segment (2023) | Segment | Revenue (after intercompany eliminations) | | :--------------- | :---------------------------------------- | | Bank | $36.3 million | | Mortgage Company | $2.6 million | - Key business strategies include building full-service banking relationships with high-quality local companies and individuals, growing the Mortgage Company's profitability, defending and expanding Net Interest Margin, building non-interest income, streamlining operations, achieving excellence in risk management, and being an attractive employer[17][19][21] Business Strategy The Company aims for top-quartile shareholder returns through strategic growth, profitability optimization, risk management, and a positive work environment - The Company aims to deliver top-quartile long-term total shareholder returns by focusing on return on equity, sustainable earnings growth, low earnings volatility, and best-quartile asset quality[17] - Strategies include building full-service banking relationships with local companies and individuals, growing the Mortgage Company's profitability, optimizing the balance sheet and income statement (e.g., improving Net Interest Margin, growing non-interest income, improving efficiency), achieving excellence in risk management, and fostering a positive work environment[17][19][21] Market Area The Company primarily serves the Central Virginia region, including Richmond and Williamsburg metropolitan areas, through its branch network - The Company primarily serves the Central Virginia region and the Richmond and Williamsburg metropolitan statistical areas, operating from nine full-service branch banking offices and one mortgage loan production office[22] Banking Services The Bank offers comprehensive deposit and lending services, including commercial, real estate, consumer loans, and various deposit products - Deposit services include checking, savings, money market, and various time deposits, offered through branches, drive-up windows, ATMs, customer care, and digital channels[23] - Lending services encompass short-to-medium term commercial and personal loans, real estate finance, commercial business lending (including SBA programs), commercial real estate acquisition, development, construction, and mortgage lending, consumer lending, loan participations (selling and purchasing), and purchasing of guaranteed student loan portfolios[24][26] - As of December 31, 2023, the legal lending limit for loans to one borrower was approximately $12,974,000[27] Competition The Company faces intense competition from diverse financial institutions with greater resources in its market areas - The Company faces strong competition from various financial institutions, including local commercial banks, credit unions, mortgage banking firms, consumer finance companies, and financial technology (fintech) companies, many of which have greater resources and higher lending limits[28] Deposit Market Share (June 30, 2023) | Location | Market Share | | :----------------------------- | :----------- | | Chesterfield County | 4.28% | | Hanover County | 5.02% | | Powhatan County | 10.98% | | Richmond metropolitan statistical area | 1.13% | | Henrico County | 1.40% | | James City County | 0.51% | Supervision and Regulation The Company and Bank are subject to extensive federal and state regulations, including capital adequacy, consumer protection, and anti-money laundering laws - The Company is regulated as a bank holding company by the Federal Reserve and the Virginia Bureau of Financial Institutions (BFI), while the Bank is regulated by the FDIC and BFI[32] - The Dodd-Frank Act significantly restructured financial regulation, and the Economic Growth, Regulatory Relief and Consumer Protection Act of 2018 (EGRRCPA) provided some relief for smaller institutions like the Company, exempting banks with less than $250 billion in assets from certain enhanced prudential standards[33][36] - The Bank is classified as 'well capitalized' as of December 31, 2023, with capital ratios exceeding minimum requirements (Common Equity Tier 1: 13.86%, Tier 1 Risk-Based: 13.86%, Total Risk-Based: 14.49%, Leverage: 11.14%)[59] - The Company is subject to various regulations including reporting obligations under securities laws (Exchange Act, Sarbanes-Oxley Act), Bank Holding Company Act, privacy legislation, merger and acquisition rules, dividend payment limits, FDIC insurance and assessments, capital adequacy standards (Basel III), prompt corrective action, restrictions on affiliate transactions, incentive compensation policies, anti-money laundering laws, OFAC reporting, mortgage banking regulations, consumer financial protection laws (CRA, CFPB), and cybersecurity regulations[38][39][42][45][46][49][53][57][61][66][69][71][72][77][80][84][85][86] Employees The Company employs 145 individuals, maintains good employee relations, and adheres to a comprehensive Code of Ethics Employee Count (December 31, 2023) | Employee Type | Count | | :------------ | :---- | | Full-time | 141 | | Part-time | 4 | | Total | 145 | - None of the Company's employees are covered by a collective bargaining agreement, and relations are considered good[89] - The Company has a Code of Ethics applicable to directors, officers, and all employees, addressing topics like asset protection, legal compliance, and financial reporting[90] Additional Information The Company files various reports with the SEC, which are publicly available on the SEC's and its own website - The Company files annual, quarterly, and current reports, proxy statements, and other information with the SEC, available electronically on the SEC's website and the Company's website (**http://www.villagebank.com**)[91](index=91&type=chunk)[92] ITEM 1A. RISK FACTORS Investing in the Company's common stock involves inherent risks, including those related to lending activities, market interest rates, business operations, liquidity, regulatory environment, and the common stock itself - An investment in the Company's common stock is subject to various risks that could impair its business and operations, potentially leading to a decline in stock value[94] Risk Related to the Company's Lending Activities Lending activities expose the Company to credit losses, particularly from real estate concentrations and small business loans, and potential insufficiency of the allowance for credit losses - Credit standards and ongoing credit assessment processes may not prevent significant credit losses, and the allowance for credit losses (ACLL) may be insufficient, especially with the adoption of CECL methodology in 2023, which introduces more volatility[95][97][98] - Nonperforming assets, which were $291,000 (0.04% of total assets) as of December 31, 2023, take significant time to resolve and negatively impact net income and financial condition[99] - A high concentration of loans secured by real estate (81.15% of all loans as of December 31, 2023), particularly construction and land development loans (8.26%) and commercial real estate loans (50.54%), exposes the Company to significant risk from downturns in the local real estate market and economic conditions[100][101][102] - Focusing on small to mid-sized community-based businesses increases credit risk due to their heightened vulnerability to economic conditions and fewer financial resources[105] - Reliance on independent appraisals for real estate collateral carries risk, as estimated values may not be realizable upon foreclosure, and the Company is exposed to environmental liabilities for properties it takes title to[106][107] Risk Related to Market Interest Rates Profitability is vulnerable to interest rate fluctuations, which can compress net interest spreads and impact loan volumes and borrower repayment capacity - The Company's profitability is subject to interest rate risk, as changes in market interest rates can reduce net interest spreads, affect loan volume and yields, and impact borrowers' ability to repay variable-rate loans[108][110] Risks Related to the Company's Business, Industry and Markets The Company faces risks from intense competition, technological changes, adverse economic conditions, market volatility, and cyclical mortgage banking revenues - Strong and growing competition from traditional financial institutions and fintech companies could reduce business and market share[111][112] - Consumers increasingly using alternative financial transaction methods (disintermediation) could lead to loss of fee income and customer deposits[113] - The Company's profitability depends on its ability to integrate and introduce new technologies; failure to do so could adversely affect business[114] - Changes in economic conditions, especially in its market areas, could lead to increased loan delinquencies, problem assets, decreased demand for services, and declining collateral values[115] - Market risk, including fluctuations in interest rates, equity prices, and credit quality, can adversely affect asset and liability values, particularly the investment securities portfolio[116] - Mortgage banking revenue is cyclical and sensitive to interest rates, economic conditions, and housing market slowdowns, which could significantly reduce income from these activities[117] Risk Related to Liquidity Liquidity risk stems from funding operations with demand deposits and less liquid assets, exacerbated by market downturns, unrealized losses, and potential deposit outflows - Liquidity risk could impair the Company's ability to fund operations, as a substantial portion of liabilities are demand deposits while assets are less liquid loans. Access to funding could be reduced by economic downturns, difficult credit markets, or depositor needs[118] - Unrealized losses in the available-for-sale securities portfolio, caused by rising interest rates, reduce book capital and tangible common equity, potentially affecting liquidity if securities must be sold at a loss[121] - In 2023, the Company executed a securities repositioning strategy, selling $55.195 million in available-for-sale securities at a pre-tax loss of $4.986 million, to improve earnings, interest rate risk protection, and tangible common equity[122] - Recent negative developments in the banking industry (e.g., Silicon Valley Bank failures) have eroded customer confidence, potentially leading to deposit outflows, especially from uninsured deposits (34.62% of total deposits at December 31, 2023), impacting liquidity and capital[120][123] Risk Related to the Company's Operations Operational risks include dependence on key personnel, challenges in growth strategies, reputational damage, fraud, system failures, and reliance on third-party information and vendors - The Company is highly dependent on key management and business development personnel; the loss of these individuals could materially affect operations and financial condition[125] - Inability to successfully implement and manage growth strategies, including identifying attractive markets or integrating acquisitions, could adversely affect results of operations and financial condition[127][129] - Operational risks include reputational risk, legal and compliance risk, fraud, theft, operational errors, and failures in computer or communications systems, which could lead to financial loss or liability[130][131][132] - The Company's ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions due to interdependencies in the financial services industry[134] - Failure to maintain effective internal and disclosure controls could harm reputation, operating results, and investor confidence[135][136] - Reliance on the accuracy and completeness of information from clients and counterparties, and on third-party vendors for business infrastructure, exposes the Company to risks if this information is misleading or if vendors fail to perform[138][139] - Information systems are vulnerable to interruptions or security breaches, which could damage reputation, lead to customer loss, regulatory scrutiny, or civil litigation[140] Risk Related to the Company's Regulatory Environment Changes in accounting standards and extensive financial regulations, including capital requirements and ESG expectations, can increase costs and restrict operations - Changes in financial accounting and reporting standards can materially impact reported financial condition and results of operations, potentially requiring retroactive application and restatement of prior periods[141] - Operating in a highly regulated industry means extensive laws and regulations govern operations, corporate governance, executive compensation, and financial accounting; changes or non-compliance can lead to increased costs, business restrictions, fines, and penalties[142][144][145] - Regulatory capital standards, particularly Basel III, may adversely affect profitability, lending, and dividend payments by requiring higher capital levels or limiting operations[146] - Increasing scrutiny and evolving expectations regarding Environmental, Social, and Governance (ESG) practices may impose additional costs, new risks, and impact reputation or stock price[147] Risk Related to the Company's Common Stock Risks include thin trading, dividend payment limitations, anti-takeover provisions, significant shareholder influence, and impacts from climate change and external events - The Company's common stock is thinly traded, which may limit shareholders' ability to sell shares and increase price volatility[148][150][151] - The ability to pay dividend payments is limited by regulatory restrictions and the need to maintain sufficient capital; failure to meet these requirements or default on subordinated notes/debt securities would prohibit dividend payments[152][153] - Anti-takeover provisions in governing documents and Virginia law could discourage acquisition attempts, even if favorable to shareholders[154] - Kenneth R. Lehman, the largest shareholder (approximately 51.47% ownership as of December 16, 2020), has significant influence, and his interests may not always align with other common stockholders[155] - If Mr. Lehman acquires more than 66.67% of outstanding common stock, it would trigger accelerated benefits under certain employment and benefit agreements, leading to additional compensation expenses[156][157] - Climate change and related legislative/regulatory initiatives may result in operational changes, increased expenditures, and direct impacts on loan collateral values and regional economic activity[158][159][161] - Severe weather, natural disasters, acts of war or terrorism, and public health issues could significantly impact business operations, deposit stability, loan repayment ability, and collateral values[162] ITEM 1B. UNRESOLVED STAFF COMMENTS There are no unresolved staff comments applicable to the Company - No unresolved staff comments are applicable[163] Item 1C. CYBERSECURITY The Company maintains a robust and dynamic cybersecurity framework integrated into its enterprise risk management, utilizing a three-lines-of-defense structure, external partners, and Board oversight to mitigate risks - The Company had no material cybersecurity incidents in 2023[164] Overview The Company employs a robust framework to mitigate cybersecurity risks through privacy policies, management oversight, technology design, and active monitoring - The Company employs a robust and dynamic framework to reduce and mitigate cybersecurity risk, which includes exposure to failures, interruptions, or security breaches from malicious attacks[163] - Mitigation strategies involve maintaining privacy policies, management oversight, accountability structures, technology design, active monitoring, a third-party cybersecurity oversight program, and Board-level oversight[166] Risk Management and Strategy Cybersecurity risk management is integrated into the enterprise framework, employing a three-lines-of-defense structure, management expertise, and independent third-party assessments - Cybersecurity risk management is integrated into the enterprise risk management framework, utilizing a three-lines-of-defense structure, management expertise, Board oversight, and outside partners[165] - Safeguards include protecting customer and corporate information, programs to mitigate known attacks, internal and external vulnerability scanning, backup and recovery systems, and cybersecurity requirements for third-party service providers[165][167] - Independent third-party service providers perform penetration testing and program assessments for regulatory compliance and industry guidelines[166] Governance Established governance structures, including an incident response plan, ensure appropriate oversight, threat monitoring, and escalation of cybersecurity risks - Established governance structures, including an incident response plan, facilitate appropriate oversight of cybersecurity risk, enabling review, management, threat monitoring, and escalation to executive management or the Board[169] Role of the Board of Directors The Board oversees the Company's cyber risk profile, strategy, and initiatives, receiving regular reports and engaging with auditors and regulators - The Board of Directors oversees cyber risk profile, enterprise cyber strategy, and key cyber initiatives, receiving regular reports from the Information Security Officer and engaging with auditors and regulators[170] - The Board Risk Committee assists in risk oversight, oversees the enterprise risk management framework, discusses major risk exposures, and receives quarterly cybersecurity risk summaries[171] Role of Management The cybersecurity risk management program is structured with three lines of defense, involving employees, risk monitoring, and independent internal audit assurance - The cybersecurity risk management program is built on three lines of defense: employees (first line, receiving annual training), second line (evaluates, monitors, and challenges risk mitigation efforts), and Internal Audit (third line, provides independent assurance)[172][173][174][176] - The Chief Risk Officer is responsible for implementing the enterprise risk management framework and reports directly to the CEO[172] - The Management Risk and Compliance Committee, led by the second line of defense, governs technology and operational risk tolerances, including cybersecurity and third-party provider risks[175] ITEM 2. PROPERTIES The Company's executive and administrative offices, along with the Mortgage Company's principal office, are owned by the Bank in Midlothian, Virginia - The Company's executive and administrative offices, and the Mortgage Company's principal office, are owned by the Bank in Midlothian, Virginia[177] - The Bank operates nine full-service branch banking offices in Central Virginia (Chesterfield, Hanover, Henrico, Powhatan, James City counties, and Richmond city), with six owned and three leased[178] - Properties are maintained in good operating condition and are considered suitable and adequate for operational needs[179] ITEM 3. LEGAL PROCEEDINGS The Company is a party to various legal proceedings in the ordinary course of business, but as of the report date, there are no pending or threatened proceedings that would materially affect its business - The Company is involved in various legal proceedings as part of its ordinary operations[180] - As of the report date, there are no pending or threatened legal proceedings that, if determined adversely, would have a material effect on the Company's business, results of operations, or financial position[180] ITEM 4. MINE SAFETY DISCLOSURES Mine safety disclosures are not applicable to the Company - Mine safety disclosures are not applicable[181] PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES The Company's common stock trades on the Nasdaq Capital Market under the symbol "VBFC", with dividends declared and no repurchases in 2023 or 2022 - The Company's common stock trades on the Nasdaq Capital Market under the symbol "VBFC"[183] Market and Dividend Information This section details the Company's common stock trading, historical dividend payments, and factors influencing future dividend declarations Quarterly Cash Dividends Per Common Share | Year | Dividend Per Share | | :--- | :----------------- | | 2023 | $0.66 | | 2022 | $0.58 | - Future dividend declarations are subject to Board approval, operating results, financial condition, capital adequacy, regulatory requirements, shareholder returns, and market conditions[185] Holders Information on the number of outstanding common shares and record holders as of a specific date is provided Common Stock Holders (March 15, 2024) | Metric | Value | | :---------------------- | :---------- | | Shares Outstanding | 1,492,879 | | Shareholders of Record | ~871 | Purchases of Equity Securities The Company did not engage in any repurchases of its common stock during the reported fiscal years - The Company did not repurchase any of its common stock during 2023 or 2022[186] ITEM 6. RESERVED This item is reserved and contains no information ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This section provides management's discussion and analysis of the Company's financial condition and results of operations for the years ended December 31, 2023 and 2022 - The Company's primary source of earnings is net interest income and income from mortgage banking activities, with principal market risk exposure to interest rate risk[191] - Management's discussion and analysis should be read in conjunction with the consolidated financial statements and notes[188][195] General The Company's earnings are primarily driven by net interest income and mortgage banking, with interest rate risk as the main market exposure - The Company's primary earnings sources are net interest income and mortgage banking activities, with interest rate risk being the principal market risk exposure[191] - Assumptions and judgments about loan portfolio collectability are crucial, and incorrect estimates could necessitate additions to the allowance for credit losses, negatively impacting net income[194] Results of Operations This section analyzes the Company's financial performance, including net income, EPS, and the impact of CECL adoption and securities repositioning Net Income and EPS (2023 vs. 2022) | Metric | 2023 | 2022 | Change ($) | Change (%) | | :----------------- | :----------- | :----------- | :----------- | :----------- | | Net Income | $1,918,000 | $8,305,000 | $(6,387,000) | -76.91% | | Diluted EPS | $1.29 | $5.62 | $(4.33) | -77.05% | - The Company adopted the CECL methodology on January 1, 2023, increasing the allowance for credit losses by $150,000 to $3.52 million[197] - A securities repositioning and balance sheet deleveraging strategy in 2023 involved selling $55.195 million in available-for-sale securities at a pre-tax loss of $4.986 million, aiming to improve earnings per share, net interest margin, return on assets, and tangible common equity[199] Net interest income Analysis of net interest income and margin, detailing factors influencing earning asset yields and the cost of interest-bearing liabilities Net Interest Income and Margin (2023 vs. 2022) | Metric | 2023 | 2022 | Change ($) | Change (%) | | :---------------------- | :----------- | :----------- | :----------- | :----------- | | Net Interest Income | $25,288,000 | $25,706,000 | $(418,000) | -1.63% | | Net Interest Margin (NIM)| 3.65% | 3.67% | -0.02% | -0.54% | - NIM contracted by two basis points due to an 88 basis point increase in earning asset yield (to 4.80%) offset by a 146 basis point increase in the cost of interest-bearing liabilities (to 1.90%)[203] - The increase in earning asset yield was driven by an improved earning asset mix and rising interest rates, with further improvement expected from securities portfolio maturities and balance sheet repositioning[203] - The cost of interest-bearing liabilities increased due to higher rates on variable-rate debt and market pressures on deposit rates, with average borrowings increasing by $33.2 million at a weighted average cost of 4.65%[203] - Total Paycheck Protection Program (PPP) income decreased significantly from $1,058,000 in 2022 to $9,400 in 2023[203] Provision for (recovery of) credit losses This section details the provision for credit losses, including the impact of CECL adoption and changes in the allowance for credit losses - The Company adopted the CECL methodology on January 1, 2023, resulting in a $150,000 increase in the allowance for credit losses[210] Allowance for Credit Losses (2023 vs. 2022) | Metric | 2023 | 2022 | | :----------------------------------- | :----------- | :----------- | | Allowance for Credit Losses (End of Period) | $3.73 million | $3.37 million | | Allowance for Credit Losses on Loans | $3.42 million | $3.37 million | | Reserve for Unfunded Commitments | $306,000 | N/A | Provision for Credit Losses (2023 vs. 2022) | Metric | 2023 | 2022 | | :----------------------------------- | :---------- | :---------- | | Provision for Credit Losses for Loans| $21,000 | $(300,000) | | Provision for Unfunded Commitments | $29,000 | $0 | | Total Provision (Recovery) | $50,000 | $(300,000) | - The 2023 provision for credit losses on loans ($21,000) was due to loan growth offset by improved credit metrics (non-performing loans decreased from 0.12% to 0.05%) and $162,000 in net recoveries[215] - The 2022 recovery of provision for loan loss expense ($300,000) resulted from reductions in qualitative factors due to improving economic conditions, better credit metrics, and fewer loan deferrals[219] Noninterest income Analysis of noninterest income components, highlighting changes in mortgage banking income, service charges, and investment security sales Noninterest Income (2023 vs. 2022) | Category | 2023 ($ thousands) | 2022 ($ thousands) | Change ($ thousands) | Change (%) | | :-------------------------------- | :----------------- | :----------------- | :------------------- | :--------- | | Service charges and fees | $2,738 | $2,625 | $113 | 4.3% | | Mortgage banking income, net | $1,690 | $3,427 | $(1,737) | -50.7% | | Loss on sale of investment securities | $(4,986) | $0 | $(4,986) | 100.0% | | Gain on sale of SBA loans | $0 | $79 | $(79) | -100.0% | | Other | $522 | $471 | $51 | 10.8% | | Total Noninterest Income | $(36) | $6,602 | $(6,638) | -100.5% | - The significant decrease in total noninterest income was primarily due to a $4,986,000 loss on sale of investment securities from a balance sheet repositioning strategy[225] - Mortgage banking income, net, decreased by $1,737,000 due to lower mortgage originations and sales, impacted by higher mortgage rates and low housing inventory[225] - Service charges and fees increased by $113,000, driven by higher interchange fee income from increased consumer and business spending[225] Noninterest expense This section reviews noninterest expenses, including salaries, benefits, data processing, and professional services, and their year-over-year changes Noninterest Expense (2023 vs. 2022) | Category | 2023 ($ thousands) | 2022 ($ thousands) | Change ($ thousands) | Change (%) | | :---------------------------- | :----------------- | :----------------- | :------------------- | :--------- | | Salaries and benefits | $13,389 | $13,768 | $(379) | -2.8% | | Occupancy | $1,242 | $1,216 | $26 | 2.1% | | Equipment | $1,112 | $1,102 | $10 | 0.9% | | Supplies | $162 | $158 | $4 | 2.5% | | Data processing | $1,943 | $1,389 | $554 | 39.9% | | Professional and outside services | $1,598 | $1,387 | $211 | 15.2% | | Advertising and marketing | $404 | $386 | $18 | 4.7% | | FDIC insurance premium | $298 | $237 | $61 | 25.7% | | Other operating expense | $2,889 | $2,670 | $219 | 8.2% | | Total Noninterest Expense | $23,037 | $22,313 | $724 | 3.2% | - Salaries and benefits decreased by $379,000, primarily due to lower mortgage production[229] - Data processing expenses increased by $554,000 due to the rollout of an updated online and mobile banking platform[229] - Professional and outside services increased by $211,000 due to new licensed software, consultant fees, and debit/credit card usage fees[229] Income taxes Analysis of income tax expense and the effective tax rate, including factors contributing to changes in tax burden Income Tax Expense and Effective Tax Rate (2023 vs. 2022) | Metric | 2023 ($ thousands) | 2022 ($ thousands) | | :---------------------- | :----------------- | :----------------- | | Income Tax Expense | $247 | $1,990 | | Effective Tax Rate | 11.4% | 19.3% | - The decrease in the effective tax rate was primarily due to an increase in tax credits related to state taxes attributed to the Company and the mortgage banking segment[228] Balance Sheet Analysis This section provides a detailed analysis of the Company's balance sheet components, including investment securities, loans, deposits, and capital resources Investment securities Overview of the Company's investment securities portfolio, including classification, composition, and weighted average yields - All investment securities are classified as available for sale[230] Investment Securities Portfolio Composition (December 31, 2023) | Category | Amortized Cost ($ thousands) | Weighted Average Yield | | :----------------------------- | :--------------------------- | :--------------------- | | U.S. Government agency obligations | $20,690 | 1.60% | | Mortgage-backed securities | $77,275 | 3.85% | | Municipals | $2,264 | 2.17% | | Subordinated debt | $12,449 | 4.94% | | Total | $112,678 | 3.52% | Loans Analysis of the loan portfolio, including quality, composition by type, geographic concentration, and underwriting practices - Management aims to maintain high loan portfolio quality through rigorous underwriting, regular creditworthiness evaluation, and diversification to minimize concentration risk[233] - Approximately 81% of all loans are secured by real property in Virginia, with commercial and industrial loans representing about 15% and rehabilitated student loans about 3%[234] Loan Portfolio Composition (December 31, 2023 vs. 2022) | Loan Type | 2023 Amount ($ thousands) | 2023 % | 2022 Amount ($ thousands) | 2022 % | | :------------------------------ | :------------------------ | :----- | :------------------------ | :----- | | Construction and land development | $47,495 | 8.26% | $45,127 | 8.38% | | Commercial real estate | $290,590 | 50.54% | $284,617 | 52.86% | | Consumer real estate | $128,532 | 22.35% | $93,680 | 17.40% | | Commercial and industrial loans | $86,203 | 14.99% | $90,348 | 16.78% | | Guaranteed student loans | $17,923 | 3.12% | $20,617 | 3.83% | | Consumer and other | $4,265 | 0.74% | $4,038 | 0.75% | | Total Loans | $575,008 | 100.00%| $538,427 | 100.00%| Allowance for Credit losses Details on the allowance for credit losses, its purpose, CECL methodology, and activity impacting its balance - The allowance for credit losses is maintained to absorb expected losses in the loan portfolio, with the Company adopting the CECL methodology on January 1, 2023[238][210] Allowance for Credit Losses Activity (2023 vs. 2022) | Metric | 2023 ($ thousands) | 2022 ($ thousands) | | :----------------------------------- | :----------------- | :----------------- | | Beginning Balance | $3,370 | $3,423 | | Impact of adopting ASC 326 | $(127) | N/A | | Provision for (Recovery of) Credit Losses | $21 | $(300) | | Charge-offs | $(33) | $(217) | | Recoveries | $192 | $464 | | Ending Balance | $3,423 | $3,370 | - The 2023 provision for credit losses on loans was $21,000, driven by loan growth offset by improved credit metrics and net recoveries[215] Asset quality Review of asset quality metrics, including nonperforming assets, nonaccrual loans, and their ratios to total assets and loans Asset Quality Information (December 31, 2023 vs. 2022) | Metric | 2023 | 2022 | | :----------------------------------- | :----------- | :----------- | | Nonaccrual loans | $291,000 | $654,000 | | Total nonperforming assets | $291,000 | $654,000 | | Nonaccrual loans to total loans | 0.05% | 0.12% | | Nonperforming assets to loans | 0.05% | 0.12% | | Nonperforming assets to total assets | 0.04% | 0.09% | | Allowance for credit losses on loans to Loans, net of deferred fees and costs | 0.59% | 0.63% | - Nonperforming assets decreased from $654,000 in 2022 to $291,000 in 2023, consisting entirely of nonaccrual loans[245] - Loans past due 90 days and still accruing totaled $2,228,000 in 2023 and $1,725,000 in 2022, all of which are rehabilitated student loans with a 98% DOE guarantee[243][250] Deposits Analysis of deposit composition, changes in balances, and strategies for managing deposit costs and maturities Deposit Composition (December 31, 2023 vs. 2022) | Deposit Type | 2023 Amount ($ thousands) | 2023 % | 2022 Amount ($ thousands) | 2022 % | | :---------------------------- | :------------------------ | :----- | :------------------------ | :----- | | Demand accounts | $247,624 | 40.9% | $255,236 | 40.9% | | Interest checking accounts | $76,289 | 12.6% | $90,252 | 14.4% | | Money market accounts | $195,249 | 32.3% | $179,036 | 28.7% | | Savings accounts | $39,633 | 6.5% | $55,695 | 8.9% | | Time deposits of $250,000 and over | $9,145 | 1.5% | $4,740 | 0.8% | | Other time deposits | $37,405 | 6.2% | $39,784 | 6.3% | | Total | $605,345 | 100.0%| $624,743 | 100.0%| - Total deposits decreased by $19,398,000 (3.10%) from December 31, 2022, primarily due to decreases in noninterest-bearing demand accounts and low-cost relationship deposits[252][253][259] - Noninterest-bearing demand accounts decreased by $7,612,000, driven by consumers and businesses drawing down balances due to inflation, tax payments, and investments in higher-yielding products[253][254] - Time deposits increased by $2,026,000 (4.55%), reflecting a strategy to lock in lower-cost time deposits with shorter maturities[259] Borrowings Overview of the Company's borrowing activities, including FHLB advances and other funding sources, used to supplement deposits - Borrowings are used to supplement deposits for funding or liability duration needs[258] Off-balance sheet arrangements Description of off-balance sheet financial instruments, such as credit commitments and letters of credit, and their associated risks - The Company uses off-balance sheet financial instruments, such as commitments to extend credit and standby letters of credit, to meet customer financing needs and manage interest rate risk[259] Capital resources Analysis of shareholders' equity and regulatory capital ratios, highlighting factors influencing capital adequacy and changes in equity Shareholders' Equity (2023 vs. 2022) | Metric | 2023 ($ thousands) | 2022 ($ thousands) | Change ($ thousands) | | :----------------- | :----------------- | :----------------- | :------------------- | | Shareholders' Equity | $67,556 | $61,111 | $6,445 | - The increase in shareholders' equity was primarily due to net income of $1,918,000 and a $5,268,000 decrease in accumulated other comprehensive loss, resulting from the balance sheet repositioning and improved valuations on available-for-sale securities[261] Bank Capital Ratios (December 31, 2023 vs. 2022) | Capital Ratio | 2023 | 2022 | | :--------------------------------- | :------ | :------ | | Leverage ratio | 11.14% | 10.95% | | Common equity tier 1 capital ratio | 13.86% | 14.22% | | Tier 1 capital to risk-weighted assets | 13.86% | 14.22% | | Total capital to risk-weighted assets | 14.49% | 14.81% | | Equity to total assets | 10.50% | 9.78% | Liquidity Assessment of the Company's liquidity position, including liquid assets, uninsured deposits, and available funding sources Liquid Assets (2023 vs. 2022) | Metric | 2023 ($ thousands) | 2022 ($ thousands) | | :----------------------------------- | :----------------- | :----------------- | | Liquid Assets (Cash, Cash Equivalents, AFS Securities) | $123,299 | $150,531 | | % of Total Assets | 16.74% | 20.81% | - At December 31, 2023, uninsured deposits were approximately $209.1 million (34.62% of total deposits), with total liquidity sources covering 71.5% of uninsured deposits[266] - The Company had $149.5 million in total liquidity sources at December 31, 2023, and an additional $110.5 million in wholesale deposit availability, providing 124.3% coverage for uninsured deposits[266][267] - The Company maintains federal funds lines of credit ($22.8 million unused at December 31, 2023) and FHLB borrowing capacity ($3.4 million unused at December 31, 2023, with potential to increase by pledging additional collateral)[268][269] Interest Rate Sensitivity Management's approach to monitoring and managing interest rate sensitivity to optimize net interest margin and mitigate risk - Management monitors interest rate sensitivity by considering expected cash flows from portfolios and repricing of assets/liabilities to maximize and stabilize net interest margin[272] - The sale of fixed-rate loans is intended to protect against precipitous changes in interest rates[274] Impact of inflation and changing prices Discussion on how inflation affects operating costs and the greater impact of interest rate changes on the Company's financial condition - Inflation primarily affects the Company through increased operating costs, but changes in interest rates have a far greater impact on financial condition[277] LIBOR and Other Benchmark Rates Details on the transition from LIBOR to SOFR for borrowings and financial instruments, and its impact on the Company - Following the discontinuation of LIBOR on June 30, 2023, the Company replaced LIBOR with the corresponding term SOFR plus an applicable tenor spread adjustment for its borrowings and financial instruments[278][279] - This transition did not have a significant impact on the Company's consolidated financial statements[280] Critical Accounting Policies and Estimates Overview of key accounting policies and estimates, particularly the highly subjective allowance for credit losses, and their reliance on management judgment - The Company's financial statements rely on management's estimates and assumptions, particularly for the allowance for credit losses, which is highly subjective and susceptible to significant revision[281][282][286] - The allowance for credit losses includes allowances for loans, unfunded commitments, and securities, measured using a WARM methodology and considering qualitative adjustment factors[284][287][289][290] New accounting standards Information on recent accounting pronouncements and their potential effects on the Company's financial statements - Information regarding recent accounting pronouncements and their effect on the Company is detailed in Note 1 of the Consolidated Financial Statements[293] ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This item is not applicable to the Company - Quantitative and qualitative disclosures about market risk are not applicable[294] ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA This section presents the Company's audited consolidated financial statements for the years ended December 31, 2023 and 2022, along with related footnotes - The consolidated financial statements and related footnotes are presented, including the Report of Independent Registered Public Accounting Firm[295][298] - The Company changed its method of accounting for the allowance for credit losses in 2023 due to the adoption of ASU 2016-13 (CECL)[299] Report of Independent Registered Public Accounting Firm This report provides the auditor's opinion on the consolidated financial statements and highlights critical audit matters, such as the allowance for credit losses - Yount, Hyde & Barbour, P.C. provided an unqualified opinion on the consolidated financial statements for December 31, 2023 and 2022, stating they present fairly the financial position, results of operations, and cash flows in conformity with GAAP[298] - The audit identified the estimation of the Allowance for Credit Losses – Loans Collectively Evaluated for Losses as a critical audit matter due to its complexity and subjectivity, requiring extensive auditor judgment[304][305][308] Consolidated Balance Sheets Presents a snapshot of the Company's assets, liabilities, and equity at specific points in time, reflecting its financial position Consolidated Balance Sheet Highlights (December 31, 2023 vs. 2022) | Asset/Liability/Equity | 2023 ($ thousands) | 2022 ($ thousands) | | :------------------------------- | :----------------- | :----------------- | | Total Assets | $736,616 | $723,270 | | Total Deposits | $605,345 | $624,743 | | Federal Home Loan Bank advances | $45,000 | $20,000 | | Total Liabilities | $669,060 | $662,159 | | Total Shareholders' Equity | $67,556 | $61,111 | Consolidated Statements of Income Details the Company's revenues, expenses, and net income over a period, illustrating its operational profitability Consolidated Statements of Income Highlights (2023 vs. 2022) | Income/Expense Item | 2023 ($ thousands) | 2022 ($ thousands) | | :------------------------------- | :----------------- | :----------------- | | Total Interest Income | $33,274 | $27,487 | | Total Interest Expense | $7,986 | $1,781 | | Net Interest Income | $25,288 | $25,706 | | Provision for (recovery of) credit losses | $50 | $(300) | | Total Noninterest Income (Loss) | $(36) | $6,602 | | Total Noninterest Expense | $23,037 | $22,313 | | Income before income tax expense | $2,165 | $10,295 | | Income tax expense | $247 | $1,990 | | Net Income | $1,918 | $8,305 | | Earnings per share, diluted | $1.29 | $5.62 | Consolidated Statements of Comprehensive Income (Loss) Reports net income and other comprehensive income items, such as unrealized gains/losses on securities, to show total comprehensive income Consolidated Statements of Comprehensive Income (Loss) Highlights (2023 vs. 2022) | Item | 2023 ($ thousands) | 2022 ($ thousands) | | :----------------------------------------- | :----------------- | :----------------- | | Net income | $1,918 | $8,305 | | Net change in unrealized holding gains (losses) on securities available for sale, net of tax | $1,320 | $(10,146) | | Reclassification for gains included in net income, net of tax | $3,939 | $0 | | Minimum pension adjustment, net of tax | $9 | $9 | | Total other comprehensive income (loss) | $5,268 | $(10,137) | | Total comprehensive income (loss) | $7,186 | $(1,832) | Consolidated Statements of Shareholders' Equity Outlines changes in the Company's equity accounts, including common stock, retained earnings, and accumulated other comprehensive loss Consolidated Statements of Shareholders' Equity Highlights (December 31, 2023 vs. 2022) | Item | 2023 ($ thousands) | 2022 ($ thousands) | | :--------------------------------- | :----------------- | :----------------- | | Common Stock | $5,908 | $5,868 | | Additional Paid-in Capital | $55,486 | $55,167 | | Retained Earnings | $11,775 | $10,957 | | Accumulated Other Comprehensive Loss | $(5,613) | $(10,881) | | Total Shareholders' Equity | $67,556 | $61,111 | - Shareholders' equity increased by $6,445,000 in 2023, primarily due to net income and a decrease in accumulated other comprehensive loss[261] Consolidated Statements of Cash Flows Summarizes cash inflows and outflows from operating, investing, and financing activities, showing changes in cash and cash equivalents Consolidated Statements of Cash Flows Highlights (2023 vs. 2022) | Cash Flow Activity | 2023 ($ thousands) | 2022 ($ thousands) | | :--------------------------------- | :----------------- | :----------------- | | Net cash provided by operating activities | $4,957 | $10,269 | | Net cash used in investing activities | $(8,542) | $(66,063) | | Net cash provided by (used in) financing activities | $4,621 | $(20,144) | | Net increase (decrease) in cash and cash equivalents | $1,036 | $(75,938) | | Cash and cash equivalents, end of period | $17,714 | $16,678 | Notes to Consolidated Financial Statements Provides detailed explanations and supplementary information for items presented in the consolidated financial statements Note 1. Summary of Significant Accounting Policies Outlines the Company's key accounting principles, including GAAP conformity, estimates, CECL adoption, and segment reporting - The Company's accounting policies conform to GAAP and banking industry practices, with financial position and results affected by management's estimates and assumptions[326][281] - The Company adopted ASU 2016-13 (CECL) on January 1, 2023, resulting in a net decrease to retained earnings of $119,000, net of taxes, and now uses a WARM methodology for estimating expected credit losses[331][332] - The Company also adopted ASU 2022-02, removing TDR recognition and measurement guidance, resulting in an $8,000 reduction in the allowance for credit losses[337] - Debt securities are classified as held to maturity, available for sale, or trading; currently, the Company only holds available for sale securities, valued at fair value with changes reported in other comprehensive income[339][340] - Mortgage banking activities involve originating residential mortgage loans for sale, with loans held for sale and interest rate lock commitments (IRLCs) accounted for at fair value[343][344] - Loans are stated at principal outstanding, net of unearned income, with origination fees and costs deferred and amortized[347] - The allowance for credit losses is a valuation allowance for expected credit losses on loans, unfunded commitments, and securities, established through a provision for credit losses[360][361] - The Company has two reportable segments: traditional commercial banking and mortgage banking, with intercompany transactions eliminated in consolidation[379][380] - Recent accounting pronouncements (ASU 2023-09, 2023-07, 2023-06, 2023-03, 2022-06, 2020-04, 2021-01) are being assessed for their impact, with most not expected to have a material effect[381][385][386][387][388][391] Note 2. Investment Securities Available for Sale Details the composition, fair value, and unrealized gains/losses of the Company's available-for-sale investment securities portfolio Investment Securities Available for Sale (December 31, 2023 vs. 2022) | Category | 2023 Amortized Cost ($ thousands) | 2023 Fair Value ($ thousands) | 2022 Amortized Cost ($ thousands) | 2022 Fair Value ($ thousands) | | :----------------------------- | :-------------------------------- | :---------------------------- | :-------------------------------- | :---------------------------- | | U.S. Government agency obligations | $20,690 | $20,615 | $64,631 | $60,902 | | Mortgage-backed securities | $77,275 | **$72