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EX-31.2 - EXHIBIT 31.2 - Village Bank & Trust Financial Corp.v403214_ex31-2.htm
EX-31.1 - EXHIBIT 31.1 - Village Bank & Trust Financial Corp.v403214_ex31-1.htm

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-K

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d)

OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the fiscal year ended December 31, 2014

 

Commission file number 0-50765

 

VILLAGE BANK AND TRUST FINANCIAL CORP.

(Exact name of registrant as specified in its charter)

 

Virginia   16-1694602
(State or other jurisdiction of   (I.R.S. Employer
incorporation or organization)   Identification No.)

 

  13319 Midlothian Turnpike, Midlothian, Virginia   23113
  (Address of principal executive offices)    (Zip Code)

 

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 ¨ Noþ

 

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Act. ¨

 

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. Yesþ  No¨

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yesþ No¨

 

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K (§ 229.405 of this chapter) 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.¨

 

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 ¨   Accelerated Filer ¨
Non-Accelerated Filer ¨ (Do not check if smaller reporting company)   Smaller Reporting Company þ

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨ No þ

 

The aggregate market value of common stock held by non-affiliates of the registrant as of the last business day of the Registrant’s most recent completed second fiscal quarter was approximately $5,114,000.

 

The number of shares of common stock outstanding as of February 20, 2015 was 350,622.

 

DOCUMENTS INCORPORATED BY REFERENCE

 

Portions of the definitive Proxy Statement to be used in conjunction with the 2015 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   17
Item 1B. Unresolved Staff Comments   17
Item 2. Properties   17
Item 3. Legal Proceedings   17
Item 4. Mine Safety Disclosures   17
       
Part II      
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   18
Item 6. Selected Financial Data   19
Item 7. Management’s Discussion and Analysis of Financial Condition And Results of Operations   20
Item 7A. Quantitative and Qualitative Disclosures About Market Risk   46
Item 8. Financial Statements and Supplementary Data   46
Item 9. Changes In and Disagreements with Accountants on Accounting and Financial Disclosure   94
Item 9A. Controls and Procedures   94
Item 9B. Other Information   94
       
Part III      
Item 10. Directors, Executive Officers, and Corporate Governance   95
Item 11. Executive Compensation   95
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters   95
Item 13. Certain Relationships and Related Transactions, and Director Independence   95
Item 14. Principal Accounting Fees and Services   95
       
Part IV      
Item 15. Exhibits, Financial Statement Schedules   96
       
Signatures     99

  

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Part I

 

In addition to historical information, the following report contains forward-looking statements that are subject to risks and uncertainties that could cause Village Bank and Trust Financial Corp.’s actual results to differ materially from those anticipated. Readers are cautioned not to place undue reliance on these forward-looking statements, which reflect management’s analysis only as of the date of the report. For discussion of factors that may cause our actual future results to differ materially from those anticipated, please see “ITEM 7 – MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS” herein.

 

ITEM 1. BUSINESS

 

Village Bank and Trust Financial Corp. (“Company”) was incorporated in January 2003 and was organized under the laws of the Commonwealth of Virginia as a bank holding company. The Company has three active wholly owned subsidiaries: Village Bank (the “Bank”), Southern Community Financial Capital Trust I, and Village Financial Statutory Trust II. The Bank has one active wholly owned subsidiary: Village Bank Mortgage Corporation (“the mortgage company”), a full service mortgage banking company. 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. Unless the context suggest otherwise, the terms “we”, “us” and “our” refer collectively to the Company, the Bank, and the Mortgage Company.

 

The Bank is the primary operating business of the Company. The Bank offers 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, primarily in the Richmond, Virginia metropolitan area. The Bank was organized in 1999 as a Virginia chartered bank to engage in a general banking business to serve the communities in and around Richmond, Virginia. Deposits with the Bank are insured to the maximum amount provided by the Federal Deposit Insurance Corporation (“FDIC”). The Bank offers a comprehensive range of financial services and products and specializes in providing customized financial services to small and medium sized businesses, professionals, and associated individuals. The Bank provides its customers with personal customized service utilizing the latest technology and delivery channels.

 

Bank revenues are derived from interest and fees received in connection with loans, deposits, and investments. Administrative and operating expenses are the major expenses, followed by interest paid on deposits and borrowings. Revenues from the mortgage company consist primarily of gains from the sale of loans and loan origination fees and its major expenses consist of personnel, advertising, and other operating expenses. In 2014, revenue (after intercompany eliminations) generated by the Bank totaled $19.4 million and $5.5 million by the mortgage company.

 

Business Strategy

 

We are implementing strategies that we believe, overtime, will help us achieve our goal of delivering long term total shareholder returns that rank in the top quartile of a nationwide peer group.  To achieve this goal, we believe that we will need to become a top performer in return on equity, produce sustainable earnings growth, achieve best quartile earnings volatility in our industry and deliver best quartile asset quality in the worst part of the economic cycle.  Our current business strategies include the following:

 

·Grow our general commercial and consumer banking businesses. Our strategy is to offer commercial and retail customers all of the basic products and services they need while maintaining the quick response and personal service of a community bank.  During 2014, we hired a new commercial banking division executive, expanded our commercial banking team, enhanced our Small Business Administration (“SBA”) lending capabilities, and installed a more intensive sales process.   In consumer banking, we upgraded all automated teller machines (“ATMs”), installed mobile deposit capture, switched debit card providers to increase exchange fees, enhanced our rewards program, expanded our customer care team staff and hours and fully implemented our overdraft protection program.  During the fourth quarter of 2014, we installed a more efficient and competitive consumer lending process and updated loan products.

 

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·Reposition our real estate lending to emphasize both construction and commercial mortgage lending on income producing properties while being selective and targeted in our land acquisition and development and single family construction lending.  Real estate lending will continue to be an important part of our business strategy, but we intend to be diligent in managing overall portfolio concentrations and focus on real estate sectors that will perform better during difficult times.

 

·Grow low cost core deposits by emphasizing relationship banking in every division.  In turn, this will lower funding costs, enhance return on assets and return on equity and help us develop long term, mutually important relationships with our clients.  We have enhanced our deposit products, realigned our treasury services specialist to work more closely with our commercial banking team, added small business bankers that will target small business deposit relationships, and established performance expectations and incentives for commercial bankers to grow deposits. We also intend to develop strategies to focus on deposit-rich business and consumer market segments.

 

·Drive fee income growth by growing mortgage banking and enhancing fee generating services, both of which will improve return on assets and return on equity.  We have been installing and updating business and consumer banking products and services that will generate additional fee income.  In 2014, we added an area manager position in retail banking to break up the span of control of our EVP-Retail Banking. This will facilitate the training and coaching needed to strengthen our sales culture in retail banking.  In mortgage banking, we have been working to add established producers, increasing our marketing spending, and expanding our joint marketing efforts with realtors and builders.  In commercial banking, we are cross selling fee generating treasury management and other services to drive fee income growth.

 

·Streamline and rationalize our processes and organization to improve productivity and efficiency.  Operational efficiency and excellence are critical to becoming a high return on equity bank.  We embrace the need to continuously improve how we get business done and to be nimble and versatile.  Along these lines, in 2014 we implemented a series of initiatives that position us to both keep in step with changing customer banking habits and streamline work processes. This allowed us to redesign our branch staffing model to reduce branch staffing needs.  We also began to realize the benefits of our renegotiated data processing and telecommunications contracts.  In November, we relocated most of our headquarters and mortgage company staff to lower cost space and are in the process of leasing out space in our old headquarters building so we are better positioned to sell the building.  We are focused on using every resource of the company (dollars, time, talent) as productively as possible rather than simple cost cutting.

 

·Achieve excellence in all risk management and credit processes.  We strive to achieve best quartile performance on credit quality metrics in the worst part of the business cycle and sustainable earnings growth over time.  Risk taking is a fundamental component of banking.  Top performing banks are very good at identifying, evaluating, measuring, tracking, managing, mitigating and getting paid for the risks the organization takes.  We are committed to building and sustaining the culture, talent, tools, policies, processes, resources and discipline needed to be a top performer in our risk management and credit processes.

 

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·Achieve full compliance with Regulatory Agreements by the end of 2015 to reduce related costs and enhance our flexibility as we grow the business.  This will require that we continue to strive to improve credit quality, complete our previously announced capital raise, achieve consistent profitability and sell our former Watkins Centre headquarters building to resolve the Regulation W violation.

 

We strongly believe that there is a continuing need for community based banks like Village and that a well-run community based bank can generate attractive returns for shareholders over the long term.

 

Market Area

 

The Company, the Bank, and the mortgage company are headquartered in Chesterfield County and primarily serve the Central Virginia region and the Richmond Metropolitan Statistical Area (the “Richmond MSA”. At the end of 2013, the Richmond MSA was the nation’s 44th largest metro area. At the end of 2014, its population was 1,251,049 representing approximately 15% of the total population in the Commonwealth of Virginia with a median age of 38.1 years.

 

The unemployment rate for Richmond MSA was 4.7% in December 2014 compared to 4.8% for the Commonwealth of Virginia and 5.6% for the nation. At December 31, 2013 the unemployment rate for Chesterfield County was 4.9%, 5.2% for the Commonwealth of Virginia and 7.0% for the nation.

 

Banking Services

 

We currently conduct business from eleven full-service branch banking offices, three offsite ATMs and two mortgage loan production offices in Central Virginia in the counties of Chesterfield, Hanover, Henrico and Powhatan. We also have a mortgage loan production office in Manassas, Virginia, and we opened a new mortgage loan production office in Newport News, Virginia in January of 2014.

 

Deposit Services. Deposits are a major source of our funding. The Bank offers a full range of deposit services that are typically available in most banks and other financial institutions including checking accounts, savings accounts and other time deposits of various types, ranging from daily money market accounts to longer term certificates of deposit and Individual Retirement Accounts. These deposit accounts are offered at rates competitive with other institutions in our market area. We service our deposit clients in our full-service branches, at drive-up windows, at our ATMs, through our customer care team and through technology such as online banking, mobile banking applications and remote deposit capture for business clients. We have not applied for permission to establish a trust department and offer trust services. The Bank is not a member of the Federal Reserve System. Deposits are insured under the Federal Deposit Insurance Act to the limits provided thereunder.

 

Lending Services. We offer a full range of short-to-medium term commercial and personal loans. We also provide a wide range of real estate finance services. Our primary focus is on making loans in the Central Virginia market where we have branch banking offices. We originate mortgage loans for sale in our Northern Virginia and Newport News mortgage loan production offices. We will periodically offer residential construction-to-permanent financing to clients of the mortgage production offices in Northern Virginia and Newport News.

 

·Commercial Business Lending. We make secured and unsecured loans to small- and medium-sized businesses for purposes such as funding working capital needs (including inventory and receivables), business expansion (including acquisition of real estate and improvements) and purchase of equipment and machinery. We also make loans under Small Business Administration and state sponsored business loan programs. In our underwriting, we evaluate the earnings and cash flows of the business, guarantor support and both the need for and the protection offered by the collateral for the loan.

 

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·Commercial Real Estate Acquisition, Development, Construction and Mortgage Lending. We make loans to our clients for the purposes of acquiring, developing, constructing and owning commercial real estate. These properties may be owner-occupied or may be held for investment purposes and repaid from rental income or from the sale of the property.

 

·Consumer Lending. Consumer loans include secured and unsecured loans for financing automobiles, home improvements, education and personal investments. We also originate fixed and variable rate mortgage loans and real estate construction and acquisition loans. Residential loans originated by our mortgage company are usually sold in the secondary mortgage market.

 

·Loan Participations. We sell loan participations in the ordinary course of business when a loan originated by us exceeds our legal lending limit or we otherwise deem it prudent to share the risk with another lending institution. Additionally, we purchase loan participations from other banks, usually without recourse against that bank. We underwrite purchased loan participations in accordance with normal underwriting practices.

 

·Loan Purchases. We purchase Federal Rehabilitated Student Loan portfolios when approved by the Board of Directors. These loans are guaranteed by the Department of Education which covers approximately 98% of the principal and interest. These loans are serviced by a third party servicer that specializes in handling these types of loans.

 

We also purchase the guaranteed portion of United State Department of Agriculture Loans (“USDA”) which are guaranteed by the USDA for 100% of the principal and interest. The originating institution holds the unguaranteed portion of the loan and services the loan.

 

Lending Limit. As of December 31, 2014, our legal lending limit for loans to one borrower was approximately $5,450,000. However, we generally do not extend credit to any one individual or entity in excess of $4,000,000, and any amount over that must be approved by the full board of directors.

 

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. We believe that the Company can capitalize on recent merger activity to attract customers from the acquired institutions.

 

At June 30, 2014, the latest date such information is available from the FDIC, the Bank’s deposit market share in Chesterfield County was 5.86%, 4.56% in Hanover County, 7.97% in Powhatan County, 0.57% in the Richmond MSA and 0.14% in Henrico County.

 

Regulation

 

We are subject to extensive regulation by certain federal and state agencies and receive periodic examinations by those regulatory authorities. As a consequence, our business is affected by state and federal legislation and regulations.

 

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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”) and Virginia Bureau of Financial Institutions (the “BFI”). As a bank holding company, the Company is required to furnish to the Federal Reserve annual and quarterly reports of its operations and such additional information as the Federal Reserve may require. The Federal Reserve, FDIC and BFI also may conduct examinations of the Company and/or the Bank.

 

Bank Regulation. As a Virginia-chartered bank that is not a member of the Federal Reserve, the Bank is subject to regulation, supervision and examination by the BFI and the FDIC. Federal and state law also specify the activities in which the Bank may engage, the investments it may make and the aggregate amount of loans that may be granted to one borrower. Various consumer and compliance laws and regulations also affect the Bank’s 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 BFI and the FDIC 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 the Bank’s operations. In addition to these regular examinations, the Bank must furnish the FDIC and BFI with periodic reports containing a full and accurate statement of its affairs. Supervision, regulation and examination of banks by these agencies are intended primarily for the protection of depositors rather than shareholders.

 

Agreements with Regulators. In February 2012, the Bank entered into a Stipulation and Consent to the Issuance of a Consent Order with the FDIC and the BFI (the “Supervisory Authorities”), and the Supervisory Authorities issued the related Consent Order effective February 3, 2012. In June 2012, the Company entered into a written agreement (“Written Agreement”) with the Federal Reserve Bank of Richmond (“Reserve Bank”). A complete description of the terms and conditions of these Agreements is provided in Note 12. Commitments and contingencies of the Notes to Consolidated Financial Statements.

 

The following description summarizes some of the laws and regulations to which we are subject.

 

The Dodd-Frank Wall Street Reform and Consumer Protection Act. In July 2010, the Dodd-Frank Act Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was signed into law, incorporating numerous financial institution regulatory reforms. Certain of these reforms are yet to be implemented through regulations to be adopted by various federal banking and securities regulatory agencies. The following discussion describes the material elements of the regulatory framework that currently apply. The Dodd-Frank Act implements far-reaching reforms of major elements of the financial landscape, particularly for larger financial institutions. Many of its provisions do not directly impact community-based institutions like the Bank. For instance, provisions that regulate derivative transactions and limit derivatives trading activity of federally-insured institutions, enhance supervision of “systemically significant” institutions, impose new regulatory authority over hedge funds, limit proprietary trading by banks, and phase-out the eligibility of trust preferred securities for Tier 1 capital are among the provisions that do not directly impact the Bank either because of exemptions for institutions below a certain asset size or because of the nature of  the Bank’s operations. Provisions that do impact the Bank include the following:

 

·FDIC Assessments. The Dodd-Frank Act changes the assessment base for federal deposit insurance from the amount of insured deposits to average consolidated total assets less its average tangible equity. In addition, it increases the minimum size of the Deposit Insurance Fund (“DIF”) and eliminates its ceiling, with the burden of the increase in the minimum size on institutions with more than $10 billion in assets.
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·Deposit Insurance. The Dodd-Frank Act makes permanent the $250,000 limit for federal deposit insurance at all insured depository institutions.
·Interest on Demand Deposits. The Dodd-Frank Act provides that depository institutions may pay interest on demand deposits, including business transaction and other accounts.
·Consumer Financial Protection Bureau. The Dodd-Frank Act centralizes responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau, responsible for implementing federal consumer protection laws, although banks below $10 billion in assets will continue to be examined and supervised for compliance with these laws by their federal bank regulator.
·Mortgage Lending. Additional requirements are imposed on mortgage lending, including minimum underwriting standards, prohibitions on certain yield-spread compensation to mortgage originators, special consumer protections for mortgage loans that do not meet certain provision qualifications, prohibitions and limitations on certain mortgage terms and various mandated disclosures to mortgage borrowers.
·Holding Company Capital Levels. Bank regulators are required to establish minimum capital levels for holding companies that are at least as stringent as those currently applicable to banks. In addition, all trust preferred securities issued after May 19, 2010 will be counted as Tier 2 capital, but the Company’s currently outstanding trust preferred securities will continue to qualify as Tier 1 capital.
·De Novo Interstate Branching. National and state banks are permitted to establish de novo interstate branches outside of their home state, and bank holding companies and banks must be well-capitalized and well managed in order to acquire banks located outside their home state.
·Transactions with Affiliates. The Dodd-Frank Act enhances the requirements for certain transactions with affiliates under Section 23A and 23B of the Federal Reserve Act, including an expansion of the definition of “covered transactions” and an increase in the amount of time for which collateral requirements regarding covered transactions must be maintained.
·Transactions with Insiders. Insider transaction limitations are expanded through the strengthening of loan restrictions to insiders and the expansion of the types of transactions subject to the various limits, including derivative transactions, repurchase agreements, reverse repurchase agreements and securities lending or borrowing transactions. Restrictions are also placed on certain asset sales to and from an insider to an institution, including requirements that such sales be on market terms and, in certain circumstances, approved by the institution’s board of directors.
·Corporate Governance. The Dodd-Frank Act includes corporate governance revisions that apply to all public companies, not just financial institutions, including with regard to executive compensation and proxy access to shareholders.

 

Many aspects of the Dodd-Frank Act are subject to rulemaking and will take effect over several years, and their impact on the Company or the financial industry is difficult to predict before such regulations are adopted. Provisions in the legislation that affect deposit insurance assessments, payment of interest on demand deposits and interchange fees could increase the costs associated with deposits as well as place limitations on certain revenues those deposits may generate.

 

Insurance of Accounts, Assessments and Regulation by the FDIC. Our deposits are insured by the FDIC up to the limits set forth under applicable law, currently $250,000. We are subject to the deposit insurance assessments of the DIF. The amount of the assessment is a function of the institution’s risk category, of which there are four, and its assessment base. An institution’s risk category is determined according to its supervisory ratings and capital levels and is used to determine the institution’s assessment rate. The assessment base is an institution’s average consolidated total assets less its average tangible equity.

 

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The FDIC is authorized to prohibit any DIF-insured institution from engaging in any activity that the FDIC determines by regulation or order to pose a serious threat to the respective insurance fund. Also, the FDIC may initiate enforcement actions against banks, after first giving the institution’s primary regulatory authority an opportunity to take such action. The FDIC may terminate the deposit insurance of any depository institution if it determines, after a hearing, that the institution has 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.

 

Payment of Dividends. The Company is a legal entity separate and distinct from the Bank and its other subsidiaries. Virtually all of the Company’s cash revenues will result from dividends paid to it by the Bank, which is subject to laws and regulations that limit the amount of dividends that it can pay. Under Virginia law, a bank may not declare a dividend in excess of its accumulated retained earnings without BFI approval. As of December 31, 2014, the Bank did not have any accumulated retained earnings. In addition, the Bank may not declare or pay any dividend if, after making the dividend, the Bank would be "undercapitalized," as defined in FDIC regulations.

 

The FDIC and the state have the general authority to limit the dividends paid by insured banks if the payment is deemed an unsafe and unsound practice. Both the state and the FDIC have indicated that paying dividends that deplete a bank's capital base to an inadequate level would be an unsound and unsafe banking practice.

 

In addition, the Company is subject to certain regulatory requirements to maintain capital at or above regulatory minimums. These regulatory requirements regarding capital affect our dividend policies. Regulators have indicated that holding companies should generally pay dividends only if the organization's net income available to common shareholders over the past year has been sufficient to fully fund the dividends, and the prospective rate of earnings retention appears consistent with the organization's capital needs, asset quality and overall financial condition. In addition, the Federal Reserve has issued guidelines that bank holding companies should inform and consult with the Federal Reserve in advance of declaring or paying a dividend that exceeds earnings for the period (e.g., quarter) for which the dividend is being paid or that could result in a material adverse change to the organization’s capital structure.

 

The Company is currently subject to a Written Agreement with the Reserve Bank pursuant to which the Company must obtain the prior written approval of the Reserve Bank to declare or pay any dividends on its common stock or preferred stock, take dividends or any other form of payment representing a reduction in capital from the Bank or make any payments on its trust preferred securities.

 

The Bank is currently subject to a Consent Order with the FDIC and the BFI which also requires the Bank to obtain prior written regulatory approval to declare or pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction of capital.

 

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Capital Adequacy.

 

2014 Capital Requirements

 

Both the Company and the Bank are required to comply with the capital adequacy standards established by the Federal Reserve, in the case of the Company, and the FDIC, in the case of the Bank. The Federal Reserve has established a risk-based and a leverage measure of capital adequacy for bank holding companies. The Bank is also subject to risk-based and leverage capital requirements adopted by the FDIC, which are substantially similar to those adopted by the Federal Reserve for bank holding companies. Under the risk-based capital requirements that were effective through December 31, 2014, the Company and the Bank were each generally required to maintain a minimum ratio of total capital to risk-weighted assets (including specific off-balance sheet activities, such as standby letters of credit) of 8%. At least half of the total capital must have been composed of “Tier 1” capital, which is defined as common equity, retained earnings, qualifying perpetual preferred stock and minority interests in common equity accounts of consolidated subsidiaries, less certain intangibles. The remainder could consist of “Tier 2” capital, which is defined as specific subordinated debt, some hybrid capital instruments and other qualifying preferred stock and a limited amount of the loan loss allowance and pretax net unrealized holding gains on certain equity securities. In addition, each of the federal banking regulatory agencies established minimum leverage capital requirements for banking organizations. Under these requirements, banking organizations were required to maintain a minimum ratio of Tier 1 capital to adjusted average quarterly assets equal to 3% to 5%, subject to federal bank regulatory evaluation of an organization’s overall safety and soundness. In summary, the capital measures used by the federal banking regulators through December 31, 2014 were:

 

·Total risk-based capital ratio, which is the total of Tier 1 risk-based capital (which includes common shareholders’ equity, trust preferred securities, minority interests and qualifying preferred stock, less goodwill and other adjustments) and Tier 2 capital (which includes preferred stock not qualifying as Tier 1 capital, mandatory convertible debt, limited amounts of subordinated debt, other qualifying term debt and the allowance for loan losses up to 1.25 percent of risk-weighted assets and other adjustments) as a percentage of total risk-weighted assets,

 

·Tier 1 risk-based capital ratio (Tier 1 capital divided by total risk-weighted assets), and

 

·Leverage ratio (Tier 1 capital divided by adjusted average total assets).

 

Under these regulations, a bank was:

 

·“well capitalized” if it had a total risk-based capital ratio of 10% or greater, a Tier 1 risk-based capital ratio of 6% or greater, a leverage ratio of 5% or greater, and was not subject to any written agreement, order, capital directive, or prompt corrective action directive by a federal bank regulatory agency to meet and maintain a specific capital level for any capital measure,

 

·“adequately capitalized” if it had a Total risk-based capital ratio of 8% or greater, a Tier 1 risk-based capital ratio of 4% or greater, and a leverage ratio of 4% or greater (or 3% in certain circumstances) and was not well capitalized,

 

·“undercapitalized” if it had a Total risk-based capital ratio of less than 8%, a Tier 1 risk-based capital ratio of less than 4% (or 3% in certain circumstances), or a leverage ratio of less than 4% (or 3% in certain circumstances),

 

·“significantly undercapitalized” if it had a total risk-based capital ratio of less than 6%, a Tier 1 risk-based capital ratio of less than 3%, or a leverage ratio of less than 3%, or

 

·“critically undercapitalized” if its tangible equity was equal to or less than 2% of tangible assets.

 

In addition, the FDIC could require banks to maintain capital at levels higher than those required by general regulatory requirements.

 

New Capital Requirements under Basel III

 

In June 2012, the federal bank regulatory agencies jointly issued proposed rules to revise the risk-based and leverage capital requirements and the method for calculating risk-weighted assets to be consistent with the agreements reached by the Basel Committee on Banking Supervision in “Basel III: A Global Regulatory Framework for More Resilient Banks and Banking Systems” (“Basel III”) and certain provisions of the Dodd-Frank Act. The proposed rules applied to all depository institutions, top-tier bank holding companies with total consolidated assets of $500 million or more, and top-tier savings and loan holding companies (“banking organizations”). On July 2, 2013, the federal bank regulatory agencies approved certain revisions to the proposed rules and finalized new capital requirements for banking organizations.

 

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 Among other things, the final rules establish a revised definition of regulatory capital, a new common equity Tier 1 minimum capital requirement (“CET1”), a higher minimum Tier 1 capital requirement, and a supplementary leverage ratio that incorporates a broader set of exposures in the denominator.  The final rules also establish limits on a banking organization’s capital distributions and certain discretionary bonus payments if the banking organization does not hold a specified amount of CET1 capital in addition to the necessary amount to meet its minimum risk-based capital requirements.

 

Effective January 1, 2015, the final rules require the Company and the Bank to comply with the following new minimum capital ratios: (i) a new ratio of CET1 to risk-weighted assets of 4.5%; (ii) a ratio of Tier 1 capital to risk-weighted assets of 6.0% (increased from the prior requirement of 4.0%); (iii) a ratio of total (that is, Tier 1 plus Tier 2) capital to risk-weighted assets of 8.0% (unchanged from the prior requirement); and (iv) a leverage ratio of 4.0% (unchanged from the prior requirement), calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter). These are the initial capital requirements, which will be phased in over a four-year period that began on January 1, 2015. When fully phased in, Basel III will require the Company and the Bank to maintain (i) a minimum ratio of CET1 to risk-weighted assets of at least 4.5%, plus a 2.5% "capital conservation buffer" (which is added to the 4.5% CET1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of CET1 to risk-weighted assets of at least 7% upon full implementation), (ii) a minimum ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the capital conservation buffer (which is added to the 6.0% Tier 1 capital ratio as that buffer is phased in, effectively resulting in a minimum Tier 1 capital ratio of 8.5% upon full implementation), (iii) a minimum ratio of total capital to risk-weighted assets of at least 8.0%, plus the capital conservation buffer (which is added to the 8.0% total capital ratio as that buffer is phased in, effectively resulting in a minimum total capital ratio of 10.5% upon full implementation) and (iv) a minimum leverage ratio of 4%.

 

Basel III will also provide for a "countercyclical capital buffer," generally designed to absorb losses during periods of economic stress and to be imposed when national regulators determine that excess aggregate credit growth becomes associated with a buildup of systemic risk. The buffer would be a CET1 add-on to the capital conservation buffer in the range of 0% to 2.5% when fully implemented (potentially resulting in total buffers of between 2.5% and 5%).

 

The Basel III capital framework is also expected to provide for a number of new deductions from and adjustments to CET1. These include, for example, the requirement that mortgage servicing rights, deferred tax assets dependent upon future taxable income and significant investments in non-consolidated financial entities be deducted from CET1 to the extent that any one such category exceeds 10% of CET1 or all such categories in the aggregate exceed 15% of CET1. Implementation of the deductions and other adjustments to CET1 are to be phased-in over a three-year period which will begin on January 1, 2016.

 

Additionally, the bank regulatory agencies’ final rules revised the “prompt corrective action” regulations pursuant to Section 38 of the Federal Deposit Insurance Corporation Improvement Act of 1991 (the “FDIC Act”) by (i) introducing a CET1 capital ratio requirement at each level (other than critically undercapitalized), with the required ratio being 6.5% for well-capitalized status; (ii) increasing the minimum Tier 1 capital ratio requirement for each category, with the minimum ratio for well-capitalized status being 8.0% (as compared to the prior ratio of 6.0%); and (iii) eliminating the provision that provides that a bank with a composite supervisory rating of 1 may have a 3.0% Tier 1 leverage ratio and still be well-capitalized. These new thresholds were effective for the Bank as of January 1, 2015. The minimum total capital to risk-weighted assets ratio (10.0%) and minimum leverage ratio (5.0%) for well-capitalized status were unchanged by the final rules. As of December 31, 2014, the Bank would have met the new minimum ratios to be classified as a well capitalized financial institution. However, as a result of the Order, the Bank currently is classified as adequately capitalized.

 

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Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to banks in the three “undercapitalized” categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, the banking regulator must appoint a receiver or conservator for an institution that is critically undercapitalized. The federal banking agencies have specified by regulation the relevant capital level for each category. An institution that is categorized as undercapitalized, significantly undercapitalized, or critically undercapitalized is required to submit an acceptable capital restoration plan to its appropriate federal banking agency. A bank holding company must guarantee that a subsidiary depository institution meets its capital restoration plan, subject to various limitations. The controlling holding company’s obligation to fund a capital restoration plan is limited to the lesser of 5% of an undercapitalized subsidiary’s assets or the amount required to meet regulatory capital requirements. An undercapitalized institution is also generally prohibited from increasing its average total assets, making acquisitions, establishing any branches or engaging in any new line of business, except under an accepted capital restoration plan or with FDIC approval. The regulations also establish procedures for downgrading an institution and a lower capital category based on supervisory factors other than capital.

 

In February 2012, the Bank entered into the Consent Order with the Supervisory Authorities which provided that, within 90 days from the date of the order and during the life of the order, the Bank must have a leverage ratio equal to or greater than 8% of its total assets, and total risk-based capital equal to or greater than 11% of the Bank’s total risk-weighted assets. At December 31, 2014, the Bank’s Tier 1 risk-based capital ratio was 10.82%, its total risk-based capital ratio was 12.08% and its leverage ratio was 7.18%, compared to 9.64%, 10.90% and 6.92% at December 31, 2013, respectively.  The Bank has submitted a Capital Plan to the Supervisory Authorities as required by the Consent Order. More information concerning our regulatory ratios at December 31, 2014 is included in Note 13 to the “Notes to Consolidated Financial Statements” included elsewhere in this Annual Report on Form 10-K.

 

Restrictions on Transactions with Affiliates. Both the Company and the Bank are subject to the provisions of Section 23A of the Federal Reserve Act. Section 23A places limits on the amount of:

 

·A bank’s loans or extensions of credit, including purchases of assets subject to an agreement to repurchase, to affiliates;
·A bank’s investment in affiliates;
·Assets a bank may purchase from affiliates, except for real and personal property exempted by the Federal Reserve;
·The amount of loans or extensions of credit to third parties collateralized by the securities or debt obligations of affiliates;
·Transactions involving the borrowing or lending of securities and any derivative transaction that results in credit exposure to an affiliate; and
·A bank’s guarantee, acceptance or letter of credit issued on behalf of an affiliate.

 

The total amount of the above transactions is limited in amount, as to any one affiliate, to 10% of a bank’s capital and surplus and, as to all affiliates combined, to 20% of a bank’s capital and surplus. In addition to the limitation on the amount of these transactions, each of the above transactions must also meet specified collateral requirements. The Bank must also comply with other provisions designed to avoid acquiring low-quality assets from its affiliates.

 

The Company and the Bank are also subject to the provisions of Section 23B of the Federal Reserve Act which, among other things, prohibits an institution from engaging in the above transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to the institution or its subsidiaries, as those prevailing at the time for comparable transactions with nonaffiliated companies.

 

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On September 30, 2010, the Company sold its headquarters building at the Watkins Centre to the Bank. This transaction allowed us to repay the outstanding mortgage loan on the building resulting in a reduction of our interest expense and improvement in earnings on a consolidated basis. The Federal Reserve Bank has determined that the sale of the headquarters building from the Company to the Bank was not permitted under Section 23A of the Federal Reserve Act as the amount of the transaction exceeded 10% of the Bank’s capital stock and surplus. As a result, the Federal Reserve Bank has directed the Company to take corrective action. The Company has taken and continues to take active steps to correct this violation including offering the building for sale. However, the Company has not been successful in these efforts and continues to update the Federal Reserve Bank on such efforts.

 

The Bank is also subject to restrictions on extensions of credit to its executive officers, directors, principal shareholders and their related interests. These extensions of credit (1) must be made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with third parties, and (2) must not involve more than the normal risk of repayment or present other unfavorable features.

 

The Dodd-Frank Act also provides that an insured depository institution may not purchase an asset from, or sell an asset to a bank insider (or their related interests) unless (1) the transaction is conducted on market terms between the parties, and (2) if the proposed transaction represents more than 10% of the capital stock and surplus of the insured institution, it has been approved in advance by a majority of the institution’s non-interested directors.

 

Support of Subsidiary Institutions. Under the Dodd-Frank Act, and previously under Federal Reserve policy, we are required to act as a source of financial strength for our bank subsidiary, Village Bank, and to commit resources to support the Bank. This support can be required at times when it would not be in the best interest of our shareholders or creditors to provide it. In the unlikely event of our bankruptcy, any commitment by us to a federal bank regulatory agency to maintain the capital of the Bank would be assumed by the bankruptcy trustee and entitled to a priority of payment. On December 31, 2012, the Company made a capital contribution of $1,500,000 to the Bank to improve its capital ratios. In addition, on December 4, 2013, the Company raised $1,684,075 through the sale of 67,907 shares of its common stock to its board of directors and executive management team at a price of $24.80 per share in a private placement. The total amount raised was contributed to the Bank as additional capital.

 

In February 2015, the Company distributed to holders of the Company’s common stock non-transferable subscription rights to purchase up to an aggregate of 1,051,866 shares of the Company’s common stock. Each shareholder received one subscription right for each share of common stock owned as of January 20, 2015. Each subscription right entitles the shareholder to purchase three shares of common stock at the subscription price of $13.87 per share. The Company also entered into a Standby Purchase Agreement with a standby investor to purchase, subject to certain limits, any shares of common stock leftover after shareholders exercise their subscription rights. If the offering is successful, the Company intends to use a portion of the net proceeds to infuse the Bank with additional capital to help achieve and maintain the capital ratios required by the Bank’s Consent Order.

 

Incentive Compensation Policies and Restrictions. In July 2010, the federal banking agencies issued guidance which applies to all banking organizations supervised by the agencies (thereby including both the Company and the Bank). Pursuant to the guidance, to be consistent with safety and soundness principles, a banking organization’s incentive compensation arrangements should: (1) provide employees with incentives that appropriately balance risk and reward; (2) be compatible with effective controls and risk management; and (3) be supported by strong corporate governance including active and effective oversight by the banking organization’s board of directors. Monitoring methods and processes used by a banking organization should be commensurate with the size and complexity of the organization and its use of incentive compensation. At December 31, 2014, we had not been made aware of any instances of non-compliance with this guidance.

 

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Emergency Economic Stabilization Act of 2008. In response to unprecedented market turmoil during the third quarter of 2008, the Emergency Economic Stabilization Act of 2008 (“EESA”) was enacted on October 3, 2008. EESA authorized 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 which the U.S. Treasury allocated $250 billion to the TARP Capital Purchase Program (the “TARP Program”).

 

On May 1, 2009, the Company issued preferred stock and a warrant to purchase its common stock to the U.S. Treasury pursuant to the TARP Capital Purchase Program. The amount of capital raised in that transaction was $14.7 million. Pursuant to the terms of the preferred stock, dividends may not be paid on common stock unless dividends have been paid on the preferred stock. The preferred stock does 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. Holders of the preferred stock also have the right to elect two directors if dividends have not been paid for six periods.

 

The Company has deferred fifteen (15) dividend payments as of December 31, 2014, but holders of the preferred stock have never nominated directors to the board.

 

In November 2013, the Company’s preferred stock was sold by the U.S. Treasury as part of its efforts to manage and recover its investments under the TARP Program. While the sale of the preferred stock to new owners did not result in any proceeds to the Company (nor did it change the Company’s capital position or accounting for these securities including accrual of dividends), it did eliminate certain restrictions put in place by the U.S. Treasury on TARP recipients.

 

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 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 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.

 

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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. At December 31, 2014, Village Bank met the ratio requirements to be classified as a well capitalized financial institution. However, as a result of the Order, Village Bank currently is classified as adequately capitalized.

 

Loans-to-One Borrower. Under applicable laws and regulations the amount of loans and extensions of credit which may be extended by a bank to any one borrower, including related entities, generally may not exceed 15% of the sum of the capital, surplus, and loan loss reserve of the institution.

 

Community Reinvestment. The requirements of the Community Reinvestment Act (“CRA”) are applicable to the Company. The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of their local communities, including low and moderate income neighborhoods, consistent with the safe and sound operation of those institutions. A financial institution’s efforts in meeting community credit needs currently are evaluated as part of the examination process pursuant to 12 assessment factors. These factors also are considered in evaluating mergers, acquisitions and applications to open a branch or facility.

 

Volcker Rule. On December 10, 2013, five U.S. financial regulators, including the FDIC, adopted final rules implementing the Volcker Rule. The final rules prohibit banking entities from (1) engaging in short-term proprietary trading for their own accounts, and (2) having certain ownership interests in and relationships with hedge funds or private equity funds. The Volcker Rule is intended to provide greater clarity with respect to both the extent of those primary prohibitions and of the related exemptions and exclusions. The final rules were effective April 1, 2014, but the conformance period has been extended from its statutory end date of July 21, 2014 until July 21, 2016. We are continuing to evaluate the impact of the Volcker Rule, but do not anticipate that it will have a material effect on our operations.

 

Employees

 

As of December 31, 2014, the Company and its subsidiaries had a total of 174 full-time employees and 11 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.

 

Code of Ethics

 

The Company has a Code of Ethics for directors, officers and all employees of the Company and its subsidiaries, and a Code of Ethics applicable to the Company’s Chief Executive Officer, Chief Financial Officer and other principal financial officers. The Code addresses such topics as protection and proper use of Company assets, compliance with applicable laws and regulations, accuracy and preservation of records, accounting and financial reporting and conflicts of interest. A copy of the Code will be provided, without charge, to any shareholder upon written request to the Secretary of the Company, whose address is P.O. Box 330, 13319 Midlothian Turnpike, Midlothian, Virginia 23113.

 

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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.

 

The Company’s Internet address is www.villagebank.com. At that address, we make available, free of charge, the Company’s annual reports 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.

 

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ITEM 1A.  RISK FACTORS

 

Not applicable

 

ITEM 1B.  UNRESOLVED STAFF COMMENTS

 

Not applicable

 

ITEM 2.  PROPERTIES

 

Our executive and administrative offices are owned by the Bank and are located at 13319 Midlothian Turnpike, Midlothian, Virginia 23113 in Chesterfield County. In November 2014 we relocated our executive and administrative offices from an 80,000 square foot building located at 15521 Midlothian Turnpike, Midlothian, Virginia (the Watkins Centre headquarters building) which the Company currently has classified as held-for-sale. The current location also houses the principal office of the mortgage company.

 

In addition to its executive offices, the Bank owns seven full service branch buildings including the land on those buildings and leases an additional four full service branch buildings. Five of our branch offices are located in Chesterfield County, with three branch offices in Hanover County, two 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.  MINE SAFETY DISCLOSURES

 

Not applicable

 

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Part Ii

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

 

On August 8, 2014, we completed a reverse split of our common stock. All financial information and per share amounts are presented as if the reverse split was effective at the beginning of the earliest period presented.

 

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 (adjusted for reverse stock split) of the Company’s common stock for the periods indicated were as follows:

 

   High   Low 
2013        
1st quarter  $41.12   $15.68 
2nd quarter   37.76    26.56 
3rd quarter   28.80    21.76 
4th quarter   27.20    18.08 
           
2014          
1st quarter  $28.80   $20.48 
2nd quarter   23.84    21.12 
3rd quarter   30.08    20.32 
4th quarter   27.22    16.22 

 

On August 8, 2014, we received a letter from The Nasdaq Stock Market LLC informing us that we were no longer in compliance with Nasdaq Listing Rule 5550(a)(4), which requires that we have at least 500,000 publicly held shares of common stock. The phrase “publicly held shares” is defined by Nasdaq to mean the total number of shares outstanding less any shares held by officers, directors or beneficial owners of 10% or more. According to the letter from Nasdaq, we had 227,276 publicly held shares as of August 8, 2014. On September 22, 2014, we submitted to Nasdaq a plan to regain compliance with such rule. The plan was accepted by Nasdaq and we were given a deadline of February 4, 2015 to implement our plan and regain compliance. On February 5, 2015, we received a determination letter from Nasdaq indicating that because we did not regain compliance by the February 4, 2015 deadline, our common stock would be delisted effective February 17, 2015 unless we appealed the determination to a Nasdaq Hearings Panel. We have appealed the determination and plan to request that we be provided additional time to regain compliance. Our common stock will continue to trade on the Nasdaq Capital Market until the Hearings Panel issues a determination otherwise. No assurance can be given as to the decision that the Hearings Panel may make.

 

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 Bank’s accumulated retained earnings. The Federal Reserve has issued guidelines that bank holding companies should inform and consult with the Federal Reserve in advance of declaring or paying a dividend that exceeds earnings for the period (e.g. quarter) for which the dividend is being paid or that could result in a material adverse charge to the organization’s capital structure.

 

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We also are subject to a Written Agreement with the Federal Reserve Bank of Richmond that we will not pay dividends on our capital stock, including our Series A preferred stock, trust preferred securities or common stock without the prior consent of the Federal Reserve. Supervisory guidance from the Federal Reserve indicates that Capital Purchase Program recipients that are experiencing financial difficulties generally should eliminate, reduce or defer dividends on Tier 1 capital instruments, including trust preferred, preferred stock or common stock, if the holding company needs to conserve capital for safe and sound operation and to serve as a source of strength to its subsidiaries.

 

In addition, we are subject to a Consent Order with the FDIC and the BFI that the Bank will not pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction of capital without regulatory approval.

 

In the third quarter of 2014 we determined that amounts previously accrued as interest expense representing compounding on unpaid preferred stock dividends should have been recorded as additional dividends. This had no effect on our capital (as interest expense and dividends increase retained deficit) but did result in higher interest expense. Because the amount involved was not significant, we adjusted interest expense by $144,000 in the third quarter of 2014, which represented the amount of interest expense that should have been recorded as dividends through June 30, 2014. This had the effect of increasing our third quarter income by $144,000, however did not have any effect on the income to common shareholders.

 

The Company has deferred interest payments on the junior subordinated debt securities of $1,061,000 as of December 31, 2014. Although we elected to defer payment of the interest due, the amount has been accrued and is included in interest expense. In addition, the Company has deferred dividend payments on the preferred stock, including interest that accrues on the unpaid balance. The total arrearage on our preferred stock as of December 31, 2014 is $3,618,000 and has been accrued and reflected as a reduction of retained earnings.

 

Holders

 

At February 16, 2015 there were approximately 1,723 active holders of common stock; including registered holders and beneficial holders of shares through banks, brokers and other nominees.

 

For information concerning the Company’s Equity Compensation Plans, see “Item 12: Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters”.

 

Purchases of Equity Securities

 

The Company did not repurchase any of its Common Stock during the fourth quarter of 2014.

 

ITEM 6.  Selected Financial data

 

Not applicable

 

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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:

 

·the inability of the Company and the Bank to comply with the requirements of agreements with its regulators;

·the inability to reduce nonperforming assets consisting of nonaccrual loans and foreclosed real estate;

·our inability to improve our regulatory capital position;
·the risks of changes in interest rates on levels, composition and costs of deposits, loan demand, and the values and liquidity of loan collateral, securities, and interest sensitive assets and liabilities;
·changes in assumptions underlying the establishment of allowances for loan losses, and other estimates;
·changes in market conditions, specifically declines in the residential and commercial real estate market, volatility and disruption of the capital and credit markets, soundness of other financial institutions we do business with;
·risks inherent in making loans such as repayment risks and fluctuating collateral values;
·changes in operations of Village Bank Mortgage Corporation as a result of the activity in the residential real estate market;
·legislative and regulatory changes, including the Dodd-Frank Wall Street Reform and Consumer Protection Act and other changes in banking, securities, and tax laws and regulations and their application by our regulators, and changes in scope and cost of FDIC insurance and other coverages;
·exposure to repurchase loans sold to investors for which borrowers failed to provide full and accurate information on or related to their loan application or for which appraisals have not been acceptable or when the loan was not underwritten in accordance with the loan program specified by the loan investor;
·the effects of future economic, business and market conditions;
·governmental monetary and fiscal policies;
·changes in accounting policies, rules and practices;
·maintaining capital levels adequate to remain adequately capitalized;
·reliance on our management team, including our ability to attract and retain key personnel;

 

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·competition with other banks and financial institutions, and companies outside of the banking industry, including those companies that have substantially greater access to capital and other resources;
·demand, development and acceptance of new products and services;
·problems with technology utilized by us;
·changing trends in customer profiles and behavior; and
·other factors described from time to time in our reports filed with the SEC.

 

These risks and uncertainties should be considered in evaluating the forward-looking statements contained herein, and readers are cautioned not to place undue reliance on such statements. Any forward-looking statement speaks only as of the date on which it is made, and the Company undertakes no obligation to update any forward-looking statement to reflect events or circumstances after the date on which it is made.  In addition, past results of operations are not necessarily indicative of future results.

 

General

 

The Company’s primary source of earnings is net interest income, and its principal market risk exposure is interest rate risk. The Company is not able to predict market interest rate fluctuations and its asset/liability management strategy may not prevent interest rate changes from having a material adverse effect on the Company’s results of operations and financial condition. Because the Company has intentionally decreased assets over the last three years as it has been resolving problem assets and attempting to improve capital ratios, net interest income has declined from $17,702,000 in 2012 to $15,189,000 in 2013 and to $13,018,000 in 2014.

 

Although we endeavor to minimize the credit risk inherent in the Company’s loan portfolio, we must necessarily make various assumptions and judgments about the collectability of the loan portfolio based on our experience and evaluation of economic conditions. If such assumptions or judgments prove to be incorrect, the current allowance for loan losses may not be sufficient to cover loan losses and additions to the allowance may be necessary, which would have a negative impact on net income. In 2014, the provision for loan losses continued to decline as we resolved nonperforming loans and real estate values have recovered somewhat.

 

Results of Operations

 

The following presents management’s discussion and analysis of the financial condition of the Company at December 31, 2014 and 2013, and results of operations for the Company for the years ended December 31, 2014, 2013 and 2012. This discussion should be read in conjunction with the Company’s audited Financial Statements and the notes thereto appearing elsewhere in this Annual Report.

 

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The following table sets forth selected financial ratios:

 

   For the Year Ended December 31, 
   2014   2013   2012 
             
Performance Ratios               
Return on average assets   (0.24)%   (0.84)%   (1.95)%
Return on average equity   (5.43)%   (17.17)%   (32.28)%
Net interest margin(1)   3.46%   3.66%   3.78%
Efficiency(2)   104.48%   110.33%   91.14%
Loans to deposits   75.72%   73.53%   81.52%
Equity to assets   4.39%   4.11%   4.89%
                
Asset Quality Ratios               
ALLL to loans at year-end   2.00%   2.52%   3.04%
ALLL to nonaccrual loans   76.62%   38.82%   42.21%
Nonperforming assets to total assets   4.63%   7.97%   8.98%
Nonperforming loans to total loans   7.01%   12.32%   12.88%
Net charge-offs to average loans   0.59%   1.49%   3.64%

 

 

(1) Net interest margin is computed by dividing net interest income for the period by average interest earning assets.

(2) Efficiency ratio is computed by dividing noninterest expense by the sum of net interest income and noninterest income.

 

Income Statement Analysis

 

Summary

 

We recorded a net loss of $1,037,000 and a net loss available to common shareholders of $2,473,000, or $(7.39) per fully diluted share, in 2014, compared to a net loss of $4,007,000 and a net loss available to common shareholders of $4,893,000, or $(18.06) per fully diluted share, in 2013, and a net loss of $10,399,000 and a net loss available to common shareholders of $11,278,000, or $(42.40) per fully diluted share, in 2012. The most significant factor affecting earnings in 2013 and 2012 were costs associated with loan defaults – the provision for loan losses and expenses related to foreclosed real estate. The impact these costs had on our operations in 2013 and 2012 is illustrated in the following table which adjusts pretax earnings for gains and losses on sales of assets other than loan sales by the mortgage company as well as the effect of problem assets (“pretax income as adjusted”). Such adjusted earnings is not a measurement under accounting principles generally accepted in the United States (“GAAP”) and is not intended to be a substitute for our income statement prepared in accordance with GAAP.

 

22
 

  

   2013   2012 
   (in thousands) 
         
Pretax income (loss) - GAAP  $(4,007)  $(6,344)
Less          
 Gain (loss) on securities   217    1,010 
Add          
 Provision for loan losses   1,173    9,095 
 OREO expenses   7,082    4,701 
    8,255    13,796 
           
Pretax income as adjusted   4,031    6,442 
Income tax expense   1,371    2,190 
           
Net income as adjusted  $2,660   $4,252 

 

In 2014, pretax income as adjusted amounted to $517,000, a decline of $3,514,000 from pretax adjusted income of $4,031,000 for 2013. This decline is not attributable to costs associated with loan defaults as in the prior two years; those costs declined by $6,911,000 in 2014 compared to 2013. The decline in pretax income as adjusted in 2014 was primarily attributable to a decline in noninterest income resulting from lower gains on sales from decreased loan production by our mortgage banking subsidiary of $3,295,000, and a decline in net interest income of $2,171,000 which resulted from a decline in average loans outstanding of $41,214,000.

 

The decline of $2,411,000 in pretax income as adjusted in 2013 was primarily attributable to a decline in net interest income of $2,513,000 which resulted from a decline in average loans outstanding of $79,038,000.

 

Net interest income

 

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.

 

Net interest income decreased to $13,018,000 in 2014, from $15,189,000 in 2013 and $17,702,000 in 2012. The decline in net interest income of $2,171,000 in 2014 was a result of declines in interest income and interest expense. Interest income declined by $3,036,000 in 2014 primarily as a result of a decline in average interest earning assets of $39,123,000 combined with a decline in the yield on those assets of 0.31% (31 basis points). The primary driver of the declines in average interest earning assets and their associated yields were continued reductions in problem loans and a competitive lending environment for new loans which resulted in a decrease in average portfolio loans of $41,214,000 and their yields by 0.12% (12 basis points). Interest expense declined by $865,000 in 2014 primarily as a result of a decline in average interest bearing liabilities of $39,856,000, with average interest bearing deposits declining by $31,579,000 and average Federal Home Loan Bank of Atlanta (“FHLB”) advances declining by $7,960,000.

 

23
 

  

The decline in net interest income of $2,513,000 in 2013 was also a result of a decline in interest income and offset by a small decline in interest expense. Interest income declined by $4,085,000 in 2013 primarily as a result of a decline in average interest-earning assets of $52,954,000. The decrease in average interest earning assets was due primarily to decreases in average portfolio loans of $79,038,000, offset by increases in average investment securities of $16,419,000 and average federal funds sold of $12,172,000. Yields on average interest-earning assets also declined from 5.06% in 2012 to 4.72% in 2013. Interest expense declined by $1,572,000 in 2013, primarily as a result of a decline in average interest-bearing liabilities of $44,673,000. The decline in average interest-bearing liabilities was a result of declines in average deposits of $1,266,000 and average FHLB advances of $8,110,000.

 

Additionally, nonaccrual loans have had a negative impact on asset yields as a result of lost interest on those loans. This effect on net interest income the last three years is reflected in the following schedule (dollars in thousands):

 

   Actual   Lost Interest   Adjusted 
       Yield   on Nonaccrual       Yield 
   Amount   Rate   Loans   Amount   Rate 
2014                    
Interest income  $16,578    4.41%  $224   $16,802    4.47%
Interest expense   3,560    1.02%   -    3,560    1.02%
                          
Net interest income  $13,018    3.39%  $224   $13,242    3.45%
                          
2013                         
Interest income  $19,614    4.72%  $1,093   $20,707    4.99%
Interest expense   4,425    1.13%   -    4,425    1.13%
                          
Net interest income  $15,189    3.59%  $1,093   $16,282    3.86%
                          
2012                         
Interest income  $23,699    5.06%  $1,592   $25,291    5.40%
Interest expense   5,997    1.38%   -    5,997    1.38%
                          
Net interest income  $17,702    3.68%  $1,592   $19,294    4.02%

 

Our interest spread (average yield on interest-earning assets less average rate on interest-bearing liabilities) was reduced by 0.06% (6 basis points) in 2014, by 0.27% (27 basis points) in 2013, and by 0.34% (34 basis points) in 2012 as a result of lost interest on nonaccrual loans. Nonaccrual loans averaged $12,441,000 in 2014, $22,752,000 in 2013 and $47,544,000 in 2012.

 

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 (dollars in thousands). 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.

 

24
 

  

   Year Ended December 31, 2014   Year Ended December 31, 2013   Year Ended December 31, 2012 
         Interest              Interest              Interest      
    Average    Income/    Yield    Average    Income/    Yield    Average    Income/    Yield 
    Balance    Expense    Rate    Balance    Expense    Rate    Balance    Expense    Rate 
Loans                                             
Commercial  $23,991   $1,321    5.51%  $29,792   $1,678    5.63%  $36,764   $2,152    5.85%
Real estate - residential   94,482    5,275    5.58%   107,116    5,827    5.44%   141,600    7,064    4.99%
Real estate - commercial   115,541    6,350    5.50%   139,468    8,203    5.88%   166,951    10,235    6.13%
Real estate - construction   30,577    1,728    5.65%   36,808    2,050    5.57%   46,267    2,704    5.84%
Student loans   8,145    204    2.50%   -    -    -    -    -    - 
Consumer   1,692    84    4.96%   2,458    122    4.96%   3,098    170    5.49%
Gross loans   274,428    14,962    5.45%   315,642    17,880    5.66%   394,680    22,325    5.66%
Investment securities   54,566    1,182    2.17%   47,943    1,083    2.26%   31,524    700    2.22%
Loans held for sale   8,204    347    4.23%   13,772    564    4.10%   16,279    615    3.78%
Federal funds and other   38,805    87    0.22%   37,769    87    0.23%   25,597    59    0.23%
Total interest earning assets   376,003    16,578    4.41%   415,126    19,614    4.72%   468,080    23,699    5.06%
Allowance for loan losses   (6,218)             (9,502)             (12,934)          
Cash and due from banks   12,376              12,280              14,304           
Premises and equipment, net   13,204              24,150              26,323           
Other assets   43,107              36,417              36,994           
Total assets  $438,472             $478,471             $532,767           
                                              
Interest bearing deposits                                             
Interest checking   42,311    78    0.18%   42,655    102    0.24%   43,037    148    0.34%
Money market   66,866    251    0.38%   64,831    203    0.31%   67,887    266    0.39%
Savings   20,555    37    0.18%   20,649    59    0.29%   17,953    88    0.49%
Certificates   193,188    2,640    1.37%   226,364    3,302    1.46%   260,383    4,430    1.70%
Total deposits   322,920    3,006    0.93%   354,499    3,666    1.03%   389,260    4,932    1.27%
Borrowings                                             
Long-tern debt - trust preferred securities   9,714    215    2.21%   8,764    238    2.72%   8,764    404    4.61%
FHLB advances   15,468    334    2.16%   23,428    513    2.19%   31,538    651    2.06%
Other borrowings   2,031    5    0.25%   3,298    8    0.24%   5,100    10    0.20%
Total interest bearing liabilities   350,133    3,560    1.02%   389,989    4,425    1.13%   434,662    5,997    1.38%
Noninterest bearing deposits   62,612              57,955              60,440           
Other liabilities   6,639              7,197              5,451           
Total liabilities   419,384              455,141              500,553           
Equity capital   19,088              23,330              32,214           
Total liabilities and capital  $438,472             $478,471             $532,767           
                                              
Net interest income before provision for loan losses       $13,018             $15,189             $17,702      
Interest spread - average yield on interest earning assets, less average rate on interest bearing liabilities             3.39%             3.59%             3.68%
Net interest margin (net interest income expressed as a percentage of average earning assets)             3.46%             3.66%             3.78%

 

  

25
 

  

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 (dollars in thousands).

 

   2014 vs. 2013   2013 vs. 2012 
   Increase (Decrease)   Increase (Decrease) 
   Due to Changes in   Due to Changes in 
   Volume   Rate   Total   Volume   Rate   Total 
Interest income                              
Loans  $(2,979)  $(156)  $(3,135)  $(4,608)  $113   $(4,495)
Investment securities   141    (42)   99    371    11    382 
Fed funds sold and other   -    -    -    28    -    28 
Total interest income   (2,838)   (198)   (3,036)   (4,209)   124    (4,085)
                               
Interest expense                              
Deposits                              
Interest checking   (1)   (23)   (24)   (1)   (45)   (46)
Money market accounts   7    41    48    (12)   (51)   (63)
Savings accounts   -    (22)   (22)   16    (45)   (29)
Certificates of deposit   (463)   (199)   (662)   (539)   (589)   (1,128)
Total deposits   (457)   (203)   (660)   (536)   (730)   (1,266)
Borrowings                              
Long-term debt   (2)   (21)   (23)   -    (166)   (166)
FHLB Advances   (172)   (7)   (179)   (181)   43    (138)
Other borrowings   (3)   -    (3)   (2)   -    (2)
Total interest expense   (634)   (231)   (865)   (719)   (853)   (1,572)
                               
Net interest income  $(2,204)  $33   $(2,171)  $(3,490)  $977   $(2,513)

 

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, 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.

 

26
 

  

The provision for loan losses for the year ended December 31, 2014 was $100,000 compared to $1,173,000 for the year ended December 31, 2013. The decline in the provision for loan losses was primarily driven by a $33,979,000 decline in net loans (excluding purchased student loans) in 2014 as well as a decline in the amount of impairment on specific nonperforming loans. The decline in the provision for loan losses to $1,173,000 in 2013 from $9,095,000 in 2012 was driven by a $68,347,000 decline in loans outstanding from $354,910,000 in 2012 to $286,563,000 in 2013, and resolution of nonperforming loans.

 

While we are encouraged by the continued decline in the provision for loan losses over the last three years as well as a decline in classified assets, overall asset quality continues to be a concern as there continues to be uncertainty in the economy and the level of nonperforming assets remains significant. Although we believe that the allowance for loan losses of $5,729,000 at December 31, 2014, which represents 2.00% of loans outstanding, is adequate to absorb potential losses in the Company’s loan portfolio at that date, we can give no assurance that significant provisions for loan losses will not be necessary in the future.

 

Noninterest income

 

Noninterest income includes service charges and fees on deposit accounts, fee income related to loan origination, gains and losses on sale of mortgage loans and securities held for sale, and rental income primarily on Watkins Centre. Over the last three years the most significant noninterest income item has been gain on loan sales generated by the mortgage company, representing 56% in 2014, 63% in 2013, and 64% in 2012 of total noninterest income. Noninterest income amounted to $7,889,000 in 2014, $12,255,000 in 2013, and $13,339,000 in 2012.

 

The decrease in noninterest income in 2014 of $4,366,000 is primarily attributable to the decrease in the gain on sale of loans of $3,295,000, decrease in gain on sale of investments of $427,000 and the decrease in the gain on sale of assets of $595,000, offset by an increase in service charges and fees on deposit accounts of $184,000. The decreased gain on sale of loans resulted from a decrease in loan production by our mortgage company, from $262 million in 2013 to $160 million in 2014. The decrease in gain on sale of assets is result of the branch sale completed in the first quarter 2013, and the decrease in gain on sale of investments resulted from the sale of investments at a loss during 2014 as we positioned our securities portfolio for rising interest rates.

 

The decrease in noninterest income in 2013 of $1,084,000 is primarily attributable to a decrease in gain on sale of loans of $818,000, decrease in gain on sale of investments of $794,000, and an increase in the gain on sale of assets of $598,000. The decreased gain on sale of loans resulted from a decrease in loan production by our mortgage company, from $304 million in 2012 to $262 million in 2013. The increase in gain on sale of assets is a result of the branch sale completed in the first quarter of the year.

 

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, occupancy and equipment costs and expenses related to foreclosed real estate. Over the last three years, the most significant noninterest expense item has been salaries and benefits, representing 54%, 46% and 47% of noninterest expense in 2014, 2013 and 2012, respectively. Noninterest expense increased from $28,290,000 in 2012 to $30,278,000 in 2013 while decreasing to $21,843,000 in 2014.

 

The decrease in noninterest expense of $8,435,000 in 2014 resulted primarily from decreases in expenses related to foreclosed real estate of $5,838,000, salaries and benefits of $2,058,000, and occupancy expense of $374,000.

 

The increase in noninterest expense of $1,987,000 in 2013 resulted primarily from an increase in expenses related to foreclosed real estate of $2,381,000.

 

27
 

  

Income taxes

 

Certain items of income and expense are reported in different periods for financial reporting and tax return purposes. The tax effects of these temporary differences are recognized currently in the deferred income tax provision or benefit. Deferred tax assets or liabilities are computed based on the difference between the financial statement and income tax bases of assets and liabilities using the applicable enacted marginal tax rate.

 

We did not recognize any income tax in 2014 and 2013 based on our valuation allowance while applicable income tax expense on the 2012 loss amounted to $4,055,000. The income tax expense in 2012 is primarily a result of the increase in the valuation allowance related to the deferred tax asset.

 

The net deferred tax asset is included in other assets on the balance sheet. Accounting Standards Codification Topic 740, Income Taxes, requires that companies assess whether a valuation allowance should be established against their deferred tax assets based on the consideration of all available evidence using a “more likely than not” standard. Management considers both positive and negative evidence and analyzes changes in near-term market conditions as well as other factors which may impact future operating results. In making such judgments, significant weight is given to evidence that can be objectively verified. The deferred tax assets are analyzed quarterly for changes affecting realization. Management determined that as of December 31, 2013, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance for all of the net deferred tax asset that is dependent on future earnings of the Company of approximately $11,940,000. At December 31, 2014, management continues to believe that the objective negative evidence represented by the Company’s continued losses outweighed the more subjective positive evidence and, as a result, recognized an addition to the valuation allowance on its net deferred tax asset of approximately $334,000 resulting in a total valuation allowance at December 31, 2014 of $12,274,000. The net operating losses available to offset future taxable income amounted to $23,580,000 at December 31, 2014 and begin expiring in 2028; $1,257,000 of such amount is subject to a limitation by Section 382 of the Internal Revenue Code of 1986, as amended, to $908,000 per year.

 

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 franchise tax expense of $163,000 for 2012. Due to the Company’s adjusted capital level we were not subject to franchise tax expense for the years ended December 31, 2014 and December 31, 2013.

 

Balance Sheet Analysis

 

Investment securities

 

At December 31, 2014 and 2013, 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 losses of $976,000 and $5,685,000 at December 31, 2014 and 2013, respectively. As of December 31, 2014, management does not have the intent to sell any of the securities classified as available for sale and which have unrealized losses, and believes that it is more likely than not that the Company will not have to sell any such securities before a recovery of cost.

 

28
 

  

In 2014, the Company sold approximately $21 million of investment securities available for sale at a loss of $210,000. The sale of these securities, which had fixed interest rates, allowed the Company to decrease its exposure to the anticipated upward movement in interest rates that would result in unrealized losses being recognized in shareholders’ equity. Approximately $15 million of the proceeds from the sale of these securities were used to purchase rehabilitated student loans that have variable interest rates that will increase as interest rates in general increase.

 

The following table presents the composition of our investment portfolio at the dates indicated (dollars in thousands).

 

           Gross   Gross   Estimated     
   Par   Amortized   Unrealized   Unrealized   Fair   Average 
   Value   Cost   Gains   Losses   Value   Yield 
December 31, 2014                              
US Government Agencies                              
One to Five years  $10,000   $10,324   $-   $(225)  $10,099    1.10%
Five to ten years   22,500    23,895    -    (647)   23,248    1.98%
    32,500    34,219    -    (872)   33,347    1.71%
Mortgage-backed securities                              
More than ten years   471    484    2    (2)   484    0.31%
Municipals                              
Five to ten years   1,000    1,131    -    (20)   1,111    2.50%
More than ten years   4,130    4,684    2    (86)   4,600    2.89%
    5,130    5,815    2    (106)   5,711    2.82%
                               
Total investment securities  $38,101   $40,518   $4   $(980)  $39,542    1.85%
                               
December 31, 2013                              
US Treasuries                              
Five to ten years  $8,000   $7,825   $-   $(615)  $7,210    2.13%
US Government Agencies                              
One to Five years   4,000    4,194    -    (166)   4,028    0.89%
Five to ten years   31,625    33,510    -    (3,187)   30,323    1.82%
    35,625    37,704    -    (3,353)   34,351    1.71%
Mortgage-backed securities                              
More than ten years   2,782    2,792    10    (50)   2,752    2.43%
Municipals                              
Five to ten years   6,155    6,684    -    (678)   6,006    2.85%
More than ten years   6,780    8,428    -    (999)   7,429    3.34%
Total   12,935    15,112    -    (1,677)   13,435    3.12%
                               
Total investment securities  $59,342   $63,433   $10   $(5,695)  $57,748    2.13%

 

Loans

 

A management objective is to improve 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, loan type and loan size diversification in order to minimize credit concentration risk. Management also focuses on originating loans in markets with which the Company is familiar. Additionally, as a significant amount of the loan losses we have experienced over the last several years is attributable to construction and land development loans, our strategy has been to reduce this type of lending.

 

Approximately 80% of all loans are secured by mortgages on real property located principally in the Commonwealth of Virginia. The composition of this real estate secured exposure is very different in 2014 than it was in 2010. Specifically, construction and land development accounted for 20% of loans in 2010 vs. 10% in 2014. Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral. Approximately 12% of the loan portfolio consists of rehabilitated student loans purchased by the Bank in 2014 (see discussion following). Commercial and industrial loans plus owner-occupied commercial real estate loans represented $81 million or 28% of the portfolio at December 31, 2014. 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, these loans may be secured in whole or in part by collateral such as liquid assets, accounts receivable, equipment, inventory, and real property. The collateral securing any loan may depend on the type of loan and may vary in value based on market conditions. The remainder of our loan portfolio is in consumer loans which represent less than 1% of the total.

 

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The Bank purchased two portfolios of rehabilitated student loans guaranteed by the Department of Education (“DOE”) totaling approximately $19 million on July 29, 2014 and approximately $14 million on December 30, 2014. The guarantee covers approximately 98% of principal and accrued interest. The loans are serviced by a third-party servicer that specializes in handling the special needs of the DOE student loan programs. The Bank used excess liquidity to purchase the loans.

 

The following tables present the composition of our loan portfolio at the dates indicated and maturities of selected loans at December 31, 2014 (dollars in thousands).

 

   December 31, 
   2014   2013   2012   2011   2010 
                     
Construction and land development                         
Residential  $4,315   $2,931   $2,845   $7,906   $11,030 
Commercial   25,152    28,179    41,210    72,621    79,743 
Total construction and land development   29,467    31,110    44,055    80,527    90,773 
Commercial real estate                         
Owner occupied   58,804    73,585    92,773    105,592    99,614 
Non-owner occupied   38,892    43,868    54,551    54,059    62,422 
Multifamily   11,438    11,560    7,979    6,680    9,362 
Farmland   434    1,463    2,581    2,465    1,829 
Total commercial real estate   109,568    130,476    157,884    168,796    173,227 
Consumer real estate                         
Home equity lines   20,082    21,246    25,521    30,687    35,482 
Secured by 1-4 family residential                         
First deeds of trust   61,837    66,872    80,788    93,219    97,359 
Second deeds of trust   7,854    8,675    9,517    12,042    13,806 
Total consumer real estate   89,773    96,793    115,826    135,948    146,647 
Commercial and industrial loans                         
(except those secured by real estate)   22,165    26,254    34,384    37,734    37,228 
Guaranteed student loans   33,562    -    -    -    - 
Consumer and other   1,611    1,930    2,761    4,865    5,368 
                          
Total Loans   286,146    286,563    354,910    427,870    453,243 
Deferred loan cost, net   722    683    788    768    624 
Less: Allowance for loan losses   (5,729)   (7,239)   (10,808)   (16,071)   (7,312)
                          
Total loans, net  $281,139   $280,007   $344,890   $412,567   $446,555 

 

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       Fixed Rate   Variable Rate     
   Within   1 to 5   After       1 to 5   After       Total 
   1 Year   Years   5 Years   Total   Years   5 Years   Total   Maturities 
Construction and land development                                        
Residential  $4,315   $-   $-   $-   $-   $-   $-   $4,315 
Commercial   11,710    5,141    68    5,209    1,936    6,297    8,233    25,152 
Total construction and land development   16,025    5,141    68    5,209    1,936    6,297    8,233    29,467 
Commercial real estate                                        
Owner occupied   1,733    18,421    12,127    30,548    1,659    24,864    26,523    58,804 
Non-owner occupied   5,035    11,594    3,433    15,027    56    18,774    18,830    38,892 
Multifamily   557    3,188    -    3,188    -    7,693    7,693    11,438 
Farmland   146    170    -    170    -    118    118    434 
Total commercial real estate   7,471    33,373    15,560    48,933    1,715    51,449    53,164    109,568 
Consumer real estate                                      0 
Home equity lines   1,327    -    6,011    6,011    955    11,789    12,744    20,082 
Secured by 1-4 family residential                                        
First deeds of trust   6,452    13,125    5,999    19,124    548    35,713    36,261    61,837 
Second deeds of trust   604    1,875    1,967    3,842    -    3,408    3,408    7,854 
Total consumer real estate   8,383    15,000    13,977    28,977    1,503    50,910    52,413    89,773 
                                         
Commercial and industrial loans (except those secured by real estate)   10,372    7,279    2,603    9,882    634    1,277    1,911    22,165 
Guaranteed student loans   -    -    -    -    286    33,276    33,562    33,562 
Consumer and other   517    782    250    1,032    62    -    62    1,611 
   $42,768   $61,575   $32,458   $94,033   $5,850   $109,933   $115,783   $286,146 

  

The Company assigns risk rating classifications to its loans. These risk ratings are divided into the following groups:

 

  • Risk rated 1 to 4 loans are considered of sufficient quality to preclude an adverse rating. These assets generally are well protected by the current net worth and paying capacity of the obligor or by the value of the asset or underlying collateral;
  • Risk rated 5 loans are defined as having potential weaknesses that deserve management’s close attention;
  • Risk rated 6 loans are inadequately protected by the current sound worth and paying capacity of the obligor or of the collateral pledged, if any; and
  • Risk rated 7 loans have all the weaknesses inherent in substandard loans, with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable.

Loans are considered impaired when, based on current information and events it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. Impairment is evaluated in total for smaller-balance loans of a similar nature and on an individual loan basis for other loans. If a loan is impaired, a specific valuation allowance is allocated, if necessary, so that the loan is reported net, at the present value of estimated future cash flows using the loan’s existing rate or at the fair value of collateral if repayment is expected solely from the collateral. Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

 

Allowance for loan losses

 

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with GAAP; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

 

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The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

 

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical net charge-off rates, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 

The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses. This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

 

The allowance for loan losses was $5,729,000, $7,239,000 and $10,808,000 at December 31, 2014, 2013 and 2012, respectively. The ratio of the allowance for loan losses to gross loans was 2.00% at December 31, 2014, 2.52% at December 31, 2013, and 3.04% December 31, 2012. The allowance for loan losses as a percentage of net loans decreased in 2014 to 2.00% primarily as a result of the decline in portfolio loans of $33,979,000, excluding student loans, as well as significant charge-offs recognized during the year for which specific provisions for loan losses had been previously provided. The allowance for loan losses as a percentage of net loans decreased in 2013 to 2.52% primarily as a result of the decline in portfolio loans of $68,348,000 as well as significant charge-offs recognized during the year for which specific provisions for loan losses had been previously provided. We believe the amount of the allowance for loan losses at December 31, 2014 is adequate to absorb the losses that can reasonably be anticipated from the loan portfolio at that date.

 

The following table presents an analysis of the changes in the allowance for loan losses for the periods indicated (dollars in thousands).

 

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   Year Ended December 31, 
   2014   2013   2012   2011   2010 
                     
Beginning balance  $7,239   $10,808   $16,071   $7,312   $10,522 
Provision for loan losses   100    1,173    9,095    18,764    4,842 
Charge-offs                         
Construction and land development                         
Residential   -    -    (797)   (66)   (1,408)
Commercial   (100)   (279)   (5,645)   (4,293)   (3,659)
Commercial real estate                         
Owner occupied   (631)   (454)   (961)   (150)   (200)
Non-owner occupied   (518)   (619)   (431)   (343)   (453)
Multifamily        -    (10)   (83)   (1,228)
Farmland   (96)   (896)   -    -    - 
Consumer real estate                         
Home equity lines   (476)   (266)   (884)   (1,232)   (99)
Secured by 1-4 family residential                         
First deed of trust   (277)   (1,953)   (3,220)   (1,129)   (758)
Second deed of trust   (86)   (367)   (663)   (363)   (187)
Commercial and industrial
(except those secured by real estate)
   (172)   (760)   (1,880)   (2,160)   (183)
Consumer and other   (25)   (64)   (408)   (249)   (191)
    (2,381)   (5,658)   (14,899)   (10,068)   (8,366)
Recoveries                         
Construction and land development                         
Residential   2    102    45    9    106 
Commercial   44    424    14    10    81 
Commercial real estate                         
Owner occupied   -    43    200    -    - 
Non-owner occupied   25    20    -    -    121 
Consumer real estate                         
Home equity lines   15    9    13    3    2 
Secured by 1-4 family residential                         
First deed of trust   72    94    86    36    - 
Second deed of trust   190    38    21    -    - 
Commercial and industrial
(except those secured by real estate)
   401    177    155    3    2 
Consumer and other   22    9    7    2    2 
    771    916    541    63    314 
Net charge-offs   (1,610)   (4,742)   (14,358)   (10,005)   (8,052)
                          
Ending balance  $5,729   $7,239   $10,808   $16,071   $7,312 
                          
Loans outstanding at end of period(1)  $286,868   $287,246   $355,698   $428,639   $453,867 
Ratio of allowance for loan losses as a percent of loans outstanding at end of period   2.00%   2.52%   3.04%   3.75%   1.61%
                          
Average loans outstanding for the period(1)  $274,428   $315,642   $394,680   $441,441   $463,365 
Ratio of net charge-offs to average loans outstanding for the period   0.59%   1.50%   3.64%   2.27%   1.74%

  

(1) Loans are net of unearned income.

 

Charge-offs decreased from $5,658,000 in 2013 to $2,381,000 in 2014 which represents the lowest level of charge-offs for the last five years. This reflects an improvement in credit quality that mirrors the overall improvement in the local economy.

 

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We have allocated the allowance for loan losses according to the amount deemed to be reasonably necessary to provide for the possibility of losses being incurred within each of the categories of loans. The allocation of the allowance as shown in the table below should not be interpreted as an indication that losses in future years will occur in the same proportions or that the allocation indicates future loss trends. Furthermore, the portion allocated to each loan category is not the total amount available for future losses that might occur within such categories since the total allowance is a general allowance applicable to the entire portfolio (dollars in thousands).

 

   December 31, 2014   December 31, 2013   December 31, 2012   December 31, 2011   December 31, 2010 
   Total   %   Total   %   Total   %   Total   %   Total   % 
     
Construction and land development                                                  
Residential  $34    0.59%  $135    1.9%  $495    4.6%  $705    4.4%  $294    4.0%
Commercial   202    3.53%   1,274    17.6%   4,612    42.6%   6,798    42.3%   2,832    38.7%
Commercial real estate                                                  
Owner occupied   1,837    32.06%   1,200    16.6%   1,359    12.6%   1,496    9.3%   78    1.1%
Non-owner occupied   607    10.60%   670    9.3%   817    7.6%   1,549    9.6%   21    0.3%
Multifamily   77    1.34%   19    0.3%   23    0.2%   407    2.5%   -    0.0%
Farmland   130    2.27%   337    4.7%   -    0.0%   -    0.0%   -    0.0%
Consumer real estate                                                  
Home equity lines   469    8.19%   424    5.9%   658    6.1%   860    5.4%   642    8.8%
Secured by 1-4 family residential                                                  
First deed of trust   1,345    23.48%   1,992    27.5%   1,358    12.6%   1,881    11.7%   1,403    19.2%
Second deed of trust   275    4.80%   394    5.4%   223    2.1%   397    2.5%   297    4.1%
Commercial and industrial
(except those secured by real estate)
   506    8.83%   724    10.0%   1,162    10.7%   1,657    10.3%   1,316    18.0%
Student loans   217    3.79%                                        
Consumer and other   30    0.52%   70    1.0%   101    0.9%   321    2.0%   429    5.8%
                                                   
Total  $5,729    100.0%  $7,239    100.0%  $10,808    99.9%  $16,071    100.0%  $7,312    100.0%

 

The reversal of the provisions for loan losses totaling $1,119,000 and $3,944,000 for the construction and land development loan portfolio during the years ended December 31, 2014 and 2013, respectively, was attributable to changes in our assessment of the general component of the allowance for loan losses as it related to this portfolio. In both years the general component allocated to this portfolio declined primarily as a result of declines in the historical loss experience from 7.81% at December 31, 2012 to 4.82% at December 31, 2013 and to a net recovery of 0.27% at December 31, 2014. Also contributing to the declines in the general component were declines of approximately $1,643,000 and $12,945,000 in the outstanding loan balance of this portfolio at December 31, 2014 and 2015, respectively. Charge-offs related to construction and land development loans declined to 4% of total charge-offs in 2014 compared to 5%, 38%, and 43% in 2013, 2012 and 2011, respectively.

 

Asset quality

 

The following table summarizes asset quality information at the dates indicated (dollars in thousands).

 

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    December 31,  
    2014     2013     2012     2011     2010  
                               
Nonaccrual loans   $ 7,478     $ 18,647     $ 25,605     $ 48,097     $ 20,324  
Foreclosed properties     12,638       16,742       20,204       9,177       12,028  
Total nonperforming assets   $ 20,116     $ 35,389     $ 45,809     $ 57,274     $ 32,352  
                                         
Restructured loans (not included in nonaccrual loans above)   $ 24,812     $ 28,236     $ 30,167     $ 37,001     $ 21,695  
                                         
Loans past due 90 days and still accruing (1)   $ 719     $ 60     $ 115     $ 1,172     $ 315  
                                         
Nonperforming assets to loans (2)     7.03 %     12.35 %     12.91 %     13.39 %     7.14 %
                                         
Nonperforming assets to total assets     4.6 %     8.0 %     9.0 %     9.8 %     5.5 %
                                         
Allowance for loan losses to nonaccrual loans     76.6 %     38.8 %     42.2 %     33.4 %     36.0 %

  

 

(1) All loans 90 days past due and still accruing at December 31, 2014 are rehabilitated student loans which have a 98% government guarantee.

(2) Loans are net of unearned income and deferred cost.

 

The following table presents an analysis of the changes in nonperforming assets for 2014 (in thousands).

 

   Nonaccrual   Foreclosed     
   Loans   Properties   Total 
                
Balance December 31, 2013  $18,647   $16,742   $35,389 
Additions   7,304    1,093    8,397 
Loans placed back on accrual   (7,806)   -    (7,806)
Transfers to OREO   (6,535)   6,535    - 
Repayments   (1,982)   -    (1,982)
Charge-offs   (2,150)   (922)   (3,072)
Sales   -    (10,810)   (10,810)
                
Balance December 31, 2014  $7,478   $12,638   $20,116 

  

The decrease in nonaccrual loans during 2014 was a result of management’s efforts to resolve nonperforming assets. In early 2012, we formed a special assets group within the Bank to focus solely on the resolution of nonperforming assets. We hired a Senior Vice President with significant problem loan workout experience to head this group. The overall decline in nonperforming assets of $15,273,000 in 2014 was primarily the result of the resolution of these assets through sale of the underlying collateral of $10,810,000 and charge-offs of $3,072,000.

 

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Interest is accrued on outstanding loan principal balances, unless the Company considers collection to be doubtful. Commercial and unsecured consumer loans are designated as non-accrual when the Company considers collection of expected principal and interest doubtful. Mortgage loans and most other types of consumer loans past due 90 days or more may remain on accrual status if management determines that concern over our ability to collect principal and interest is not significant. When loans are placed in non-accrual status, previously accrued and unpaid interest is reversed against interest income in the current period and interest is subsequently recognized only to the extent cash is received. Interest accruals are resumed on such loans only when in the judgment of management, the loans are estimated to be fully collectible as to both principal and interest.

 

Of the total nonaccrual loans of $7,478,000 at December 31, 2014 that were considered impaired, 14 loans totaling $3,332,000 had specific allowances for loan losses totaling $1,108,000. This compares to $18,647,000 in nonaccrual loans at December 31, 2013 of which 18 loans totaling $4,673,000 had specific allowances for loan losses of $1,189,000.

 

Cumulative interest income that would have been recorded had nonaccrual loans been performing would have been $224,000, $1,093,000 and $1,592,000 for 2014, 2013 and 2012, respectively. Student loans totaling $720,000 at December 31, 2014 were past due 90 days or more and interest was still being accrued as principal and interest on such loans were considered collectible.

 

Other real estate owned consists of assets acquired through or in lieu of foreclosure. $10,558,000 of the $12,638,000 other real estate owned at December 31, 2014 relates to loans previously classified as construction loans.

 

Deposits

 

The following table gives the composition of our deposits at the dates indicated (dollars in thousands).

 

   December 31, 2014   December 31, 2013   December 31, 2012 
   Amount   %   Amount   %   Amount   % 
                         
Demand accounts  $77,496    20.5%  $57,244    14.7%  $57,049    13.1%
Interest checking accounts   42,924    11.3%   43,691    11.2%   45,861    10.5%
Money market accounts   64,987    17.2%   63,357    16.2%   66,007    15.1%
Savings accounts   20,643    5.4%   20,229    5.2%   20,922    4.8%
Time deposits of $100,000 and over   75,559    19.9%   94,245    24.1%   113,332    26.0%
Other time deposits   97,251    25.7%   111,862    28.6%   133,151    30.5%
                               
Total  $378,860    100.0%  $390,628    100.0%  $436,322    100.0%

 

Total deposits decreased by 3.0%, 10.5% and 10.1% in 2014, 2013 and 2012, respectively. The decline in deposits in 2014 is a result of repricing maturing time deposits at rates below market for noncore depositors. The decline in deposits in 2013 was a result of the branch sale during the year as well repricing maturing time deposits at rates below market for noncore depositors. In reducing deposits, we targeted higher cost deposits to reduce our overall cost of funds. Higher cost time deposits declined as a percentage of total deposits from 56.5% at December 31, 2012 to 52.7% at December 31, 2013 and to 45.6% at December 31, 2014.

 

The variety of deposit accounts offered by the Company has allowed us to be competitive in obtaining funds and has allowed us to respond with flexibility to, although not to eliminate, the threat of disintermediation (the flow of funds away from depository institutions such as banking institutions into direct investment vehicles such as government and corporate securities). Our ability to attract and retain deposits, and our cost of funds, has been, and will continue to be, significantly affected by money market conditions.

 

The following table is a schedule of average balances and average rates paid for each deposit category for the periods presented (dollars in thousands).

 

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   Year Ended December 31, 
   2014   2013   2012 
Account Type  Amount   Rate   Amount   Rate   Amount   Rate 
                         
Noninterest-bearing demand accounts  $62,612        $57,955        $60,440      
Interest-bearing deposits                              
Interest checking accounts   42,311    0.18%   42,655    0.24%   43,037    0.34%
Money market accounts   66,866    0.38%   64,831    0.31%   67,887    0.39%
Savings accounts   20,555    0.18%   20,649    0.29%   17,953    0.49%
Time deposits of $100,000 and over   105,829    1.20%   104,526    1.51%   104,475    1.71%
Other time deposits   87,359    1.56%   121,838    1.42%   155,908    1.70%
Total interest-bearing deposits   322,920    0.93%   354,499    1.04%   389,260    1.27%
                               
Total average deposits  $385,532        $412,454        $449,700      

 

With short-term interest rates remaining at historic lows throughout the last few years, we were able to significantly reduce the interest rates paid on deposits, particularly on longer term certificates of deposit, as higher rate certificates of deposit matured in 2014 and 2013.

 

The following table is a schedule of maturities for time deposits of $100,000 or more at December 31, 2014 (in thousands).

 

Due within three months  $7,897 
Due after three months through six months   25,713 
Due after six months through twelve months   34,720 
Over twelve months   7,229 
      
   $75,559 

 

The Dodd-Frank Act permanently raises the current standard maximum deposit insurance amount to $250,000. The FDIC insurance coverage limit applies per depositor, per insured depository institution for each account ownership category.

 

Borrowings

 

We utilize borrowings to supplement deposits to address funding or liability duration needs.

 

As a member of the Federal Home Loan Bank of Atlanta, the Bank is required to own capital stock in the FHLB and is authorized to apply for borrowings from the FHLB. Each FHLB credit program has its own interest rate, which may be fixed or variable, and range of maturities. The FHLB may prescribe the acceptable uses to which the advances may be put, as well as on the size of the advances and repayment provisions. Borrowings from the FHLB were $14,000,000 and $18,000,000 at December 31, 2014 and 2013, respectively. The FHLB advances are secured by the pledge of investment securities and cash. Available borrowings at December 31, 2014 were approximately $721,000 based on currently pledged collateral; however, with additional pledges, the Company could be granted up to 15% of assets in advances.

 

Federal funds purchased represent unsecured and secured borrowings from other banks and generally mature daily. We did not have any purchased federal funds at December 31, 2014 or 2013.

 

Other borrowings increased by $589,000 from $2,713,000 at December 31, 2013 to $3,302,000 at December 31, 2014. These borrowings represent business checking sweep accounts that bear interest and are secured by pledged securities.

 

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Off-balance sheet arrangements

 

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers and to reduce its own exposure to fluctuations in interest rates. These financial instruments include commitments to extend credit and standby letters of credit. These instruments involve elements of credit risk and interest rate risk in excess of the amount recognized in the consolidated balance sheets. The contractual amounts of these instruments reflect the extent of the Company’s involvement in particular classes of financial instruments.

 

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instruments for commitments to extend credit and letters of credit written is represented by the contractual amount of these instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. Unless noted otherwise, the Company does not require collateral or other security to support financial instruments with credit risk.

 

At December 31, 2014, the Company had outstanding the following approximate off-balance-sheet financial instruments whose contract amounts represent credit risk (in thousands):

 

   Contract   Contract 
   Amount   Amount 
   2014   2013 
           
Undisbursed credit lines  $38,064   $37,474 
Commitments to extend or originate credit   9,207    10,581 
Standby letters of credit   1,571    2,192 
           
Total commitments to extend credit  $48,842   $50,247 

 

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being completely drawn upon, the total commitment amounts do not necessarily represent future cash requirements.

 

Capital resources

 

Stockholders’ equity at December 31, 2014 was $19,058,000, compared to $18,244,000 at December 31, 2013 and $24,965,000 at December 31, 2012. The $814,000 increase in stockholders’ equity in 2014 is primarily due to the improvement in the market value of available for sale investments of $3,108,000, offset by the net loss of $1,037,000 and dividends on preferred stock of $1,386,000. The $6,721,000 decrease in stockholders’ equity in 2013 is primarily due to the net loss of $4,007,000, the decline in the market value of available for sale investments of $3,680,000 and dividends on preferred stock of $737,000, offset by proceeds from sale of common stock of $1,684,000. The changes in the market value of available for sale securities is attributable to changes in interest rates during the respective years.

 

On May 1, 2009, the Company received a $14,738,000 investment by the United States Department of the Treasury under the TARP Program. The TARP Program is a voluntary program designed to provide capital for healthy banks to improve the flow of funds from banks to their customers. Under the TARP Program, the Company issued to the Treasury $14,738,000 of preferred stock and warrants to purchase 31,190 shares of the Company’s common stock at a purchase price of $4.43 per share. The preferred stock issued by the Company under the TARP Program carried a 5% dividend until May 1, 2014, and now carries a 9% dividend. In November 2013 the Company participated in a successful auction of the Company’s preferred stock securities by the U.S. Treasury that resulted in the purchase of the securities by private and institutional investors. The Treasury continues to own the warrants. This freed the Company from some constraints and costs that were in place while the U.S. Treasury held the securities.

 

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During the first quarter of 2005, the Company issued $5.2 million in Trust Preferred Capital Notes to increase its regulatory capital and to help fund its expected growth in 2005. During the third quarter of 2007, the Company issued $3.6 million in Trust Preferred Capital Notes to partially fund the construction of an 80,000 square foot headquarters building at the Watkins Centre completed in July 2008. The Trust Preferred Capital Notes may be included in Tier 1 capital for regulatory capital adequacy determination purposes up to 25% of Tier 1 capital after its inclusion. See Note 15 of the Notes to Consolidated Financial Statements for a more detailed discussion of the Trust Preferred Capital Notes.

 

The Company is currently prohibited by its Written Agreement with the Reserve Bank from making dividend or interest payments on the TARP Program preferred stock or trust preferred capital notes without prior regulatory approval. In addition, the Consent Order with the Supervisory Authorities provides that the Bank will not pay any dividends, pay bonuses or make any other form of payment outside the ordinary course of business resulting in a reduction of capital, without regulatory approval. At December 31, 2014, the aggregate amount of all of the Company’s total accrued but deferred dividend payments on its preferred stock was $3,618,000.

 

On December 4, 2013 the Company issued 67,907 new shares of common stock through a private placement to directors and executive officers. The sale raised $1,684,075 in new capital for the Company. The $24.80 sale price for the common shares was the stock’s book value at September 30, 2013, which represented a 30% premium over the closing price of the stock on December 3, 2013.

 

On August 6, 2014, the Company filed Articles of Amendment to its Articles of Incorporation with the Virginia State Corporation Commission to affect a 1-for-16 reverse stock split of its outstanding common stock. The Articles of Amendment became effective on August 8, 2014. As a result of the reverse split, every sixteen shares of the Company’s issued and outstanding common stock were consolidated into one issued and outstanding share of common stock.

 

In February 2015, the Company distributed to holders of the Company’s common stock non-transferable subscription rights to purchase up to an aggregate of 1,051,866 shares of the Company’s common stock. Each shareholder received one subscription right for each share of common stock owned as of January 20, 2015. Each subscription right entitles the shareholder to purchase three shares of common stock at the subscription price of $13.87 per share. The Company also entered into a Standby Purchase Agreement with a standby investor to purchase, subject to certain limits, any shares of common stock leftover after shareholders exercise their subscription rights. If the offering is successful, the Company intends to use a portion of the net proceeds to infuse the Bank with additional capital to help achieve and maintain the capital ratios required by the Bank’s Consent Order.

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The following table presents the composition of regulatory capital and the capital ratios for the Company at the dates indicated (dollars in thousands).

 

   December 31, 
   2014   2013   2012 
             
Tier 1 capital               
Total equity capital  $19,058   $18,244   $24,965 
Net unrealized loss on available-for-sale securities   644    3,753    94 
Defined benefit postretirement plan   77    85    72 
Qualifying trust preferred securities   1,456    2,240    3,306 
Disallowed intangible assets   (198)   (295)   (393)
Total Tier 1 capital   21,037    24,027    28,044 
                
Tier 2 capital               
Qualifying trust preferred securities   7,308    7,089    5,458 
Allowance for loan losses   3,601    3,685    4,795 
Total Tier 2 capital   10,909    10,774    10,253 
                
Total risk-based capital   31,946    34,652    38,296 
                
Risk-weighted assets  $285,937   $324,965   $377,572 
                
Average assets  $429,265   $452,029   $505,046 
                
Capital ratios               
Leverage ratio (Tier 1 capital to average assets)   4.90%   5.32%   5.55%
Tier 1 capital to risk-weighted assets   7.36%   7.39%   7.43%
Total capital to risk-weighted assets   11.17%   10.66%   10.14%
Equity to total assets   4.40%   4.11%   4.89%

 

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The following table presents the composition of regulatory capital and the capital ratios for the Bank at the dates indicated (dollars in thousands).

 

   December 
   2014   2013   2012 
             
Tier 1 capital               
Total Bank equity capital  $30,158   $27,574   $33,163 
Net unrealized loss on available-for-sale securities   644    3,753    72 
Defined benefit postretirement plan   77    86    94 
Disallowed intangible assets   (198)   (295)   (393)
Total Tier 1 capital   30,681    31,118    32,936 
                
Tier 2 capital               
Allowance for loan losses   3,572    4,075    4,769 
Total Tier 2 capital   3,572    4,075    4,769 
                
Total risk-based capital   34,253    35,193    37,705 
                
Risk-weighted assets  $283,581   $322,853   $375,451 
                
Average assets  $427,113   $449,606   $505,150 
                
Capital ratios               
Leverage ratio (Tier 1 capital to average assets)   7.18%   6.92%   6.52%
Tier 1 capital to risk-weighted assets   10.82%   9.64%   8.77%
Total capital to risk-weighted assets   12.08%   10.90%   10.04%
Equity to total assets   7.02%   6.24%   6.55%

 

Federal regulatory agencies are required by law to adopt regulations defining five capital tiers: well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized, and critically undercapitalized. The Bank met the ratio requirements to be categorized as a “well capitalized” institution as of December 31, 2014, 2013 and 2012. However, due to the minimum capital ratios required by the Consent Order, the Bank currently is considered adequately capitalized. The Consent Order requires the Bank to maintain a leverage ratio of at least 8% and a total capital to risk-weighted assets ratio of at least 11%. At December 31, 2014, the Bank’s leverage ratio was 7.18% and the total capital to risk-weighted assets ratio was 12.08%. As required by the Consent Order, the Bank has provided a capital plan to the FDIC and BFI that demonstrates how the Bank will come into compliance with the required minimum capital ratios set forth in the Consent Order. As discussed previously, the Company intends to use a portion of the net proceeds of its previously announced shareholder rights offering (assuming the offering is successful) to infuse the Bank with additional capital to help achieve and maintain the capital ratios required by the Bank’s Consent Order. See “Item 1. Business – Regulation – Capital Adequacy”

 

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.

 

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Liquidity

 

Liquidity represents the ability of a company to convert assets into cash or cash equivalents without significant loss, and the ability to raise additional funds by increasing liabilities. Liquidity management involves monitoring our sources and uses of funds in order to meet our day-to-day cash flow requirements while maximizing profits. Liquidity management is made more complicated because different balance sheet components are subject to varying degrees of management control. For example, the timing of maturities of our investment portfolio is fairly predictable and subject to a high degree of control at the time investment decisions are made. However, net deposit inflows and outflows are far less predictable and are not subject to the same degree of control.

 

At December 31, 2014 and 2013, our liquid assets, consisting of cash, cash equivalents and investment securities available for sale, totaled $88,645,000 and $97,957,000, or 20.0% and 22.0% of total assets, respectively. Investment securities traditionally provide a secondary source of liquidity since they can be converted into cash in a timely manner. However, approximately $17,567,000 of these securities are pledged against borrowings. Therefore, the related borrowings would need to be repaid prior to the securities being sold in order for these securities to be converted to cash.

 

Our holdings of liquid assets plus the ability to maintain and expand our deposit base and borrowing capabilities serve as our principal sources of liquidity. We plan to meet our future cash needs through the liquidation of temporary investments, the generation of deposits, and from additional borrowings. In addition, we will receive cash upon the maturity and sale of loans and the maturity of investment securities. We maintain two federal funds lines of credit with correspondent banks totaling $17 million for which there were no borrowings against the lines at December 31, 2014.

 

We are also a member of the FHLB, from which applications for borrowings can be made. The FHLB requires that securities, qualifying mortgage loans, and stock of the FHLB owned by the Bank be pledged to secure any advances from the FHLB. The unused borrowing capacity currently available from the FHLB at December 31, 2014 was $1 million, based on the Bank's qualifying collateral available to secure any future borrowings. However, we are able to pledge additional collateral to the FHLB in order to increase our available borrowing capacity up to 15% of assets. Liquidity provides us with the ability to meet normal deposit withdrawals, while also providing for the credit needs of customers. We are committed to maintaining liquidity at a level sufficient to protect depositors, provide for reasonable growth, and fully comply with all regulatory requirements.

 

At December 31, 2014, we had commitments to originate $48,842,000 of loans. Fixed commitments to incur capital expenditures were approximately $597,000 at December 31, 2014. Certificates of deposit scheduled to mature or reprice in the 12-month period ending December 31, 2015 total $75,437,000. We believe that a significant portion of such deposits will remain with us. We further believe that deposit growth, loan repayments and other sources of funds will be adequate to meet our foreseeable short-term and long-term liquidity needs.

 

Interest Rate Sensitivity

 

An important element of asset/liability management is the monitoring of our sensitivity to interest rate movements. In order to measure the effects of interest rates on our net interest income, management takes into consideration the expected cash flows from the securities and loan portfolios and the expected magnitude of the repricing of specific asset and liability categories. We evaluate interest sensitivity risk and then formulate guidelines to manage this risk based on management’s outlook regarding the economy, forecasted interest rate movements and other business factors. Our goal is to maximize and stabilize the net interest margin by limiting exposure to interest rate changes.

 

Contractual principal repayments of loans do not necessarily reflect the actual term of our loan portfolio. The average lives of mortgage loans are substantially less than their contractual terms because of loan prepayments and because of enforcement of due-on-sale clauses, which gives us the right to declare a loan immediately due and payable in the event, among other things, the borrower sells the real property subject to the mortgage and the loan is not repaid. In addition, certain borrowers increase their equity in the security property by making payments in excess of those required under the terms of the mortgage.

 

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The sale of fixed rate loans is intended to protect us from precipitous changes in the general level of interest rates. The valuation of adjustable rate mortgage loans is not as directly dependent on the level of interest rates as is the value of fixed rate loans. As with other investments, we regularly monitor the appropriateness of the level of adjustable rate mortgage loans in our portfolio and may decide from time to time to sell such loans and reinvest the proceeds in other adjustable rate investments.

 

Critical Accounting Policies and Estimates

 

General

 

The accounting and reporting policies of the Company and the Bank are in accordance with GAAP and conform to general practices within the banking industry. The Company’s financial position and results of operations are affected by management’s application of accounting policies, including estimates, assumptions and judgments made to arrive at the carrying value of assets and liabilities, and amounts reported for revenues, expenses and related disclosures. Different assumptions in the application of these policies could result in material changes in the Company’s consolidated financial position and/or results of operations.

 

The more critical accounting and reporting policies include the Company’s accounting for the allowance for loan losses, real estate acquired in settlement of loans, and income taxes. The Company’s accounting policies are fundamental to understanding the Company’s consolidated financial position and consolidated results of operations. Accordingly, the Company’s significant accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements.

 

The following is a summary of the Company’s critical accounting policies that are highly dependent on estimates, assumptions, and judgments.

 

Allowance for loan losses

 

We monitor and maintain an allowance for loan losses to absorb an estimate of probable losses inherent in the loan portfolio. We maintain policies and procedures that address the systems of controls over the following areas of maintenance of the allowance: the systematic methodology used to determine the appropriate level of the allowance to provide assurance they are maintained in accordance with GAAP; the accounting policies for loan charge-offs and recoveries; the assessment and measurement of impairment in the loan portfolio; and the loan grading system.

 

The allowance reflects management’s best estimate of probable losses within the existing loan portfolio and of the risk inherent in various components of the loan portfolio, including loans identified as impaired as required by FASB Codification Topic 310: Receivables. Loans evaluated individually for impairment include non-performing loans, such as loans on non-accrual, loans past due by 90 days or more, restructured loans and other loans selected by management. The evaluations are based upon discounted expected cash flows or collateral valuations. If the evaluation shows that a loan is individually impaired, then a specific reserve is established for the amount of impairment.

 

Loans are grouped by similar characteristics, including the type of loan, the assigned loan classification and the general collateral type. A loss rate reflecting the expected loss inherent in a group of loans is derived based upon historical net charge-off rates, the predominant collateral type for the group and the terms of the loan. The resulting estimate of losses for groups of loans is adjusted for relevant environmental factors and other conditions of the portfolio of loans and leases, including: borrower and industry concentrations; levels and trends in delinquencies, charge-offs and recoveries; changes in underwriting standards and risk selection; level of experience, ability and depth of lending management; and national and local economic conditions.

 

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The amounts of estimated impairment for individually evaluated loans and groups of loans are added together for a total estimate of loan losses. This estimate of losses is compared to our allowance for loan losses as of the evaluation date and, if the estimate of losses is greater than the allowance, an additional provision to the allowance would be made. If the estimate of losses is less than the allowance, the degree to which the allowance exceeds the estimate is evaluated to determine whether the allowance falls outside a range of estimates. We recognize the inherent imprecision in estimates of losses due to various uncertainties and variability related to the factors used, and therefore a reasonable range around the estimate of losses is derived and used to ascertain whether the allowance is too high. If different assumptions or conditions were to prevail and it is determined that the allowance is not adequate to absorb the new estimate of probable losses, an additional provision for loan losses would be made, which amount may be material to the financial statements.

 

Troubled debt restructurings

 

A loan is accounted for as a troubled debt restructuring if we, for economic or legal reasons, grant a concession to a borrower considered to be experiencing financial difficulties that we would not otherwise consider. A troubled debt restructuring may involve the receipt of assets from the debtor in partial or full satisfaction of the loan, or a modification of terms such as a reduction of the stated interest rate or balance of the loan, a reduction of accrued interest, an extension of the maturity date or renewal of the loan at a stated interest rate lower than the current market rate for a new loan with similar risk, or some combination of these concessions. Troubled debt restructurings can be in either accrual or nonaccrual status. Nonaccrual troubled debt restructurings are included in nonperforming loans. Accruing troubled debt restructurings are generally excluded from nonperforming loans as it is considered probable that all contractual principal and interest due under the restructured terms will be collected. Troubled debt restructurings generally remain categorized as nonperforming loans and leases until a six-month payment history has been maintained.

 

In accordance with current accounting guidance, loans modified as troubled debt restructurings are, by definition, considered to be impaired loans.  Impairment for these loans is measured on a loan-by-loan basis similar to other impaired loans as described above under Allowance for loan losses.  Certain loans modified as troubled debt restructurings may have been previously measured for impairment under a general allowance methodology (i.e., pooling), thus at the time the loan is modified as a troubled debt restructuring the allowance will be impacted by the difference between the results of these two measurement methodologies.  Loans modified as troubled debt restructurings that subsequently default are factored into the determination of the allowance in the same manner as other defaulted loans.

 

Real estate acquired in settlement of loans

 

Real estate acquired in settlement of loans represents properties acquired through foreclosure or physical possession.  Write-downs to fair value of foreclosed assets less estimate costs to sell at the time of transfer are charged to allowance for loan losses.  Subsequent to foreclosure, the Company periodically evaluates the value of foreclosed assets held for sale and records an impairment charge for any subsequent declines in fair value less selling costs. If fair value declines subsequent to foreclosure a valuation allowance is recorded through expense. Operating costs after acquisition are expensed as incurred. The valuation allowance at December 31, 2014 was $2,369,000.   Fair value is based on an assessment of information available at the end of a reporting period and depends upon a number of factors, including historical experience, economic conditions, and issues specific to individual properties.  The evaluation of these factors involves subjective estimates and judgments that may change.

 

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Income taxes

 

The Company uses the asset and liability method of accounting for income taxes.  Under this method, deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases.  Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.  If current available information raises doubt as to the realization of the deferred tax assets, a valuation allowance may be established.  Management considers the determination of this valuation allowance to be a critical accounting policy due to the need to exercise significant judgment in evaluating the amount and timing of recognition of deferred tax liabilities and assets, including projections of future taxable income.  These judgments and estimates are reviewed on a continual basis as regulatory and business factors change.  A valuation allowance for deferred tax assets may be required if the amounts of taxes recoverable through loss carry backs decline, or if management projects lower levels of future taxable income.  Management determined that as of December 31, 2013, the objective negative evidence represented by the Company’s recent losses outweighed the more subjective positive evidence and, as a result, recognized a valuation allowance for all of the net deferred tax asset that is dependent on future earnings of the Company of approximately $11,940,000. At December 31, 2014, management continues to believe that the objective negative evidence represented by the Company’s continued losses outweighed the more subjective positive evidence and, as a result, recognized an addition to the valuation allowance on its net deferred tax asset of approximately $334,000 resulting in a total valuation allowance at December 31, 2014 of $12,274,000.

 

New accounting standards

 

In January 2014, the FASB issued ASU 2014-01, “Investments – Equity Method and Joint Ventures: Accounting for Investments in Qualified Affordable Housing Projects”.  This ASU applies to all reporting entities that invest in qualified affordable housing projects through limited liability entities that are flow through entities for tax purposes.  The amendments in the ASU eliminate the effective yield election and permit reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met.  Those not electing the proportional amortization method would account for the investment using the equity method or cost method.  The amendments in this ASU are effective for public business entities for annual periods beginning after December 15, 2014.  The adoption of this guidance should not have a material effect on the Company’s financial condition or results of operations. 

 

In January 2014, the FASB issued ASU 2014-04, “Receivables – Troubled Debt Restructurings by Creditors”.  ASU 2014-04 clarifies when a creditor should be considered to have received physical possession of residential real estate property during a foreclosure.  ASU 2014-04 establishes a loan receivable should be derecognized and the real estate property recognized upon the creditor obtaining legal title to the residential real estate property upon completion of foreclosure or the borrower conveying all interest in the residential real estate property to the creditor to satisfy the loan.  The provisions of ASU 2014-04 are effective for annual periods beginning after December 15, 2014.  The adoption of this guidance should not have a material effect on the Company’s financial condition or results of operations.

 

In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers (Topic 606). The amendments in this ASU modify the guidance companies use to recognize revenue from contracts with customers for transfers of goods or services and transfers of nonfinancial assets, unless those contracts are within the scope of other standards. The ASU requires that entities apply a specific method to recognize revenue reflecting the consideration expected from customers in exchange for the transfer of goods and services. The guidance also requires new qualitative and quantitative disclosures, including information about contract balances and performance obligations. Entities are also required to disclose significant judgments and changes in judgments for determining the satisfaction of performance obligations. Most revenue associated with financial instruments, including interest and loan origination fees, is outside the scope of the guidance. This ASU is effective for annual periods and interim periods within those annual periods beginning after December 15, 2016, with early adoption prohibited. The company is evaluating the effect ASU 2014-09 will have on its consolidated financial statements.

 

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Impact of inflation and changing prices

 

The Company’s financial statements included herein have been prepared in accordance with GAAP, which require the Company to measure financial position and operating results primarily in terms of historical dollars. Changes in the relative value of money due to inflation or recession are generally not considered. The primary effect of inflation on the operations of the Company is reflected in increased operating costs. In management’s opinion, changes in interest rates affect the financial condition of a financial institution to a far greater degree than changes in the inflation rate. While interest rates are greatly influenced by changes in the inflation rate, they do not necessarily change at the same rate or in the same magnitude as the inflation rate. Interest rates are highly sensitive to many factors that are beyond the control of the Company, including changes in the expected rate of inflation, the influence of general and local economic conditions and the monetary and fiscal policies of the United States government, its agencies and various other governmental regulatory authorities.

 

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

 

Not applicable.

 

ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

 

The consolidated financial statements and related footnotes of the Company are presented following.

 

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Report of Independent Registered Public Accounting Firm

 

Board of Directors

Village Bank and Trust Financial Corp.

Midlothian, Virginia

 

We have audited the accompanying consolidated balance sheets of Village Bank and Trust Financial Corp. and Subsidiary as of December 31, 2014 and 2013, and the related consolidated statements of operations, comprehensive income (loss), changes in shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2014. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

 

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. Our audits included consideration of internal control over financial reporting as a basis for designing audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. An audit also includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

 

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Village Bank and Trust Financial Corp. and Subsidiary as of December 31, 2014 and 2013, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2014, in conformity with accounting principles generally accepted in the United States of America.

 

/s/ BDO USA, LLP

 

Richmond, Virginia

March 2, 2015

 

47
 

  

Village Bank and Trust Financial Corp. and Subsidiary

Consolidated Balance Sheets

December 31, 2014 and 2013

(dollars in thousands, except per share data)

 

   2014   2013 
Assets          
Cash and due from banks  $25,115   $15,221 
Federal funds sold   23,988    24,988 
Total cash and cash equivalents   49,103    40,209 
Investment securities available for sale   39,542    57,748 
Loans held for sale   9,914    8,371 
Loans          
Outstandings   286,146    286,563 
Allowance for loan losses   (5,729)   (7,239)
Deferred fees and costs, net   722    683 
Total loans, net   281,139    280,007 
Other real estate owned, net of valuation allowance   12,638    16,742 
Asset held for sale   13,502    13,359 
Premises and equipment, net   14,301    12,409 
Bank owned life insurance   6,947    6,765 
Accrued interest receivable   1,372    1,486 
Other assets   5,546    7,077 
           
   $434,004   $444,173 
           
Liabilities and Shareholders' Equity          
Liabilities          
Deposits          
Noninterest bearing demand  $77,496   $57,244 
Interest bearing   301,364    333,384 
Total deposits   378,860    390,628 
Federal Home Loan Bank advances   14,000    18,000 
Long-term debt - trust preferred securities   8,764    8,764 
Other borrowings   3,302    2,713 
Accrued interest payable   1,167    1,093 
Other liabilities   8,853    4,731 
Total liabilities   414,946    425,929 
           
Shareholders' equity          
Preferred stock, $4 par value, $1,000 liquidation preference,  1,000,000 shares authorized, 14,738 shares issued and outstanding   59    59 
Common stock, $4 par value - 10,000,000 shares authorized;   350,622 shares issued and outstanding at December 31, 2014  333,644 shares issued and outstanding at December 31, 2013   1,339    1,335 
Additional paid-in capital   58,188    58,072 
Retained earnings (deficit)   (40,539)   (38,066)
Common stock warrant   732    732 
Discount on preferred stock   -    (50)
Stock in directors rabbi trust   (878)   (878)
Directors deferred fees obligation   878    878 
Accumulated other comprehensive loss   (721)   (3,838)
Total shareholders' equity   19,058    18,244 
           
   $434,004   $444,173 

 

See accompanying notes to consolidated financial statements.

 

48
 

  

Village Bank and Trust Financial Corp. and Subsidiary

Consolidated Statements of Operations

Years Ended December 31, 2014, 2013 and 2012

(dollars in thousands, except per share data)

 

   2014   2013   2012 
Interest income               
Loans  $15,309   $18,444   $22,939 
Investment securities   1,182    1,083    701 
Federal funds sold   87    87    59 
Total interest income   16,578    19,614    23,699 
                
Interest expense               
Deposits   3,006    3,666    4,932 
Borrowed funds   554    759    1,065 
Total interest expense   3,560    4,425    5,997 
                
Net interest income   13,018    15,189    17,702 
Provision for loan losses   100    1,173    9,095 
Net interest income after provision for loan losses   12,918    14,016    8,607 
                
Noninterest income               
Service charges and fees   2,245    2,314    2,259 
Gain on sale of loans   4,449    7,744    8,562 
Gain (loss) on sale of investment securities   (210)   217    1,010 
Rental income   965    854    794 
Other   440    1,126    714 
Total noninterest income   7,889    12,255    13,339 
                
Noninterest expense               
Salaries and benefits   10,685    11,905    11,275 
Commissions   1,165    2,003    2,012 
Occupancy   1,690    2,064    2,213 
Equipment   708    715    807 
Supplies   344    436    431 
Professional and outside services   2,550    2,420    2,779 
Advertising and marketing   321    249    225 
Expenses related to foreclosed real estate   1,244    7,082    4,701 
FDIC insurance premium   968    1,048    1,204 
Other operating expense   2,169    2,356    2,643 
Total noninterest expense   21,844    30,278    28,290 
                
Net loss before income taxes   (1,037)   (4,007)   (6,344)
Income tax expense   -    -    4,055 
                
Net loss   (1,037)   (4,007)   (10,399)
                
Preferred stock dividends and amortization of discount   1,436    886    879 
Net loss available to common shareholders  $(2,473)  $(4,893)  $(11,278)
                
Earnings (loss) per share, basic and diluted  $(7.39)  $(18.06)  $(42.40)

 

See accompanying notes to consolidated financial statements.

 

49
 

  

Village Bank and Trust Financial Corp. and Subsidiary

Consolidated Statements of Changes in Comprehensive Income (Loss)

Years Ended December 31, 2014, 2013 and 2012

(dollars in thousands)

 

  2014   2013   2012 
                
Net loss  $(1,037)  $(4,007)  $(10,399)
Other comprehensive income (loss)               
Unrealized holding gains (losses) arising during the period   4,499    (5,359)   756 
Tax effect   1,529    (1,822)   257 
Net change in unrealized holding gains (losses) on securities available for sale, net of tax   2,970    (3,537)   499 
                
Reclassification adjustment               
Reclassification adjustment for (gains) losses realized in net income (loss)   210    (217)   (1,010)
Tax effect   72    (74)   (343)
Reclassification for (gains) losses included in net income (loss), net of tax   138    (143)   (667)
                
Minimum pension adjustment   14    13    13 
Tax effect   5    5    4 
Minimum pension adjustment, net of tax   9    8    9 
                
Total other comprehensive income (loss)   3,117    (3,672)   (159)
                
 Total comprehensive income (loss)  $2,080   $(7,679)  $(10,558)

  

See accompanying notes to consolidated financial statements.

 

50
 

  

Village Bank and Trust Financial Corp. and Subsidiary

Consolidated Statements of Shareholders' Equity

Years Ended December 31, 2014, 2013 and 2012

(dollars in thousands)

 

                               Directors   Accumulated     
           Additional   Retained       Discount on   Stock in   Deferred   Other     
   Preferred   Common   Paid-in   Earnings       Preferred   Directors   Fees   Comprehensive     
   Stock   Stock   Capital   (Deficit)   Warrant   Stock   Rabbi Trust   Obligation   Income (loss)   Total 
                                                   
Balance, December 31, 2011  $59   $16,973   $40,732   $(21,895)  $732   $(347)  $-   $-   $(7)  $36,247 
Amortization of preferred stock discount   -    -    -    (148)   -    148    -    -         - 
Preferred stock dividend   -    -    -    (731)   -    -    -    -    -    (731)
Issuance of common stock   -    34    (34)   -    -    -    -    -    -    - 
Stock based compensation   -    -    7    -    -    -    -    -    -    7 
Minimum pension adjustment (net of income taxes of $4)   -    -    -    -    -    -    -    -    9    9 
Net loss   -    -    -    (10,399)   -    -    -    -    -    (10,399)
Change in unrealized gain (loss) on investment securities available-for-sale, net of reclassification and tax effect   -    -    -    -    -    -    -    -    (168)   (168)
                                                   
Balance, December 31, 2012   59    17,007    40,705    (33,173)   732    (199)   -    -    (166)   24,965 
Amortization of preferred stock discount   -    -    -    (149)   -    149    -    -         - 
Preferred stock dividend   -    -    -    (737)   -    -    -    -    -    (737)
Issuance of common stock   -    4,346  <