Virginia National Bankshares Corp - Quarter Report: 2021 June (Form 10-Q)

Large accelerated filer

Accelerated filer

Non-accelerated filer

Smaller reporting company

Emerging growth company

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

FORM 10-Q

(Mark One)

☒	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2021

☐	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from ___________ to ___________

Commission File Number: 001-40305

VIRGINIA NATIONAL BANKSHARES CORPORATION

(Exact Name of Registrant as Specified in its Charter)

Virginia	46-2331578
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)
404 People Place
Charlottesville, Virginia	22911
(Address of principal executive offices)	(Zip Code)

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

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

Title of each class

Trading

Symbol(s)

Name of each exchange on which registered

Common Stock

VABK

The Nasdaq Capital Market

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 ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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 ☒

Indicate by check mark whether the registrant has filed all documents and reports required to be filed by Sections 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes ☒ No ☐

As of August 10, 2021, the registrant had 5,306,419 shares of common stock, $2.50 par value per share, outstanding.

VIRGINIA NATIONAL BANKSHARES CORPORATION

FORM 10-Q

TABLE OF CONTENTS

Part I. Financial Information
Item 1 Financial Statements		Page 3
Consolidated Balance Sheets (unaudited)		Page 3
Consolidated Statements of Income (unaudited)		Page 4
Consolidated Statements of Comprehensive Income (unaudited)		Page 5
Consolidated Statements of Changes in Shareholders’ Equity (unaudited)		Page 6
Consolidated Statements of Cash Flows (unaudited)		Page 7
Notes to Consolidated Financial Statements (unaudited)		Page 8

Item 2 Management’s Discussion and Analysis of Financial Condition and Results of Operations		Page 36
Application of Critical Accounting Policies and Estimates		Page 39
Financial Condition		Page 40
Results of Operations		Page 46

Item 3 Quantitative and Qualitative Disclosures About Market Risk		Page 55

Item 4 Controls and Procedures		Page 55

Part II. Other Information
Item 1 Legal Proceedings		Page 55
Item 1A Risk Factors		Page 55
Item 2 Unregistered Sales of Equity Securities and Use of Proceeds		Page 55
Item 3 Defaults Upon Senior Securities		Page 55
Item 4 Mine Safety Disclosures		Page 55
Item 5 Other Information		Page 55
Item 6 Exhibits		Page 56

Signatures		Page 57

PART I. FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED BALANCE SHEETS

(Dollars in thousands, except per share data)

	June 30, 2021			December 31, 2020*
ASSETS	(Unaudited)
Cash and due from banks	$	29,605		$	8,116
Interest-bearing deposits in other banks		177,753			—
Federal funds sold		106,621			26,579
Securities:
Available for sale, at fair value		266,973			174,086
Restricted securities, at cost		4,272			3,010
Total securities		271,245			177,096
Loans		1,166,161			609,406
Allowance for loan losses		(5,522	)		(5,455	)
Loans, net		1,160,639			603,951
Premises and equipment, net		25,386			5,238
Bank owned life insurance		30,832			16,849
Goodwill		8,898			372
Core deposit intangible, net		8,272			—
Other intangible assets, net		307			341
Other real estate, net		611			—
Right of use asset, net		8,371			3,527
Accrued interest receivable and other assets		18,582			6,341
Total assets	$	1,847,122		$	848,410
LIABILITIES AND SHAREHOLDERS' EQUITY
Liabilities:
Demand deposits:
Noninterest-bearing	$	449,483		$	209,772
Interest-bearing		431,556			148,910
Money market and savings deposit accounts		577,414			272,980
Certificates of deposit and other time deposits		170,995			99,102
Total deposits		1,629,448			730,764
Advances from the FHLB		42,989			30,000
Junior subordinated debt		3,345			—
Lease liability		7,833			3,589
Accrued interest payable and other liabilities		4,905			1,459
Total liabilities		1,688,520			765,812

Commitments and contingent liabilities
Shareholders' equity:
Preferred stock, $2.50 par value, 2,000,000 shares authorized, no shares outstanding		—			—
Common stock, $2.50 par value, 10,000,000 shares authorized; 5,305,819 shares issued and outstanding as of June 30, 2021 (includes 35,495 nonvested), and 2,714,273 shares issued and outstanding as of December 31, 2020 (includes 25,268 nonvested)		13,176			6,722
Capital surplus		104,360			32,457
Retained earnings		41,201			41,959
Accumulated other comprehensive income (loss)		(135	)		1,460
Total shareholders' equity		158,602			82,598
Total liabilities and shareholders' equity	$	1,847,122		$	848,410

*	Derived from audited Consolidated Financial Statements

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF INCOME

(Dollars in thousands, except per share data)

(Unaudited)

	For the three months ended					For the six months ended
	June 30, 2021			June 30, 2020		June 30, 2021		June 30, 2020
Interest and dividend income:
Loans, including fees	$	13,009		$	6,156	$	18,947	$	12,027
Federal funds sold		21			10		33		95
Other interest-bearing accounts		39			-		39		-
Investment securities:
Taxable		757			229		1,264		738
Tax exempt		273			92		449		167
Dividends		32			24		66		48
Total interest and dividend income		14,131			6,511		20,798		13,075

Interest expense:
Demand and savings deposits		548			390		925		1,085
Certificates and other time deposits		324			366		604		860
Repurchase agreements and other borrowings		108			-		144		-
Total interest expense		980			756		1,673		1,945
Net interest income		13,151			5,755		19,125		11,130
Provision for (recovery of) loan losses		(141	)		378		210		1,143
Net interest income after provision for (recovery of) loan losses		13,292			5,377		18,915		9,987

Noninterest income:
Wealth management fees		980			228		1,309		538
Advisory and brokerage income		359			163		550		341
Royalty income		12			24		17		71
Deposit account fees		426			143		586		322
Debit/credit card and ATM fees		599			134		753		291
Earnings/increase in value of bank owned life insurance		199			109		306		216
Fees on mortgage sales		-			30		-		77
Gains on sales of securities		-			590		-		643
Loan swap fee income		20			124		35		633
Other		325			81		403		163
Total noninterest income		2,920			1,626		3,959		3,295

Noninterest expense:
Salaries and employee benefits		4,741			2,258		7,143		4,682
Net occupancy		1,109			452		1,604		904
Equipment		340			136		456		267
Bank franchise tax		429			163		602		326
Computer software		216			136		383		276
Data processing		994			338		1,283		666
FDIC deposit insurance assessment		182			28		245		28
Marketing, advertising and promotion		232			140		369		279
Merger expenses		5,874			-		6,152		-
Professional fees		510			190		687		376
Core deposit intangible amortization		428			-		428		-
Other		938			563		1,422		1,143
Total noninterest expense		15,993			4,404		20,774		8,947

Income before income taxes		219			2,599		2,100		4,335
Provision for income taxes		72			511		448		843
Net income	$	147		$	2,088	$	1,652	$	3,492
Net income per common share, basic	$	0.03		$	0.77	$	0.41	$	1.29
Net income per common share, diluted	$	0.03		$	0.77	$	0.41	$	1.29

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Dollars in thousands)

(Unaudited)

	For the three months ended						For the six months ended
	June 30, 2021			June 30, 2020			June 30, 2021			June 30, 2020
Net income	$	147		$	2,088		$	1,652		$	3,492

Other comprehensive income (loss)

Unrealized gains (losses) on securities, net of tax of $506 and ($394) for the three and six months ended June 30, 2021; and net of tax of $512 and $403 for the three and six months ended June 30, 2020, respectively		1,903			1,920			(1,484	)		1,514

Reclassification adjustment for realized gains on sales of securities, net of tax of ($0) and ($0) for the three and six months ended June 30, 2021; and net of tax of ($124) and ($135) for the three and six months ended June 30, 2020, respectively		—			(466	)		—			(508	)

Unrealized losses on interest rate swaps, net of tax of ($30) and ($30) for the three and six months ended June 30, 2021; and net of tax of $0 and $0 for the three and six months ended June 30, 2020, respectively		(111	)		—			(111	)		—

Total other comprehensive income (loss)		1,792			1,454			(1,595	)		1,006

Total comprehensive income	$	1,939		$	3,542		$	57		$	4,498

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS' EQUITY

FOR THE THREE AND SIX MONTHS ENDED JUNE 30, 2021 AND 2020

(Dollars in thousands, except per share data)

(Unaudited)

									Accumulated
									Other
	Common		Capital			Retained			Comprehensive
	Stock		Surplus			Earnings			Income (Loss)			Total
Balance, December 31, 2019	$	6,720	$	32,195		$	37,235		$	(43	)	$	76,107
Stock option expense		-		24			-			-			24
Restricted stock grant expense		-		15			-			-			15
Cash dividends declared ($0.30 per share)		-		-			(811	)		-			(811	)
Net income		-		-			1,404			-			1,404
Other comprehensive loss		-		-			-			(448	)		(448	)
Balance, March 31, 2020	$	6,720	$	32,234		$	37,828		$	(491	)	$	76,291
Stock option expense		-		34			-			-			34
Restricted stock grant expense		-		39			-			-			39
Cash dividends declared ($0.30 per share)		-		-			(814	)		-			(814	)
Net income		-		-			2,088			-			2,088
Other comprehensive income		-		-			-			1,454			1,454
Balance, June 30, 2020	$	6,720	$	32,307		$	39,102		$	963		$	79,092

Balance, December 31, 2020	$	6,722	$	32,457		$	41,959		$	1,460		$	82,598
Exercise of stock options		1		14			-			-			15
Stock option expense		-		34			-			-			34
Restricted stock grant expense		-		61			-			-			61
Vested stock grants		7		(7	)		-			-			-
Cash dividends declared ($0.30 per share)		-		-			(814	)		-			(814	)
Net income		-		-			1,505			-			1,505
Other comprehensive loss		-		-			-			(3,387	)		(3,387	)
Balance, March 31, 2021	$	6,730	$	32,559		$	42,650		$	(1,927	)	$	80,012
Common stock issued in acquisition of Fauquier Bankshares, Inc.		6,428		71,608									78,036
Exercise of stock options		2		13			-			-			15
Stock option expense		-		31			-			-			31
Restricted stock grant expense		-		165			-			-			165
Vested stock grants		16		(16	)		-			-			-
Cash dividends declared ($0.30 per share)		-		-			(1,596	)		-			(1,596	)
Net income		-		-			147			-			147
Other comprehensive income		-		-			-			1,792			1,792
Balance, June 30, 2021	$	13,176	$	104,360		$	41,201		$	(135	)	$	158,602

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION

CONSOLIDATED STATEMENTS OF CASH FLOWS

(dollars in thousands)

(Unaudited)

	For the six months ended
	June 30, 2021			June 30, 2020
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income	$	1,652		$	3,492
Adjustments to reconcile net income to net cash provided by operating activities:
Provision for loan losses		210			1,143
Net accretion of certain acquisition-related discounts		(804	)		-
Amortization of intangible assets		462			57
Net amortization and accretion of securities		661			210
Net gains on sale of securities		-			(643	)
Earnings on bank owned life insurance		(306	)		(216	)
Deferred tax		25			-
Depreciation and other amortization		1,406			915
Stock option expense		65			58
Stock grant expense, restricted		226			-
Net change in:				54
Accrued interest receivable and other assets		(1,939	)		(430	)
Accrued interest payable and other liabilities		2,808			292
Net cash provided by operating activities		4,466			4,932

CASH FLOWS FROM INVESTING ACTIVITIES:
Acquisition of Fauquier Bankshares		153,278			-
Net decrease (increase) in restricted investments		358			(53	)
Purchases of available for sale securities		(15,217	)		(62,259	)
Proceeds from maturities, calls and principal payments of available for sale securities		12,923			29,161
Proceeds from sales of available for sale securities		—			46,075
Net decrease (increase) in loans		46,452			(93,296	)
Cash payment for wealth management book of business		-			(50	)
Purchase of bank premises and equipment		(818	)		(80	)
Net cash provided by (used in) investing activities		196,976			(80,502	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Net increase in demand deposits, NOW accounts, and money market accounts		78,892			105,669
Net increase (decrease) in certificates of deposit and other time deposits		2,167			(12,679	)
Net decrease in other borrowings		(23	)		—
Proceeds from stock options exercised		30			-
Cash dividends paid		(3,224	)		(1,618	)
Net cash provided by financing activities		77,842			91,372
NET INCREASE IN CASH AND CASH EQUIVALENTS	$	279,284		$	15,802

CASH AND CASH EQUIVALENTS:
Beginning of period	$	34,695		$	19,085
End of period	$	313,979		$	34,887

SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION
Cash payments for:
Interest	$	1,611		$	2,032
Taxes	$	1,042		$	375

SUPPLEMENTAL SCHEDULE OF NONCASH INVESTING AND FINANCING ACTIVITIES
Unrealized (losses) gains on available for sale securities	$	(1,878	)	$	1,274
Unrealized (losses) gains on interest rate swaps	$	(141	)	$	—
Assets acquired in business combination	$	909,736		$	—
Liabilities assumed in business combination	$	840,226		$	—
Change in goodwill	$	8,526		$	—

See Notes to Consolidated Financial Statements

VIRGINIA NATIONAL BANKSHARES CORPORATION AND SUBSIDIARIES

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

June 30, 2021

Note 1. Summary of Significant Accounting Policies

Principles of Consolidation: The unaudited consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) for interim financial information. Accordingly, the unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring items) considered necessary for a fair presentation have been included. The statements should be read in conjunction with the Notes to Consolidated Financial Statements included in the Company’s Form 10-K for the year ended December 31, 2020.

Nature of Operations: The accompanying unaudited consolidated financial statements include the accounts of Virginia National Bankshares Corporation (the “Company”), and its subsidiaries Virginia National Bank (the “Bank”) and Masonry Capital Management, LLC (“Masonry Capital”), a registered investment advisor. Beginning in 2019, the services offered under the umbrella of VNB Wealth are provided by Masonry Capital or by the Bank under VNB Trust & Estate Services or Sturman Wealth Advisors, formerly known as VNB Investment Services. All significant intercompany balances and transactions have been eliminated in consolidation.

Basis of Presentation: The preparation of financial statements in conformity with GAAP and the reporting guidelines prescribed by regulatory authorities requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are particularly susceptible to significant change in the near term relate to the determination of the allowance for loan losses, accounting for business combinations, including loans acquired in the business combination, impairment of loans, goodwill impairment, other-than-temporary impairment of securities, other intangible assets, and fair value measurements. Operating results for the three and six months ended June 30, 2021 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.

Reclassifications: If needed, certain previously reported amounts have been reclassified to conform to current period presentation. No such reclassifications were significant

Business Combination: On April 1, 2021, the Company completed the merger with Fauquier Bankshares, Inc. with and into the Company for total consideration paid of $78.0 million. Additional information about this transaction is presented in Note 2 – Business Combinations.

Recent Significant Accounting Pronouncements

Financial Instruments – Credit Losses In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2016-13, “Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments.” The amendments in this ASU, among other things, require the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. Financial institutions and other organizations will now use forward-looking information to better inform their credit loss estimates. Many of the loss estimation techniques applied today will still be permitted, although the inputs to those techniques will change to reflect the full amount of expected credit losses. In addition, the ASU amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. The FASB has issued multiple updates to ASU 2016-13 as codified in Topic 326, including ASUs 2019-04, 2019-05, 2019-10, 2019-11, 2020-02, and 2020-03. These ASUs have provided for various minor technical corrections and improvements to the codification as well as other transition matters. Smaller reporting companies who file with the U.S. Securities and Exchange Commission (“SEC”), such as the Company, and all other entities who do not file with the SEC are required to apply the guidance for fiscal years, and interim periods within those years, beginning after December 15, 2022. The Company is currently assessing the impact that ASU 2016-13 will have on its consolidated financial statements. Early in 2017, the Company formed a cross-functional steering committee, including some members of senior management, to provide governance and guidance over the project plan. The Company is capturing the additional loan data which is anticipated to be needed for this calculation. The extent of the change is indeterminable at this time as it will be dependent upon portfolio composition and credit quality at the adoption date, as well as economic conditions and forecasts at that time. Upon adoption, the impact to the allowance for credit losses (currently allowance for loan losses) will have an offsetting one-time cumulative-effect adjustment to retained earnings.

Effective November 25, 2019, the SEC adopted Staff Accounting Bulletin (“SAB”) 119. SAB 119 updated portions of SEC interpretative guidance to align with FASB Accounting Standards Codification (“ASC”) 326, “Financial Instruments – Credit Losses.” It covers topics including (1) measuring current expected credit losses; (2) development, governance, and documentation of a systematic methodology; (3) documenting the results of a systematic methodology; and (4) validating a systematic methodology.

LIBOR and Other Reference Rates In March 2020, the FASB issued ASU 2020-04 “Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting.” These amendments provide temporary optional guidance to ease the potential burden in accounting for reference rate reform. The ASU provides optional expedients and exceptions for applying generally accepted accounting principles to contract modifications and hedging relationships, subject to meeting certain criteria, that reference the London Inter-bank Offered Rate (“LIBOR”) or another reference rate expected to be discontinued. It is intended to help stakeholders during the global market-wide reference rate transition period. The guidance is effective for all entities as of March 12, 2020 through December 31, 2022. Subsequently, in January 2021, the FASB issued ASU 2021-01 “Reference Rate Reform (Topic 848): Scope.” This ASU clarifies that certain optional expedients and exceptions in Topic 848 for contract modifications and hedge accounting apply to derivatives that are affected by the discounting transition. The ASU also amends the expedients and exceptions in Topic 848 to capture the incremental consequences of the scope clarification and to tailor the existing guidance to derivative instruments affected by the discounting transition. An entity may elect to apply ASU 2021-01 on contract modifications that change the interest rate used for margining, discounting, or contract price alignment retrospectively as of any date from the beginning of the interim period that includes March 12, 2020, or prospectively to new modifications from any date within the interim period that includes or is subsequent to January 7, 2021, up to the date that financial statements are available to be issued. An entity may elect to apply ASU 2021-01 to eligible hedging relationships existing as of the beginning of the interim period that includes March 12, 2020, and to new eligible hedging relationships entered into after the beginning of the interim period that includes March 12, 2020. The Company has identified all loans that are directly or indirectly impacted by LIBOR. The Company is assessing ASU 2020-04 and its impact on the Company’s transition away from LIBOR for its loan and other financial instruments.

Recently Adopted Accounting Developments

CARES Act In December 2020, the Consolidated Appropriates Act of 2021 (“CAA”) was passed. Under Section 541 of the CAA, Congress extended or modified many of the relief programs first created by the Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”), including the Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) and treatment of certain loan modifications related to the COVID-19 pandemic. The adoption of the CARES Act had no material impact on the Company’s consolidated financial statements. See further discussion of PPP loans and loan modifications in Notes 4 and 5 of the notes to the Consolidated Financial Statements.

Other accounting standards that have been issued by the FASB or other standards-setting bodies are not currently expected to have a material effect on the Company’s financial position, results of operations or cash flows.

Note 2. Business Combinations

On April 1, 2021 (The “Effective Date”), the Company completed the merger with Fauquier Bankshares, Inc. (“Fauquier”) with and into the Company (the “Merger”), with the Company surviving, pursuant to the terms of the Agreement and Plan of Reorganization, dated September 30, 2020, between the Company and Fauquier (the “Merger Agreement”).

Pursuant to the Merger Agreement, holders of shares of Fauquier common stock received 0.675 shares of the Company’s common stock for each share of Fauquier common stock held immediately prior to the Effective Date of the Merger, plus cash in lieu of fractional shares. In connection with the transaction, the Company issued 2,571,213 shares of its common stock to the shareholders of Fauquier and paid $4 thousand in cash lieu of fractional shares. Each share of the Company’s common stock outstanding immediately prior to the Merger remained outstanding and was unaffected by the Merger.

Shortly after the Effective Date of the Merger, The Fauquier Bank (“TFB”), Fauquier’s wholly-owned bank subsidiary, was merged with and into Virginia National Bank, the Company’s wholly-owned bank subsidiary, with Virginia National Bank surviving.

The Company accounted for the Merger using the acquisition method of accounting in accordance with ASC 805, Business Combinations. Under the acquisition method of accounting, the assets acquired and liabilities assumed in the Merger and the common stock of the Company issued as consideration were recorded at their respective acquisition date fair values. Determining the fair value of assets and liabilities, particularly related to the loan portfolio, is inherently subjective and involves significant judgment regarding the methods and assumptions used to estimate fair value. Under ASC 805, during the measurement period of up to one year, the acquirer shall adjust the amounts recognized at the acquisition date and may recognize additional assets or liabilities to reflect new information obtained from facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. Measurement period adjustments are recognized in the reporting period in which they are determined. The measurement period may not exceed one year from the acquisition date.

The following table presents as of April 1, 2021 the total consideration paid by the Company in connection with the Merger, the fair values of the assets acquired and liabilities assumed, and the resulting goodwill (dollars in thousands):

	As Recorded					As Recorded
	by Fauquier		Fair Value			by Virginia National
	Bankshares, Inc.		Adjustment			Bankshares

Assets:
Cash and cash equivalents	$	153,282	$	-		$	153,282
Securities available for sale		93,133		-			93,133
Loans, net		615,766		(13,123	)		602,643
Premises and equipment		16,276		3,872			20,148
Other real estate owned		1,356		(745	)		611
Bank-owned life insurance		13,677		-			13,677
Right-of-use assets		4,355		1,077			5,432
Core deposit intangible		-		8,700			8,700
Other assets		12,917		(807	)		12,110
Total assets acquired	$	910,762	$	(1,026	)	$	909,736

Liabilities:
Deposits		817,499		191			817,690
Short-term borrowings		12,582		473			13,055
Junior subordinated debt		4,124		(790	)		3,334
Lease liability		4,440		352			4,792
Other liabilities		1,355		-			1,355
Total liabilities assumed	$	840,000	$	226		$	840,226
Net assets acquired						$	69,510
Total consideration paid							78,036
Goodwill						$	8,526

In connection with the Merger, the Company recorded approximately $8.5 million of goodwill and $8.7 million of other intangible assets related to the core deposits of Fauquier. The goodwill arising from the Merger of Fauquier is not deductible for income taxes. The core deposit intangible asset (“CDI”) will be amortized over a period of seven years using the sum of years digits method.

Loans acquired from Fauquier (the “Acquired Loans”) had aggregate outstanding principal of $622.9 million and an estimated fair value of $602.6 million. The discount between the outstanding principal balance and fair value of $20.3 million represents expected credit losses and adjustments for market interest rates of $21.3 million, offset by elimination of net deferred fees/costs of $979 thousand.

As of the Effective Date, the fair value of the performing loans was $513.8 million, which was 1.7% less than the book value of the loans. The total fair value discount on performing loans of $9.0 million consisted of a credit discount of $8.4 million and an other fair value discount of $647 thousand. Loans that have evidence of deterioration in credit quality since origination are categorized as purchased credit impaired (“PCI”). As of the Effective Date, the fair value of PCI loans was $87.3 million, which was 12.3% below the book value of the loans. The total fair value mark on PCI loans of $12.3 million consisted of a credit discount of $11.2 million and an other fair value discount of $1.1 million.

Under the acquisition method (ASC 805), the allowance for loan losses recorded in the books of Fauquier in the amount of $7.2 million was not carried over into the books of the Company.

Information about PCI loans acquired from Fauquier as of April 1, 2021 is as follows (dollars in thousands):

	April 1, 2021
Contractual principal and interest at acquisition	$	136,476
Nonaccretable difference		(33,712	)
Expected cash flows at acquisition		102,764
Accretable yield		(15,499	)
Basis in PCI loans at acquisition, estimated fair value	$	87,265

Fair values of the major categories of assets acquired and liabilities assumed as part of the Merger were determined as follows:

Cash and due from banks: The carrying amount of cash and due from banks was used as a reasonable estimate of fair value.

Securities available for sale: The estimated fair value of investment securities available for sale was based on quoted pricing for those securities.

Loans: The Acquired Loans were recorded at fair value at the Merger date without carryover of Fauquier's allowance for loan losses. The fair value of the Acquired Loans was determined using market participant assumptions in estimating the amount and timing of both principal and interest cash flows expected to be collected on the loans and then discounting those cash flows based on a discount rate that would be required by a market participant. In this regard, the Acquired Loans were segregated into pools based on loan type and credit risk. Loan type was determined based on collateral type, loan purpose and loan structure. Credit risk characteristics included risk rating groups (pass rated loans and adversely classified loans), updated loan-to-value ratios and lien position, and past loan performance. For valuation purposes, these pools were further disaggregated by maturity and pricing characteristics (e.g., fixed-rate, adjustable-rate, balloon maturities).

Premises and equipment: The land and buildings acquired were recorded at fair value as determined by current appraisals by independent third parties and tax assessments at Effective Date.

Other real estate owned: Other real estate owned was recorded at fair value based on an existing purchase contract, less estimated selling costs.

Bank owned life insurance: The carrying amount of bank owned life insurance was used as a reasonable estimate of fair value.

Right of use assets and lease liabilities: Lease liabilities were measured at the present value of the remaining lease payments, as if the acquired lease were a new lease of the Company at the Effective Date. Right-of-use assets were measured at the same amount as the lease liability as adjusted to reflect favorable or unfavorable terms of the lease when compared with market terms.

Core deposit intangible: The fair value of the CDI was determined based on a discounted cash flow analysis using a discount rate based on the estimated cost of equity capital for a market participant. To calculate cash flows, deposit account servicing costs (net of deposit fee income) and interest expense on deposits were compared to the cost of alternative funding sources available through the FHLB. The life of the deposit base and projected deposit attrition rates were determined using Fauquier’s historical deposit data. The CDI was estimated at $8.7 million or 1.2% of non-maturity deposits.

Deposits: The fair value adjustment of deposits represents a premium over the value of the contractual repayments of fixed-maturity deposits using prevailing market interest rates for similar term certificates of deposit, using a discounted cash flow method. The resulting estimated fair value adjustment of certificates of deposit ranging in maturity from one month to three years is a $191,000 premium and is being amortized into income over a period of seven months.

Short-term borrowings: The fair value of borrowings was determined by comparison to current interest rates for similar borrowings. The resulting fair value adjustment to short-term borrowings is a $473,000 premium which will be amortized into interest expense over the remaining life of the debt on a straight-line basis.

Junior subordinated debt: The fair value of the junior subordinated debt was determined by forecasting the cash flows at the stated coupon rate and discount at a prevailing market rate. The prevailing market rate was based on implied market yields for recently issued debt with similar duration, credit quality, seniority and structure, issued by institutions of similar asset size. The resulting estimated fair value adjustment of junior subordinated debt is a $790,000 discount and is being accreted over the remaining life of the debt on a straight-line basis.

The revenue and earnings amounts specific to Fauquier since the Effective Date that are included in the consolidated results for 2021 are not readily determinable. The disclosures of these amounts are impracticable due to the merging of certain processes and systems at the Effective Date.

Merger related expenses associated with the Merger of Fauquier were $5.9 million ($4.6 million after taxes) for the three months ended June 30, 2021, $6.2 million ($4.7 million after taxes) for the six months ended June 30, 2021 and $7.7 million ($5.4 million after taxes) in the aggregate through June 30, 2021. These costs included investment banker fees, expenses related to the integration of systems and operations, change of control payments and legal and consulting expenses, which have been expensed as incurred. There were no merger related expenses during the three and six months ended June 30, 2020.

Note 3. Securities

The amortized cost and fair values of securities available for sale as of June 30, 2021 and December 31, 2020 were as follows (dollars in thousands):

June 30, 2021			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	35,839	$	58	$	(669	)	$	35,228
Mortgage-backed securities/CMOs		136,503		842		(927	)		136,418
Municipal bonds		94,661		1,352		(686	)		95,327
Total Securities Available for Sale	$	267,003	$	2,252	$	(2,282	)	$	266,973

December 31, 2020			Gross		Gross
	Amortized		Unrealized		Unrealized			Fair
	Cost		Gains		(Losses)			Value
U.S. Government agencies	$	25,496	$	7	$	(198	)	$	25,305
Mortgage-backed securities/CMOs		77,438		844		(182	)		78,100
Municipal bonds		69,303		1,499		(121	)		70,681
Total Securities Available for Sale	$	172,237	$	2,350	$	(501	)	$	174,086

As of June 30, 2021, there were $132.7 million, or 86 issues of individual securities, held in an unrealized loss position. These securities have an unrealized loss of $2.3 million and consisted of 46 mortgage-backed/collateralized mortgage obligations (“CMOs”), 25 municipal bonds, and 15 agency bonds.

The following table summarizes all securities with unrealized losses, segregated by length of time in a continuous unrealized loss position, at June 30, 2021, and December 31, 2020 (dollars in thousands):

June 30, 2021
	Less than 12 Months					12 Months or more					Total
			Unrealized					Unrealized					Unrealized
	Fair Value		Losses			Fair Value		Losses			Fair Value		Losses
U.S. Government agencies	$	26,817	$	(669	)	$	—	$	—		$	26,817	$	(669	)
Mortgage-backed/CMOs		68,035		(897	)		1,537		(30	)		69,572		(927	)
Municipal bonds		35,582		(683	)		762		(3	)		36,344		(686	)
	$	130,434	$	(2,249	)	$	2,299	$	(33	)	$	132,733	$	(2,282	)

December 31, 2020
	Less than 12 Months					12 Months or more				Total
			Unrealized					Unrealized				Unrealized
	Fair Value		Losses			Fair Value		Losses		Fair Value		Losses
U.S. Government agencies	$	19,298	$	(198	)	$	—	$	—	$	19,298	$	(198	)
Mortgage-backed/CMOs		24,523		(182	)		—		—		24,523		(182	)
Municipal bonds		21,501		(121	)		—		—		21,501		(121	)
	$	65,322	$	(501	)	$	—	$	—	$	65,322	$	(501	)

The Company’s securities portfolio is primarily made up of fixed rate instruments, the prices of which move inversely with interest rates. Any unrealized losses are considered by management to be driven by increases in market interest rates over the yields available at the time the underlying securities were purchased. The fair value is expected to recover as the instruments approach their maturity date or repricing date or if market yields for such investments decline. At the end of any accounting period, the portfolio may have both unrealized gains and losses. Management does not believe any of the securities in an unrealized loss position are impaired due to credit quality. Accordingly, as of June 30, 2021, management believes the impairments detailed in the table above are temporary, and no impairment loss has been realized in the Company’s consolidated income statement.

An “other-than-temporary impairment” (“OTTI”) is considered to exist if either of the following conditions are met: it is more likely than not that the Company will be required to sell the security before recovery of its amortized cost basis, or the Company does not expect to recover the security’s entire amortized cost basis (even if the Company does not intend to sell). In the event that a security would suffer impairment for a reason that was “other than temporary,” the Company would be expected to write down the security’s value to its new fair value, and the amount of the write down would be included in earnings as a realized loss. As of June 30, 2021, management has concluded that none of its investment securities have an OTTI based upon the information available. Additionally, management has the ability to hold any security with an unrealized loss until maturity or until such time as the value of the security has recovered from its unrealized loss position.

Securities having carrying values of $10.4 million at June 30, 2021 were pledged as collateral to secure deposits and for other purposes and facilitate borrowing from the Federal Reserve Bank of Richmond (“FRB”). At December 31, 2020, securities having carrying values of $6.0 million were similarly pledged.

For the six months ended June 30, 2021, there were no sales of securities. For the six months ended June 30, 2020, proceeds from the sales of securities amounted to $46.1 million, with realized gains of $655 thousand and realized losses of $12 thousand.

Restricted securities are securities with limited marketability and consist of stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), and CBB Financial Corporation, the holding company for Community Bankers Bank. Additionally with the Fauquier merger, the Company acquired an investment in an SBA loan fund of $500 thousand. These restricted securities, totaling $4.3 million and $3.0 million as of June 30, 2021 and December 31, 2020, are carried at cost.

Note 4. Loans

The composition of the loan portfolio by major loan classifications at June 30, 2021 and December 31, 2020 appears below (dollars in thousands).

	June 30,			December 31,
	2021			2020
Commercial	$	160,473		$	118,688
Real estate construction and land		96,421			22,509
1-4 family residential mortgages		381,801			132,966
Commercial mortgages		455,795			277,109
Consumer		71,671			58,134
Total loans		1,166,161			609,406
Less: Allowance for loan losses		(5,522	)		(5,455	)
Net loans	$	1,160,639		$	603,951

Primarily within the second quarter of 2020 and the first quarter of 2021, the Company, including Virginia National Bank and The Fauquier Bank prior to the Merger, assisted nonprofit organizations and local businesses by funding a combined total of $207.5 million of Small Business Administration (“SBA”) Paycheck Protection Program (“PPP”) loans, which were designed to provide economic relief to small businesses adversely impacted by COVID-19. As of June 30, 2021, the Company had PPP loans of $68.8 million outstanding on its balance sheet, with the remainder having been forgiven by the SBA.

The balances in the table above include unamortized premiums and net deferred loan costs (fees) on PPP loans and loans purchased prior to the Merger. As of June 30, 2021 and December 31, 2020, unamortized premiums on loans purchased prior to the Merger were $1.4 million and $1.8 million, respectively. Net deferred loan costs (fees) totaled $(1.7) million and $(931) thousand as of June 30, 2021 and December 31, 2020, respectively. The deferred fees increased $805 thousand due to the fees collected from the SBA for the additional PPP loans funded during the six months ended June 30, 2021. Net deferred fees on PPP loans and loans purchased prior to the Merger are being amortized over the contractual life of the underlying loans. As loans are forgiven by the SBA, accounting principles allow for the accelerated recognition of unamortized fees at that time.

Loans acquired in business combinations are recorded in the Consolidated Balance Sheets at fair value at the acquisition date under the acquisition method of accounting. The table above includes a net fair value mark of $12.4 million on the purchased impaired loans and $8.2 million on the purchased performing loans as of June 30, 2021 on the loans acquired in the Merger. See Note 2 – Business Combinations for more information on fair value of loan balances acquired in the Merger.

The outstanding principal balance and the carrying amount at June 30, 2021 on these Acquired Loans were as follows:

	June 30, 2021
	Acquired Loans - Purchased Credit Impaired		Acquired Loans - Purchased Performing		Acquired Loans - Total
Outstanding principal balance	$	87,930	$	470,189	$	558,119
Carrying amount:
Commercial	$	1,983	$	61,013	$	62,996
Real estate construction and land		27,972		31,953		59,925
1-4 family residential mortgages		17,324		215,898		233,222
Commercial mortgages		25,348		145,570		170,918
Consumer		2,925		7,552		10,477
Total Acquired Loans	$	75,552	$	461,986	$	537,538

The following table presents a summary of the change in the accretable yield of loans classified as purchased credit impaired:

	June 30, 2021

Accretable yield, beginning of period	$	—
Additions		15,499
Accretion		(858	)
Accretable yield, end of period	$	14,641

Accounting guidance requires certain disclosures about investments in impaired loans, the allowance for loan losses and interest income recognized on impaired loans. A loan is considered impaired when it is probable that the Company will be unable to collect all principal and interest amounts when due according to the contractual terms of the loan agreement. Factors involved in determining impairment include, but are not limited to, expected future cash flows, financial condition of the borrower, and current economic conditions.

The following tables reflect the breakdown by class of the Company’s loans classified as impaired loans, excluding Acquired Loans that are not impaired, as of June 30, 2021 and December 31, 2020. These loans are reported at their recorded investment, which is the carrying amount of the loan as reflected on the Company’s balance sheet, net of charge-offs and other amounts applied to reduce the net book balance. Average recorded investment in impaired loans is computed using an average of month-end balances for these loans for either the six months ended June 30, 2021 or the twelve months ended December 31, 2020. Interest income recognized is for the six months ended June 30, 2021 or the twelve months ended December 31, 2020 (dollars in thousands).

June 30, 2021	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Real estate construction and land	$	—	$	—	$	-	$	4	$	-
1-4 family residential mortgages		103		103		-		105		3
Total impaired loans without a valuation allowance		103		103		-		109		3

Impaired loans with a valuation allowance
Consumer		955		955		4		1,004		27
Total impaired loans with a valuation allowance		955		955		4		1,004		27
Total impaired loans	$	1,058	$	1,058	$	4	$	1,113	$	30

December 31, 2020	Recorded Investment		Unpaid Principal Balance		Associated Allowance		Average Recorded Investment		Interest Income Recognized
Impaired loans without a valuation allowance:
Real estate construction and land	$	8	$	55	$	-	$	97	$	-
1-4 family residential mortgages		109		109		-		113		6
Commercial real estate		-		-		-		781		48
Total impaired loans without a valuation allowance		117		164		-		991		54

Impaired loans with a valuation allowance
Consumer		1,156		1,156		4		1,145		70
Total impaired loans with a valuation allowance		1,156		1,156		4		1,145		70
Total impaired loans	$	1,273	$	1,320	$	4	$	2,136	$	124

Included in the impaired loans are non-accrual loans. Generally, a loan is placed on non-accrual when it is specifically determined to be impaired or when principal or interest is delinquent for 90 days or more. Any unpaid interest previously accrued on those loans is reversed from income. Interest income generally is not recognized on specific impaired loans unless the likelihood of further loss is remote. Interest payments received on such loans are applied as a reduction of the loan principal balance. Interest income on other non-accrual loans is recognized only to the extent of interest payments received. The recorded investment in non-accrual loans is shown below by class (dollars in thousands):

	June 30, 2021		December 31, 2020
Real estate construction and land	$	—	$	8
Consumer		17		-
Total non-accrual loans	$	17	$	8

Additionally, troubled debt restructurings (“TDRs”) are considered impaired loans. 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.

In accordance with regulatory guidance, the Company has approved for certain customers who have been adversely affected by COVID-19 to defer principal-only, or principal and interest. Such short-term modifications, which were made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief, are not to be considered TDRs. While interest will continue to accrue to income, in accordance with GAAP, if the Company ultimately incurs a credit loss on these deferred payments, interest income would need to be reversed and therefore, interest income in future periods could be negatively impacted. A total of $59.7 million in loan deferments have been approved since the beginning of the pandemic. As of June 30, 2021, $57.7 million, or 96.6%, of the total loan deferments approved have returned to normal payment schedules and are now current.

Based on regulatory guidance on student lending, the Company has classified 57 of its student loans purchased (“Purchased Student Loans”), which exclude the student loans acquired from Fauquier that are 98% guaranteed by the U. S. Government (the “Acquired Student Loans”), as TDRs for a total of $1.0 million as of June 30, 2021. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered TDRs. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Initially, all student loans were fully insured by a surety bond, and the Company did not expect to experience a loss on these loans. Based on the loss of insurance after July 27, 2018 due to the insolvency of the insurer, management has evaluated these loans individually for impairment and included any expected loss in the allowance for loan losses; interest continues to accrue on these TDRs during any deferment and forbearance periods.

The following provides a summary, by class, of TDRs that continue to accrue interest under the terms of the restructuring agreement, which are considered to be performing, and TDRs that have been placed in non-accrual status, which are considered to be nonperforming (dollars in thousands).

Troubled debt restructurings	June 30, 2021				December 31, 2020
	No. of		Recorded		No. of		Recorded
	Loans		Investment		Loans		Investment
Performing TDRs
1-4 family residential mortgages		1	$	103		1	$	109
Consumer		57		955		75		1,156
Total performing TDRs		58	$	1,058		76	$	1,265

Nonperforming TDRs
Real estate construction and land development		0	$	-		1	$	8
Total nonperforming TDRs		0	$	-		1	$	8
Total TDRs		58	$	1,058		77	$	1,273

A summary of loans shown above that were modified under the terms of a TDR during the three and six months ended June 30, 2021 and 2020 is shown below by class (dollars in thousands). The Post-Modification Recorded Balance reflects the period end balances, inclusive of any interest capitalized to principal, partial principal paydowns, and principal charge-offs since the modification date. Loans modified as TDRs that were fully paid down, charged-off, or foreclosed upon by period end are not reported.

	For the three months ended						For the three months ended
	June 30, 2021						June 30, 2020
	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance
Consumer		0	$	—	$	—		6	$	49	$	49
Total loans modified during the period		0	$	—	$	—		6	$	49	$	49

	For the six months ended						For the six months ended
	June 30, 2021						June 30, 2020
	Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance		Number of Loans		Pre- Modification Recorded Balance		Post- Modification Recorded Balance
Consumer		6	$	63	$	63		11	$	109	$	109
Total loans modified during the period		6	$	63	$	63		11	$	109	$	109

During the six months ended June 30, 2021, there were three loans modified as a TDR that subsequently defaulted which had been modified as a TDR during the twelve months prior to default. These student loans had balances of $22 thousand prior to being charged off. There were five loans modified as a TDR that subsequently defaulted during the year ended December 31, 2020 which had been modified as a TDR during the twelve months prior to default. These student loans had balances totaling $48 thousand prior to being charged off.

There was one loan secured by 1-4 family residential property, from the Acquired Loans, that was in the process of foreclosure with a principal balance of $220 thousand at June 30, 2021 and no loans secured by 1-4 family residential property were in the process of foreclosure at December 31, 2020.

Note 5. Allowance for Loan Losses

The allowance for loan losses is maintained at a level which, in management’s judgment, is adequate to absorb probable credit losses inherent in the loan portfolio. The amount of the allowance is based on management’s quarterly evaluation of the collectability of the loan portfolio, credit concentrations, historical loss experience, specific impaired loans, and economic conditions. To determine the total allowance for loan losses, the Company estimates the reserves needed for each segment of the portfolio, including loans analyzed individually and loans analyzed on a pooled basis. Allowances for impaired loans are generally determined based on collateral values or the present value of estimated cash flows.

For purposes of determining the allowance for loan losses on the outstanding loans that were not Acquired Loans (the “Non-Acquired Loans”), the Company has segmented certain loans in the portfolio by product type. Within these segments, the Company has sub-segmented its portfolio by classes within the segments, based on the associated risks within these classes. Note that under the acquisition method of accounting (ASC 805), the allowance for loan losses recorded in the books of Fauquier was not carried over into the books of the Company.

Management utilizes a loss migration model for determining the quantitative risk assigned to unimpaired loans in order to capture historical loss information at the loan level, track loss migration through risk grade deterioration, and increase efficiencies related to performing the calculations. The quantitative risk factor for each loan class primarily utilizes a migration analysis loss method based on loss history for the prior twelve quarters.

The migration analysis loss method is used for all loan pools except for the following:

•

Student loans purchased (excluding Acquired Student Loans) - On June 27, 2018, the Company was notified that ReliaMax Surety Company (“ReliaMax Surety”), the South Dakota insurance company which issued surety bonds for the student loan pools, was placed into liquidation due to insolvency. As such, the historical charge-off rate on this portfolio is determined by using the Company’s own losses/charge-offs since July 1, 2018 together with prior insurance claim history. For reporting periods prior to June 30, 2018, the Company did not charge off student

loans as the insurance covered the past due loans, but the Company did apply qualitative factors to calculate a reserve on these loans, net of the deposit reserve accounts held by the Company for this group of loans.

•

Commercial and industrial government guaranteed loans and PPP loans - These loans require no reserve as these are 100% guaranteed by either the SBA or the United States Department of Agriculture.

Under the migration analysis method, average loss rates are calculated at the risk grade and class levels by dividing the twelve-quarter average net charge-off amount by the twelve-quarter average loan balances. Qualitative factors are combined with these quantitative factors to arrive at the overall general allowances.

The Company’s internal creditworthiness grading system is based on experiences with similarly graded loans. The Company performs regular credit reviews of the loan portfolio to review the credit quality and adherence to its underwriting standards. Additionally, external reviews of a portion of the credits are conducted annually.

Loans that trend upward on the risk ratings scale, toward more positive risk ratings, generally exhibit lower risk factor characteristics. Conversely, loans that migrate toward more negative ratings generally will result in a higher risk factor being applied to those related loan balances.

Risk Ratings and Historical Loss Factor Assigned

Excellent

A 0% historical loss factor is applied, as these loans are secured by cash or fully guaranteed by a U.S. government agency and represent a minimal risk. The Company has never experienced a loss within this category.

Good

A 0% historical loss factor is applied, as these loans represent a low risk and are secured by marketable collateral within margin. In an abundance of caution, a nominal loss reserve is applied to these loans. The Company has never experienced a loss within this category.

Pass

A historical loss factor for loans rated “Pass” is applied to current balances of like-rated loans, pooled by class. Loans with the following risk ratings are pooled by class and considered together as “Pass”:

Satisfactory – modest risk loans where the borrower has strong and liquid financial statements and more than adequate cash flow

Average – average risk loans where the borrower has reasonable debt service capacity

Marginal – acceptable risk loans where the borrower has acceptable financial statements but is leveraged

Watch

These loans have an acceptable risk but require more attention than normal servicing. A historical loss factor for loans rated “Watch” is applied to current balances of like-rated loans pooled by class.

Special Mention

These potential problem loans are currently protected but are potentially weak. A historical loss factor for loans rated “Special Mention” is applied to current balances of like-rated loans pooled by class.

Substandard

These problem loans are inadequately protected by the sound worth and paying capacity of the borrower and/or the value of any collateral pledged. These loans may be considered impaired and evaluated on an individual basis. Otherwise, a historical loss factor for loans rated “Substandard” is applied to current balances of all other “Substandard” loans pooled by class.

Doubtful

Loans with this rating have significant deterioration in the sound worth and paying capacity of the borrower and/or the value of any collateral pledged, making collection or liquidation of the loan in full highly questionable. These loans would be considered impaired and evaluated on an individual basis.

The following represents the loan portfolio designated by the internal risk ratings assigned to each credit as of June 30, 2021 and December 31, 2020 (dollars in thousands). There were no loans rated “Doubtful” as of either period.

June 30, 2021	Excellent		Good		Pass		Watch		Special Mention		Sub- standard		TOTAL
Commercial	$	100,879	$	14,189	$	44,911	$	39	$	236	$	219	$	160,473
Real estate construction and land		-		-		94,159		-		1,595		667		96,421
1-4 family residential mortgages		-		-		368,975		2,873		663		9,290		381,801
Commercial mortgages		-		3,344		429,966		5,604		1,517		15,364		455,795
Consumer		544		25,691		44,227		1,122		32		55		71,671
Total Loans	$	101,423	$	43,224	$	982,238	$	9,638	$	4,043	$	25,595	$	1,166,161

December 31, 2020	Excellent		Good		Pass		Watch		Special Mention		Sub- standard		TOTAL
Commercial	$	87,014	$	14,336	$	16,126	$	485	$	-	$	727	$	118,688
Real estate construction and land		-		-		22,305		-		-		204		22,509
1-4 family residential mortgages		-		-		126,910		3,634		1,357		1,065		132,966
Commercial mortgages		-		-		261,663		5,854		-		9,592		277,109
Consumer		1,012		18,929		36,573		1,373		64		183		58,134
Total Loans	$	88,026	$	33,265	$	463,577	$	11,346	$	1,421	$	11,771	$	609,406

In addition, the adequacy of the Company’s allowance for loan losses is evaluated through reference to eight qualitative factors, listed below and ranked in order of importance:

Changes in national and local economic conditions, including the condition of various market segments;

Changes in the value of underlying collateral;

Changes in volume of classified assets, measured as a percentage of capital;

Changes in volume of delinquent loans;

The existence and effect of any concentrations of credit and changes in the level of such concentrations;

Changes in lending policies and procedures, including underwriting standards;

Changes in the experience, ability and depth of lending management and staff; and

Changes in the level of policy exceptions.

It has been the Company’s experience that the first five factors drive losses to a much greater extent than the last three factors; therefore, the first five factors are weighted more heavily. Qualitative factors are not assessed against loans rated “Excellent” or “Good,” as the Company has never experienced a loss within these categories.

As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarters ended September 30, 2020, December 31, 2020 or March 31, 2021. During the quarter ended June 30, 2021, the Company upgraded the economic qualitative factors, resulting in a release of a portion of the reserves for loan losses related to the pandemic, as credit deterioration since the onset of COVID-19 has so far not been experienced to the extent anticipated. If economic conditions improve or worsen, the Company could experience changes in the required ALLL. It is possible that asset quality metrics could decline in the future if there is a resurgence of COVID-19 cases that disrupts economic activity.

For each segment and class of loans, management must exercise significant judgment to determine the estimation method that fits the credit risk characteristics of its various segments. Although this evaluation is inherently subjective, qualified management utilizes its significant knowledge and experience related to both the Company’s markets and the history of the Company’s loan losses.

Impaired loans are individually evaluated and, if deemed appropriate, a specific allocation is made for these loans. In reviewing the loans classified as impaired loans totaling $1.1 million at June 30, 2021, a specific valuation allowance was recognized after consideration was given for each borrowing as to the fair value of the collateral on the loan or the present value of expected future cash flows from the borrower. The $4 thousand in the allowance total shown below as individually evaluated for impairment was attributed to the impaired student loans that required an allowance as of June 30, 2021 due to the loss of the insurance on this portfolio as discussed previously.

A summary of the transactions in the Allowance for Loan Losses by major loan portfolio segment for the six months ended June 30, 2021 and the year ended December 31, 2020 appears below (dollars in thousands):

Allowance for Loan Losses Rollforward by Portfolio Segment

As of and for the period ended June 30, 2021
	Commercial Loans			Real Estate Construction and Land		Real Estate Mortgages		Consumer Loans			Total
Allowance for Loan Losses:
Balance as of beginning of year	$	209		$	160	$	3,897	$	1,189		$	5,455
Charge-offs		—			—		—		(397	)		(397	)
Recoveries		181			2		3		68			254
Provision for (recovery of) loan losses		(257	)		79		50		338			210
Ending Balance	$	133		$	241	$	3,950	$	1,198		$	5,522

Ending Balance:
Individually evaluated for impairment	$	—		$	—	$	—	$	4		$	4
Collectively evaluated for impairment		133			241		3,950		1,194			5,518
Acquired loans - purchased credit impaired	$	—		$	—	$	—	$	—		$	—
Loans:
Individually evaluated for impairment	$	—		$	—	$	103	$	955		$	1,058
Collectively evaluated for impairment		158,490			68,449		794,821		67,791			1,089,551
Acquired loans - purchased credit impaired		1,983			27,972		42,672		2,925			75,552
Ending Balance	$	160,473		$	96,421	$	837,596	$	71,671			1,166,161

As of and for the period ended December 31, 2020
	Commercial Loans			Real Estate Construction and Land		Real Estate Mortgages		Consumer Loans			Total
Allowance for Loan Losses:
Balance as of beginning of year	$	302		$	109	$	2,684	$	1,114		$	4,209
Charge-offs		—			—		—		(805	)		(805	)
Recoveries		28			-		1		400			429
Provision for (recovery of) loan losses		(121	)		51		1,212		480			1,622
Ending Balance	$	209		$	160	$	3,897	$	1,189		$	5,455

Ending Balance:
Individually evaluated for impairment	$	—		$	—	$	—	$	4		$	4
Collectively evaluated for impairment		209			160		3,897		1,185			5,451
Loans:
Individually evaluated for impairment	$	—		$	8	$	109	$	1,156		$	1,273
Collectively evaluated for impairment		118,688			22,501		409,966		56,978			608,133
Ending Balance	$	118,688		$	22,509	$	410,075	$	58,134		$	609,406

As previously mentioned, one of the major factors that the Company uses in evaluating the adequacy of its allowance for loan losses is changes in the volume of delinquent loans. Management monitors payment activity on a regular basis. For all classes of loans, the Company considers the entire balance of the loan to be contractually delinquent if the minimum payment is not received by the due date. Interest and fees continue to accrue on past due loans until they are placed in nonaccrual or charged off.

The following tables show the aging of past due loans as of June 30, 2021 and December 31, 2020 (dollars in thousands).

Past Due Aging as of June 30, 2021	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		PCI		Current		Total Loans		90 Days Past Due and Still Accruing

Commercial	$	790	$	77	$	1,117	$	1,984	$	1,983	$	156,506	$	160,473	$	1,117
Real estate construction and land		51		-		-		51		27,972		68,398		96,421		-
1-4 family residential mortgages		1,528		-		280		1,808		17,324		362,669		381,801		280
Commercial mortgages		1,923		-		-		1,923		25,348		428,524		455,795		-
Consumer loans		304		44		158		506		2,925		68,240		71,671		141
Total Loans	$	4,596	$	121	$	1,555	$	6,272	$	75,552	$	1,084,337	$	1,166,161	$	1,538

Past Due Aging as of December 31, 2020	30-59 Days Past Due		60-89 Days Past Due		90 Days or More Past Due		Total Past Due		Current		Total Loans		90 Days Past Due and Still Accruing

Commercial	$	1,130	$	470	$	-	$	1,600	$	117,088	$	118,688	$	-
Real estate construction and land		-		-		-		-		22,509		22,509		-
1-4 family residential mortgages		501		-		-		501		132,465		132,966		-
Commercial mortgages		46		-		-		46		277,063		277,109		-
Consumer loans		298		66		137		501		57,633		58,134		137
Total Loans	$	1,975	$	536	$	137	$	2,648	$	606,758	$	609,406	$	137

NOTE 6: Goodwill and Other Intangible Assets

The carrying amount of goodwill was $8.9 million and $372 thousand at June 30, 2021 and December 31, 2020, respectively. The following table presents the changes in goodwill during the six months ended June 30, 2021. There were no changes in the recorded balance of goodwill during the three and six months ended June 30, 2020.

	Sturman Wealth Advisors		Fauquier		Total
Balance as of January 1, 2021	$	372	$	-	$	372
Acquisition of Fauquier Bankshares, Inc.		-		8,526		8,526
Balance at June 30, 2021	$	372	$	8,526	$	8,898

The Corporation had $8.6 million and $341 thousand of other intangible assets as of June 30, 2021 and December 31, 2020, respectively. Other intangible assets were recognized in connection with the core deposits acquired from Fauquier in 2021 and the book of business, including interest in the client relationships of an officer, acquired by VNB Wealth in 2016, Sturman Wealth Advisors. The following table summarizes the gross carrying amounts and accumulated amortization of other intangible assets (dollars in thousands):

	June 30, 2021					December 31, 2020
	Gross Carrying Amount		Accumulated Amortization			Gross Carrying Amount		Accumulated Amortization
Amortized intangible assets:
Core deposit intangible	$	8,700	$	(428	)	$	-	$	-
Customer relationships intangible		773		(466	)		773		(432	)
Total	$	9,473	$	(894	)	$	773	$	(432	)

Amortization expense was $445 thousand and $17 thousand for the three months ended June 30, 2021 and 2020, respectively and $462 thousand and $57 thousand for the six months ended June 30, 2021 and 2020, respectively.

Estimated future amortization expense as of June 30, 2021 is as follows (dollars in thousands):

	Core		Customer
	Deposit		Relationships
	Intangible		Intangible
For the six months ending December 31, 2021	$	823	$	34
For the year ending December 31, 2022		1,517		67
For the year ending December 31, 2023		1,345		67
For the year ending December 31, 2024		1,172		67
For the year ending December 31, 2025		999		67
Thereafter		2,416		5
Total	$	8,272	$	307

Note 7. Net Income Per Share

The table below shows the weighted average number of shares used in computing net income per common share and the effect of the weighted average number of shares of potential dilutive common stock for the three and six months ended June 30, 2021 and 2020. Diluted net income per share is computed based on the weighted average number of shares of common stock equivalents outstanding, to the extent dilutive. The Company’s common stock equivalents relate to outstanding common stock options. Unvested restricted stock as noted in the Consolidated Balance Sheets as of June 30, 2021 and June 30, 2020 is included in the calculation of basic and diluted net income per share (dollars below reported in thousands except per share data).

Three Months Ended	June 30, 2021						June 30, 2020
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic net income per share	$	147		5,305,277	$	0.03	$	2,088		2,710,019	$	0.77
Effect of dilutive stock options		-		15,013		-		-		625		-
Diluted net income per share	$	147		5,320,290	$	0.03	$	2,088		2,710,644	$	0.77

Six Months Ended	June 30, 2021						June 30, 2020
	Net Income		Weighted Average Shares		Per Share Amount		Net Income		Weighted Average Shares		Per Share Amount
Basic net income per share	$	1,652		4,019,700	$	0.41	$	3,492		2,701,411	$	1.29
Effect of dilutive stock options		-		11,601		-		-		900		-
Diluted net income per share	$	1,652	$	4,031,301	$	0.41	$	3,492	$	2,702,311	$	1.29

For the three and six months ended June 30, 2021, there were 78,301 option shares considered anti-dilutive and excluded from this calculation. For the three and six months ended June 30, 2020, there were 105,404 and 104,301 option shares, respectively, considered anti-dilutive and excluded from this calculation.

Note 8. Stock Incentive Plans

At the Annual Shareholders Meeting on May 21, 2014, shareholders approved the Virginia National Bankshares Corporation 2014 Stock Incentive Plan (“2014 Plan”). The 2014 Plan makes available up to 275,625 shares of the Company’s common stock, as adjusted by prior issued stock dividends, to be issued to plan participants. The 2014 Plan provides for granting of both incentive and nonqualified stock options, as well as restricted stock, unrestricted stock and other stock based awards. No new grants will be issued under the 2005 Stock Incentive Plan (“2005 Plan”) as this plan has expired.

For the 2014 Plan and the 2005 Plan (the “Plans”), the option price of incentive stock options cannot be less than the fair value of the stock at the time an option is granted. Nonqualified stock options may be granted at prices established by the Board of Directors, including prices less than the fair value on the date of grant. Outstanding stock options generally expire ten years from the grant date. Stock options generally vest by the fourth or fifth anniversary of the date of the grant.

A summary of the shares issued and available under each of the Plans is shown below as of June 30, 2021. Share data and exercise price range per share have been adjusted to reflect prior issued stock dividends. Although the 2005 Plan has expired and no new grants will be issued under this plan, there were options issued before the plan expired that are still outstanding as shown below.

	2005 Plan			2014 Plan
Aggregate shares issuable		253,575			275,625
Options issued, net of forfeited and expired options		(59,870	)		(146,506	)
Unrestricted stock issued		-			(11,535	)
Restricted stock grants issued		-			(49,898	)
Cancelled due to Plan expiration		(193,705	)		-
Remaining available for grant		-			67,686

Stock grants issued and outstanding:
Total vested and unvested shares		—			57,036
Fully vested shares		—			21,541

Option grants issued and outstanding:
Total vested and unvested shares		1,379			144,301
Fully vested shares		1,379			47,293

Exercise price range	$13.69			$23.75 to $42.62

The Company accounts for all of its stock incentive plans under recognition and measurement accounting principles which require that the compensation cost relating to stock-based payment transactions be recognized in the financial statements. Stock-based compensation arrangements include stock options and restricted stock. All stock-based payments to employees are required to be valued at a fair value on the date of grant and expensed based on that fair value over the applicable vesting period.

Stock Options

Changes in the stock options outstanding related to the Plans are summarized below (dollars in thousands except per share data):

	June 30, 2021
	Number of Options			Weighted Average Exercise Price		Aggregate Intrinsic Value
Outstanding at January 1, 2021		146,783		$	33.51	$	-
Issued		—			—
Exercised		(1,103	)		27.39
Expired		—			—
Outstanding at June 30, 2021		145,680		$	33.56	$	996

Options exercisable at June 30, 2021		48,672		$	39.42	$	106

For the six months ended June 30, 2021 and 2020, the Company recognized $65 thousand and $58 thousand, respectively, in compensation expense for stock options. As of June 30, 2021, there was $362 thousand in unrecognized compensation expense remaining to be recognized in future reporting periods through 2025. The fair value of any stock option grant is estimated at the grant date using the Black-Scholes pricing model. No stock option grants were issued during the three months ended June 30, 2021, or during the three months ended June 30, 2020. No stock option grants were issued in the six months ended June 30, 2021, and 420 stock options grants were issued during the six months ended June 30, 2020.

The fair value of each option granted in the six months ended June 30, 2021 and 2020 was estimated based on the assumptions noted in the following table:

	For the six months ended
	June 30, 2021	June 30, 2020
Expected volatility¹	N/A	22.97%
Expected dividends²	N/A	4.75%
Expected term (in years)³	N/A		6.50
Risk-free rate⁴	N/A	0.68%

Based on the monthly historical volatility of the Company’s stock price over the expected life of the options.

Calculated as the ratio of historical dividends paid per share of common stock to the stock price on the date of grant.

Based on the average of the contractual life and vesting period for the respective option.

Based upon an interpolated U.S. Treasury yield curve interest rate that corresponds to the contractual life of the option, in effect at the time of the grant.

Summary information pertaining to options outstanding at June 30, 2021 is shown below. Share and per share data have been adjusted to reflect the prior stock dividends issued.

	Options Outstanding					Options Exercisable
Exercise Price	Number of Options Outstanding		Weighted- Average Remaining Contractual Life	Weighted- Average Exercise Price		Number of Options Exercisable		Weighted- Average Exercise Price
$13.69 to $20.00		1,379	1.6 Years	$	13.69		1,379	$	13.69
$20.01 to $30.00		66,000	9.0 Years		24.64		5,200		26.00
$30.01 to $40.00		20,820	7.7 Years		38.14		7,608		38.73
$40.01 to $42.62		57,481	6.9 Years		42.62		34,485		42.62
Total		145,680	7.9 Years	$	33.56		48,672	$	39.42

Stock Grants

Restricted stock grants – During the three and six months ended June 30, 2021,5,730 and 19,233 restricted shares, respectively, were granted to employees and non-employee directors, vesting over a four- or five-year period. During the three and six months ended June 30, 2020, 11,900 and 22,268 restricted shares, respectively, were granted. For the three and six months ended June 30, 2021, $165 thousand and $226 thousand, respectively, was expensed as a result of restricted stock grants. For the three and six months ended June 30, 2020, $39 thousand and $54 thousand, respectively, in expense was incurred. As of June 30, 2021, there was $1.1 million in unrecognized compensation expense for restricted stock grants remaining to be recognized in future reporting periods through 2026.

Changes in the restricted stock grants outstanding during the six months ended June 30, 2021 are summarized below (dollars in thousands except per share data):

	June 30, 2021
	Number of Shares			Weighted Average Grant Date Fair Value Per Share		Aggregate Intrinsic Value
Nonvested as of January 1, 2021		25,268		$	26.60	$	982
Issued		19,233			30.20	748
Vested		(9,006	)		26.01		(350	)
Nonvested at June 30, 2021		35,495		$	28.70	$	1,380

Note 9. Fair Value Measurements

Determination of Fair Value

The Company follows ASC 820, “Fair Value Measurements and Disclosures,” to record fair value adjustments to certain assets and liabilities and to determine fair value disclosures. This codification clarifies that the fair value of a financial instrument is the price that would be received to sell an asset or paid to transfer a liability (exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants at the measurement date. Fair value is best determined based upon quoted market prices. However, in many instances, there are no quoted market prices for the Company’s various financial instruments. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. Accordingly, the fair value estimates may not be realized in an immediate settlement of the instrument.

The fair value guidance provides a consistent definition of fair value, which focuses on exit price in the principal or most advantageous market for the asset or liability in an orderly transaction (that is, not a forced liquidation or distressed sale) between market participants at the measurement date under current market conditions. If there has been a significant decrease in the volume and level of activity for the asset or liability, a change in valuation technique or the use of multiple valuation techniques may be appropriate. In such instances, determining the price at which willing market participants would transact at the measurement date under current market conditions depends on the facts and circumstances and requires the use of significant judgment. The fair value is a reasonable point within the range that is most representative of fair value under current market conditions.

Fair Value Hierarchy

In accordance with this guidance, the Company groups its financial assets and financial liabilities generally measured at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value.

	Level 1 –		Valuation is based on quoted prices in active markets for identical assets and liabilities.

	Level 2 –		Valuation is based on observable inputs including quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in less active markets, and model-based valuation techniques for which significant assumptions can be derived primarily from or corroborated by observable data in the market.

	Level 3 –		Valuation is based on model-based techniques that use one or more significant inputs or assumptions that are unobservable in the market

The following describes the valuation techniques used by the Company to measure certain financial assets and liabilities recorded at fair value on a recurring basis in the consolidated financial statements:

Securities available for sale

Securities available for sale are recorded at fair value on a recurring basis. Fair value measurement is based upon quoted market prices, when available (Level 1). If quoted market prices are not available, fair values are measured utilizing independent valuation techniques of identical or similar securities for which significant assumptions are derived primarily from or corroborated by observable market data. Third party vendors compile prices from various sources and may determine the fair value of identical or similar securities by using pricing models that consider observable market data (Level 2).

The following tables present the balances measured at fair value on a recurring basis as of June 30, 2021 and December 31, 2020 (dollars in thousands):

			Fair Value Measurements at June 30, 2021 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Government agencies	$	35,228	$	-	$	35,228	$	-
Mortgage-backed securities/CMOs		136,418		-		136,418		-
Municipal bonds		95,327		-		95,327		-
Total securities available for sale	$	266,973	$	-	$	266,973	$	-

			Fair Value Measurements at December 31, 2020 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
U.S. Government agencies	$	25,305	$	-	$	25,305	$	-
Mortgage-backed securities/CMOs		78,100		-		78,100		-
Municipal bonds		70,681		-		70,681		-
Total securities available for sale	$	174,086	$	-	$	174,086	$	-

Certain assets are measured at fair value on a nonrecurring basis in accordance with GAAP. Adjustments to the fair value of these assets usually result from the application of lower-of-cost-or-market accounting or write downs of individual assets. The following describes the valuation techniques used by the Company to measure certain assets recorded at fair value on a nonrecurring basis in the consolidated financial statements:

Other Real Estate Owned

Other real estate owned (“OREO”) is measured at fair value less cost to sell, based on an appraisal conducted by an independent, licensed appraiser outside of the Company. If the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3. OREO is measured at fair value on a nonrecurring basis. Any initial fair value adjustment is charged against the Allowance for Loan Losses. Subsequent fair value adjustments are recorded in the period incurred and included in other noninterest expense on the Consolidated Statements of Income. As of June 30, 2021, the Company had one OREO property acquired through the merger with Fauquier which is carried at a fair value of $611 thousand. As of December 31, 2020, the Company had no OREO property.

Impaired Loans

Loans are designated as impaired when, in the judgment of management based on current information and events, it is probable that all amounts due according to the contractual terms of the loan agreement will not be collected when due. The measurement of loss associated with impaired loans can be based on either (a) the observable market price of the loan or the fair value of the collateral, or (b) using the present value of expected future cash flows discounted at the loan’s effective interest rate, which is not a fair value measurement. Collateral may be in the form of real estate or business assets including equipment, inventory, and accounts receivable. The vast majority of the collateral is real estate. The value of real estate collateral is determined utilizing an income or market valuation approach based on an appraisal conducted by an independent, licensed appraiser outside of the Company using observable market data

(Level 2). However, if the collateral value is significantly adjusted due to differences in the comparable properties, or is discounted by the Company because of marketability, then the fair value is considered Level 3.

Impaired loans that are measured based on expected future cash flows discounted at the loan’s effective interest rate rather than the market rate of interest are not recorded at fair value, and are therefore excluded from fair value disclosure requirements.

The value of business equipment is based upon an outside appraisal if deemed significant, or the net book value on the applicable business’ financial statements if not considered significant. Likewise, values for inventory and accounts receivables collateral are based on financial statement balances or aging reports (Level 3).

Impaired loans allocated to the Allowance for Loan Losses are measured at fair value on a nonrecurring basis. Any fair value adjustments are recorded in the period incurred as provision for loan losses on the Consolidated Statements of Income. The Company had impaired loans, excluding acquired impaired loans, of $1.1 million as of June 30, 2021 and $1.3 million as of December 31, 2020. All impaired loans were measured based on expected future cash flows discounted at the loan’s effective interest rate, or fair value of collateral, as noted above.

The following table presents the Company’s assets that were measured at fair value on a nonrecurring basis as of June 30, 2021. There were no such assets to report as of December 31, 2020.

			Fair Value Measurements at June 30, 2021 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
Description	Balance		(Level 1)		(Level 2)		(Level 3)
Assets:
Other Real Estate Owned	$	611	$	—	$	—	$	611

For the assets measured at fair value on a nonrecurring basis as of June 30, 2021, the following table displays quantitative information about Level 3 Fair Value Measurements (dollars in thousands):

Description

Fair Value

Valuation Technique

Unobservable Inputs

Weighted Average

Assets:

Other Real Estate Owned

611

Market comparables

Discount applied to bonafide offer*

6.0

^*A discount percentage is applied based on age of independent appraisals, current market conditions, and cost to sell.

ASC 825, “Financial Instruments,” requires disclosures about fair value of financial instruments for interim periods and excludes certain financial instruments and all non-financial instruments from its disclosure requirements. Accordingly, the aggregate fair value amounts presented may not necessarily represent the underlying fair value of the Company.

The Company uses the exit price notion in calculating the fair values of financial instruments not measured at fair value on a recurring basis.

Interest rate swaps

The Company recognizes interest rate swaps at fair value. The Company has contracted with a third-party to provide valuations for interest rate swaps using standard valuation techniques. The Company’s interest rate swaps are classified as Level 2.

The carrying values and estimated fair values of the Company's financial instruments as of June 30, 2021 and December 31, 2020 are as follows (dollars in thousands):

			Fair Value Measurements at June 30, 2021 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	313,979	$	313,979	$	-	$	-	$	313,979
Available for sale securities		266,973		-		266,973		-		266,973
Loans, net		1,160,639		-		-		1,174,565		1,174,565
Bank owned life insurance		30,775		-		30,775		-		30,775
Other real estate, net		611		-		-		611		611
Accrued interest receivable		4,197		-		1,135		3,062		4,197

Liabilities
Demand deposits and
interest-bearing transaction, money market, and savings accounts	$	1,458,453	$	-	$	1,458,453	$	-	$	1,458,453
Certificates of deposit and other time deposits		170,995		-		171,295		-		171,295
Borrowings		42,989		-		42,741		-		42,741
Junior subordinated debt		3,345		-		-		3,345		3,345
Accrued interest payable		221		-		221		-		221
Interest rate swaps		291				291

			Fair Value Measurements at December 31, 2020 Using:
			Quoted Prices in Active Markets for Identical Assets		Significant Other Observable Inputs		Significant Unobservable Inputs
	Carrying value		Level 1		Level 2		Level 3		Fair Value
Assets
Cash and cash equivalent	$	34,695	$	34,695	$	-	$	-	$	34,695
Available for sale securities		174,086		-		174,086		-		174,086
Loans, net		603,951		-		-		602,859		602,859
Bank owned life insurance		16,849		-		16,849		-		16,849
Accrued interest receivable		2,904		-		729		2,175		2,904

Liabilities
Demand deposits and
interest-bearing transaction and money market accounts	$	631,662	$	-	$	631,662	$	-	$	631,662
Certificates of deposit and other time deposits		99,102		-		99,580		-		99,580
Borrowings		30,000		-		30,000		-		30,000
Accrued interest payable		159		-		159		-		159

The Company assumes interest rate risk (the risk that general interest rate levels will change) as a result of its normal operations. Consequently, the fair values of the Company’s financial instruments will fluctuate when interest rate levels change, and that change may be either favorable or unfavorable to the Company. Management attempts to match maturities of assets and liabilities to the extent believed necessary to minimize interest rate risk; however, borrowers with fixed rate obligations are less likely to prepay in a rising rate environment and more likely to prepay in a falling rate environment. Conversely, depositors who are receiving fixed rates are more likely to withdraw funds before maturity in a rising rate environment and less likely to do so in a falling rate environment. Management monitors rates and maturities of

assets and liabilities and attempts to minimize interest rate risk by adjusting terms of new loans and deposits and by investing in securities with terms that mitigate the Company’s overall interest rate risk.

Note 10. Other Comprehensive Income

A component of the Company’s other comprehensive income, in addition to net income from operations, is the recognition of the unrealized gains and losses on available for sale securities, net of income taxes. Reclassifications of realized gains and losses on available for sale securities are reported in the income statement as “Gains on sales of securities” with the corresponding income tax effect reflected as a component of income tax expense. There were no sales of securities in the first two quarters of 2021. Amounts reclassified out of accumulated other comprehensive income are presented below for the three and six months ended June 30, 2021 and 2020 (dollars in thousands).

	Three Months Ended					Six Months Ended
	June 30, 2021		June 30, 2020			June 30, 2021		June 30, 2020
Available for sale securities
Realized gains on sales of securities	$	—	$	590		$	—	$	643
Tax effect	---			(124	)	---			(135	)
Realized gains, net of tax	$	—	$	466		$	—	$	508

The following table presents the cumulative balances of the components of accumulated other comprehensive income (loss), net of deferred taxes of $36 thousand and ($389) thousand, as of June 30, 2021 and December 31, 2020, respectively (dollars in thousands).

	June 30, 2021			December 31, 2020
Accumulated other comprehensive income (loss) on securities	$	(24	)	$	1,460
Accumulated other comprehensive income (loss) on interest rate swap		(111	)	---
Total accumulated other comprehensive income (loss)	$	(135	)	$	1,460

Note 11. Segment Reporting

The Company has four reportable segments. Each reportable segment is a strategic business unit that offers different products and services. They are managed separately, because each segment appeals to different markets and, accordingly, require different technology and marketing strategies. The accounting policies of the segments are the same as those described in the summary of significant accounting policies provided earlier in this report.

The four reportable segments are:

•

Bank - The commercial banking segment involves making loans and generating deposits from individuals, businesses and charitable organizations. 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 the Bank segment.

•

Sturman Wealth Advisors – Sturman Wealth Advisors, formerly known as VNB Investment Services, offers wealth management and investment advisory services. Revenue for this segment is generated primarily from investment advisory and financial planning fees, with a small and decreasing portion attributable to brokerage commissions.

•

VNB Trust & Estate Services – VNB Trust & Estate Services offers corporate trustee services, trust and estate administration, IRA administration and custody services. Revenue for this segment is generated from administration, service and custody fees, as well as management fees that are derived from Assets Under Management and, prior to 2020, incentive income that was based on the investment returns generated on performance-based Assets Under Management. Investment management services currently are offered through in-house and third-party managers. In addition, royalty income, in the form of fixed and incentive fees, from the sale of Swift Run Capital Management, LLC in 2013 is reported as income of VNB Trust & Estate Services. More information on royalty income and the related sale can be found under Summary of Significant Accounting Policies in Note 1 of the notes to consolidated financial statements, which is found in Item 8. Financial Statements and Supplementary Data, in the Company’s Form 10-K Report for December 31, 2020.

•

Masonry Capital - Masonry Capital offers investment management services for separately managed accounts and a private investment fund employing a value-based, catalyst-driven investment strategy. Revenue for this segment is generated from management fees that are derived from Assets Under Management and incentive income that is based on the investment returns generated on performance-based Assets Under Management.

A management fee for administrative and technology support services provided by the Bank is allocated to the other three lines of business. For both the three months ended June 30, 2021 and 2020, management fees totaling $25 thousand were charged by the Bank and eliminated in consolidated totals. For both the six months ended June 30, 2021 and 2020, management fees totaling $50 thousand were charged by the Bank and eliminated in consolidated totals.

Segment information for the three and six months ended June 30, 2021 and 2020 is shown in the following tables (dollars in thousands). Note that asset information is not reported below, as the assets of Sturman Wealth Advisors and VNB Trust & Estate Services are reported at the Bank level; also, assets specifically allocated to the lines of business other than the Bank are insignificant and are no longer provided to the chief operating decision maker.

Three months ended June 30, 2021	Bank			Sturman Wealth Advisors		VNB Trust & Estate Services			Masonry Capital			Consolidated
Net interest income	$	13,151		$	-	$	-		$	-		$	13,151
Provision for (recovery of) loan losses		(141	)		-		-			-			(141	)
Noninterest income		2,356			202		203			159			2,920
Noninterest expense		15,416			167		215			195			15,993
Income (loss) before income taxes		232			35		(12	)		(36	)		219
Provision for (benefit from) income taxes		75			7		(3	)		(7	)		72
Net income (loss)	$	157		$	28	$	(9	)	$	(29	)	$	147


Six months ended June 30, 2021	Bank			Sturman Wealth Advisors		VNB Trust & Estate Services			Masonry Capital			Consolidated
Net interest income	$	19,125		$	-	$	-		$	-		$	19,125
Provision for loan losses		210			-		-			-			210
Noninterest income		2,870			393		404			292			3,959
Noninterest expense		19,671			327		421			355			20,774
Income (loss) before income taxes		2,114			66		(17	)		(63	)		2,100
Provision for income taxes		451			14		(4	)		(13	)		448
Net income (loss)	$	1,663		$	52	$	(13	)	$	(50	)	$	1,652

Three months ended June 30, 2020	Bank		Sturman Wealth Advisors		VNB Trust & Estate Services			Masonry Capital			Consolidated
Net interest income	$	5,755	$	-	$	-		$	-		$	5,755
Provision for loan losses		378		-		-			-			378
Noninterest income		1,211		162		175			78			1,626
Noninterest expense		3,811		154		234			205			4,404
Income (loss) before income taxes		2,777		8		(59	)		(127	)		2,599
Provision for (benefit from) income taxes		547		2		(12	)		(26	)		511
Net income (loss)	$	2,230	$	6	$	(47	)	$	(101	)	$	2,088

Six months ended June 30, 2020	Bank		Sturman Wealth Advisors		VNB Trust & Estate Services			Masonry Capital			Consolidated
Net interest income	$	11,130	$	-	$	-		$	-		$	11,130
Provision for loan losses		1,143		-		-			-			1,143
Noninterest income		2,346		340		433			176			3,295
Noninterest expense		7,774		328		472			373			8,947
Income (loss) before income taxes		4,559		12		(39	)		(197	)		4,335
Provision for income taxes		889		3		(8	)		(41	)		843
Net income (loss)	$	3,670	$	9	$	(31	)	$	(156	)	$	3,492

Note 12. Leases

Lease liabilities represent the Company’s obligation to make lease payments and are presented at each reporting date as the net present value of the remaining contractual cash flows. Cash flows are discounted at the Company’s incremental borrowing rate in effect at the commencement date of the lease for a term similar to the length of the lease, including any probable renewal options available. Right-of-use assets represent the Company’s right to use the underlying asset for the lease term and are calculated as the sum of the lease liability and if applicable, prepaid rent, initial direct costs and any incentives received from the lessor.

Lease payments for short-term leases are recognized as lease expense on a straight-line basis over the lease term. Payments for leases with terms longer than twelve months are included in the determination of the lease liability. The right-of-use asset and lease liability are included in other assets and other liabilities, respectively, in the Consolidated Balance Sheets.

Each of the Company’s long-term lease agreements are classified as operating leases. Certain of these leases offer the option to extend the lease term and the Company has included such extensions in its calculation of the lease liabilities to the extent the options are reasonably assured of being exercised. The lease agreements do not provide for residual value guarantees and have no restrictions or covenants that would impact dividends or require incurring additional financial obligations.

The following tables present information about the Company’s leases (dollars in thousands):

	June 30, 2021			June 30, 2020
Lease liability	$	7,833		$	3,966
Right-of-use asset	$	8,371		$	3,923
Weighted average remaining lease term	6.37 years			5.55 years
Weighted average discount rate		1.98	%		2.56	%

	Three Months Ended June 30,				Six Months Ended June 30,
Lease Expense	2021		2020		2021		2020
Operating lease expense	$	427	$	204	$	649	$	408
Short-term lease expense		32		29		61		57
Total lease expense	$	459	$	233	$	710	$	465
Cash paid for amounts included in lease liabilities	$	389	$	199	$	608	$	398

A maturity analysis of operating lease liabilities and reconciliation of the undiscounted cash flows to the total of operating lease liabilities is as follows (dollars in thousands):

Undiscounted Cash Flow	June 30, 2021
Six months ending December 31, 2021	$	781
Twelve months ending December 31, 2022		1,534
Twelve months ending December 31, 2023		1,462
Twelve months ending December 31, 2024		1,175
Twelve months ending December 31, 2025		968
Twelve months ending December 31, 2026		622
Thereafter		1,771
Total undiscounted cash flows	$	8,313
Less: Discount		(480	)
Lease liability	$	7,833

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion should be read in conjunction with the unaudited consolidated financial statements, and notes thereto, of Virginia National Bankshares Corporation (the “Company”) included in this report and the audited consolidated financial statements, and notes thereto, of the Company included in the Company’s Form 10-K for the year ended December 31, 2020. Operating results for the three and six months ended June 30, 2021 are not necessarily indicative of the results for the year ending December 31, 2021 or any future period.

FORWARD-LOOKING STATEMENTS AND FACTORS THAT COULD AFFECT FUTURE RESULTS

Certain statements contained or incorporated by reference in this quarterly report on Form 10-Q may contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements include, without limitation, statements with respect to the Company’s operations, performance, future strategy and goals, and are often characterized by use of qualified words such as “expect,” “believe,” “estimate,” “project,” “anticipate,” “intend,” “will,” “should,” or words of similar meaning or other statements concerning the opinions or judgement of the Company and its management about future events. While Company management believes such statements to be reasonable, future events and predictions are subject to circumstances that are not within the control of the Company and its management. Actual results may differ materially from those included in the forward-looking statements due to a number of factors, including, without limitation, the effects of and changes in: general economic and market conditions, including the effects of declines in real estate values, an increase in unemployment levels and general economic contraction as a result of COVID-19 or other pandemics; fluctuations in interest rates, deposits, loan demand, and asset quality; assumptions that underlie the Company’s allowance for loan losses (“ALLL”); the potential adverse effects of unusual and infrequently occurring events, such as weather-related disasters, terrorist acts or public health events (e.g., COVID-19 or other pandemics), and of governmental and societal responses thereto; the performance of vendors or other parties with which the Company does business; competition; technology; changes in laws, regulations and guidance; changes in accounting principles or guidelines; performance of assets under management; expected revenue synergies and cost savings from the recently completed merger with Fauquier Bankshares, Inc. (“Fauquier”) may not be fully realized or realized within the expected timeframe; the businesses of the Company and Fauquier may not be integrated successfully or such integration may be more difficult, time-consuming or costly than expected; revenues following the merger may be lower than expected; customer and employee relationships and business operations may be disrupted by the merger; and other factors impacting financial services businesses. Many of these factors and additional risks and uncertainties are described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020 and other reports filed from time to time by the Company with the Securities and Exchange Commission (“SEC”). These statements speak only as of the date made, and the Company does not undertake to update any forward-looking statements to reflect changes or events that may occur after this release.

MERGER WITH FAUQUIER BANKSHARES, INC., AND THE FAUQUIER BANK

On April 1, 2021, the Company completed its merger with Fauquier. The merger of Fauquier with and into the Company (the “Merger”) was effected pursuant to the terms and conditions of the Agreement and Plan of Reorganization, dated as of September 30, 2020, between the Company and Fauquier, and a related Plan of Merger (together, the “Merger Agreement”). Immediately after the Merger, The Fauquier Bank, Fauquier’s wholly-owned bank subsidiary, merged with and into Virginia National Bank (the “Bank”), the Company’s wholly-owned bank subsidiary.

Pursuant to the Merger Agreement, former holders of shares of Fauquier common stock received 0.675 shares of the Company’s common stock for each share of Fauquier common stock held immediately prior to the Merger, with cash paid in lieu of fractional shares. Each share of common stock of the Company outstanding immediately prior to the Merger remained outstanding and was unaffected by the Merger.

Refer to Note 2 - Business Combinations, in the Notes to Consolidated Financial Statements, for further detail on the accounting policy for business combinations, fair values of assets and liabilities assumed, assumptions used in determining the fair values of assets and liabilities and the resulting goodwill.

OVERVIEW

Our primary financial goal is to maximize the Company’s earnings to increase long-term shareholder value. We monitor three key financial performance measures to determine our success in realizing this goal: 1) return on average assets (ROAA), 2) return on average equity (ROAE), and 3) net income per share (EPS).

•

Return on average assets (“ROAA”) for the second quarter of 2021 was 0.03% compared to 1.07% realized in the same period in the prior year. ROAA excluding the impact of merger expenses (a non-GAAP financial measure) would have been 1.02% for the second quarter of 2021. ROAA for the six months ended June 30, 2021 was 0.24% compared to 0.93% realized in the same period in the prior year. ROAA excluding the impact of merger expenses (a non-GAAP financial measure) would have been 0.93% for the six months ended June 30, 2021, equaling the ROAA for the prior comparable period.

•

Return on average equity (“ROAE”) for the second quarter of 2021 was 0.37% compared to 10.64% realized in same period in the prior year. ROAE excluding the impact of merger expenses (a non-GAAP financial measure) would have been 11.89% for the second quarter of 2021. ROAE for the six months ended June 30, 2021 was 2.76% compared to 8.98% realized in same period in the prior year. ROAE excluding the impact of merger expenses (a non-GAAP financial measure) would have been 10.66% for the six months ended June 30, 2021, exceeding the ROAE from the comparable period in the prior year.

•

The Company incurred $5.9 million in merger expenses during the second quarter of 2021 related to the combination with Fauquier, which closed on April 1, 2021. Of this total, $2.2 million was incurred for system deconversion, termination and conversion fees, $1.5 million was accrued for the change-of-control payment for Marc Bogan resulting from his resignation, $1.1 million related to buyer investment banker fees, $510 thousand was associated with valuation and integration professional fees, $269 thousand related to other personnel expenses, $235 thousand was incurred for regulatory and shareholder expenses, and $150 thousand was recognized for legal expenses. This pre-tax expense of $5.9 million represents $1.11 per diluted share for the second quarter of 2021. The Company incurred $6.2 million in merger expenses during the six months ended June 30, 2021. First quarter expenses of $278 thousand related primarily to professional fees.

•

Net income per share was $0.03 for the second quarter of 2021, compared to $0.77 for the second quarter in the prior year. Net income per share, excluding merger expenses (a non-GAAP financial measure), would have been $0.89 in the current quarter, exceeding the net income per share of the comparable prior period. Net income per share was $0.41 for the first half of 2021, compared to $1.29 for the same period in the prior year. Net income per share, excluding merger expenses (a non-GAAP financial measure), would have been $1.33 for the first half of 2021, exceeding the net income per share of the comparable prior period.

We also manage our capital levels through growth, quarterly cash dividends, periodic stock dividends and share repurchases, when prudent, while maintaining a strong capital position. Refer to the Results of Operations, Non-GAAP Presentation section, later in this Management’s Discussion and Analysis for more discussion on these financial performance measures.

IMPACT OF COVID-19

Continuing cases of COVID-19, including the emergence of variants of the COVID-19 virus, continue to be a public health concern in the Company’s markets. While more than 50% of adults in the U.S. and in Virginia are fully vaccinated against COVID-19, the rate of vaccinations appears to have peaked during the second quarter of 2021, and the Delta variant has shown that there remains a threat of a resurgence of cases. There have been encouraging signs of strength in the economic recovery, including growth in consumer spending and improvement in the labor market, but many businesses continue to face difficulty in hiring desirable employees and meeting consumer demand, and certain portions of the global supply chain remain challenged by shortages and delays that first occurred due to the initial COVID-19 outbreak. There remains uncertainty about the pace of economic recovery, including uncertainty related to the labor market, inflation and fiscal and monetary policy responses from the federal government. There remains a risk that consumers and borrowers who have been supported during the pandemic by government stimulus measures may not return to employment and may not be able to repay debts as agreed following the cessation of government stimulus programs, including expanded unemployment benefits.

Management continues to carefully monitor the pandemic and its impact on the Company’s markets, customers and employees, and believes that the pandemic continues to present risks of elevated loan losses, sustained net interest margin compression and falling demand for loans; however, at this time management cannot determine the ultimate impact of the pandemic on the results of operations of the Company.

Financial Condition and Results of Operations

Throughout the onset of this pandemic, the Company has maintained its high standards of credit quality on organic loan funding to limit credit risk exposure.

During the year ended December 31, 2020, we provided an additional $1.6 million for loan losses primarily by downgrading the qualitative economic factors within the ALLL model in light of the effects of COVID-19 on the economy. As of June 30, 2021, credit deterioration since the onset of the COVID-19 pandemic has so far not been experienced to the extent previously anticipated, and therefore, during the second quarter of 2021, we released a portion of these added reserves through a reversal of provision for loan losses. The Company continues to maintain reserves for loan losses at June 30, 2021 related to the pandemic and believe that our allowance for loan losses will be adequate to absorb probable losses that are inherent in our loan portfolio. If loan losses ultimately are not realized to the extent of the reserves provided for during the pandemic, our allowance for loan losses may be reduced in future periods through further reversals of provision for loan losses, which could benefit our results of operations for any such future period. However, if there are further challenges to the economic recovery, including a resurgence in COVID-19 cases or the emergence of variants of the COVID-19 virus that threaten to disrupt economic activity, additional provision for loan losses may be required in future periods.

Interest income could be reduced due to the economic impact of COVID-19. In accordance with guidance from regulators, the Company is working with borrowers who were adversely affected by COVID-19 to defer principal only, or principal and interest. While interest will continue to accrue to income, in accordance with accounting principles generally accepted in the United States (“GAAP”), if the Company ultimately incurs a credit loss on these deferred payments, interest income would need to be reversed and therefore, interest income in future periods could be negatively affected. Since the beginning of the pandemic, the Company has accommodated 194 deferrals on outstanding loan balances of $59.7 million (of which 131 deferrals on outstanding loan balances of $1.8 million were related to student loans). As of June 30, 2021, $57.7 million in loan balances, or 96.6% of the total loan deferments approved, have returned to normal payment schedules and are now current, leaving a remaining balance of deferments of $2.0 million. Of this remaining balance, $1.9 million, or 92.8%, are 100% government-guaranteed loans for which the deferrals were approved by the United States Department of Agriculture; and $144 thousand, or 7.2%, are student loans, which are private student loans not subject to potential federal forgiveness. In accordance with interagency guidance issued in March 2020 and the CARES Act, these short-term deferrals are not considered troubled debt restructurings (“TDRs”).

Primarily within the second quarter of 2020 and the first quarter of 2021, the Company devoted significant resources to accept PPP applications, a program designed to provide a direct incentive for small businesses to keep employees on their payroll. In total, the Company, including Virginia National Bank and The Fauquier Bank, funded $207.5 million in PPP loans, with average origination fees of 3.9%, assisting many nonprofits and local businesses through this program. As of June 30, 2021, 66.9% of the total dollars of PPP loans had been forgiven by the SBA, with $68.8 million outstanding. Loans funded through the PPP are fully guaranteed by the U.S. government. The Company believes that it performed the required due diligence pursuant to the established SBA criteria; nonetheless, if a determination is made that certain loans did not meet the criteria established for the program, the Company may be required to establish additional ALLL through provision for loan loss expense which will negatively impact net income.

Capital and Liquidity

As of June 30, 2021, capital ratios of the Company were in excess of regulatory requirements. While currently included in the category of “well capitalized” by bank regulators, a prolonged economic recession could adversely impact reported and regulatory capital ratios. The Company maintains access to multiple sources of liquidity. Management has also revisited its capital and liquidity stress tests, as well as capital and liquidity contingency plans to validate how the Company can react effectively to the economic downturn caused by this pandemic.

Goodwill

The Company’s goodwill was recognized in connection with the acquisition of Fauquier in 2021 and Sturman Wealth Management in 2016. The Company reviews the carrying value of goodwill at least annually or more frequently if certain impairment indicators exists. In testing goodwill for impairment, the Company may first consider qualitative factors to determine whether the existence of events or circumstances lead to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the events and circumstance, the Company concludes that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, the no further testing is required and the goodwill of the reporting unit is not impaired. If the Company elects to bypass the qualitative assessment or if the conclusion is that it is more likely than not that the fair value of a reporting unit is less than its carrying amount, then the fair value of the reporting unit is compared with its carrying value to determine whether an impairment exists. As of June 30, 2021, the goodwill on the balance sheet was not deemed to be impaired. However,

management may determine that goodwill is required to be evaluated for impairment in the future due to the presence of a triggering event, which may have a negative impact on the Company’s results of operations.

Operations, Processes, Controls and Business Continuity Plan

The Company reacted quickly to the COVID-19 pandemic. We began internal social distancing in mid-March of 2020, as well as distancing from the public by keeping our drive-thru services available, and encouraging customers to conduct transactions at ATMs, through online banking and/or the mobile app. The Company also increased consumer and business mobile deposit limits to encourage customers to make deposits remotely from the safety of their home or business. The Company implemented a schedule whereby most staff members are working remotely at any given time, allowing the remaining essential staff to create more distance between each other within the offices. We temporarily increased the number of staff in the client service center to assist more customers by telephone and encourage them to utilize online and mobile banking. The client service center was also temporarily moved to a larger location to allow for appropriate social distancing. In addition, the Company enhanced disinfecting procedures to include hospital-grade cleaning solution and foggers, increased the frequency of cleaning and issued personal protective equipment, including N-95 and disposable face masks, face shields, sneeze guards, gloves and thermometers, to employees, along with specific instructions for use, to enhance their safety. We also installed disinfecting protective strips to high touch areas and placed free-standing air filter machines throughout our facilities. We purchased COVID-19 instant test kits that we have on-site, ready to be deployed when needed, and we provided antibody testing options to all employees. Management provides frequent email communications and social media updates regarding COVID-19, helpful tips and status of Company initiatives, as well as warning customers of potential scams during this pandemic. Beginning mid-July of 2020, the Company took steps to resume normal branch activities with specific guidelines in place to continue protecting our customers and employees.

The Company’s preparedness resulted in minimal impact to the Company’s operations as a result of COVID-19. Business continuity planning allowed for successful deployment of most of our employees to work in a remote environment. No material operational or internal control risks have been identified to date, and the Company has enhanced fraud-related controls.

APPLICATION OF CRITICAL ACCOUNTING POLICIES AND ESTIMATES

The accounting and reporting policies followed by the Company conform, in all material respects, to 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 consolidated financial statements. The Company’s accounting policies are fundamental to understanding management’s discussion and analysis of financial condition and results of operations.

For additional information regarding critical accounting policies, refer to the Application of Critical Accounting Policies and Critical Accounting Estimates section under Item 7 in the Company’s 2020 Form 10-K. The only significant changes in the Company’s application of critical accounting policies since December 31, 2020 relates to loans acquired in a business combination, as follows.

Loans acquired in a business combination: Acquired Loans are classified as either i) purchased credit-impaired (PCI) loans or ii) purchased performing loans and are recorded at fair value on the date of acquisition. PCI loans are those for which there is evidence of credit deterioration since origination and for which it is probable at the date of acquisition that the Company will not collect all contractually required principal and interest payments. When determining fair value, PCI loans are aggregated into pools of loans based on common risk characteristics as of the date of acquisition such as loan type, date of origination, and evidence of credit quality deterioration such as internal risk grades and past due and nonaccrual status. The difference between contractually required payments at acquisition and the cash flows expected to be collected at acquisition is referred to as the “nonaccretable difference.” Any excess of cash flows expected at acquisition over the estimated fair value is referred to as the “accretable yield” and is recognized as interest income over the remaining life of the loan when there is a reasonable expectation about the amount and timing of such cash flows.

On a quarterly basis, we evaluate our estimate of cash flows expected to be collected on PCI loans. Estimates of cash flows for PCI loans require significant judgment. Subsequent decreases to the expected cash flows will generally result in a provision for loan losses resulting in an increase to the allowance for loan losses. Subsequent significant increases in cash flows may result in a reversal of post-acquisition provision for loan losses or a transfer from nonaccretable difference to accretable yield that increases interest income over the remaining life of the loan or pool(s) of loans. Disposals of loans, which may include sale of loans to third parties, receipt of payments in full or in part from the borrower or foreclosure of the collateral, result in removal of the loan from the PCI loan portfolio at its carrying amount.

PCI loans are not classified nonperforming loans by the Company at the time they are acquired, regardless of whether they had been classified as nonperforming by the previous holder of such loans, and they will not be classified as nonperforming so long as, at quarterly re-estimation periods, we believe we will fully collect the new carrying value of the pools of loans.

The Company accounts for purchased performing loans using the contractual cash flows method of recognizing discount accretion based on the Acquired Loans’ contractual cash flows. Purchased performing loans are recorded at fair value, including a credit discount. The fair value discount is accreted as an adjustment to yield over the estimated lives of the loans. There is no allowance for loan losses established at the acquisition date for purchased performing loans. A provision for loan losses may be required for any deterioration in these loans in future periods.

FINANCIAL CONDITION

Total assets

The total assets of the Company as of June 30, 2021 were $1.8 billion. This is a $998.7 million, or 117.7%, increase from the $848.4 million total assets reported at December 31, 2020 and a $1.0 billion, or 131.0%, increase from the $799.6 million reported at June 30, 2020. These increases were substantially due to the acquisition of Fauquier, which became effective April 1, 2021.

Interest-bearing deposits in other banks

The Company had $177.8 million of interest-bearing deposits in other banks as of June 30, 2021, compared to zero as of December 31, 2020 and June 30, 2020, as the current balance included accounts held by Fauquier, primarily at the Federal Reserve Bank of Richmond.

Federal funds sold

The Company had overnight federal funds sold of $106.6 million as of June 30, 2021, compared to $26.6 million as of December 31, 2020 and $24.8 million as of June 30, 2020. Any excess funds are sold on a daily basis in the federal funds market. The Company intends to maintain sufficient liquidity at all times to meet its funding commitments.

The Company continues to participate in the Excess Balance Account (“EBA”) of the Federal Reserve Bank of Richmond (“FRB”). The EBA is a limited-purpose account at the FRB for the maintenance of excess cash balances held by financial institutions. The EBA eliminates the potential of concentration risk that comes with depositing excess balances with one or multiple correspondent banks.

Securities

The Company’s investment securities portfolio as of June 30, 2021 totaled $271.2 million, an increase of $94.1 million compared with the $177.1 million reported at December 31, 2020 and an increase of $166.7 million from the $104.5 million reported at June 30, 2020. The increases are primarily due to the inclusion of the investment securities portfolio of Fauquier upon effective date of the merger as of April 1, 2021. Management proactively manages the mix of earning assets and cost of funds to maximize the earning capacity of the Company. At June 30, 2021 and December 31, 2020, the investment securities holdings represented 14.7% and 20.9% of the Company’s total assets, respectively.

The Company’s investment securities portfolio included restricted securities totaling $4.3 million as of June 30, 2021, compared to $3.0 million as of December 31, 2020 and $1.7 million as of June 30, 2020. These securities represent stock in the FRB, the Federal Home Loan Bank of Atlanta (“FHLB”), CBB Financial Corporation, the holding company for Community Bankers Bank, and stock in an SBA loan fund. The level of FRB and FHLB stock that the Company is required to hold is determined in accordance with membership guidelines provided by the Board of Governors of the Federal Reserve System (“Federal Reserve”) and the FHLB, respectively. Stock ownership in the bank holding company

for Community Bankers’ Bank provides the Company with several benefits that are not available to non-shareholder correspondent banks. None of these restricted securities are traded on the open market and can only be redeemed by the respective issuer.

At June 30, 2021, the unrestricted securities portfolio totaled $267.0 million. The following table summarizes the Company's available for sale securities by type as of June 30, 2021, December 31, 2020, and June 30, 2020 (dollars in thousands):

	June 30, 2021					December 31, 2020					June 30, 2020
			Percent					Percent					Percent
	Balance		of Total			Balance		of Total			Balance		of Total
U.S. Government agencies	$	35,228		13.2	%	$	25,305		14.5	%	$	9,037		8.8	%
Mortgage-backed securities/CMOs		136,418		51.1	%		78,100		44.9	%		58,402		56.8	%
Municipal bonds		95,327		35.7	%		70,681		40.6	%		35,333		34.4	%
Total available for sale securities	$	266,973		100.0	%	$	174,086		100.0	%	$	102,772		100.0	%

The securities are held primarily for earnings, liquidity, and asset/liability management purposes and are reviewed quarterly for possible other-than-temporary impairments. During this review, management analyzes the length of time the fair value has been below cost, the expectation for that security’s performance, the creditworthiness of the issuer, and the Company’s intent and ability to hold the security to recovery or maturity. These factors are analyzed for each individual security.

Loan portfolio

A management objective is to grow loan balances while maintaining the asset quality of the loan portfolio. The Company seeks to achieve this objective by maintaining rigorous underwriting standards coupled with regular evaluation of the creditworthiness of, and the designation of lending limits for, each borrowing relationship. The portfolio strategies include seeking industry, loan size, and loan type diversification to minimize credit exposure and originating loans in markets with which the Company is familiar. The predominant market area for the loans shown below includes the cities of Charlottesville, Winchester and Richmond, the counties of Albemarle, Fauquier, Prince William and Frederick, and areas in the Commonwealth of Virginia that are within a 75-mile radius of any office of the Company.

As of June 30, 2021, total loans were $1.2 billion, compared to $609.4 million as of December 31, 2020 and $632.4 million at June 30, 2020. Loans as a percentage of total assets at June 30, 2021 were 63.1%, compared to 79.1% as of June 30, 2020. Loans as a percentage of deposits at June 30, 2021 were 71.6%, compared to 88.5% as of June 30, 2020.

The following table summarizes the Company's loan portfolio by type of loan as of June 30, 2021, December 31, 2020, and June 30, 2020 (dollars in thousands):

	June 30, 2021					December 31, 2020					June 30, 2020
	Balance		Percent of Total			Balance		Percent of Total			Balance		Percent of Total
Commercial	$	160,473		13.8	%	$	118,688		19.5	%	$	162,036		25.6	%
Real estate construction and land		96,421		8.3	%		22,509		3.7	%		26,500		4.2	%
1-4 family residential mortgages		381,801		32.7	%		132,966		21.8	%		129,051		20.4	%
Commercial mortgages		455,795		39.1	%		277,109		45.5	%		251,420		39.8	%
Consumer		71,671		6.1	%		58,134		9.5	%		63,387		10.0	%
Total loans	$	1,166,161		100.0	%	$	609,406		100.0	%	$	632,394		100.0	%

Loan balances increased $556.8 million, or 91.4%, since December 31, 2020 and increased $533.8 million, or 84.4%, from June 30, 2020. The increases are primarily due to the inclusion of Fauquier’s loans of $602.6 million, net of the fair value mark, as of the effective date of the merger of April 1, 2021, for which the carrying amount as of June 30, 2021 amounts to $537.5 million. The increase from the same period in the prior year was offset by the decline in PPP loans of $18.1 million due to loan forgiveness. As of June 30, 2021, 67% of the total dollars of PPP loans had been forgiven by the SBA, with $68.8 million outstanding.

Loan quality

Non-accrual loans totaled $17 thousand at June 30, 2021, compared to the $8 thousand and $11 thousand reported at December 31, 2020 and June 30, 2020, respectively.

The Company had loans in its portfolio totaling $2.8 million, $137 thousand and $1.1 million, as of June 30, 2021, December 31, 2020 and June 30, 2020, respectively, that were 90 or more days past due, with all such loans still accruing interest as the Company deemed them to be collectible. The balance as of June 30, 2021 includes three government-guaranteed loans in the amount $1.7 million and 54 federally insured student loans totaling $572 thousand. This past due total only includes four non-insured student loans that are 90 days or more past due and still accruing interesting, amounting to $52 thousand.

At June 30, 2021, the Company had loans classified as impaired loans in the amount of $1.1 million, a decline compared to $1.3 million at December 31, 2020 and $2.1 million at June 30, 2020. Based on regulatory guidance on student lending, the Company has classified 57 of its Purchased Student Loans as TDRs for a total of $1.0 million as of June 30, 2021. These borrowers that should have been in repayment have requested and been granted payment extensions or reductions exceeding the maximum lifetime allowable payment forbearance of twelve months (36 months lifetime allowance for military service), as permitted under the regulatory guidance, and are therefore considered TDRs. Student loan borrowers are allowed in-school deferments, plus an automatic six-month grace period post in-school status, before repayment is scheduled to begin, and these deferments do not count toward the maximum allowable forbearance. Management has evaluated these loans individually for impairment and included any probable loss in the allowance for loan loss; interest continues to accrue on these TDRs during any deferment and forbearance periods.

Management identifies potential problem loans through its periodic loan review process and considers potential problem loans as those loans classified as special mention, substandard, or doubtful.

Allowance for loan losses

In general, the Company determines the adequacy of its ALLL by considering the risk classification and delinquency status of loans and other factors. Management may also establish specific allowances for loans which management believes require allowances greater than those allocated according to their risk classification. The purpose of the allowance is to provide for 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. The Company is committed to determining, on an ongoing basis, the adequacy of its ALLL. The Company applies historical loss rates to various pools of loans based on risk rating classifications. In addition, the adequacy of the ALLL is further evaluated by applying estimates of loss that could be attributable to any one of the following eight qualitative factors:

Changes in national and local economic conditions, including the condition of various market segments;

Changes in the value of underlying collateral;

Changes in volume of classified assets, measured as a percentage of capital;

Changes in volume of delinquent loans;

The existence and effect of any concentrations of credit and changes in the level of such concentrations;

Changes in lending policies and procedures, including underwriting standards;

Changes in the experience, ability and depth of lending management and staff; and

Changes in the level of policy exceptions.

The Company utilizes a loss migration model, which uses loan level attributes to track the movement of loans through various risk classifications in order to estimate the percentage of losses likely in the portfolio. As of March 31, 2020 and June 30, 2020, the Company downgraded the economic qualitative factors within its ALLL model in light of the effects of COVID-19 on the economy. No additional downgrades of such factors were taken during the quarter ended September 30, 2020, December 31, 2020 or March 31, 2021. As of June 30, 2021, credit deterioration since the onset of the pandemic has so far not been experienced to the extent previously anticipated and therefore, during the second quarter of 2021, we released a portion of these added reserves through a reversal of provision for loan losses. If economic conditions improve or worsen, the Company could experience changes in the required ALLL. It is possible that asset quality metrics could decline in the future if there are further challenges to the economic recovery, including a resurgence in COVID-19 cases or the emergence of variants of the COVID-19 virus.

The relationship of the ALLL to total loans appears below (dollars in thousands):

	June 30, 2021			December 31, 2020			June 30, 2020
Loans held for investment at period-end	$	1,166,161		$	609,406		$	632,394
Allowance for loan losses	$	5,522		$	5,455		$	4,917
Allowance as a percent of period-end loans		0.47	%		0.90	%		0.78	%

The ALLL as a percentage of loans was 0.47% as of June 30, 2021, 0.90% as of December 31, 2020, and 0.78% as of June 30, 2020. The percentage decrease as compared to year-end and the same period in the prior year relate to the elimination of Fauquier’s ALLL as the Acquired Loans were recorded at fair value. The ALLL as a percentage of loans, excluding the impact of Acquired Loans and the fair value mark (a non-GAAP financial measure), would have been 0.88% as of June 30, 2021. The ALLL as a percentage of loans, excluding PPP loans (a non-GAAP financial measure), would have been 0.51% as of June 30, 2021 and 0.98% as of December 31, 2020. Refer to the Reconciliation of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP ALLL as a percentage of loans.

Provisions for loan losses totaling $210 thousand and $1.1 million were recorded in the six months ended June 30, 2021 and 2020, respectively. The following is a summary of the changes in the ALLL for the six months ended June 30, 2021 and 2020 (dollars in thousands):

	2021			2020
Allowance for loan losses, January 1	$	5,455		$	4,209
Charge-offs		(397	)		(581	)
Recoveries		254			146
Provision for loan losses		210			1,143
Allowance for loan losses, June 30	$	5,522		$	4,917

For additional insight into management’s approach and methodology in estimating the ALLL, please refer to the earlier discussion of “Allowance for Loan Losses” in Note 5 of the Notes to Consolidated Financial Statements. In addition, Note 5 includes details regarding the rollforward of the allowance by loan portfolio segments. The rollforward tables indicate the activity for loans that are charged-off, amounts received from borrowers as recoveries of previously charged-off loan balances, and the allocation by loan portfolio segment of the provision made during the period. The events that can positively impact the amount of allowance in a given loan segment include any one or all of the following: the recovery of a previously charged-off loan balance; the decline in the amount of classified or delinquent loans in a loan segment from the previous period, which most commonly occurs when these loans are repaid or are foreclosed; or when there are improvements in the ratios used to estimate the probability of loan losses. Improvements to the ratios could include lower historical loss rates, improvements to any of the qualitative factors mentioned above, or reduced loss expectations for individually-classified loans.

Management reviews the ALLL on a quarterly basis to ensure it is adequate based upon the calculated probable losses inherent in the portfolio. Management believes the ALLL was adequately provided for as of June 30, 2021 and acknowledges that the ALLL may increase throughout the year as economic conditions may continue to deteriorate for the foreseeable future.

Premises and equipment

The Company’s premises and equipment, net of depreciation, as of June 30, 2021 totaled $25.4 million compared to $5.2 million as of December 31, 2020 and $5.7 million as of June 30, 2020, with the increases due to the inclusion of Fauquier’s land and buildings at fair value effective April 1, 2021. Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed by the straight-line method based on the estimated useful lives of assets. Expenditures for repairs and maintenance are charged to expense as incurred. The costs of major renewals and betterments are capitalized and depreciated over their estimated useful lives. Upon disposition, assets and related accumulated depreciation are removed from the books, and any resulting gain or loss is charged to income.

As of June 30, 2021, the Company occupied sixteen full-service banking facilities throughout Albemarle, Fauquier and Prince William counties and the cities of Charlottesville and Winchester, Virginia. The Company also operates a drive-through location at 301 East Water Street, Charlottesville, Virginia. The Company entered into a lease for branch and office space in Richmond, Virginia during the first quarter of 2020 and anticipates opening the office during the second half of 2021.

The five-story office building at 404 People Place, Charlottesville, Virginia, located in Albemarle County, also serves as the Company’s corporate headquarters, operations center, and offices of both Masonry Capital and Sturman Wealth Advisors. VNB Trust & Estate Services is located at 112 Third Street, SE, Charlottesville, Virginia, which is part of the same leased space that the Company uses to operate the drive-through location at 301 East Water Street, Charlottesville, Virginia. TFB Wealth Management is located at 10 Courthouse Square, Warrenton, Virginia.

Both the Arlington Boulevard facility in Charlottesville and the People Place facility in Albemarle County also contain office space that is currently under lease to tenants.

Leases

As of June 30, 2021, the Company has recorded $8.4 million of right-of-use assets and $7.8 million of lease liabilities, in accordance with Accounting Standards Update 2016-02 “Leases” (Topic 842). As of December 31, 2020, $3.5 million of right-of-use assets and $3.6 million of lease liabilities were included on the balance sheet. The increase is due to the inclusion of Fauquier’s leases effective April 1, 2021, at fair value. Right-of-use assets are assets that represent the Company’s right to use, or control the use of, a specified asset for the lease term, offset by the lease liability, which is the Company’s obligation to make lease payments arising from a lease, measured on a discounted basis.

Deposits

Deposit accounts represent the Company’s primary source of funds and are comprised of demand deposits, interest-bearing checking, money market, and savings accounts as well as time deposits. These deposits have been provided predominantly by individuals, businesses and charitable organizations in the Charlottesville, Albemarle, Fauquier, Prince William, Richmond and Winchester areas.

Total deposits as of June 30, 2021 were $1.6 billion, an increase of $898.7 million compared to the balances of $730.8 million at December 31, 2020, and an increase of $915.2 million compared to the $714.2 million total as of June 30, 2020. The primary reason for the increases in the periodic comparisons is the inclusion of Fauquier’s deposits of $817.7 million, at fair value, effective upon the merger date of April 1, 2021, as well as increased balances in PPP customer accounts.

Deposit accounts
(dollars in thousands)	June 30, 2021					December 31, 2020					June 30, 2020
	Balance		% of Total Deposits			Balance		% of Total Deposits			Balance		% of Total Deposits
No cost and low cost deposits:
Noninterest demand deposits	$	449,483		27.6	%	$	209,772		28.71	%	$	197,227		27.6	%
Interest checking accounts		431,556		26.5	%		148,910		20.37	%		136,274		19.1	%
Money market and savings deposit accounts		577,414		35.4	%		272,980		37.36	%		284,101		39.8	%

Total noninterest and low cost deposit accounts		1,458,453		89.5	%		631,662		86.4	%		617,602		86.5	%

Time deposit accounts:
Certificates of deposit		162,217		10.0	%		90,615		12.4	%		88,071		12.3	%
CDARS deposits		8,778		0.5	%		8,487		1.2	%		8,528		1.2	%
Total certificates of deposit and other time deposits		170,995		10.5	%		99,102		13.6	%		96,599		13.5	%

Total deposit account balances	$	1,629,448		100.0	%	$	730,764		100.0	%	$	714,201		100.0	%

Noninterest-bearing demand deposits on June 30, 2021 were $449.5 million, representing 27.6% of total deposits. Interest-bearing transaction, money market, and savings accounts totaled $1.0 billion, and represented 61.9% of total deposits at June 30, 2021. Collectively, noninterest-bearing and interest-bearing transaction and money market accounts represented 89.5% of total deposit accounts at June 30, 2021. These account types are an excellent source of low-cost funding for the Company.

The Company also offers insured cash sweep (“ICS^®”) deposit products. ICS^® deposit balances of $29.2 million and $121.7 million are included in the interest checking accounts and the money market and savings deposit accounts balances, respectively, in the table above, as of June 30, 2021. As of December 31, 2020, ICS^® deposit balances of $28.0 million and $81.1 million are included in the interest checking accounts and the money market and savings deposit account balances, respectively. All ICS accounts consist of reciprocal balances for the Company’s customers.

The remaining 10.5% and 13.6% of total deposits consisted of certificates of deposit and other time deposit accounts totaling $171.0 million and $99.1 million at June 30, 2021 and December 31, 2020, respectively. Included in these deposit totals are Certificate of Deposit Account Registry Service CDs, known as CDARS^TM, whereby depositors can obtain Federal Deposit Insurance Corporation (“FDIC”) deposit insurance on account balances of up to $50 million. CDARS^TM deposits totaled $8.8 million as of June 30, 2021 and $ 8.5 million as of December 31, 2020, all of which were reciprocal balances for the Company’s customers.

Borrowings

Short-term borrowings, consisting primarily of FHLB advances and federal funds purchased, are additional sources of funds for the Company. The level of these borrowings is determined by various factors, including customer demand and the Company's ability to earn a favorable spread on the funds obtained.

The Company has a collateral dependent line of credit with the FHLB. As of June 30, 2021 and December 31, 2020, the Company had $43.0 million and $30 million in outstanding balances from FHLB advances, respectively. As of June 30, 2020, the Company had no outstanding balances from FHLB advances.

Additional borrowing arrangements maintained by the Company include formal federal funds lines with five major regional correspondent banks and the Federal Reserve discount window. The Company had no outstanding balances on these lines or facilities as of June 30, 2021, December 31, 2020 or June 30, 2020.

Shareholders' equity and regulatory capital ratios

The following table displays the changes in shareholders' equity for the Company from December 31, 2020 to June 30, 2021 (dollars in thousands):

Equity, December 31, 2020	$	82,598
Net income		1,652
Acquisition of Fauquier Bankshares, Inc.		78,036
Other comprehensive loss		(1,595	)
Cash dividends declared		(2,410	)
Equity increase due to exercise of stock options		30
Equity increase due to expensing of stock options		65
Equity increase due to expensing of restricted stock		226
Equity, June 30, 2021	$	158,602

The Basel III capital rules require banks and bank holding companies to comply with the following minimum capital ratios: (i) a ratio of common equity Tier 1 capital to risk-weighted assets of at least 4.5%, plus a 2.5% “capital conservation buffer” (effectively resulting in a minimum ratio of common equity Tier 1 to risk-weighted assets of at least 7%); (ii) a ratio of Tier 1 capital to risk-weighted assets of at least 6.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum Tier 1 capital ratio of 8.5%); (iii) a ratio of total capital to risk-weighted assets of at least 8.0%, plus the 2.5% capital conservation buffer (effectively resulting in a minimum total capital ratio of 10.5%); and (iv) a leverage ratio of 4%, calculated as the ratio of Tier 1 capital to balance sheet exposures plus certain off-balance sheet exposures (computed as the average for each quarter of the month-end ratios for the quarter).

The Company’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 12.96%, 12.96%, 13.47% and 7.66%, respectively, as of June 30, 2021, thus exceeding the minimum requirements. The Bank’s Tier 1, common equity Tier 1, total capital to risk-weighted assets, and leverage ratios were 13.26%, 13.26%, 13.77% and 7.86%, respectively, as of June 30, 2021, also exceeding the minimum requirements.

As of June 30, 2021, the Bank exceeded all of the following minimum capital ratios in order to be considered “well capitalized” under the “prompt corrective action” regulations, as revised: (i) a common equity Tier 1 capital ratio of at least 6.5%; (ii) a Tier 1 capital to risk-weighted assets ratio of at least 8.0%; (iii) a total capital to risk-weighted assets ratio of at least 10.0%; and (iv) a leverage ratio of at least 5.0%.

RESULTS OF OPERATIONS

Non-GAAP presentations

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

•

Performance measures exclude nonrecurring merger expenses, which were incurred in connection with change-in-control, severance, due diligence, legal, and other professional fees associated with the merger with Fauquier. Management believes that the exclusion of the significant one-time effect of merger expenses provides users of the Company’s financial information a presentation of the Company’s financial results that is representative of its ongoing operations. In this non-GAAP presentation, the merger expenses incurred is added to the Company’s net income.

•

Fully taxable-equivalent (“FTE”) adjustments – Net interest margin and efficiency ratios are presented on an FTE basis, consistent with SEC guidance in Industry Guide 3 which states that tax exempt income may be calculated on a tax equivalent basis. This is a non-GAAP presentation. The FTE basis adjusts for the tax-exempt status of net interest income from certain investments using a federal tax rate of 21%, where applicable, to increase tax-exempt interest income to a taxable-equivalent basis.

•

Efficiency ratio – One of the ratios the Company monitors in its evaluation of operations is the efficiency ratio, which measures the cost to produce one dollar of revenue. The Company computes its efficiency ratio (FTE) by dividing noninterest expense by the sum of net interest income (FTE) and noninterest income. A lower ratio is an indicator of increased operational efficiency. This non-GAAP metric is used to assist investors in understanding how management assesses its ability to generate revenues from its non-funding-related expense base, as well as to align presentation of this financial measure with peers in the industry. The Company believes this measure to be the preferred industry measurement of operational efficiency, which is consistent with FDIC studies.

•

Net interest margin – Net interest margin (FTE) is calculated as net interest income, computed on an FTE basis, expressed as a percentage of average earning assets. The Company believes this measure to be the preferred industry measurement of net interest margin and that it enhances comparability of net interest margin among peers in the industry.

•

The ALLL as a percentage of loans, excluding the impact of acquired loans and the related fair value mark, excluded the fair value of Acquired Loans from Fauquier. Management believes that the exclusion of the Acquired Loans provides users of the Company’s financial information a presentation of the Company’s ALLL percentage that is representative of its ongoing operations.

•

The ALLL as a percentage of loans, excluding PPP loans, measure eliminates the impact of PPP loans. Management believes that the elimination of the impact of PPP loans provides users of the Company’s financial information a presentation of the Company’s ALLL percentage that is representative of its ongoing operations.

•

Tangible book value per share excludes the impact of the balances of goodwill and other intangibles. Tangible book value per share is often regarded as a more meaningful comparative ratio than book value per share as calculated under GAAP, to evaluate use of equity, financial condition and capital strength.

Management uses these non-GAAP measures to evaluate the Company’s operating performance on a basis comparable to other financial periods. Net income is discussed in Management’s Discussion and Analysis on a GAAP basis unless noted as “non-GAAP.”

The reconcilement below shows how these non-GAAP measures are computed from their respective GAAP measures (dollars in thousands):

Reconcilement of Non-GAAP Measures:	As of or for the Three Months Ended						For the Six Months Ended
	June 30, 2021			June 30, 2020			June 30, 2021			June 30, 2020
Performance measures
Return on average assets ("ROAA")		0.03	%		1.07	%		0.24	%		0.93	%
Impact of merger expenses, net of tax		0.99	%		—			0.69	%		—
ROAA, excluding merger expenses (non-GAAP)		1.02	%		1.07	%		0.93	%		0.93	%

Return on average equity ("ROAE")		0.37	%		10.64	%		2.76	%		8.98	%
Impact of merger expenses, net of tax		11.51	%		—			7.90	%		—
ROAE, excluding merger expenses (non-GAAP)		11.88	%		10.64	%		10.66	%		8.98	%

Net income	$	147		$	2,088		$	1,652		$	3,492
Impact of merger expenses, net of tax		4,553			-			4,722			-
Net income, excluding merger expenses (non-GAAP)	$	4,700		$	2,088		$	6,374		$	3,492

Net income per share, basic and diluted	$	0.03		$	0.77		$	0.41		$	1.29
Impact of merger expenses, net of tax		0.86			-			0.92			-
Net income per share, excluding merger expenses (non-GAAP), basic and diluted	$	0.89		$	0.77		$	1.33		$	1.29

Fully tax-equivalent measures
Net interest income	$	13,151		$	5,755		$	19,125		$	11,130
Fully tax-equivalent adjustment		73			25			120			45
Net interest income (FTE)	$	13,224		$	5,780		$	19,245		$	11,175

Efficiency ratio		99.5	%		59.7	%		90.0	%		62.0	%
Fully tax-equivalent adjustment		-0.4	%		-0.2	%		-0.5	%		-0.2	%
Efficiency ratio (FTE)		99.1	%		59.5	%		89.5	%		61.8	%

Net interest margin		3.03	%		3.11	%		3.02	%		3.14	%
Fully tax-equivalent adjustment		0.02	%		0.01	%		-0.02	%		0.02	%
Net interest margin (FTE)		3.05	%		3.12	%		3.00	%		3.16	%

Other financial measures
ALLL to total loans		0.47	%		0.78	%
Impact of acquired loans and fair value mark		0.41	%		0.00	%
ALLL to total loans, excluding acquired loans and fair value mark (non-GAAP)		0.88	%		0.78	%

ALLL to total loans		0.47	%		0.78	%
Impact of PPP loans		0.04	%		0.12	%
ALLL to total loans, excluding PPP loans (non-GAAP)		0.51	%		0.90	%

Book value per share	$	29.89		$	29.14
Impact of intangible assets		(3.29	)		(0.28	)
Tangible book value per share (non-GAAP)	$	26.60		$	28.86

Net income

Net income for the three months ended June 30, 2021 was $147 thousand, a $1.9 million or 93.0% decrease compared to net income reported for the three months ended June 30, 2020. Net income per diluted share was $0.03 for the quarter ended June 30, 2021 compared to $0.77 per diluted share for the same quarter in the prior year. The entirety of the decrease in net income for the three months ended June 30, 2021, when compared to the same period of 2020, was attributable to $5.9 million in pre-tax ($4.6 million after-tax) merger expenses incurred in the second quarter of 2021. Excluding merger costs, the Company would have posted net income of $0.89 per diluted share (a non-GAAP financial measure).

Net interest income

Net interest income (FTE) for the three months ended June 30, 2021 was $13.2 million, a $7.4 million or 128.8% increase compared to net interest income (FTE) of $5.8 million for the three months ended June 30, 2020. Net interest income (FTE) increased primarily due to the inclusion of Fauquier’s net interest income (FTE) for the current quarter, as the merger was effective April 1, 2021. Net interest income (FTE) was also positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $431 thousand, offset by the increased volume of deposits, which increased interest expense by $547 thousand. The increased volume of loans, also a result of the merger with Fauquier, increasing from an average of $618.1 million in the second quarter of 2020 to $1.2 billion in the second quarter of 2021, positively impacted interest income by $6.4 million. The higher average yield earned on loans, increasing from 4.01% to 4.30% for the periods noted, positively impacted interest income by $500 thousand. In addition, the fair value accretion on loans acquired positively impacted net interest income by 16 basis points during the three months ended June 30, 2021. The increase in volume of securities held, increasing from an average balance of $68.7 million for the second quarter of 2020 to $270.2 million for the second quarter of 2021, positively impacted net interest income by $865 thousand, while the decline in yield earned on such securities decreased from 2.15% to 1.68% for the periods noted, negatively impacted net interest income by $97 thousand.

Net interest income (FTE) for the six months ended June 30, 2021 was $19.2 million, an $8.1 million or 72.2% increase compared to net interest income (FTE) of $11.2 million for the six months ended June 30, 2020 Net interest income (FTE) increased primarily due to the inclusion of Fauquier’s net interest income (FTE) for the first half of the current year as the merger was effective April 1, 2021. Net interest income (FTE) was also positively impacted by the decrease in rates paid on deposit accounts, which decreased interest expense by $1.2 million, offset partially by the increased volume of deposits, which increased interest expense by $938 thousand. The increased volume of loans, also a result of the merger with Fauquier, increasing from an average of $577.0 million in the six months ended June 30, 2020 to $910.0 million in the six months ended June 30, 2021, positively impacted interest income by $6.9 million. The increase in volume of securities held, increasing from an average balance of $91.5 million for the six months ended June 30, 2020 to $222.0 million for the six months ended June 30, 2021, positively impacted net interest income by $1.2 million, while the decline in yield earned on such securities decreased from 2.18% to 1.65% for the periods noted, negatively impacted net interest income by $335 thousand.

Net interest margin (FTE) is the ratio of net interest income (FTE) to average earning assets for the period. The level of interest rates, together with the volume and mix of earning assets and interest-bearing liabilities, impact net interest income (FTE) and net interest margin (FTE). The net interest margin (FTE) of 3.05% for the three months ended June 30, 2021 was 7 basis points lower than the 3.12% for the three months ended June 30, 2020. The net interest margin (FTE) of 3.00% for the six months ended June 30, 2021 was 16 basis points lower than the 3.16% for the six months ended June 30, 2020. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP net interest margin.

Interest expense increased $224 thousand for the three months ended June 30, 2021 compared to the same period in the prior year, due to increased volume of deposits from the Fauquier merger, as average interest-bearing deposits increased $681.8 million for the period noted, negatively impacting interest expense by $547 thousand, offset by lower rates paid on deposits, positively impacting interest expense by $431 thousand. The rate paid on interest-bearing deposits averaged 30 basis points in the three months ended June 30, 2021, compared to 62 basis points for the three months ended June 30, 2020. Average balances of borrowed funds, from FHLB advances, increased from zero in the three months ended June 30, 2020 to $43.0 million in the three months ended June 30, 2021, causing an increase in interest expense on borrowed funds of $59 thousand. Average balances of junior subordinated debt, increased from zero in the three months ended June 30, 2020 to $3.3 million in the three months ended June 30, 2021, causing an increase in interest expense on borrowed funds of $49 thousand.

Interest expense decreased $272 thousand for the six months ended June 30, 2021 compared to the same period in the prior year, due primarily to the lower rates paid on deposits, positively impacting interest expense by $1.2 million, offset by the increased volume of deposits from the Fauquier merger, as average interest-bearing deposits increased $373.5 million for the period noted, negatively impacting interest expense by $794 thousand. The rate paid on interest-bearing deposits averaged 36 basis points in the six months ended June 30, 2021, compared to 83 basis points for the six months ended June 30, 2020. Average balances of borrowed funds, from FHLB advances, increased from zero in the six months ended June 30, 2020 to $36.60 million in the six months ended June 30, 2021, causing an increase in interest expense on borrowed funds of $95 thousand. Average balances of junior subordinated debt, increased from zero in the six months ended June 30, 2020 to $1.3 million in the six months ended June 30, 2021, causing an increase in interest expense on borrowed funds of $49 thousand.

The following tables detail the average balance sheet, including an analysis of net interest income (FTE) for earning assets and interest-bearing liabilities, for the three and six months ended June 30, 2021 and 2020. These tables also include rate/volume analyses for these same periods (dollars in thousands).

Consolidated Average Balance Sheet and Analysis of Net Interest Income

	For the three months ended
	June 30, 2021								June 30, 2020								Change in Interest Income/ Expense
	Average			Interest		Average			Average			Interest		Average			Change Due to : ⁴					Total
	Balance			Income/		Yield/Cost			Balance			Income/		Yield/Cost			Volume		Rate			Increase/
(dollars in thousands)				Expense								Expense										(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities	$	211,827		$	792		1.50	%	$	53,953		$	253		1.88	%	$	600	$	(61	)	$	539
Tax Exempt Securities ¹		58,398			346		2.37	%		14,793			117		3.16	%		265		(36	)		229
Total Securities ¹		270,225			1,138		1.68	%		68,746			370		2.15	%		865		(97	)		768
Total Loans		1,214,123			13,009		4.30	%		618,096			6,156		4.01	%		6,353		500			6,853
Fed Funds Sold		106,934			21		0.08	%		57,920			10		0.07	%		9		2			11
Other interest-bearing deposits		149,056			36		0.10	%		—			—		—			36		0			36
Total Earning Assets		1,740,338			14,204		3.27	%		744,762			6,536		3.53	%		7,263		405			7,668
Less: Allowance for Loan Losses		(5,732	)							(4,788	)
Total Non-Earning Assets		124,287								46,543
Total Assets	$	1,858,893							$	786,517

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking	$	437,611		$	93		0.09	%	$	131,333		$	26		0.08	%	$	65	$	2		$	67
Money Market and Savings Deposits		561,940			455		0.32	%		257,174			365		0.57	%		296		(206	)		90
Time Deposits		169,556			324		0.77	%		98,762			365		1.49	%		186		(227	)		(41	)
Total Interest-Bearing Deposits		1,169,107			872		0.30	%		487,269			756		0.62	%		547		(431	)		116
Short term borrowings		43,030			59		0.55	%		—			—		—			59		—			59
Junior subordinated debt		3,334			49		5.89	%		—			—		—			49		0			49
Total Interest-Bearing Liabilities		1,215,471			980		0.32	%		487,269			756		0.62	%		655		(431	)		224
Non-Interest-Bearing Liabilities:
Demand deposits		471,078								216,747
Other liabilities		14,109								3,577
Total Liabilities		1,700,658								707,593
Shareholders' Equity		158,235								78,924
Total Liabilities & Shareholders' Equity	$	1,858,893							$	786,517
Net Interest Income (FTE)				$	13,224							$	5,780				$	6,608	$	836		$	7,444
Interest Rate Spread ²							2.95	%							2.91	%
Interest Expense as a Percentage of Average Earning Assets							0.23	%							0.41	%
Net Interest Margin (FTE) ³							3.05	%							3.12	%

(1)	Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations earlier in this section.

(2)	Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.

(3)	Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.

(4)

The impact on the net interest income (FTE) resulting from changes in average balances and average rates is shown for the period 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.

Consolidated Average Balance Sheet and Analysis of Net Interest Income

	For the Six Months Ended
	June 30, 2021								June 30, 2020								Change in Interest Income/ Expense
	Average			Interest		Average			Average			Interest		Average			Change Due to : ⁴					Total
	Balance			Income/		Yield/Cost			Balance			Income/		Yield/Cost			Volume		Rate			Increase/
(dollars in thousands)				Expense								Expense										(Decrease)
ASSETS
Interest Earning Assets:
Securities
Taxable Securities	$	176,151		$	1,264		1.44	%	$	78,370		$	786		2.01	%	$	753	$	(275	)	$	478
Tax Exempt Securities ⁽¹⁾		45,818			569		2.48	%		13,109			212		3.23	%		417		(60	)		357
Total Securities ⁽¹⁾		221,969			1,833		1.65	%		91,479			998		2.18	%		1,170		(335	)		835
Total Loans		910,040			18,947		4.20	%		576,952			12,027		4.19	%		6,935		(15	)		6,920
Fed Funds Sold		87,276			72		0.17	%		43,409			95		0.44	%		59		(82	)		(23	)
Other interest-bearing deposits		74,475			66		0.18	%		—			—		—			66		0			66
Total Earning Assets		1,293,760			20,918		3.26	%		711,840			13,120		3.71	%		8,230		(432	)		7,798
Less: Allowance for Loan Losses		(5,624	)							(4,523	)
Total Non-Earning Assets		84,069								45,650
Total Assets	$	1,372,205							$	752,967

LIABILITIES AND SHAREHOLDERS' EQUITY
Interest Bearing Liabilities:
Interest Bearing Deposits:
Interest Checking	$	291,025		$	119		0.08	%	$	127,026		$	57		0.09	%	$	67	$	(5	)	$	62
Money Market and Savings Deposits		422,048			806		0.39	%		243,036			1,029		0.85	%		520		(743	)		(223	)
Time Deposits		134,355			604		0.91	%		103,851			859		1.66	%		207		(462	)		(255	)
Total Interest-Bearing Deposits		847,428			1,529		0.36	%		473,913			1,945		0.83	%		794		(1,210	)		(416	)
Short term borrowings		36,551			95		0.52	%		—			—		—			95		—			95
Junior subordinated debt		1,255			49		7.87	%		—			—		—			49		—			49
Total Interest-Bearing Liabilities		885,234			1,673		0.38	%		473,913			1,945		0.83	%		938		(1,210	)		(272	)
Non-Interest-Bearing Liabilities:
Demand deposits		363,709								197,312
Other liabilities		2,877								3,507
Total Liabilities		1,251,820								674,732
Shareholders' Equity		120,385								78,235
Total Liabilities & Shareholders' Equity	$	1,372,205							$	752,967
Net Interest Income (FTE)				$	19,245							$	11,175				$	7,292	$	778		$	8,070
Interest Rate Spread ²							2.88	%							2.88	%
Interest Expense as a Percentage of Average Earning Assets							0.26	%							0.55	%
Net Interest Margin (FTE) ³							3.00	%							3.16	%

(1)	Tax-exempt income for investment securities has been adjusted to a fully tax-equivalent basis (FTE), using a Federal income tax rate of 21%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP Presentations earlier in this section.

(2)	Interest spread is the average yield earned on earning assets less the average rate paid on interest-bearing liabilities.

(3)	Net interest margin (FTE) is net interest income expressed as a percentage of average earning assets.

(4)

Provision for loan losses

A recovery of loan losses of $141 thousand was recognized during the three months ended June 30, 2021 compared to a provision for loan losses of $378 thousand recognized during the three months ended June 30, 2020, and a provision for loan losses of $210 thousand was recognized during the six months ended June 30, 2021, compared to $1.1 million recognized during the six months ended June 30, 2020. During the first two quarters of 2020, the Company increased the economic qualitative factors in the ALLL calculation due to the deterioration in the economic outlook resulting from the impact of COVID-19. During the second quarter of 2021, the Company released of a portion of the reserves that were added during 2020 since the credit deterioration has so far not been experienced to the extent previously anticipated.

The period-end ALLL as a percentage of assets was 0.47% as of June 30, 2021, 0.90% as of December 31, 2020 and 0.78% as of June 30, 2020. The percentage decrease as compared to the prior year end and the same period in the prior year was due to the addition of purchased loans upon the acquisition of Fauquier, and the elimination of their ALLL as the loans were acquired and booked at fair value. The ALLL as of June 30, 2021, excluding the impact of the Acquired Loans and the fair value mark, would have been 0.88%. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to Non-GAAP ALLL.

Further discussion of management’s assessment of the ALLL is provided earlier in the report and in Note 5 – Allowance for Loan Losses, found in the Notes to the Consolidated Financial Statements. In management’s opinion, the allowance was adequately provided for at June 30, 2021. The ALLL calculation, provision for loan losses, asset quality and collateral values may be significantly impacted by deterioration in economic conditions. We have downgraded, then upgraded slightly, the qualitative factors pertaining to economic conditions within our ALLL methodology; should economic conditions worsen, we could experience further increases in our required ALLL and record additional provision for loan loss exposure.

Noninterest income

The components of noninterest income for the three months ended June 30, 2021 and 2020 are shown below (dollars in thousands):

	For the three months ended				Variance
	June 30, 2021		June 30, 2020		$			%
Noninterest income:
Wealth management fees	$	980	$	228	$	752			329.8	%
Advisory and brokerage income		359		163		196			120.2	%
Royalty income		12		24		(12	)		-50.0	%
Deposit account fees		426		143		283			197.9	%
Debit/credit card and ATM fees		599		134		465			347.0	%
Earnings/increase in value of bank owned life insurance		199		109		90			82.6	%
Fees on mortgage sales		-		30		(30	)		-100.0	%
Gains on sales of securities		-		590		(590	)		-100.0	%
Loan swap fee income		20		124		(104	)		-83.9	%
Other		325		81		244			301.2	%
Total noninterest income	$	2,920	$	1,626	$	1,294			79.6	%

Noninterest income for the three months ended June 30, 2021 of $2.9 million was $1.3 million or 79.6% higher than the amount recorded for the three months ended June 30, 2020. Noninterest income increased predominantly due to the inclusion of TFB’s wealth management fees of $647 thousand, advisory and brokerage income of $157 thousand, deposit fees of $258 thousand and debit card income of $418 thousand. Gains on sales of securities declined from the second quarter of the prior year by $590 thousand, as no securities were sold and swap fee income declined $104 thousand, as swap arrangements are not as attractive to borrowers in the current rate environment.

The components of noninterest income for the six months ended June 30, 2021 and 2020 are shown below (dollars in thousands):

	For the Six Months Ended				Variance
	June 30, 2021		June 30, 2020		$			%
Noninterest income:
Wealth management fees	$	1,309	$	538	$	771			143.3	%
Advisory and brokerage income		550		341		209			61.3	%
Royalty income		17		71		(54	)		-76.1	%
Deposit account fees		586		322		264			82.0	%
Debit/credit card and ATM fees		753		291		462			158.8	%
Earnings/increase in value of bank owned life insurance		306		216		90			41.7	%
Fees on mortgage sales		-		77		(77	)		-100.0	%
Gains on sales of securities		-		643		(643	)		-100.0	%
Loan swap fee income		35		633		(598	)		-94.5	%
Other		403		163		240			147.2	%
Total noninterest income	$	3,959	$	3,295	$	664			20.2	%

Noninterest income for the six months ended June 30, 2021 of $4.0 million was $664 thousand or 20.2% higher than the amount recorded for the six months ended June 30, 2020. Noninterest income increased predominantly due to the inclusion of TFB’s wealth management fees of $647 thousand, advisory and brokerage income of $157 thousand, deposit fees of $258 thousand and debit card income of $418 thousand, which are the same increases as noted above, as the effective date of the merger was April 1, 2021 and therefore, only TFB’s second quarter is included in the year-to-date figures. Gains on sales of securities declined from the second quarter of the prior year by $643 thousand, as no securities were sold and swap fee income declined $598 thousand, as swap arrangements are not as attractive to borrowers in the current rate environment.

Noninterest expense

The components of noninterest expense for the three months ended June 30, 2021 and 2020 are shown below (dollars in thousands):

	For the three months ended				Variance
	June 30, 2021		June 30, 2020		$		%
Noninterest expense:
Salaries and employee benefits	$	4,741	$	2,258	$	2,483		110.0	%
Net occupancy		1,109		452		657		145.4	%
Equipment		340		136		204		150.0	%
ATM, debit and credit card		73		41		32		78.0	%
Bank franchise tax		429		163		266		163.2	%
Computer software		216		136		80		58.8	%
Data processing		994		338		656		194.1	%
FDIC deposit insurance assessment		182		28		154		550.0	%
Loan expenses		145		66		79		119.7	%
Marketing, advertising and promotion		232		140		92		65.7	%
Merger expenses		5,874		-		5,874	N/A
Professional fees		510		190		320		168.4	%
Core deposit intangible amortization		428		-		428	N/A
Other		720		456		264		57.9	%
Total noninterest expense	$	15,993	$	4,404	$	11,589		263.1	%

Noninterest expense for the quarter ended June 30, 2021 of $16.0 million was $11.6 million or 263.1% higher than the quarter ended June 30, 2020. The predominant reason for the increase was that the Company incurred $5.9 million in merger-related expenses during the three months ended June 30, 2021. Additionally, the second quarter of 2021 includes the salaries of the employees of the combined company, as the effective date of merger with Fauquier was April 1, 2021.

The components of noninterest expense for the six months ended June 30, 2021 and 2020 are shown below (dollars in thousands):

	For the Six Months Ended				Variance
	June 30, 2021		June 30, 2020		$		%
Noninterest expense:
Salaries and employee benefits	$	7,143	$	4,682	$	2,461		52.6	%
Net occupancy		1,604		904		700		77.4	%
Equipment		456		267		189		70.8	%
ATM, debit and credit card		115		94		21		22.3	%
Bank franchise tax		602		326		276		84.7	%
Computer software		383		276		107		38.8	%
Data processing		1,283		666		617		92.6	%
FDIC deposit insurance assessment		245		28		217		775.0	%
Loan expenses		208		157		51		32.5	%
Marketing, advertising and promotion		369		279		90		32.3	%
Merger expenses		6,152		-		6,152	N/A
Professional fees		687		376		311		82.7	%
Core deposit intangible amortization		428		-		428	N/A
Other		1,099		892		207		23.2	%
Total noninterest expense	$	20,774	$	8,947	$	11,827		132.2	%

Noninterest expense for the six months ended June 30, 2021 of $20.8 million was $11.8 million or 132.2% higher than the six months ended June 30, 2020. The predominant reason for the increase was that the Company incurred $6.2 million in merger-related expenses during the six months ended June 30, 2021. Additionally, the first half of 2021 includes the salaries of the employees of the combined company, as the effective date of merger with Fauquier was April 1, 2021.

The efficiency ratio (FTE) of 99.1% for the three months ended June 30, 2021 was elevated compared to the 59.5% for the same quarter of 2020, due primarily to the increase in noninterest expense, as described above. The efficiency ratio (FTE) of 89.5% for the six months ended June 30, 2021 was elevated compared to the 61.8% for the same period of 2020, also due to the increase in noninterest expense, as described above. Refer to the Reconcilement of Non-GAAP Measures table within the Non-GAAP presentations section for a reconcilement of GAAP to non-GAAP efficiency ratio.

Provision for Income Taxes

For the three months ended June 30, 2021 and 2020, the Company provided $72 thousand and $511 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 32.9% and 19.7%, respectively. The effective income tax rate for the three months ended June 30, 2021 was higher than the prior year, as certain merger related expenses are non-deductible for tax purposes. For the six months ended June 30, 2021 and 2020, the Company provided $448 thousand and $843 thousand for Federal income taxes, respectively, resulting in an effective income tax rate of 21.3% and 19.4%, respectively. The effective income tax rate for the six months ended June 30, 2021 was higher than the prior year, as certain merger related expenses are non-deductible for tax purposes. For all periods, the effective income tax rate differed from the U.S. statutory rate of 21% due to the effect of tax-exempt income from life insurance policies and municipal bonds.

OTHER SIGNIFICANT EVENTS

None

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

Not required

ITEM 4. CONTROLS AND PROCEDURES

The Company maintains “disclosure controls and procedures,” as such term is defined in Rule 13a-15(e) under the Securities Exchange Act of 1934 (the “Exchange Act”), that are designed to ensure that information required to be disclosed in reports that it files or submits under the Exchange Act is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure.

In designing and evaluating its disclosure controls and procedures, management recognized that disclosure controls and procedures, no matter how well conceived and operated, can provide only reasonable assurance that the objectives of the disclosure controls and procedures are met. Additionally, in designing disclosure controls and procedures, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible disclosure controls and procedures. The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

Based on their evaluation as of the end of the period covered by this quarterly report on Form 10-Q, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the disclosure controls and procedures were effective at the reasonable assurance level. There was no change in the internal control over financial reporting that occurred during the quarter ended June 30, 2021 that has materially affected, or is reasonably likely to materially affect, the internal control over financial reporting.

PART II. OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS.

None

ITEM 1A. RISK FACTORS.

There have been no material changes from the risk factors described in the Company’s Form 10-K for the year ended December 31, 2020. The risks described may not be the only risks facing us. Additional risks and uncertainties not currently known to us or that are currently considered to not be material also may materially adversely affect our business, financial condition and/or operating results.

ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS.

None

ITEM 3. DEFAULTS UPON SENIOR SECURITIES.

None

ITEM 4. MINE SAFETY DISCLOSURES.

Not applicable

ITEM 5. OTHER INFORMATION.

(a)	Required 8-K disclosures.

None

(b)	Changes in procedures for director nominations by security holders.

None

ITEM 6. EXHIBITS.

Exhibit Number		Description of Exhibit


31.1		302 Certification of Principal Executive Officer

31.2		302 Certification of Principal Financial Officer

32.1		906 Certification

101		The following financial statements from the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2021, formatted in Inline eXtensible Business Reporting Language, pursuant to Rule 405 of Regulation S-T (1): (i) Consolidated Balance Sheets (unaudited), (ii) Consolidated Statements of Income (unaudited), (iii) Consolidated Statements of Comprehensive Income (Loss) (unaudited), (iv) Consolidated Statements of Stockholders' Equity (unaudited), (v) Consolidated Statements of Cash Flows (unaudited), and (vi) Notes to Consolidated Financial Statements (unaudited), tagged as blocks of text and including detailed tags
104		The cover page from the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2021, formatted in Inline eXtensible Business Reporting Language (included with Exhibit 101.0)

SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

VIRGINIA NATIONAL BANKSHARES CORPORATION
(Registrant)

By:		/s/ Glenn W. Rust
		Glenn W. Rust
		President and Chief Executive Officer (principal executive officer)

Date:		August 13, 2021

By:		/s/ Tara Y. Harrison
		Tara Y. Harrison
		Executive Vice President and Chief Financial Officer
		(principal financial and accounting officer)
Date:		August 13, 2021