Virginia National Bankshares Corp - Annual Report: 2014 (Form 10-K)

Table of Contents

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

VIRGINIA NATIONAL BANKSHARES CORPORATION

(Exact name of registrant as specified in its charter)

(434) 817-8621
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.      Yes   _     No   X

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.      Yes   _     No   X

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.      Yes   X     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 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).      Yes   X     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 the registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-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 definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).      Yes   _     No   X

On June 30, 2014, the aggregate market value of the common equity held by non-affiliates of the registrant was $58,831,849.

The registrant has one class of common stock, of which 2,688,781 shares were outstanding as of close of business March 14, 2015.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the following documents are hereby incorporated into Part I and Part III of this Form 10-K by reference: the Proxy Statement for the Annual Meeting of Shareholders to be held on May 20, 2015.

Table of Contents

INDEX

2

Table of Contents

FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS

Certain statements contained or incorporated by reference in this annual report on Form 10-K, including but not limited to, statements concerning future results of operations or financial position, borrowing capacity and future liquidity, future investment results, future credit exposure, future loan losses and plans and objectives for future operations, change in laws and regulations applicable to the Company and its subsidiaries, adequacy of funding sources, actuarial expected benefit payment, valuation of foreclosed assets, regulatory requirements, economic environment and other statements contained herein regarding matters that are not historical facts, are “forward-looking statements” as defined in the Securities Exchange Act of 1934. Such statements are often characterized by use of qualified words such as “expect,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “will,” or words of similar meaning or other statements concerning the opinions or judgment of the Company and its management about future events. These statements are not historical facts but instead are subject to numerous assumptions, risks and uncertainties, and represent only our belief regarding future events, many of which, by their nature, are inherently uncertain and outside our control. Any forward-looking statements made by the Company speak only as of the date on which such statements are made. Our actual results and financial position may differ materially from the anticipated results and financial condition indicated in or implied by these forward-looking statements. The Company makes no commitment to update or revise forward-looking statements in order to reflect new information or subsequent events or changes in expectations.

Factors that could cause our actual results to differ materially from those in the forward-looking statements include, but are not limited to, the following: inflation, interest rates, market and monetary fluctuations; geopolitical developments including acts of war and terrorism and their impact on economic conditions; the effects of, and changes in, trade, monetary and fiscal policies and laws, including interest rate policies of the Federal Reserve Board; changes, particularly declines, in general economic conditions and in the local economies in which the Company operates; the financial condition of the Company’s borrowers; competitive pressures on loan and deposit pricing and demand; changes in technology and their impact on the marketing of new products and services and the acceptance of these products and services by new and existing customers; the willingness of customers to substitute competitors’ products and services for the Company’s products and services; the impact of changes in financial services laws and regulations (including laws concerning taxes, banking, securities and insurance); changes in accounting principles, policies and guidelines; other risks and uncertainties described from time to time in press releases and other public filings; and the Company’s performance in managing the risks involved in any of the foregoing. The foregoing list of important factors is not exclusive, and the Company will not update any forward-looking statement, whether written or oral, that may be made from time to time.

Part I

Item 1. BUSINESS.

General

Virginia National Bankshares Corporation (the “Company”) was incorporated under the laws of the Commonwealth of Virginia on February 21, 2013 at the direction of the Board of Directors of Virginia National Bank (the “Bank”) for the purpose of acquiring all of the outstanding shares of the Bank and becoming the holding company of the Bank. On June 19, 2013, the shareholders of the Bank approved the Reorganization Agreement and Plan of Share Exchange, dated March 6, 2013, whereby the Bank would reorganize into a holding company structure (the “Reorganization”).

On December 16, 2013, when the Reorganization became effective, the Bank became a wholly-owned subsidiary of the Company, and each share of the Bank’s common stock was exchanged for one share of the Company’s common stock. The Company is regulated under the Bank Holding Company Act of 1956, as amended (“BHC Act”), and is subject to inspection, examination and supervision by the Board of Governors of the Federal Reserve System (the “Federal Reserve Board” or “Federal Reserve”). The Company is also under the jurisdiction of the Securities and Exchange Commission (“SEC”) and is subject to the disclosure and regulatory requirements of the Securities Exchange Act of 1934, as amended, (the “Exchange Act”) as administered by the SEC. Virginia National Bankshares Corporation is headquartered at 404 People Place, Charlottesville, Virginia.

3

Table of Contents

Virginia National Bank, the principal operating subsidiary of the Company, was organized in 1998 under federal law as a national banking association to engage in a general commercial and retail banking business. The Bank received its charter from the Office of the Comptroller of the Currency (the “OCC”) and commenced operations on July 29, 1998. The Bank is headquartered in Charlottesville, Virginia. The Bank’s deposits are insured up to the maximum amount provided by the Federal Deposit Insurance Act by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is subject to the supervision, examination and regulation of the OCC.

The Bank serves the Virginia communities in and around the City of Charlottesville, Albemarle County, Orange County and the City of Winchester. The Bank offers a full range of banking and related financial services, including checking accounts, NOW accounts, money market deposit accounts, certificates of deposit, individual retirement accounts and other depository services. The Bank actively solicits such accounts from individuals, businesses, associations and other organizations within its trade area. The Bank also offers short-to-long term commercial, real estate and consumer loans. The Bank is committed to being a reliable and consistent source of credit, with loans that are priced based upon an overall banking relationship, easy access to the Bank’s local decision makers who possess strong local market knowledge, local delivery, fast response, and continuity in the banking relationship. Other services offered by the Bank include automated teller machines (“ATMs”), Internet banking, safe deposit boxes, merchant card services, cash management services and direct deposit of payroll and federal recurring payments. In addition, the Bank is affiliated with Visa^® which is accepted worldwide and offers debit cards to consumer and business customers.

Late in the second quarter of 2014, the Company hired a secondary market mortgage originator. The Company now originates and sells residential mortgage loans sold on the secondary market which the Company does not wish to retain for its own loan portfolio due to the interest rate risks that are inherent with long-term fixed rate loans.

Since late 2012, the Company has offered annuity, insurance and brokerage services to the public at its banking offices, under the title of VNB Investment Strategies. The Bank entered into an agreement with LPL Financial LLC, which provides broker/dealer and advisory services through registered representatives. The goal of the program is to offer customers opportunities to access additional financial products and services beyond the traditional banking products.

Investment management, trust, estate administration and financial planning services are offered through the Bank’s wholly-owned subsidiary, VNBTrust, National Association, which now does business under the trade name VNB Wealth Management (“VNBTrust”, “VNB Wealth” or “VNB Wealth Management”). The flagship product for managed accounts employs a value-based, catalyst-driven investment strategy. The financial instruments used include common and preferred stock, corporate bonds, bank loans and other debt securities, convertible securities, Exchange Traded Funds (“EFTs”), options, warrants and cash equivalents.

On January 1, 2014, VNBTrust began doing business under the trade name of VNB Wealth Management. While the trade name is new, clients will continue to receive community-based trust and investment services. More information on VNB Wealth Management is available at www.vnbwealth.com.

Prior to July 18, 2013, VNBTrust was the sole owner of an operating subsidiary, Swift Run Capital Management, LLC (“SRCM”), formerly known as VNB Investment Management Company, LLC, a Delaware limited liability corporation. SRCM operates as the general partner of Swift Run Capital L.P. (“Fund”), a hedge fund. On July 18, 2013 (the “Closing Date”), VNBTrust completed the sale of all of the membership interests of SRCM to SRCM Holdings LLC (“SRCM Holdings”) pursuant to a purchase and sale agreement dated June 27, 2013 among SRCM Holdings, VNBTrust, SRCM and the Bank (the “Sale Agreement”). The Fund managed by SRCM represented less than 7 percent of the total assets managed by VNBTrust and SRCM at the Closing Date. A former officer of VNBTrust is the principal owner of SRCM Holdings. Additional details on this transaction are available in Note 1, in the notes to the consolidated financial statements, contained in Item 8 – Consolidated Financial Statements and Supplementary Data.

References to the Company’s subsidiaries in this document include both the Bank and the Bank’s subsidiary, VNBTrust.

4

Table of Contents

As of March 31, 2015, the Company and its subsidiaries occupied the following seven full-service banking facilities in the cities of Charlottesville and Winchester, as well as the counties of Albemarle and Orange in Virginia:

Additionally, the multi-story office building at 404 People Place also serves as the Company’s corporate headquarters and operations center, as well as the principal offices of VNB Wealth Management. The Bank also has a loan production office in Warrenton, Virginia and a business development office in Culpeper, Virginia.

Market Area

The population in the market area served by the Company continues to grow. According to the U.S. Census Bureau, the total market area served by the Company grew 21.7 percent between 2000 and 2010, as compared to 13.0 percent for the Commonwealth of Virginia as a whole. The Virginia State Demographer (the “VSD”) estimates that, by 2014, the population of the Commonwealth had grown by 4.1%, while the Company’s current markets had grown by 4.8 percent.

The combined populations of the City of Charlottesville and Albemarle County stood at 142,445 persons as of April 1, 2010, an increase of approximately 14.6 percent between April 1, 2000 and April 1, 2010. The VSD estimates that the two municipalities have grown by an additional 6.4 percent to a population of 151,490 as of 2014 and projects these municipalities will continue to grow to a population of 161,278 by 2020. Charlottesville and Albemarle County support a diverse, well-rounded economy. Stability in the local economy stems from the significant number of persons employed by a wide variety of employers including the University of Virginia, large medical and research facilities such as Martha Jefferson and UVA Health Services, insurance and technology industries, large number of national retail chains and Federal government-based facilities.

The combined populations of the City of Winchester and Frederick County increased approximately 26.2 percent between April 1, 2000 and April 1, 2010, to a population of 104,508 persons in 2010. The VSD estimates that the combined populations for these two areas have already grown to 109,259 by 2014, a 4.6 percent increase, and expects these populations to be 125,159 by 2020, an increase of 19.8 percent over the 2010 census figure.

Orange and Culpeper Counties had a combined population of approximately 80,170 persons as of 2010. Between April 1, 2000 and April 1, 2010, its population grew 33.3 percent. 2014 VSD estimates show the population at 83,045, a 3.6 percent increase over the 2010 population.

The Company’s newest market area of Warrenton and Fauquier County is estimated by VSD to have a population of 67,512 as of 2014 and is projected to grow to 74,118 persons by 2020.

Over the next decade, Virginia is expected to have only a 10.1 percent growth, where the Company’ s current market area is projected by VSD to be 15.5 percent higher by 2020 than reported by the 2010 Census.

Competition

The Company engages in highly competitive activities. Each activity involves competition with other banks, as well as with non-banking enterprises that offer financial products and services that compete directly with the Company’s product and service offerings. The Company actively competes with other banks in its efforts to obtain deposits and make loans, in the scope and types of services offered, in interest rates paid on time deposits and charged on loans, and in other aspects of banking.

In addition to competing with other commercial banks within and outside its primary service areas, the Company competes with other financial institutions engaged in the business of making loans or accepting deposits, such as credit unions, insurance companies, small loan companies, finance companies, mortgage companies, certain governmental agencies and other enterprises. Competition for funds from securities brokers and mutual funds for money market accounts is strong. Additional competition for deposits comes from government and private issues of debt obligations and other investment alternatives for depositors such as money market funds.

5

Table of Contents

The market areas served by the Company are highly competitive with respect to banking. Competition for loans to small businesses and professionals is intense, and pricing is important. Many of the Company’s competitors have substantially greater resources and lending limits than the Company and offer certain services such as extensive and established branch networks that the Company does not expect to match. Deposit competition is also very strong. Management believes, however, that a market exists for the personal and customized financial services an independent, locally owned bank can offer.

Supervision and Regulation

Bank holding companies and banks are extensively regulated under both federal and state laws. The following description briefly addresses certain historic and current provisions of federal and state laws and certain regulations, proposed regulations and the potential impacts on the Company and the Bank. To the extent statutory or regulatory provisions or proposals are described in this Report, the description is qualified in its entirety by reference to the particular statutory or regulatory provisions or proposals.

The Company

General. As a bank holding company registered under the BHC Act, the Company is subject to supervision, regulation, and examination by the Federal Reserve. The Company is also registered under the bank holding company laws of Virginia and is subject to supervision, regulation, and examination by the Virginia State Corporation Commission (the “SCC”).

Permitted Activities. A bank holding company is limited to managing or controlling banks, furnishing services to or performing services for its subsidiaries, and engaging in other activities that the Federal Reserve determines by regulation or order to be so closely related to banking or managing or controlling banks as to be a proper incident thereto. In determining whether a particular activity is permissible, the Federal Reserve must consider whether the performance of such an activity reasonably can be expected to produce benefits to the public that outweigh possible adverse effects. Possible benefits include greater convenience, increased competition, and gains in efficiency. Possible adverse effects include undue concentration of resources, decreased or unfair competition, conflicts of interest, and unsound banking practices. Despite prior approval, the Federal Reserve may order a bank holding company or its subsidiaries to terminate any activity or to terminate ownership or control of any subsidiary when the Federal Reserve has reasonable cause to believe that a serious risk to the financial safety, soundness or stability of any bank subsidiary of that bank holding company may result from such an activity.

Banking Acquisitions; Changes in Control. The BHC Act requires, among other things, the prior approval of the Federal Reserve in any case where a bank holding company proposes to (i) acquire direct or indirect ownership or control of more than 5% of the outstanding voting stock of any bank or bank holding company (unless it already owns a majority of such voting shares), (ii) acquire all or substantially all of the assets of another bank or bank holding company, or (iii) merge or consolidate with any other bank holding company. In determining whether to approve a proposed bank acquisition, the Federal Reserve will consider, among other factors, the effect of the acquisition on competition, the public benefits expected to be received from the acquisition, the projected capital ratios and levels on a post-acquisition basis, and the acquiring institution’s performance under the Community Reinvestment Act of 1977 and its compliance with fair housing and other consumer protection laws.

Subject to certain exceptions, the BHC Act and the Change in Bank Control Act, together with the applicable regulations, require Federal Reserve approval (or, depending on the circumstances, no notice of disapproval) prior to any person or company’s acquiring “control” of a bank or bank holding company. A conclusive presumption of control exists if an individual or company acquires the power, directly or indirectly, to direct the management or policies of an insured depository institution or to vote 25% or more of any class of voting securities of any insured depository institution. A rebuttable presumption of control exists if a person or company acquires 10% or more but less than 25% of any class of voting securities of an insured depository institution and either the institution has registered its securities with the SEC under Section 12 of the Exchange Act or no other person will own a greater percentage of that class of voting securities immediately after the acquisition. The Company’s common stock is registered under Section 12 of the Exchange Act.

6

Table of Contents

In addition, Virginia law requires the prior approval of the SCC for (i) any Virginia bank or Virginia bank holding company to acquire more than 5% of the voting shares of a Virginia bank or any holding company that controls a Virginia bank, or (ii) the acquisition by a Virginia bank holding company of a bank or its holding company domiciled outside Virginia.

Source of Strength. Federal Reserve policy has historically required bank holding companies to act as a source of financial and managerial strength to their subsidiary banks. The Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”) codified this policy as a statutory requirement. Under this requirement, the Company is expected to commit resources to support the Bank, including at times when the Company may not be in a financial position to provide such resources. Any capital loans by a bank holding company to any of its subsidiary banks are subordinate in right of payment to depositors and to certain other indebtedness of such subsidiary banks. In the event of a bank holding company’s bankruptcy, any commitment by the bank holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank will be assumed by the bankruptcy trustee and entitled to priority of payment.

Safety and Soundness. There are a number of obligations and restrictions imposed on bank holding companies and their subsidiary banks by law and regulatory policy that are designed to minimize potential loss to the depositors of such depository institutions and the FDIC insurance fund in the event of a depository institution default. For example, under the Federal Deposit Insurance Company Improvement Act of 1991, to avoid receivership of an insured depository institution subsidiary, a bank holding company is required to guarantee the compliance of any subsidiary bank that may become “undercapitalized” with the terms of any capital restoration plan filed by such subsidiary with its appropriate federal bank regulatory agency up to the lesser of (i) an amount equal to 5% of the institution’s total assets at the time the institution became undercapitalized, or (ii) the amount that is necessary (or would have been necessary) to bring the institution into compliance with all applicable capital standards as of the time the institution fails to comply with such capital restoration plan.

Under the Federal Deposit Insurance Act (“FDIA”), the federal bank regulatory agencies have adopted guidelines prescribing safety and soundness standards. These guidelines establish general standards relating to internal controls and information systems, internal audit systems, loan documentation, credit underwriting, interest rate exposure, asset growth and compensation, fees and benefits. In general, the guidelines require, among other things, appropriate systems and practices to identify and manage the risk and exposures specified in the guidelines.

Capital Requirements. The Federal Reserve imposes certain capital requirements on bank holding companies under the BHC Act, including a minimum leverage ratio and a minimum ratio of “qualifying” capital to risk-weighted assets. These requirements are described below under “The Bank – Capital Requirements.”

Limits on Dividends and Other Payments. The Company is a legal entity, separate and distinct from its subsidiaries. A significant portion of the revenues of the Company result from dividends paid to it by the Bank. There are various legal limitations applicable to the payment of dividends by the Bank to the Company and to the payment of dividends by the Company to its shareholders. The Bank is subject to various restrictions on its ability to pay dividends to the Company. The OCC has advised that a national bank should generally pay dividends only out of current operating earnings. Under current regulations, prior approval from the Federal Reserve is required if cash dividends declared in any given year exceed net income for that year, plus retained net profits of the two preceding years. The payment of dividends by the Bank or the Company may be limited by other factors, such as requirements to maintain capital above regulatory guidelines. Bank regulatory agencies have the authority to prohibit the Bank or the Company from engaging in an unsafe or unsound practice in conducting their business. The payment of dividends, depending on the financial condition of the Bank, or the Company, could be deemed to constitute such an unsafe or unsound practice.

Under the FDIA, insured depository institutions such as the Bank, are prohibited from making capital distributions, including the payment of dividends, if, after making such distributions, the institution would become “undercapitalized” (as such term is used in the statute). Based on the Bank’s current financial condition, the Company does not expect this provision will have any impact on its ability to receive dividends from the Bank.

7

Table of Contents

The Bank

General. The Bank is supervised and regularly examined by the OCC. The various laws and regulations administered by the bank regulatory agencies affect corporate practices, such as the payment of dividends, incurrence of debt and acquisition of financial institutions and other companies; they also affect business practices, such as the payment of interest on deposits, the charging of interest on loans, types of business conducted and location of offices. Certain of these law and regulations are referenced above under “The Company.”

Capital Requirements:

2014 Capital Requirements. The OCC and the other federal banking agencies have issued risk-based and leverage capital guidelines applicable to U.S. banking organizations. In addition, those regulatory agencies may from time to time require that a banking organization maintain capital above the minimum levels because of its financial condition or actual or anticipated growth. Under the risk-based capital requirements of the Federal Reserve and the OCC that were effective through December 31, 2014, the Company and the Bank were required to maintain a minimum ratio of total capital (which is defined as core capital and supplementary capital less certain specified deductions from total capital such as reciprocal holdings of depository institution capital instruments and equity investments) to risk-weighted assets of at least 8.0%. In determining the amount of risk-weighted assets, all assets, including certain off-balance sheet activities, recourse obligations, residual interests and direct credit substitutes, were multiplied by a risk-weight factor assigned by the capital regulation based on the risks believed inherent in the type of asset. At least half of the total capital was required to be “Tier 1 capital,” which consisted principally of common and certain qualifying preferred shareholders’ equity (including grandfathered trust preferred securities), less certain intangibles and other adjustments. The remainder (“Tier 2 capital”) consisted of cumulative preferred stock, long-term perpetual preferred stock, a limited amount of subordinated and other qualifying debt (including certain hybrid capital instruments), and a limited amount of the general loan loss allowance. The Tier 1 and total capital to risk-weighted asset ratios of the Company were 16.98% and 17.87%, respectively, as of December 31, 2014, thus exceeding the minimum requirements. The Tier 1 and total capital to risk-weighted asset ratios of the Bank were 14.74% and 15.63%, respectively, as of December 31, 2014, also exceeding the minimum requirements.

Each of the federal bank regulatory agencies also established a minimum leverage capital ratio of Tier 1 capital to average adjusted assets (“Tier 1 leverage ratio”) that was effective through December 31, 2014. The guidelines required a minimum Tier 1 leverage ratio of 3.0% for bank holding companies and banking organizations with the highest supervisory rating. All other banking organizations were required to maintain a minimum Tier 1 leverage ratio of 4% unless a different minimum was specified by an appropriate regulatory authority. In addition, for a depository institution to have been considered “well capitalized” under the regulatory framework for prompt corrective action, its Tier 1 leverage ratio must have been at least 5.0%. The guidelines also provide that banking organizations experiencing internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels without significant reliance on intangible assets. The Federal Reserve and the OCC have not advised the Company or the Bank of any specific minimum leverage ratio applicable to either entity. As of December 31, 2014, the Tier 1 leverage ratio of the Company and the Bank were 11.38% and 9.86%, respectively, well above the minimum requirements.

Basel III Capital Requirements Effective January 1, 2015. In June 2012, the federal bank regulatory agencies issued a series of proposed rules intended to revise and strengthen its risk-based and leverage capital requirements and its method for calculating risk-weighted assets. The rules were proposed to implement the Basel III regulatory capital reforms from the Basel Committee on Banking Supervision and certain provisions of the Dodd-Frank Act. In July 2013, the federal bank regulatory agencies approved certain revisions to the proposals and finalized new capital requirements for banking organizations.

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 common equity Tier 1 capital ratio of 4.5% of risk-weighted assets; (ii) a Tier 1 capital ratio of 6% of risk-weighted assets (increased from the prior requirement of 4%); (iii) a total capital ratio of 8% of risk-weighted assets (unchanged from the prior requirement); and (iv) a leverage ratio of 4% of total assets (unchanged from the prior requirement). These are the initial capital requirements, which will be phased in over a four-year period. When fully phased in on January 1, 2019, the rules will require the Company and the Bank to maintain (i) a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (which is added to the 4.5% common equity Tier 1 ratio as that buffer is phased in, effectively resulting in a minimum ratio of common equity Tier 1 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 2.5% 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 2.5% 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%, calculated as the ratio of Tier 1 capital to average assets.

8

Table of Contents

The capital conservation buffer requirement will be phased in beginning January 1, 2016, at 0.625% of risk-weighted assets, increasing by the same amount each year until fully implemented at 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress. Banking institutions with a ratio of common equity Tier 1 to risk-weighted assets above the minimum but below the conservation buffer will face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall.

With respect to the Bank, the rules also revised the “prompt corrective action” regulations pursuant to Section 38 of the FDIA by (i) introducing a common equity Tier 1 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 current 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.

The new capital requirements also include changes in the risk weights of assets to better reflect credit risk and other risk exposures. These include a 150% risk weight (up from 100%) for certain high volatility commercial real estate acquisition, development and construction loans and nonresidential mortgage loans that are 90 days past due or otherwise on non-accrual status, a 20% (up from 0%) credit conversion factor for the unused portion of a commitment with an original maturity of one year or less that is not unconditionally cancellable, a 250% risk weight (up from 100%) for mortgage servicing rights and deferred tax assets that are not deducted from capital, and increased risk-weights (from 0% to up to 600%) for equity exposures.

Based on management’s understanding and interpretation of the new capital rules, it believes that, as of December 31, 2014, the Company and the Bank would meet all capital adequacy requirements under such rules on a fully phased-in basis as if such requirements were in effect as of such date.

Deposit Insurance. The deposits of the Bank are insured up to applicable limits by the Deposit Insurance Fund (“DIF”) of the FDIC and are subject to deposit insurance assessments to maintain the DIF. On April 1, 2011, the deposit insurance assessment base changed from total deposits to average total assets minus average tangible equity, pursuant to a rule issued by the FDIC as required by the Dodd-Frank Act.

The Federal Deposit Insurance Act (the “FDIA”), as amended by the Federal Deposit Insurance Reform Act and the Dodd-Frank Act, requires the FDIC to set a ratio of deposit insurance reserves to estimated insured deposits of at least 1.35%. The FDIC utilizes a risk-based assessment system that imposes insurance premiums based upon a risk matrix that takes into account a bank’s capital level and supervisory rating. On February 27, 2009, the FDIC introduced three possible adjustments to an institution’s initial base assessment rate: (i) a decrease of up to five basis points for long-term unsecured debt, including senior unsecured debt (other than debt guaranteed under the Temporary Liquidity Guarantee Program) and subordinated debt and, for small institutions, a portion of Tier 1 capital; (ii) an increase not to exceed 50% of an institution’s assessment rate before the increase for secured liabilities in excess of 25% of domestic deposits; and (iii) for non-Risk Category I institutions, an increase not to exceed 10 basis points for brokered deposits in excess of 10% of domestic deposits. In 2014 and 2013, the Company expensed only the base assessment rate for “well capitalized” institutions, which totaled $240 thousand and $220 thousand, respectively, in regular deposit insurance assessments.

9

Table of Contents

On May 22, 2009, the FDIC issued a final rule that levied a special assessment applicable to all insured depository institutions totaling 5 basis points of each institution’s total assets less Tier 1 capital as of June 30, 2009, not to exceed 10 basis points of domestic deposits. The special assessment was part of the FDIC’s efforts to rebuild the DIF. Deposit insurance expense during 2009 for the Company included an additional $184 thousand related to the special assessment.

On November 12, 2009, the FDIC issued a rule that required all insured depository institutions, with limited exceptions, to prepay their estimated quarterly risk-based assessments for the fourth quarter of 2009 and for all of 2010, 2011, and 2012. In the fourth quarter of 2009, the Company paid $1.939 million in prepaid risk-based assessments, most of which has been expensed in the appropriate periods through December 31, 2012. On June 28, 2013, $582 thousand was refunded to the Company from the FDIC. Beginning September 30, 2013, payments are being assessed and charged to financial institutions on a quarterly basis, rather than being applied against the prepaid balance.

In addition, all FDIC insured institutions are required to pay assessments to the FDIC at an annual rate of approximately one basis point of insured deposits to fund interest payments on bonds issued by the Financing Corporation, an agency of the federal government established to recapitalize the predecessor to the Savings Association Insurance Fund. These assessments will continue until the Financing Corporation bonds mature in 2017 through 2019. In both 2014 and 2013, the Company paid a Financing Corporation assessment of $28 thousand.

Transactions with Affiliates. Pursuant to Sections 23A and 23B of the Federal Reserve Act and Regulation W, the authority of the Bank to engage in transactions with related parties or “affiliates” or to make loans to insiders is limited. Loan transactions with an affiliate generally must be collateralized and certain transactions between the Bank and its affiliates, including the sale of assets, the payment of money or the provision of services, must be on terms and conditions that are substantially the same, or at least as favorable to the Bank, as those prevailing for comparable nonaffiliated transactions. In addition, the Bank generally may not purchase securities issued or underwritten by affiliates.

Loans to executive officers, directors or to any person who directly or indirectly, or acting through or in concert with one or more persons, owns, controls or has the power to vote more than 10% of any class of voting securities of a bank (a “10% Shareholder”), are subject to Sections 22(g) and 22(h) of the Federal Reserve Act and their corresponding regulations (Regulation O) and Section 13(k) of the Exchange Act relating to the prohibition on personal loans to executives (which exempts financial institutions in compliance with the insider lending restrictions of Section 22(h) of the Federal Reserve Act). Among other things, these loans must be made on terms substantially the same as those prevailing on transactions made to unaffiliated individuals and certain extensions of credit to those persons must first be approved in advance by a disinterested majority of the entire board of directors. Section 22(h) of the Federal Reserve Act prohibits loans to any of those individuals where the aggregate amount exceeds an amount equal to 15% of an institution’s unimpaired capital and surplus plus an additional 10% of unimpaired capital and surplus in the case of loans that are fully secured by readily marketable collateral, or when the aggregate amount on all of the extensions of credit outstanding to all of these persons would exceed the Bank’s unimpaired capital and unimpaired surplus. Section 22(g) of the Federal Reserve Act identifies limited circumstances in which the Bank is permitted to extend credit to executive officers.

Prompt Corrective Action. Federal banking regulators are authorized and, under certain circumstances, required to take certain actions against banks that fail to meet their capital requirements. The federal bank regulatory agencies have additional enforcement authority with respect to undercapitalized depository institutions. “Well capitalized” institutions may generally operate without supervisory restriction. With respect to “adequately capitalized” institutions, such banks cannot normally pay dividends or make any capital contributions that would leave it undercapitalized; they cannot pay a management fee to a controlling person if, after paying the fee, it would be undercapitalized; and they cannot accept, renew or roll over any brokered deposit unless the bank has applied for and been granted a waiver by the FDIC.

Immediately upon becoming “undercapitalized,” a depository institution becomes subject to the provisions of Section 38 of the FDIA, which: (i) restrict payment of capital distributions and management fees; (ii) require that the appropriate federal banking agency monitor the condition of the institution and its efforts to restore its capital; (iii) require submission of a capital restoration plan; (iv) restrict the growth of the institution’s assets; and (v) require prior approval of certain expansion proposals. The appropriate federal banking agency for an undercapitalized institution also may take any number of discretionary supervisory actions if the agency determines that any of these actions is necessary to resolve the problems of the institution at the least possible long-term cost to the DIF, subject in certain cases to specified procedures. These discretionary supervisory actions include: (i) requiring the institution to raise additional capital; (ii) restricting transactions with affiliates; (iii) requiring divestiture of the institution or the sale of the institution to a willing purchaser; and (iv) any other supervisory action that the agency deems appropriate. These and additional mandatory and permissive supervisory actions may be taken with respect to significantly undercapitalized and critically undercapitalized institutions. The Bank meets the definition of being “well capitalized” as of December 31, 2014.

10

Table of Contents

As described above in “The Bank – Capital Requirements – Basel III Capital Requirements Effective January 1, 2015,” the new capital requirement rules issued by the OCC incorporate new requirements into the prompt corrective action framework.

Community Reinvestment Act. The Bank is subject to the requirements of the Community Reinvestment Act of 1977 (the “CRA”). The CRA imposes on financial institutions an affirmative and ongoing obligation to meet the credit needs of the local communities they serve, including low and moderate income neighborhoods. The CRA requires the appropriate federal banking agency, in connection with its examination of a bank, to assess the bank’s record in meeting such credit needs. Furthermore, such assessment is also required of banks that have applied, among other things, to merge or consolidate with or acquire the assets or assume the liabilities of an insured depository institution, or to open or relocate a branch. In the case of a bank holding company applying for approval to acquire a bank or another bank holding company, the record of each subsidiary bank of the applicant bank holding company is subject to assessment in considering the application. Under the CRA, institutions are assigned a rating of “outstanding,” “satisfactory,” “needs to improve,” or “substantial non-compliance.” The Bank received a “satisfactory” CRA rating in its most recent examination.

Privacy Legislation. Several recent laws, including the Right to Financial Privacy Act, and related regulations issued by the federal bank regulatory agencies, provide new protections against the transfer and use of customer information by financial institutions. A financial institution must provide to its customers information regarding its policies and procedures with respect to the handling of customers’ personal information. Each institution must conduct an internal risk assessment of its ability to protect customer information. These privacy provisions generally prohibit a financial institution from providing a customer’s personal financial information to unaffiliated parties without prior notice and approval from the customer.

USA Patriot Act of 2001. In October 2001, the USA Patriot Act of 2001 (“Patriot Act”) was enacted in response to the September 11, 2001 terrorist attacks in New York, Pennsylvania, and Northern Virginia. The Patriot Act is intended to strengthen U.S. law enforcement and the intelligence communities’ abilities to work cohesively to combat terrorism. The continuing impact on financial institutions of the Patriot Act and related regulations and policies is significant and wide ranging. The Patriot Act contains sweeping anti-money laundering and financial transparency laws, and imposes various regulations, including standards for verifying customer identification at account opening, and rules to promote cooperation among financial institutions, regulators and law enforcement entities to identify persons who may be involved in terrorism or money laundering.

Volcker Rule. The Dodd-Frank Act prohibits insured depository institutions and their holding companies from engaging in proprietary trading except in limited circumstances, and prohibits them from owning equity interests in excess of 3% of Tier 1 capital in private equity and hedge funds (known as the “Volcker Rule”). On December 10, 2013, the federal bank regulatory agencies adopted final rules implementing the Volcker Rule. These final rules prohibit banking entities from (i) engaging in short-term proprietary trading for their own accounts, and (ii) having certain ownership interests in and relationships with hedge funds or private equity funds. The final rules are 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 also require each regulated entity to establish an internal compliance program that is consistent with the extent to which it engages in activities covered by the Volcker Rule, which must include (for the largest entities) making regular reports about those activities to regulators. Although the final rules provide some tiering of compliance and reporting obligations based on size, the fundamental prohibitions of the Volcker Rule apply to banking entities of any size, including the Company and the Bank. The final rules were effective April 1, 2014, with full compliance being phased in over a period which will end on July 21, 2016. The Company has evaluated the implications of the final rules on its investments and does not expect any material financial implications.

Under the rules implementing the Volcker Rule, banking entities would have been prohibited from owning certain collateralized debt obligations (“CDOs”) backed by trust preferred securities (“TruPS”) as of July 21, 2015, which could have forced banking entities to recognize unrealized market losses based on the inability to hold any such investments to maturity. However, on January 14, 2014, the federal bank regulatory agencies issued an interim rule, effective April 1, 2014, exempting TruPS CDOs from the Volcker Rule if (i) the CDO was established prior to May 19, 2010, (ii) the banking entity reasonably believes that the offering proceeds of the CDO were used to invest primarily in TruPS issued by banks with less than $15 billion in assets, and (iii) the banking entity acquired the CDO on or before December 10, 2013. The regulators solicited comments on the interim final rule, and this exemption could change prior to its effective date. The Company currently does not have any impermissible holdings of TruPS CDOs under the interim final rule and, therefore, will not be required to divest of any such investments or change their accounting treatment. The Company is continuously reviewing its investments to ensure compliance as the various provisions of the Volcker Rule regulations become effective.

11

Table of Contents

Consumer Financial Protection. The Bank is subject to a number of federal and state consumer protection laws that extensively govern its relationship with its customers. These laws include the Equal Credit Opportunity Act, the Fair Credit Reporting Act, the Truth in Lending Act, the Truth in Savings Act, the Electronic Fund Transfer Act, the Expedited Funds Availability Act, the Home Mortgage Disclosure Act, the Fair Housing Act, the Real Estate Settlement Procedures Act, the Fair Debt Collection Practices Act, the Service Members Civil Relief Act, Secure and Fair Enforcement for Mortgage Licensing Act, laws governing flood insurance, federal and state laws prohibiting unfair and deceptive business practices, foreclosure laws, and various regulations that implement some or all of the foregoing. These laws and regulations mandate certain disclosure requirements and regulate the manner in which financial institutions must deal with customers when taking deposits, making loans, collecting loans and providing other services. If the Bank fails to comply with these laws and regulations, it may be subject to various penalties. Failure to comply with consumer protection requirements may also result in failure to obtain any required bank regulatory approval for merger or acquisition transactions the Bank may wish to pursue or being prohibited from engaging in such transactions even if approval is not required.

The Dodd-Frank Act centralized responsibility for consumer financial protection by creating a new agency, the Consumer Financial Protection Bureau (the “CFPB”), and giving it responsibility for implementing, examining, and enforcing compliance with federal consumer protection laws. The CFPB focuses on (i) risks to consumers and compliance with the federal consumer financial laws, (ii) the markets in which firms operate and risks to consumers posed by activities in those markets., (iii) depository institutions that offer a wide variety of consumer financial products and services, and (iv) non-depository companies that offer one or more consumer financial products or services.

The CFPB has broad rulemaking authority for a wide range of consumer financial laws that apply to all banks, including, among other things, the authority to prohibit “unfair, deceptive or abusive” acts and practices. Abusive acts or practices are defined as those that materially interfere with a consumer’s ability to understand a term or condition of a consumer financial product or service or take unreasonable advantage of a consumer’s (i) lack of financial savvy, (ii) inability to protect himself in the selection or use of consumer financial products or services, or (iii) reasonable reliance on a covered entity to act in the consumer’s interests. The CFPB can issue cease-and-desist orders against banks and other entities that violate consumer financial laws. The CFPB may also institute a civil action against an entity in violation of federal consumer financial law in order to impose a civil penalty or injunction.

Ability-to-Repay and Qualified Mortgage Rule. Pursuant to the Dodd-Frank Act, the CFPB issued a final rule on January 10, 2013 (effective on January 10, 2014), amending Regulation Z as implemented by the Truth in Lending Act, requiring mortgage lenders to make a reasonable and good faith determination based on verified and documented information that a consumer applying for a mortgage loan has a reasonable ability to repay the loan according to its terms. Mortgage lenders are required to determine consumers’ ability to repay in one of two ways. The first alternative requires the mortgage lender to consider the following eight underwriting factors when making the credit decision: (i) current or reasonably expected income or assets; (ii) current employment status; (iii) the monthly payment on the covered transaction; (iv) the monthly payment on any simultaneous loan; (v) the monthly payment for mortgage-related obligations; (vi) current debt obligations, alimony, and child support; (vii) the monthly debt-to-income ratio or residual income; and (viii) credit history. Alternatively, the mortgage lender can originate “qualified mortgages,” which are entitled to a presumption that the creditor making the loan satisfied the ability-to-repay requirements. In general, a “qualified mortgage” is a mortgage loan without negative amortization, interest-only payments, balloon payments, or terms exceeding 30 years. In addition, to be a qualified mortgage the points and fees paid by a consumer cannot exceed 3% of the total loan amount and the consumer’s debt-to-income (“DTI”) must be below the prescribed threshold. Qualified mortgages that are “higher-priced” (e.g. subprime loans) garner a rebuttable presumption of compliance with the ability-to-repay rules, while qualified mortgages that are not “higher-priced” (e.g. prime loans) are given a safe harbor of compliance. Small creditors, those financial institutions that meet the following requirements: (i) have assets below $2 billion (adjustable annually by CFPB); (ii) originated no more than 500 first-lien, closed-end residential mortgages subject to the ability-to-repay requirements in the preceding calendar year; and (iii) holds the qualified mortgage loan in its portfolio after origination, may originate qualified mortgages that are not restricted by the specific DTI threshold (however, the DTI must still be considered) and may make balloon loans that will still be considered a qualified mortgage. The Company, as a small creditor, does comply with the “qualified mortgage rules” and the other applicable Truth in Lending requirements.

12

Table of Contents

Incentive Compensation. In June 2010, the federal bank regulatory agencies issued comprehensive final guidance on incentive compensation policies intended to ensure that the incentive compensation policies of financial institutions do not undermine the safety and soundness of such institutions by encouraging excessive risk-taking. The Interagency Guidance on Sound Incentive Compensation Policies, which covers all employees that have the ability to materially affect the risk profile of financial institutions, either individually or as part of a group, is based upon the key principles that a financial institution’s incentive compensation arrangements should (i) provide incentives that do not encourage risk-taking beyond the institution’s ability to effectively identify and manage risks, (ii) be compatible with effective internal controls and risk management, and (iii) be supported by strong corporate governance, including active and effective oversight by the financial institution’s board of directors.

The Federal Reserve and the OCC will review, as part of the regular, risk-focused examination process, the incentive compensation arrangements of financial institutions, such as the Company and the Bank, that are not “large, complex banking organizations.” These reviews will be tailored to each financial institution based on the scope and complexity of the institution’s activities and the prevalence of incentive compensation arrangements. The findings of the supervisory initiatives will be included in reports of examination. Deficiencies will be incorporated into the institution’s supervisory ratings, which can affect the institution’s ability to make acquisitions and take other actions. Enforcement actions may be taken against a financial institution if its incentive compensation arrangements, or related risk-management control or governance processes, pose a risk to the institution’s safety and soundness and the financial institution is not taking prompt and effective measures to correct the deficiencies. At December 31, 2014, the Company and the Bank have not been made aware of any instances of non-compliance with the final guidance.

Effect of Governmental Monetary Policies

The Company’s operations are affected not only by general economic conditions but also by the policies of various regulatory authorities. In particular, the Federal Reserve regulates money and credit conditions and interest rates to influence general economic conditions. These policies have a significant impact on overall growth and distribution of loans, investments and deposits; they affect interest rates charged on loans or paid for time and savings deposits. Federal Reserve monetary policies have had a significant effect on the operating results of commercial banks, including the Company, in the past and are expected to do so in the future.

Reporting Obligations under Securities Laws

The Company is subject to the periodic and other reporting requirements of the Exchange Act, including the filing of annual, quarterly and other reports with the SEC. The Company provides access to its SEC filings through the “Investor Relations” section of the Bank’s website at www.vnb.com and at www.vnbcorp.com. The Company’s SEC filings are posted and available at no cost on the website as soon as reasonably practicable after the reports are filed electronically with the SEC. The information on the website is not incorporated into this report or any other filing the Company makes with the SEC. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC at www.sec.gov.

Employees

At December 31, 2014, the Company had 101 full time equivalent employees. None of its employees are represented by any collective bargaining unit. The Company considers relations with its employees to be good.

The Company owns Bank Owned Life Insurance (“BOLI”) policies on executives and key personnel of the Company. BOLI is a bank-eligible asset designed to recover costs of providing pre- and post-retirement benefits and/or to finance general employee benefit expenses. Under BOLI policies, the executives and other key personnel are the insured, and the Company is the owner and beneficiary of the policies. The insured has no claim to the insurance policy or to the policy’s cash value. Under separate split dollar agreements, a portion of any death benefit may be paid to the beneficiaries of the insured employees, subject to the terms and restrictions of the split dollar endorsement agreement between the officer and the Company.

13

Table of Contents

Availability of Information

Prior to the Reorganization, the Bank filed its periodic and annual reports with the OCC. Beginning with the Reorganization on December 16, 2013, the Company files annual, quarterly, and other reports under the Exchange Act with the SEC. The Company’s filings are available through the SEC’s website at www.sec.gov. In addition, our annual report on Form 10-K, quarterly reports on Form 10-Q and current reports on Form 8-K, plus any amendments to these reports, are available, free of charge, at www.vnbcorp.com. These reports are available as soon as reasonably practical after they are filed with the SEC. The information on the Bank’s Internet website is not incorporated into this Annual Report on Form 10-K or any other filing the Company makes with the SEC.

Item 1A. RISK FACTORS.

Not required

Item 1B. UNRESOLVED STAFF COMMENTS.

None

Item 2. PROPERTIES.

The Company and its subsidiaries currently occupy seven full-service banking facilities in Charlottesville, Winchester, and Albemarle and Orange Counties. The Company’s main office and a full-service banking facility are located at 404 People Place, Charlottesville, Virginia. Full-service banking facilities are also located at 222 East Main Street, Charlottesville, Virginia; 1580 Seminole Trail, Charlottesville, Virginia; 1900 Arlington Boulevard, Charlottesville, Virginia; 102 East Main Street, Orange, Virginia; 186 North Loudoun Street, Winchester, Virginia; and 3119 Valley Avenue, #102, Winchester, Virginia. In addition, an administrative office was opened in 2013 at 402 South Main Street, Culpeper, Virginia and a loan production office was opened in 2014 at 92 Main Street, Suite 202-6, in Warrenton, Virginia.

The five-story building located at 404 People Place, Charlottesville, Virginia, just east of the Charlottesville city limits on Pantops Mountain, was constructed by the Bank on a pad site leased in 2005 from Pantops Park, LLC for a term of twenty years, with seven five-year renewal options. William D. Dittmar, Jr., a director of the Company, is the sole managing member of Pantops Park, LLC. Monthly rent for this space is a fair market rate as verified by an independent third-party appraisal. The building, consisting of approximately 43,000 square feet, was completed in early 2008, and the Bank opened this full-service office in April, 2008. Additionally, the office building serves as the corporate headquarters for the Company and its operations center, as well as the principal offices of VNB Wealth Management. A portion of the additional space not occupied by the Company and its subsidiaries is leased to tenants.

The property located at 1580 Seminole Trail, Charlottesville, Virginia has been fully owned by the Company since 2012. As of December 31, 2014, all of the other locations were leased from parties other than related parties. The banking facility located at 1900 Arlington Boulevard, Charlottesville, Virginia, was constructed by the Bank on a pad site which is leased by the Company. This space has additional space not occupied by the banking facility that has been leased to tenants.

Previously, VNBTrust leased space at 310 4^th Street, NE, Suite 102, Charlottesville, Virginia. As of January 1, 2014, this property was subleased to SRCM Holdings LLC, as part of the Sale Agreement described in Note 1 of the notes to the consolidated financial statements contained in Item 8 – Consolidated Financial Statements and Supplementary Data. Effective August 1, 2014, VNBTrust assigned its interest in the lease to SRCM Holdings, and the landlord released VNBTrust from all further liability on the lease. VNBTrust main office is now located at 404 People Place, Charlottesville, Virginia.

14

Table of Contents

See Note 6 – Premises and Equipment in the notes to the consolidated financial statements in Item 8 – Consolidated Financial Statements and Supplementary Data for information with respect to the amounts at which the Company’s premises and equipment are carried and commitments under long-term leases.

Item 3. LEGAL PROCEEDINGS.

In the ordinary course of its operations, the Company’s subsidiaries are parties to various legal proceedings. Based on the information presently available, management believes that the ultimate outcome of such proceedings will not have an adverse effect on the business or financial condition of the Company and its subsidiaries.

Item 4. MINE SAFETY DISCLOSURES.

Not applicable

15

Table of Contents

Part II

Common Stock Performance and Dividends

Virginia National Bankshares Corporation’s Common Stock is quoted on the OTC Markets Group’s OTCQX tier (“OTCQX”) under the symbol VABK. As of December 31, 2014, the Company had issued and outstanding 2,688,336 shares of Common Stock. These shares were held by approximately 556 shareholders of record and others who held shares at brokerage firms.

Prior to the second quarter of 2013, the Company had not paid a cash dividend. On June 18, 2013, the Board of Directors declared a quarterly cash dividend of $0.05 per share, payable on July 19, 2013 to shareholders of record as of July 8, 2013. Subsequently, quarterly dividends of $0.05 per share were declared as of September 19, 2013, December 17, 2013, and March 18, 2014 and quarterly dividends of $0.075 per share were declared May 20, 2014, September 18, 2014, and December 16, 2014. The payment of dividends is at the discretion of the Company’s Board of Directors and is subject to various federal and state regulatory limitations. As a bank holding company, the ability to pay dividends is dependent upon the overall performance and capital requirements of the subsidiary Bank.

For the years ended December 31, 2014 and December 31, 2013, the data in the table below represents the high bid and low bid quotations that occurred for the periods shown as reported by the OTCQX. These over-the-counter market quotations reflect inter-dealer prices, without retail mark-up, mark-down or commission and may not necessarily represent actual transactions. Additionally, the table shows the dividends declared per quarter in 2014 and 2013.

American Stock Transfer and Trust Company is the Company’s stock transfer agent and registrar.

Stock Repurchase Program

On September 22, 2014, the Company issued a press release and filed a Form 8-K with the Securities and Exchange Commission to announce the approval by its Board of Directors of a stock repurchase program authorizing repurchase of up to 400,000 shares of the Company's common shares through the open market or in privately negotiated transactions. The repurchase program is authorized through September 18, 2015.

16

Table of Contents

The table below represents the number of shares repurchased by quarter since the Plan’s inception on September 22, 2014 through December 31, 2014.

Item 6. SELECTED FINANCIAL DATA.

Not required.

The following discussion provides information about the major components of the results of consolidated operations and financial condition, liquidity and capital resources of Virginia National Bankshares Corporation. This discussion and analysis should be read in conjunction with the Consolidated Financial Statements and Notes to Consolidated Financial Statements.

Application of Critical Accounting Policies and Critical Accounting Critical Estimates

The accounting and reporting policies followed by the Company conform, in all material respects, to accounting principles generally accepted in the United States (“GAAP”) and to general practices within the financial services industry. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and accompanying notes. While the Company bases estimates on historical experience, current information and other factors deemed to be relevant, actual results could differ from those estimates.

The Company considers accounting estimates to be critical to reported financial results if (i) the accounting estimate requires management to make assumptions about matters that are highly uncertain and (ii) different estimates that management reasonably could have used for the accounting estimate in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, could have a material impact on the Company’s financial statements. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.

Following are the accounting policies and estimates that the Company considers as critical:

17

Table of Contents

Non-GAAP Presentations

The Company, in referring to its net income, is referring to income computed under GAAP. Management’s Discussion and Analysis of Financial Condition and Results of Operations also refer to various calculations that are non-GAAP presentations. They include:

18

Table of Contents

Results of Operations

The Company reported net income totaled $1.898 million, or $0.70 diluted per common share in 2014 compared to $6.896 million, or $2.56 diluted per common share in 2013. The decrease was primarily the result of a $12.257 million decrease in noninterest income and an increase in provision for loan losses of $146 thousand. Positively affecting net income for 2014 compared to 2013 was a decrease of $4.644 million in noninterest expense, an increase of $5 thousand in net interest income, and a decrease in provision for income taxes of $2.756 million.

The Company has two reportable segments, the Bank and VNB Wealth. Commercial banking involves making loans and generating deposits from individuals and businesses. Loan fee income, service charges from deposit accounts, and other non-interest-related fees such as fees for debit cards and ATM usage and fees for treasury management services generate additional income for this segment. VNB Wealth services include investment management, trust and estate administration, custody services, and financial planning. Fees for these services are charged on a fixed basis and a performance basis.

The Bank earned net income of $1.771 million in 2014, $278 thousand less than the $2.049 million earned in 2013. VNB Wealth earned net income of $127 thousand in 2014, compared to net income of $4.847 million in 2013.

The decrease in noninterest income of $12.257 million and the decrease of $4.644 million in noninterest expense resulted primarily from the sale of Swift Run Capital Management, LLC (“SRCM”) in July, 2013 and the subsequent transfer of other assets under management to SRCM (together, “SRCM Transfers”) contemplated by the Sale Agreement previously discussed. Both performance fees earned and the related incentive compensation payable decreased significantly from 2013 to 2014 as a result of the SRCM Transfers. VNBTrust earned $523 thousand in performance fees in 2014 and earned $12.267 million in performance fees in 2013. This amount for 2013 included 100% of the fees earned on assets under management on which performance fees are earned (“Incentive AUMs”) that were sold or transferred to SRCM (the “Transferred Assets”) during 2013, as well as on Incentive AUMs remaining at VNBTrust. Likewise, the incentive compensation was accrued on all performance fees earned by VNBTrust in 2013, including the fees earned on the Transferred Assets. At December 31, 2013, the Incentive AUMs related to the Transferred Assets had an aggregate market value of $99.6 million, which represented 38.7% of the total Incentive AUMs on which VNBTrust earned performance fees in 2013. As provided in the Sales Agreement, starting in 2014, VNBTrust received only 20 percent of the performance fees earned on the Transferred Assets. A further discussion of the changes in Noninterest Income and Noninterest Expense can be found under these respective headings later in this report.

19

Table of Contents

Details of the changes in the various components of net income are further discussed below.

Consolidated Return on Equity and Assets

The annualized ratio of net income to average total assets and average shareholders' equity and certain other ratios for the periods indicated are as follows:

One of the ratios the Company examines in its evaluation of net income is the efficiency ratio, which measures the cost to produce one dollar of revenue. A lower ratio, computed by dividing noninterest expense by the sum of net interest income (on an FTE basis) and noninterest income, is an indicator of increased efficiency. The efficiency ratio for 2014 was negatively impacted as a result of a revenue decrease of $12.236 million as compared to 2013 and despite a decrease in noninterest expense of $4.644 million in 2014 over 2013. The contraction in revenue and expense in 2014 from 2013 were primarily attributable to a decrease in Trust performance fee revenue and the associated incentive compensation expense. This is a result of the restructuring of VNBTrust (now operating under the trade name VNB Wealth Management) and the transactions related to Swift Run Capital Management, LLC discussed earlier under Item 1: Business.

The efficiency ratio for 2013 improved from 2012 as a result of the increased revenue of $4.810 million that came primarily from VNBTrust performance fee revenue as discussed above. Noninterest expense for 2013 was $2.385 million greater than 2012 due mainly to the increase in VNBTrust’s incentive compensation that was associated with 2013’s higher performance fee revenue.

The efficiency ratio for the years ended December 31, 2014, 2013, and 2012 is shown below.

Net Interest Income

Net interest income is computed as the difference between the interest income on earning assets and the interest expense on deposits and other interest bearing liabilities. Net interest income represents the principal source of revenue for the Company and accounted for 72.1% of the total revenue in 2014. Net interest margin is the ratio of taxable-equivalent net interest income to average earning assets for the period. The level of interest rates and the volume and mix of earning assets and interest-bearing liabilities impact net interest income and net interest margin.

During 2014, net interest income, on a tax equivalent basis, totaled $14.700 million and was fairly level with the 2013 total of $14.679 million. Despite average earning assets for 2014 being $23.845 million higher compared to 2013, lower interest rates and the mix of earning asset balances for 2014 versus 2013 offset the benefits from the increased volume. The average balance for loans as a percentage of earnings assets for 2014 was 61.8% while average loan balances during 2013 were 64.5% of earning assets. The decrease in average loans as a percentage of earning assets was offset by increases in average balances as a percentage of earning assets for lower yielding investment securities and Federal Funds Sold. Investment securities balances were 29.2% of earning assets in 2014; up from 27.8% in 2013. Similarly, Federal Funds average balances were 8.6% of earning assets in 2014, up from 7.4% in 2013. The tax equivalent yield on investment securities was 2.13% for 2014, or 211 basis points less than the yield of 4.24% for the loan portfolio. This illustrates the impact that the mix of investments and loans had not only on the earning asset yield but on the related interest income.

20

Table of Contents

The net interest margin declined 16 basis points to 3.07% for the year ended December 31, 2014 from 3.23% reported for 2013. Further, the decrease in the net interest margin for 2013 was 19 basis points from the 3.42% net interest margin reported for the year ended December 31, 2012.

Total interest income, on a tax equivalent basis, aggregated $15.628 million for 2014, down $48 thousand from 2013, primarily as a result of a decline in loan interest income of $450 thousand. The decline from loan interest income was partially offset by an increase of $380 thousand in tax equivalent interest income from the investment portfolio when comparing 2014 to 2013. In comparing 2013 to 2012, total interest income, on a tax equivalent basis, declined $1.318 million to $15.676 million in 2013 from $16.994 million in 2012. The tax-equivalent yield on interest-earning assets was 3.27% for 2014, compared to 3.45% for 2013 and 3.70% for 2012.

The $450 thousand decrease in interest income earned on the loan portfolio for 2014, from $12.998 million in 2013, was mainly attributable to lower yields realized on new production and loans with rate adjustments in the protracted low interest rate environment combined with payoffs of higher interest loans. The yield on the loan portfolio decreased to 4.24% for 2014 from 4.43% for 2013, resulting in a decrease of $550 thousand in loan interest income solely attributable to yields. Partially offsetting the decline in yields on loans was a $100 thousand increase in loan interest income that is solely attributable to higher average loan balances of $295.9 million in 2014 compared to $293.5 million for 2013.

The decline in interest income earned on the loan portfolio during 2014 was a continuation of the yield compression experienced over the past few years and intense competition for loans. Loan interest income had decreased $1.722 million for 2013 from $14.720 million in 2012. The yield on the loan portfolio decreased 56 basis points in 2013 from 4.99% for 2012.

Interest earned on the securities portfolio, on a tax-equivalent basis, increased to $2.971 million for 2014 from $2.591 million in 2013 and $2.154 million in 2012. Average securities balances increased to $139.650 million (29.2% of average earning assets) for 2014 from $126.157 million (27.7% of average earning assets) and $104.800 million (22.8% of average earning assets) in 2013 and 2012, respectively. The average yield on investment securities increased 8 basis points in 2014 from 2.05% in the corresponding 2013 period. In 2012, the average yield on the investment portfolio was 2.06%.

Management’s asset/liability strategy for the investment portfolio is to maintain diversity within the investment portfolio by adding mortgage-backed securities, bank-qualified municipal bonds, and corporate bonds. The average duration of the investment portfolio continues to be relatively short. Adding mortgage-backed securities has resulted in providing a consistent stream of cash flow that can be diverted to loan growth or re-invested in higher yielding securities if interest rates rise. The level of bank-qualified municipal bonds has favorably contributed to reducing the Company’s effective income tax rate.

Total interest expense decreased slightly by $69 thousand for 2014 to $928 thousand from $997 thousand for 2013, mainly due to a decline in the rates paid for interest-bearing liabilities from 0.32% for 2013 to 0.30% for 2014. Average balances of interest-bearing liabilities of $309.1 million for 2014 was virtually unchanged from 2013. Total interest expense decreased by $284 thousand for 2013 from $1.281 million for 2012. Further, rates paid for interest-bearing liabilities declined from 0.43% for 2012 to 0.32% for 2013.

A continuing primary driver of the Company’s low cost of funds compared to peers is the Company’s level of non-interest bearing demand deposits and low-cost deposit accounts. Below is a table illustrating the average balances of these accounts as a percentage of total deposit account balances.

Non-interest and low-cost deposit account analysis

21

Table of Contents

Consolidated Average Balance Sheet And Analysis of Net Interest Income

22

Table of Contents

Volume and Rate Analysis

The following table describes the impact on the net interest income of the Company resulting from changes in average balances and average rates for the periods indicated. The change in interest due to both volume and rate has been allocated to volume and rate changes in proportion to the relationship of the absolute dollar amounts of the change in each. Interest income is reported on a tax-equivalent basis.

2014 compared to 2013
(dollars in thousands)

2013 compared to 2012
(dollars in thousands)

23

Table of Contents

Provision for Loan Losses

The level of the allowance reflects changes in the size of the portfolio or in any of its components as well as management’s continuing evaluation of industry concentrations, specific credit risks, loan loss experience, current loan portfolio quality and 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. Additional information concerning management’s methodology in determining the adequacy of the allowance for loan losses is contained in Note 1 and Note 4 of the notes to consolidated financial statements, found in Item 8 – Consolidated Financial Statements and Supplementary Data, later in this report.

Based on management’s continuing evaluation of the loan portfolio in 2014, the Company recorded a provision for loan losses of $306 thousand, compared to 2013 when the Company recorded a provision for loan losses of $160 thousand. One of the major factors in driving the $146 thousand increase in the provision for loan loss between 2014 and 2013 was the net increase in loan balances of $13.22 million as of December 31, 2014 from December 31, 2013. The other major factor that influenced an increase in the provision expense was the higher level of net charge-offs in 2014 compared to 2013.

There were $551 thousand in loan balances charged off during 2014, with a total of $49 thousand in recoveries of previously charged-off balances. This resulted in net charge-offs of $502 thousand during 2014. There were $161 thousand in loan balances charged off during 2013, with a total of $94 thousand in recoveries of previously charged-off balances, resulting in net charge-offs of $67 thousand during 2013. The ratio of net charge-offs to average loans remained strong at 0.17% for 2014 compared to 0.02% for 2013 and 0.13% for 2012.

As of December 31, 2014, the allowance for loan losses was $3.164 million, a decrease of $196 thousand from $3.360 million at December 31, 2013. Factors positively affecting the provision for the years 2014 compared to 2013 included a continuing improved economic climate and an overall improvement in asset quality. Management’s estimates for the allowance for loan losses resulted in the Company’s allowance to total loans outstanding ratio to be 1.01% at December 31, 2014, compared to the 1.12% reported at December 31, 2013 and the 1.15% at December 31, 2012. See the section captioned “Allowance for Loan Losses” later in this report and Note 3 – Loans and Note 4 – Allowance for Loan Losses in the notes to consolidated financial statements, included in Item 8 – Consolidated Financial Statements and Supplementary Data, later this report for further details of the risk factors considered by management in estimating the necessary level of the allowance for loan losses.

Noninterest Income

Noninterest income decreased from $17.854 million for 2013 to $5.597 million in 2014. The decrease of $12.257 million principally resulted from fee revenues from VNB Wealth, which were down $12.614 million in 2014 compared to 2013. Noninterest income, exclusive of trust fees, totaled $3.230 million in 2014, an increase of $357 thousand as compared to $2.873 million in 2013.

Late in the third quarter of 2014, a new fee structure for the Bank was implemented as part of management’s revenue enhancement strategy. Many of the Bank’s fees had not been increased in several years, and the reassessment of the fees allowed the Bank to increase revenue while remaining at the same level or lower than its competition.

In addition, in mid-2014, the Company initiated a new source of revenue by hiring a secondary market mortgage loan originator. Since the new business line and new fee schedules were not completely implemented until the fourth quarter of 2014, the Company has not yet fully realized the impact that these changes would have on a full-year basis.

24

Table of Contents

The major components of noninterest income are detailed below. Year-to-year variances are shown for trust income and for other noninterest income categories.

Trust income is primarily derived from two forms of fee income: management fees and performance fees. Management fees will vary depending on the type of account, investment authority and assets under management (“AUMs”). During 2014, VNB Wealth recognized $1.844 million in management fees, a decrease of $870 thousand compared to 2013. The decrease in management fees is attributed in large part to the net decrease in AUMs from $583.6 million at December 31, 2013 to $484.7 million at December 31, 2014.

Performance fees are based on the year-over-year increase in the market value (both realized and unrealized gains) of managed Incentive AUMs. Performance fees are assessed based upon the appreciation in the market value of Incentive AUMs at December 31^st compared to the preceding January 1^st. As discussed in the Results of Operations section earlier in this report, the decrease in performance fees resulted primarily from the sale of SRCM and SRCM Transfers under the Sale Agreement. VNBTrust earned 100% of the performance fees earned on the Incentive AUMs of $99.6 million which were managed by SRCM as of December 31, 2013. The performance fees earned in 2013 by VNBTrust on Incentive AUMs transferred to SRCM and to other investment managers totaled $5.548 million, representing 45.2% of the total performance fees of $12.267 million earned by VNBTrust. As of December 31, 2014, Incentive AUMs on which VNBTrust received performance fees were $55.1 million compared to $257.2 million at December 31, 2013. The remaining decrease in performance fees in 2014 resulted from lower level of market appreciation of Incentive AUMs in 2014 compared to 2013.

Starting in 2014, VNBTrust received 20% of the management and performance fee revenue from AUMs that transferred to SRCM as contemplated under Sale Agreement, which VNBTrust recorded as royalty income rather than as performance fees or management fees of VNBTrust. VNBTrust recorded royalty revenue of $593 thousand for the twelve months ended December 31, 2014 on Incentive AUMs that transferred to SRCM. Additional information on royalty income is discussed below.

Royalty income of $593 thousand was recorded in 2014 in accordance with the first year of the Sale Agreement with SRCM Holdings. Beginning in 2014 for a ten-year period, ongoing royalty payments will be paid to VNBTrust. Performance fee royalty income is recognized in the same manner and timeframe as the performance fees earned by VNB Wealth and totaled $426 thousand for 2014, with the remaining $167 thousand representing fixed fee royalty income. Additional details on this Sale Agreement with SRCM Holdings, LLC are discussed in Note 1 of the notes to the consolidated financial statements and are found under Item 8 – Consolidated Financial Statements and Supplementary Data, later in this report.

25

Table of Contents

Gains on sales of assets decreased $260 thousand in the year-over-year comparison. The $304 thousand gain in 2013 was the result of the sale of the former fund management business to SRCM Holdings, LLC Additional details on this transaction are found in Note 1, of the notes to the consolidated financial statements, under Item 8 – Consolidated Financial Statements and Supplementary Data, later in this report. The $44 thousand gain in 2014 was the result of the sale of stock and a Company-owned automobile.

Other noninterest income increased $70 thousand in 2014 to $494 thousand from $424 thousand. Approximately $59 thousand of the increase in other noninterest income for 2014 can be associated with the Bank’s new deposit account fee schedule implemented in late 2014, as discussed above. In addition, in mid-2014, the Company hired a secondary market mortgage loan originator; income of $76 thousand was generated from this new line of business. These increases were partially offset by contractions in brokerage fees of $47 thousand and miscellaneous other fees of $32 thousand.

Noninterest Expense

Total noninterest expense for the year ended December 31, 2014 was $17.391 million, or $4.644 million lower than the $22.035 million reported for the year ended December 31, 2013. The decrease was almost entirely due to the decrease of $4.995 million in VNB Wealth incentive compensation. In 2013, incentive compensation paid by VNB Wealth was based entirely on the performance fee revenue earned by VNBTrust through December 31, 2013, including 100% of the revenue earned on assets associated with the sale of SRCM under the Sale Agreement, as explained earlier in the Results of Operations and Noninterest Income sections of the management’s discussion and analysis. Following the sale of SRCM, changes were made to VNB Wealth’s compensation agreements for 2014 to separate incentive compensation paid by VNB Wealth from the amount of performance fees earned by VNB Wealth. Noninterest expense, excluding the VNB Wealth incentive compensation cost, was $16.842 million for 2014, $351 thousand higher than the $16.491 million recorded in 2013 as noninterest expense.

The major components of noninterest expense are detailed below for the years ended December 31, 2014 and December 31, 2013. The personnel expenses related to the VNB Wealth incentive compensation have been separated from the remaining noninterest expense categories to allow a more meaningful year-to-year comparison.

Total Salaries and employee benefits were lower in 2014, by $4.441 million compared to 2013. The primary reason was a decrease of $4.995 million in the total booked as VNB Wealth incentive compensation as discussed previously. Incentive compensation expenses of $5.544 million were recorded for 2013, compared to $549 thousand recorded for 2014. Higher incentive compensation costs, calculated in accordance with pre-established formulas, were related to the increased performance fee revenue for VNB Wealth in 2013. Excluding the VNB Wealth incentive compensation cost for both years, personnel expense was $8.756 million for 2014 or $554 thousand higher than the $8.202 million recorded for 2013. In 2014 VNB Wealth made key hires to augment operational improvements, trading and financial planning and changed the method of calculating incentive compensation. The increase in salaries and employee benefits is directly related to these hires, as well as the Bank’s hiring of experienced lenders to increase loan production. In addition, benefits expenses were higher due to an increase in the rate of the 401(k) employer match for contributions for all eligible Company employees.

26

Table of Contents

Net occupancy and equipment expenses were reduced by $150 thousand and $155 thousand, respectively, in 2014 from the 2013 levels. The decrease in occupancy expense is largely attributable to the reduction in rent expense as a result of relocating VNB Wealth offices from formerly leased space into available space at the Company’s Pantops Office building in Charlottesville. Equipment expense was lower primarily due to a decline in depreciation cost of $107 thousand, as various equipment became fully depreciated in 2014.

Bank franchise tax increased $75 thousand in 2014 to $328 thousand as compared to $253 thousand for 2013. In 2013, the Bank was able to take advantage of available Neighborhood Assistance Credits that directly reduced the tax liability.

Data processing expense of $1.025 million during 2014 were $76 thousand higher than the $949 thousand recognized in 2013. The increase was mainly attributable to deconversion costs associated with the VNB Wealth’s core system conversion in the fourth quarter of 2014. This change was planned and implemented to improve portfolio reporting and portfolio management capabilities to provide better service to VNB Wealth clients.

Professional fees and other expenses decreased by $245 thousand in 2014 as compared to 2013 when the Company paid legal and consulting fees associated with the formation of the bank holding company and the sale of Swift Run Capital Management, LLC.

Provision for Income Taxes

In 2014, the Company provided $456 thousand for Federal income taxes, resulting in an effective income tax rate of 19.4%. For 2013, the Company provided $3.212 million for Federal income taxes, resulting in an effective income tax rate of 31.8%. The effective income tax rates differed from the U.S. statutory rate of 34% during the comparable periods primarily due to the effect of tax-exempt income from municipal bonds and life insurance policies. The lower effective tax rate during 2014 was related to the relative level of the income from these tax-exempt instruments to other taxable income. The significantly high level of trust performance fee income in 2013 caused the effective tax rate to be higher for that year. More information on income taxes, including net deferred taxes can be found in Note 8 of the notes to the consolidated financial statements which is found in Item 8 – Consolidated Financial Statements and Supplementary Data, later in this report.

BALANCE SHEET ANALYSIS

Securities

The investment securities portfolio has a primary role in the management of the Company’s liquidity requirements, interest rate sensitivity and in generating substantial interest income. Investment securities play a key role in diversifying the Company’s balance sheet. In addition, a portion of the investment securities portfolio is pledged as collateral for public fund deposits and for commercial customers utilizing the Bank’s overnight repurchase program. Changes in deposit and other funding balances and in loan production will impact the overall level of the investment portfolio.

As of December 31, 2014, the Company’s investment portfolio totaled $143.381 million, of which obligations of U.S. government corporations and government-sponsored enterprises amounted to $98.354 million which is approximately 68.6% of the total. The investment portfolio as of December 31, 2013 totaled $134.672 million. The year over year growth of 6.5% was primarily a result of management’s focus on maximizing the earning capacity of the Company’s excess liquidity by moving funds from overnight federal funds and into investment securities.

In accordance with ASC 320, “Investments - Debt and Equity Securities,” the Company has categorized its unrestricted securities portfolio as Available for Sale (“AFS”). Securities classified as AFS may be sold in the future, prior to maturity. Any decision to sell a security classified as AFS would be based on various factors, including significant movements in interest rates, changes in the maturity mix of the Company’s assets and liabilities, liquidity needs, regulatory capital considerations, and other similar factors. AFS 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. All of the Company’s securities were investment grade or better as of December 31, 2014. 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. AFS securities included gross unrealized gains of $870 thousand and gross unrealized losses of $803 thousand as of December 31, 2014.

27

Table of Contents

During the third quarter of 2013, the Company reclassified its held to maturity (“HTM”) securities as AFS. Management determined that it no longer had the positive intent to hold the securities classified as HTM for an indefinite period of time because of management’s desire to have more flexibility in managing the investment portfolio. As of June 30, 2013, the Company had three corporate and municipal securities designated as HTM recorded at an amortized cost of $2.699 million. The fair value of these securities was $2.733 million, reflecting an unrealized gross gain of $34 thousand. The unrealized gross gain of $34 thousand, net of income taxes, was recorded as other comprehensive income at the time of the transfer. As a result of this transfer, there were no securities classified as held to maturity as of December 31, 2014 or December 31, 2013.

For the year ended December 31, 2014, proceeds from the sales of securities amounted to $7.498 million and realized gains on these securities were $24 thousand. For the year ended December 31, 2013, proceeds from the sales of securities amounted to $16.854 million and realized gains on these securities were $50 thousand.

Securities Held to Maturity and Available for Sale
(dollars in thousands)

All mortgage-backed securities included in the tables above were issued by U.S. government agencies and corporations. At December 31, 2014, the securities issued by political subdivisions or agencies (“municipal bonds”) were highly rated, with 83% of the municipal bonds having credit ratings from nationally recognized statistical rating organizations of AA or higher. Approximately 79% of the municipal bonds are general obligation bonds with issuers that are geographically diverse.

28

Table of Contents

The Company does not hold any derivative instruments. The Company held no issues that exceeded 10% of Shareholders' Equity at December 31, 2014.

The Company’s holdings of restricted securities totaled $1.565 million at December 31, 2014 and $1.645 million at December 31, 2013 and consisted of Federal Reserve Bank of Richmond, Federal Home Loan Bank of Atlanta, and for December 31, 2014, stock of CBB Financial Corporation, the holding company for Community Bankers Bank. The Bank is required to hold stock in the Federal Reserve Bank of Richmond and the Federal Home Loan Bank of Atlanta as a condition of membership with each of these correspondent banks. The amount of stock required to be held by the Bank is periodically assessed by each bank, and the Bank may be subject to purchase or put back stock held in these banks, as determined by their respective calculations. Stock ownership in the bank holding company for Community Bankers’ Bank provides the Bank with several benefits that are not available to non-shareholder correspondent banks. None of these stock issues are traded on the open market and can only be redeemed by the respective issuer. Restricted stock holdings are recorded at cost.

The table shown below details the amortized cost and fair value of available for sale securities at December 31, 2014 based upon contractual maturities, by major investment categories. Expected maturities may differ from contractual maturities because issuers have the right to call or prepay obligations. The tax-equivalent yield is based upon a federal tax rate of 34%.

Maturity Distribution and Average Yields
(dollars in thousands)

29

Table of Contents

The above table reflects the distribution of the contractual maturities of investment portfolio at December 31, 2014. Management’s investment portfolio strategy is to structure the portfolio so that it is a constant source of liquidity for the balance sheet. In order to achieve greater liquidity in the portfolio, securities that have a monthly flow of principal repayments become a key component. To illustrate the difference between contractual maturity and average life, consider the difference for the fixed rate mortgage-backed securities (MBS) component of this portfolio. At December 31, 2014, the weighted average maturity (WAM) of the fixed rate MBS sector was 10.75 years, and the projected average life for this group of securities is 3.8 years.

Another indication of the investment portfolio’s liquidity potential is shown by the projected annual principal cash flow from maturities, callable bonds, and monthly principal repayments. For the next three years, the principal cash flows are estimated to be $30.4 million for 2015, $19.3 million for 2016, and $21.1 million for 2017, based upon rates remaining at current levels. This represents nearly 50% of the investment portfolio’s balance at December 31, 2014 that will be available to support the future liquidity needs of the Company. Cash flow projections are subject to change based upon changes to market interest rates.

Loan Portfolio

The Company’s loan portfolio totaled $313.254 million as of December 31, 2014 or 58.3% of total assets. Loan balances increased $13.22 million, or 4.4% from the balance of $300.034 million as of December 31, 2013.

The Company’s objective is to maintain the historically strong credit quality of the loan portfolio by maintaining rigorous underwriting standards. These standards coupled with regular evaluation of the creditworthiness of and the designation of lending limits for each borrower has helped to Company achieve this objective. The primary portfolio strategy includes seeking industry and loan size diversification in order to minimize credit exposure and originating loans in markets with which the Company is familiar. The predominant market area for loans is Charlottesville, Albemarle County, Orange County, Winchester, Frederick County and adjacent counties.

The Company also purchases commercial and industrial loans from the syndicated loan market. The same underwriting standards applied to the organic loan portfolio are applied to purchased syndicated loans. Additionally, the Company has developed policies to limit overall credit exposure to the syndicated market as a whole and to each borrower. The purchase of syndicated loans is considered a secondary strategy, which allows the Company to supplement organic loan growth and enhance earnings until sufficient loan demand returns to the Company’s market area.

The Company’s commercial and industrial loan portfolio totaled $60.940 million and represented approximately 19.5% of all loans as of December 31, 2014. This category includes loans made to individuals and small and medium-sized businesses, as well as loans purchased on the syndicated market. Syndicated loans totaled $14.815 million of the commercial loan total.

The Company’s real estate loan portfolio increased by $7.093 million, from the balance of $219.909 million at December 31, 2013, to $227.002 million at December 31, 2014. This category represented approximately 72.5% of all loans, and these loans are secured by mortgages on real property located principally in Virginia. Of this amount, approximately $85.660 million represented loans on residential properties. Commercial real estate loans totaled $141.342 million as of December 31, 2014. Sources of repayment are from the borrower’s operating profits, cash flows and liquidation of pledged collateral.

Loans for construction and land development totaled $11.912 million and represented 3.8% of all loans as of December 31, 2014. Loans to consumers, included revolving credit and other fixed payment loans, totaled $13.400 million as of December 31, 2014 or 4.3% of all loans.

Based on underwriting standards, loans and leases 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.

30

Table of Contents

Loan Portfolio

(dollars in thousands)

31

Table of Contents

Maturities and Sensitivities of Loans to Changes in Interest Rates. The following table presents the maturity distribution of the Company’s loans at December 31, 2014. The table also presents the portion of loans that have fixed interest rates or variable/floating interest rates that fluctuate over the life of the loans in accordance with changes in an interest rate index such as the prime rate or U.S. Treasury bond indices.

Loan Asset Quality

Intrinsic to the lending process is the possibility of loss. In times of economic slowdown, the risk of loss inherent in the Company’s loan portfolio may increase. While management endeavors to minimize this risk, it recognizes that loan losses will occur and that the amount of these losses will fluctuate depending on the risk characteristics of the loan portfolio, which in turn depend on current and future economic conditions, the financial condition of borrowers, the realization of collateral, and the credit management process.

The Company places a loan on non-accrual status when management believes, after considering economic and business conditions and collections efforts, that it is probable that the Company will be unable to collect all amounts due according to the contractual terms of the loan agreement, or when the loan is past due for 90 days or more, unless the debt is both well-secured and in the process of collection.

Troubled debt restructurings (“TDRs”) occur when the Company agrees to modify the original terms of a loan by granting a concession that it would not otherwise consider due to the deterioration in the financial condition of the borrower. These concessions are done in an attempt to improve the paying capacity of the borrower, and in some cases to avoid foreclosure, and are made with the intent to restore the loan to a performing status once sufficient payment history can be demonstrated. These concessions could include reductions in the interest rate, payment extensions, forgiveness of principal, forbearance or other actions. TDRs that are considered to be performing continue to accrue interest under the terms of the restructuring agreement. TDRs that have been placed in non-accrual status are considered to be nonperforming.

32

Table of Contents

At December 31, 2014, the Company had three loans with balances of $218 thousand classified as non-accrual. This compares favorably to December 31, 2013, when the Company had five loans with balances of $367 thousand classified as non-accrual and to December 31, 2012 when the Company had seven loans with balances of $1.403 million in this category. Troubled Debt Restructurings that are still performing have remained fairly constant over the three years shown and ended December 31, 2014 with three loans totaling $1.479 million classified as TDRs. The Company ended the year with no loans over 90 days past due that were still accruing interest. Below is a summary of loans identified with these risk elements:

See Note 3 – Loans and Note 4 – Allowance for Loan Losses in the accompanying notes to consolidated financial statements included in Item 8 – Consolidated Financial Statements and Supplementary Data for further details regarding the Company’s loan asset quality measurements.

Allowance for Loan Losses

The Company is committed to determining, on an ongoing basis, the adequacy of its allowance for loan losses. The Company applies historical loss rates to various pools of loans. Thereafter, the adequacy of the allowance is evaluated through reference to the following qualitative factors: national and local economic trends; underlying collateral values; loan delinquency status and trends; loan risk classifications; industry concentrations; lending policies; experience, ability and depth of lending staff; and levels of policy exceptions.

At December 31, 2014, the allowance was $3.164 million and represented 1.01% of outstanding loans. The allowance for loan losses at December 31, 2013, was $3.360 million and represented 1.12% of outstanding loans. The purpose of the allowance is to provide for probable losses inherent in the loan portfolio. Since risks to the loan portfolio include general economic trends as well as conditions affecting individual borrowers, the allowance is an estimate.

33

Table of Contents

Activity for the allowance for loan losses is provided in the following table.

Summary of the Allowance for Loan Losses

(dollars in thousands)

Please refer to Note 4 – Allowance for Loan Losses in the accompanying notes to consolidated financial statements for additional details into management's approach and methodology in estimating the allowance for loan losses.

34

Table of Contents

The table below provides an allocation of year-end allowance for loan losses by loan type; however, allocation of a portion of the allowance to one loan category does not preclude its availability to absorb losses in other categories.

Allocation of the Allowance for Loan Losses

(dollars in thousands)