Village Bank & Trust Financial Corp. - FORM 10-K - March 30, 2010

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EX-21 - VILLAGE FORM 10-K EXHIBIT 21 - Village Bank & Trust Financial Corp.exhibit21.htm
EX-32 - VILLAGE FORM 10-K EXHIBIT 32 - Village Bank & Trust Financial Corp.exhibit32.htm
EX-99.2 - VILLAGE FORM 10-K EXHIBIT 99.2 - Village Bank & Trust Financial Corp.exhibit992.htm
EX-31.2 - VILLAGE FORM 10-K EXHIBIT 31.2 - Village Bank & Trust Financial Corp.exhibit312.htm
EX-99.1 - VILLAGE FORM 10-K EXHIBIT 99.1 - Village Bank & Trust Financial Corp.exhibit991.htm
EX-31.1 - VILLAGE FORM 10-K EXHIBIT 31.1 - Village Bank & Trust Financial Corp.exhibit311.htm
EX-3.1 - VILLAGE FORM 10-K EXHIBIT 3.1 - Village Bank & Trust Financial Corp.exhibit31.htm

 
 
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-K
ANNUAL REPORT UNDER SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the fiscal year ended December 31, 2009
 
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.)
 
                                                     15521 Midlothian Turnpike, Suite 200, Midlothian, Virginia                           23113
     (Address of principal executive offices)                                                                          (Zip Code)
 
Issuer’s telephone number 804-897-3900
 
Securities registered under Section 12(b) of the Exchange Act:
 
                                   Title of each class                                                              Name of each exchange on which registered
                              Common Stock, $4.00 par value                                                                               The Nasdaq Stock Market
 
Securities registered under Section 12(g) of the Exchange Act:
None
 
         
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes o No x
          
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. o
        
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 
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 x  No o
 
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not
be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III
of this Form10-K or any amendment to this Form 10-K. o
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller
reporting company. See the definition of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2
of the Exchange Act.
 
Large Accelerated Filer o                                                                                              Accelerated Filer o
Non-Accelerated Filer o (Do not check if smaller reporting company)                                                Smaller Reporting Company x
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o  No  x
 
The aggregate market value of common stock held by non-affiliates of the registrant as of June 30, 2009 was approximately $19,884,000
 
The number of shares of common stock outstanding as of March 5, 2010 was 4,230,628.
 
   DOCUMENTS INCORPORATED BY REFERENCE
  
Portions of the definitive Proxy Statement to be used in conjunction with the 2010 Annual Meeting of Shareholders are incorporated
by reference into Part III of this Form 10-K.



 
 
 

 
Village Bank and Trust Financial Corp.
Form 10-K
 
TABLE OF CONTENTS
 
Part I
    Item 1.
Business
3
    Item 1A.
Risk Factors
16
    Item 1B.
Unresolved Staff Comments
24
    Item 2.
Properties
24
    Item 3.
Legal Proceedings
24
    Item 4.
Reserved
24
 
Part II
    Item 5.
Market for Registrant’s Common Equity, Related Stockholder
Matters and Issuer Purchases of Equity Securities
25
    Item 6.
Selected Financial Data
27
    Item 7.
Management’s Discussion and Analysis of Financial Condition
And Results of Operations
 
28
    Item 8.
Financial Statements and Supplementary Data
52
    Item 9.
Changes In and Disagreements with Accountants
on Accounting and Financial Disclosure
 
88
    Item 9A.
Controls and Procedures
88
    Item 9B.
Other Information
89
 
Part III
    Item 10.
Directors, Executive Officers, and Corporate Governance
90
    Item 11.
Executive Compensation
90
    Item 12.
Security Ownership of Certain Beneficial Owners and
Management and Related Stockholder Matters
 
90
    Item 13.
Certain Relationships and Related Transactions,
and Director Independence
 
90
    Item 14.
Principal Accounting Fees and Services
90
 
Part IV
    Item 15.
Exhibits, Financial Statement Schedules
91
 
Signatures
  
94

 
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PART I
 
 
ITEM 1.  BUSINESS
 
The disclosures set forth in this item are qualified by ITEM 1A. RISK FACTORS on pages 17 to 24 and the section captioned “Caution About Forward-Looking Statements” on page 29 and other cautionary statements set forth elsewhere in this report.
 
General
 
Village Bank and Trust Financial Corp. (the “Company”) was incorporated in January 2003 and was organized under the laws of the Commonwealth of Virginia as a bank holding company whose activities consist of investment in its wholly-owned subsidiary, Village Bank (the “Bank”).  The Bank opened to the public on December 13, 1999 as a traditional community bank offering deposit and loan services to individuals and businesses in the Richmond, Virginia metropolitan area.  During 2003, the Company acquired or formed three wholly owned subsidiaries of the Bank, Village Bank Mortgage Corporation (“Village Bank Mortgage”), a full service mortgage banking company, Village Insurance Agency, Inc. (“Village Insurance”), a full service property and casualty insurance agency, and Village Financial Services Corporation (“Village Financial Services”), a financial services company.  Currently, Village Insurance and Village Financial Services have no ongoing operations.
 
The Company is the holding company of and successor to the Bank.  Effective April 30, 2004, the Company acquired all of the outstanding stock of the Bank in a statutory share exchange transaction.  In the transaction, the shares of the Bank’s common stock were exchanged for shares of the Company’s common stock, par value $4.00 per share (“Common Stock”), on a one-for-one basis.  As a result, the Bank became a wholly-owned subsidiary of the Company, the Company became the holding company for the Bank and the shareholders of the Bank became shareholders of the Company.  All references to the Company in this annual report for dates or periods prior to April 30, 2004 are references to the Bank.
 
 
On October 14, 2008, Village Bank and Trust Financial Corp. and Village Bank completed its merger with River City Bank pursuant to an Agreement and Plan of Reorganization and Merger (the “Merger Agreement”) dated as of March 9, 2008 by and among the Company, the Bank and River City Bank.  The merger had previously been approved by both companies’ shareholders at their respective annual meetings on September 30, 2008 as well as the banking regulators.  The Merger Agreement sets forth the terms and conditions of the Company’s merger with River City Bank through the merger of River City Bank with and into Village Bank.  Under the terms of the Merger Agreement, Village Bank acquired all of the outstanding shares of River City Bank.  The shareholders of River City Bank received, for each share of River City Bank common stock that they owned immediately prior to the effective time of the merger, either $11 per share in cash or one share of common stock of the Company.  Pursuant to the terms of the Merger Agreement, shareholders of River City Bank elected to receive cash, shares of common stock of the Company, or a combination of both, subject to allocation and proration procedures which ensured that 20% of the total merger consideration was in cash and 80% was in common stock of the Company.  In addition, at the effective time of the merger, each outstanding option to purchase shares of River City Bank common stock under any stock plans vested pursuant to its terms and was converted into an option to acquire the number of shares of the Company’s common stock equal to the number of shares of River City Bank common stock underlying the option.  The Company issued approximately 1,440,000 shares in the Merger.

 
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Business Strategy
 
Our current business strategies include the following:
 
 
●
To be a full service financial services provider enabling us to establish and maintain relationships with our customers.
 
 
●
To attract customers by providing the breadth of products offered by larger banks while maintaining the quick response and personal service of a community bank.  We will continue to look for opportunities to expand our products and services.  In our first nine years of operation, we have established a diverse product line, including commercial, mortgage and consumer loans as well as a full array of deposit products and services.
 
 
●
To increase net income and return to shareholders through moderate loan growth, while controlling the cost of our deposits and noninterest expenses.
 
 
●
To reduce the level of our nonperforming assets.  Nonperforming assets, consisting of nonaccrual loans and real estate acquired through foreclosure, reached record highs in 2009 and are having a negative affect on profitability.  We have committed significant resources to reduce the level of nonperforming assets.
 
 
●
To expand our capacity to generate noninterest income through the sale of mortgage loans.  In 2009 our mortgage company hired additional mortgage loan officers which should expand our ability to originate mortgage loans.
 
 
●
To continue to emphasize commercial banking products and services.  Small-business commercial customers are a source of prime-based loans, fee income from cash management services, and low cost deposits, which we need to fund our growth.  We have been able to build a commercial business base because our staff of commercial bankers seeks opportunities to network within the local business community.  Significant additional growth in this banking area will depend on expanding our lending staff.
 
Our officers, employees and the directors live and work in our market area.  We believe that the existing and future banking market in our community represents an opportunity for locally owned and locally managed community banks.  In view of the continuing trend in the financial services industry toward consolidation into larger, sometimes impersonal, statewide, regional and national institutions, the market exists for the personal and customized financial services that an independent, locally owned bank with local decision making can offer.  With the flexibility of our smaller size and through an emphasis on relationship banking, including personal attention and service, we can be more responsive to the individual needs of our customers than our larger competitors.  As a community oriented and locally managed institution, we make most of our loans in our community and can tailor our services to meet the banking and financial needs of our customers who live and do business in our market.
 
We provide customers with high quality, responsive and technologically advanced banking services.  These services include loans that are priced on a deposit-based relationship, easy access to our decision makers, and quick and innovative action necessary to meet a customer’s banking needs.
 
Location and Market Area
 
Our overall strategy is to become the premier financial institution serving the Richmond metropolitan area.  We recognized early on that to be successful with this strategy, we needed to grow aggressively, expanding our branch network to reach the most people possible.  Initially, we focused our operations in Chesterfield County, Virginia, which, despite its potential for business development and population growth, has been underserved by community banks.  Chesterfield’s resources are very favorable for businesses seeking a profitable and stable environment.  The county offers superb commercial and industrial sites, an educated work force, well-designed and developed infrastructure and a competitive tax structure.  Chesterfield has been awarded the U.S. Senate Gold Medallion for

 
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Productivity and Quality.  The county has the highest bond rating from three rating agencies - Standard and Poors, Moody’s and Fitch.
 
Once we established a strong banking presence in the lucrative Chesterfield County market with eight branches, we continued the implementation of our strategy by expanding our franchise into other counties in the Richmond Metropolitan area.  In addition to Chesterfield County, we have now opened three branches in both Hanover and Henrico Counties and one in Powhatan County, all three along with Chesterfield have seen strong population growth in recent years.
 
At December 31, 2009, we had fifteen full service banking offices, which were staffed by 54 full-time employees.  Our senior staff averages more than 25 years of professional or banking experience.  Our principal office, which houses our executive officers and loan department, was opened in August 2008 and is located at 15521 Midlothian Turnpike, Midlothian, Virginia 23113.  Our main telephone number is (804) 897-3900.  Our main office which includes a branch facility and seven of our branch offices are located in Chesterfield County, with three branch offices in Hanover County, three in Henrico County and one in Powhatan County.  Each branch office has been strategically located to be convenient to business and retail customers in the growth sectors of each County.
 
Historically the Richmond Metropolitan area has been a favorable market for us to provide banking services.  However with the depressed economy that started in late 2008 and was prevalent throughout 2009, this market area was negatively impacted by the decline in the housing market, especially in Chesterfield County where residential housing has been an economic driver in the past.  Because a substantial part of our loan portfolio is collateralized by residential real estate primarily in Chesterfield County, this decline in the housing market has had a negative impact on our asset quality.  The result has been a substantial increase in nonperforming assets, and in turn, a negative impact on profitability.  See further discussion of nonperforming assets under Asset Quality in Management’s Discussion and Analysis of Financial Condition and Results of Operations following.
 
Banking Services
 
We receive deposits, make consumer and commercial loans, and provide other services customarily offered by a commercial banking institution, such as business and personal checking and savings accounts, drive-up windows, and 24-hour automated teller machines.  We have not applied for permission to establish a trust department and offer trust services.  We are not a member of the Federal Reserve System.  Our deposits are insured under the Federal Deposit Insurance Act to the limits provided thereunder.
 
 
Our lending activities are subject to a variety of lending limits imposed by federal and state law.  While differing limits apply in certain circumstances based on the type of loan or the nature of the borrower (including the borrower’s relationship to the bank), in general, for loans that are not secured by readily marketable or other permissible collateral, we are subject to a loans-to-one borrower limit of an amount equal to 15% of our capital and surplus.  We may voluntarily choose to impose a policy limit on loans to a single borrower that is less than the legal lending limit.  We are a member of the Community Bankers’ Bank and may participate out portions of loans when loan amounts exceed our legal lending limits or internal lending policies.
 
Lending Activities
 
Our primary focus is on making loans to small businesses and consumers in our local market area.  In addition, we also provide a select range of real estate finance services.  Our primary lending

 
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activities are principally directed to our market area.
 
 
Commercial Real Estate Lending.  We finance commercial real estate for our clients and commercial real estate loans represent the largest segment of our loan portfolio.  This segment of our loan portfolio has been the largest segment since 2004 due to the significant real estate opportunities in our market area.  We generally will finance owner-occupied commercial real estate at an 80% loan-to-value ratio or less.  In many cases our loan-to-value ratio is less than 80%, which provides us with a higher level of collateral security.  Our underwriting policies and procedures focus on the borrower’s ability to repay the loan as well as assessment of the underlying real estate.  Risks inherent in managing a commercial real estate loan portfolio relate to sudden or gradual drops in property values as well as changes in the economic climate.  We attempt to mitigate those risks by carefully underwriting loans of this type as well as following appropriate loan-to-value standards.  Commercial real estate loans (generally owner occupied) at December 31, 2009 were $240,829,000, or 51.5% of the total loan portfolio.
 
 
Before we make a loan we evaluate both the borrower’s ability to make principal and interest payments and the value of the property that will secure the loan.  We make first mortgage loans in amounts up to 90% of the appraised value of the underlying real estate.  We retain some second mortgage loans secured by property in our market area, as long as the loan-to-value ratio combined with the first mortgage does not exceed 90%.  For conventional loans in excess of 80% loan-to-value, private mortgage insurance is required.
 
Our current one-to-four-family residential adjustable rate mortgage loans have interest rates that adjust annually after a fixed period of 1, 3 and 5 years, generally in accordance with the rates on comparable U.S. Treasury bills plus a margin.  Our adjustable rate mortgage loans generally limit interest rate increases to 2% each rate adjustment period and have an established ceiling rate at the time the loans are made of up to 6% over the original interest rate.  There are risks resulting from increased costs to a borrower as a result of the periodic repricing mechanisms of these loans.  Despite the benefits of adjustable rate mortgage loans to our asset/liability management, they pose additional risks, primarily because as interest rates rise; the underlying payments by the borrowers rise, increasing the potential for default.  At the same time, the marketability of the underlying property may be adversely affected by higher interest rates.  At December 31, 2009, $93,657,000, or 20.0% of our loan portfolio, consisted of residential mortgage loans.
 
Real Estate Construction Lending.  This segment of our loan portfolio is predominately residential in nature and comprised of loans with short duration, meaning maturities of twelve months or less.  Residential houses under construction and the underlying land for which the loan was obtained secure the construction loans.  Construction lending entails significant risks compared with residential mortgage lending.  These risks involve larger loan balances concentrated with single borrowers with funds advanced upon the security of the land and home under construction, which is estimated prior to the completion of the home.  Thus it is more difficult to evaluate accurately the

 
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Commercial Business Lending.  Our commercial business lending consists of lines of credit, revolving credit facilities, term loans, equipment loans, stand-by letters of credit and unsecured loans.  Commercial loans are written for any business purpose including the financing of plant and equipment, carrying accounts receivable, general working capital, contract administration and acquisition activities.  Our client base is diverse, and we do not have a concentration of loans in any specific industry segment.  Commercial business loans are generally secured by accounts receivable, equipment, inventory and other collateral such as marketable securities, cash value of life insurance, and time deposits.  Commercial business loans have a higher degree of risk than residential mortgage loans, but have higher yields.  To manage these risks, we generally obtain appropriate collateral and personal guarantees from the borrower’s principal owners and monitor the financial condition of business borrowers.  The availability of funds for the repayment of commercial business loans may substantially depend on the success of the business itself.  Further, the collateral for commercial business loans may depreciate over time and cannot be appraised with as much precision as residential real estate.  All commercial loans we make have recourse under the terms of a promissory note.  At December 31, 2009, commercial loans totaled $39,576,000, or 8.5% of the total loan portfolio.
 
Consumer Installment Lending.  We offer various types of secured and unsecured consumer loans.  We make consumer loans primarily for personal, family or household purposes as a convenience to our customer base since these loans are not the primary focus of our lending activities.  Our general guideline is that a consumer’s total debt service should not exceed 40% of the consumer’s gross income.  Our underwriting standards for consumer loans include making a determination of the applicant’s payment history on other debts and an assessment of his or her ability to meet existing obligations and payments on the proposed loan.  The stability of an applicant’s monthly income may be determined by verification of gross monthly income from primary employment and additionally from any verifiable secondary income.  Consumer loans totaled $11,609,000 at December 31, 2009, which was 2.5% of the total loan portfolio.
 
Loan Commitments and Contingent Liabilities.  In the normal course of business, the Company makes various commitments and incurs certain contingent liabilities which are disclosed in the footnotes of our annual financial statements, including commitments to extend credit.  At December 31, 2009, undisbursed credit lines, standby letters of credit and commitments to extend credit totaled $72,876,000.
 
Credit Policies and Administration.  We have adopted a comprehensive lending policy, which includes stringent underwriting standards for all types of loans.  Our lending staff follows pricing guidelines established periodically by our management team.  In an effort to manage risk, all credit decisions in excess of the officers’ lending authority must be approved prior to funding by a management loan committee and/or a board of directors-level loan committee.  Any loans above $5,000,000 require full board of directors’ approval.  Management believes that it employs experienced lending officers, secures appropriate collateral and carefully monitors the financial conditions of our borrowers and the concentration of such loans in the portfolio.
 
In addition to the normal repayment risks, all loans in our portfolio are subject to the state of the economy and the related effects on the borrower and/or the real estate market.  Generally, longer-term loans have periodic interest rate adjustments and/or call provisions.  Our senior management monitors the loan portfolio closely to ensure that past due loans are minimized and that potential problem loans are swiftly dealt with.  In addition to the internal business processes employed in the credit administration area, the Company utilizes an outside consulting firm to review the loan portfolio.  A detailed annual review is performed, with an interim update occurring at least once a year.  Results of the report are used to validate our internal loan ratings and to provide independent

 
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commentary on specific loans and loan administration activities.
 
 
Investments and Funding
 
We balance our liquidity needs based on loan and deposit growth via the investment portfolio, purchased federal funds, and Federal Home Loan Bank advances.  It is our goal to provide adequate liquidity to support our loan growth.  Should we have excess liquidity, investments are used to generate positive earnings.  In the event deposit growth does not fully support our loan growth, a combination of investment sales, federal funds and Federal Home Loan Bank advances will be used to augment our funding position.  However, we believe that due to a continued depressed economy as well as capital limitations, we will not see any significant growth in our loan portfolio in 2010.  Accordingly, any growth in our deposits will be used to increase our investment portfolio or reduce higher cost borrowings.
 
Our investment portfolio is actively monitored and is classified as “available for sale.”  Under such a classification, investment instruments may be sold as deemed appropriate by management.  On a monthly basis, the investment portfolio is marked to market via equity as required by generally accepted accounting principles.  Additionally, we use the investment portfolio to balance our asset and liability position.  We will invest in fixed rate or floating rate instruments as necessary to reduce our interest rate risk exposure.
 
For securities classified as available-for-sale securities, we will evaluate whether a decline in fair value below the amortized cost basis is other than temporary.  If the decline in fair value is judged to be other than temporary, the cost basis of the individual security is written down to fair value as a new cost basis and the amount of the write-down is included in earnings.  There were no securities at December 31, 2009 where a decline in market value was considered other than temporary.
 
Competition
 
We encounter strong competition from other local commercial banks, savings and loan associations, credit unions, mortgage banking firms, consumer finance companies, securities brokerage firms, insurance companies, money market mutual funds and other financial institutions.  A number of these competitors are well-established.  Competition for loans is keen, and pricing is important.  Most of our competitors have substantially greater resources and higher lending limits than ours and offer certain services, such as extensive and established branch networks and trust services, which we do not provide at the present time.  Deposit competition also is strong, and we may have to pay higher interest rates to attract deposits.  Nationwide banking institutions and their branches have increased competition in our markets, and federal legislation adopted in 1999 allows non-banking companies, such as insurance and investment firms, to establish or acquire banks.
 
The greater Richmond metropolitan market has experienced several significant mergers or acquisitions involving all four regional banks formerly headquartered in central Virginia over the past fifteen years.  Additionally, other larger banks from outside Virginia have acquired local banks.  We believe that the Company can capitalize on the recent merger activity and attract customers from those who are dissatisfied with the recently acquired banks.
 
At June 30, 2009, the latest date such information is available from the FDIC, the Bank’s deposit market share in Chesterfield County was 7.36% and 0.91% in the Richmond MSA.
 
Regulation
 
We are subject to regulations of certain federal and state agencies and receive periodic examinations by those regulatory authorities.  As a consequence of the extensive regulation of

 
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commercial banking activities, our business is susceptible to being affected by state and federal legislation and regulations.
 
General. The discussion below is only a summary of the principal laws and regulations that comprise the regulatory framework applicable to us.  The descriptions of these laws and regulations, as well as descriptions of laws and regulations contained elsewhere herein, do not purport to be complete and are qualified in their entirety by reference to applicable laws and regulations.  In recent years, regulatory compliance by financial institutions such as ours has placed a significant burden on us both in costs and employee time commitment.
 
Bank Holding Company.  The Company is a bank holding company under the Federal Bank Holding Company Act of 1956, as amended, and is subject to supervision and regulation by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) and Virginia State Corporation Commission (“SCC”).  As a bank holding company, the Company is required to furnish to the Federal Reserve Board an annual report of its operations at the end of each fiscal year and to furnish such additional information as the Federal Reserve Board may require pursuant to the Bank Holding Company Act.  The Federal Reserve Board, FDIC and SCC also may conduct examinations of the Company and/or its subsidiary bank.
 
Gramm-Leach-Bliley Act.  On November 12, 1999, the Gramm-Leach-Bliley Act was signed into law. Gramm-Leach-Bliley permits commercial banks to affiliate with investment banks.  It also permits bank holding companies which elect financial holding company status to engage in any type of financial activity, including securities, insurance, merchant banking/equity investment and other activities that are financial in nature.  The merchant banking provisions allow a bank holding company to make a controlling investment in any kind of company, financial or commercial.  These new powers allow a bank to engage in virtually every type of activity currently recognized as financial or incidental or complementary to a financial activity.  A commercial bank that wishes to engage in these activities is required to be well capitalized, well managed and have a satisfactory or better Community Reinvestment Act rating.  Gramm-Leach-Bliley also allows subsidiaries of banks to engage in a broad range of financial activities that are not permitted for banks themselves.
 
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 implemented a broad range of corporate governance, accounting and reporting measures for companies, like the Company, that have securities registered under the Securities Exchange Act of 1934.  Specifically, the Sarbanes-Oxley Act and the various regulations promulgated under the Act, established, among other things: (i) new requirements for audit committees, including independence, expertise, and responsibilities; (ii) additional responsibilities regarding financial statements for the Chief Executive Officer and Chief Financial Officer of the reporting company; (iii) new standards for auditors and regulation of audits, including independence provisions that restrict non-audit services that accountants may provide to their audit clients; (iv) increased disclosure and reporting obligations for the reporting company and their directors and executive officers, including accelerated reporting of stock transactions and a prohibition on trading during pension blackout periods; and (v) a range of new and increased civil and criminal penalties for fraud and other violations of the securities laws.  In addition, Sarbanes-Oxley required stock exchanges, such as NASDAQ, to institute additional requirements relating to corporate governance in their listing rules.
 
Section 404 of the Sarbanes-Oxley Act requires the Company to include in its Annual Report on Form 10-K a report by management.  Management’s internal control report must, among other things, set forth management’s assessment of the effectiveness of the Company’s internal control over financial reporting.
 
Emergency Economic Stabilization Act of 2008. In response to unprecedented market turmoil during the third quarter of 2008, the Emergency Economic Stabilization Act (“EESA”) of 2008 was enacted on October 3, 2008.  EESA authorizes the U.S. Treasury to provide up to $700 billion to support the financial services industry.  Pursuant to the EESA, the U.S. Treasury was initially authorized to use $350 billion for the Troubled Asset Relief Program (“TARP”).  Of this amount, the U.S. Treasury allocated $250 billion to the TARP Capital Purchase Program.  On January 15, 2009, the second $350 billion of TARP monies was released to the U.S. Treasury.  The Secretary’s

 
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authority under TARP was to expire on December 31, 2009, unless the Secretary certifies to Congress that extension is necessary provided that his authority may not extend beyond October 3, 2010.  On December 9, 2009, the Secretary sent such a letter to the Congress, extending his authority under the TARP through October 3, 2010.
 
On May 1, 2009, the Company issued preferred shares and a warrant to purchase its common shares to the U.S. Treasury as a participant in the TARP Capital Purchase Program.  The amount of capital raised in that transaction was $14.7 million, approximately three percent of the Company’s risk-weighted assets.  Prior to May 1, 2012, unless the parent company has redeemed all such preferred shares or the U.S. Treasury has transferred all such preferred shares to a third party, the consent of the U.S. Treasury will be required for us to, among other things, pay a dividend on the   Company’s common shares or repurchase our common shares or outstanding preferred shares except in limited circumstances.  No dividends may be paid on common stock unless dividends have been paid on the senior preferred stock.  The senior preferred will not have voting rights other than the right to vote as a class on the issuance of any preferred stock ranking senior, any change in its terms or any merger, exchange or similar transaction that would adversely affect its rights.  The senior preferred will also have the right to elect two directors if dividends have not been paid for six periods.  The Company filed a registration statement on Form S-3 covering the warrant as required under the terms of the TARP investment, on May 29, 2009.  The registration statement was declared effective by the SEC on June 16, 2009.
 
In addition, until the U.S. Treasury ceases to own any of the Company’s securities sold under the TARP Capital Purchase Program, the compensation arrangements for our senior executive officers must comply in all respects with EESA and the rules and regulations there under.  In compliance with such requirements, each of our senior executive officers agreed in writing to accept the compensation standards in existence at that time under the TARP Capital Purchase Program and thereby cap or eliminate some of their contractual or legal rights.
 
American Recovery and Reinvestment Act of 2009.  On February 17, 2009, President Obama signed the American Recovery and Reinvestment Act of 2009 (“ARRA”) into law.  ARRA modified the compensation-related limitations contained in the TARP Capital Purchase Program (the “CPP”), created additional compensation-related limitations and directed the Secretary of the Treasury to establish standards for executive compensation applicable to participants in TARP.  Thus, the newly enacted compensation-related limitations are applicable to the Company which have been added or modified by ARRA are as follows, which provisions must be included in standards established by the U.S. Treasury:
 
 
●
No Severance Payments.  Under ARRA “golden parachutes” were redefined as any severance payment resulting from involuntary termination of employment, or from bankruptcy of the employer, except for payments for services performed or benefits accrued. Consequently under ARRA the Company is prohibited from making any severance payment to our “senior executive officers” (defined in ARRA as the five highest paid executive officers) and our next five most highly compensated employees during the CPP Covered Period.
 
 
 
●
Recovery of Incentive Compensation if Based on Certain Material Inaccuracies.  ARRA also contains the “clawback provision” discussed above but extends its application to any bonus or retention awards and other incentive compensation paid to any of our senior executive officers or next 20 most highly compensated employees during the CPP Covered Period that is later found to have been based on materially inaccurate financial statements or other materially inaccurate measurements of performance
 
 
 
●
No Compensation Arrangements That Encourage Earnings Manipulation.  Under ARRA, during the CPP Covered Period, the Company is not allowed to enter into compensation arrangements that encourage manipulation of the reported earnings of the Company to enhance the compensation of any of our employees.
 
 
 
●
Limits on Incentive Compensation.  ARRA contains a provision that prohibits the payment or accrual of any bonus, retention award or incentive compensation to any of our 5 most highly compensated employees during the CPP Covered Period other than awards of long-term
 
 
 
 
 

 
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restricted stock that (i) do not fully vest during the CPP Coverage Period, (ii) have a value not greater than one-third of the total annual compensation of the awardee and (iii) are subject to such other restrictions as determined by the Secretary of the Treasury.  The prohibition on bonus, incentive compensation and retention awards does not preclude payments required under written employment contracts entered into on or prior to February 11, 2009.
 
 
 
●
Compensation Committee Functions.  ARRA requires that our Compensation Committee be comprised solely of independent directors and that it meet at least semiannually to discuss and evaluate our employee compensation plans in light of an assessment of any risk posed to us from such compensation plans.
 
 
 
●
Compliance Certifications.  ARRA also requires a written certification by our Chief Executive Officer and Chief Financial Officer of our compliance with the provisions of ARRA.  These certifications must be contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2009 and any subsequent year during the Capital Purchase Plan Covered Period the relevant U.S. Treasury regulations are issued.
 
 
 
●
Treasury Review of Excessive Bonuses Previously Paid.  ARRA directs the Secretary of the Treasury to review all compensation paid to our senior executive officers and our next 20 most highly compensated employees to determine whether any such payments were inconsistent with the purposes of ARRA or were otherwise contrary to the public interest.  If the Secretary of the Treasury makes such a finding, the Secretary of the Treasury is directed to negotiate with the TARP Capital Purchase Program recipient and the subject employee for appropriate reimbursements to the federal government with respect to the compensation and bonuses.
 
 
 
●
Say on Pay.  Under ARRA the SEC promulgated rules requiring a non-binding say on pay vote by the shareholders on executive compensation at the annual meeting during the CPP Covered Period.
 
 
ARRA also provides that the U.S. Treasury, after consultation with the Company’s federal regulator, permit the Company at any time to redeem our Series A Preferred Shares at liquidation value.  Upon such redemption, the warrant to purchase the parent company’s common stock that was issued to the U.S. Treasury would also be repurchased at its then current fair value.
 
On June 10, 2009, the U.S. Treasury issued guidance on the compensation and corporate governance standards that apply to TARP recipients, as summarized below:
 
 
●
Bonuses accrued or paid before the effective date of the rule adopted by the U.S. Treasury are not subject to the rule’s bonus payment limitation.  In addition, separation pay for departures that occurred before receipt of TARP assistance also is not subject to the limits of the rule (even if payments continue to be made after effectiveness).
 
 
●
The term “most highly compensated employees” covers all employees, not only executive officers or other policy makers.  The determination of the most highly compensated employees is based on annual compensation for the prior year calculated in accordance with SEC disclosure rules.
 
 
●
The rule permits salary paid in property, including stock, so long as it is based on a dollar amount (not a number of shares), is fully vested and accrues as cash salary would.  The rule also permits salary paid in stock units in respect of shares of the TARP recipient, or subsidiaries or divisions of the TARP recipient (though not below the subsidiary or division for which the employee directly provides services).  Holding periods also are permitted.
 
 
●
Commission payments for sales, brokerage and asset management services for unrelated customers will not be subject to the bonus restrictions, but only if they are consistent with an existing plan of the TARP recipient in effect before February 17, 2009.

 
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●
The rule imposes a restrictive set of “best practices” on TARP recipients: (i) the five senior executive officers and the next 20 most highly compensated employees may not receive any tax “gross-up” payment of any kind, including payments to cover taxes due on company-provided benefits or separation payments; (ii) the prohibition on separation payments to the five senior executive officers and the next five most highly compensated employees is extended to payments in connection with a change in control; (iii) the compensation committee must review all employee compensation plans every six months for unnecessary risk and provide an expanded certification including narrative disclosure of its analysis and conclusions; (iv) TARP recipients must exercise their clawback rights unless doing so would be unreasonable; and (v) TARP recipients must adopt a policy reasonably designed to eliminate excessive or luxury expenditures.
 
 
●
An institution will not become subject to the compensation standards merely as a result of acquiring a TARP recipient. In addition, if an acquiror is not subject to the standards immediately after the transaction, any employees of the acquiror (including former employees of the TARP recipient who become acquiror employees as a result of the transaction) will not be subject to the standards.
 
 
●
The “TARP period” during which the compensation standards apply ceases when the obligations arising from financial assistance cease and specifically excludes any period when the only outstanding obligation of a TARP recipient consists of U.S. Treasury warrants to purchase common stock.
 
Comprehensive Financial Stability Plan of 2009.  On February 10, 2009, the Treasury Secretary announced a new comprehensive financial stability plan (the “Financial Stability Plan”), which earmarked the second $350 billion of unused funds originally authorized under the EESA.   The major elements of the Financial Stability Plan included: (i) a capital assistance program that has invested in convertible preferred stock of certain qualifying institutions, (ii) a consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances, (iii) a public/private investment fund intended to leverage public and private capital with public financing to purchase up to $500 billion to $1 trillion of legacy “toxic assets” from financial institutions, and (iv) assistance for homeowners by providing up to $75 billion to reduce mortgage payments and interest rates and establishing loan modification guidelines for government and private programs.
 
Regulatory Reform.  In June 2009, the Obama administration proposed a wide range of regulatory reforms that, if enacted, may have significant effects on the financial services industry in the United States.  Significant aspects of the Obama administration’s proposals included, among other things, proposals (i) that any financial firm whose combination of size, leverage and interconnectedness could pose a threat to financial stability be subject to certain enhanced regulatory requirements, (ii) that federal bank regulators require loan originators or sponsors to retain part of the credit risk of securitized exposures, (iii) that there be increased regulation of broker-dealers and investment advisers, (iv) for the creation of a federal consumer financial protection agency that would, among other things, be charged with applying consistent regulations to similar products (such as imposing certain notice and consent requirements on consumer overdraft lines of credit), (v) that there be comprehensive regulation of OTC derivatives, (vi) that the controls on the ability of banking institutions to engage in transactions with affiliates be tightened, and (vii) that financial holding companies be required to be “well-capitalized” and “well-managed” on a consolidated basis.
 
The Congress, state lawmaking bodies and federal and state regulatory agencies continue to consider a number of wide-ranging and comprehensive proposals for altering the structure, regulation and competitive relationships of the nation’s financial institutions, including rules and regulations related to the broad range of reform proposals set forth by the Obama administration described above.  Separate comprehensive financial reform bills intended to address the proposals set forth by the Obama administration were introduced in both houses of Congress in the second half of 2009 and remain under review by both the U.S. House of Representatives and the U.S. Senate.  In addition, both the U.S. Treasury Department and the Basel Committee on Banking

 
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Supervision (the “Basel Committee”) have issued policy statements regarding proposed significant changes to the regulatory capital framework applicable to banking organizations.
 
We cannot predict whether or in what form further legislation and/or regulations may be adopted or the extent to which the Company’s business may be affected thereby.
 
Incentive Compensation.  On October 22, 2009, the Federal Reserve Board issued a comprehensive proposal on incentive compensation policies (the “Incentive Compensation Proposal”) intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking.  The Incentive Compensation Proposal, which covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group, is based upon the key principles that a banking organization’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the organization’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the organization’s board of directors.  The Incentive Compensation Proposal also contemplates a detailed review by the Federal Reserve Board of the incentive compensation policies and practices of a number of “large, complex banking organizations”.  Any deficiencies in compensation practices that are identified may be incorporated into the organization’s supervisory ratings, which can affect its ability to make acquisitions or perform other actions.  The Incentive Compensation Proposal provides that enforcement actions may be taken against a banking organization if its incentive compensation arrangements or related risk-management control or governance processes pose a risk to the organization’s safety and soundness and the organization is not taking prompt and effective measures to correct the deficiencies.  In addition, on January 12, 2010, the FDIC announced that it would seek public comment on whether banks with compensation plans that encourage risky behavior should be charged at higher deposit assessment rates than such banks would otherwise be charged.
 
The scope and content of the U.S. banking regulators’ policies on executive compensation are continuing to develop and are likely to continue evolving in the near future.  It cannot be determined at this time whether compliance with such policies will adversely affect the ability of the Company to hire, retain and motivate its and their key employees
 
Bank Regulation.  As a Virginia state-chartered FDIC bank that is not a member of the Federal Reserve System, the Bank is subject to regulation, supervision and examination by the SCC’s Bureau of Financial Institutions (“BFI”).  The Bank is also subject to regulation, supervision and examination by the FDIC.  Federal law also governs the activities in which we may engage, the investments we may make and the aggregate amount of loans that may be granted to one borrower.  Various consumer and compliance laws and regulations also affect our operations.  Earnings are affected by general economic conditions, management policies and the legislative and governmental actions of various regulatory authorities, including those referred to above.  The following description summarizes some of the laws to which we are subject.  The BFI and the FDIC will conduct regular examinations, reviewing such matters as the overall safety and soundness of the institution, the adequacy of loan loss reserves, quality of loans and investments, management practices, compliance with laws, and other aspects of their operations.  In addition to these regular examinations, we must furnish the FDIC with periodic reports containing a full and accurate statement of our affairs. Supervision, regulation and examination of banks by these agencies are intended primarily for the protection of depositors rather than shareholders.
 

 
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engaged or is engaging in unsafe or unsound practices, is in an unsafe or unsound condition to continue operations, or has violated any applicable law, regulation, order or any condition imposed in writing by the FDIC.  It also may suspend deposit insurance temporarily during the hearing process for the permanent termination of insurance if the institution has no tangible capital.  If deposit insurance is terminated, the deposits at the institution at the time of termination, less subsequent withdrawals, shall continue to be insured for a period from six months to two years, as determined by the FDIC.  We are aware of no existing circumstances that could result in termination of our deposit insurance.
 
Additionally, on October 14, 2008, after receiving a recommendation from the boards of the FDIC and the Federal Reserve, and consulting with the President, the Secretary of the Treasury signed the systemic risk exception to the FDIC Act, enabling the FDIC to establish its Temporary Liquidity Guarantee Program (“TLGP”). Under one component of this program, the Transaction Account Guarantee Program (“TAGP”), the FDIC temporarily provided a full guarantee on all non-interest bearing transaction accounts held by any depositor, regardless of dollar amount, through December 31, 2009.  The $250,000 deposit insurance coverage limit was scheduled to return to $100,000 on January 1, 2010, but was extended by congressional action until December 31, 2013.  The TLGP has been extended to cover debt of FDIC-insured institutions issued through April 30, 2010, and the TAGP has been extended through June 30, 2010.  The TLGP also guarantees all senior unsecured debt of insured depository institutions or their qualified holding companies issued between October 14, 2008 and June 30, 2009 with a stated maturity greater than 30 days. All eligible institutions were permitted to participate in both of the components of the TLGP without cost for the first 30 days of the program. Following the initial 30 day grace period, institutions were assessed at the rate of ten basis points for transaction account balances in excess of $250,000 for the transaction account guarantee program and at the rate of either 50, 75, or 100 basis points of the amount of debt issued, depending on the maturity date of the guaranteed debt, for the debt guarantee program. Institutions were required to opt-out of the TLGP if they did not wish to participate. The Company and its applicable subsidiaries elected to participate in both of these programs.
 
Capital.  The FDIC has issued risk-based and leverage capital guidelines applicable to banking organizations they supervise.  Under the risk-based capital requirements, we are generally required to maintain a minimum ratio of total capital to risk-weighted assets (including certain off-balance sheet activities, such as standby letters of credit), of 8%.  At least half of the total capital is to be composed of common equity, retained earnings and qualifying perpetual preferred stock, less certain intangibles (“Tier 1 capital”).  The remainder may consist of certain subordinated debt, certain hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance (“Tier 2 capital” and, together with Tier 1 capital, “total capital”).  In addition, each of the Federal bank regulatory agencies has established minimum leverage capital ratio requirements for banking organizations.  These requirements provide for a minimum leverage ratio of Tier 1 capital to adjusted average quarterly assets equal to 4% for banks and bank holding companies that meet certain specified criteria.  All other banks and bank holding companies will generally be required to maintain a leverage ratio of at least 100 to 200 basis points above the stated minimum.  The risk-based capital standards of the FDIC explicitly identify concentrations of credit risk and the risk arising from non-traditional activities, as well as an institution’s ability to manage these risks, as important factors to be taken into account by the agency in assessing an institution’s overall capital adequacy.  The capital guidelines also provide that an institution’s exposure to a decline in the economic value of its capital due to changes in interest rates be considered by the agency as a factor in evaluating a bank’s capital adequacy.
 
USA Patriot Act. The USA Patriot Act became effective on October 26, 2001 and provides for the facilitation of information sharing among governmental entities and financial institutions for the purpose of combating terrorism and money laundering. Among other provisions, the USA Patriot Act permits financial institutions, upon providing notice to the United States Treasury, to share information with one another in order to better identify and report to the federal government concerning activities that may involve money laundering or terrorists’ activities. The USA Patriot Act is considered a significant banking law in terms of information disclosure regarding certain customer transactions. Certain provisions of the USA Patriot Act impose the obligation to establish anti-money

 
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laundering programs, including the development of a customer identification program, and the screening of all customers against any government lists of known or suspected terrorists. Although it
does create a reporting obligation and compliance costs, the USA Patriot Act has not materially affected the Bank’s products, services or other business activities.
 
Reporting Terrorist Activities. The Office of Foreign Assets Control (OFAC), which is a division of the Department of the Treasury, is responsible for helping to insure that United States entities do not engage in transactions with “enemies” of the United States, as defined by various Executive Orders and Acts of Congress.  OFAC has sent, and will send, our banking regulatory agencies lists of names of persons and organizations suspected of aiding, harboring or engaging in terrorist acts. If the Bank finds a name on any transaction, account or wire transfer that is on an OFAC list, it must freeze such account, file a suspicious activity report and notify the FBI. The Bank has appointed an OFAC compliance officer to oversee the inspection of its accounts and the filing of any notifications. The Bank actively checks high-risk OFAC areas such as new accounts, wire transfers and customer files. The Bank performs these checks utilizing software, which is updated each time a modification is made to the lists provided by OFAC and other agencies of Specially Designated Nationals and Blocked Persons.
 
Other Safety and Soundness Regulations.  There are a number of obligations and restrictions imposed on depository institutions by federal law and regulatory policy that are designed to reduce potential loss exposure to the depositors of such depository institutions and to the FDIC insurance funds in the event the depository institution becomes in danger of default or is in default.  The Federal banking agencies also have broad powers under current Federal law to take prompt corrective action to resolve problems of insured depository institutions.  The extent of these powers depends upon whether the institution in question is well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized or critically undercapitalized, as defined by the law.  Federal regulatory authorities also have broad enforcement powers over us, including the power to impose fines and other civil and criminal penalties, and to appoint a receiver in order to conserve the assets of any such institution for the benefit of depositors and other creditors.  Village Bank is currently classified as well capitalized financial institution.
 
 
 
Economic and Monetary Policies.  Our operations are affected not only by general economic conditions, but also by the economic and monetary policies of various regulatory authorities.  In particular, the Federal Reserve regulates money, credit and interest rates in order to influence general economic conditions. These policies have a significant influence on overall growth and distribution of loans, investments and deposits and affect interest rates charged on loans or paid for time and savings deposits.  Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks in the past and are expected to continue to do so in the future.

 
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Employees
 
As of December 31, 2009, the Company and its subsidiaries had a total of 194 full-time employees and 13 part-time employees.  None of the Company’s employees are covered by a collective bargaining agreement.  The Company considers its relations with its employees to be good.
 
Control by Certain Shareholders
 
The Company has one shareholder who owns 8.38% of its outstanding Common Stock.  As a group, the Board of Directors and the Company’s Executive Officers control 16.42% of the outstanding Common Stock of the Company as of March 1, 2009.  Accordingly, such persons, if they were to act in concert, would not have majority control of the Bank and would not have the ability to approve certain fundamental corporate transactions or the election of the Board of Directors.
 
Additional Information
 
The Company files annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission.  You may read and copy any reports, statements and other information we file at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information on the operations of the Public Reference Room. Our SEC filings are also available on the SEC’s Internet site (http://www.sec.gov).
 
The Company’s common stock trades under the symbol “VBFC” on the Nasdaq Capital Market.  You may also read reports, proxy statements and other information we file at the offices of the National Association of Securities Dealers, Inc., 1735 K Street, N.W., Washington, DC 20006.
 
The Company’s Internet address is www.villagebank.com.  At that address, we make available, free of charge, the Company’s annual report on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Exchange Act (see “Investor Relations” section of website), as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC.
 
In addition, we will provide, at no cost, paper or electronic copies of our reports and other filings made with the SEC (except for exhibits). Requests should be directed to C. Harril Whitehurst, Jr., Chief Financial Officer, Village Bank and Trust Financial Corp., PO Box 330, Midlothian, VA 23113.
 
The information on the websites listed above is not and should not be considered to be part of this annual report on Form 10-K and is not incorporated by reference in this document.
 
ITEM 1A.  RISK FACTORS
 
An investment in the parent company’s common stock is subject to risks inherent to the Company’s business, including the material risks and uncertainties that are described below.  Before making an investment decision, you should carefully consider the risks and uncertainties described below together with all of the other information included or incorporated by reference in this report.  The risks and uncertainties described below are not the only ones facing the Company.  Additional risks and uncertainties that management is not aware of or focused on, or that management currently deems immaterial, may also impair the Company’s business operations.  This report is qualified in its entirety by these risk factors.  If any of the following risks adversely affect the Company’s business, financial condition or results of operations, the value of the parent company’s common stock could decline significantly and you could lose all or part of your investment.
 
 
 

 
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The Company’s business may be adversely affected by conditions in the financial markets and economic conditions generally.
 
Since December 2007, the United States has experienced a recession and a slowing of economic activity.  Business activity across a wide range of industries and regions is greatly reduced, and local governments and many businesses are in serious difficulty, due to the lack of consumer spending and the lack of liquidity in the credit markets.  Unemployment has increased significantly.
 
The financial services industry and the securities markets generally were materially and adversely affected by significant declines in the values of nearly all asset classes and by a serious lack of liquidity.  This was initially triggered by declines in home prices and the values of subprime mortgages, but spread to all mortgage and real estate asset classes, to leveraged bank loans and to nearly all asset classes, including equities.  The global markets have been characterized by substantially increased volatility and short selling and an overall loss of investor confidence, initially in financial institutions, but more recently in companies in a number of other industries and in the broader markets.
 
Market conditions have also led to the failure or merger of a number of prominent financial institutions.  Financial institution failures or near-failures have resulted in further losses as a consequence of defaults on securities issued by them and defaults under contracts entered into with such entities as counterparties.  Furthermore, declining asset values, defaults on mortgages and consumer loans, and the lack of market and investor confidence, as well as other factors, have all combined to increase credit default swap spreads, to cause rating agencies to lower credit ratings, and to otherwise increase the cost of and decrease the availability of liquidity, despite very significant declines in Federal Reserve borrowing rates and other government actions.  Some banks and other lenders have suffered significant losses and have become reluctant to lend, even on a secured basis, due to the increased risk of default and the impact of declining asset values on the value of collateral.  The foregoing has significantly weakened the strength and liquidity of some financial institutions worldwide.  In 2008 and 2009, the U.S. Government, the Federal Reserve and other regulators took numerous steps to increase liquidity and to restore investor confidence, including investing approximately $200 billion in the equity of other banking organizations, but asset values have continued to decline and access to liquidity continues to be very limited.
 
Although the rate of increase in unemployment and the rate of decline in housing prices have slowed and the consumer spending and liquidity in the credit markets have been somewhat improved towards the end of 2009, the economic slowdown generally continues and there can be no assurance such indicia of recovery would herald any prolonged period of economic recovery and growth in 2010.
 
The Company’s financial performance generally, and in particular the ability of borrowers to pay interest on and repay the principal of outstanding loans and the value of collateral securing those loans, is highly dependent upon the business environment in the market where the Company operates, the Richmond Metropolitan area.  A favorable business environment is generally characterized by, among other factors, economic growth, efficient capital markets, low inflation, high business and investor confidence, and strong business earnings.  Unfavorable or uncertain economic and market conditions can be caused by: declines in economic growth, business activity, or investor or business confidence; limitations on the availability or increases in the cost of credit and capital; increases in inflation or interest rates; natural disasters; or a combination of these or other factors.  Overall, during 2009, the business environment was adverse for many households and businesses in the United States and worldwide. The business environment in the Richmond Metropolitan area, the United States and worldwide may continue to deteriorate for the foreseeable future.  There can be no assurance that these conditions will improve in the near term.  Such conditions could adversely affect the credit quality of the Company’s loans, results of operations and financial condition.
 
 
 

 
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Improvements in economic indicators disproportionately affecting the financial services industry may lag improvements in the general economy.
 
Should the stabilization of the U.S. economy lead to a general economic recovery, the improvement of certain economic indicators, such as unemployment and real estate asset values and rents, may nevertheless continue to lag behind the overall economy.  These economic indicators typically affect certain industries, such as real estate and financial services, more significantly.  For example, improvements in commercial real estate fundamentals typically lag broad economic recovery by 12 to 18 months.  The Company’s clients include entities active in these industries.  Furthermore, financial services companies with a substantial lending business are dependent upon the ability of their borrowers to make debt service payments on loans.  Should unemployment or real estate asset values fail to recover for an extended period of time, the Company could be adversely affected.
 
Our results of operations are significantly affected by the ability of our borrowers to repay their loans.
 
A significant source of risk is the possibility that losses will be sustained because borrowers, guarantors and related parties may fail to perform in accordance with the terms of their loan agreements.  Most of the Company’s loans are secured but some loans are unsecured.  With respect to the secured loans, the collateral securing the repayment of these loans may be insufficient to cover the obligations owed under such loans.  Collateral values may be adversely affected by changes in economic, environmental and other conditions, including declines in the value of real estate, changes in interest rates, changes in monetary and fiscal policies of the federal government, widespread disease, terrorist activity, environmental contamination and other external events.  In addition, collateral appraisals that are out of date or that do not meet industry recognized standards may create the impression that a loan is adequately collateralized when it is not.  The Company has adopted underwriting and credit monitoring procedures and policies, including regular reviews of appraisals and borrower financial statements, that management believes are appropriate to mitigate the risk of loss.
 
As of December 31, 2009, approximately 77.5% of the Company’s loan portfolio consisted of commercial and industrial, construction and commercial real estate loans. These types of loans are generally viewed as having more risk of default than residential real estate loans or consumer loans.  These types of loans are also typically larger than residential real estate loans and consumer loans.  Because the Company’s loan portfolio contains a significant number of commercial and industrial, construction and commercial real estate loans with relatively large balances, the deterioration of one or a few of these loans could cause a significant increase in non-performing loans.  An increase in nonperforming loans could result in a net loss of earnings from these loans, an increase in the provision for loan losses and an increase in loan charge-offs, all of which could have a material adverse effect on the Company’s financial condition and results of operations.  Further, if repurchase and indemnity demands with respect to the Company’s loan portfolio increase, its liquidity, results of operations and financial condition will be adversely affected.
 
The Company’s allowance for loan losses may be insufficient.
 
The Company maintains an allowance for loan losses, which is a reserve established through a provision for loan losses charged to expense, that represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans.  The allowance, in the judgment of management, is necessary to reserve for estimated loan losses and risks inherent in the loan portfolio.
 
The level of the allowance reflects management’s continuing evaluation of industry concentrations; specific credit risks; loan loss experience; current loan portfolio quality; present economic, political and regulatory conditions and unidentified losses inherent in the current loan portfolio.  The determination of the appropriate level of the allowance for loan losses inherently involves a high degree of subjectivity and requires the Company to make significant estimates of current credit risks and future trends, all of which may undergo material changes.  Continuing deterioration of economic conditions affecting borrowers, new information regarding existing loans, identification of additional

 
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problem loans and other factors, both within and outside the Company’s control, may require an increase in the allowance for loan losses.  In addition, bank regulatory agencies periodically review the Company’s allowance for loan losses and may require an increase in the provision for loan
losses or the recognition of further loan charge-offs, based on judgments different than those of management.  Further, if charge-offs in future periods exceed the allowance for loan losses, the Company will need additional provisions to increase the allowance for loan losses.  Any increases in the allowance for loan losses will result in a decrease in net income and, possibly, capital, and may have a material adverse effect on the Company’s financial condition and results of operations.
 
Changes in interest rates may have an adverse effect on the Company’s profitability.
 
The operations of financial institutions such as the Company are dependent to a large degree on net interest income, which is the difference between interest income from loans and investments and interest expense on deposits and borrowings.  An institution’s net interest income is significantly affected by market rates of interest that in turn are affected by prevailing economic conditions, by the fiscal and monetary policies of the federal government and by the policies of various regulatory agencies.  The Federal Reserve Board (FRB) regulates the national money supply in order to manage recessionary and inflationary pressures.  In doing so, the FRB may use techniques such as engaging in open market transactions of U.S. Government securities, changing the discount rate and changing reserve requirements against bank deposits.  The use of these techniques may also affect interest rates charged on loans and paid on deposits.  The interest rate environment, which includes both the level of interest rates and the shape of the U.S. Treasury yield curve, has a significant impact on net interest income.  Like all financial institutions, the Company’s balance sheet is affected by fluctuations in interest rates.  Volatility in interest rates can also result in disintermediation, which is the flow of deposits away from financial institutions into direct investments, such as US Government and corporate securities and other investment vehicles, including mutual funds, which, because of the absence of federal insurance premiums and reserve requirements, generally pay higher rates of return than bank deposit products.  See “Item 7: Management’s Discussion of Financial Condition and Results of Operations” and “Item 7A: Quantitative and Qualitative Disclosure about Market Risk”.
 
Declines in value may adversely impact the investment portfolio.
 
We have not realized any non-cash, other-than-temporary impairment charges during 2009 as a result of reductions in fair value below original cost of any investments in our investment portfolio.  However, we could be required to record future impairment charges on our investment securities if they suffer any declines in value that are considered other-than-temporary.  Considerations used to determine other-than-temporary impairment status to individual holdings include the length of time the stock has remained in an unrealized loss position, and the percentage of unrealized loss compared to the carrying cost of the stock, dividend reduction or suspension, market analyst reviews and expectations, and other pertinent news that would affect expectations for recovery or further decline.
 
The Company may not be able to meet the cash flow requirements of its depositors and borrowers or meet its operating cash needs.
 
Liquidity is the ability to meet cash flow needs on a timely basis at a reasonable cost.  The liquidity of the Company is used to service its debt.  The liquidity of the Bank is used to make loans and leases and to repay deposit liabilities as they become due or are demanded by customers.  Liquidity policies and limits are established by the board of directors.  The overall liquidity position of the Company and the Bank are regularly monitored to ensure that various alternative strategies exist to cover unanticipated events that could affect liquidity.  Funding sources include Federal funds purchased, securities sold under repurchase agreements and non-core deposits. The Bank is a member of the Federal Home Loan Bank of Atlanta, which provides funding through advances to members that are collateralized with mortgage-related assets.

 
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If the Company is unable to access any of these funding sources when needed, we might be unable to meet customers’ needs, which could adversely impact our financial condition, results of operations, cash flows, and level of regulatory-qualifying capital
 
Negative perceptions associated with the Company’s continued participation in the U.S. Treasury’s Capital Purchase Program may adversely affect its ability to retain customers, attract investors and compete for new business opportunities.
 
Several financial institutions which participated in the TARP Capital Purchase Program received approval from the U.S. Treasury to exit the program during the second half of 2009.  These institutions have, or are in the process of, repurchasing the preferred stock and repurchasing or auctioning the warrant issued to the U.S. Treasury as part of the program.  The Company has not yet requested the U.S. Treasury’s approval to repurchase the preferred stock and warrant from the U.S. Treasury.  In order to repurchase one or both securities, in whole or in part, the Company must establish that it has satisfied all of the conditions to repurchase and must obtain the approval of the U.S. Treasury.  There can be no assurance that the Company will be able to repurchase these securities from the U.S. Treasury.  The Company’s customers, employees and counterparties in its current and future business relationships may draw negative implications regarding the strength of the Company as a financial institution based on its continued participation in the program following the exit of one or more of its competitors or other financial institutions.  Any such negative perceptions may impair the Company’s ability to effectively compete with other financial institutions for business or to retain high performing employees.  If this were to occur, the Company’s business, financial condition and results of operations may be adversely affected, perhaps materially.
 
The soundness of other financial institutions could adversely affect us.
 
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services institutions are interrelated as a result of trading, clearing, counterparty or other relationships. We have exposure to many different industries and counterparties, and we routinely execute transactions with counterparties in the financial industry. As a result, defaults by, or even rumors or questions about, one or more financial services institutions, or the financial services industry generally, have led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. Many of these transactions expose us to credit risk in the event of default of our counterparty or client. In addition, our credit risk may be exacerbated when the collateral held by us cannot be realized upon or is liquidated at prices not sufficient to recover the full amount of the financial instrument exposure due us. There is no assurance that any such losses would not materially and adversely affect our results of operations.
 
Changes in economic conditions and related uncertainties may have an adverse affect on the Company’s profitability.
 
Commercial banking is affected, directly and indirectly, by local, domestic, and international economic and political conditions, and by governmental monetary and fiscal policies.  Conditions such as inflation, recession, unemployment, volatile interest rates, tight money supply, real estate values, international conflicts and other factors beyond the Company’s control may adversely affect the potential profitability of the Company.  Any future rises in interest rates, while increasing the income yield on the Company’s earnings assets, may adversely affect loan demand and the cost of funds and, consequently, the profitability of the Company.  Any future decreases in interest rates may adversely affect the Company’s profitability because such decreases may reduce the amounts that the Company may earn on its assets.  A continued recessionary climate could result in the delinquency of outstanding loans. Management does not expect any one particular factor to have a material effect on the Company’s results of operations.  However, downtrends in several areas, including real estate, construction and consumer spending, could have a material adverse impact on the Company’s profitability.
 
 

 
20
 

The supervision and regulation to which the Company is subject can be a competitive disadvantage.
 
The operations of the Company and the Bank are heavily regulated and will be affected by present
and future legislation and by the policies established from time to time by various federal and state regulatory authorities.  In particular, the monetary policies of the Federal Reserve have had a significant effect on the operating results of banks in the past, and are expected to continue to do so in the future.  Among the instruments of monetary policy used by the Federal Reserve to implement its objectives are changes in the discount rate charged on bank borrowings and changes in the reserve requirements on bank deposits.  It is not possible to predict what changes, if any, will be made to the monetary polices of the Federal Reserve or to existing federal and state legislation or the effect that such changes may have on the future business and earnings prospects of the Company.
 
The Company is subject to changes in federal and state tax laws as well as changes in banking and credit regulations, accounting principles and governmental economic and monetary policies.
 
During the past several years, significant legislative attention has been focused on the regulation and deregulation of the financial services industry.  Non-bank financial institutions, such as securities brokerage firms, insurance companies and money market funds, have been permitted to engage in activities that compete directly with traditional bank business.
 
Regulation of the financial services industry is undergoing major changes, and future legislation could increase our cost of doing business or harm our competitive position.
 
In 2009, many emergency government programs enacted in 2008 in response to the financial crisis and the recession slowed or wound down, and global regulatory and legislative focus has generally moved to a second phase of broader reform and a restructuring of financial institution regulation. Legislators and regulators in the United States are currently considering a wide range of proposals that, if enacted, could result in major changes to the way banking operations are regulated. Some of these major changes may take effect as early as 2010, and could materially impact the profitability of our business, the value of assets we hold or the collateral available for our loans, require changes to business practices or force us to discontinue businesses and expose us to additional costs, taxes, liabilities, enforcement actions and reputational risk.
 
Certain reform proposals under consideration could result in our becoming subject to stricter capital requirements and leverage limits, and could also affect the scope, coverage, or calculation of capital, all of which could require us to reduce business levels or to raise capital, including in ways that may adversely impact our shareholders or creditors. In addition, we anticipate the enactment of certain reform proposals under consideration that would introduce stricter substantive standards, oversight and enforcement of rules governing consumer financial products and services, with particular emphasis on retail extensions of credit and other consumer-directed financial products or services. We cannot predict whether new legislation will be enacted and, if enacted, the effect that it, or any regulations, would have on our business, financial condition, or results of operations.
 
The competition the Company faces is increasing and may reduce our customer base and negatively impact the Company’s results of operations.
 
There is significant competition among banks in the market areas served by the Company.  In addition, as a result of deregulation of the financial industry, the Bank also competes with other providers of financial services such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, the mutual funds industry, full service brokerage firms and discount brokerage firms, some of which are subject to less extensive regulations than the Company with respect to the products and services they provide.  Some of the Company’s competitors have greater resources than the Corporation and, as a result, may have higher lending limits and may offer other services not offered by our Company.  See “Item 1: Business — Competition.”

 
21
 

Our deposit insurance premium could be substantially higher in the future which would have an adverse effect on our future earnings.
 
The FDIC insures deposits at FDIC-insured financial institutions, including Village Bank.  The FDIC
charges the insured financial institutions premiums to maintain the Deposit Insurance Fund at a certain level.  Current economic conditions have increased bank failures and expectations for further failures, which may result in the FDIC making more payments from the Deposit Insurance Fund and, in connection therewith, raising deposit premiums.  In addition, the FDIC instituted two temporary programs to further insure customer deposits at FDIC insured banks: deposit accounts are currently insured up to $250,000 per customer (up from $100,000) and non-interest bearing transactional accounts at institutions participating in the Transaction Account Guarantee Program are currently fully insured (unlimited coverage).  These programs have placed additional stress on the Deposit Insurance Fund.
 
In February 2009, the FDIC finalized a rule that increases premiums paid by insured institutions and makes other changes to the assessment system.  Due to mounting losses from failed banking institutions in 2009, the FDIC adopted an interim rule that imposed an emergency special assessment in the second quarter of 2009 and further gave the FDIC authority to impose additional emergency special assessments of up to 10 basis points in subsequent quarters.  In addition, on November 12, 2009, the FDIC adopted a rule requiring banks to prepay three years’ worth of premiums to replenish the depleted fund.  The Company is generally unable to control the amount of premiums that it is required to pay for FDIC insurance.  If there are additional bank or financial institution failures the Company may be required to pay even higher FDIC premiums than the recently increased levels.  Further, on January 12, 2010, the FDIC requested comments on a proposed rule tying assessment rates of FDIC-insured institutions to the institution’s employee compensation programs.  The exact requirements of such a rule are not yet known, but such a rule could increase the amount of premiums the Company must pay for FDIC insurance.  These announced increases and any future increases or required prepayments of FDIC insurance premiums may adversely impact its earnings.
 
Concern of customers over deposit insurance may cause a decrease in deposits.
 
With the continuing news about bank failures, customers are increasingly concerned about the extent to which their deposits are insured by the FDIC.  Customers may withdraw deposits in an effort to ensure that the amount they have on deposit with us is fully insured.  Decreases in deposits may adversely affect our funding costs and net income.
 
Fluctuations in the stock market could negatively affect the value of the Company’s common stock.
 
The Company’s common stock trades under the symbol “VBFC” on the Nasdaq Capital Market. There can be no assurance that a regular and active market for the Common Stock will develop in the foreseeable future.  See “Item 5: Market for Registrant’s Common Equity and Related Stockholder Matters and Issuer Purchases of Equity Securities.”  Investors in the shares of common stock may, therefore, be required to assume the risk of their investment for an indefinite period of time.  Current lack of investor confidence in large banks may keep investors away from the banking sector as a whole, causing unjustified deterioration in the trading prices of well-capitalized community banks such as the Company.
 
If the Company fails to maintain an effective system of internal controls, it may not be able to accurately report its financial results or prevent fraud.  As a result, current and potential shareholders could lose confidence in the Company’s financial reporting, which could harm its business and the trading price of its common stock.
 
The Company has established a process to document and evaluate its internal controls over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations, which require annual management assessments of the effectiveness of the Company’s internal controls over financial reporting.  In this regard,

 
22
 

management has dedicated internal resources, engaged outside consultants and adopted a detailed work plan to (i) assess and document the adequacy of internal controls over financial reporting, (ii) take steps to improve control processes, where appropriate, (iii) validate through testing that controls are functioning as documented and (iv) implement a continuous reporting and improvement process for internal control over financial reporting.  The Company’s efforts to comply with Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding the Company’s assessment of its internal controls over financial reporting.  The Company’s management and audit committee have given the Company’s compliance with Section 404 a high priority.  The Company cannot be certain that these measures will ensure that the Company implements and maintains adequate controls over its financial processes and reporting in the future.  Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm the Company’s operating results or cause the Company to fail to meet its reporting obligations.  If the Company fails to correct any issues in the design or operating effectiveness of internal controls over financial reporting or fails to prevent fraud, current and potential shareholders could lose confidence in the Company’s financial reporting, which could harm its business and the trading price of its common stock.
 
The Company is subject to a variety of operational risks, including reputational risk, legal and compliance risk, and the risk of fraud or theft by employees or outsiders.
 
The Company is exposed to many types of operational risks, including reputational risk, legal and compliance risk, the risk of fraud or theft by employees or outsiders, and unauthorized transactions by employees or operational errors, including clerical or record-keeping errors or those resulting from faulty or disabled computer or telecommunications systems.  Negative public opinion can result from its actual or alleged conduct in any number of activities, including lending practices, corporate governance and acquisitions and from actions taken by government regulators and community organizations in response to those activities.  Negative public opinion can adversely affect its ability to attract and keep customers and can expose the Company to litigation and regulatory action.
 
Because the nature of the financial services business involves a high volume of transactions, certain errors may be repeated or compounded before they are discovered and successfully rectified.  The Company’s necessary dependence upon automated systems to record and process its transaction volume may further increase the risk that technical flaws or employee tampering or manipulation of those systems will result in losses that are difficult to detect.  The Company also may be subject to disruptions of its operating systems arising from events that are wholly or partially beyond its control (for example, computer viruses or electrical or telecommunications outages), which may give rise to disruption of service to customers and to financial loss or liability.  The Company is further exposed to the risk that its external vendors may be unable to fulfill their contractual obligations (or will be subject to the same risk of fraud or operational errors by their respective employees as the Company is) and to the risk that its (or its vendors’) business continuity and data security systems prove to be inadequate.  The occurrence of any of these risks could result in a diminished ability of the Company to operate its business, potential liability to clients, reputational damage and regulatory intervention, which could adversely affect its business, financial condition and results of operations, perhaps materially.
 
The Company relies on other companies to provide key components of its business infrastructure.
 
Third parties provide key components of the Company’s business infrastructure, for example, system support, and Internet connections and network access.  While the Company has selected these third party vendors carefully, it does not control their actions.  Any problems caused by these third parties, including those resulting from their failure to provide services for any reason or their poor performance of services, could adversely affect its ability to deliver products and services to its customers and otherwise conduct its business.  Replacing these third party vendors could also entail significant delay and expense.
 
 

 
23
 

The Company may have to rely on dividends from the Bank.
 
The Company is a separate and distinct legal entity from its subsidiary bank.  Although the Company has never received any dividends from the Bank, it is entitled to receive dividends in accordance
with federal and state regulations.  These federal and state regulations limit the amount of dividends that the Bank may pay to the Company.  In the event the Bank is unable to pay dividends to the Company, the Company may not be able to service debt, pay obligations or pay dividends on the Company’s common stock.  The inability of the Company to receive dividends from the Bank could have a material adverse effect on the Company’s business, financial condition and results of operations.
 
The Bank may not be able to remain well capitalized
 
Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, under capitalized, significantly under capitalized, and critically under capitalized.  The Bank meets the criteria to be categorized as a “well capitalized” institution as of December 31, 2009 and 2008.  However, the Bank may not be able to remain well capitalized for various reasons including a change in the mix of assets or a lack of profitability.  When capital falls below the “well capitalized” requirement, consequences can include: new branch approval could be withheld; more frequent examinations by the FDIC; brokered deposits cannot be renewed without a waiver from the FDIC; and other potential limitations as described in FDIC Rules and Regulations sections 337.6 and 303, and FDIC Act section 29.  In addition, the FDIC insurance assessment increases when an institution falls below the “well capitalized” classification.
 
 
ITEM 1B.  UNRESOLVED STAFF COMMENTS
 
None.
 
 
ITEM 2.  PROPERTIES
 
Our executive and administrative offices are owned by the Company and are located at 15521 Midlothian Turnpike, Midlothian, Virginia 23113 in Chesterfield County where an 80,000 square foot corporate headquarters and operations center was opened in August 2008.  The Company and the Bank currently occupy approximately forty percent of the space, which includes a full service branch location leased by the Bank.  The Company leases the other portions to unrelated parties.  In addition to leasing the branch to the Bank, the Bank’s wholly-owned subsidiary, Village Bank Mortgage Corporation, also leases space in the building from the Company.
 
In addition to the branch in the corporate headquarters and operations center, the Bank owns 9 full service branch buildings including the land on those buildings and leases an additional five full service branch buildings.  Eight of our branch offices are located in Chesterfield County, with three branch offices in Hanover County, three in Henrico County and one in Powhatan County.
 
Our properties are maintained in good operating condition and are suitable and adequate for our operational needs.
 
ITEM 3.  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 a party or of which the property of the Company is subject.
 
 
ITEM 4.  RESERVED
 

 
24
 

PART II
 
 
ITEM 5.  MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
 
Market Information
 
Shares of the Company’s Common Stock trade on the Nasdaq Capital Market under the symbol “VBFC”.  The high and low prices of shares of the Company’s Common Stock for the periods indicated were as follows:
 
 
 
High
  
Low
2008
            
1st quarter
  
$
11.47
  
$
9.25
2nd quarter
    
 10.99
    
 8.08
3rd quarter
    
 9.58
    
 6.11
4th quarter
    
 8.43
    
 3.38
             
2009
            
1st quarter
  
$
5.00
  
$
3.77
2nd quarter
    
 4.95
    
 4.12
3rd quarter
    
 5.98
    
 3.85
4th quarter
    
 4.43
    
 2.01
 
 
Dividends
 
The Company has not paid any dividends on its Common Stock.  We intend to retain all of our earnings to finance the Company’s operations and we do not anticipate paying cash dividends for the foreseeable future.  Any decision made by the Board of Directors to declare dividends in the future will depend on the Company’s future earnings, capital requirements, financial condition and other factors deemed relevant by the Board.  Banking regulations limit the amount of cash dividends that may be paid without prior approval of the Bank’s regulatory agencies.  Such dividends are limited to the lesser of the Bank’s retained earnings or the net income of the previous two years combined with the current year net income.  In addition, for as long as the U.S. Treasury holds shares of our preferred stock, the consent of the U.S. Treasury will be required prior to the payment of any dividends on our common stock.
 
Holders
 
At March 3, 2010, there were approximately 1,634 holders of record of Common Stock.
 
For information concerning the Company’s Equity Compensation Plans, see “Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.
 
Recent Sales of Unregistered Securities
 
None
 
Purchases of Equity Securities
 
The Company did not repurchase any of its Common Stock during the fourth quarter of 2009.
 
 
 
 

 
25
 

Performance Graph
 
The following graph shows the yearly percentage change in the Company’s cumulative total shareholder return on its common stock from December 31, 2004 to December 31, 2009 compared with the NASDAQ Composite Index and peer group indexes based on asset size.
 


 
 
    Period Ending
Index
12/31/04
12/31/05
12/31/06
12/31/07
12/31/08
12/31/09
Village Bank and Trust Financial Corp.
100.00
110.78
122.41
92.24
38.79
20.11
NASDAQ Composite
100.00
101.37
111.03
121.92
72.49
104.31
SNL Bank $250M-$500M
100.00
106.17
110.93
90.16
51.49
47.66
SNL Bank $500M-$1B
100.00
104.29
118.61
95.04
60.90
58.00

 
26
 

ITEM 6.  SELECTED FINANCIAL DATA
 
 
   
Year Ended December 31,
     
2009
    
2008
    
2007
    
2006
  
2005
Balance Sheet Data
                            
At year-end
                            
Assets
    
 $   602,962,943
    
 $ 572,407,993
    
 $   393,263,999
    
 $ 291,217,760
  
 $214,974,952
Loans, net of unearned income
    
 467,568,547
    
 470,722,286
    
 327,343,013
    
 241,051,025
  
 172,378,272
Investment securities
    
 54,857,211
    
 24,300,962
    
 13,711,399
    
 12,787,644
  
 2,981,903
Goodwill
    
 -
    
 7,422,141
    
 689,108
    
 689,108
  
 689,108
Deposits
    
 498,285,124
    
 466,232,043
    
 339,297,258
    
 253,309,881
  
 186,752,807
Borrowings
    
 52,593,521
    
 57,726,898
    
 24,736,569
    
 9,859,265
  
 9,641,810
Stockholders' equity
    
 48,941,989
    
 46,162,574
    
 26,893,299
    
 25,644,115
  
 17,151,893
Number of shares outstanding
    
 4,230,628
    
 4,229,372
    
 2,575,985
    
 2,562,088
  
 1,854,618
                             
Average for the year
                            
Assets
    
 600,034,107
    
 442,604,327
    
 337,750,179
    
 246,562,178
  
 184,498,899
Stockholders' equity
    
 56,089,455
    
 31,067,165
    
 27,798,307
    
 22,278,897
  
 16,410,583
Weighted average shares outstanding
    
 4,230,462
    
 3,013,175
    
 2,569,529
    
 2,269,092
  
 1,800,061
                             
Income Statement Data
                            
Interest income
    
 $   33,195,973
    
 $  29,072,146
    
 $    25,665,235
    
 $   19,019,111
  
 $  11,925,133
Interest expense
    
 16,407,679
    
 15,969,783
    
 13,806,715
    
 8,786,600
  
 4,877,376
Net interest income
    
 16,788,294
    
 13,102,363
 
  
 11,858,520
    
 10,232,511
  
 7,047,757
Provision for loan losses
    
 13,220,000
    
 2,005,633
    
 1,187,482
    
 796,006
  
 460,861
Noninterest income
    
 8,285,100
    
 4,184,727
    
 2,666,956
    
 2,482,793
  
 2,890,316
Goodwill impairment
    
 7,422,141
    
 -
    
 -
    
 -
  
 -
Noninterest expense
    
 20,915,737
    
 14,572,271
    
 11,821,232
    
 9,817,089
  
 7,778,004
Income tax expense (benefit)
    
 (4,973,116)
    
 241,097
    
 515,699
    
 702,990
  
 468,025
Net income (loss)
    
 $ (11,511,368)
    
 $      468,089
    
 $     1,001,063
    
 $    1,399,219
  
 $    1,231,183
                             
Per Share Data
                            
Earnings (loss) per share - basic
    
 $            (2.84)
    
 $            0.16
    
 $              0.39
    
 $             0.62
  
 $             0.68
Earnings (loss) per share - diluted
    
 $            (2.84)
    
 $            0.16
    
 $              0.37
    
 $             0.59
  
 $             0.61
Book value at year-end
    
$               8.07
    
 $          10.91
    
 $            10.44
    
 $           10.01
  
 $             9.25
                             
Performance Ratios
                            
Return on average assets
    
(1.92)%
    
0.11%
    
0.30%
    
0.57%
  
0.67%
Return on average equity
    
(20.52)%
    
1.51%
    
3.60%
    
6.28%
  
7.50%
Net interest margin
    
3.13%
    
3.25%
    
3.80%
    
4.48%
  
4.15%
Efficiency (1)
    
83.42%
    
84.30%
    
81.38%
    
77.21%
  
78.26%
Loans to deposits
    
93.84%
    
100.96%
    
96.48%
    
95.16%
  
92.30%
Equity to assets
    
8.12%
    
8.06%
    
6.84%
    
8.81%
  
7.98%
                             
Asset Quality Ratios
                            
ALLL to loans at year-end
    
2.25%
    
1.29%
    
1.06%
    
1.06%
  
1.12%
ALLL to nonaccrual loans
    
49.37%
    
71.05%
    
134.20%
    
91.12%
  
105.28%
Nonperforming assets to year-end loans
    
7.95%
    
2.43%
    
0.87%
    
1.16%
  
1.06%
Net charge-offs to average loans
    
1.84%
    
0.60%
    
0.10%
    
0.12%
  
0.03%
                             
(1)  Efficiency ratio is computed by dividing noninterest expense by the sum of net interest income and noninterest income.
The goodwill impairment write-off is excluded in 2009 from noninterest expense.
 
 

 
27
 

 
ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion is intended to assist readers in understanding and evaluating the financial condition, changes in financial condition and the results of operations of the Company, consisting of the parent company and its wholly-owned subsidiary, the Bank. This discussion should be read in conjunction with the consolidated financial statements and other financial information contained elsewhere in this report.
 
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, changes in interest rates, general economic conditions, the quality or composition of the loan or investment portfolios, the level of nonperforming assets and charge-offs, the local real estate market, volatility and disruption in national and international financial markets, government intervention in the U.S. financial system, demand for loan products, deposit flows, competition, and accounting principles, policies and guidelines. Monetary and fiscal policies of the U.S. Government could also adversely effect the Company; such policies include the impact of any regulations or programs implemented pursuant to the Emergency Economic Stabilization Act of 2008 (EESA), the American Recovery and Reinvestment Act of 2009 (ARRA) and other policies of the Office of the Comptroller of the Currency, U.S. Treasury and the Federal Reserve Board.
 
The Company experienced significant losses during the year related to the current economic climate.  A continuation of the turbulence in significant portions of the global financial markets, particularly if it worsens, could further impact the Company’s performance, both directly by affecting revenues and the value of the Company’s assets and liabilities, and indirectly by affecting the Company’s counterparties and the economy generally.  Dramatic declines in the housing market in the past year have resulted in significant write-downs of asset values by financial institutions in the United States.  Concerns about the stability of the U.S. financial markets generally have reduced the availability of funding to certain financial institutions, leading to a tightening of credit, reduction of business activity, and increased market volatility.  It is not clear at this time what impact liquidity and funding initiatives of the Treasury and other bank regulatory agencies that have been announced or any additional programs that may be initiated in the future will have on the financial markets and the financial services industry.  The extreme levels of volatility and limited credit availability currently being experienced could continue to affect the U.S. banking industry and the broader U.S. and global economies, which would have an effect on all financial institutions, including the Company.
 
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.
 

 
28
 

Recent Market Developments
 
In response to the financial crises affecting the banking system and financial markets and going concern threats to investment banks and other financial institutions, on October 3, 2008, the Emergency Economic Stabilization Act of 2008 (the “EESA”) was signed into law.  Pursuant to EESA, the United States Department of the Treasury (the “U.S. Treasury”) was given the authority to, among other things, purchase up to $700 billion of mortgages, mortgage-backed securities and certain other financial instruments from financial institutions for the purpose of stabilizing and providing liquidity to the U.S. financial markets.
 
On October 14, 2008, the Secretary of the Department of the Treasury announced that the U.S. Treasury will purchase equity stakes in a wide variety of banks and thrifts.  Under the program, known as the Troubled Asset Relief Program (“TARP”) Capital Purchase Program, from the $700 billion authorized by EESA, the U.S. Treasury made $250 billion of capital available to U.S. financial institutions in the form of preferred stock.  In conjunction with the purchase of preferred stock, the U.S. Treasury received, from participating financial institutions, warrants to purchase common stock with an aggregate market price equal to 15% of the preferred investment. Participating financial institutions were required to adopt the U.S.  Treasury’s standards for executive compensation and corporate governance for the period during which the U.S. Treasury holds equity issued under the TARP Capital Purchase Program.  On May 1, 2009, the Company elected to participate in the TARP Capital Purchase Program, under which the Company issued preferred shares and a warrant to purchase common shares to the U.S. Treasury.  As of the date of this report, the Company has not yet repurchased the preferred stock or the warrant to purchase common stock.
 
On November 21, 2008, the Board of Directors of the FDIC adopted a final rule relating to the Temporary Liquidity Guarantee Program (“TLG Program”).  The TLG Program was announced by the FDIC on October 14, 2008, preceded by the determination of systemic risk by the Secretary of the Department of Treasury (after consultation with the President), as an initiative to counter the system-wide crisis in the nation’s financial sector.  Under the TLG Program (as amended from time to time thereafter) the FDIC would (i) guarantee, through the earlier of maturity or June 30, 2012, certain newly issued senior unsecured debt issued by participating institutions and (ii) provide full FDIC deposit insurance coverage for noninterest bearing transaction deposit accounts, Negotiable Order of Withdrawal (“NOW”) accounts paying less than 0.5% interest per annum and Interest on Lawyers Trust Accounts (“IOLA”) accounts held at participating FDIC-insured institutions.  The transaction account guarantee program described in clause (ii) will expire on June 30, 2010. Coverage under the TLG Program was available for the first 30 days without charge.  The fee assessment for coverage of senior unsecured debt ranges from 50 basis points to 100 basis points per annum, depending on the initial maturity of the debt.  The fee assessment for deposit insurance coverage is 10 basis points per quarter on amounts in covered accounts exceeding $250,000.
 
On February 10, 2009, the Treasury Secretary announced a new comprehensive financial stability plan which included: (i) a capital assistance program that has invested in convertible preferred stock of certain qualifying institutions, (ii) a consumer and business lending initiative to fund new consumer loans, small business loans and commercial mortgage asset-backed securities issuances, (iii) a public-private investment fund intended to leverage public and private capital with public financing to purchase legacy “toxic assets” from financial institutions, and (iv) assistance for homeowners to reduce mortgage payments and interest rates and establishing loan modification guidelines for government and private programs.
 
In response to concerns relating to capital adequacy of large financial institutions, the Federal Reserve Board implemented Supervisory Capital Assessment Program (“SCAP”) under which all banking institutions with assets over $100 billion were required to undergo a comprehensive “stress test” to determine if they had sufficient capital to continue lending and to absorb losses that could result from a more severe decline in the economy than projected.  The results of the stress test were announced on May 7, 2009.  In addition, on September 3, 2009, the U.S. Treasury issued a policy statement relating to bank capital requirements, which calls for higher and stronger capital requirements for bank and non-bank financial firms that are deemed to pose a risk to financial stability due to their combination of size, leverage, interconnectedness and liquidity risk.  Also, on

 
29
 

December 17, 2009, the Basel Committee issued a set of proposals relating to the capital adequacy and liquidity risk exposures of financial institutions.
 
In order to restore the depleted Deposit Insurance Fund (“DIF”) and maintain a sound reserve ratio, the FDIC imposed higher base assessment rates and special one-time assessments and required prepayment of deposit insurance premium.  The FDIC stated that, after its semi-annual reviews, it may further increase assessment rates or take other actions to bring the DIF’s reserve ratio back to a desirable level.
 
In June of 2009, the Obama administration proposed a wide range of regulatory reforms that included, among other things, proposals (i) that any financial firm whose combination of size, leverage and interconnectedness could pose a threat to financial stability be subject to certain enhanced regulatory requirements, (ii) that federal bank regulators require loan originators or sponsors to retain part of the credit risk of securitized exposures, (iii) that there be increased regulation of broker-dealers and investment advisers, (iv) for the creation of a federal consumer financial protection agency that would, among other things, be charged with applying consistent regulations to similar products (such as imposing certain notice and consent requirements on consumer overdraft lines of credit), (v) that there be comprehensive regulation of OTC derivatives, (vi) that the controls on the ability of banking institutions to engage in transactions with affiliates be tightened, and (vii) that financial holding companies be required to be “well-capitalized” and “well-managed” on a consolidated basis.
 
On October 22, 2009, the Federal Reserve Board issued a comprehensive proposal on incentive compensation policies intended to ensure that the incentive compensation policies of banking organizations do not undermine the safety and soundness of such organizations by encouraging excessive risk-taking. The proposal covers all employees that have the ability to materially affect the risk profile of an organization, either individually or as part of a group.
 
General
 
The Company was organized under the laws of the Commonwealth of Virginia to engage in commercial and retail banking.  The Bank opened to the public on December 13, 1999 as a traditional community bank offering deposit and loan services to individuals and businesses in the Richmond, Virginia metropolitan area.  During 2003, the Company acquired or formed three wholly owned subsidiaries of the Bank, Village Bank Mortgage Corporation (“Village Bank Mortgage”), a full service mortgage banking company, Village Insurance Agency, Inc. (“Village Insurance”), a full service property and casualty insurance agency, and Village Financial Services Corporation (“Village Financial Services”), a financial services company.  On October 14, 2008, the Company completed its merger with River City Bank pursuant to an Agreement and Plan of Reorganization and Merger, dated as of March 9, 2008, by and among the Company, the Bank and River City Bank.  The merger had previously been approved by both companies’ shareholders at their respective annual meetings on September 30, 2008 as well as the banking regulators.
 
We offer a wide range of banking and related financial services, including checking, savings, certificates of deposit and other depository services, and commercial, real estate and consumer loans.  We are a community-oriented and locally managed financial institution focusing on providing a high level of responsive and personalized services to our customers, delivered in the context of a strong direct relationship with our customers.  We conduct our operations from our main office/corporate headquarters location and fourteen branch offices.
 
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 management endeavors to minimize the credit risk inherent in the Company’s loan portfolio, it must necessarily make various assumptions and judgments about the collectibility of the loan portfolio based on its experience and evaluation of economic conditions.  If such assumptions

 
30
 

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.
 
There is intense competition in all areas in which the Company conducts its business. The Company competes with banks and other financial institutions, including savings and loan associations, savings banks, finance companies, and credit unions.  Many of these competitors have substantially greater resources and lending limits and provide a wider array of banking services.  To a limited extent, the Company also competes with other providers of financial services, such as money market mutual funds, brokerage firms, consumer finance companies and insurance companies.  Competition is based on a number of factors, including prices, interest rates, services, availability of products and geographic location.
 
The Company had a net loss of $11,511,000 in 2009 as compared to net income of $468,000 in 2008 and of $1,001,000 in 2007.  The single most significant factor in our declining earnings the last two years has been the recessionary economy.
 
Total assets increased to $602,963,000 at December 31, 2009 from $572,408,000 at December 31, 2008 and $393,264,000 at December 31, 2007, representing increases of 5% in 2009 and 46% in 2008.  The growth in total assets in 2008 is attributable to our merger with River City Bank, which added approximately $157.7 million in assets at the time of merger.  The growth in 2009 was primarily a result of an increase in investment securities of $30,556,000, funded by an increase in deposits of $32,053,000.
 
Much of our internal growth has been driven by lending on real estate.  As a result, the material decline in real estate values experienced in 2009 had a significant adverse effect on the growth and profitability of the Company.  At December 31, 2009, 89.0% of our loan portfolio was collateralized by real estate.  Declines in real estate values can reduce projected cash flows from commercial properties and the ability of borrowers to use home equity to support borrowings and increase the loan-to-value ratios of loans previously made by us, thereby weakening collateral coverage and increasing the possibility of a loss in the event of default.  In addition, delinquencies, foreclosures and losses generally increase during economic slowdowns or recessions.
 
The following presents management’s discussion and analysis of the financial condition of the Company at December 31, 2009 and 2008, and results of operations for the Company for the years ended December 31, 2009, 2008 and 2007.  This discussion should be read in conjunction with the Company’s audited Financial Statements and the notes thereto appearing elsewhere in this Annual Report.
 
Income Statement Analysis
 
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”) 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.
 
We recorded a net loss of $11,511,000, or $2.84 per fully diluted share, in 2009, compared to net income of $468,000, or $0.16 per fully diluted share, in 2008, and $1,001,000, or $0.37 per fully diluted share, in 2007.  The decline in our profitability in 2009 was attributable to four significant increases in expenses from 2008 to 2009 as follows:

 
31
 

 
   
2009
  
2008
  
Increase
             
Provision for loan losses
  
 $13,220,000
  
 $2,005,633
  
 $11,214,367
Goodwill impairment
  
 7,422,141
  
 -
  
 7,422,141
Expenses related to
            
foreclosed real estate
  
 1,475,338
  
 165,455
  
 1,309,883
FDIC insurance premium
  
 1,366,612
  
 400,394
  
 966,218
             
           
 $20,912,609
 
 
All of these increases in expenses are attributable primarily to the recessionary economy that dominated 2009.  The increases in the provision for loan losses and in expenses related to foreclosed real estate reflect the difficulties that many of our borrowers experienced with their ability to repay our loans to them.  The write-off of goodwill was based on our annual evaluation of the value of goodwill which was performed by an independent third party.  Goodwill was considered fully impaired at December 31, 2009 primarily because the value of the Company’s stock, and thus its overall value, declined significantly in 2009 as did many other banks’ stock.  The increase in the FDIC insurance premium was related to the losses the FDIC incurred in 2009 in closing 140 banks as it sought to restore the DIF to a desirable level.  Total assets of failed banks in 2009 totaled $170.9 billion with the loss to the DIF of $4.6 billion.
 
The decline in earnings from $1,001,000 in 2007 to $468,000 in 2008 was attributable to a decline in our net interest margin from 3.80% for 2007 to 3.27% for 2008, as well as an increase in the provision for loan losses of $818,000, from $1,187,000 in 2007 to $2,005,000 in 2008.  The decline in our net interest margin is attributable to declining interest rates and our acquisition of River City Bank which had a lower net interest margin.  The increase in the provision for loan losses was a result of deteriorating asset quality.
 
Net interest income
 
Net interest income is our primary source of earnings and represents the difference between interest and fees earned on interest-earning assets and the interest paid on interest-bearing liabilities.  The level of net interest income is affected primarily by variations in the volume and mix of those assets and liabilities, as well as changes in interest rates when compared to previous periods of operation.
 
Growth in loans and deposits has resulted in net interest income increasing from $11,859,000 in 2007, to $13,102,000 in 2008 and to $16,788,000 in 2009.  However, net interest income as a percentage of average assets has steadily declined the last two years, from 3.5% in 2007 to 3.0% in 2008 and to 2.8% in 2009.  The growth in net interest income has not kept pace with the growth of the Company.  This is attributable to a declining net interest margin, from 3.80% in 2007 to 3.27% in 2008 and to 3.13% in 2009.  This declining interest margin resulted from declines in short-term interest rates that started in 2007 and continued into 2008.  A significant portion of our loan portfolio, the primary source of revenue to Village Bank, has interest rates that adjust according to the direction of short-term interest rates.  Accordingly, as short-term rates were reduced by the Federal Reserve, the income from our loan portfolio was reduced.  While the reduction of short-term interest rates also reduced the rates we pay on deposits, our largest expense, the reduction in interest rates paid on deposits was slower than the reduction of interest rates on our loan portfolio as our deposits generally do not reprice as quickly as our loans.  Consequently, our net interest income, the primary source of our earnings, was negatively impacted as short-term interest rates were reduced by the Federal Reserve.
 
Although the year to year comparison reflects a declining net interest margin, we are starting to experience a turnaround in this decline.  During 2009, the average interest rate we paid on deposits declined by 1.42%.  This decline outpaced the decline in the average interest rate earned on loans of .67%, which had a positive impact on our net interest margin.  While the net interest margin of 3.13% for the full year of 2009 was lower than the net interest margin of 3.27% for 2008, it increasedfrom 3.29% for the month of December 2008 to 3.38% for the month of December 2009.  If short-term interest rates remain stable in 2010, we expect further declines in the average rate paid on

 
32
 

 
deposits and an improving net interest margin.
 
Average interest-earning assets increased by $135,350,000, or 34%, in 2009 and by $88,383,000, or 28%, in 2008.  These increases in interest-earning assets were due primarily to the growth of our loan portfolio.  However, the average yield on interest-earning assets decreased to 6.19% in 2009 from 7.26% in 2008 and 8.22% in 2007.  Many of our loans are indexed to short-term rates affected by the Federal Reserve's decisions about short-term interest rates, and, accordingly, as the Federal Reserve increases or decreases short-term rates, the yield on interest-earning assets is affected.  As the Federal Reserve decreased interest rates starting in 2007 and continuing through 2008, decreasing short-term interest rates by 5% over twelve months, the average yield on our interest-earning assets decreased.
 
Our average interest-bearing liabilities increased by $120,065,000, or 31%, in 2009 and by $96,873,000, or 34%, in 2008.  These increases in average interest-bearing liabilities were due to strong growth in average deposits of $111,034,000 in 2009 and $70,321,000 in 2008 as well as borrowings of $19,990,000 in 2008. The average cost of interest-bearing liabilities decreased to 3.27% in 2009, from 4.18% in 2008 and 4.84% in 2007.  The significant decrease in our cost of funds in 2009 and 2008 was a result of decreases in short-term interest rates by the Federal Reserve in 2007 and 2008.  As with our interest-earning assets, the declines in the short-term interest rates by the Federal Reserve also reduced the interest rates we pay on interest-bearing liabilities in 2008, however, the reduction in interest rates on our interest-bearing liabilities has been slower than the reduction of interest rates on our interest-earning assets as the liabilities generally do not reprice as quickly as the assets.  Consequently, our net interest income, the primary source of our earnings, is negatively impacted as long as short-term interest rates continue to be reduced by the Federal Reserve.  See “Interest rate sensitivity” on page 48 for further discussion of the repricing of assets and liabilities.
 
The following table illustrates 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.  The average balances used in these tables and other statistical data were calculated using daily average balances.  We have no tax exempt assets for the periods presented.
 

 
33
 

 
Average Balance Sheets
(In thousands)
                                     
   
Year Ended December 31, 2009
  
Year Ended December 31, 2008
  
Year Ended December 31, 2007
       
Interest
  
Annualized
      
Interest
  
Annualized
      
Interest
  
Annualized
   
Average
  
Income/
  
Yield
  
Average
  
Income/
  
Yield
  
Average
  
Income/
  
Yield
   
Balance
  
Expense
  
Rate
  
Balance
  
Expense
  
Rate
  
Balance
  
Expense
  
Rate
Loans
                                    
Commercial
  
 $47,607
  
 $2,959
  
6.22%
  
 $39,275
  
 $2,034
  
5.18%
  
 $21,791
  
 $1,795
  
8.24%
Real estate - residential
  
 89,386
  
 5,802
  
6.49%
  
 61,416
  
 5,291
  
8.62%
  
 42,461
  
 3,418
  
8.05%
Real estate - commercial
  
 230,621
  
 15,591
  
6.76%
  
 160,019
  
 10,968
  
6.85%
  
 120,797
  
 9,722
  
8.05%
Real estate - construction
  
 99,103
  
 6,038
  
6.09%
  
 105,732
  
 8,965
  
8.48%
  
 92,886
  
 8,707
  
9.37%
Consumer
  
 10,642
  
 788
  
7.40%
  
 7,779
  
 657
  
8.45%
  
 6,488
  
 582
  
8.97%
Gross loans
  
 477,359
  
 31,178
  
6.53%
  
 374,221
  
 27,915
  
7.46%
  
 284,423
  
 24,224
  
8.52%
Investment securities
  
 33,174
  
 1,458
  
4.40%
  
 12,125
  
 699
  
5.76%
  
 16,471
  
 847
  
5.14%
Loans held for sale
  
 10,305
  
 533
  
5.17%
  
 3,721
  
 225
  
6.05%
  
 2,368
  
 155
  
6.55%
Federal funds and other
  
 15,034
  
 27
  
0.18%
  
 10,455
  
 233
  
2.23%
  
 8,877
  
 439
  
4.95%
Total interest earning assets
  
 535,872
  
 33,196
  
6.19%
  
 400,522
  
 29,072
  
7.26%
  
 312,139
  
 25,665
  
8.22%
Allowance for loan losses
  
 (8,367)
          
 (4,309)
          
 (2,956)
        
Cash and due from banks
  
 15,998
          
 8,179
          
 5,169
        
Premises and equipment, net
  
 27,880
          
 23,951
          
 13,901
        
Other assets
  
 28,651
          
 14,261
          
 9,497
        
Total assets
  
 $600,034
          
 $442,604
          
 $337,750
        
                                     
Interest bearing deposits
                                    
Interest checking
  
 26,530
  
 443
  
1.67%
  
 $12,735
  
 $159
  
1.25%
  
 $10,454
  
 $104
  
0.99%
Money market
  
 69,267
  
 1,242
  
1.79%
  
 28,215
  
 561
  
1.99%
  
 21,618
  
 726
  
3.36%
Savings
  
 7,009
  
 85
  
1.21%
  
 6,891
  
 193
  
2.80%
  
 3,669
  
 42
  
1.14%
Certificates
  
 347,698
  
 12,664
  
3.64%
  
 291,629
  
 13,435
  
4.61%
  
 233,408
  
 12,078
  
5.17%
Total deposits
  
 450,504
  
 14,434
  
3.20%
  
 339,470
  
 14,348
  
4.23%
  
 269,149
  
 12,950
  
4.81%
Borrowings
                                    
Long-tern debt - trust
                                    
preferred securities
  
 8,764
  
 392
  
4.47%
  
 8,764
  
 508
  
5.80%
  
 6,173
  
 447
  
7.24%
FHLB advances
  
 26,348
  
 970
  
4.22%
  
 20,620
  
 834
  
4.22%
  
 7,945
  
 340
  
4.22%
Other borrowings
  
 16,337
  
 612
  
1.77%
  
 13,034
  
 280
  
1.77%
  
 1,748
  
 70
  
1.77%
Total interest bearing liabilities
  
 501,953
  
 16,408
  
3.27%
  
 381,888
  
 15,970
  
4.18%
  
 285,015
  
 13,807
  
4.84%
Noninterest bearing deposits
  
 39,626
          
 27,657
          
 22,686
        
Other liabilities
  
 2,366
          
 1,992
          
 2,251
        
Total liabilities
  
 543,945
          
 411,537
          
 309,952
        
Equity capital
  
 56,089
          
 31,067
          
 27,798
        
Total liabilities and capital
  
 $600,034
          
 $442,604
          
 $337,750
        
                                     
Net interest income before
                                    
provision for loan losses
      
 $16,788
          
 $13,102
          
 $11,858
    
Interest spread - average yield
                                    
on interest earning assets,
                                    
less average rate on
                                    
interest bearing liabilities
          
2.93%
          
3.08%
          
3.38%
Net interest margin
                                    
(net interest income
                                    
expressed as a percentage
                                    
of average earning assets)
          
3.13%
          
3.27%
          
3.80%
 
Interest income and interest expense are affected by changes in both average interest rates and average volumes of interest-earning assets and interest-bearing liabilities.  The following table analyzes changes in net interest income attributable to changes in the volume of interest-sensitive assets and liabilities compared to changes in interest rates.  Nonaccrual loans are included in average loans outstanding. The changes in interest due to both rate and volume have been allocated to changes due to volume and changes due to rate in proportion to the relationship of the absolute dollar amounts of the changes in each.

 
34
 

 
Rate/Volume Analysis
(In thousands)
                         
   
2009 vs. 2008
  
2008 vs. 2007
   
Increase (Decrease)
  
Increase (Decrease)
   
Due to Changes in
  
Due to Changes in
   
Volume
  
Rate
  
Total
  
Volume
  
Rate
  
Total
Interest income
                        
Loans
  
 $6,333
  
 $(2,762)
  
 $3,571
  
 $5,297
  
 $(1,606)
  
 $3,691
Investment securities
  
 879
  
 (120)
  
 759
  
 (273)
  
 125
  
 (148)
Fed funds sold and other
  
 187
  
 (393)
  
 (206)
  
 169
  
 (305)
  
 (136)
Total interest income
  
 7,399
  
 (3,275)
  
 4,124
  
 5,193
  
 (1,786)
  
 3,407
                         
Interest expense
                        
Deposits
                        
Interest checking
  
 217
  
 66
  
 283
  
 24
  
 31
  
 55
Money market accounts
  
 731
  
 (48)
  
 683
  
 489
  
 (654)
  
 (165)
Savings accounts
  
 3
  
 (110)
  
 (107)
  
 57
  
 94
  
 151
Certificates of deposit
  
 8,613
  
 (9,386)
  
 (773)
  
 2,423
  
 (1,066)
  
 1,357
Total deposits
  
 9,564
  
 (9,478)
  
 86
  
 2,993
  
 (1,595)
  
 1,398
Borrowings
                        
Long-term debt
  
 -
  
 (116)
  
 (116)
  
 18
  
 43
  
 61
FHLB Advances
  
 201
  
 (65)
  
 136
  
 512
  
 (18)
  
 494
Other borrowings
  
 332
  
 -
  
 332
  
 210
  
 -
  
 210
Total interest expense
  
 10,097
  
 (9,659)
  
 438
  
 3,733
  
 (1,570)
  
 2,163
                         
Net interest income
  
 $(2,698)
  
 $6,384
  
 $3,686
  
 $1,460
  
 $(216)
  
 $1,244
                         
Note: the combined effect on interest due to changes in both volume and rate, which cannot be
separately identified, has been allocated proportionately to the change due to volume and the
change due to rate.
                        
 
 
Provision for loan losses
 
The amount of the loan loss provision 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, present economic, and 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.
 
Profitability has been negatively impacted the last two years by increasing provisions for loan losses.  The provision for loan losses increased from $1,187,000 in 2007 to $2,006,000 in 2008 and to $13,220,000 in 2009.  These increases in the provision for loan losses are attributable to the growth in our loan portfolio and a deterioration in asset quality as the depressed economy has negatively impacted the ability of our borrowers to repay us.  The deterioration in asset quality has occurred primarily in loans secured by real estate.  Loans secured by real estate represent 89% of our total loan portfolio at December 31, 2009.

 
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We believe that the level of the provision for loan losses experienced in 2009 will not be repeated in 2010, as the economy is showing some signs of recovery which should help the ability of borrowers to repay loans.  However, no assurances can be given that the provision for loan losses in 2010 will not equal or exceed that in 2009.
 
Noninterest income
 
Noninterest income includes service charges and fees on deposit accounts, fee income related to loan origination, and gains and losses on sale of mortgage loans and securities held for sale. Over the last three years the most significant noninterest income item has been gain on loan sales generated by Village Bank Mortgage, representing 57% in both 2007 and 2008 and 70% in 2009 of total noninterest income.  Noninterest income amounted to $2,667,000 in 2007, $4,185,000 in 2008 and $8,285,000 in 2009.
 
The increase in noninterest income in 2009 of $4,100,000 is primarily attributable to an increase in gain on sale of loans of $3,447,000 and increased service charges and fees on transactional deposit accounts of $452,000.  The gain on sale of loans resulted from an increase in loan production by our mortgage company, from $100 million in loan closings in 2008 to $252 million in 2009.  Despite the depressed economic conditions in 2009, the mortgage company was able to increase loan production due to the addition of new loan officers.  Management expects the mortgage company to further increase loan production in 2010 due to declining mortgage loan interest rates that will allow more borrowers to qualify for loans and provide refinance opportunities for existing home owners.  Service charges and fees increased because transactional deposits grew by $108,215,000, or 132%, in 2009 as a result of maturing time deposits moving to money market accounts.
 
The increase in noninterest income in 2008 of $1,518,000 is primarily attributable to increased service charges and fees on transactional deposit accounts of $412,000 and an increase in gain on sale of loans of $868,000.  Transactional deposits grew by $26,112,000, or 47%, in 2008 as a result of the maturing of our branch network coupled with the addition of the deposits of River City Bank, resulting in the increase in service charges and fees.  The gain on sale of loans resulted from an increase in loan production by our mortgage company, from $67 million in loan closings in 2007 to $100 million in 2008.
 
Noninterest expense
 
Noninterest expense includes all expenses of the Company with the exception of interest expense on deposits and borrowings, provision for loan losses and income taxes.  Some of the primary components of noninterest expense are salaries and benefits, and occupancy and equipment costs.  Over the last three years, the most significant noninterest expense item has been salaries and benefits, representing 58%, 55% and 50% of noninterest expense (excluding the write-off of goodwill in 2009) in 2007, 2008 and 2009, respectively.  Noninterest expense increased from $11,821,000 in 2007, to $14,572,000 in 2008 and to $28,338,000 in 2009.  In 2009 the write-off of all goodwill of $7,422,141 was included in noninterest expense.  This was a one time expense as we no longer have any goodwill.
 
The increase in noninterest expense of $13,766,000 in 2009 resulted from the goodwill write-off of $7,422,000 as well as increases in expenses related to foreclosed assets of $1,310,000 and the FDIC insurance premium of $966,000.  Other growth related increases in noninterest expense in 2009 were increases in salaries and benefits of $2,500,000, occupancy of $493,000, loan underwriting expense of $430,000, data processing of $159,000 and equipment of $126,000.
 
The increases in noninterest expense of $2,751,000 in 2008 resulted from the addition of new branches and the growth in the Company overall as well as the merger with River City Bank.  Growth related increases in noninterest expense in 2008 were increases in salaries and benefits of $1,133,000, professional and outside services of $372,000, occupancy of $364,000, loan underwriting expense of $271,000 and the FDIC insurance premium of $225,000.

 
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Income taxes
 
Tax expense (benefit) amounted to $(4,973,000), $241,000 and $516,000 in 2009, 2008 and 2007, respectively.  The $5,241,000 decline in income tax expense in 2009 is related to the loss of $(16,484,000) and $275,000 decline in 2008 were attributable to the lower taxable income.
 
Commercial banking organizations conducting business in Virginia are not subject to Virginia income taxes.  Instead, they are subject to a franchise tax based on bank capital.  The Bank recorded a franchise tax expense of $355,000, $180,000 and $210,000 for 2009, 2008 and 2007, respectively.
 
Balance Sheet Analysis
 
Investment securities
 
At December 31, 2009 and 2008, all of our investment securities were classified as available-for-sale.  Investment securities classified as available for sale may be sold in the future, prior to maturity. These securities are carried at fair value.  Net aggregate unrealized gains or losses on these securities are included, net of taxes, as a component of shareholders’ equity.  Given the generally high credit quality of the portfolio, management expects to realize all of its investment upon market recovery or, the maturity of such instruments and thus believes that any impairment in value is interest rate related and therefore temporary.  Available for sale securities included net unrealized gains of $97,000 at December 31, 2009 and net unrealized losses of $26,000 at December 31, 2008.  As of December 31, 2009, management does not have the intent to sell any of the securities classified as available for sale and management believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.
 
The following table presents the composition of our investment portfolio at the dates indicated.

 
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Investment Securities Available-for-Sale
(Dollars in thousands)
                     
           
Unrealized
  
Estimated
    
   
Par
  
Amortized
  
Gain
  
Fair
  
Average
   
Value
  
Cost
  
(Loss)
  
Value
  
Yield
December 31, 2009
                    
US Government Agencies
                    
One to five years
  
 $  9,000
  
 $  9,315
  
 $    (66)
  
 $  9,249
  
2.32%
Five to ten years
  
 3,000
  
 3,029
  
 32
  
 3,061
  
4.50%
More than ten years
  
 34,250
  
 35,284
  
 75
  
 35,359
  
5.22%
Total
  
 46,250
  
 47,628
  
 41
  
 47,669
  
4.61%
                     
Mortgage-backed securities
                    
One to five years
  
 389
  
 435
  
 (37)
  
 398
  
4.40%
Five to ten years
  
 471
  
 471
  
 29
  
 500
  
5.24%
More than ten years
  
 3,141
  
 3,227
  
 53
  
 3,280
  
5.53%
Total
  
 4,001
  
 4,133
  
 45
  
 4,178
  
5.39%
                     
Municipals
                    
More than ten years
  
 1,000
  
 1,026
  
 1
  
 1,027
  
5.28%
                     
Other investments
                    
More than five years
  
 2,000
  
 1,973
  
 10
  
 1,983
  
5.65%
                     
Total investment securities
  
 $53,251
  
 $ 54,760
  
 $     97
  
 $ 54,857
  
4.72%
                     
December 31, 2008
                    
US Government Agencies
                    
Within one year
  
 $     360
  
 $     360
  
 $     (4)
  
 $      356
  
4.50%
More than five years
  
 16,546
  
 16,095
  
 564
  
 16,659
  
5.73%
Total
  
 16,906
  
 16,455
  
 560
  
 17,015
  
5.70%
                     
Mortgage-backed securities
                    
One to five years
  
 874
  
 905
  
 (23)
  
 $882
  
4.47%
More than five years
  
 4,603
  
 4,694
  
 (76)
  
 4,618
  
5.42%
   
 5,477
  
 5,599
  
 (99)
  
 5,500
  
5.27%
Other investments
                    
More than five years
  
 2,000
  
 1,970
  
 (184)
  
 1,786
  
5.65%
                     
Total investment securities
  
 $ 24,383
  
 $ 24,024
  
 $  277
  
 $ 24,301
  
5.60%
 
Loans
 
A management objective is to maintain the quality of the loan portfolio.  The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower.  The portfolio strategies include seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar.
 
The Company’s real estate loan portfolios, which represent approximately 89% of all loans, are secured by mortgages on real property located principally in the Commonwealth of Virginia.  Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral.  The Company’s commercial loan portfolio represents approximately 8.5% of all loans.  Loans in this category are typically made to individuals, small and medium-sized businesses and range between $250,000 and $2.5 million.  Based on underwriting standards, commercial and

 
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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 2.5% of the total.
 
The following tables present the composition of our loan portfolio at the dates indicated and maturities of selected loans at December 31, 2009.
 
 
Loan Portfolio, Net
(In thousands)
                   
     
December 31,
 
2009
  
2008
  
2007
  
2006
  
2005
                   
Commercial
 $   39,576
  
 $   52,438
  
 $    23,152
  
 $   17,889
  
 $   14,121
Real estate - residential
 93,657
  
 84,612
  
 51,281
  
 36,408
  
 30,043
Real estate - commercial
 240,830
  
 220,400
  
 140,176
  
 100,039
  
 66,274
Real estate - construction
 81,688
  
 103,161
  
 106,556
  
 80,324
  
 56,146
Consumer
 11,609
  
 10,307
  
 6,611
  
 6,730
  
 6,161
                   
Total loans
 467,360
  
 470,918
  
 327,776
  
 241,390
  
 172,745
Less:  unearned income, net
 209
  
 (196)
  
 (433)
  
 (339)
  
 (367)
Less:  Allowance for loan losses
 (10,522)
  
 (6,059)
  
 (3,469)
  
 (2,553)
  
 (1,931)
                   
Total loans, net
 $  457,047
  
 $ 464,663
  
  $  323,874
  
 $ 238,498
  
 $ 170,447
 
 
December 31, 2009
(In thousands)